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ZNGA > SEC Filings for ZNGA > Form 10-Q on 8-Aug-2014All Recent SEC Filings

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Form 10-Q for ZYNGA INC


8-Aug-2014

Quarterly Report


ITEM 2. 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 Quarterly Report on Form 10-Q. 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 Quarterly Report on Form 10-Q, particularly in "Special Note Regarding Forward-Looking Statements" and "Risk Factors." The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date hereof.

Overview

We are a leading social game developer with approximately 130 million average MAUs for the three months ended June 30, 2014. 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.

On February 11, 2014, we completed the acquisition of 100% of the equity interests of NaturalMotion. 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. NaturalMotion possesses industry leading technology and tools and its proven simulation technologies have powered some of the biggest console games and blockbuster movies. Zynga's acquisition of NaturalMotion expanded our creative pipeline into two new consumer categories - Racing and People simulation - and provided Zynga with cutting edge technology and tools, including Euphoria, that we believe will help fast track Zynga's ability to deliver hit games.

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 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 largest 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 three months ended June 30, 2014 and 2013, we estimate that 45% and 68% of our bookings, respectively, were generated through the Facebook platform, while 50% and 27% of our bookings, respectively, were generated through mobile platforms, with the three months ended June 30, 2014 being the first quarter in which bookings generated through mobile platforms represented a majority of our bookings. For the three months ended June 30, 2014 and 2013, we estimate that 59% and 76% of our revenue, respectively, was generated through the Facebook platform, while 37% and 23% 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.


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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 in July 2013, Facebook began to transition to Facebook's local currency-based payments program. We completed this in the fourth quarter of 2013. For all payment transactions in our games under Facebook's local currency based 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 PayPal, Apple iTunes accounts, Google Wallet, credit cards and direct wires.

Advertising and other. Advertising revenue primarily includes branded virtual goods and sponsorships, engagement ads and offers, mobile ads and display ads and other. We generally report our advertising revenue net of amounts due to advertising agencies and brokers. Other revenue includes software licensing and maintenance related to technology acquired in our acquisition of NaturalMotion as well as licensing of our brands.

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 a non-GAAP financial measure that is equal to revenue recognized during the period plus the change in deferred revenue during the period. We record the sale of virtual goods as deferred revenue and then recognize that revenue over the estimated average life of the purchased virtual goods or as the virtual goods are consumed. Advertising sales which consist of certain branded virtual goods and sponsorships is also deferred and recognized over the estimated average life of the branded virtual good, similar to online game revenue. Bookings, as opposed to revenue, 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.

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.

The following table presents a reconciliation of revenue to bookings for each of the periods presented:

                                             Three Months Ended June 30,            Six Months Ended June 30,
                                              2014                 2013               2014               2013
Reconciliation of Revenue to Bookings:
Revenue                                  $      153,232       $      230,735      $     321,252       $  494,324
Change in deferred revenue                       21,870              (43,157 )           15,208          (76,931 )

Bookings                                 $      175,102       $      187,578      $     336,460       $  417,393

Adjusted EBITDA. Adjusted EBITDA is a non-GAAP financial measure that we calculate as net income (loss), adjusted for provision for / (benefit from) income taxes; other income (expense), net; interest income; gain (loss) from significant legal settlements; restructuring expense; depreciation and amortization; impairment of intangible assets; stock-based expense; contingent consideration fair value adjustments; acquisition-related transaction expenses, and change in deferred revenue. We believe that adjusted EBITDA 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.

We have included adjusted EBITDA in this Quarterly Report on Form 10-Q because it is a key measure we use to evaluate our financial and operating performance, generate future operating plans and make strategic decisions for the allocation of capital. Accordingly, we believe that adjusted EBITDA 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. 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 the related financial information prepared in accordance with U.S. GAAP.


