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ZNGA > SEC Filings for ZNGA > Form 10-K on 21-Feb-2014All Recent SEC Filings

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Form 10-K for ZYNGA INC


21-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Special Note Regarding Forward-Looking Statements" and "Risk Factors."

Overview

We are a leading online social game developer with approximately 112 million average MAUs for the three months ended December 31, 2013. We have launched some of the most successful social games in the industry. Our games are accessible on Facebook and other social networks, mobile platforms and Zynga.com. Our games are generally available for free, and we generate revenue through the in-game sale of virtual goods, mobile game download fees and advertising services.

We are a pioneer and innovator of social games and a leader in making play a core activity on the Internet. Our objective is to become the worldwide leader in play by connecting the world through games.

Consistent with our free-to-play business model, compared to all players who play our games in any period, only a small portion of our players are payers. Because the opportunity for social interactions increases as the number of players increases, we believe that maintaining and growing our overall number of players, including the number of players who may not purchase virtual goods, is important to the success of our business. As a result, we believe that the number of players who choose to purchase virtual goods will continue to constitute a small portion of our overall players.

The games that constitute our top games vary over time but historically the top three revenue-generating games in any period contributed the majority of our revenue. Our top three games accounted for 54%, 55% and 57% of our online game revenue in 2013, 2012 and 2011, respectively. The percentage of online game revenue related to our top three games has declined during these periods as we continue to launch new games. These more recently launched games increased our total online game revenue without necessarily being included as a top three game.

During 2013 we drove efficiencies to properly align our cost-structure with our key strategic initiatives and to better position us to execute on our strategy and achieve long-term growth. Our headcount decreased from 3,058, as of December 31, 2012, to 2,034, as of December 31, 2013, we began to consolidate certain facilities and data centers, and reduced our total costs and expenses by $525.3 million in 2013. We continue to invest in game development, creating both new games and new features and content in existing games designed to engage our players on the web and on mobile devices.

On February 11, 2014, we completed the acquisition of 100% of the equity interests in NaturalMotion, pursuant to the share purchase agreement, dated January 30, 2014, by and among us, Zynga Game International Limited, NaturalMotion, NaturalMotion's shareholders and Shareholder Representative Services LLC, as sellers' representative. NaturalMotion's shareholders and vested option holders received an aggregate of $391 million in cash and 39.8 million shares of our Class A common stock.

How We Generate Revenue

We operate our games as live services that allow players to play for free. We generate revenue primarily from the in-game sale of virtual goods and advertising. Revenue growth will depend largely on our ability to


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attract and retain players and more effectively monetize our player base through the sale of virtual goods and advertising. We intend to do this through the launch of new games, enhancements to current games and expansion into new markets and distribution platforms.

Online Game. We provide our players with the opportunity to purchase virtual goods that enhance their game-playing experience. We believe players choose to pay for virtual goods for the same reasons they are willing to pay for other forms of entertainment. They enjoy the additional playing time or added convenience, the ability to personalize their own game boards, the satisfaction of leveling up and the opportunity for sharing creative expressions. We believe players are more likely to purchase virtual goods when they are connected to and playing with their friends, whether those friends play for free or also purchase virtual goods. Players may also elect to pay a one-time download fee to obtain certain mobile games free of third-party advertisements.

Facebook is currently the primary distribution, marketing, promotion and payment platform for our games. We generate a significant portion of our revenue through the Facebook platform. For example, for the twelve months ended December 31, 2013 and 2012, we estimate that 69% and 81% of our bookings, respectively, were generated through the Facebook platform, while 27% and 18% of our bookings, respectively, were generated through mobile platforms. For the twelve months ended December 31, 2013 and 2012, we estimate that 75% and 86% of our revenue, respectively, was generated through the Facebook platform, while 24% and 13% of our revenue, respectively, was generated through mobile platforms. We have had to estimate this information because certain payment methods we accept and certain advertising networks do not allow us to determine the platform used.

