Zynga Inc.
Q3 2015 Earnings Call Transcript

Published: 4 Nov 2015

[Operator:]

Good day, ladies and gentlemen. And welcome to the Zynga Third Quarter 2015 Results Conference Call. At this time, all participants are in a listen-only mode. Later we open up to question-and-answer session, and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to hand the meeting over to Melissa Fisher, Vice President, FP&A, Investor Relations and Treasury. Please go ahead.

[Melissa B. Fisher:]

Thank you, Karen. And welcome to Zynga's Third Quarter Earnings Call. As most of you will have seen, we published our quarterly earnings letter on our Investor website, so we can increase the time you have with Mark Pincus, our Chief Executive Officer and Chairman, and David Lee, our Chief Financial Officer to answer questions. Shortly we will open it up for live questions and just first as appropriate with questions submitted to me in advance. During the course of today's call we will make forward-looking statements related to, among other things, our business plan, strategy and expectation for future performance, including our guidance for Q4, and expectations relating to our cost reduction plan, and our plans for our game slate and launches in the 2015 and 2016. Actual results may differ materially from the results predicted. Factors that could cause or contribute to such differences are detailed in our press release, quarterly earnings letter and under the caption Risk Factors 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, and when filed our 10-Q 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. Operator, we're ready for our first question.

[Operator:]

Thank you. Our first question comes from the line of Eric Sheridan from UBS.

[Eric J. Sheridan:]

Thanks for taking the question. I appreciate all the color in the shareholder letter. Just in terms of some of the things you wrote in there with respect to Empires & Allies and Dawn of Titans, I want to understand maybe a little more granularity on what you've learned from Empires & Allies as it's been out sort of as a live game on a global basis, and what some of those learnings might be that sort of prompted you to look at Dawn of Titans, pushing it out into 2016. Thanks.

[Mark Jonathan Pincus:]

Sure. Thanks, Eric. Mark, I'll take that. So, I think there's three important points to take away from Empires & Allies launch, both what happened in that launch and as it relates to our thinking about our slate and launch timing in the future. So first, there are some specific lessons in the launch of Empires & Allies. If we could turn the clock back on that, seeing what we've seen since launch, we would delay that launch. We realized two things that we've learned subsequently. The first is the value of getting it right at launch. And that's the whole point of the soft launch period. That gives us the time to – with real player feedback – work on the roadmap of the game and see real metrics for how we're doing. The second is, we specifically saw, post-launch, the power of the social features that we brought to our players and unfortunately, those features came post-launch, and they came a while post-launch. But, they generated real excitement and heat with our players and features like Leagues and Alliance War, and even, in the last week or so, introducing War Factory, all features that led to more social play and enhanced the elder game. All moved engagement, moved monetization, excitement. But the getting it right at launch is key, because you have what a lot of us in the game industry call the golden cohort, the really excited fans who are there initially at launch. And you want to keep them engaged. And so you don't want to bring out those features too much later. This is also – you know these instincts have been verified a bunch of different ways. One of which is, the number one piece of feedback we've gotten from our players in Empires & Allies is that they wish that there was more social. And for them, that means – they ask us – they wish that it was easier to find their friends and find community and join alliances. So that's the first lesson. And the second is that specifically, we saw that the value in our forward slate of investing in social features and deeper elder game functionality can drive long-term retention in the game. And we saw that both in the metrics post-launch in Empires & Allies, but we also have seen that in the player feedback on both of these games, CSR2 and Dawn of Titans. The third point, as it relates to metrics, and we have some other questions on this as well, that I'm going to hit now, that came in through our website, are – and we referenced this in the letter – that we see a significant opportunity to move the day 30 and beyond retention of these games through further investment in these features. And where we are as a mobile game industry, that is the difference between moving your player LTV, which moves your ability to buy an audience through advertising at scale, which moves your ability to grow that game into a franchise over a long period of time. And so, for all three of those reasons, we looked at the economics of these games and realized that their four business plans are much more valuable with further investment than we thought they were going to be if we brought them out this year.

[Melissa B. Fisher:]

Operator, we're ready for our next question.

[Operator:]

Thank you. Our next question comes from the line of Brian Pitz from Jefferies.

