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Edited Transcript of ZNGA earnings conference call or presentation 2-May-18 9:30pm GMT

Q1 2018 Zynga Inc Earnings Call

San Francisco May 9, 2018 (Thomson StreetEvents) -- Edited Transcript of Zynga Inc earnings conference call or presentation Wednesday, May 2, 2018 at 9:30:00pm 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

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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

* Dae K. Lee

JP Morgan Chase & Co, Research Division - Analyst

* Douglas Lippl Creutz

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

* Eric James Sheridan

UBS Investment Bank, Research Division - MD and Equity Research Internet 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 and Senior Research Analyst

* Richard Scott Greenfield

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

* Stephen D. Ju

Crédit Suisse AG, Research Division - Director

* 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 First Quarter 2018 Earnings Results 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, [2]

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Thank you, and welcome to Zynga's first 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'll 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 our risk factors in our most recently filed Form 10-K 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 webcasted 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 call. Zynga had a great start to 2018, outperforming guidance in the quarter across all key financial measures and delivering our highest mobile audience in over 4 years. We're pleased with the player engagement we're seeing in our forever franchises, and we're well on our way to achieving our near-term margin goals.

Before we detail our Q1 performance, today, we announced that Mark Pincus, Zynga's founder, has converted all of his high-voting shares into our Class A common stock. This decision enables us to simplify our stock structure and move from a multi-class to a single-class structure. Mark's share conversion establishes voting rights parity for all Zynga shareholders, creating a 1 share, 1 vote structure. While there's no change to Mark's economic interest in Zynga, his decision reduces his overall voting rights in the company from approximately 70% to approximately 10%. Moving forward, Mark will continue to serve on Zynga's Board of Directors as nonexecutive Chairman. We welcome this decision as a significant sign of confidence from Mark in Zynga's future growth prospects.

Turning to our Q1 financials. Revenue was $208.2 million, and bookings were $219.5 million, both ahead of our guidance. We continued to improve our profitability, moving from a net loss of $9.5 million in Q1 2017 to net income of $5.6 million this quarter, an improvement of $15.1 million and ahead of our guidance. Our positive performance in the quarter was driven by growth in our forever franchises, in particular, CSR2 and Words With Friends, as well as our recent Casual Cards acquisition, which has been a great addition to our live services portfolio.

Our mobile momentum also continued with mobile revenue up 13% year-over-year and mobile bookings up 10% year-over-year. We significantly increased our mobile audience from 18 million average DAU in Q1 2017 to 23 million this quarter, up 24% year-over-year. Our Q1 performance is an example of our team's execution against our growth strategy of focusing on our live services, launching new games, investing in emerging platforms and accretive M&A.

First, we're committed to delivering growth in our live services, and CSR's performance in the quarter shows what's possible when our forever franchise teams deliver on bold beat innovation. Last quarter, we released a new event series with Universal's Fast & the Furious that gave players the opportunity to acquire the most in-demand cars in the history of this blockbuster franchise like the Honda S2000.

Additionally, in Q1, we deepened our auto partnerships and worked with the Lamborghini to release 2 new vehicles in CSR2 that were timed with the real world launches of these supercars at the 2018 Geneva International Motor Show. These efforts drove 2% year-over-year revenue growth and 25% year-over-year bookings growth, highlighting how innovation in our live services can contribute to strong year-over-year growth.

Second, we're focused on building new games with the goal of creating new forever franchises. Our latest release, the successful sequel, Words With Friends 2, benefited from strong momentum following its holiday launch. We saw continued player engagement in our boost features like Tile Swap, Hindsight and Word Radar as well as new features such as Solo Challenge and Lightning Round, which have delivered players more value and enhanced their game experience with friends and family.

This new game continues to capture the attention of new and lapsed players, increasing engagement overall. As a result, average moves per DAU were up more than 20% year-over-year, and we increased mobile average DAU by 8% year-over-year. Words With Friends delivered mobile revenues up 18% year-over-year and mobile bookings up 32% year-over-year, highlighting our team's ability to launch new games to strengthen our portfolio of forever franchises.

In addition to Words With Friends 2, we have new games in development in the Action Strategy, Casual, Invest and Express, and Social Casino categories. We expect to launch new titles in some or all of these categories beginning in the second half of 2018 and continuing into 2019 and beyond. Today, we're excited to share that we've entered into soft launch with a new Casual mobile game, Willy Wonka's Sweet Adventure, which combines Match-3 and builder gameplay to innovate within the popular Match-3 genre.

Third, we're continuing to innovate and engage with new audiences on emerging platforms like chat. While we don't expect monetization to have a meaningful impact in 2018, we see a big opportunity to make social gaming more accessible. Our approach is to move fast and apply proven mechanics, simple design and lightweight tech to iterate quickly and determine what's resonating with players. We're starting to see chat platforms have a positive impact on our audience. In fact, chat audiences were a key contributor to growing our overall mobile average MAUs 30% year-over-year, from $63 million in Q1 2017 to $82 million in Q1 of 2018. In the coming quarters, we expect to accelerate our launch cadence with chat games on Facebook Instant Games, which could cause our average revenue or average bookings per DAU metrics to fluctuate over the near term.

