Zynga Inc.
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Zynga First Quarter 2015 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, David Lee, Chief Financial Officer and Chief Accounting Officer. Please go ahead, sir.

[David J. Lee:]

Thank you, Danielle, and thank you, everyone, for joining our call and being flexible, as we moved up our timing to accommodate today's cost-reduction announcement. Joining us today are Mark Pincus, our Founder, Chairman and Chief Executive Officer; and Melissa Fisher, our new Vice President of Investor Relations, Corporate FP&A and Treasury. Melissa most recently ran Investor Relations, Corporate Development and Treasury at Digital River and prior to that, was a technology investment banker at Goldman Sachs and Bank of America. Please join me in welcoming her to Zynga.

[Melissa Fisher:]

Thanks, David. I'm excited to join the team at Zynga and look forward to an active dialogue with our investors and analysts during the coming months. With that, let's get started with the call. Please note that we are targeting a 1-hour call. During the course of today's call, we will make forward-looking statements related to, among other things, strategy and expectations for future performance and outlook for Q2, our cost-reduction plan and expected savings and our plans for our game slate and launches in 2015. 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 forms 10-Q and 10-K and elsewhere in our SEC filings. These include our ability to launch successful new games and features in 2015 and the ability of key games, including our top franchises, to sustain or grow audience and bookings. 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 Mark Pincus.

[Mark Pincus:]

Thanks, Melissa, and thanks, everybody, for joining us today. Before we get into the call, I want to thank Don Mattrick for his commitment and leadership over the past 2 years. Don joined Zynga at a crucial time, and under his guidance, we've become a mobile-first company. He recognized the need to -- for a much deeper investment in game quality for us to win the hearts and minds of mobile gamers. He led the acquisition of NaturalMotion and grew our capabilities across creative and visual design, and he remains a friend and adviser to me and the company today. Now let's talk about the first quarter. We delivered results above our guidance, generating $167 million in bookings and adjusted EBITDA of $2 million. Our Q1 results reflect the progress we made in our transition to mobile, which now represent 63% of our total bookings, up 84% year-over-year. The teams did a great job. Over the past 4 weeks, I've been working closely with our teams, and I'm excited to be back here today. I want to update all of you on our company in 3 key areas

[David J. Lee:]

Thank you, Mark, and good afternoon, everyone. I'm going to spend some time discussing our financial results for Q1, our cost-reduction plan and our guidance for Q2. I'll take you through the details over the quarter, but before I begin, please note that many financial measures herein are expressed on a non-GAAP basis. Q1 total bookings were $167 million in the first quarter, an increase of 4% year-over-year and above the top range of guidance. Q1 performance was primarily driven by better-than-anticipated results in our Social Casino and Farm franchises due to successful new features and events. The Q1 year-over-year improvement was driven by strong growth in our Slots category and our Words franchises. We also benefited from the full quarter of the Racing franchise resulting the acquisition of NaturalMotion in Q1 of 2014 as well as from Looney Tunes Dash!. Q1 bookings declined 8% quarter-over-quarter primarily driven by the expected seasonal declines in advertising after the holiday season as well as the decline of our web products inclusive of game sunsets that we discussed on our last call. Q1 mobile bookings were $106 million, up 84% year-on-year but down 4% sequentially. Web bookings were down 33% year-over-year and 15% quarter-over-quarter at $61 million. In terms of platform mix, mobile bookings grew from 60% of total bookings in Q4 to 63% in Q1. Facebook-related bookings mix decreased from 36% of total in Q4 to 33% in Q1. Social Casino franchise bookings grew 55% year-over-year and 14% quarter-over-quarter. The sequential increase in bookings was primarily driven by the recently launched Wizard of Oz Slots as well as a 6% quarter-over-quarter growth in Hit It Rich! Slots bookings. Moving to Invest & Express. FarmVille franchise bookings grew 3% year-over-year but declined 19% quarter-over-quarter. The year-over-year increase was due primarily to the addition of FarmVille 2

[Operator:]

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

[Eric James Sheridan:]

Maybe just 2. Mark, I would appreciate a little color about the way the -- sort of the organization is going to be positioned going forward in terms of going to market. Wanted to get some color from you in terms of the marketing spend or how you think titles need to be positioned as they launch. Going forward, we've seen a lot more money being put behind marketing, around mobile app install ads, even video campaigns across the web and how you think Zynga is going to position themselves for game launches as well. And then maybe one for David. David, last quarter, you provided that guidance about where mix might go over time to mobile and sort of the trajectory of mix. Any update to that given some of the push in on titles that could come to market and some of the titles that might be decommissioned?

