Zynga Inc.
Q2 2015 Earnings Call Transcript

Published: 7 Aug 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to Zynga's Second Quarter 2015 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference call may be recorded. At this time, I would like to hand the conference over to Ms. Melissa Fisher, Vice President, Investor Relations, FP&A and Treasury. Ma'am, you may begin.

[Melissa B. Fisher:]

Thank you. As most of you will have seen, we published a quarterly earnings letter on our investor website so that we can increase the time made available to you for Mark Pincus, our Chief Executive Officer and Chairman; and David Lee, our Chief Financial Officer, to answer questions. Mark will provide brief comments, and then we will open it up for live questions, interspersed as appropriate with questions submitted to me in advance. We will answer as many questions as possible. During the course of today's call, we will make forward-looking statements related to, among other things, our business plan, strategy and expectations for future performance including our guidance for Q3 and expectations relating to our cost reduction plan 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 quarterly earnings letter, in our Form 10-Q and 10-K, and elsewhere in our SEC filings. We will also discuss non-GAAP financial measures. Our press release and the investor presentation on our website include reconciliation of GAAP and non-GAAP financial measures. 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 Jonathan Pincus:]

Thanks, Melissa. Thanks everybody for joining us today. Since our last earnings call, our teams have been executing well, and we had a great quarter. Our results exceeded our expectations, and we continue to increase our mix of mobile. We launched Empires & Allies and FarmVille

[Melissa B. Fisher:]

Great. Saied, we're ready for our first live question.

[Operator:]

Thank you. The first question comes from Eric Sheridan from UBS. Your line's open. Please go ahead.

[Eric J. Sheridan:]

Thanks for taking the questions; I just got two quick ones. One on Words With Friends, in the commentary what you said there was that you saw declines in audience, but the teams were addressing it in number of ways. Maybe we get a little bit more color on what the teams are doing to pivot sort of audience metrics around Words With Friends going forward. And then maybe one for David on cost, the commentary called out the fact that some of the costs will continue as a group (3

[David J. Lee:]

Thanks, Eric. This is David Lee. Why don't I start with your last question first, as it's relatively straightforward, and then we'll cover the audience question on Words. With regard to our cost reduction, as you saw in our letter, the phasing of the $100 million of annualized cost reduction remains on track; which means, consistent with our last quarterly release, we believe we will complete the labor-related portion of that $100 million of annualized cost savings by the end of Q4 of this fiscal year, and complete the non-labor-related portion on track by the end of Q3 of next year. So there isn't any new news, we're on track and we're continuing to proceed. With regard to your question on Words With Friends and audience, broadly let me just take a minute and frame this audience piece. Year-on-year our MAU declined as expected, primarily driven by the games we're sunsetting, as well as the continued decline of our Web business. The portion relating to Words With Friends is really a sequential change quarter-on-quarter, and the team is already addressing it. We did see some competitive pressure in the quarter that resulted in the decline, but the team is already taking on the task by localizing in international markets as we disclose, which will bring new audience to the game. And I want to note that the fundamental game itself remains healthy with very good metrics. Finally, I'd also turn your attention to the other part of Words With Friends, which is how well we monetize our audience, so that we saw a decline quarter-on-quarter, you also saw us disclose a very significant 44% increase year-on-year in our ad bookings, and a 15% sequentially, all driven by better ad integration, stronger brand advertisement, and frankly, better deals with key partners that we've changed. So there's a very healthy story with regard to how we're monetizing our audience.

[Eric J. Sheridan:]

Great. Thank you very much.

[Melissa B. Fisher:]

Next question...

[Operator:]

Thank you. Our next question comes from Brian Pitz from Jefferies. Your line is open. Please go ahead.