[Brian J. Pitz:]

Thanks. On Dawn of Titans, you mentioned that 200 basis point improvement in player retention can turn that game into a breakout hit. Hoping you can point us to the specific types of investments you're making to drive this? And just separately on the advertising business, which continues to show nice progress, curious if you can help us understand the core drivers there and maybe help us think about your strategy to monetize the large audience of free players. I know you introduced SponsoredPLAY ad product recently, but how does that fit into the strategy as well? Thanks.

[Mark Jonathan Pincus:]

Sure. So your first question is on what are the specific investments that we're making on Dawn of Titans. And as I said, we see clear opportunities to deliver more social features and functions at launch. I mean you think that when you realize that in Dawn of Titans, already there is some level of elder players, and they go on the line chat service to find each other and talk to each other. We think more specifically social features, some of which again we've seen the value of an Empires & Allies like matchmaking, so that you're doing a better job of both appropriately setting people up on the PvP fighting with the right level of player, and then surfacing and helping them find alliances, which we've seen significantly moves all metrics when players are involved in the alliances. And then – that's the social side – and the second part of it, I think we've learned inside our company and in the industry, you can never invest too much in the elder game play, and we are constantly seeing that by enabling deeper and more varied elder game play we can retain players and payers much longer. And on your second question on the ad business, I'll let David answer that.

[David J. Lee:]

Thanks for the question. It's true that our ad bookings have shown significant growth, both on a year-on-year basis, up 39%, and sequentially 17%. There're really three drivers, two of which are associated with the great team we have here. An example would be the fact that the majority of our U.S. mobile network ad bookings are now driven through real-time bidding channels, which has improved our rates of being able to create value for advertisers. Another key point is the way in which we partner strategically with key networks, continues to be a source of improvement in growth. But the third is something that we've seen, which is the value of our mobile audience has been a great tailwind for our business and something that's driven a lot of the performance we see. We believe we can do it, as you mentioned, through in-game authentic sponsored play that doesn't compromise engagement for the player. And we have stated, and I believe this is a continued area of opportunity and growth over time.

[Melissa B. Fisher:]

Great. I'd like to read a submitted question now. Please comment on the M&A environment. Inevitably the worlds of console gaming will overlap with mobile gaming when hardware-software connectivity allow it to happen. It seems that console gamers would be natural acquirers of mobile gaming companies like today's deal. Please outline what strategic benefits a mobile gamer provides for a console gamer?

[Mark Jonathan Pincus:]

Okay. So I'll answer that. I think – I'm guessing that that question relates to the news on Activision and King. I'm not going to comment on the strategy of console game developers, but I will comment on what our strategy has been and is going forward to grow in mobile and how I think that relates to the broader industry and maybe M&A. So what we've been reporting back to you on these calls over time consistently is that we're in the middle of a multiyear investment in creating what we believe can be both a leader in mobile games for social gaming and casual. And also we're putting – the purpose of this investment is to enable the conditions for a long-term growing company. And we think that there's three factors that any company needs to do to be in that position. First, it's to focus on a broad player network. Second, it's participation across multiple categories and genres. And third, it's developing leading mobile franchises. And we've built out a position in social casino where we're number one in Poker, and number two in Slots, and we already have this leadership position in casual with Words with Friends. And most recently, we've entered the action strategy category with Empires & Allies, and obviously made a large commitment with our acquisition of NaturalMotion. And finally, we hope to and plan to reenter the invest-express category. So we've made the commitments to what we believe are the four most valuable categories. So we've made this commitment to being a multi-category player, and we believe that we're positioned to have the leading category leaders in each of those, which sets us up for the future. And I think that that is in part what you're seeing with Activision and King, where, in one fell swoop with King, Activision both entered a leadership position in mobile, they got into casual, Asia, and a female audience. Next question.

[Melissa B. Fisher:]

Operator, next question.

[Operator:]

Thank you. Our next question comes from the line of Mike Hickey from Benchmark.

[Michael Hickey:]

Hey guys. Great quarter, and thanks for taking my questions. I have two. The first one on your share repurchase plan, obviously a nice development here. Cash is seemingly been a strategic asset for you historically as you've navigated your turnaround. So I guess I'm kind of curious, why now you determined is the right time to initiate a repurchase plan? And while the $200 million is, in my view, a material cash allocation, curious if you can help us gauge your real intent to use it, as it's hard to see your valuation getting much lower here? Thank you.