[Mark Pincus:]

Sure, Eric. So on marketing spend, really, we've seen in our experience in the Slots category that when -- we've continued to back our game, while the team has increased the quality and the average revenues per user quarter-over-quarter. We've been able to support a larger user acquisition and marketing spend, and we think that's a good model going forward that, obviously, you see us with games coming out in valuable categories like Action Strategy and more and Slots that we're focusing on games that can deliver a higher ARPU and support a higher accretive ad spend so that we can drive better customer acquisition. And also, that's part of our increased investment in data analytics. We think that we can get a lot better at the way that we go about buying traffic. David?

[David J. Lee:]

Thanks, Eric, for the second question with regard to guidance. As you recall, we ended our last call noting that our achievement in Q4 of 60% mobile bookings penetration would continue to advance in the course of the year. In fact, we talked on our last call of ending the year with approximately 75% mobile penetration. What we've announced today in focusing on our 6 to 8 products in 2015 in no way changes our ability to achieve that objective and overall, our mid- to long-term prospects for growth. In fact, with the announcement of the cost-reduction program, we feel that by focusing and simplifying we can improve upon our ability to execute well.

[Operator:]

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

[Sean P. McGowan:]

One detail question, David. What is the -- what's in other income that made that jump up so much in the quarter?

[David J. Lee:]

In the other income line, we had to deal with the completion of an important acquisition that drove a lot of the benefit we're seeing from our Hit it Rich! and Wizard of Oz Slots program. This is referenced in my portion of the script as relating to Spooky Cool. So it really is, frankly, a nonrecurring but an important impact to the P&L and a great acquisition for us that's delivered well as we mentioned on -- in the call.

[Sean P. McGowan:]

I thought it was a positive there in the first quarter. No?

[David J. Lee:]

We can follow up. I want to make sure I understand what you're looking at. The other income adjustment that we have for Hit it Rich! is also complemented by the fact that we had a gain on sale in Tapson [ph] , one of other investments. There was a gain on sale from our original basis of $4 million, so we can kind of bridge you through all the components to make sure you have it.

[Sean P. McGowan:]

And then when you talk about be $100 million of savings, can you talk about whether or not that is net of any investments you might be looking to make? Or was that a gross number that you might turn around and invest elsewhere?

[David J. Lee:]

The $100 million in annualized cost savings is a gross number. I mean, as you heard, we will make strategic investments in certain areas such as data analytics, where we think it creates a competitive advantage.

[Operator:]

And our next question comes from the line of Brian Pitz from Jefferies.

[Brian J. Pitz:]

David, you may have mentioned this on the call, but last quarter, you said to expect strong cash flow and profitability by year end. Just wondering whether there have been any changes to that thinking under new management. And Mark, when you returned to Zynga, you remarked your intent to refocus on analytics. I thought it may make sense if you can give us a bit more color on that strategy, maybe if you could give us a real world example of how better analytics could essentially impact the business.

[David J. Lee:]

Thanks for the question, Brian. On your first, no changes have been made in our view on establishing a strong cash flow and position in profitability. For us, as we entered Q1 and exit the quarter for 2016, if anything, you're seeing us begin to execute against that objective. And for the second, I think your question is addressed to Mark.

[Mark Pincus:]

Sure. So Brian, you're asking for more depth on our focus on analytics.

[Brian J. Pitz:]

Yes.

