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ZYNGA INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in "Special Note Regarding Forward-Looking Statements" and "Risk Factors." The forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date hereof. Overview We are a leading social game developer with approximately 112 million average MAUs for the three months ended September 30, 2014. We have launched some of the most successful social games in the industry. Our games are accessible on Facebook and other social networks, mobile platforms and Zynga.com. Our games are generally available for free, and we generate revenue through the in-game sale of virtual goods, mobile game download fees and advertising services. We are a pioneer and innovator of social games and a leader in making play a core activity on the Internet. Our objective is to become the worldwide leader in play by connecting the world through games. Consistent with our free-to-play business model, compared to all players who play our games in any period, only a small portion of our players are payers. Because the opportunity for social interactions increases as the number of players increases, we believe that maintaining and growing our overall number of players, including the number of players who may not purchase virtual goods, is important to the success of our business. As a result, we believe that the number of players who choose to purchase virtual goods will continue to constitute a small portion of our overall players. The games that constitute our top games vary over time, but historically the top three revenue-generating games in any period contributed the majority of our revenue. Our top three games accounted for 54%, 55% and 57% of our online game revenue in 2013, 2012 and 2011, respectively. On February 11, 2014, we completed the acquisition of 100% of the equity interests of NaturalMotion. NaturalMotion's shareholders and vested option holders received an aggregate of $391 million in cash and 39.8 million shares of our Class A common stock. NaturalMotion possesses industry leading technology and tools and its proven simulation technologies have powered some of the biggest console games and blockbuster movies. Zynga's acquisition of NaturalMotion expanded our creative pipeline into two new consumer categories - People simulation and Racing - and provided Zynga with cutting-edge technology and tools, including Euphoria, that we believe will help fast track Zynga's ability to deliver hit games. How We Generate Revenue We operate our games as live services that allow players to play for free. We generate revenue primarily from the in-game sale of virtual goods, mobile game download fees and advertising. Revenue growth will depend largely on our ability to attract and retain players and more effectively monetize our player base through the sale of virtual goods and advertising. We intend to do this through the launch of new games, enhancements to current games and expansion into new markets and distribution platforms. Online game. We provide our players with the opportunity to purchase virtual goods that enhance their game-playing experience. We believe players choose to pay for virtual goods for the same reasons they are willing to pay for other forms of entertainment - they enjoy the additional playing time or added convenience, the ability to personalize their own game boards, the satisfaction of leveling up and the opportunity for sharing creative expressions. We believe players are more likely to purchase virtual goods when they are connected to and playing with their friends, whether those friends play for free or also purchase virtual goods. Players may also elect to pay a one-time download fee to obtain certain mobile games free of third-party advertisements. Facebook is currently the largest single distribution, marketing, promotion and payment platform for our games. We generate a significant portion of our revenue through the Facebook platform. For example, for the three months ended September 30, 2014 and 2013, we estimate that 41% and 65% of our bookings, respectively, were generated through the Facebook platform, while 55% and 30% of our bookings, respectively, were generated through multiple mobile platforms, with the three months ended June 30, 2014 being the first quarter in which bookings generated through mobile platforms represented a majority of our bookings. For the three months ended September 30, 2014 and 2013, we estimate that 48% and 77% of our revenue, respectively, was generated through the Facebook platform, while 48% and 23% of our revenue, respectively, was generated through mobile platforms. We have had to estimate this information because certain payment methods we accept and certain advertising networks do not allow us to determine the platform used. 21-------------------------------------------------------------------------------- Table of Contents We began migrating to Facebook Credits in July 2010 pursuant to an addendum to Facebook's standard terms and conditions, and in April 2011, we completed this migration. Contractually, Facebook remitted to us an amount equal to 70% of the face value of Facebook credits for each Facebook credit redeemed in our games, and