Fourth, as we've shown through our recent Casual Card acquisition, we'll use the strength of our balance sheet and positive cash flow from operations to execute M&A opportunities that will enhance our growth potential. Q1 marked the first full-quarter contribution from the Casual Cards acquisition. Our Istanbul studio team is -- is meeting our expectations, and we're pleased with their successful integration into our publishing and studio operations. Looking ahead, our Istanbul team will continue to focus on delivering world-class experiences to our Casual Cards game players through new content and innovative bold beats. We'll continue to take a diligent approach towards M&A, prioritizing opportunities that are accretive to our near-term margin goals and create shareholder value.

In summary, we are proud of the way that we have started 2018, and we're confident in our performance and execution in the year ahead. We're excited about how we're bringing to life our growth strategy as we continue to prioritize delivering value to our players and shareholders over the long term.

With that, I'd like turn the call over to Ger, so that he can further discuss Q1 results and our Q2 guidance.

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

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Thanks, Frank. We've kicked off 2018 with another strong quarter as we continue to progress towards our near-term margin goals. Our delivery was driven by strong player engagement and monetization across our live services, coupled with effective cost management. Our revenue and bookings both exceeded our guidance. Revenue, which is comprised of the net change in deferred revenue and bookings, was $208.2 million, $8.2 million ahead of our guidance and up $13.9 million or 7% year-over-year. The change in deferred revenue was a net increase of $11.3 million versus our guidance of an increase of $10 million. The increase in deferred revenue was primarily driven by the first full quarter of bookings from our Casual Cards acquisition.

Bookings were $219.5 million, $9.5 million ahead of our guidance and up $12.1 million or 6% year-over-year. Our top line beat in the quarter was driven primarily by better-than-expected monetization across our live service portfolio, in particular, CSR2, Words With Friends and our recently acquired Casual Cards portfolio.

Taking a minute to double click on mobile, which now represents 88% of our revenue and bookings. Mobile revenue was $182.6 million, up $21 million or 13% year-over-year. Mobile bookings were $193.4 million, up $17.3 million or 10% year-over-year. Mobile user pay revenue was $139.8 million, up $12.6 million or 10% year-over-year. And mobile user pay bookings were $150.4 million, up $10.3 million or 7% year-over-year.

This performance was driven by a full quarter contribution from our Casual Cards acquisition and double-digit growth collectively across our forever franchises, partially offset by declines in older mobile games. Mobile advertising revenue was $42.8 million, up $8.4 million or 24% year-over-year, and mobile advertising bookings were $43 million, up $7 million or 20% year-over-year. This growth in advertising was driven primarily by Words With Friends and Solitaire.

Turning to our Q1 operating expenses. GAAP operating expenses were $134.9 million, down 2% year-over-year, representing 65% of revenue, down from 71% of revenue in the prior year. Stock-based compensation was $14.1 million, down 19% year-over-year, representing 7% of revenue, down from 9% of revenue in the prior year. Non-GAAP operating expenses were $120.3 million, down 1% year-over-year, representing 55% of bookings, down from 58% of bookings in the prior year. All of this contributed to a net income of $5.6 million, $10.6 million ahead of our guidance and an improvement of $15.1 million year-over-year.

Our adjusted EBITDA, which includes $11.3 million of a net increase in deferred revenue, was $26.6 million. This was above our guidance and up $9.9 million year-over-year.

We had a net use of operating cash flow of $3.9 million as compared to a net use of $4.7 million in the prior year quarter. This year's cash flow was negatively impacted by a onetime legal settlement payment of around $11.9 million. We ended the quarter with cash and short-term investments of $635 million. And today, we announced a new $200 million share repurchase program. This program follows the completion of our existing $200 million program, where we repurchased 67 million shares at an average price of $2.99 per share.

And now to Q2 guidance, which is as follows: revenue of $208 million, a net increase in deferred revenue of $10 million, bookings of $218 million, net income of $1 million and adjusted EBITDA of $27 million. Some additional factors to consider in assessing our Q2 guidance include the following: We expect Q2 to be similar in profile to the performance we delivered in Q1, driven by our live services and our planned cadence of bold beats against those live services. Similar to Q1, we anticipate our year-over-year growth to benefit from a full year contribution from our Casual Cards acquisition. We expect low double-digit growth collectively across CSR2, our Social Slots portfolio, Words With Friends and Zynga Poker. This growth will be partially offset by declines in Web and older mobile games. We expect our gross margins and operating expenses to be broadly in line with Q1 levels.

