Zynga Inc.
Q3 2014 Earnings Call Transcript

Published: 7 Nov 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Zynga Third Quarter 2014 Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Darren Yip, Senior Director of Finance and Investor Relations. Please go ahead.

[Darren Yip:]

Thank you, Danielle, and good afternoon. Welcome to all of you who are joining us today. On behalf of the Zynga management team, I would like to thank you for spending time with us this afternoon. We have with us our Chief Executive Officer, Don Mattrick; Chief Operating Officer, Clive Downie; and Chief Financial Officer, David Lee. Before we begin, please note that we are targeting a 1-hour call. During the course of today's call, we will be making forward-looking statements related to, among other things, strategy and expectations for future performance, our 2015 slate and outlook for Q4. Actual results may differ materially from the results predicted. Factors that could cause or contribute to such differences are detailed under the caption Risk Factors in our Form 10-K and elsewhere in our SEC filings. These include the ability of key games, including our top franchises, to sustain or grow audience and bookings and our ability to launch successful new games and features in a timely manner. We will also discuss certain non-GAAP financial measures during the call. Reconciliations to the most directly comparable GAAP financial measures are provided in the press release and on our Investor Relations website. Be sure to look at these reconciliations as the non-GAAP measures are not intended to be a substitute for our GAAP results. This conference call is being webcast on the Internet and is available through Zynga's Investor Relations website. An audio replay of this call will also be available on our website in a few hours. With that, I would like to turn the call over to Don Mattrick, Zynga's Chief Executive Officer.

[Don A. Mattrick:]

Thank you, Darren, and welcome to everyone joining us on our Q3 conference call. Today we'll be discussing our quarterly financial performance as well as providing an update on our strategy and investments we're making to position us for success in 2015. Looking at our quarterly financial performance. In Q3, we reported bookings at the high end of our guidance range at $175 million and adjusted EBITDA near the midpoint of our guidance range at $2.2 million. These results were driven primarily by the growth of our Casino Slots business and our advertising performance in Words With Friends. I'm encouraged by the results of the quarter as we navigate through this timely transition. As we move forward, we aspire to improve our execution in terms of product quality and audience growth. In Q3, we achieved meaningful growth in mobile, delivering 111% increase in mobile bookings year-over-year. This past year, we demonstrated our ability to grow our cross-platform capabilities with mobile now representing 55% of total bookings, up from 50% in Q2. The investments we continue to make to grow and sustain our franchises showed up in our results this past quarter. Our top franchises, Casino, Words With Friends, FarmVille and Racing grew bookings 7% sequentially in total. In addition to our Q3 franchise growth, there are a number of product highlights this past quarter that represent what is working across our organization. Starting with Casino. In June of 2013, Zynga acquired a small company named Spooky Cool Labs that was building unique products to compete in the social slots category. Over the last year, the team has worked hard to launch Hit It Rich! Slots and iterate based on consumer feedback. Based on their work, Hit It Rich! has become a category leader with more than 40 themed slots, and the game is currently in the top 10 grossing charts as the #3 top grossing Casino game on iPhone. Our Slots products are fast gaining market share with an engaged consumer audience and a high product quality across web, iOS, Android and Kindle. In Q3, the team delivered double-digit percentage bookings growth, up 77% sequentially and up 35% in terms of audience across monthly active users. We believe it's early days for our Hit It Rich! Slots game, and we're continuing to invest in the product with new branded and progressive Slots launching throughout the end of this year and early next. Our Words With Friends franchise just celebrated its fifth anniversary, and we timed the recent launch of New Words With Friends product to this milestone. While it's only been a few weeks since our global launch, the community sentiment, global chart position and organic word-of-mouth factor is among the strongest we've seen at Zynga. Shortly after launch, it became the #3 top free app in the Apple App Store and is currently the #1 top free game on iPhone, an exciting milestone for our company. Weeks after launch, we're starting to see positive trend lines as we stay focused on driving engagement for one of our most important game communities. Looking at FarmVille. In Q3, our mobile game FarmVille 2

[Clive Downie:]

Thanks, Don, and hello, everyone. First, I want to spend some time discussing our progress against our grow and sustain efforts, particularly as it relates to our Casino and Words franchises as well as our commitment to creating new hits that engage mainstream audiences across a number of content categories. Starting with our Casino franchise. As Don mentioned, with the launch of the New Zynga Poker, we set out to evolve our original Poker game with an entirely new experience for mobile that includes a new design and feature set that inspires more competition and social connections between friends. Since the launch, we've been listening closely to our players and heard from many of them that they like the look and feel of the New Zynga Poker, while others miss the classic design and play style of the original game. Another segment of consumers playing on legacy devices found the game less performant. In response to the player feedback that we received, we made the strategic decision to offer 2 distinct products

[David J. Lee:]

Thank you, Clive, and good afternoon, everyone. In Q3, we continued to execute against our initiatives to grow and sustain our key franchises and delivered our fourth consecutive quarter of double-digit percentage growth for mobile bookings. While we did see costs rise quarter-over-quarter as we continued to make deliberate investments for future growth, I believe the decisions we are making will bear fruit as we begin to roll out our new products globally over the next few quarters. Looking forward, we continue to be prudent with costs and focused on expanding margins. I'd like to now take you through the details of the quarter. But before I begin, please note that many financial measures herein are expressed on a non-GAAP basis. Total bookings were $175 million, up slightly quarter-over-quarter, driven by strong growth in Hit It Rich!, FarmVille 2

[Operator:]

[Operator Instructions] And our first question comes from Eric Sheridan from UBS.