we recognize revenue net of amounts retained by Facebook. Prior to our transition from Facebook Credits to Facebook's local currency-based payment model, our players were able to purchase Facebook Credits from Facebook directly through our games or through game cards purchased from retailers and distributors. In June 2012, Facebook announced its plans to discontinue the use of Facebook Credits and in July 2013, Facebook began to transition to Facebook's local currency-based payments program. We completed this transition in the fourth quarter of 2013. For all payment transactions in our games under Facebook's local currency-based payments model, Facebook remits to us an amount equal to 70% of the price we requested to be charged to our players. On platforms other than Facebook, players purchase our virtual goods through various widely accepted payment methods offered in the games, including PayPal, Apple iTunes accounts, Google Wallet, credit cards and direct wires. Advertising and other. Advertising revenue primarily includes branded virtual goods and sponsorships, engagement ads and offers, mobile ads and display ads and other. We generally report our advertising revenue net of amounts due to advertising agencies and brokers. Other revenue includes software licensing and maintenance related to technology acquired in our acquisition of NaturalMotion as well as licensing of our brands. Key Metrics We regularly review a number of metrics, including the following key financial and operating metrics, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions. Key Financial Metrics Bookings. Bookings is a non-GAAP financial measure that is equal to revenue recognized during the period plus the change in deferred revenue during the period. We record the sale of virtual goods as deferred revenue and then recognize that revenue over the estimated average life of the purchased virtual goods or as the virtual goods are consumed. Advertising sales which consist of certain branded virtual goods and sponsorships is also deferred and recognized over the estimated average life of the branded virtual good, similar to online game revenue. Bookings, as opposed to revenue, is the fundamental top-line metric we use to manage our business, as we believe it is a better indicator of the sales activity in a given period. Over the long term, the factors impacting our bookings and revenue are the same. However, in the short term, there are factors that may cause revenue to exceed or be less than bookings in any period. We use bookings to evaluate the results of our operations, generate future operating plans and assess the performance of our company. While we believe that this non-GAAP financial measure is useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for revenue recognized in accordance with U.S. GAAP. In addition, other companies, including companies in our industry, may calculate bookings differently or not at all, which reduces its usefulness as a comparative measure. The following table presents a reconciliation of revenue to bookings for each of the periods presented: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Reconciliation of Revenue to Bookings: Revenue $ 176,611 $ 202,580 $ 497,863 $ 696,904 Change in deferred revenue (1,123 ) (50,474 ) 14,085 (127,405 ) Bookings $ 175,488 $ 152,106 $ 511,948 $ 569,499 Adjusted EBITDA. Adjusted EBITDA is a non-GAAP financial measure that we calculate as net income (loss), adjusted for provision for / (benefit from) income taxes; other income (expense), net; interest income; gain (loss) from significant legal settlements; restructuring expense; depreciation and amortization; impairment of intangible assets; stock-based expense; contingent consideration fair value adjustments; acquisition-related transaction expenses, and change in deferred revenue. We believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. We have included adjusted EBITDA in this Quarterly Report on Form 10-Q because it is a key measure we use to evaluate our financial and operating performance, generate future operating plans and make strategic decisions for the allocation of capital. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating 22-------------------------------------------------------------------------------- Table of Contents our operating results in the same manner as our management and board of directors. While we believe that this non-GAAP financial measure is useful in evaluating our business, this information should be considered as supplemental in nature and is not meant as a substitute for the related financial information prepared in accordance with U.S. GAAP. The following table presents a reconciliation of net income (loss) to adjusted EBITDA for each of the periods indicated (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Reconciliation of Net Income (Loss) to Adjusted EBITDA: Net income (loss) $ (57,058 ) $ (68 ) $ (180,774 ) $ (11,740 ) Provision for (benefit from) income taxes (783 ) (891 ) (9,874 ) (27,646 ) Other income (expense), net (647 ) (929 ) (2,668 ) 4,465 Interest income (expense), net (841 ) (965 ) (2,487 ) (3,233 ) Restructuring expense, net 287 6,769 27,672 37,317 Depreciation and amortization 19,283 33,986 64,553 96,905 