[Tim O'shea:]

Yes. Hi. Tim O'shea for Brian Pitz. Thank you for taking my question. So Slots seems to be working very well for you guys, just looking at that 32% sequential improvement; is there anything specific you can call out, which might have driven such a large sequential impact? And are the increases coming from adding new users or increased monetization of existing users? Any update would be appreciated. And then just secondly, quick, on that restructuring charge, I guess, you previously expected that the pre-tax charge of about $80 million to $90 million. Now you expect restructuring expenses around $22 million to $32 million; it's a pretty big difference. I think you mentioned the lower cost of terminating contracts. Just wondering if there's a specific contract you can point to as driving the bulk of that change. Thanks.

[David J. Lee:]

Two great questions. Again, I'll take the second first. We are not calling out specific contracts that have reduced our expected restructuring charges, but I call your attention to what we did previously disclose. A number of the cost reductions outside labor relate to, for example, large infrastructure plays are moved to the cloud as we move out of our owned data farms. So you can understand that, over time as we negotiate better terms for those remaining assets, you'll see improvement, which we're driving towards, in how we take as restructuring. With regard to your question on Slots, you're right, it was a very strong quarter for that franchise, up 32% quarter-on-quarter, but importantly up 274% year-on-year. Slots is a great example of not just managing existing live games, like our Hit it Rich! Slots game, but as well, more recent entries as we've seen great growth from Wizard of Oz Slots, which drove a large portion of the sequential increase. I also think it's a great example of what Mark is driving as he's returned. Why don't I turn it to him?

[Mark Jonathan Pincus:]

Sure. Well, I mentioned on the call last quarter that, the approach that we've taken in Slots is to back a proven team against a clearly valuable category, develop a winning, repeatable engine, and then make a persistent, kind of patient investment over time. And I think the way that story plays out is, that it takes a couple years to create an overnight success. And that's the same approach that we are taking with Action Strategy, where we just launched Empires & Allies, a new category we're seeding with Match 3, with FarmVille

[Melissa B. Fisher:]

Great. Next question, please.

[Operator:]

Thank you. And our next question comes from Chris Merwin from Barclays. Your line is open. Please go ahead.

[Chris Merwin:]

Great. Thank you. So you mentioned – I think you gave some engagement statistics for Dawn of Titans and there was 10 sessions a day versus the 5 sessions a day that you were seeing for Empires versus Allies (sic) [Empires & Allies] (8

[Mark Jonathan Pincus:]

Thank you for the questions. With regard to Dawn of Titans, we've seen very strong monetization as we mentioned. And seeing 10 sessions per user, per day is a great early indicator, but it is early going. This game has been in geo-lock since March of 2015, and we are going to give the game sufficient time, so that when we launch it, as we stated in Q4, it's ready. Turning our attention to DAU specifically, quarter-on-quarter DAU is down 15%. And when you look at the components of it, I want to make note that a very large portion, the largest portion is actually driven by our expected web declines in audience. There was a decline in Words With Friends and Looney, a great game that brought new users to the Zynga franchise, but a game that we have not highlighted as our primary area of investment going forward. You note that, as we've discussed, our actual ad bookings significantly increased despite a reduction in sequential DAU, and really I'd call your attention again to the three factors mentioned, which is great ad integration by a strong performant advertising team, increased brand advertising which has better rates, and then even across all of our network, better partnership with key partners that allow us to increase the rates we're seeing per unit of audience.

[Chris Merwin:]

All right. Thank you.

[Operator:]

Thank you. Our next question comes from Mike Olson from Piper Jaffray. Your line is open. Please go ahead.

[Michael J. Olson:]

Hey, good afternoon. Just a quick one here, how do you think about the trade-off between games with a licensed brand versus those that are wholly-owned IP like this deal for Willy Wonka that you announced or your Wizard of Oz deal? Have you been able to quantify, if adding those known consumer brands is significantly beneficial to engagement, and then fully offsets any rev share that comes along with license deals? And maybe based on answer to that question, should we expect more license deals going forward, and could that be in all genres or would it be more specific to Slots?