With respect to fiscal 2018, we continue to believe that our financial performance in the year will broadly follow the financial themes we outlined in our Q4 2017 quarterly earnings letter. In particular, we remain on track to deliver low double-digit growth in mobile bookings and expect live services to deliver more than 95% of our revenue and bookings. We remain on track to achieving our near-term margin goals and are committed to delivering margins more in line with our peers over the long-term.

In summary, we're proud of the way we started 2018 and are confident in our performance and execution ability in the year ahead. We're excited about how we're executing against our growth strategy as we continue to prioritize delivering value to our players and 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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So with Fortnite and PUBG recently coming to mobile, I'm just curious if you've seen any measurable impact to your business. What's the audience overlap there, if any? And then maybe just broadly speaking, I'd love to hear your thoughts on competition as publishers bring established gaming franchises to mobile.

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

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Thanks for your question, Tim. This is Frank. We've seen no impact on our business from Fortnite and PUBG. In fact, we like the fact that there's new innovation and a new genre on mobile in shooters and bringing new audience to play there. The fact that you can play across platforms as an innovation that I think is drawing a lot of attention to mobile as a destination gaming platform. The audiences that we serve with our game services, we've seen no impact from those 2 games. We are excited about the attention it brings to mobile. In terms of the second question, we're a big believer in big brands and big IPs. We think that those are the way to generate audiences, both organically and to sustain them over the long term. We have a lot of brands in our company's history and portfolio, like FarmVille, like CityVille, obviously, Words With Friends, CSR2, Zynga Poker. So we're big believers in that type of brand power coming to mobile. More console brands or PC brands coming over is, again, I think it's great to establish mobile as a destination gaming platform. And as the devices get more and more capable from a performance standpoint, it's really going to blur the line between traditional gaming platforms in mobile as a place to spend your time and money.

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Operator [4]

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And the next question comes from the line of Eric Sheridan with UBS.

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Eric James Sheridan, UBS Investment Bank, Research Division - MD and Equity Research Internet Analyst [5]

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Maybe 2, if I can. You continue to show nice progress in terms of leverage, getting increased leverage in the business on the margins side of the equation. Maybe talk a little bit, question one, about leverage, how we should think about that going through the model going forward versus the demands for capital, the demands for OpEx inside the business model, where you want to make those big bets for the medium to long term? Second, we got a lot of questions from investors intraquarter on the federal court ruling with respect to Social Casino. Just want to know if you had any comment there or a way in which investors should think about that.

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

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Thanks, Eric. This is Frank. I'll start with the Washington State Social Casino question and hand off to Ger for the leverage in the margins topic. At this time, we don't foresee any material impact on our business from the Washington State ruling. It goes against precedent decisions, in our view and in the view of many. It's something that will take years to resolve, and we'll continue to watch. For our perspective, the business risk is extremely low. Less than 1% of our total bookings are Social Casino in Washington State. Other states have different positions on this issue. So from our perspective, it's a very narrow issue. It's a very manageable issue, and it's one that's going to take a lot of time and not have an impact on Zynga.

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James Gerard Griffin, Zynga Inc. - CFO [7]

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Eric, it's Ger. In terms of leverage, the way we think about it is we spent the last few years rightsizing the ship and refocusing the company in terms of our investment against live games and new development. And we feel good about the shape of our operating structure to support our live portfolio, in addition to innovating into new games and innovating into new areas like chat. As we think forward, we're looking to drive scale. We're looking to continue to drive strong bookings from our live business, obviously, get a contribution from new games as they come into the live portfolio over time. And we believe that's what will drive an improvement in our margins over time. We will also leverage the balance sheet to add talented teams and IP into our portfolio with the same ambition, obviously, is to drive stronger growth and a stronger appeal for our player base, so that we can continue to drive a strong bookings growth and then, obviously, a stronger margin profile. And we're very happy at the progress we're making against that, and looking forward to showing more of that over the course to come.

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Operator [8]

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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 [9]

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My first question is maybe a follow-up on the Social Casino and more specifically on Poker. You didn't talk as much about the product development roadmap for that title. Is that reflective of the maturity of that game or maybe a changing approach to the franchise? And then secondly, I wanted to ask about the Instant Games in Messenger. Are you seeing that more as a customer acquisition vehicle? Or do you see the monetization capabilities unfolding? And long term, what's sort of context should we think about that platform relative to other platforms?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [10]