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The following table presents a reconciliation of net income (loss) to adjusted EBITDA for each of the periods indicated (in thousands):

                                          Three Months Ended June 30,            Six Months Ended June 30,
                                           2014                 2013               2014               2013
Reconciliation of Net Income (Loss)
to Adjusted EBITDA:
Net income (loss)                      $     (62,533 )      $     (15,805 )    $    (123,716 )      $ (11,672 )
Provision for (benefit from) income
taxes                                         (2,012 )            (17,989 )           (9,091 )        (26,755 )
Other income (expense), net                     (896 )              4,531             (2,021 )          5,394
Interest income (expense), net                  (776 )             (1,105 )           (1,646 )         (2,268 )
Restructuring expense, net                    (2,270 )             25,089             27,385           30,548
Depreciation and amortization                 19,926               30,858             45,270           62,919
Contingent consideration fair value
adjustment                                    12,070                   -              13,350               -
Acquisition-related transaction
expenses                                         265                   -               6,425               -
Stock-based expense                           28,847               25,888             57,173           55,810
Change in deferred revenue                    21,870              (43,157 )           15,208          (76,931 )

Adjusted EBITDA                        $      14,491        $       8,310      $      28,337        $  37,045

Limitations of Bookings and Adjusted EBITDA

Some limitations of bookings and adjusted EBITDA are:

• adjusted EBITDA does not include the impact of stock-based expense;

• bookings and adjusted EBITDA do not reflect that we defer and recognize online game revenue and revenue from certain advertising transactions over the estimated average life of virtual goods or as virtual goods are consumed;

• adjusted EBITDA does not reflect income tax expense;

• adjusted EBITDA does not include other income expense (net), which includes foreign exchange gains and losses and interest income;

• adjusted EBITDA excludes depreciation and amortization and although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future;

• adjusted EBITDA does not include the impairment of intangible assets previously acquired, contingent consideration fair value adjustments, and does not include acquisition-related transaction expenses;

• adjusted EBITDA does not include gains and losses associated with significant legal settlements or restructuring expense; and

• other companies, including companies in our industry, may calculate bookings and adjusted EBITDA differently or not at all, which reduces their usefulness as a comparative measure.

Because of these limitations, you should consider bookings and adjusted EBITDA along with other financial performance measures, including revenue, net income
(loss) and our other financial results presented in accordance with U.S. GAAP.

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. The numbers for these operating metrics are calculated using internal company data based on tracking the activity of user accounts. We believe that the numbers are reasonable estimates of our user base for the applicable period of measurement; however, factors relating to user activity and systems may impact these numbers.

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 or social networks (e.g., Facebook.com, Zynga.com, iPad, Android Phone, iPhone, etc.) 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.


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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 or social networks (e.g., Facebook.com, Zynga.com, iPad, Android Phone, iPhone, etc.) 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 on two different social networks, a player playing on two different social networks in a given 30-day period may be counted as two MUUs. 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. Because we cannot always distinguish unique individuals playing on two different social networks, an individual who makes a payment on two different social networks in a given 30-day period may be counted as two MUPs. MUPs are presented as an average of the three months in the applicable quarter.

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 three and six months ended June 30, 2014 and 2013:

                         Three Months Ended June 30,           Six Months Ended June 30,
                          2014                2013              2014               2013
                                         (users and payers in millions)
   Average DAUs                  29                  39               28                 46
   Average MAUs                 130                 187              126                220
   Average MUUs (1)              89                 123               88                136
   Average MUPs (1)             1.7                 1.9              1.5                2.2

ABPU $ 0.067 $ 0.053 $ 0.065 $ 0.051

(1) MUUs and MUPs exclude NaturalMotion as our systems are unable to distinguish whether a player of a NaturalMotion game is also a player of a Zynga game so we exclude NaturalMotion payers to avoid potential double counting of MUUs and MUPs.