[Mark Jonathan Pincus:]

Sure. Mike, I'll answer that. It's Mark. I'd say that, there isn't one answer across the industry, across categories, and you're going to see it vary. So in some categories, like obviously Slots for us, we see a terrific partnership we can have with brands, especially when they can let us replicate the – kind of authentic Slots experience that people have in casinos, which gives a very direct value to our players and to the most valuable players, so that's a great partnership. Obviously, we are always focused on looking at what's going to be the most accretive long-term investment. There's always the trade-off in every category, between whether that brand helps drive more organic growth which – Looney Tunes, while the game hasn't been the level of success we wanted, it did prove that in some casual areas we could see surprising high new-to-network, and new organic installs driven by brand. In some cases like Slots, we see that it can really enhance the value perceived by the players. But it's not – I wouldn't say that, that is our core go-to-market strategy, and there's, as you might imagine, there's lots of interesting IP deals that come up, and there's lots that we are not bidding on or are not the highest bidder on, because we can't always pencil it out, it's not always going to make sense. And then in other areas we're pursuing different strategies. With NaturalMotion games, that's all owned, IP so far. And there the strategy is to leverage stunning movie, cinematic-quality production values that have been proven in the past to drive very high organic word of mouth and App Store promotion. So – and then, there's examples where it'll be an owned IP, but we can drive such high LTVs that we can buy the traffic like the Empires & Allies. And the question on more; kind of answered it, I think it's a part of every game company's mix today, and we're always making the trade-off on the value of bringing new-to-network versus building our own long-term franchise.

[Michael J. Olson:]

All right. Thanks a lot.

[Melissa B. Fisher:]

Great. Now, I would like to read a submitted question. Mark and David, this question was submitted from an individual investor. Will you explain your approach to advertising your games to maximize downloads at launch and beyond? Please explain your communication strategy to create long-lasting brands with strong brand equity. And the context of this question is that we see other competitors advertising on television and elsewhere.

[David J. Lee:]

That's a great question. Our marketing organization really bases these decisions around building brands on the return on investment you need to each game. Zynga has the benefit of having great franchises as Mark has already mentioned that we can leverage. So the decision we make is unique to the title, as well as the long-term value we see in each player, in the genre that we're looking. There's not a one size fits all approach. You've seen us primarily leverage targeted digital forms of marketing, but we are not ideological about what form of advertising or marketing. We're focused on the return that we're driving for the spend that we're making.

[Melissa B. Fisher:]

Great. Operator, we can open the queue back up for questions from our next callers.

[Operator:]

Thank you. Our next question comes from Colin Sebastian, Robert Baird. Your line is open. Please go ahead. Mr. Colin Sebastian, your line is open. Please go ahead. If you have your phone on mute, can you unmute your phone, please?

[Colin A. Sebastian:]

Great. Can you hear me now?

[Operator:]

Yes, sir. Please proceed.

[Colin A. Sebastian:]

Thanks. So first, I've a couple of questions on Empires & Allies. Based on the reviews, Mark and his team did a really nice job on the game, and I was hoping you could provide a bit more color on how you'd expect the game from this point to trend in terms of the user base and monetization. It seems to skew a little more towards core gamers than, say, some of the other games in the Action Strategy category. And then secondly, was just – wanted to get a measure of your confidence in the Q4 release dates for the NaturalMotion games. Thanks.

[David J. Lee:]

Great. Let me take the Empires & Allies question, turn it over to Mark for more color. We clearly are seeing great early signs. You're right; Mark and his team have done a great job. We've highlighted, for example, a very strong level of monetization in bookings per user. And we even highlighted it at being three times the company's overall average. You also saw a top five grossing chart placement in iPad, and this is impressive given that it launched on May 5, and it didn't geo-lock (16

[Mark Jonathan Pincus:]