[Mark Pincus:]

Sure. It's still early days for me. I'm closing out my first month, but I do see and the team sees a lot more opportunity. And if you think analytics was -- and our analytics leadership was key to our leadership on the web, and it's even more relevant today on mobile, where data is key to user acquisition so really making sure that we're buying the right audience against our games and really measuring clearly where we're driving value. It's also key in how we think about cross promoting our games and getting better at that, which obviously increases the overall LTV or long-term value of any user we add to the network, which also lets us spend more on acquisitions. It's also key -- it's even more key on mobile when you're -- you have such long -- much longer lead times on development and releasing of features through the App Store to really make sure that we're being data driven in how we're picking the features that we're going to invest deeply and for our players. And finally, as we think about making sure that we are serving our most valuable players, we can leverage data to make sure that they're -- we're extending the life and engagement of our best players in our games.

[Operator:]

Our next question comes from Mike Olson from Piper Jaffray.

[Michael J. Olson:]

One question I've gotten is does the equation of lower headcount will kind of help to create more successful games make sense. In other words, does that just end up giving you less shots on goal because you have fewer games to launch with fewer development teams to launch them? Or are you thinking that you want to launch fewer games but make each of them count more or be better games? And secondly, can you just talk about the decision to get out of the Sports and Runner segments given those were both areas that were kind of more recent additions to the platform? Do you think those segments just aren't significant enough to kind of warrant investment? Or is it that you believe Zynga needs to kind of pick its battles and can't be successful in every category right now?

[Mark Pincus:]

Sure, Mike. This is Mark. I'll answer that. So in terms of -- there's really kind of 2 halves to the same -- 2 sides of the same coin. So what we're trying to do is focus, intensify, narrow our execution focus around the opportunities that we think really are biggest for the company. And in a lot of ways, we've been surrounded by too many opportunities as a company, and it's been hard for us historically to get to a narrow-enough focus. And so Sports is a terrific opportunity, but we don't want to pursue Sports at the expense of near-term, more obvious opportunities that we have with the slate late that we're just in the beginning of launching. So obviously, we just launched Empires & Allies yesterday, and we're seeing encouraging results. We want to intensify the organization's focus around these best opportunities before we expand what's on our plate and go after more. And the other thing I'd say, in terms of how you should think about shots on goal is, really, there's 2 focuses that I was trying to get to when I talked about our products and people focus. One is narrow and intensify our execution focus around the big opportunities that are in front of us today, and then at the same time, we want to enable more small teams to get out ahead of us and pursue new innovations. But we want to be careful about when we step up the investment in those teams, and we don't want to find ourselves -- we don't want to find ourselves in the middle. So we want to either be pursuing proven opportunity, most valuable category with proven teams and go after that in a big way and persistent way, like we did in Slots, or we want to have very small teams out proving a new opportunity.

[David J. Lee:]

I think the only other comment to add is that it's important to note that of the -- all the cuts we are making to our cost structure, approximately 3/4 of those cuts actually don't directly relate to the game teams that are important for our growth. It really goes to Mark's point about simplification and focus so that we can be more effective in growing our business.

[Operator:]

And our next question comes from Tony Wible from Janney Capital Markets.

[Anthony Wible:]

I'm curious on the Sports exit. Will you guys have an impairment charge with that? And then as you guys simplify the expense structure, how scalable is the business after you guys realign it?

[David J. Lee:]

Let me tackle the first part of the question. We have not and don't disclose terms of the agreements that we've made with our third-party partners. Certainly, as we consider shutting down activity with those partners, we would include in our future costs, restructuring charges anything that's relevant related to that. And then can you repeat the second question? I think it was, just to make sure we got it right, how scalable is business after we realign it.

[Anthony Wible:]

Correct.

[David J. Lee:]

About -- this realignment is truly about focus and simplification on our slate. It's about making sure that we can deploy our people to the best opportunities. In some ways, one could view that as making the business more scalable with greater focus than less as many of the reductions are really not in the area of game makers but rather in some of their impediments in the complexity that we've created.