Impairment of intangible assets - 10,217 - 10,217 Contingent consideration fair value adjustment 6,750 - 20,100 - Acquisition-related transaction expenses - - 6,425 - Stock-based expense 36,295 9,256 93,468 65,066 Change in deferred revenue (1,123 ) (50,474 ) 14,085 (127,405 ) Adjusted EBITDA $ 2,163 $ 6,901 $ 30,500 $ 43,946 Limitations of Bookings and Adjusted EBITDA Some limitations of bookings and adjusted EBITDA are: • adjusted EBITDA does not include the impact of stock-based expense; • bookings and adjusted EBITDA do not reflect that we defer and recognize online game revenue and revenue from certain advertising transactions over the estimated average life of virtual goods or as virtual goods are consumed; • adjusted EBITDA does not reflect income tax expense; • adjusted EBITDA does not include other income (expense) net, which includes foreign exchange gains and losses and interest income; • adjusted EBITDA excludes depreciation and amortization and although these are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future; • adjusted EBITDA does not include the impairment of intangible assets previously acquired, contingent consideration fair value adjustments, and does not include acquisition-related transaction expenses or restructuring expense; • adjusted EBITDA does not include gains and losses associated with significant legal settlements; and • other companies, including companies in our industry, may calculate bookings and adjusted EBITDA differently or not at all, which reduces their usefulness as a comparative measure. Because of these limitations, you should consider bookings and adjusted EBITDA along with other financial performance measures, including revenue, net income (loss) and our other financial results presented in accordance with U.S. GAAP. Key Operating Metrics We manage our business by tracking several operating metrics: "DAUs," which measure daily active users of our games, "MAUs," which measure monthly active users of our games, "MUUs," which measure monthly unique users of our games, "MUPs," which measure monthly unique payers in our games, and "ABPU," which measures our average daily bookings per average DAU, each of which is recorded by our internal analytics systems. The numbers for these operating metrics are calculated using internal company data based on tracking the activity of user accounts. We believe that the numbers are reasonable estimates of our user base for the applicable period of measurement; however, factors relating to user activity and systems may impact these numbers. 23-------------------------------------------------------------------------------- Table of Contents DAUs. We define DAUs as the number of individuals who played one of our games during a particular day. Under this metric, an individual who plays two different games on the same day is counted as two DAUs. Similarly, an individual who plays the same game on two different platforms or social networks (e.g., Facebook.com, Zynga.com, iPad, Android Phone, iPhone, etc.) on the same day would be counted as two DAUs. Average DAUs for a particular period is the average of the DAUs for each day during that period. We use DAUs as a measure of audience engagement. MAUs. We define MAUs as the number of individuals who played a particular game in the 30-day period ending with the measurement date. Under this metric, an individual who plays two different games in the same 30-day period is counted as two MAUs. Similarly, an individual who plays the same game on two different platforms or social networks (e.g., Facebook.com, Zynga.com, iPad, Android Phone, iPhone, etc.) in a 30-day period would be counted as two MAUs. Average MAUs for a particular period is the average of the MAUs at each month-end during that period. We use MAUs as a measure of total game audience size. MUUs. We define MUUs as the number of unique individuals who played any of our games on a particular platform in the 30-day period ending with the measurement date. An individual who plays more than one of our games in a given 30-day period would be counted as a single MUU. However, because we cannot always distinguish unique individuals playing on two different social networks, a player playing on two different social networks in a given 30-day period may be counted as two MUUs. Because many of our players play more than one game in a given 30-day period, MUUs are always lower than MAUs in any given time period. Average MUUs for a particular period is the average of the MUUs at each month-end during that period. We use MUUs as a measure of total audience reach across our network of games. MUPs. We define MUPs as the number of unique players who made a payment at least once during the applicable month through a payment method for which we can quantify the number of unique payers, including payers from certain mobile games. MUPs does not include payers who use certain payment methods for which we cannot quantify the number of unique payers. Because we cannot always distinguish unique individuals playing on two different social networks, an individual who makes a payment on two different social networks in a given 30-day period may be counted as two MUPs. MUPs are presented as an average of the three months