[Mark Jonathan Pincus:]

Sure. So I'll answer the first part, and then I'll let David answer more specifically. So, as I said, we're in the middle of this multiyear investment strategy to build this multi-category leader in mobile. And really, when you get down to it, I think that the current financial state of our company, in terms of our operating metrics, so where we are with profitability and growth, don't yet reflect what we think will be the potential of these investments. And one example is the NaturalMotion games that we're now planning to launch next year, that we are big believers in. So we think that this is a good time for us to repurchase some of our shares. And I'll also add, given the cost reduction program that we put in place, we've been in a position to both fund our live operations, and also our investments in new, to enter these new categories without needing large capital reserves. David?

[David J. Lee:]

Yeah. I appreciate the question, Mike. Really, this program underscores – as Mark just outlined, it underscores the confidence we have in our long-term potential. And while we're certainly going to leverage market conditions, share price and other factors to determine the timing of how we consummate it, we intend to pursue this, as we think it's in the long-term interests of our shareholders.

[Michael Hickey:]

Thank you.

[Melissa B. Fisher:]

Karen, next question.

[Operator:]

Thank you. And our next question comes from the line of Douglas Anmuth from JPMorgan.

[Unknown Speaker:]

Hi. This is (17

[David J. Lee:]

Great. Let me take that question. This is David Lee. Let me take the second first. We are very pleased with the progress we've made against our cost savings program. I think as you noted in the quarter, our non-GAAP OpEx declined 9% sequentially, in part through that program. And while we believe in it, we believe in it not just for the P&L benefit, we believe in it strategically, to allow us to invest in our future growth. With regard to E&A, we've noted in the past that E&A has had great monetization and strength in certain markets. I think on our last call I specifically called out strength in South Korea as an example. While we have learned many things, as Mark has pointed out, about how we could have tuned and optimized that launch, we are continuing to invest in it with many of the features that he's outlined for its future. And that hasn't changed since our last call.

[Melissa B. Fisher:]

Thanks. Karen, next question.

[Operator:]

Thank you. Our next question comes from the line of Dean Prissman from Morgan Stanley.

[Unknown Speaker:]

Hi. This is actually John (18

[Mark Jonathan Pincus:]

Sure. So we have benefited as we've built our footprint in Slots and built our player network, and I mentioned on the last couple of calls that we've been able to successfully cross promote – both cross promote new games into that audience because they have a desire to play more multiple types of Slot games. And so both we've been able to vary the brands and IP where we've delivered that in an authentic way in line with those brands and also the kinds of styles of game play. We added the acquisition of Rising Tide. I'll just add in addition to what you mentioned that they also recently have launched Black Diamond Casino in Q3. And what we've seen is our team has been effective both at cross promoting these games to the audience and at bringing a lot of the technology for testing and optimization and the insights from one game to another. And so we – I think the team was – our Slots team was very excited to partner with the team at Rising Tide which included Maytal who had been a leader here previously. We're excited to see her come back to the fold. But they were excited to partner and be able to help that game in its launch, both with the cross promotion and the key insights that they could bring to engagement and monetization. And then we also have been investing in our poker game where we've been throughout the year investing in the quality and we hope and expect to bring that game, both from an audience and revenue standpoint, back to clear growth next year.

[Melissa B. Fisher:]

Karen, next question?

[Operator:]

Thank you. Our next question comes from the line of Chris Merwin from Barclays.

[David J. Lee:]

Hi. This is David Lee speaking on behalf of Chris. Thanks for taking my question. I just had a question on revenue mix between your different franchises. I noticed that Farmville 2 revenue started growing again in the quarter to $32 million from $29 million in the previous quarter, while Farmville 2

[David J. Lee:]

This is David Lee. Listen, the Q3 performance broadly that we saw that beat our expectations was really driven by great execution in live game select Farmville 2, the one that you're asking about. It's impressive. The team with the business that is on the web and mature, and importantly, as we disclosed with a dramatic move in location to India, successfully continued to push that game forward. I think it's a compliment to the team, their execution, their focus on the right features that delight our customers, even in a game that is not young. With regard to the second question on Country Escape, you know we believe in our Farmville franchise. We've talked about this. But we've also acknowledged that we are still working through the right way to payoff and delight our customers in that franchise. And that continues to be an area of focus, but one that we're not satisfied with.

[Mark Jonathan Pincus:]

David, what was your second question?

[David J. Lee:]

Very impressive...

[Operator:]

Your line is open again.

[Mark Jonathan Pincus:]

Hello.