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Thank you for the question, Colin. On the first one, I think when you look at Poker, we have a lot of bold beats planned for the franchise. It's very healthy and doing well. In the second half, we have -- we've announced in the past with World Poker Tour, it's going to be a major bold beat for us in the second half. We have a lot of features planned to be able to flesh out that tournament structure in the ways that you can compete in Poker and grow it into the second half of the year. It's done very well in the first half of the year. We just have a lot of news today to get out. So the absence of Poker wasn't a communication there. In terms of Instant Games in Messenger, it is a pre-monetization platform. But what we like about it is that it's a new channel on mobile. The most social part of the phone is in chat. That's where people like to spend their time. And it's becoming more and more technically capable to entertain people there. And so as we look at Facebook Instant Games as well as some of the other investments, some of the other social platforms we're making, we see a real opportunity to reach a younger audience, an audience that engages with games in a -- on a more frequent basis. And they're also lighter, more bite-sized games that appeal to that audience. And so we found actually with Words With Friends on chat versus Words With Friends in native is that it's a different audience. It's younger, more male. It engages differently in terms of its dynamics. But overall, they love playing games in chat. Facebook and others will start to develop, and there's been some recent announcements on how they propose to monetize the platform. But one of the things we really like about it is it's an organic acquisition channel. We're able to bring players into the games without resorting to paid acquisition like you sometimes have to on native. And we believe that pursuing the high velocity release schedule that we have for a lot of our games, we're going to be able to build a very nice position on those platforms, a very nice audience that we'll be able to introduce new experiences over time and innovate for the long term. So we see it as an innovative channel within mobile. And it is the third leg of our 4-point strategy in that we want to always be in position for the platform transitions that come within mobile. Whether it's chat becoming a gaming platform, whether it's 5G, AR, VR, we're constantly experimenting and looking at those new opportunities for growth.

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Operator [11]

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And 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 and Senior Research Analyst [12]

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I had a couple of questions. First, DAU was up a lot on the Casual Cards acquisition. But ABPU was down a bit. And I missed the prepared remarks, so apologies if you mentioned it. But first of all, why was that the case? And then secondly, just any thoughts on over what time period you'll execute the $200 million share repurchase program. Maybe you could remind us how long it took you to work through the previous $200 million authorization.

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James Gerard Griffin, Zynga Inc. - CFO [13]

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Well, I'll start with the share repurchase. The first share repurchase we announced was when I joined. It was my first quarter. So we did it in just over a year, that was 1.25 years. So as it relates to this one, it really will depend on ultimately the market in terms of the share price out there and our ability to execute against it. The first one, we essentially got it done in essentially 1.25 years at an average price of $2 99, so we feel really good about that given where we believe the stock should be. In terms of the DAU question, could you just repeat that again, please?

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Michael Joseph Olson, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [14]

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Yes, it's really more around ABPU. So the DAU, I was just mentioning, was up a lot, and that was explained by the Casual Cards acquisition. But why was ABPU down, is basically the question?

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

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I think one of the things Frank talked about earlier, as we think about audience, we're growing our chat audience, which is -- it's great groundbreaking in terms of building, obviously, new players into our ecosystem. But those players are not monetizing at the moment, so it is diluting the overall average.

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Operator [16]

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The next question will come from the line of Justin Post with Merrill Lynch.

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

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Wanted to ask about the new franchises and whether you think about these incremental titles over the next 1.5 years as kind of big brand-,new franchises or kind of more incremental on the franchises you have. How are you thinking about that? And then on the R&D, it's nice to see the leverage there. You got it down to $61 million. With a lot of potentially new stuff and bold beats coming over the next 12 months, how do you feel about where you are with that $61 million now? And where it could go in the future?

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

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Thanks for the question, Justin. I'll take 1, and Ger can talk about number 2. In terms of new franchises over the next 1.5 years, we're looking at a portfolio opportunity there. There will be titles that will be released, that will be original IPs that haven't been seen before. There will be brands that we have brought back from the Zynga vault, in categories where we've been successful in the past. We've been very open about the idea that we want to get back into the Invest Express category, where CityVille and FarmVille have traditionally been very successful, so you'll see new products in that category. In addition to that, we are looking at strategic licensing as an opportunity. We feel that there's room in our portfolio, and we have audience adjacencies that lends itself to pick up some additional licenses. Obviously, we announced today and in -- that Wonka’s Sweet Adventure is in soft launch right now, which is a Match-3 game but uses some of our experience in builders. And so it gives an all new experience there, but it's a brand that we've been successful with in the past that we've built an audience with. So it'll be a mixture of adjacencies, all new titles, strategic licenses and sequels.

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James Gerard Griffin, Zynga Inc. - CFO [19]

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Just in terms of the R&D leverage, as I said in one of my previous answers, we're very happy with the efforts we've taken to essentially sharpen the operating model across the company. As it relates to R&D, we spent a lot of time focused on the core talent, realigning our focus within live and within new. As we think about that going forward, the core studios we have in the company right now are, obviously, driving the momentum you've seen in our live business, but they're also building games in the 4 genres we're operating in. So we have the capability today to support our live business to build new games and also to invest in new areas like chat. So we feel good about that. I think over time, as we add more games to the portfolio, we potentially acquire additional studios. You may see a tick-up in that absolute dollars. But I think from an operating leverage perspective, we feel like we're in a good place, and we obviously continue to manage that business very carefully. One of the things that Frank and I and Matt Bromberg, our COO, and our senior leadership, have a lot of experience in is making sure we're managing the role-on and the roll-off of teams from new into live and then, ultimately, into new projects. And that's -- there's a lot of focus in that area. I think the development framework that we've put in place is a solid one. It's one we've used in our past lives. And so as you look at the future, we are going to focus continually on our live business, new bold beats, building new games and, obviously, investing into new areas.