in the applicable quarter. ABPU. We define ABPU as (i) our total bookings in a given period, divided by (ii) the number of days in that period, divided by, (iii) the average DAUs during the period. We believe that ABPU provides useful information to investors and others in understanding and evaluating our results in the same manner as our management and board of directors. We use ABPU as a measure of overall monetization across all of our players through the sale of virtual goods and advertising. Our business model for social games is designed so that, as there are more players that play our games, social interactions increase and the more valuable the games and our business become. All engaged players of our games help drive our bookings and, consequently, both online game revenue and advertising revenue. Virtual goods are purchased by players who are socializing with, competing against or collaborating with other players, most of whom do not buy virtual goods. Accordingly, we primarily focus on bookings, DAUs, MAUs, MUUs, MUPs and ABPU, which together we believe best reflect key audience metrics. The table below shows average DAUs, MAUs, MUUs, MUPs and ABPU for the three and nine months ended September 30, 2014 and 2013: Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 (users and payers in millions) Average DAUs 26 30 28 40 Average MAUs 112 133 122 191 Average MUUs (1) 77 97 83 123 Average MUPs (1) 1.3 1.6 1.5 2.0 ABPU $ 0.073 $ 0.055 $ 0.068 $ 0.052 (1) MUUs and MUPs exclude NaturalMotion as our systems are unable to distinguish whether a player of a NaturalMotion game is also a player of a Zynga game so we exclude NaturalMotion payers to avoid potential double counting of MUUs and MUPs. 24 -------------------------------------------------------------------------------- Table of Contents Average DAUs, MAUs and MUUs declined when comparing the three months ended September 30, 2014 and 2013. The declines in users for our existing games have exceeded the contribution to these metrics from newer titles including FarmVille 2: Country Escape. ABPU increased in the third quarter of 2014 compared to the third quarter of 2013 due to a faster decline in DAUs in those periods than the decline in bookings. Future growth in audience and engagement will depend on our ability to retain current players, attract new players, launch new games and expand into new market and distribution platforms. Other Metrics Although our management primarily focuses on the operating metrics above, we also monitor periodic trends in our paying players of our games. The table below shows average monthly unique payer bookings, average MUPs and unique payer bookings per unique payer for the last five quarters: For the Three Months Ended: Sep 30, 2014 Jun 30, 2014 Mar 31, 2014 Dec 31, 2013 Sep 30, 2013 Average monthly unique payer bookings (in thousands) (1) $ 43,739 $ 44,844 $ 39,073 $ 37,432 $ 39,535 Average MUPs (in millions) (2) 1.3 1.7 1.4 1.3 1.6 Monthly unique payer bookings per MUP (3) $ 33 $ 27 $ 27 $ 28 $ 25 (1) Average monthly unique payer bookings represent the monthly average amount of bookings for the applicable quarter that we received through payment methods for which we can quantify the number of unique payers and excludes bookings from certain payment methods for which we cannot quantify the number of unique payers. Also excluded are bookings from advertising and NaturalMotion. (2) MUPs exclude NaturalMotion as our systems are unable to distinguish whether a player of a NaturalMotion game is also a player of a Zynga game so we exclude NaturalMotion payers to avoid potential double counting of MUPs. (3) Monthly unique payer bookings per MUP is calculated by dividing average monthly unique payer bookings by average MUPs. Average monthly unique payer bookings decreased between the second quarter of 2014 and the third quarter of 2014 primarily due to declines in bookings and users in FarmVille 2, offset by growth in bookings and users in Hit it Rich and FarmVille 2: Country Escape. Although we monitor our unique payer metrics, we focus on monetization, including through in-game advertising, of all of our players and not just those who are payers. Accordingly, we strive to enhance content and our players' game experience to increase our bookings and ABPU, which is a measure of overall monetization across all of our players through the sale of virtual goods and advertising. Future growth in audience and engagement will depend on our ability to retain current players, attract new players, launch new games and expand into new markets and distribution platforms, and the success of our network. Our operating metrics may not correlate directly to quarterly bookings or revenue trends in the short term. Recent Developments • Updates to our Board of Directors. In July 2014, Zynga announced Dr. Regina E. Dugan, Vice President of Engineering at Google Inc., and the leader of the company's Advanced Technology and Projects (ATAP) group, was appointed to Zynga's Board of Directors. Previously, Dr. Dugan served as the 19th Director and first female leader of the Defense Advanced Research Projects Agency (DARPA), the principal agency within the U.S. Department of Defense for research, development and demonstration