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Edited Transcript of ZNGA earnings conference call or presentation 1-Aug-18 9:00pm GMT

Q2 2018 Zynga Inc Earnings Call

San Francisco Aug 2, 2018 (Thomson StreetEvents) -- Edited Transcript of Zynga Inc earnings conference call or presentation Wednesday, August 1, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Frank D. Gibeau

Zynga Inc. - CEO & Director

* James Gerard Griffin

Zynga Inc. - CFO

* Rebecca Lau

Zynga Inc. - Director of IR & Corporate Finance

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Conference Call Participants

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* Benjamin Ari Schachter

Macquarie Research - Head of TMET Research

* Brian Thomas Nowak

Morgan Stanley, Research Division - Research Analyst

* Christopher David Merwin

Goldman Sachs Group Inc., Research Division - Research Analyst

* Colin Alan Sebastian

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Douglas Lippl Creutz

Cowen and Company, LLC, Research Division - MD and Senior Research Analyst

* Justin Post

BofA Merrill Lynch, Research Division - MD

* Michael Joseph Hickey

The Benchmark Company, LLC, Research Division - Research Analyst

* Michael Joseph Olson

Piper Jaffray Companies, Research Division - MD & Senior Research Analyst

* Raymond Leonard Stochel

Consumer Edge Research, LLC - Analyst of Interactive Entertainment

* Richard Scott Greenfield

BTIG, LLC, Research Division - Co-Head of Research, MD and Media & Technology Analyst

* Timothy Larkin O'Shea

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Zynga Second Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to Ms. Rebecca Lau, Director of Investor Relations. Ma'am, you may begin.

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Rebecca Lau, Zynga Inc. - Director of IR & Corporate Finance [2]

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Thank you, Sabrina, and welcome, everyone to Zynga's second quarter earnings call. On the call with me today are: Frank Gibeau, our Chief Executive Officer; and Ger Griffin, our Chief Financial Officer. Shortly, we will open up the call for live questions.

During the course of today's call, we will make forward-looking statements related to our business plan and strategy as well as expectations for our future performance. Actual results may differ materially from the results predicted. Please review the risk factors in our most recently filed Form 10-Q as well as elsewhere in our SEC filings for further clarification.

In addition, we will also discuss non-GAAP financial measures. Our earnings letter, earnings slides and, when filed, our 10-Q will include reconciliations of our GAAP and non-GAAP financial measures. Please be sure to look at these reconciliations as the non-GAAP measures are not intended to be a substitute for, or superior to, our GAAP results. This conference call is being webcast-ed and will be available for audio replay on our Investor Relations website in a few hours.

Now I'll turn over the call to Frank for his opening remarks.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [3]

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Thanks, Rebecca. Good afternoon, and thank you for joining our Q2 earnings call. We had a strong quarter, delivering results ahead of our guidance, driven by strength in our mobile live services and continued improvement in our operating leverage. Revenue was $217 million, up 4% year-over-year, and bookings were $233.9 million, up 12% year-over-year. We saw growth across user pay and advertising, which drove mobile revenue up 7% year-over-year, and mobile bookings up 17% year-over-year. We also generated positive operating cash flow of $41.1 million in the quarter, up 9% year-over-year, and progressed towards our near-term margin goals.

Our live services strategy of creating innovative bold beats and feature enhancements that increase player engagement is paying off, as our forever franchises, Words With Friends, CSR2 and Zynga Poker collectively delivered double-digit year-over-year mobile revenue and bookings growth.

Starting with Words With Friends. We're excited by how our players are responding to the way we've reimagined this classic word game, delivering mobile revenue up 30% year-over-year and mobile bookings up 49% year-over-year. In the quarter, we introduced a new feature called Daily Goals and extended our Solo Challenge game mode. We also saw players increase their use of Boosts, which include Word Radar, Hindsight and Tile Swap. All of these features drove higher levels of player engagement, which contributed to our strong advertising performance as well as the continued adoption of user pay monetization in the game.

Looking ahead, we are focused on creating more value for players by further enhancing our popular new Solo Challenge, Lightning Round and Boost features over the coming quarters.

Next, CSR2 had another quarter driven by our Fast & Furious finale event, which represents the game's strongest performing release from our licensing partnership with Universal Brand Development. While mobile revenue was down 4% year-over-year due to the timing of when we recognize bookings into revenue, CSR2 delivered its best quarterly bookings in franchise history, up 21% year-over-year. This record performance was particularly notable as the game marked its 2-year anniversary in Q2.

A key component to the success of CSR2 is our strong partnerships with leading auto manufacturers and our focus on connecting our players with the most coveted cars in the world. Last quarter, we released a new in-game BMW M2 competition that gave CSR2 players the opportunity to race this high-performance car ahead of its real-world debut.

For the remainder of 2018, CSR2 has more bold beats planned, including a series of events featuring some of Porsche's most iconic cars, collectors and drivers in celebration of Porsche's 75th anniversary.

In Zynga Poker, mobile revenue was up 19% year-over-year and mobile bookings were up 13% year-over-year. The game's performance was supported by additional updates to our Challenges and Jackpot features, which give players new ways to improve their poker skills and bring to life the thrill of a big win. Up next, we will introduce our World Poker Tour themed in-game tournaments in Zynga Poker towards the end of Q3 and expect the feature to steadily ramp with new tournament modes in future quarters.