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Operator [20]

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And the next question will come from the line of Doug Creutz with Cowen and Company.

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Douglas Lippl Creutz, Cowen and Company, LLC, Research Division - MD and Senior Research Analyst [21]

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I noticed on the last couple of quarters, the Web portion of your business seems to be just about flat sequentially, which is a pretty noticeable change. Is that something sustainable? Is it something you're doing something differently? Any color you can add there would be helpful.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [22]

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Doug, we're -- as we've said in the past, we do expect our Web business to decline. However, we're not giving up on those players. We -- just like our players on the mobile side, we continue to focus on bringing entertaining games to them. And what we found is when you look at Q1, in particular, our Web business performed well. It still declined overall. In terms of 21%, or down quarter-on-quarter 6%. But our aim there is to continue to excite and delight those players. It's a fairly core audience at this point. And I think with the challenges around Flash, we obviously still believe there's choppy waters ahead as we go through the year. But again, just like other parts of our business, we're very much focused on the player. And what I would say is right now, it's -- that's an audience, if you're still playing on Web, you're going to hang around. And as long as you keep bringing compelling content to them, I think we've got an opportunity to sustain it. However, the Flash issues and the deprecation is probably the biggest issue we see in the future as it relates to that business.

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Operator [23]

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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 [24]

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First of all, on Words With Friends 2, you did a good job at showing a blend of in-game bookings and monetization and advertising. Where -- you didn't talk about the other franchises. Talk about the potential to sort of develop a dual revenue stream model across some of the other franchises you have. And then secondly, it's good to hear about investments you're making on existing versus new IP. Is there any way you can help us going to understand as the level of investment in the new IP now just so we can certainly understand for investment spend versus core spend? And lastly, really fast, any updates on new potential financing arrangements around the building?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [25]

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Yes, I'll take number 1, Brian. So Words With Friends 2 was always an ad-driven model. And this year, we innovated with some new features that allow players to get engaged in the game in new ways like with the boost system that we created around Tile Swap, Hindsight and Word Radar. And those have been proven to be very popular, especially when you look at some of the new multi-player modes, we've added like team battle. That has been something that has helped really drive engagement, but also, it's created value inside the game the players are really excited about. Engagement within Words With Friends 2 is up 20% year-over-year, which is a phenomenal result. So I think our ambition to create a more diversified kind of stream business from Words of Friends is well under way and doing well. We also look at our other IEP businesses, things like CSR2 or Zynga Poker, and we look for opportunities for advertising there. Our advertising business year-over-year is up double digits and doing quite well in the first quarter. A lot of that has to do with the optimizations that we've been doing, adding new inventory and looking at ways that we can better serve advertising to our players in a way that enhances engagement in the gameplay. We always operate with -- one of our players thanked us for a player-first orientation. But what we have found is that Watch to Earn as an add unit, for example, drives engagement. So we are actively looking at that, in addition to what we've been doing with IEP and inside Words With Friends.

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James Gerard Griffin, Zynga Inc. - CFO [26]

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Brian, on your new IP investment, I think that what I would say is sort of what I said earlier in some of the other questions is we look at our R&D investment and our talent pool holistically. And right now, we feel like we've got the right shape to deliver growth off of our life portfolio that we have in the market today, and that includes the Casual Cards acquisition. And it also gives us the ability to build games in the 4 categories we're operating in, in addition to chat. So it's very important, obviously, in the development of organization to make sure you've got a lot of good creativity going on to keep the teams focused on innovating within their games, and that's what we're doing. In terms of the overall shape of that spend, the only reason that spend should grow in absolute terms is if you add more studios into the mix either through acquisition or through building out new studios. The profile is different, obviously, by studio. If we were in Helsinki right now, that team they're totally new. They're building a new game, and they're very much focused on that. But if you go through our studios in London, they're managing live businesses like CSR2, Dawn of Titans, but they're also building innovative new IP in the Action Strategy category for release sometime in the future. So it's a mix. What I would say to you is if you look at our P&L today, I like the shape of that P&L. And I think the main variability in that P&L on the operating spend is more around marketing as we inflect that in absolute terms against growth on bookings and on a percentage basis, looking to drive efficiency. Oh, sorry, the building. Excuse me. On the building front, I've been here now 1.5 years. And I think one of the first questions I got from an investor is, what's going on with the building? And since then what's going on with the building is it's appreciated in value. It's now a cash-generating asset. And we're happy with, obviously, the value that, that creates for our shareholders and for Zynga. But we continue to evaluate other ways to optimize the building. But for now, we're happy with that.

