Zynga reported record revenue and bookings in the first quarter ended March 31 as more people turned to social mobile games while isolated because of the pandemic. But payouts to acquired companies that are producing these hit games have hurt the bottom line.
While the increase in mobile gameplay due to the pandemic was good for the company in the last two weeks of the quarter, Zynga didn’t have any particular big hits that launched during the quarter.
But in terms of costs, the payouts to Small Giant Games and Gram Games led to a larger than expected loss. The problem is that, because of accounting rules, Zynga can’t recognize the revenue for the acquired companies as quickly as it is required to recognize the expenses.
Revenue was $404 million in Q1, up 52% from a year ago, while bookings were $425 million, up 18%, thanks to good results from Empires & Puzzles, Merge Magic, and Merge Dragons — games that San Francisco-based Zynga acquired in acquisitions. The company reported a GAAP net loss of 11 cents a share, or $103.9 million, compared to a loss of 14 cents a share, or $128.8 million in the first quarter of 2019.
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On a GAAP basis, analysts had expected a loss per share of 2 cents on bookings of $407 million. As usual, it’s a bit hard to parse due to the way Zynga has to report its revenues and earnings due to regulatory requirements. Zynga itself had expected $400 million in bookings and a loss of 3 cents.
But CEO Frank Gibeau said in an interview with GamesBeat that the company has to defer a considerable amount of the revenue to future quarters, based on accounting rules for deferred revenue. When a player buys a pack of virtual items they may use in a game, Zynga typically spreads the recognition of that revenue out over 10 months, rather than recording the revenue in the current quarter. Zynga has a balance of about $453 million in deferred revenue, which will help the company’s performance in future quarters.
“It’s a strange time for the world. Games have really stepped to the forefront in being a great way to keep people connected and socializing and playing,” Gibeau said. “This is probably the most meaningful time in terms of what our products do for society. The feedback coming back from our fans has been really positive.”
In after-hours trading, Zynga’s stock is falling 5.7% to $7.53 a share.
One of the things that affects Zynga’s earnings is strong performance from the acquired companies Small Giant Games (maker of Empires & Puzzles) and Gram Games (maker of Merge Dragons), both acquired in 2018. The only trouble is that contingent consideration expenses (performance bonuses) related to those deals raises Zynga’s expenses as it has to pay bonuses to those divisions. It would probably be better for the financial picture if homegrown games like Words With Friends performed better, but that’s not what it is happening at the moment, with the exception of good performance from Game of Thrones: Slots Casino.
“These types of payments are going to be coming through the P&L, and it’s part of the deal structure we put in place,” Gibeau said. “It’s a good news, bad news thing. The good news is the products are absolutely crushing it and are well ahead of the deal models we used to acquire the companies. Contingent consideration [bonuses] goes up. Deferred revenue goes up. And it pushes out a lot of the revenue but you have to record the costs now.”
In addition to the acquired games, Zynga has a half-dozen strong titles that keep performing well every quarter — its “Forever Franchises” such as Zynga Poker and CSR2. Zynga is keeping those games strong through live operations, such as special events or new in-game items.
Some games are weakening, like older mobile titles and chat games. But Zynga has plans for some big launches, with upcoming games FarmVille 3, Harry Potter match-3, and Puzzle Combat. And Gibeau said the company felt good about the launch of Play Apart Together, a campaign that promotes the physical distancing during the pandemic as advocated by the World Health Organization (WHO). More than 55 companies banded together during recent weeks to promote the campaign.
The stock market reaction to Zynga’s results are usually driven by whether it hits revenue or earnings targets. But it’s complicated because Zynga is required to report some revenue later than when it actually receives it (like when a user buys in-game currency but doesn’t use it until much later). This is called deferred revenue. But if you add the changes in deferred revenue and revenue, you get a better picture of the actual quarter’s results in a number dubbed bookings. Zynga’s management uses this number in how it guides expectations.
Zynga’s actual earnings results for the first quarter fell short of expectations, with a loss per share of 11 cents, or $103.9 million, compared to a loss of 14 cents a share, or $128.8 million, a year earlier. Zynga had guided analysts to a net loss of $26 million, adjusted EBITDA of $57 million, and a net loss of $57 million. Adjusted EBITDA came in at $68 million, about $11 million above guidance.
One of the things that was weaker in the quarter was advertising revenue and bookings, which were $59 million, down 9% from a year ago, as the company saw some pullback in advertising in mid-March. Still, this negative was offset by stronger player engagement during the quarter. Gibeau said advertisers for Zynga’s games did not cut back as much as larger brands did on spending elsewhere.
“In general, our ad business is hanging in there,” Gibeau said. “It’s down a little bit, but it is hanging in there.”
Zynga saw a lower net increasing deferred revenue, which helped improve GAAP gross profit margins, which hit 64% in Q1 compared to 54% a year ago. GAAP operating expenses were also lower in the quarter, though Zynga saw some costs rise from marketing and bonuses paid to acquired companies. Zynga had expected to pay a bonus of $25 million in the quarter, but the acquired companies did so well that the bonus was actually $120 million, much higher and resulting in the net loss.
As a public company, Zynga is required to report quarterly results on a U.S. GAAP basis, while analysts and investors use non-GAAP financial metrics to assess a company’s underlying performance. Bookings and adjusted earnings before income tax, depreciation, and amortization (EBITDA), excluding the impact of deferred revenue, are among those metrics that are most highly scrutinized as they reflect the actual operating activity of the company better.
How well Zynga performs on EBITDA versus analyst expectations is another thing that determines whether the stock rises or falls after earnings.
Zynga’s stock price is also affected by how the company predicts it will do in the second quarter and the outlook for the full year. Zynga has raised its full-year guidance to $1.65 billion in revenues, up 25% from 2019, or rosier than previously expected. Overall, Zynga’s cash position is strong at $1.43 billion.
In Q1, the average mobile daily active users (DAUs) were 21 million, and mobile monthly active users were 68 million, down 7% and 5% respectively from a year earlier, respectively. Merge Magic grew its audience, but older mobile titles, Words With Friends, and chat games saw decreases in mobile DAUs, while chat games and older mobile titles saw decreases in mobile MAUs. Bookings per average mobile DAU was up 27% from a year earlier. Sequentially, Q1 mobile DAUs and mobile MAUs increased modestly, led by growth in casual cards and Words With Friends.
Since late March, as more people sheltered-in-place, Zynga has seen higher levels of engagement in games and it expects this to positively affect Q2 mobile DAUs and MAUs. On a sequential basis, Gibeau said he expects the number of users to go up in the second quarter.