In late May, we acquired the London- and Istanbul-based Gram Games, bringing a talented team to Zynga that helped define the hyper-Casual genre with games like 1010!. The acquisition expanded our portfolio of live services and adds to our pipeline of new games. Specifically, Gram's newest title, Merge Dragons!, appeals to players across multiple genres, demographics and geographies by combining merge mechanics with Builder and Collection features. We believe that Merge Dragons! has the potential to become a forever franchise for Zynga and are actively working on new features to grow the game over the long term.

Turning to new game development. In Q2, we entered into soft launch on our new Casual mobile game Willy Wonka's Sweet Adventure. While it's early in the soft launch process, we are pleased with how the game is progressing, and we'll continue to collect player feedback while rigorously testing the game for long-term engagement and retention.

Across our broader portfolio, we are actively developing new titles across the Action Strategy, Casual, Invest Express and Social Casino categories. Our approach to new game development is to combine strong teams with high-potential sequels, reinvigorated Zynga brands, new intellectual properties and strategic licenses with global appeal. While we don't expect new games to contribute materially to 2018, we are encouraged by the potential contribution from new games in 2019 and beyond.

In summary, we are pleased with our execution so far in 2018 and the work we've done to grow the business while also improving our operating efficiency. We are focused on building on this momentum in the second half of the year and expect the strength we're seeing in player engagement and monetization across our live services to continue to serve as the foundation of our growth strategy. We're excited to introduce new bold beats in our forever franchises over the coming quarters as we execute on our growth strategy.

It is a 4-point growth strategy: number one, delivering growth in our live services; number two, building new games with the goal of creating forever franchises; number three, investing in emerging mobile technologies; and number four, exploring M&A opportunities that will enhance our growth potential.

With that, I'd like to turn the call over to Ger so that he can further discuss our Q2 results and our Q3 guidance.

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James Gerard Griffin, Zynga Inc. - CFO [4]

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Thank you, Frank. Q2 was another strong quarter for Zynga, delivering results ahead of our guidance, driven by strength in our mobile live services and continued improvement in our operating leverage. Our top line delivery was marked by strong player engagement and monetization across our live services, in particular, our portfolio of forever franchises.

Our revenue and bookings both exceeded our guidance. Revenue, which is comprised of net change in deferred revenue and bookings, was $217 million, $9 million ahead of our guidance and up $7.8 million or 4% year-over-year. We had a net increase in deferred revenue of $16.9 million versus our guidance of a net increase of $20 million and a net release of $0.1 million in the prior year quarter.

The main contributors to the net increase in deferred revenue were user pay bookings from our recently acquired portfolio of titles from Gram Games, from Words With Friends, as players engage with the game's Boost features, and from CSR2, where we had our best quarterly bookings performance in franchise history.

In assessing year-over-year variances, please note that the year-over-year variance and change in deferred revenue represents a $17 million negative component of the year-over-year variance in revenue, net income and Adjusted EBITDA.

Bookings were $233.9 million, $5.9 million ahead of our guidance and up $24.7 million or 12% year-over-year. Our top line beat in the quarter was driven primarily by better-than-expected monetization across our live services portfolio, in particular, strong performances from CSR2 and Words With Friends.

Taking a minute to double click on mobile, which now represents 89% of our total revenues and 90% of our total bookings. Mobile revenue was $192.7 million, up $12.9 million or 7% year-over-year. Mobile bookings were $211.6 million, up $30 million or 17% year-over-year. Mobile user pay revenue was $143 million, up $3.8 million or 3% year-over-year. And mobile user pay bookings were $161.1 million, up $19.6 million or 14% year-over-year. This mobile performance was driven by a full quarter contribution from our Casual Cards acquisition, a partial quarter contribution from our Gram Games acquisition, as well as double-digit growth collectively from our forever franchises, partially offset by declines in older mobile games.

Mobile advertising revenue was $49.7 million, up $9.1 million or 22% year-over-year. And mobile advertising bookings were $50.5 million, up $10.4 million or 26% year-over-year. Our strength in advertising in the quarter was primarily driven by increased player engagement within Words With Friends as well as network optimizations across our advertising portfolio.

Q2 was a dynamic quarter for our mobile audience. Year-over-year, average mobile DAUs and MAUs increased by 12% and 10%, respectively. Sequentially, average mobile DAUs and MAUs decreased by 8% and 4%, respectively. In Q2, our mobile audience was impacted by unique events in the quarter, including platform changes made by Facebook and our recent sunsets of several older mobile games. Despite these events, we are pleased with the player engagement and monetization across our forever franchises and have confidence in our ability to continue this trend in the coming quarters.

Turning to Q2 operating expenses. GAAP operating expenses were $145.8 million, up 5% year-over-year, representing 67% of revenue, consistent with 67% of revenue in the prior year. Stock-based compensation was $17.4 million, up 7% year-over-year, representing 8% of revenue, consistent with 8% of revenue in the prior year. Non-GAAP operating expenses were $125.4 million, up 3% year-over-year, representing 54% of bookings, down from 58% of bookings in the prior year. All of this contributed to a net loss of $0.9 million, $14.1 million better than our guidance and a decline of $6 million in net income year-over-year.

Our adjusted EBITDA was $26.7 million. This was above our guidance by $7.7 million and a decrease of $3.2 million year-over-year. We generated operating cash flow of $41.1 million in the quarter, up 9% year-over-year. We ended the quarter with cash and short-term investments of approximately $392 million. The sequential decrease in cash and short-term investments is primarily driven by the acquisition of Gram Games and common stock repurchases.