We began migrating to Facebook Credits in July 2010 pursuant to an addendum to Facebook's standard terms and conditions, and in April 2011, we completed this migration. Contractually, Facebook remitted to us an amount equal to 70% of the face value of Facebook credits for each Facebook credit redeemed in our games, and we recognize revenue net of amounts retained by Facebook. Prior to our transition from Facebook Credits to Facebook's local currency-based payment model, our players were able to purchase Facebook Credits from Facebook directly through our games or through game cards purchased from retailers and distributors.

In June 2012, Facebook announced its plans to discontinue the use of Facebook Credits and instead support pricing in local currencies. In July 2013, Facebook began to transition away from Facebook Credits to Facebook's local currency-based payments program. We completed the transition in full in the fourth quarter of 2013. For all payment transactions in our games under Facebook's local currency payments model, Facebook remits to us an amount equal to 70% of the price we requested to be charged to our players

On platforms other than Facebook, players purchase our virtual goods through various widely accepted payment methods offered in the games, including credit cards, PayPal, Apple iTunes accounts, Google Wallet and direct wires.

Advertising. Advertising revenue primarily includes branded virtual goods and sponsorships, engagement ads and offers, mobile ads, display ads and licensing. We generally report our advertising revenue net of amounts due to advertising agencies and brokers.

Key Metrics

We regularly review a number of metrics, including the following key financial and operating metrics, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions.

Key Financial Metrics

Bookings. Bookings is as defined in the section titled "-Non-GAAP Financial Measures" included in "Item 6. Selected Consolidated Financial and Other Data" of this Annual Report on Form 10-K, is the fundamental top-line metric we use to manage our business, as we believe it is a better indicator of the sales activity in a given period. Over the long term, the factors impacting our bookings and revenue are the same. However, in the short term, there are factors that may cause revenue to exceed or be less than bookings in any period.


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We use bookings to evaluate the results of our operations, generate future operating plans and assess the performance of our company. While we believe that this non-GAAP financial measure is useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for revenue recognized in accordance with U.S. GAAP. In addition, other companies, including companies in our industry, may calculate bookings differently or not at all, which reduces its usefulness as a comparative measure.

Adjusted EBITDA. Adjusted EBITDA is a non-GAAP financial measure that we believe provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors.

For a reconciliation of net income (loss) to adjusted EBITDA, see the section titled "-Non-GAAP Financial Measures" included in "Item 6. Selected Consolidated Financial and Other Data" of this Annual Report on Form 10-K.

Key Operating Metrics

We manage our business by tracking several operating metrics: "DAUs," which measure daily active users of our games, "MAUs," which measure monthly active users of our games, "MUUs," which measure monthly unique users of our games, "MUPs," which measure monthly unique payers in our games, and "ABPU," which measures our average daily bookings per average DAU, each of which is recorded by our internal analytics systems.

DAUs. We define DAUs as the number of individuals who played one of our games during a particular day. Under this metric, an individual who plays two different games on the same day is counted as two DAUs. Similarly, an individual who plays the same game on two different platforms (e.g. web and mobile) or on two different social networks on the same day would be counted as two DAUs. Average DAUs for a particular period is the average of the DAUs for each day during that period. We use DAUs as a measure of audience engagement.

MAUs. We define MAUs as the number of individuals who played a particular game in the 30-day period ending with the measurement date. Under this metric, an individual who plays two different games in the same 30-day period is counted as two MAUs. Similarly, an individual who plays the same game on two different platforms (e.g., web and mobile) or on two different social networks in a 30-day period would be counted as two MAUs. Average MAUs for a particular period is the average of the MAUs at each month-end during that period. We use MAUs as a measure of total game audience size.

MUUs. We define MUUs as the number of unique individuals who played any of our games on a particular platform in the 30-day period ending with the measurement date. An individual who plays more than one of our games in a given 30-day period would be counted as a single MUU. However, because we cannot always distinguish unique individuals playing across multiple platforms, an individual who plays any of our games on two different platforms (e.g., web and mobile) in a given 30-day period may be counted as two MUUs in the event that we do not have data that allows us to de-duplicate the player. Because many of our players play more than one game in a given 30-day period, MUUs are always lower than MAUs in any given time period. Average MUUs for a particular period is the average of the MUUs at each month-end during that period. We use MUUs as a measure of total audience reach across our network of games.