I don't have much to add on that. We think it's a great game, a great entry from a proven team. We think they're on their way to developing a winning engine, similar to what we saw our Slots team do. And like David said, the team doesn't view the game as complete. There's a lot of exciting social features in the game, yet they still have a great opportunity to unlock those features. And a lot of – what's really great about the game, through going further, Leagues, David mentioned, Alliance vs. Alliance, and a bunch of the now proven social features that we've seen in some other Action Strategy PVP games. And I think the team is optimistic about bringing those to market this year. And I think another way of thinking about where that game is, is if I go into more detail, is that it's done a great job on launch of attracting a valuable audience. That audience seeing value in the game, converting to payers, but they need to bring the elder social competitive features to see those payers continue to stack after they've been in the game for a month, and continue to buy. And so the payers are retaining in the game, but in order to show them continued value to keep spending, we need to bring out these elder social features. And so that is something that makes us optimistic about the game, because we think we've attracted this audience, and we have a bigger opportunity to give them a reason to spend in the game. And then, David, why don't you answer the Q4 release date?

[David J. Lee:]

I think, with regard to our slate guidance, I want to first start with the fact that we've been very careful to acknowledge that we are going to give games the time they need to be ready at launch. And Mark has been clear, even with the great games like Empires & Allies that we are patient, and we're building them out, and we're learning from what we've done in the past. That said, our guidance always reflects our best understanding of where the business is going, not just the slate that we're intending to launch in Q4, but our existing live games. There's always a degree of uncertainty when we launch new live features or intend to launch new games, but our guidance reflects, as it always has, our best understanding of the business.

[Colin A. Sebastian:]

Thank you.

[David J. Lee:]

Thank you.

[Operator:]

Thank you. Our next question...

[Melissa B. Fisher:]

Wait. Next question, please.

[Operator:]

Our next question comes from Dean Prissman from Morgan Stanley. Your line is open. Please go ahead.

[Dean J. Prissman:]

Hey, guys. Thanks for taking the question. So a number of companies this quarter have called out pricing issues with their display ad businesses. Clearly your numbers suggest otherwise, and I recognize the use case is unique, but I was wondering if you could comment on your level of comfort with the sustainability of pricing going forward. Thank you.

[David J. Lee:]

Interesting question. We have not disclosed any headwinds with regard to our ability to monetize our audience, and in fact I think you've now heard not just on this last release, but at least in the last three to four, a pretty persistent trend. Not just on how we monetize our audience through advertising, again in the three area of ad integration, how much we do with brands and who we partner with, but you've also seen us show positive trend in how broadly we're monetizing, period, with our conversion continuing to show a great rate. So I – it's an interesting question, I can't point to any evidence or any disclosure we've done to suggest that there's a headwind in this area.

[Dean J. Prissman:]

Got it. And then maybe one follow-up; I'm guessing you don't have this handy, but you've done the analysis internally. If you were to completely remove the costs of maintaining your web business and looked at the underlying EBITDA margin of your mobile business, any color you can share on what the current margin profile is?

[David J. Lee:]

We actually do that analysis extensively. We do it actually game-by-game, so what I could point you to is, in previous disclosures we've been clear that we see no structural reason why great high-performing games in mobile would have less EBITDA or profitability than in web. We've also pointed to our social casino businesses on mobile already with very strong monetization, our Slots and our Poker business, and as we enter Empires & Allies, we've been clear, almost three times level of bookings per DAU that we've seen. So if I point you to those disclosures it should indicate that there is no meaningful reason why we can't be as profitable or even more profitable on mobile as we have been on the web.

[Dean J. Prissman:]

Great. Thanks, David.

[Melissa B. Fisher:]

Next question, operator.

[Operator:]

Thank you. Our next question comes from Ben Schachter from Macquarie. Your line is open, please go ahead. Ben Schachter - Macquarie Capital (USA), Inc. Yeah, a few questions for Mark, and then a quick one for David. Mark, China is starting to generate some real revenue for some of your competitors, and Apple is highlighting the China App Store sales there, do you see that as a potential market for you guys any time in near or even longer-term? And then, just on the – on the movement around the top games, we see so many of the same games in the top 20 of the top grossing charts over the past year or really the year two, how do you think that's going to evolve over time? And then finally, VR a hot topic, anything to watch for there from you guys? And then a last one for David, there's lot of cash on the balance sheet, any chance we'll be seeing any of that coming back to shareholders through buybacks or special dividend? Thanks.