And now to Q3 guidance, which is as follows: revenue of $218 million, a net increase in deferred revenue of $30 million, bookings of $248 million, a net loss of $21 million and Adjusted EBITDA of $16 million.

Some additional factors to consider in assessing our Q3 guidance include: our Q3 bookings performance will be driven primarily by bold beat execution across our live services and a full quarter contribution from our acquisition of Gram Games. Year-over-year bookings growth will benefit from full quarter contributions from our Casual Cards and Gram Games acquisitions as well as strength across our forever franchises.

We continue to expect our sequential and year-over-year progression to be affected by declines in web and older mobile games. Similar to Q2, we expect a significant net increase in deferred revenue as we continue to defer the majority of user bookings from our recently acquired portfolio titles from Gram Games in addition to increases from our live services user pay bookings, in particular, Words With Friends and CSR2.

At this point, I would like to take a few more moments to add some additional context around changes in deferred revenue as this line can have a meaningful impact on revenue, net income and adjusted EBITDA in any given reported period as well as comparability against other reported periods. Ultimately, deferred revenue represents a timing difference between when a dollar of bookings occurs and when it is recognized as revenue over the estimated average playing period of payers. In any given quarter, this line can have a meaningful impact, but over the long term, it should be a wash.

For illustration: In Q3, we expect a net increase in deferred revenue of $30 million, representing a deferral of approximately 12% of our Q3 bookings and 188% of our Q3 adjusted EBITDA. Looking over a more extended period, i.e., over the last 8 quarters ending December 2017, the change in deferred revenue was a net increase of $6 million, representing less than 1% of our bookings and approximately 3% of adjusted EBITDA during that time period.

All that said, let's get back to Q3. In assessing year-over-year variances, please note that the year-over-year variance in change in deferred revenue represents a $41.1 million negative component of the year-over-year variance in revenue, net income and Adjusted EBITDA. I'm going to stop there for a second. $41.1 million variance, so please take that into consideration as you're looking at year-over-year. We expect our gross margins to be comparable with Q2 and our operating expenses to increase sequentially, primarily due to a full quarter contribution from Gram Games as well as slight growth in our investments in new game development.

With respect to fiscal 2018, we remain on track to deliver low double-digit growth in mobile bookings, excluding Gram Games, and expect live services to deliver well north of 95% of our revenue and bookings. While we don't expect new games to have a material revenue or bookings impact in 2018, we are encouraged by the potential contribution from new games in 2019 and beyond. We also remain on track to achieve our near-term margin goals later this year and expect the timing to primarily be a function of the performance of our live services as well as our decisions around the level of investment against marketing and new game development.

In summary, we've had a strong first half of the year, driven by the strength in our mobile live services and continued improvement in our operating leverage. We're excited about how we're executing against our 4-pillar growth strategy as we prioritize delivering value to our players, our employees and our investors.

With that, we are happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from the line of Tim O'Shea with Jefferies.

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Timothy Larkin O'Shea, Jefferies LLC, Research Division - Equity Analyst [2]

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I wanted to get an update on how the integration of your recent acquisitions is going, Harpan, Peak, Gram. So under the Zynga umbrella, I'm curious where there's still work to do, where Zynga's made some improvements and particularly, if you could comment around User Acquisition, analytics, sort of your live services strategy. And then a follow-up. In the letter and then Ger mentioned some platform changes made by Facebook and the impact on user levels, I'd just love to dig into that. Can you just help us understand what's going on there? How does it impact the business? Is this impact isolated to the Web business? Or does this also impact the mobile business, maybe impact UA. Would just love to hear a little more detail there.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [3]

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Hi Tim, this is Frank. I'll take the questions. On the first one about the status of our acquisition integrations, Harpan and Peak are fully integrated into Zynga and operating as part of the company. And in fact, they're fully integrated across all aspects of operations, marketing and development. Gram, we're only about 2 months in, into the integration process, and it's going very well. The overall approach that Gram takes to the development of their games is very unique and was one of the critical components for why we acquired the company. And that is, job one is to make sure that that continues in a healthy and leveraged way. And so that is underway, and we're looking at every aspect of UA, Live Ops, where we can help Gram solve scaling issues and where we can learn from Gram in terms of prototyping and new product development. So that's going very well.

On your second question related to the platform shifts and the sequential DAU issues that we communicated, I just would call out a couple of things. First, overall, on a year-over-year basis, audience is up 12% in mobile. Total DAUs are up 11%. In the quarter, we saw a couple of things that make it a little dynamic. The first was we had been sunsetting older games that were contributing DAUs, but weren't part of our future strategy. They weren't profitable, and they weren't in a position where it was best that we start to move towards a sunsetting exercise. That has started to build momentum this quarter, and that's where you saw one of the headwinds on audience DAU. The second place was, in the quarter, Facebook made several platform shifts as it related to Facebook Connect. It added certain prompts, it introduced some new bugs that caused players to have to re-log in and frankly, added friction to the player experience for some of our franchises. The good news is that that was a short-term problem that we were able to work with Facebook on, that we responded to. Audience has stabilized and is in a position where we're starting to grow it again. So that is -- that's in a nutshell, what happened there. It had no impact on UA. UA, as usual, works very efficiently and effectively with Facebook. It was just a Facebook Connect log-on issue, and I'm happy to report that we've put that behind us.