MUPs. We define MUPs as the number of unique players who made a payment at least once during the applicable month through a payment method for which we can quantify the number of unique payers, including payers from certain of our mobile games. MUPs does not include payers who use certain payment methods for which we cannot quantify the number of unique payers. If a player made a payment in our games on two separate platforms (e.g., Facebook and Google+) in a period, the player would be counted as two unique payers in that period. MUPs are presented as an average of the three months in the applicable quarter.


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ABPU. We define ABPU as (i) our total bookings in a given period, divided by
(ii) the number of days in that period, divided by, (iii) the average DAUs during the period. We believe that ABPU provides useful information to investors and others in understanding and evaluating our results in the same manner as our management and board of directors. We use ABPU as a measure of overall monetization across all of our players through the sale of virtual goods and advertising.

Our business model for social games is designed so that, as there are more players that play our games, social interactions increase and the more valuable the games and our business become. All engaged players of our games help drive our bookings and, consequently, both online game revenue and advertising revenue. Virtual goods are purchased by players who are socializing with, competing against or collaborating with other players, most of whom do not buy virtual goods. Accordingly, we primarily focus on bookings, DAUs, MAUs, MUUs, MUPs and ABPU, which together we believe best reflect key audience metrics.

The table below shows average DAUs, MAUs, MUUs, MUPs and ABPU for the last eight quarters:

                                                                 For the Three Months Ended
                             Dec 31,      Sep 30,      Jun 30,      Mar 31,      Dec 31,      Sep 30,      Jun 30,      Mar 31,
                               2013         2013         2013         2013         2012         2012         2012         2012
                                                               (users and payers in millions)
Average DAUs                       27           30           39           52           56           60           72           65
Average MAUs                      112          133          187          253          298          311          306          292
Average MUUs                       80           97          123          150          167          177          192          182
Average MUPs                      1.3          1.6          1.9          2.5          2.9          2.9          4.1          3.5
ABPU                         $  0.060     $  0.055     $  0.053     $  0.049     $  0.051     $  0.047     $  0.046     $  0.055

Average DAUs, MAUs and MUUs declined in each consecutive quarter in 2013, and declined when comparing the three months ended December 31, 2013 to December 31, 2012. We have seen declines in users for our existing games, and our new game launches during 2013 did not grow sufficiently to offset the declines in users for our existing games. In addition, MUPs declined in the three months ended December 31, 2013 compared to the three months ended December 31, 2012, as payers in Zynga Poker, FarmVille 2 and ChefVille contributed more MUPs in 2012 than in 2013. ABPU increased in each of the last three quarters of 2013 compared to the prior quarter due to a faster decline in DAUs in those periods than the decline in bookings. Future growth in audience and engagement will depend on our ability to retain current players, attract new players, launch new games and expand into new market and distribution platforms.

Other Metrics

Although our management primarily focuses on the operating metrics above, we
also monitor periodic trends in paying players of our games. The table below
shows average monthly unique payer bookings, average MUPs and unique payer
bookings per unique payer for the last eight quarters:



                                                                    For the Three Months Ended
                                Dec 31,      Sep 30,      Jun 30,      Mar 31,      Dec 31,      Sep 30,      Jun 30,      Mar 31,
                                  2013         2013         2013         2013         2012         2012         2012         2012
Average monthly unique payer
bookings (in thousands)(1)      $ 37,432     $ 39,535     $ 50,657     $ 64,028     $ 72,867     $ 71,760     $ 86,282     $ 96,277
Average MUPs (in millions)           1.3          1.6          1.9          2.5          2.9          2.9          4.1          3.5
Monthly unique payer bookings
per MUP(2)                      $     28     $     25     $     26     $     26     $     25     $     25     $     21     $     28

(1) Average monthly unique payer bookings represent the monthly average amount of bookings from certain payment methods for which we cannot quantify the number of unique payers. Also excluded are bookings from advertising.