[Mark Pincus:]

And I would just add to that, Tony, that when we think about scale, we got to think about where we want to get scale. And we want to get scale in places like data and analytics where we need to be world class in order to arm our game teams to deliver the most value for our players. There's a lot of places that are not strategic for us to have scale and we think not appropriate like running our own data centers. We're going to let Amazon do that. So what we're really trying to do here is have scale where it can give us a real leverage across our product teams and not maintain scale that we really can't justify.

[Operator:]

And our next question comes from Doug Creutz from Cowen and Company.

[Douglas Creutz:]

Just a question about your Q1 results relative to your initial guide. I think, on the last call, you had indicated that your guide incorporated the sunsetting of some of your web titles in Q1. And correct me if I'm wrong, but I don't think those titles actually got sunsetted until just after the end of the quarter. So can you give us some idea of how much the over performance in Q1 was due to the runout of those titles?

[David J. Lee:]

Sure. In Q4, we talked about our intent in the quarter in Q1 to sunset approximately 10 web games, consistent with the total number we disclosed for fiscal '14. We actually did sunset 8 out of the 10 within the quarter. We've talked about the over performance versus guidance as really being driven by our strong performance versus expectations in Casino, Slots and Poker and the Farm franchise and Words. So that really was the driver with regard to both EBITDA and the top line rather than any dramatic change in our sunsetting of games.

[Operator:]

And our next question comes from Chris Merwin from Barclays.

[Christopher David Merwin:]

So just a question on branded IP. You sort of talked a bit about the decision to shut down NFL Showdown and Tiger Woods golf. But bigger picture, when you think about branded IP, is that something that you're eager to pursue longer term or not? It's just -- because I noticed a lot of the competitors are doing it. There's talk about how that lowers the cost of customer acquisition. Curious about your thoughts there. And then secondly, in terms of Empires & Allies, are you able to call out what you're expecting from that title into 2Q? And I know it's still very, very early. But any reactions to the initial success of that so far?

[Mark Pincus:]

Sure, Chris. So I don't have a single answer for you on branded IP because there's definitely places where we see major brands and licensed IP having accretive value for us in our business. For instance, in Slots, it's been a terrific part of us delivering this most authentic, valuable slots experience for the most valuable players. So obviously, it's been core to our strategy there. We've definitely seen places, like with Looney Toons, where it's been very helpful on driving initial trial and install. But at the same time, we want to build sustainable profitable franchises that we can invest in over long periods of time, and so you're not going to see us in a -- we don't have a strategy built all around branded IP. We'll, if you look at our strategy with NaturalMotion, they're -- there's a terrific studio, a terrific company that has been able to leverage market-leading talent and technology and game quality to drive a level of organic word of mouth that's driven the trial and huge numbers of installs across CSR and Clumsy Ninja. And we have upcoming releases with them of Dawn of Titans, and we just announced CSR2 where -- we're hopeful that the level of novelty and quality can drive large numbers of installs. And when we see an opportunity to get a brand that ties in really well with the audience, the category and what we're doing with the game mechanics, we'll continue to engage. It's -- but we're not relying on that as a single strategy, and you will definitely see other companies outbid us on some of these where we don't -- it's not clear to us it's going to be accretive. Oh, and the second question was what our specific expectations on Empires & Allies. Well, we're 33 hours in, so it's early for us or anybody to really be making projections on that game. But we're encouraged that the game averaged 4.5 stars during its soft launch period, and we've seen a 5-star rating in the first day or 24 hours in the U.S. iPhone store. So we're clearly seeing good feedback from customers on the value. And as I said, earlier in the call, it's had one of the highest monetization rates that we've ever seen in a Zynga game at this point its trajectory. And we have huge belief in Skaggs, Mark Skaggs -- we call him Skaggs around here -- being a really both high-quality and scrappy entrepreneurial leader who brought us -- developed FarmVille, developed CityVille but earlier in his career developed games like Command and Conquer that really make him have great domain expertise. So we're looking forward to updating you on the next call about that game.