[David J. Lee:]

Hi. Can you guys hear me?

[Mark Jonathan Pincus:]

We can hear you.

[Melissa B. Fisher:]

Yeah, we can hear you.

[David J. Lee:]

Oh. Great. Yeah, so the second question is around ABPU growth. It seems to have accelerated nicely, up 27% year-over-year and up 10% sequentially. I was just wondering how much of that growth in ABPU is coming from having a full quarter of higher monetizing Empires & Allies versus improvements in ad revenues and mix shift toward slots. Thanks.

[Mark Jonathan Pincus:]

Well, I mean, David, as you know, I talked before. It's important. This ABPU measure is a good indicator of how we engage our customers. But it's reported bookings per DAU. So it includes a lot of the growth that we've seen in our advertising business that we've talked about associated with Words With Friends. But also along with that what you note, which is the mix of our portfolio as we continue to grow in higher monetizing genres and categories like action strategy and like slots drives a higher rate of overall company ABPU, which continues to be the driver this quarter as it was last.

[Melissa B. Fisher:]

Karen, next question.

[David J. Lee:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Justin Post from Merrill Lynch.

[Justin Post:]

Thank you. David, maybe you could talk a little bit about the CFO change, why the change? Where head count is now? Is there room for further cost cuts as you go into next year? And then if you could let us know what percent of the ad revenues are on mobile? Thank you.

[David J. Lee:]

Great. So that's three questions there. The last one let's cover first. You know we continue to be very prudent in managing our staffing levels, and our head count in the quarter tracked to us being in line with our cost reduction program. As you recall, when we launched the cost reduction program, we talked about it being consummated by the end of Q4 with regard to labor and actually, by the end of Q3 of next fiscal year with regard to non-labor, and so we are still on track, but implementing it. With regard to me and the CFO change, I believe Zynga is in a much stronger position today than when I started a little under two years ago. In partnership with Mark, when he returned, we really focused on three key initiatives. We focused on funding our future with $100 million cost reduction program. And we did it, secondly, to make sure we could make the move to mobile, which you're continuing to see progress on each quarter. The third is what we've most recently announced, which is, we believe in our long-term future, and that is proved by the $200 million share buyback program that we put in place. I'm heads down focused on seamlessly transitioning to Michelle Quejado, our Chief Accounting Officer and our Interim CFO. She is a very capable finance executive, and I'm proud to have her on the team. And so I think we're in good position for future growth.

[Justin Post:]

And then ad revenue, what percent of that was on mobile?

[David J. Lee:]

While we do disclose our overall ad and other bookings on a percent basis, so you know that in the quarter for example it's 26%, last year it was 18% and the previous quarter it was 22%, I don't know that we've actually disclosed in the past what portion of that is on mobile. You can take from our color commentary, however, that a large portion of the increased rates of monetization we've seen has been driven by very attractive audience that you see us delivering now in mobile, but I haven't disclosed in the past the specific number.

[Justin Post:]

Thank you.

[Melissa B. Fisher:]

Next question, Karen.

[Operator:]

Thank you. Our next question comes from the line of Sean McGowan from Oppenheimer & Company.

[Sean P. McGowan:]

Thank you and best wishes, David, in the future. A couple of questions on the shift of these two NaturalMotion titles; can you give us some sense of how far into 2016 the movement is going to be? And secondly, what are you doing in those markets where those games are currently available? What changes are you making? How quickly you're making those changes? Thank you.

[David J. Lee:]

So with regard to the shifts that we've discussed – this is David Lee – underlying the shifts in the slate is really our commitment to the long term growth we see in both those games. We have not provided 2016 guidance, in part because we sought to avoid being falsely precise, and we want to be transparent about our commitment and belief in the games. So at this point, we are not specifying a specific date for either game. With regard to your second question; some of the color commentary that we've seen in what we call geo-lock for CSR2 and Dawn of Titans is in the shareholder letter that we moved to as a format last quarter. For example, highlighting that, we've seen CSR2 seven territories and so far, pretty strong 4.6 quality ratings in the app stores associated with them, and had good monetization, and particularly for Dawn of Titans, because we're now in 11 territories with a good 4.5 quality rating. So we're making progress with both as we move into more territories. But I think that's all the color we provided today.

[Sean P. McGowan:]

Thank you.