of high-risk, high-payoff capabilities for the future combat force. As Director, Dr. Dugan advanced strategic initiatives in cyber security, hypersonics, social media, and advanced manufacturing. On Zynga's Board, Dr. Dugan chairs the Nominating and Governance Committee and is a member of the Product Committee. • Product Launches and Updates. In the third quarter of 2014, we launched new games and made several product updates to our most popular franchises. • Entered the Sports category in September with the launch of our sports brand Zynga Sports 365. We launched NFL Showdown in September across iPhone, iPad, iPod Touch and Google Play. • In September, we launched the new Zynga Poker and set out to deliver players an authentic poker experience coupled with newfeatures that inspire competition and mastery such as Leagues. 25 -------------------------------------------------------------------------------- Table of Contents • Launched two upcoming titles in the Words and Runner categories in select geo-lock markets - New Words With Friends, which represented the most significant update to Words With Friends since its launch in 2009 - and Looney Tunes Dash!, a Runner game that leverages a multi-year agreement with Warner Bros. InteractiveEntertainment to license the beloved Looney Tunes brand for mobile. • Continued our commitment to growing and sustaining our core franchises through a series of events and feature updates to a number of our games including FarmVille 2: Country Escape, Hit It Rich! Slots and CSR Classics. Factors Affecting Our Performance Launch of new games and release of enhancements. Our bookings and revenue results have been driven by the launch of new mobile and web games and the release of fresh content and new features in existing games. Our future success depends on our ability to launch and monetize successful new hit titles on various platforms. Although the amount of revenue and bookings we generate from a new game or an enhancement to an existing game can vary significantly, we expect our revenue and bookings to be correlated to the success and timely launch of our new games and our success in releasing engaging content and features. In addition, revenue and bookings from many of our games tend to decline over time after reaching a peak of popularity and player usage. We often refer to the speed of this decline as the decay rate of a game. As a result of this decline in the revenue and bookings of our games, our business depends on our ability to consistently and timely launch new games that achieve significant popularity and have the potential to become franchise games. Game monetization. We generate most of our bookings and revenue from the sale of virtual goods in our games. The degree to which our players choose to pay for virtual goods in our games is driven by our ability to create content and virtual goods that enhance the game-play experience. Our bookings, revenue and overall financial performance are affected by the number of players and the effectiveness of our monetization of players through the sale of virtual goods and advertising. For example ABPU increased from $0.055 in the three months ended September 30, 2013 to $0.073 in the three months ended September 30, 2014 due to higher decline in DAU of non-paying players (compared to paying players) who do not contribute to online game bookings. In addition, mobile and international players have historically monetized on average at a lower level than web and U.S. players, respectively. The percentage of paying mobile and international players may increase or decrease based on a number of factors, including growth in mobile games as a percentage of total game audience and our overall international players, localization of content and the availability of payment options. Investment in game development. In order to develop new games and enhance the content and features in our existing games, we must continue to invest in a significant amount of engineering and creative resources. These expenditures generally occur months in advance of the launch of a new game or the release of new content, and the resulting revenue may not equal or exceed our development costs. Player acquisition costs. We utilize advertising and other forms of player acquisition and retention to grow and retain our player audience. These expenditures generally relate to the promotion of new game launches and ongoing performance-based programs to drive new player acquisition and lapsed player reactivation. Over time, these acquisition and retention-related programs may become either less effective or more costly, negatively impacting our operating results. We may incur increased player acquisition costs as our ability to cross-promote traffic to games that are offered on platforms other than Facebook are limited by Facebook's standard terms of service, and we may need to spend greater amounts on advertising and marketing our games. New market development. We are investing in new distribution channels, mobile platforms and international markets to expand our reach and grow our business. For example, we have continued to hire additional employees and acquire companies with experience developing mobile applications. Our ability