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Average DAUs, MAUs and MUUs declined when comparing the three months ended June 30, 2014 and 2013. The declines in users for our existing games have exceeded the contribution to these metrics from newer titles including FarmVille 2: Country Escape. ABPU increased in the second quarter of 2014 compared to the second quarter of 2013 due to a faster decline in DAUs in those periods than the decline in bookings and due to strong ABPU from FarmVille 2: Country Escape. 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 our 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 five quarters:



                                                                              For the Three Months Ended:
                                                Jun 30, 2014       Mar 31, 2014       Dec 31, 2013       Sep 30, 2013       Jun 30, 2013
Average monthly unique payer bookings (in
thousands) (1)                                 $       44,844     $       39,073     $       37,432     $       39,535     $       50,657
Average MUPs (in millions) (2)                            1.7                1.4                1.3                1.6                1.9
Monthly unique payer bookings per MUP (3)      $           27     $           27     $           28     $           25     $           26

(1) Average monthly unique payer bookings represent the monthly average amount of bookings for the applicable quarter that we received through payment methods for which we can quantify the number of unique payers and excludes bookings from certain payment methods for which we cannot quantify the number of unique payers. Also excluded are bookings from advertising and NaturalMotion.

(2) MUPs exclude NaturalMotion as our systems are unable to distinguish whether a player of a NaturalMotion game is also a player of a Zynga game so we exclude NaturalMotion payers to avoid potential double counting of MUPs.

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

Average monthly unique payer bookings increased between the first quarter of 2014 and the second quarter of 2014 due to the bookings contribution from FarmVille 2: Country Escape, offset by declines in other games.

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

• Executive Team Appointments. In April 2014, Zynga announced it appointed David Lee as Chief Financial Officer and Chief Accounting Officer, replacing Mark Vranesh. Mr. Lee oversees accounting, corporate finance and investor relations for Zynga. We also announced several other hires including: Alex Garden, President of Zynga Studios, who has 25 years of entertainment industry experience, and a history of architecting consumer entertainment experiences across video, music, free-to-play and console games; Academy Award nominated visual artist, Henry LaBounta as its first Chief Visual Officer and Jennifer Nuckles, a proven consumer marketer with more than 18 years of experience, as its Chief Marketing Officer. Additionally, Zynga announced its founder Mark Pincus stepped down from his operational role as Chief Product Officer to focus on serving in his role as Chairman of the Board of Directors.

• Updates to our Board of Directors. In June 2014, Directors Jeffrey Katzenberg and Reid Hoffman did not seek re-election to the Board of Directors (the "Board") at the Company's 2014 Annual Meeting of Stockholders. Mr. Hoffman served since 2008 and Mr. Katzenberg served for more than three years. In July 2014, Zynga announced Dr. Regina E. Dugan, Vice President of Engineering at Google Inc., and the leader of the company's Advanced Technology and Projects (ATAP) group, was appointed to Zynga's Board of Directors. Dr. Dugan joined L. John Doerr, William "Bing" Gordon, Stanley J. Meresman, Sunil Paul, Ellen F. Siminoff Don Mattrick and Mark Pincus on the Board.

• Product Launches and Updates. In the second quarter of 2014, we launched new games and made several product updates, including:


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¡ The FarmVille team continues to make strides in growing and sustaining the core franchise. We are seeing promising results from bringing FarmVille to mobile with the April launch of FarmVille 2: Country Escape. Since the launch, the team has focused on delivering engaging content to a global audience.

¡ As part of Zynga's growing Casino franchise, which includes Zynga Poker and Hit It Rich! Slots, Zynga partnered with A&ENetwork®'s Duck Dynasty series to expand its branded social casino experience for consumers with the June 2014 launch of Duck Dynasty Slots on iPhone, iPad and Google Play.

¡ In keeping with our commitment to bring play to multiple platforms, we also released CSR Classics and Clumsy Ninja on Google Play.

Factors Affecting Our Performance

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, such as our launch of FarmVille 2: Country Escape. 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 $0.053 in the three months ended June 30, 2013 to $0.067 in the three months ended June 30, 2014 due to higher decline in DAU of non-paying players (compared to paying players) who do not contribute to online game bookings. In addition, mobile and international . . .

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