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Operator [27]

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The next question will come from the line of Chris Merwin with Goldman Sachs.

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Christopher David Merwin, Goldman Sachs Group Inc., Research Division - Research Analyst [28]

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Just have a couple of questions. So in the letter, you talked about the mobile ad market being competitive and price-sensitive, but you also saw solid growth for ad bookings in the 1Q. And, Frank, I think you talked about some of the reasons for that. So in light of those comments, can you help shed some light on the trajectory of ad bookings going forward in the context of your 2Q guidance and beyond as well? And then just a second question. You mentioned your intention to leverage balance sheet for M&A. You just, obviously, completed 1 acquisition. Are you looking to expand into more genres? And did anything change in the competitive environment? Or what are you seeing with the private companies that made M&A more of a focus as of late?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [29]

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Yes. I'll start with the M&A question. Then Ger can talk about advertising as it relates to guidance. Look, the M&A, M&A as an opportunity within mobile has always been hot. It's a very large global development community that has a lot of change in it. And so from our perspective, we've always been interested in growing the company through acquisition if we find the right team with the right talent, the right cultural fit, with franchises that fit in with the Zynga mission of social gaming. Obviously, we have a very large casual offering, and we have a very large player base that are women. So we tend to look at acquisitions that are able to fit into that overall construct. And so we've been participating, ever since we started the turnaround, in looking at opportunities. We just have been very disciplined about not being overly fixated on growing through M&A and trying to get the organic growth part of the business going, which has been our focus over the last 9 quarters. And then be able to plug in the inorganic opportunities as we've seen fit. We've done 2 acquisitions, the Solitaire business as well as the Casual Card games out of Turkey. So I wouldn't say that our activity in M&A has increased. I would just say that we continue to look at it. And when we find the right opportunity that's accretive, that fits with our culture, that is on the same mission that we are, we feel like we should be able to execute on that. And it feels good to have the momentum inside the company now because there's a lot of good conversations inside the industry going on right now about how things are going to evolve. But overall, it's -- after we focus on live games, then we focus on new games, then we focus in on chat, and then we finally get to M&A in terms of how we spend our time and prioritize.

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James Gerard Griffin, Zynga Inc. - CFO [30]

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Yes, I would just add that when you're in a company that's got momentum and particularly in the creative industry like ours, acquiring talent, whether it's organically through people joining the company or through acquisition, is a lot easier. So we do see opportunities out there. But to Frank's point, we're being very judicious in terms of looking at what we want to bring in to the company. In terms of the ad market, I will continue with my position that it is a competitive space. We had a very good Q1, and that was down to obviously the power of Words With Friends and the innovation we've put into that brand and the rejuvenation of the franchise plus Solitaire. As I think about the year, ultimately, we expect to grow our advertising business over the course of the year. We do expect it to be competitive. But the one thing we will continue to do is look for our relevant addressable audience against our advertising business model and ways to optimize that audience as it relates to the inventory we have. So right now, we expect to grow it. I would say it's in that sort of low single digits right now. But again, I do believe it's one of those areas where you're going to see ups and downs. Right now, we feel good about our advertising business, and we expect to grow it over the course of the year.

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Operator [31]

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The next question comes from the line of Mike Hickey with Benchmark Company.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Research Analyst [32]

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Two for me. I guess, first, on Peak, if you could maybe size the contribution in the quarter. Obviously, I wouldn't ask you to do that on an ongoing basis. But perhaps, it's helpful, as a starting point, in bookings and DAU. And I'm also curious if you're including that within Zynga Poker, if you were to strip that out, if you're still able to grow Zynga Poker sequentially or year-over-year. And the second question, on FarmVille, tell me if this was asked, but obviously, this has been deteriorating year-over-year for a while, it looks like. But pretty aggressive fallback here in Q1. Just any insight there on why you're seeing what looks to be a little more aggressive deterioration from FarmVille.

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

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Mike, this is Frank. I'll start with the -- talking about Peak a little bit. In terms of the over performance in the quarter, it had a lot more to do with the CSR2 and Words With Friends 2, and Peak was a contributor in that mix. It did help on audience, certainly, on the MAU front. But chat and also the growth in Words With Friends was a good one. Poker did grow in the quarter, so that is not being impacted on a negative front by our expansion in the Casual Card games. It was up 7% year-over-year in bookings and up 13% year-over-year in revenues, with a focus on the second half around the World Poker Tour being our big issue there -- or big opportunity there. In terms of the FarmVille fallback, actually, Country Escape grew in that period of time. It was the Web that saw a lot of the headwinds. Tropic Escape has also done okay and held its own on native. But with FarmVille 1 and FarmVille 2 on the Web, it's operated out of our India group, and we're doing a very good job updating that user base with new content, new ways to play. But overall, there's a decline there happening with regards to the overall platform structurally as well as things like the deprecation of Flash, having impact on installs, et cetera.