to be successful will depend on our ability to develop a successful mobile network, obtain new players and retain existing players on new and existing social networks, and attract advertisers. In the first quarter of 2014, we completed the acquisition of NaturalMotion, the maker of Clumsy Ninja and CSR Racing. This allowed us to enter into two new consumer categories - People simulation and Racing - and our future success is dependent upon our ability to leverage the games, workforce, and technology we acquired. As we expand into new markets and distribution channels, we expect to incur headcount, marketing and other operating costs in advance of the associated bookings and revenue. Our financial performance will be impacted by our investment in these initiatives and their success. Hiring and retaining key personnel. Our ability to compete and grow depends in large part on the efforts and talents of our employees. In addition to employee attrition, we have also implemented, and continue to implement, certain cost reduction initiatives to better align our operating expenses with our revenue, including reducing our headcount and consolidating certain facilities. For example, in the first quarter of 2014, we implemented a restructuring plan that included a work force reduction. These cost reduction initiatives could negatively impact our ability to attract, hire and retain key employees, which is critical to our ability to grow our business and execute on our business strategy. 26 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our results of operations for the periods presented as a percentage of revenue for those periods: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Consolidated Statements of Operations Data: Revenue 100 % 100 % 100 % 100 % Costs and expenses: Cost of revenue 30 29 32 27 Research and development 57 40 59 48 Sales and marketing 25 10 23 11 General and administrative 22 17 26 17 Impairment of intangible assets - 5 - 2 Total costs and expenses 134 101 140 105 Income (loss) from operations (34 ) (1 ) (40 ) (5 ) Interest income - - - - Other income (expense), net - - 1 (1 ) Income (loss) before income taxes (34 ) - (39 ) (6 ) Provision for (benefit from) income taxes - - (2 ) (4 ) Net income (loss) (34 )% - % (37 )% (2 )% Revenue Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Revenue by type: Online game $ 139,372 $ 174,370 (20 %) $ 402,608 $ 607,262 (34 %) Advertising and other 37,239 28,210 32 % 95,255 89,642 6 % Total revenue $ 176,611 $ 202,580 (13 %) $ 497,863 $ 696,904 (29 %) Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Total revenue decreased $26.0 million in the third quarter of 2014, as compared to the same period of the prior year as a result of a decline in online game revenue. Bookings increased by $23.4 million in the third quarter of 2014, compared to the same period of the prior year. ABPU increased from $0.055 in the third quarter of 2013 to $0.073 in the third quarter of 2014, while average DAUs decreased from 30 million in the third quarter of 2013 to 26 million in the third quarter of 2014 and average MUPs decreased from 1.6 million in the third quarter of 2013 to 1.3 million in the third quarter of 2014. Online game revenue decreased $35.0 million in the third quarter of 2014 as compared to the same period of the prior year. This decrease is primarily attributable to decreases in revenue from FarmVille and ChefVille in the amounts of $23.6 million and $11.4 million, respectively. The decreases in online game revenue from FarmVille and ChefVille were due to overall decay rate in bookings and audience metrics in these games. The decrease in online game revenue was partially offset by an increase in online game revenue of $17.2 million from Hit it Rich. All other games accounted for the remaining net decrease of $17.2 million. International revenue as a percentage of total revenue was 38% and 39% in the third quarter of 2014 and 2013, respectively. In the three months ended September 30, 2014, FarmVille 2, Zynga Poker and Hit it Rich were our top revenue-generating games and comprised 27%, 22% and 12%, respectively, of our online game revenue for the period. In the three months ended September 30, 2013, FarmVille 2, Zynga Poker and FarmVille were our top revenue-generating games and comprised 22%, 19% and 18%, respectively, of our online game revenue for the period. No other game generated more than 10% of online game revenue during either of these periods. Consumable virtual goods accounted for 40% of online game revenue in the third quarter of 2014 and 27% of online game revenue in the third quarter of 2013. Durable virtual goods accounted for 60% of online game revenue in the third quarter of 2014 and 27 -------------------------------------------------------------------------------- Table of Contents 73% of online game revenue in the third quarter of 2013. The estimated weighted average life of durable virtual goods was 13 months in the third quarter of 2014 compared to 11 months in the third quarter of 2013. In addition, there was no material impact to revenue recognized in the third quarter of 2014 from changes in our estimated average life of durable virtual goods. Advertising and other revenue increased $9.0 million in the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 due to an $11.0 million increase in in-game display ads driven primarily by favorable contractual terms with our new mobile advertising partners, offset by a $1.2 million decrease in in-game sponsorships and a $0.8 million decrease in in-game offers, engagement ads and other advertising revenue. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Total revenue decreased $199.0 million in the nine months ended September 30, 2014, as compared to the same period of the prior year. Bookings decreased by $57.6 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. ABPU increased from $0.052 for the nine months ended September 30, 2013 to $0.068 for the nine months ended September 30, 2014. DAUs decreased from 40 million for the nine months ended September 30, 2013 to 28 million for the nine months ended September 30, 2014 and average MUPs decreased from 2.0 million in the nine months ended September 30, 2013 to 1.5 million in the nine months ended September 30, 2014. Online game revenue decreased $204.7 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. This decrease is primarily attributable to decreases in revenue from FarmVille, CastleVille, Zynga Poker (web), ChefVille, CityVille and FrontierVille in the amounts of $71.4 million, $33.6 million, $32.2 million, $31.1 million, $22.5 million and $12.3 million, respectively. The decreases in online game revenue from these games were the result of the overall decay rate in bookings and audience metrics in these games. These decreases were partially offset by an increase in online game revenue of $28.8 million from FarmVille 2 and $25.8 million from Hit it Rich. All other games accounted for the remaining net decrease of $56.2 million. International revenue as a percentage of total revenue was 40% in the nine months ended September 30, 2014 and 2013. In the nine months ended September 30, 2014, FarmVille 2 and Zynga Poker were our top revenue-generating games and comprised 29% and 24%, respectively, of our online game revenue for the period. In the nine months ended September 30, 2013, Zynga Poker, FarmVille and FarmVille 2, were our top revenue-generating games and comprised 21%, 17% and 15%, respectively, of our online game revenue for the period. No other game generated more than 10% of online game revenue during either of these nine month periods. Consumable virtual goods accounted for 37% of online game revenue in the nine months ended September 30, 2014 and accounted for 29% of online game revenue in the nine months ended September 30, 2013. Durable virtual goods accounted for 63% of online game revenue in the nine months ended September 30, 2014 and accounted for 71% of online game revenue in the nine months ended September 30, 2013. The estimated weighted-average life of durable virtual goods was 12 months in the nine months ended September 30, 2014 and September 30, 2013. In addition, changes in our estimated average life of durable virtual goods during the nine months ended September 30, 2014 for various games resulted in a decrease in revenue and income from continuing operations of $0.8 million in that period, which is the result of adjusting the remaining recognition period of deferred revenue generated in prior periods at the time of a change in estimate. These changes in estimates did not impact our reported earnings per share for the nine months ended September 30, 2014. For the same period in the prior year, changes in our estimated average life of durable virtual goods resulted in an increase in revenue of $7.3 million, which did not impact our reported earnings per share in that period. Advertising revenue increased $5.6 million from the nine months ended September 30, 2013 to the nine months ended September 30, 2014, due a $7.9 million increase in licensing revenue and a $7.5 million increase in in-game display ads, offset by a $5.1 million decrease in in-game offers, engagement ads, and other advertising revenue and a $4.7 million decrease in in-game sponsorships. Cost of revenue Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Cost of revenue $ 53,286 $ 59,011 (10 %) $ 158,078 $ 189,482 (17 %) 28 -------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Cost of revenue decreased $5.7 million in the third quarter of 2014 as compared to the same period of the prior year. The decrease was primarily attributable to a $13.3 million decrease in depreciation expense due to the consolidation of data center facilities and the related disposition of certain data center assets in prior periods and a $5.6 million decrease in hosting and data center costs due to lower data usage needs, offset by a $14.5 million increase in payment processing fees primarily from bookings generated from mobile payment processors. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Cost of revenue decreased $31.4 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. The decrease was primarily attributable to a $25.7 million decrease in depreciation expense due to the consolidation of data center facilities and the related disposition of certain data center assets in prior periods, a $18.6 million decrease in third party hosting expense due to lower data center usage needs, a $10.5 million decrease in customer service expense and a $4.2 million decrease in headcount-related expense, offset by a $26.8 million increase in payment processing fees primarily from bookings generated from mobile payment processors. Research and development Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Research and development $ 100,113 $ 81,023 24 % $ 291,419 $ 334,526 (13 %) Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Research and development expenses increased $19.1 million in the third quarter of 2014 as compared to the same period of the prior year. The increase was primarily attributable to a $14.2 million increase in stock-based expense and $6.7 million of expense recorded in the third quarter of 2014 to reflect the change in estimated fair value of the contingent consideration liability for Spooky Cool Labs, offset by a $1.0 million decrease in headcount related expense. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Research and development expenses decreased $43.1 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. The decrease was primarily attributable to a $49.8 million decrease in headcount related expense, and a $13.6 million decrease in restructuring expense, offset by $20.0 million of expense recorded in 2014 to reflect the change in estimated fair value of the contingent consideration liability for Spooky Cool Labs. Sales and marketing Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Sales and marketing $ 44,005 $ 21,170 108 % $ 115,466 $ 79,640 45 % Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Sales and marketing expenses increased $22.8 million in the third quarter of 2014 as compared to the same period of the prior year. The increase was primarily attributable to a $23.0 million increase in marketing expense due to higher mobile player acquisition costs and consumer marketing costs. 29-------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Sales and marketing expenses increased $35.8 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. The increase was primarily attributable to a $43.8 million increase in marketing expense due to higher mobile player acquisition costs and consumer marketing costs, offset by a $3.8 million decrease in stock-based expense and a $3.6 million decrease in headcount related expense. General and administrative Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) General and administrative $ 38,536 $ 34,012 13 % $ 128,703 $ 121,193 6 % Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 General and administrative expenses increased $4.5 million in the third quarter of 2014 as compared to the same period of the prior year. The increase was primarily attributable to a $12.9 million increase in stock-based expense, offset by a $6.5 million decrease in restructuring expense and a $2.4 million decrease in headcount-related expense. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 General and administrative expenses increased $7.5 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. The increase was primarily attributable to a $15.1 million increase in stock-based expense and a $14.4 million increase from higher allocated facilities and overhead costs, offset by a $13.3 million decrease in headcount-related expense and a $7.7 million decrease in depreciation expense due to the consolidation of data center facilities and the related disposition of certain data center assets in prior periods. Other income (expense), net Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Other income (expense), net $ 647 $ 929 N/M $ 2,668 $ (4,465 ) N/M Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Other income (expense) net decreased by $0.3 million in the third quarter 2014 as compared to the same period of the prior year due to the loss on sale of equipment of $1.0 million, offset by a $0.6 million increase in net sublease rental income. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Other income (expense), net increased $7.1 million in the nine months ended September 30, 2014 as compared to the same period of the prior year due to a $5.2 million decrease in interest expense in connection with the termination of our interest rate swap and repayment of our loan in the second quarter of 2013 and a $1.7 million increase in net sublease rental income, offset by a $1.3 million loss on an equity investment. Provision for (benefit from) income taxes Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Provision for (benefit from) income taxes $ (783 ) $ (891 ) N/M $ (9,874 ) $ (27,646 ) N/M 30 -------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 The benefit from income taxes decreased by $0.1 million in the third quarter of 2014 as compared to the same period of the prior year. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 The benefit from income taxes decreased by $17.8 million in the nine months ended September 30, 2014 as compared to the same period of the prior year. This decrease is attributable primarily to the incremental benefit of $5.0 million recorded in the first quarter of 2013 related to the recognition of Federal research and development tax credits and the net benefit related to changes in the estimated jurisdictional mix of earnings between the two periods of $12.8 million. |