[Mark Jonathan Pincus:]

Okay. Four questions. I'll take the first three, and David can take the fourth, and David can add on the first if he wants. So first question was on; what's the potential that we see in the China market. And obviously Asia is huge in mobile gaming, and even in casual social gaming and Japan and China within that are particularly large and then South Korea. And we see a growing mix in some of our games, especially like in Empires & Allies coming from Asia. So it's of growing interest and importance to us, at the same time, when you look at both our opportunity and which games have made a successful entrée into Asia, our current strategy is to stick to our knitting and focus on building out our games and valuable audiences in the West, and build those games and brands up before making a big commitment in any of the games in Asia. Having said that, our game mix is by bringing on more action strategy and more games that are in bigger, more popular categories in Asia, it's of growing interest to us, and so it's coming up on the radar, but we still see that, we don't want to spread ourselves too thin. And the other lesson that goes with that, and the reason why I think you have to be careful is, it does look like the games that have done well in China have made a big commitment to a very localized version of their game that has a better chance in the market. Your second question on the change in the top games on the charts and evolution; I don't know that I have any more insight into evolution than you do, other than to say, if you look at the strategy that we've pursued that I think is working in Slots, we are steadily coming up the charts. And we're over time collecting a range of brands and engines that are – they're getting a bigger and bigger footprint in the category, and we are taking the same approach in Action Strategy, and we expect soon and best express where we want to be a bigger factor in mobile. And we're going to compete and we're going to continue to invest in differentiating our products based on being more mass-market accessible, more social, and we've got to innovate on those experiences to win over hearts and minds. And third question, VR. I'm personally very interested in it. I love it, I think it's cool. I would love to do more in it. And I think, at the point that there is a mass market, I think it will open up interesting opportunities, especially in social gaming. But again, for us today, with keeping a narrow focus, it's not an area that we can invest a lot in. And I'll turn over to David on the capital, the cash.

[David J. Lee:]

With regard to your question on capital allocation, as you've heard me say before, we do very regularly evaluate how to best build our long-term shareholder value. And we look at all forms of use of capital. I want to make note, however, that we're really focused on investing in our business and growing at an accretive way, our value to customers, and as a result, our shareholder value. And that shows up in our Q2 performance, as disclosed as well as in our Q3 guidance. Notably in Q2, we delivered the level of EBITDA and cash flow despite investing tens of millions of dollars in the quarter for a bright future that we believe we can build. And we're also reflecting that in the guidance we've provided for the next quarter. And that's our area of focus.

[Melissa B. Fisher:]

Great. Next question, operator.

[Operator:]

Thank you. Our next question comes from Mike Hickey from The Benchmark Co. Your line is open. Please go ahead.

[Mike Hickey:]

Hey, guys. Good afternoon, thanks for taking my questions. Just curious – there's been some ongoing market noise as it relates to maybe attempts of taking Zynga private. So I'm sort of curious, your view today on going private versus staying public. And obviously, Mark, you've made some changes internally, but perhaps, what other changes you would want to make besides cutting costs to driving innovation. And I have a follow-up, thanks.

[David J. Lee:]

Thank you for the question. With regarding going private, look, we don't comment on rumors and speculation in the market. We're very focused on making the right decisions to create shareholder value, and I think you've heard, even in the last – answer on the last question that, our area of focus is about investing in the growth in a deliberate, disciplined way. I'll turn it over to Mark with the regard to his experience in the last few months.