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Operator [4]

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The next question will come from the line of Mike Olson with Piper Jaffray.

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Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [5]

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As far as the pipeline, I know there's not a lot you can share, but just curious. You talked about pushing new titles from existing genres. Are there actually existing titles from Zynga's kind of past that can be resurfaced on mobile that we could expect in 2019, like FarmVille or CityVille or others?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [6]

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As I -- this is Frank, Mike. I'm definitely looking at Zynga brands from the past and bringing them back into the marketplace, reimagined and updated for the current market. We talked about the strategic licenses, Zynga brands, bringing some of those back, in addition to new intellectual properties. And it's -- and then, sequels. So that's definitely part of the mix.

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Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD & Senior Research Analyst [7]

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And then, are there any updates on Facebook Messenger as a new platform to reach additional players? I recall you talking about that a bit in the past.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [8]

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Yes, one of our growth strategies is to invest in emerging mobile technologies, whether it's VR, AR, in this case, chat, as a gaming platform. It's a new platform for the West, and Facebook is investing in building up the capabilities there. It is early days. It's pre-monetization, so there's a lot of experimentation and trials happening in terms of chat. So this quarter was about releasing products, understanding the acquisition flows, what player behavior looks like. So it's something that we're continuing to invest and then build against. It's just early days for the platform, and it'll develop over time.

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Operator [9]

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And the next question will come from the line of Brian Nowak with Morgan Stanley.

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Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [10]

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I have 2. The first one, Frank, you mentioned that you think Merge Dragons! has the potential to become a forever franchise. Can you just talk to us a little bit about what you think the sort of key hurdles you have to overcome to really make that into a forever multiyear franchise for the company? Then we're just looking for any further detail on the DAU or the payer trends across the large franchises you have now. And where do you still see the biggest opportunity to really drive faster user growth or payer growth across the existing franchises?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [11]

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Great. Brian, I'll take those questions. In terms of Merge Dragons!, what we're working with Gram on is looking at the social gameplay, the elder gameplay and some of the features as it relates to how collection and PVP works in the game. The game has a really compelling, unique mix or collection of puzzles as well as building. And so it has a lot of opportunity and potential to grow in different ways. And prioritizing what to build first and then how to operate and scale it in live ops is what we're really focused on. And so we were really compelled by Merge Dragons! when we first saw it and started playing. And when we talked to Gram about their vision about where it's going, we believe that it has that potential to get to forever franchise. It's just going to take some time to add in the features. It has good momentum now. It's built a very strong audience that is internationally dispersed. It appeals in Asia. It appeals in markets where we're not currently that strong. And so we're excited about the potential to grow it and also work together with Gram on how you scale live ops into the level of a forever franchise. In terms of player/payer trends across the portfolio, I think this quarter was a really interesting one from the standpoint of what you saw in engagement and monetization in the existing live franchises. Words With Friends, when we launched it in November, we introduced new ways to play with the Boost economy and the Power Ups. And it really added to the engagement of the game. The moves per player per day were up over 20%, which really drove player engagement to new heights. And with Solo Play and Team Play being there, we gave players inside these -- the Words With Friends franchise, more ways to compete, more ways to collaborate and communicate and socialize. And as we look at our forever franchises, that's the thing that we're constantly looking at. What are the things that we can do on a feature level that can drive higher levels of engagement, while at the same time, using the example of WPT, which is a bold beat coming up in Poker, to potentially acquire new players that are interested in WPT that might not have played Zynga Poker, but also recapitalize players that have lapsed from the game that are interested in WPT, it gives them a reason to come back with new features. So we're constantly looking at acquiring new players, getting existing players to play more and looking at players that have lapsed to come back. And when we look at our bold beat strategy going forward, each of the forever franchises has a strategy for each of those segments with bold beats that we're talking about in the future. And we've only announced the WPT bold beat at this point for the second half of the year for Poker, but you can expect more from CSR, starting with Porsche. But there'll be more as well as with Words With Friends for the holiday. And that's the key to our success so far in live ops, is keeping them fresh and focusing on engagement and retention before we focus on other attributes.

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Operator [12]

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And the next question will come from the line of Colin Sebastian with Robert Baird.

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Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

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Maybe as a follow-up there. You've done a really nice job layering in brand and product licenses into games as part of the bold beats. And I wonder, how much of a boost in monetization you can specifically tie back to those licenses, in terms of maybe the ROI? And do you see more licenses perhaps being attached to your portfolio of games? And then, Ger, one follow-up in terms of the commentary on deferred revenues. Just wondering how we should interpret that with respect to the timing of recognizing revenues and then if there was something implied in your comments there.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [14]

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Colin, I'll start with the first question. The layering in of brand licenses works on a couple of levels beyond monetization. It -- first and foremost, we look at the opportunity to place a license inside of a game, we look at obviously the context. Does it fit? Does it feel right for the players? And does it acquire users that we might not ordinarily get on our own? So in some ways, it's a way of attracting players without using paid acquisition. You pay for the license, but it's organically attracting players into CSR if you're a huge fan of Fast & Furious. It gives us a new fresh idea that might bring them into the category in a way that they might not have expected. So it acquires players. It then operates -- does operate on an engagement layer, because we can unfold the licenses over multiple events. So you're collecting cars 1 month and the next and you follow the storyline. And then ultimately, it does lead to monetization potential with a collection of cars. If you want to get Vin Diesel's charger, you engage in a monetization. WPT operates that way in Poker. We're looking at it as an acquisition tool. We're looking at it as the way to build new features that are unique and can drive engagement of existing players and then also bring players back who might have lapsed. And then also, you'll have new tournaments, which will probably monetize players as they engage in the tournaments and go after chips. So there is criteria. There's examples where we've successfully done this. And we look at each of our franchises for those types of opportunities. Ger?