[Operator:]

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

[Ryan Gee:]

This is Ryan calling in for Justin, one quick question for Mark and then a clarification from David. Mark, can you talk a little bit about how -- the importance of growing the payer, the payer base for you guys. I think you had 1.1 million monthly payers. Is that an opportunity? And then specifically, what can you do to grow the payers for your existing games versus expanding to new categories and getting payers that way? And then, David, a clarification. Can you talk about why is revenue more stable sequentially in your guidance versus the kind of the decline in bookings that's implied quarter-over-quarter? I'm assuming that has something to do with the mix of booking type, but any additional color would be great.

[Mark Pincus:]

Sure. So I'll take the first question, Brian (sic) [Ryan] on the importance of payers. We -- on mobile, we're all seeing that it's much more about a tighter focus on delivering value for your most passionate players first because the #1 source of new player acquisition is through ads, and so it's vital on mobile. And I said earlier that we want to leverage a greater investment in data and analytics to be even better at user acquisition, and we're going into categories and game mechanics where we can support higher-value ad-based installs. So the first part on new audiences, we've shown with Slots that we can acquire a new audience in a new category if we could raise the value bar high enough for our players. And then your second question on focusing on our existing core properties and growing payers in those, as I said, we've focused on increasing the quality in Poker where we saw sequential bookings and traffic growth, and it's definitely an important area for us. And then there's core audiences that we engage deeply on the web like in our Invest & Express that we're really excited to engage on mobile. But again, the approach on mobile will be a little different. It's going to be more about focusing on the most passionate and delivering the highest value and highest ARPU experiences for them.

[David J. Lee:]

With regard to the second question, which was around revenue recognition versus bookings, just to review, as you know, we recognize revenue on a game-by-game basis as we look at the life of the game. So conversely, if there were a game to be shut down, it would actually accelerate the recognition of that revenue into the period in which the game is shut. That is one factor. The second factor is, the overall life of our games has stayed as a company relatively stable. For example, roughly 10 to 12 months has been the typical lifespan on average for our portfolio, so we aren't seeing a dramatic change in our ongoing mobile games estimate of lifetime, how we amortize over revenue. But there is a factor in our guidance associated with the shutdown of our games.

[Operator:]

And your next question comes from Mike Hickey from The Benchmark Company.

[Michael Hickey:]

Welcome back Mark. Mark, when you think about your run as a CEO previously and now back again, can you provide us some insight, I guess, or any adjustment that you might make to your leadership style? I'm curious your motivation ultimately to reset as CEO as you've seem to have basically removed yourself from the daily operation of the business. And then secondarily, curious how you described the culture within Zynga today. Now obviously, you're working through some leadership changes and a material headcount reduction as announced today but your view on the importance of a strong culture that relates to producing successful games and retaining your more talented developers and leadership.

[Mark Pincus:]

Sure, Mike. So let's see, 2 big questions. So first question, I think it's always helpful to have time to step back and reflect on what you did well in leadership and what you could have improved on. And I think that some of what I brought to the job in the first 6.5 years, I hope to bring back here of a real focus on entrepreneuring and bringing a real energy to everybody, game makers to every part of the company, and a founder can do that in a unique way. But at the same time, I'd like to bring some greater patience than what I might have brought, where we were kind of in a series of sprints. It felt like weekly sprints that went on for 6.5 years as we built the company. And I'm working with the leadership team on a different cadence that reflects where the company is today and the difference in mobile releases versus web releases and things like that and a different platform relationship with mobile than we had on the web with companies like Facebook. In terms of the culture at Zynga today, I think that it's -- there's a bunch of mixed DNA here that I think is terrific. Don helped develop a new DNA at the company that, I think, is great for us in mobile that is focused on AAA console quality game experiences, and that's mixed with some previous DNA from my tenure. And we want to continue to bring in new DNA here as well. And I think that the energy around the company is terrific. There's -- people just want to get down to making great products and bringing them to market. And I said this a month ago, I guess, to the media and to the company when I came in that I think we have a real opportunity to instill a sense of ownership with our product leaders where they can feel like real CEOs empowered to make decisions, take risk, move quickly. And I think that's what we need to do to win in the market. And so I'm hopeful that I can be a catalyst for all that.

[Operator:]

And our next question comes from Heath Terry from Goldman Sachs.