[Mark Jonathan Pincus:]

Sure. First, I just want to echo what David said. We're not spending our time – the majority of our time thinking about financial engineering as a way to deliver more shareholder value. We think, like David said, that the way that we're going to deliver value is by building great products, which happens over time, which happens from great proven teams, which happens from building winning engines, from differentiating our approach to the market, all that. And so that gets me back to your second part of your question, which is, what have I been doing – what am I focused on doing here to drive that innovation. And what I said to everybody about 100 days ago when I got here, that I wanted to bring us back to and intensify our focus on, number one, our core vision of social gaming, and I fundamentally, even though all of this looks like one sector and one business of gaming to the outside world, it doesn't to me. So to me, I believe that social gaming within that is a different product, and somewhat different business opportunity. And I think one thing that we pioneered on the Web is introducing gaming to a busy mass-market adults, hopefully like all of you on the phone. And we found that, that was a blue ocean opportunity, and it was a great growth opportunity for us and for our industry. And so, I want us to get back to focusing on that market, on you guys and gals, and on innovating, in a different area, innovating on how make those games more accessible to you and more social. The second pillar that I came back to focus on is, an approach to the market that's player-centric and data-driven, that we're investing deeply in industry-leading data and analytics, and integrating a metrics driven approach to the way that we develop and hopefully delivering on the promise that 80% of our engineering days should go towards something that our players will thank us for, that are delivering clear obvious quality for our players. And I believe that by leveraging metrics, we can do a better job of making sure that we're building things that players want before we make huge investments of engineering days. And the third pillar that I mentioned is getting back to our founding values and culture around empowered entrepreneurs, and I hate to throw out jargon, what I really mean is that, we have an amazing talent and ability across our company, and a lot of what we need to do as a leadership team is, is make the opportunity available to these creative terrific people to go and innovate. And we've seen a lot of examples, even in the last couple of months. You know, we mentioned Mountain Goat Mountain effort from a five or six person team that post the call, got great acclaim, and was high in the App Store and got a lot of five star reviews. And we're proud of that, not because it moved our business, but because it proved the level of entrepreneuring and creativity and innovation. And I think it's those kind of breakthroughs that are going to move the company.

[Melissa B. Fisher:]

Great. Operator, I'm going to now read a submitted question. Mark and David, the game Empires & Allies appear to have some success in Asia, especially South Korea. What percentage of the games revenue came from Asian countries, and in terms of monetization, what did you learn from E&A?

[David J. Lee:]

Well, thanks for the question. It's parallel – it's a bit of the question that was asked regarding Asian markets probably, that Mark already answered. Empires & Allies in Action Strategy is relevant globally as noted in the question. We have seen, as observed, great success, particularly in markets such as South Korea where, the popularity of where it's placed in the charts seems to have a halo effect to the performant nature of the game. That being said, we don't break our percent geographic revenue with bookings by game. We do know in the investor materials, overall the company's performance outside the U.S., but at this point we're not being specific on Empires & Allies.

[Melissa B. Fisher:]

Great, thanks. Let's go back to the live queue.

[Operator:]

Thank you. Our next question comes from Justin Post from Merrill Lynch. Your line is open. Please go ahead.

[Justin Post:]

Great. I apologize if you already said this, but can you give us any help with the size of the daily users or monthly users of Empires & Allies and Harvest Swap, and could those make a difference in 3Q when we start looking at those metrics? Thank you.

[David J. Lee:]

Great. Let me take that question. We haven't been specific on the size of audience with regard to those games. And as you asked the question about our guidance for Q3, as I stated before, our guidance for Q3 does reflect what we know at this point, and does include the continued performance of the games we've launched in the previous quarter. But with anything that is new, be it a new event for an existing live game or a recently launched product, there are degrees of uncertainty on the performance. We haven't broken out in guidance specifically Harvest Swap and Empires & Allies, but as we've said, we think both games show a great promise.

[Justin Post:]

Thank you.

[Melissa B. Fisher:]

Great. Next question.

[Operator:]

I'm showing no one in the queue at this time, ma'am.

[Melissa B. Fisher:]

Great. Well, thank you everyone for joining us. We appreciate your interest in Zynga, and we look forward to speaking with you next quarter.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect, and have a wonderful day.