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James Gerard Griffin, Zynga Inc. - CFO [15]

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Yes, no, the main point I'm trying to make when you think about deferred revenue is, I know it's confusing for some people when they're looking at our financials, in terms of how to interpret the performance in the quarter. So when you look at this quarter and last quarter in particular, we've had some meaningful increases in deferred revenue for the reasons I've noted. And all of those reasons are very good indicators of the health of our business in terms of the performance of CSR2, Words With Friends and the inclusion of a very interesting portfolio of IP for the future, in terms of the Gram Games IP. However, given the nature of all of those things as elements that are growing in our business, they have resulted in a deferral of around $30 million. And so when you look at that, you look at our External EBITDA definition and you say okay, we're going from prior year $44.6 million to $16 million. That, on paper, looks like it's a business that's actually going backwards. But if you actually reflect on the fact that included in that delta is $41.1 million of a net change in deferred revenue, that obviously is a different complexion. And as we stated in our investor letter at the start, when we look at our business, we look at it excluding the impact to deferred revenue, which if you were to do it on that basis, you'd see that our actual profitability is growing 37% quarter-on-quarter based on our guidance in the prior year. So again, I'm just trying to emphasize that all of our financial metrics are important to review. None of them are more important than any one other one. But what I will say is, given the materiality of the growth in deferred revenue due to the factors I've already outlined, I think it's important that you do your math very carefully when you're looking at year-over-year comps and looking at profitability over the next few quarters.

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Operator [16]

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And the next question comes from the line of Justin Post with Bank of America Merrill Lynch.

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Justin Post, BofA Merrill Lynch, Research Division - MD [17]

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A couple of questions on kind of a couple of dynamics in the quarter. First, can you give us any help on acquisition benefit to bookings or EBITDA in the third quarter? And then secondly, you did highlight the headwinds of kind of shutting down some older Web and mobile games. Is that something that will be less of a headwind as you look forward to maybe Q4 or next year? And then finally, just on the new games. Seems like the language maybe in the release has changed a little bit. Has some of that stuff been pushed out a bit? And anything, any titles that you're really excited about for next year?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [18]

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Yes. I'll just start with the overall dynamics of the business. First thing I would say is the themes that we laid out at the start of the year and in our Q4 earnings letter are broadly similar. So back then, we talked about our core mobile bookings growing at in the low double digits. We talked about our Casual Cards acquisition offsetting the impact of older mobile games. And we expected similar headwinds in Web. That is, broadly speaking, how the year is unfolding for us. So that's just a macro point. In terms of our recent acquisition, the Gram Games acquisition, we talked about that being roughly around $10 million of bookings upgrade to our previous guidance. I'll just make the point that excluding Gram Games, we did deliver ahead of our original guidance. And obviously, we delivered ahead of our guidance, including Gram, primarily due to the strength of our core business. What I would say about Gram is, what I indicated back then is the profile of Gram going forward. Broadly speaking, we said roughly $10 million was the impact for Q2. And you can either extrapolate up over an annualized basis to up somewhere between $100 million and $120 million on a natural run rate. I'll leave it there.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [19]

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This is Frank. In terms of the new games, we haven't announced or changed anything in terms of what we've been communicating. We're very encouraged by the fact that the Wonka Sweet Adventure game is in soft launch. It's about 3 months in. We really like what we're seeing in terms of the performance of the software. And we're getting early reads on retention and engagement, and then, there'll be further things that we test as we go on. One of the strengths of the business is that given that the live business is performing well, it does take a bit of pressure off in terms of when we have to release games. So we tend to look at overall KPIs in soft launch to make sure that the games are delivering against their potential in terms of engagement and retention so these can be long-term contributors to the business. And I think that if we can keep live business in '18 cranking, '19 is really the year to start to think about new contributions. We will be announcing more product information on further calls. But as of right now, we're remaining focused on our strategy and what we've communicated.

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Justin Post, BofA Merrill Lynch, Research Division - MD [20]

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And maybe one follow-up. I was just wondering, definitely had some pressure from declines in Web and older mobile games. Is that something you see kind of lessening next year as you kind of clean that out this year?

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James Gerard Griffin, Zynga Inc. - CFO [21]

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Yes. I think you're always going to have a life cycle on games. I think the interesting thing is we look at our portfolio within Zynga, you've got games like CSR2, 2 years after we launched it, and it's having some of its strongest performance. So I think in our core mobile business, we feel good that based on our bold beat strategy, we can continue to drive that aspect of the business. Obviously, we want to add more forever franchises to the mix because that obviously helps in terms of looking at growth for the future. I think on the Web front, we've been pleasantly surprised that it hasn't decayed as much as we originally thought, but it is still decaying in that sort of 20% range. So at some point, that's going to taper off. I think it's got another 1 to maybe 2 years. What I will say about players in that space, they're resilient. And our team in India continue to obviously manage those games and create content that continues to engage those players. But it is a category that's going to expire. As it relates to older mobile, I think we, for the most part, as I said, Gram Games is covering it. (inaudible) Gram Games Casual Cards division is sort of covering off that decline this year. And I think it's not going to be a meaningful one in future years.