[Eric James Sheridan:]

I guess first one just maybe on mobile, up to 55%. I think that's really good result. I wanted to understand what we're seeing in terms of monetization on mobile versus nonmobile and how you see that trending going forward. And then maybe for David, looking through into 2015, I wanted to understand how you guys are thinking about the buyback and the authorization that remains as part of your broader capital allocation plans.

[David J. Lee:]

Eric, thank you. Two great questions. Let me take them in turn. First, with regard to monetization, you'll see in our disclosures that the overall monetization for the company has sequentially grown. We've also disclosed in the past that we do not see any structural reason why our growth in mobile would in any way preclude the same degree of strong performance financially as we've seen historically in the web. With regard to your second question, our balance sheet is a tremendous asset for the company. It allows us to attract and retain talent during a transition, and it also allows us to evaluate organic and inorganic opportunities in an explosively growing market. That said, we continue to evaluate the best use of our capital. And we are not, today, announcing any additional stock buyback beyond the program that expired in October.

[Operator:]

And our next question comes from Chris Merwin from Barclays.

[Christopher Merwin:]

So you talked a bit about investing behind NFL Showdown, and I believe you mentioned that the NFL may actually help on the marketing front there. Can you talk a little bit about what that would entail and how impactful that could be for audience for that particular title? And then also after launching NFL Showdown, what was the most important lesson you took away from that as you prepare to launch the Tiger Woods game in 2015?

[Clive Downie:]

Chris, this is Clive. Thanks for the question. It's a good one. So in terms of NFL Showdown, I mentioned that we are iterating that product based on forging strong relationships with NFL fans and then iterating the product through a successive phased rollout of features. And then once we have that product to the point where we want to, we're going to invest in marketing and also bring our partners into the marketing cycle. When you have a license with someone that's as powerful as the NFL, you have the opportunity through that partnership to unlock all of their channels across all of the marketing mix. And we look forward to doing that at the appropriate time in the future. In terms of the lessons that we've taken away from the NFL Showdown launch and how that relates to Tiger, as I've mentioned in the call, it's a phased rollout. We're in the business of creating long-term services that extends beyond just one season and one year. And we're really taking away the fact that, that's a strategy that is, at the moment, we're happy with the performance of, and we look forward to rolling it out for Tiger in 2015.

[Operator:]

Our next question comes from Ben Schachter from Macquarie.

[Benjamin A. Schachter:]

If we look at the sales and marketing line, it's ramping up quite a bit as a percentage of revenue. I think it was among the highest ever. How should we be thinking about that over time? Are you targeting it to specific levels? How should we look at near term versus long term? And then separately, just on mobile, can we talk a bit about the network effects that you see there? Obviously, early on in the company's history, there were a lot of network effects on Facebook. Are we seeing similar types of things on mobile? How is it the same and how is it different?

[Clive Downie:]

Ben, this is Clive. Thanks for the questions. So in terms of the first question and the sales and marketing, now we're in midst of transitioning the company, as we mentioned on the call, to mobile. And you're seeing that come in our growth on mobile. A large part of that is growing our user base on those formats. And we have and will continue to invest in that growth through marketing. I'm happy with the way we've constructed both product marketing, performance marketing, consumer marketing disciplines. But we continue to view that construction as a work in progress and look forward to optimizing all 3 of those disciplines as part of the marketing as we move through into 2015. In terms of the network effect on mobile, again, network effect on mobile for us is -- continues to be a work in progress. We're creating a daily active user base of consumers on mobile and starting to move our consumers among product based on their different likes that we are identifying through their tastes. And again, we look forward to doing more and more of that as we build a scalable use -- daily active user base through 2015.

[Operator:]

And our next question comes from Tim O'Shea from Jefferies.

[Timothy O'Shea:]

So it sounds like you're continuing to sign new licensing partnerships with Bridesmaids and Real Housewives. Just wondering if you found it's easier to launch licensed games like NFL and Looney Tunes given the brand awareness and maybe if you feel the risk-reward in launching a licensed game makes more sense than developing on the IP. And then should we expect to see more of these licensed games going forward?

[Don A. Mattrick:]

Tim, thanks for question. This is Don. We're going to continue to have a mix of Zynga and NaturalMotion-owned IP and licensed partners where we think it's a fit for our company, for consumers and for the partners that we work with. So no change in strategy, being smart about finding long-term partnerships with, at its core, something we think customers value, something we think we can do a good job of executing on as a company, and most importantly, economics that make sense for everyone.