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Operator [34]

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The next question will come from the line of Douglas Anmuth with JPMorgan.

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Dae K. Lee, JP Morgan Chase & Co, Research Division - Analyst [35]

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This is Dae Lee for Doug. So my question first is how we should think about the timing going from soft launch to full launch? And then second, can you help us understand how resource [and tested] messaging game parts are? Would they be similar to a big bold beat or is it more closer to new launches? Just trying to gauge how fast you can move there.

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

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This is Frank. The messaging game development model is very efficient. You're talking about very small teams, less, sometimes, single digit in terms of the number of people. They can be very fast in terms of how you can bring them to market and develop them. So really comparing them to native is not a good comparison. They're very -- they're a lot smaller, a lot faster, and you're able to fully fund those in a way that is already included in the R&D discussions that we've had and a bit demonstrated. In terms of soft launch to full launch, in terms of the process there, what we're trying to do is go into soft launch with more robust games, so that we can have very clear reads on the game as quickly as possible. We also want to find the fund, frankly, earlier than going into soft launch. So we tend to have some benchmarks of 6 months to a year for soft launch. But really, the focus is on long-term engagement. And when you feel like the core loop is in a -- is in good shape and able to generate an audience that would then retain, and we'll look at organic to paid ratios of acquisition. We'll look at a lot of different metrics. But honestly, it's when quality and engagement are where they need to be, that's when we'll come out of soft launch. That doesn't mean that we want to have soft launches that extend past -- much past a year. But if the model makes sense in terms of a small development team that's iterating, that's kind of the beauty of mobile. We have lots of different ways to come to market. And the only thing I would remind in the context of this question is the reason we're still focused on growing the company through live services is that we aren't reliant on the new games delivering 1 quarter or another. We're going to consistently grow our audience, our profitability and our top line by focusing in on growing live services, so that when we layer in a new release, like a Wonka's Sweet Adventure or some new game that we haven't announced yet, those will then be added as an incremental to the portfolio as opposed to us having to bank a quarter on a new launch or not. And so I just want you guys to understand our mindset and our orientation that launching new games on mobile is a difficult endeavor, and you really need to be able to take the right amount of time and focus in order to really pull that off.

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Operator [37]

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The next 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 and Technology Analyst [38]

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You were mentioning before the $2.99 average purchase price for your stock was pretty compelling. Wondering how do you feel about your stock at current levels, given the move it's had over the last year. And does the shift in voting control that Mark Pincus made, does that shift your view or impact your view in terms of how compelling your stock is to repurchase at these levels? And then just a couple of quick follow-ups on other things that you've mentioned. You talked about Fortnite expanding the market for mobile gaming, which you liked. Should Zynga be in that category of shooters over time? And then lastly, just on Wonka, obviously, there's a trade-off between known IP and the cost of that IP. Can you just remind us of what that looks like in terms of licensing versus having your own IP in terms of how to think about the economics of the game?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [39]

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Yes, this is Frank. I'll start, and then maybe Ger can dive in a little bit on the repurchasing part. We're obviously looking at the Fortnite, Battle Royale, PUBG category. It's really exciting place in mobile right now, both in Asia as well as in Western markets. So it's something that we've definitely taken note of, and we love the new audience that's coming into mobile in a more aggressive way there. In terms of known IP versus original IPs, we have a lot of original IPs we own, like Poker and Words With Friends and the Villes. And what I mentioned earlier about strategic licenses being available to us, we believe that for the right price and the right rates, it is possible to build a very profitable and strong business. And we have a fairly good handle on that, we believe, in terms of being able to acquire and look at licenses that we feel are additive and contributive to us on the right risk profile. So it's difficult to say there's a generic range. It really depends on the license. But we like licenses that our mass market in orientation, that are global and that can last for a number of years. That's really how we think about it. And ultimately, we think of a license and as a forever franchise potential, can it add 1 more new forever franchise to our overall portfolio? So that's how we think about that piece. In terms of Mark Pincus' decision to convert his high-vote shares to common, that had no bearing or impact or any type of relationship to our go-forward $200 million repurchase that we just announced today. So that was unrelated. And in terms of the average price of $2.99 on the last repurchase program, we believe in our company long term. Our job is to build long-term shareholder value. We think that there's a tremendous amount of value in what we can do with our forever franchises, with our live services, the talent that we have with the company, the global mobile opportunity that presents itself in front of us. So, yes, we're here to really grow long-term shareholder value, and we believe that at current levels, there's an opportunity to repurchase stock in a way that makes sense.

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Operator [40]

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And the next question will come from the line of Ben Schachter with Macquarie.