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Operator [22]

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And the next question comes from the line of Doug Creutz with Cowen.

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Douglas Lippl Creutz, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [23]

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If I could get a little granular on guidance. First of all, just wanted to confirm. It looks like you Q3 guide suggests that ex Gram, you're expecting the business to be roughly flat sequentially. Secondly, if I look at sort of what that implies with -- for Q4 relative to your low double-digit mobile guide, it does seem that's just you expect some nice sequential acceleration in Q4 beyond what you might see normally due to advertising seasonality. So if you could talk a little bit about what you think could drive that in Q4, that would be helpful.

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James Gerard Griffin, Zynga Inc. - CFO [24]

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I think we do expect some, obviously, improvement quarter-on-quarter as you go through the end of the year. And the main reason we believe that is if we think about our forever franchises, the World Poker Tour bold beat is coming close near the end of the quarter. And we have some other bold beats coming as it relates to Words With Friends, CSR2 also into Q4. So from a bold beat perspective, if you sort of look at the cadence of the bold beats, I would have to say that through the end of Q3 into Q4 that there's some interesting engagement optionality there for players. The other thing is you've got seasonality. As you know, when we look at advertising, we generally see a pickup going into Q4. Overall, we've been very happy with the performance of our advertising business as is evidenced with our performance in Q3. And generally speaking, Q4 is a stronger quarter. What I would say is it will have some interesting comps year-on-year because obviously, we had a very good quarter in Q4 of last year given the launch of Words With Friends 2. But broadly speaking, when we look at our core mobile business, that is progressing nicely. And again, we'll see how Q4 plays out in terms of new. But right now, overall, yes, we'd expect some pickup in Q4.

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Operator [25]

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And the next question comes from the line of Chris Merwin with Goldman Sachs.

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Christopher David Merwin, Goldman Sachs Group Inc., Research Division - Research Analyst [26]

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Just the first one is on the M&A landscape. You've done a number of nice tuck-in acquisitions lately, and this is obviously still a very big and fragmented market. So do you see a lot more opportunities out there to continue doing this type of M&A? Are there certain genres that you're targeting that could be easier to buy rather than build? And just a second question on Facebook, going back to that for a minute. Do the Facebook API changes prevent players from connecting to friends via Facebook? Or are there any major changes there? Or is the issue you described in the quarter purely just a function of Facebook Connect and people logging in to some of your games?

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James Gerard Griffin, Zynga Inc. - CFO [27]

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I think mainly it was friction, just dealing with the Facebook. It created short-term friction in terms of players logging in. And there was additional bugs that were introduced due to the changes Facebook were making. We obviously addressed those in our games, but obviously, it would have been something we could have done without in the quarter. Obviously, the quarter was still a very strong quarter, but in terms of connecting with friends, I don't think that was the main issue. I think it was just more connecting into the game and giving players that additional friction which obviously, as you're on your phone, you don't really want that kind of abuse. Talking about the M&A landscape. From our perspective, we're active in the market talking to both our partners and other peers within the gaming sector. As you've seen through the last 3 acquisitions we've made, they've been very much relationship-based. And we continue to leverage our network into the space and look for opportunities to add quality teams and quality IP into our portfolio. As Frank outlined, we are -- our growth strategy has 4 tracks to it, obviously focused on live, building new games, new IP for franchises, investing and building into new technologies and then into M&A. We're not chasing M&A. We're being very careful in making sure that the IP and the teams we're bringing into the company are teams that we feel can engage in our culture and can grow in our culture. And so far, we've been very happy with the Casual Cards team, the Gram team. We didn't get a team when we bought the Solitaire game, but we're very happy with the game. So from our perspective, we still have a very strong balance sheet. And if we can find ways of converting that balance sheet into additional IP and teams that can help grow the company, we'll do that. But we're not going to chase deals. I think there's a lot of stuff that pops up on our radar that when we look at it, we just -- it just doesn't make sense in terms of the economics. And that's one thing we're going to be very careful is that we're bringing in the kind of assets we like to see in the company at the right kind of valuations.

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Operator [28]

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The next question will come from the line of Raymond Stochel with Consumer Edge.

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Raymond Leonard Stochel, Consumer Edge Research, LLC - Analyst of Interactive Entertainment [29]

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We do understand that you sound most excited about the Merge series. But I know you mentioned the Gram Games hyper-Casual portfolio with 1010. What do you think about that market as we've seen growth from Ketchapp and Voodoo, and your opportunity to grow your portfolio in that market overall? And then do you see any chat app opportunities from the acquisition of Gram Games? We noticed one of your larger Facebook Messenger games is pretty similar to 1010! from Gram.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [30]

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Yes, Raymond, this is Frank. I'll take that question. Yes, there was a -- a big part of the acquisition was thinking about Gram's history in hyper-Casual, the applicability of those games to the new distribution channel on chat as well as looking at some of the SCO-, ASO-driven distribution that you're seeing from the companies that you described. So it's definitely something that we believe is an asset for us as we consider options and our strategy there.

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Operator [31]

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And the next question will go to Ben Schachter with Macquarie.