[Melissa B. Fisher:]

I'm going to read another submitted question. This is probably for David. You acquired your building for $200 million in 2012. Clearly that has appreciated strongly since. Would you consider a sale lease back transaction at this point? What is the approximate market value of the building?

[David J. Lee:]

Well, we very much appreciate the decision that I inherited, candidly, from Mark. I mean, purchasing the building was a very smart investment decision. But we're not real estate investors, and while we've seen the value of the asset appreciate, we treat it the way we treat any important asset of the company, which is every period, every quarter, we evaluate what is the best way to manage it. I would note that in other income, we see the benefit of the market rates subleasing that we enjoy, as we do not occupy the entirety of the building. And we have not announced a process to sell the building, nor have we declared a value today. But it is a very important asset that's appreciated, and one that we carefully monitor every period.

[Melissa B. Fisher:]

Thanks, Karen. Next question?

[Operator:]

Thank you. Our next question from the phones comes from Ben Schachter from Macquarie. Ben Schachter - Macquarie Capital (USA), Inc. Mark, can you talk about how marketing mobile games has evolved over time and maybe some of the recent trends around marketing costs? And then David, just a couple of modeling questions, right now you have less than 1 million paying users in the quarter. When do you think we're going to see the bottom for that metric? And when do you think we should expect that to grow? I should say, what do you think is the bottom for that metric and when do you think it'll grow? And then the same question, Web bookings, they're down to $55 million in the quarter. How low is that going to get? Thanks.

[Mark Jonathan Pincus:]

Sure. I'll answer the first part. So in terms of the trends in mobile game marketing, first of all, the big shift for us in the social gaming industry was from Web to mobile where on Web there were much more significant free channels for marketing where players had more channels available to them to communicate with each other and to share games and share within games. And so that led to greater levels of what I would think of as highly casual players in games and larger audiences in general for games. Mobile has been terrific from a monetization standpoint. And mobile, the accessibility of mobile has expanded games to many more people. But at the same time, the number one obviously marketing channel for the industry for acquisition is advertising based. And so there is a much greater focus in the industry on the LTVs of paying players that you can get to, and then the associated ability to target and buy those players through advertising based awareness. And we've seen this with our portfolio of proven IP, that what can be a game changer is the level of organic marketing that you get. And we see the power of that both with licensed brands that we have brought into our slots portfolio, and their ability to bring a follower audience that really loves those. We've seen it with Wizard of Oz most recently. We're just launching Princess Bride. But then also with our own portfolio of proven IP where we have fan bases. In our invest/express games, we've had 700 million installs of those games across Web and mobile. And so we see those players finding us again on mobile. And that's also why we're so excited to bring that portfolio of invest/express games to mobile. With NaturalMotion's portfolio of games, we're excited to – that's part of the reason that we're excited for the launch of CSR2 where they've had 150 million installs on mobile, and there's a large fan base that is interested in the next chapter in that game. And then, David, on the second?

[David J. Lee:]

Great. So on the modeling question, what's interesting is if you look at the last four quarters, and by the way, the company has continuously gotten better about refining the deduping process which we've been clear about in our MUU and MUP measures. But even with the most latest accurate methodology; in the last four quarters MUP has fluctuated between 0.9 and 1.0 as you see in our materials. So that's one part of your model. I turn you, though, to the dynamic that Mark has mentioned earlier which is as our games continue to mature and in the cases of Farm 2 show signs of growth in any given week, you're seeing players persist with the game who in some cases have higher rates of investment in the game, given how engaged they are. It is a factor in how we see this trend in monetization, which is what we call ABPU. And I'll just note the question that David Lee at Barclays – great name, by the way, asked with regard to Farm 2 Web, that's an example of how you should model it. In terms of Web bookings, we did not disclose as we did in Q1 and in Q2 that we aggressively shut down additional games, and that's important. So as you build your model while I haven't given you guidance that breaks out Web versus mobile, you now have a set of live games that in the last quarter we chose not to aggressively shut down, and you have some trend data that can help you on monetization. Unfortunately, we haven't given you much more in terms of breakout between Web and mobile, but that's where I'd start.

[Melissa B. Fisher:]

Any other questions, Karen?

[Operator:]

I currently see no additional questions from the phone lines.

[Melissa B. Fisher:]

Great. Thanks everyone for joining us today. We appreciate your interest in Zynga, and we look forward to speaking with you again soon.

[Operator:]

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.