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Benjamin Ari Schachter, Macquarie Research - Head of TMET Research [41]

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A few questions. One, on the chat, I believe Zuckerberg was talking a bit about changing the platform, simplifying it a little bit. I was wondering how or what a change might impact your strategy or how you can go to market maybe impacted there. Secondly, obviously China, Japan, Asia, in general, so important. Can you just talk about what opportunities that you might have there down the road? And then finally, given your tenure in this space, I wonder if you could expand a bit more on Fortnite, not just as it relates to Zynga, but just in general for the industry. Do you think this is sort of a fad? Do you think this is a new franchise that can be as dominant as it has been recently going forward? How do you think this thing plays out over time?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [42]

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Yes. So on chat, there's been a lot of announcements this week as it relates to that platform. One thing to know about Facebook platforms and mobile is they change a lot. And we stay very close with our platform partners to try and anticipate changes in monetization, changes in APIs, testing protocols, the whole nine yards. So from our perspective, we are positioned to be fast, be nimble and be in a position to leverage the growth within the chat platform as it's currently manifesting in the West on Facebook. But eventually, it could be a potential opportunity in other ones. So we're excited to hear that they're interested in the platform, that they're investing in the platform, and we think that it could be a great growth driver for Zynga. In terms of China, Japan and Asia for Zynga, I've talked about on prior calls and in some of our investor materials, we really don't have a significant business in Asia, and it's a very -- it's a significant, if not the majority, of the business in the mobile market. We are actively looking at ways to enter that market. But one thing to know about those regions is they're very competitive. You have to have the right intellectual property. You have to have the right partners. You've got to have the right go-to-market strategies, and you have to have the long-term view. So you can't really jump in really fast and expect that a lot is going to happen. You really have to lay the infrastructure, build relationships and then have the right game with the right kind of user experiences, right monetization schemes in order to be successful. So our corporate development group is looking at ways to get us into that mix, and our publishing unit is looking at properties that we have currently in the market that are appealing. We have actively, in the last 2 quarters, been buying advertising in some of the Asian markets to drive some of the franchises that we have that do have audiences of significance there. So long term, we know we need to be there, but we want to do it in the right way that leads to success and not go too quickly. Look, I don't think Fortnite's a fad. I'm a fan. I've had the use case where I got 1 kid on an Xbox, a kid on the PC and a couple of other kids on mobile phones all playing together and then jumping and watching the streams of what's going on from -- with Ninja and other guys. I think PUBG, there's a lot of Battle Royale dynamics and cross-platform social gameplay available to the market in Fortnite. So I don't think it's a fad. I think it's actually broken new ground. I think it's super innovative and supercool. It has a very broad base of players, and it's also shown that shooters can come over to the mobile platform at scale. There just has -- there hasn't been -- up until PUBG and Fortnite recently, there hasn't been a shooter in the West that's really jumped into the top of the charts. So I'm a little biased, because I love playing the game, but I think it's here to stay.

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Operator [43]

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And our last question comes from the line of Stephen Ju with Crédit Suisse.

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Stephen D. Ju, Crédit Suisse AG, Research Division - Director [44]

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So,, Frank, I want to convene in a little bit on Ben's question. So it seems like the economics for Instant Games seems to be about a 30% fee paid on the booking dollar after you paid Google for platform fees. And if you look at the other sort of global Messenger platforms, it's probably a range of 20% to 30% towards the fee you may incur. So as you look at that acquisition cost versus your other channels, is this a more attractive channel for you? I want to believe that despite what the margin structure may be, ultimately, this should be found free cash flow dollars for you.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [45]

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Yes. It's a good point that it has a different structure. I won't go into detail about how the flow works there because it's actually not completely determined because a lot of these are new markets that are getting developed, and it's not -- it's pre-monetization, and it's still growing. There obviously are some precedents in WeChat or KaKao or LINE, but that hasn't proven to be the case in the West yet. I'm not saying it is or isn't, but it's just pre -- too early to talk too detailed about specific numbers there. But in -- on a theory level, you want to keep R&D pretty low. It's a fast-moving market. The gain engagement curves and how fast they come to market are extreme relative to things like a PC game or a native game. So you really want to carefully manage the other parts of the P&L, so that you are conquering the scale opportunity. This really is a volume game. And it's also a game where you might be able to acquire audiences organically as opposed to paid. So you might pick up some room there. They're cheaper to build. You can build more of them faster, and the channels are highly social. So we believe that there is a thesis to be successful on the platform regardless of how the margin shake out. But ultimately, we, as a company, have committed to a margin structure for this company to be in line with peers. And so as we look at lines of businesses, we're constantly evaluating our investment in different things like native or chat or emerging platforms. And we're constantly keeping in mind that we need to do that in a way that provides a return for our shareholders.

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Operator [46]

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At this time, I would like to turn the call back to Ms. Rebecca Lau for closing remarks.

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Rebecca Lau, [47]

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All right. Thank you, Sabrina. We want to thank everyone for joining our earnings call today, and look forward to connecting more in 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 all disconnect. Everyone, have a great day.