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Benjamin Ari Schachter, Macquarie Research - Head of TMET Research [32]

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Can you talk a little bit about how your marketing efforts are evolving on mobile? Talk about changes you're seeing in the privacy data issues, pricing, platforms, et cetera, anything there. And specifically, can you also talk about how Facebook opening up more advertising opportunities on chat may impact that business over time? And then separately, just any update on China, given the tremendous growth there we're seeing for China mobile games, any way you guys can benefit or participate in that market?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [33]

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Yes. Thanks, Ben. In terms of our marketing efforts, we have been evolving our UA capabilities pretty aggressively in looking at how to generate the returns that we believe we deserve on our games. So it's really looking at the marketing concept from the perspective of how do we generate organic installs, installs that we don't pay for, and then the paid acquisition component. And the organic piece is the most important in many ways, because there is a level of capability you get with UA. But if you can break through on the organic front, that's where you can really see nice leverage show up in the business and especially on the marketing and sales line. So our marketing organization really starts with how do we generate organic installs. And we include licenses in that mix. We include our relationships with Apple and Google in terms of their merchandising in stores, as well as partnerships and other avenues. And so we really go after that. And then we've been executing on the paid front, as you've seen, but holding that in terms of an affordability point of view. When we look at our overall portfolio of games, there's always an argument to spend paid acquisition, but really being strict about the returns, being strict about the prioritizations and looking at the overall shape of the value that we want to create at Zynga and making sure that, that doesn't become a drain. And that's something that we look at fairly rigorously. Another part of the marketing aspect is lifestyle -- or life cycle marketing. We'll look at, as I described earlier, who are new players, who are existing players, how much are they playing and then also, players that might have lapsed, why did they lapse? And is there a way to bring them back, with something that is really valuable to them? And that becomes part of the publishing, marketing partnership with the game teams and in terms of using consumer insights to prioritize, which bold beats we believe have the highest expected outcomes, and then going after them from a development and marketing standpoint. And that's why you start to see things like the Porsche 70th anniversary and understanding how those cars will activate the audience, or how WPT will inflect on those segments and how it works in UA. And what kind of partnership we can have with the WPT to help grow their audience as they grow our audience? So I think there's a lot of examples I could talk about, but I think that gives you a sense of the spirit of how we go after it. In terms of Facebook on chat, I don't believe that there's really a determined set of advertising or marketing channels developed yet on Facebook Messenger. There's a lot of experimentation to see what works, how discovery works, the changes in the user flow. So I'm hesitant because it's so early to really say one thing is going to happen versus the other, or what's more important. I think that's something that we're learning and why we're excited about chat, but at the same time, need to be cautious about how fast it grows and how monetization grows. In terms of Asia, that is a very significant priority for our company. Obviously, I think it's -- 3 of the top 4 markets in mobile are in Asia with Korea, Japan and China. We're looking at each. They're very different markets. How you go to market there is very different. What intellectual properties work in different markets is also a factor. But I think if you look at one of the things that we really liked about Gram was, how Merge Dragons! was starting to build an audience in those geographies. And so as we look at China specifically, there are certain things in the Chinese market that you have to take into account. And we're looking at partnership opportunities to bring the intellectual properties that make the most sense for Chinese gamers and finding the right partner and going after it. There is a huge opportunity in China, but just rushing in and not being patient and having the right partner will lead to failure and a lot of money lost. And so we're taking a very patient, go slow to go fast approach in China. But we are looking at Korea, Japan, Southeast Asia in addition to the China opportunity to grow our geographic locations.

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Operator [34]

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And the next question will come from the line of Mike Hickey with Benchmark Company.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Research Analyst [35]

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Two questions for me. I guess, one, just maybe some charity on Gram Games and Merge Dragons!. I think Merge Dragons! is sort of the vast majority of the economics as you think forward. And so I'm a little bit curious why you're not more confident, I guess, that this is not -- or that this is could be, I guess, a forever franchise. So I'm just curious why there's some uncertainty there. And if you're having player retention issues here in Q3. And I have a follow-up.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [36]

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Mike, thanks for the question. In terms of Gram Games, let me just clarify something. Gram Games is more than just Merge Dragons. It's the hyper-Casual products like 1010! and Six!. It's Merge Dragons!, and it's also a pipeline of future intellectual properties using games that we're very excited about. So it's not just a 1-product shop. The second issue is we are confident that Merge Dragons! can be, become a forever franchise, and we are investing and partnering with Gram with that concept in mind. So if there's any sense that we're not confident in that, let me correct that. Because we believe that on future earnings calls, we'll be talking a lot about Merge Dragons! right alongside Words With Friends and Poker and CSR2. The game really has demonstrated some very strong mechanics, momentum, connection with players. And we have a robust lineup of bold beats planned for the game, both short term and long term. So we're very excited and very confident in Merge Dragons!.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Research Analyst [37]

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Okay. The next one, the Social Slots portfolio. Maybe you could speak to sort of the general complexities of trying to grow your category of games or portfolio of games within this genre. And then, I guess, strategically I'm sort of a little confused on the strategy. It sounds like you want to have fewer Slots games. But I think you also have at least one in your pipeline. So maybe just sort of your macro view of competing in this genre and what you're doing strategically to try to grow it, because I think it's been declining a bit here for a couple of quarters.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [38]