(2) Monthly unique payer bookings per MUP is calculated by dividing average monthly unique payer bookings by average MUPs.


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Average monthly unique payer bookings decreased in each quarter during 2013 due to the decline in bookings and users in our existing games that were not offset by growth from new game launches. Monthly unique payer bookings per MUP increased to $28 in the fourth quarter of 2013 due to MUP decreasing faster than unique payer bookings for the period. Average MUPs decreased from 2.5 million in the first quarter of 2013 to 1.3 million in the fourth quarter of 2013. In periods with more mobile game launches we have seen higher MUPs without a significant increase in average monthly unique payer bookings due to the inclusion of payers who make one-time download payments for the ad-free version of our game within our reported MUPs.

Although we monitor our unique payer metrics, we focus on monetization, including through in-game advertising, of all of our players and not just our payers. Accordingly, we strive to enhance content and our players' game experience to increase our bookings and ABPU, which is a measure of overall monetization across all of our players through the sale of virtual goods and advertising.

Future growth in audience and engagement will depend on our ability to retain current players, attract new players, launch new games and expand into new markets and distribution platforms, and the success of our network. Our operating metrics may not correlate directly to quarterly bookings or revenue trends in the short term.

Recent Developments

Game Launches. We launched several new games in 2013, including Hidden Shadows, Ninja Kingdom and Hit it Rich on web platforms and Stampede Run, What's the Phrase, Draw Something 2 and CastleVille Legends on mobile platforms.

Operating Results. Our operating results generally declined in 2013 as compared to 2012. Total bookings decreased by 38% and adjusted EBITDA decreased by 78% compared to 2012. These results primarily reflect weakness and declines in our existing games and the lack of successful launches of new hit games. We have reduced our total costs and expenses by $525.3 million in 2013, reflecting our focus on driving efficiencies during this period where players are using mobile devices more frequently.

Mobile Growth. In 2013, we saw 9% and 11% year-over-year growth in bookings and revenue, respectively, on mobile platforms as our players continued to play our games on their phones and tablets.

RMG. In April 2013, we launched our first real money gaming (RMG) offerings, ZyngaPlusPoker and ZyngaPlusCasino, in the United Kingdom through our agreement with bwin.party digital entertainment plc ("bwin.party"). Although we are still exploring our options with respect to real money gaming, including with our partner, bwin.party in the United Kingdom, in July 2013, we decided to withdraw our application from the Nevada Gaming Control Board and made the focused choice not to pursue a license for real money gaming in other U.S. jurisdictions at this time in order to focus our resources and priorities against the growing market in free, social gaming, including social casino offerings.

Changes in Executive Team and Board of Directors. In July 2013, Don A. Mattrick replaced Mark Pincus as our Chief Executive Officer and was appointed as a director. Mr. Pincus continues to serve as Chairman of the Board and Chief Product Officer of the Company. Additionally, Mr. Pincus and Mr. Mattrick were appointed to a newly formed Executive Committee of the Board of Directors, (the "Board"), the Executive Committee, which serves as an administrative committee of the Board to facilitate approval of certain corporate actions in the intervals between full meetings of the Board. Subject to certain limitations set forth in its charter, the Executive Committee will serve to manage our operations and affairs between Board meetings, and will report to the full Board.

In June of 2013, Owen Van Natta resigned from his position as a director of the Company.

During 2013, three members of our executive management team, Reginald Davis, David Ko and Cadir Lee, left the Company.


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In the fourth quarter of 2013, we hired Clive Downie, as our Chief Operating Officer.

2013 Restructuring. In 2013, we implemented restructuring plans that included a reduction in work force of approximately 550 employees and the closure of certain data center facilities and offices as part of an overall plan to reduce our long term cost structure. In total, we recorded restructuring charges of $44.7 million in 2013.

Stock Repurchase Program. In October 2012, our Board authorized a program for the repurchase of our common stock in an amount of up to $200 million. During 2013, we repurchased approximately 3.4 million shares of our common stock for $9.3 million under our 2012 program, and as of December 31, 2013, the remaining authorized amount of stock repurchases that may be made under the program was $178.9 million.