[Heath P. Terry:]

Great. I was wondering if you could just give us an idea of what your view is on like-for-like pricing in the app download market to the extent that you're starting to see any real inflation or maybe from another perspective change in the ROI from the advertising that you're able to do through those channels.

[David J. Lee:]

Sure. Listen, with regard to our advertising business, as we disclosed, we have seen our ad bookings per DAU significantly improve more as a function of our own efforts to include features that have deeper targeting and deeper engagement with those that play our games. I think the second part of your question, I think, was actually more targeted at is the cost of creating demand for our own games increasing. Just to clarify, was that the question actually? Or were you asking about our ad business?

[Heath P. Terry:]

Yes, that was definitely more what I was aiming towards.

[David J. Lee:]

Yes. We have not disclosed any significant increase in the cost per install with regard to how we've launched our games. We have disclosed, for example, our steady investment at Hit It Rich! that has paid off. We also talked about, when we launched Country Escape, how with very little initial marketing we achieved good feature support that resulted in a top-charting game. So I really feel that there are ways to leverage Zynga's resources, brands and assets in order to be able to minimize the CPI that we have to pay for any install. But we have not disclosed or commented on a market-wide increase.

[Operator:]

[Operator Instructions] And our next question comes from Ben Schachter from Macquarie.

[Benjamin A. Schachter:]

A few questions. Mark, a couple of your competitors, King and Supercell specifically, seem to be executing much better than others in terms of their ability to cross promote and drive network effects. What is that they're doing so well? And why haven't you and the others been able to replicate it? And then, David, for our modeling purposes, can you clarify some of the comments around timing of $100 million in annualized gross savings and help us translate that into a more specific guidance number for total non-GAAP OpEx for 2015? And then finally, are you currently investing anything in games for any of the upcoming virtual reality platforms?

[Mark Pincus:]

Sure. So I'll take the first part on how we're doing -- benchmarked against competitors like King and Supercell on cross promotion. I think there's 2 advantages that they're both benefiting from in the market, and one is they have some of the leading games that have very deep engagement with players. And you saw this with us when we were in that position on the web that when you have a deeply engaged player base, it makes it easier to cross promote more properties. And then the second is, in both cases, they are cross promoting very similar kinds of games, but when we see them cross promote similar kinds of games that have the appeal to the same audience, we see very positive pickup. I'll point out that we've seen in both cases and especially with King when they've tried to cross promote to games that were significantly different, we didn't see that kind of pickup for them. We're after those same kinds of network effects with our audience. We've seen similar kinds of success in Slots where we've managed to launch new titles in late last year. And as I said, we have another one -- we launched Wizard of Oz late last year on top of Hit it Rich!, and we have another one come out this year. When you build a deeply engaged audience and they want more games in a certain category, that can be very effective in cross promotion. And so we've done that there, and we're hoping to do that in these new categories like Action Strategy. And David, second question.

[David J. Lee:]

Yes. With regard to how to think about the year, well, first, I acknowledge the difficulty in modeling it. We've continued in our approach to focus on being able to invest for the mid and long term and ensure we have the best quality. And that's why just as with the last call a point estimate on annual guidance is not being provided today. That said, what I can point to you, too, to help in your model is that the $45 million of what we called reduction in force annualized benefit, we talked about being complete by the end of Q4. So as you model '15 and '16, you can imagine that, that is fully executed and beginning to flow through your P&L by the end of Q4. We've also said that the $55 million or $50 million to $55 million or so of non-headcount related benefit on an annualized basis should be complete by the end of Q3 of 2016, which you can then flow into your model as well. And with that, I think that's all that we've disclosed to help you model our performance for the year. We have not disclosed any significant investment in virtual reality as an area of strategic focus. In fact, we're actually much more trying to convey the fact that we have a very tight, effective focus on what we are considering our best opportunities in free-to-play social mobile gaming, and that's all we said.

[Operator:]

There are no further questions at this time.

[Melissa Fisher:]

Great. Well, thank you, everyone, for joining our Q1 2015 earnings call.

[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.