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The Slots portfolio is composed of 4 key games that we're excited about, which are Hit It Rich!, Willy Wonka, Wizard of Oz as well as Black Diamond. And what we've been focused on inside those games is adding features and systems that drives higher levels of engagement, retention and monetization. There's a -- it's -- the category is very UA-intense, but if you participate in the UA without having the LTVs or the engagement metrics, the monetization metrics, we're not in a position to be an effective competitor. So what we've been doing consciously is trading off top line growth to generate bottom line growth and focusing in on generating the types of returns and engagement retention metrics that we believe we need in order to compete. So it's been down, but it is sustainable business and it's been flattish. And in fact, if you look at Hit It Rich! and the Wizard of Oz products, they were actually up this quarter, in terms of their top line. So it is a portfolio, it's not just one franchise. And overall, though, we are focused in on the retention, engagement and monetization effects. It is a category that if you get it right, it can be very lucrative. And we think that we've made significant progress from the beginning of the turnaround to now, to making the Slots business a sustainable, profitable contributor to Zynga's growth. At some point in the future, we'll be in a position where we can start to look at growing the business from where we are now. But right now, we still think that there's some room to grow in terms of the monetization metrics and the engagement and retention metrics.

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Operator [39]

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And our last question will come from the line of Rich Greenfield with BTIG.

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Richard Scott Greenfield, BTIG, LLC, Research Division - Co-Head of Research, MD and Media & Technology Analyst [40]

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I got 2 questions. I know it's been a long call. Just real quick. You mentioned that DAUs were down. You gave 2 key reasons, one being Facebook, but the other being sunsetting of games. I was wondering, if you look at just light games, so games that existed in the year-ago quarter, is there any way to think about what the trends in DAUs were organically, or from kind of -- you looked at a kind of a same-store sales like way of thinking about it. What DAUs from ongoing games were, and maybe put another way, is there any way to think about kind of overall time spent? Are you seeing more time spent with your ongoing games this year than last year or even sequentially from quarter-to-quarter? And then I've got a quick follow-up after that.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [41]

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Thanks, Rich. It's been a good call, so it doesn't feel long at all. So I would like to start with your first question on DAUs. And I think one way of answering your question directly is look at MUU, and that's at $53 million right now. It's up 2% quarter-over-quarter and 1% year-over-year. So those represent the players that are in the games. And when you look at recent M&A, they're largely excluded from MUU. So that gives you a good sense of what the thinking on acquisitions and that sort of thing and the sustainability, and it takes out chat as well. So that $53 million MUU number gives you a sense of the health of our overall base. And it's one of the reasons why even with the sequential setback, but the strong year-over-year growth, we feel pretty good. I mean, we feel like we had a, there was a hiccup in the quarter. We responded, and now we're moving on. And we're just trying to very upfront about what happened to the number and why in the quarter. But we don't believe this is an ongoing problem for us.

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Richard Scott Greenfield, BTIG, LLC, Research Division - Co-Head of Research, MD and Media & Technology Analyst [42]

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Then the other question is, if I think about Q1, I know you haven't released your Q yet. But in Q1, your top 3 games, Poker, Words With Friends -- sorry, Poker, CSR2 and Slots, roughly, I think you put in the Q was 45% of revenues versus 44% last year. Is that type of concentration -- are you seeing any type of change in that? And should we expect really no change to what that looks like until we get into 2019, when some of the new games start to have more of an impact? Just wondering how we think about that, the kind of the lopsidedness of your revenue right now.

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James Gerard Griffin, Zynga Inc. - CFO [43]

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I think the overall shape of the forever franchises includes what is basically Poker, Slots, Words With Friends, CSR2, if you put those together, the overall shape of those will be broadly similar. I think within that portfolio, you may see certain games grow at a stronger clip like right now, Words With Friends is doing very nicely given it's coming off its recent launch. But in terms of the overall shape, and contribution of those games, yes, they are the critical mass of our business. They're the core element of our mobile business.

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Richard Scott Greenfield, BTIG, LLC, Research Division - Co-Head of Research, MD and Media & Technology Analyst [44]

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Is there anything else getting close to get, to breaking into that, where you'd actually need to disclose the revenue?

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James Gerard Griffin, Zynga Inc. - CFO [45]

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We'll see over time. As Frank mentioned earlier, Merge Dragons! is on track to become a forever franchise, which will put it into that category. And obviously, as we start launching new games, initially, those games will obviously, they'll need to ramp. But the reason we're taking our time with new game development is, we want to give our projects the best chance of becoming forever franchises. And so it's not about a machinegun approach, just spewing a bunch of things out there. We're taking our time, and as we look at this business going forward, you can technically grow on a volume basis by putting a lot of stuff out there, and it'll look okay. But the challenge with that is you need to invest in marketing. (inaudible) you need to invest talent against it. We're taking the approach that, in particular over the last year or so, where we had high-potential franchises not getting the right level of attention, we needed to start there and now we're building into new games and into new platforms.

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Operator [46]

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Thank you. And this does conclude today's question-and-answer session. I'd like to turn the conference back over to Ms. Rebecca Lau for closing remarks.

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Rebecca Lau, Zynga Inc. - Director of IR & Corporate Finance [47]

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Great. We want to thank everyone for joining our earnings call today, and we look forward to connecting with you folks over the coming weeks.

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Operator [48]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude your program. You may now disconnect. Everyone, have a great day.