[Operator:]

Your next question comes from Justin Post from Bank of America.

[Ryan Gee:]

This is Ryan Gee calling in for Justin. Looking at the web business, it looks like it declined again sequentially, and so it remains a headwind for the overall business. I was wondering if you could outline some of the things you're seeing or some of the things you're doing that could maybe stabilize the web business or even maybe get it to grow again sequentially. At what point do we start to see that business stabilize?

[Don A. Mattrick:]

We've disclosed in the past that our focus has really been migrating the company to the levels of penetration you're now seeing in mobile. That said, as our older catalog games beginning -- begin to run its course, we disclosed that the rate of decline in the web may be tempered in the future. We've also said that we will go where the consumer needs us to go. And that will be a category and genre-specific evaluation on where we should launch and where the consumer wants to play our games.

[Operator:]

And our next question comes from Sean McGowan from Needham & Company.

[Sean P. McGowan:]

Two areas that the performance was perhaps a little counterintuitive, at least relative to my expectations, were the average bookings per paying user of $0.073 being up in an environment where DAUs and MAUs are down. And the same type of question for ad revenue increasing in the face of DAUs being below where I thought they'd be. So can you tell us a little bit more color on how you're driving that kind of better-than-expected performance on those 2 metrics?

[Don A. Mattrick:]

I think an important driver for our in-app purchases is around engagement. And as you think about how engaged whatever audience we have in a given period, as we drive higher engagement, it results naturally in higher degrees of bookings per average user. Your question on ad revenue is very important. It's a great question because even as we see declines in DAU and MAU in certain areas, as we created more engagement with our advertising partners, we are seeing an improvement in the rates that we are being able to develop for the audience we have. We also, in the quarter, as we grew our ad revenue 67% quarter-on-quarter, did have a benefit associated with better contractual terms with an advertising partner. But even excluding that, we have just seen double-digit, triple-digit growth in the way in which we're developing better engaged ad revenue per DAU.

[Operator:]

And our next question comes from Arvind Bhatia from Sterne Agee.

[Arvind Bhatia:]

I wanted to see if you could talk about 2015 in general directional terms. It seems to me that with the quarterly increase you've had in overall bookings, that you might have hit some sort of inflection point, especially given your Q4 guidance. But I also wonder if Q4 is up more because of seasonality and a few product launches and -- or if you think that, that might be the new level of bookings run rate, close to $190 million, $200 million. And then similarly, as you think 2015 directionally in terms of profitability, your game launches, the costs associated with those, selling and marketing, everything put together, just wanted to see if you could give us a feel directionally for top and bottom line.

[David J. Lee:]

Thanks for the question. We said consistently that 2014 is a transition year, where we were deliberately and intentionally investing for the growth that we will see beyond 2014. That remains true. We're not providing quantitative guidance. But as we've discussed with all of you in the past, we imagine a world where we're bringing to the market growth with a cost structure that doesn't scale at the same rate at the delivery of that top line growth. And in that world, regarding your long-term EBITDA margin question, there's no reason why Zynga could not be at the level of performance you're seeing at scale players deliver an EBITDA margin. But at this point, we want to complete Q4 and not get ahead of ourselves with regard to guidance specific to F '15.

[Operator:]

And our next question comes from Daniel Ernst from Hudson Square.

[Daniel Ernst:]

I wanted to follow up to, I think it was Ben's question on advertising spend and how you feel about the effectiveness that's been relative to your unique players declining and to contrast that with some comments that King has been making about their spend and moving spend towards television advertising. Can you just talk to me about your ad strategy, about your strategy about broadening your user base again?

[Clive Downie:]

Daniel, this is Clive. Thanks for the question. So our ad spend is a mix of products in their particular life cycle at the time. And so on a quarter-by-quarter basis, we have many different products that we're looking to, either in geo-lock or in growing sustained mode or either in a growth mode. And what we do is we cycle our ad spend accordingly. We're broadening our user base through a variety of different channels as I mentioned, in our marketing department growth earlier. We have both product marketing, consumer marketing and performance marketing. And so what we're doing is we're investing in broader marketing campaigns and above-the-line media as well as in performance marketing campaigns, bringing consumers in, in very targeted ways through mobile advertising. We always look to do that in an ROI-positive way. And we're finding that we're seeing very, very strong, positive signs as we increase the maturity of our marketing team.

[Operator:]

[Operator Instructions]

[Don A. Mattrick:]

This is Don. If there are no additional questions, I want to thank everyone for calling in today and just thank our teams. There's a lot of great work going on both at Zynga and NaturalMotion, and I'm really pleased with the way our teams are showing up their commitment to customers, customer excellence. And again, I appreciate their great work as we move our business to the next level. So we want to thank you for your call today, and look forward to seeing everyone over the coming months.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.