Factors Affecting Our Performance

Changes in Facebook Agreements. Facebook is the primary distribution, marketing, promotion and payment platform for our social games. We generate a significant portion of our bookings, revenue and players through the Facebook platform and expect to continue to do so for the foreseeable future. Facebook and other platforms generally have the discretion to change their platforms, terms of service and other policies with respect to us or other developers, and those changes may be unfavorable to us.

Launch of new games and release of enhancements. Our bookings and revenue results have been driven by the launch of new mobile and web games and the release of fresh content and new features in existing games. Our future success depends on our ability to launch successful new hit titles on mobile platforms. Although the amount of revenue and bookings we generate from a new game or an enhancement to an existing game can vary significantly, we expect our revenue and bookings to be correlated to the success and timely launch of our new games and our success in releasing engaging content and features. In addition, revenue and bookings from many of our games tend to decline over time after reaching a peak of popularity and player usage. We often refer to the speed of this decline as the decay rate of a game. As a result of this decline in the revenue and bookings of our games, our business depends on our ability to consistently and timely launch new games that achieve significant popularity and have the potential to become franchise games.

Game monetization. We generate most of our bookings and revenue from the sale of virtual goods in our games. The degree to which our players choose to pay for virtual goods in our games is driven by our ability to create content and virtual goods that enhance the game-play experience. Our bookings, revenue and overall financial performance are affected by the number of players and the effectiveness of our monetization of players through the sale of virtual goods and advertising. For example ABPU increased from $0.050 in the twelve months ended December 31, 2012 to $0.053 in the twelve months ended December 31, 2013, due to a decline in DAU of non-paying players (versus paying players) who do not contribute to online game bookings and due to a lower decline in advertising bookings as compared to the decline in DAU. In addition, mobile and international players have historically monetized at a lower level than web and U.S. players, respectively, on average. The percentage of paying mobile and international players may increase or decrease based on a number of factors, including growth in mobile games as a percentage of total game audience and our overall international players, localization of content and the availability of payment options.

Investment in game development. In order to develop new games and enhance the content and features in our existing games, we must continue to invest in a significant amount of engineering and creative resources. These expenditures generally occur months in advance of the launch of a new game or the release of new content, and the resulting revenue may not equal or exceed our development costs.

Player acquisition costs. We utilize advertising and other forms of player acquisition and retention to grow and retain our player audience. These expenditures generally relate to the promotion of new game launches and ongoing performance-based programs to drive new player acquisition and lapsed player reactivation. Over time,


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these acquisition and retention-related programs may become either less effective or more costly, negatively impacting our operating results. We may incur increased player acquisition costs as our ability to cross-promote traffic to games that are offered on platforms other than Facebook, for example, games offered on Zynga.com, as well as our RMG offerings with bwin.party, are limited by Facebook's standard terms of service, subject to certain exceptions.

New market development. We are investing in new distribution channels, mobile platforms and international markets to expand our reach and grow our business. For example, we have continued to hire additional employees and acquire companies with experience developing mobile applications. Our ability to be successful will depend on our ability to develop a successful mobile network, obtain new players and retain existing players on new and existing social networks and attract advertisers.

We entered into an agreement with bwin.party to offer RMG products in the United Kingdom and in the second quarter of 2013, we launched our first RMG offerings, ZyngaPlusPoker and ZyngaPlusCasino, in the United Kingdom. However, we are evaluating our RMG products in the United Kingdom to determine whether or not they are on strategy and aligned with our near term market opportunities and priorities. In July 2013, we decided to withdraw our application from the Nevada Gaming Control Board and made the focused choice not to pursue a license for real money gaming in other U.S. jurisdictions at this time in order to focus our resources and priorities against the growing market in free, social gaming, including social casino offerings.

As we expand into new markets and distribution channels, we expect to incur headcount, marketing and other operating costs in advance of the associated bookings and revenue. Our financial performance will be impacted by our investment in these initiatives and their success.

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