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Edited Transcript of ZNGA.OQ earnings conference call or presentation 6-May-20 9:00pm GMT

Q1 2020 Zynga Inc Earnings Call

San Francisco Jun 14, 2020 (Thomson StreetEvents) -- Edited Transcript of Zynga Inc earnings conference call or presentation Wednesday, May 6, 2020 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. - VP of IR & Corporate Finance

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Conference Call Participants

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* Alexander Joseph Giaimo

Jefferies LLC, Research Division - Equity Analyst

* Andrew Edward Crum

Stifel, Nicolaus & Company, Incorporated, Research Division - VP

* Brian Nicholas Fitzgerald

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* David James Beckel

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Douglas Lippl Creutz

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

* Jeffrey A. Cohen

Stephens Inc., Research Division - Analyst

* Matthew Andrew Cost

Morgan Stanley, Research Division - Research Associate

* Matthew Corey Thornton

SunTrust Robinson Humphrey, Inc., Research Division - VP

* Michael Ng

Goldman Sachs Group Inc., Research Division - Research Analyst

* Michael Joseph Hickey

The Benchmark Company, LLC, Research Division - Senior Equity Analyst

* Raymond Leonard Stochel

Consumer Edge Research, LLC - Analyst of Entertainment

* Ryan Gee

BofA Merrill Lynch, Research Division - VP of US Equity Research

* X. Lu

Barclays Bank PLC, Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Zynga First Quarter 2020 Results Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Rebecca Lau, Vice President of Investor Relations and Corporate Finance. Thank you. Please go ahead, ma'am.

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

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Thank you, and welcome to Zynga's first quarter 2020 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. Before we cover the safe harbor, please note that in an effort to keep our team members safe, each member on the call is dialed in remotely. We appreciate your understanding as we work through the call and hope everyone is staying safe and healthy during this time.

During the course of today's call, we will make forward-looking statements related to our business plan 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-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 the call over to Frank for his opening remarks.

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

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Thank you, Rebecca. Good afternoon, everyone, and thank you for joining our Q1 earnings call. The human cost of the COVID-19 pandemic have been extraordinary, straining global capabilities and forcing massive societal change. Amidst this global crisis, which has done so much to separate us from colleagues, friends and family, Zynga's founding mission to connect the world through games has never been more vital. We've been humbled to see millions of people turning to our deeply social game experiences for entertainment and a sense of community and continuity.

Today, all Zynga employees are working from home, a transition we executed without any material disruptions to our operations. Our global workforce has rallied, adapting quickly to keep pace with the increasing demand for innovative bold beats while also making strong progress on our new game pipeline. We've also been grateful for the opportunity to serve our community during this time and are collaborating with the World Health Organization and more than 55 other game companies on the #PlayApartTogether campaign to promote physical distancing through special in-game events, content and giveaways. Zynga's collaborative culture has never been stronger. And while the duration of shelter-in-place rules is uncertain, we are confident in our ability to effectively operate our business remotely for as long as it is necessary.

In Q1, we delivered our best first quarter revenue in bookings in Zynga history, driven by our live services which performed well throughout the quarter. We achieved revenue of $404 million, up 52% year-over-year, and bookings of $425 million, up 18% year-over-year. Our top line performance was above guidance, driven by broad-based strength across our portfolio, especially by a record quarter from Empires & Puzzles and a great start to the year from Merge Dragons!. Additionally, the new titles we launched in 2019, Merge Magic! and Game of Thrones Slots Casino, are doing well and were meaningful year-over-year contributors. Given our Q1 beat and strong Q2 outlook, we are raising our full year 2020 revenue and bookings guidance, which Ger will discuss later in the call.

We continue to expect live services anchored by our forever franchises to drive the vast majority of our 2020 performance. Our new game pipeline is on schedule, and we expect to release new titles worldwide in the second half of the year. In March, Harry Potter: Puzzles & Spells joined Puzzle Combat and FarmVille 3 in soft launch, and all 3 games are progressing well in test markets. We also continue to see opportunities to acquire talented teams and franchises around the world to further accelerate our growth.

While there is uncertainty around the full impact and duration of the COVID-19 pandemic, there are several factors that speak to the strength and resiliency of our business: First, our mission to connect the world through games has never been more relevant as more people are turning to our titles for entertainment and to socialize with friends and family. Second, we have a highly diversified portfolio of live services anchored by our forever franchises, which has entertained players for years. Third, our games are free-to-play and highly accessible as we operate on the largest and fastest-growing gaming platform in the world, mobile. Last, our mobile games are built in a flexible development environment, allowing our teams to continue to create new, compelling content while working remotely. As a result of these factors and our strong balance sheet, we are confident in our ability to navigate the current environment and remain well positioned for growth over the long term.

With that, I would now like to turn the call over to Ger to discuss our Q1 results in further detail as well as our outlook for the year.

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

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Thank you, Frank. We had a strong start to 2020, delivering our best Q1 revenue and bookings in Zynga history. Strength across our live services delivered a better-than-expected top line and resulting operating leverage. While we are operating in unprecedented times, based on our anticipated performance for the first half of the year, we are raising our full year outlook for revenue and bookings, but first, let's discuss Q1 results.

Revenue was $404 million comprised of bookings of $425 million, offset by a net increase in deferred revenue of $21 million. Revenue was $19 million ahead of our guidance, driven by a $25 million bookings beat, offset partially by a $6 million higher-than-expected increase in deferred revenue. Our top line beat was driven by broad-based strength across our live services, especially a record quarter for Empires & Puzzles and our Social Slots portfolio as well as a great start to the year for Merge Dragons! Stronger user pay performance was the primary source of our top line beat with advertising largely in line with our expectations. Revenue was up $138 million or 52% year-over-year driven by bookings growth of $65 million or 18% year-over-year and a $73 million lower increase in deferred revenue. Our year-over-year bookings growth was driven by our mobile live services, including Empires & Puzzles and Merge Dragons! and a full quarter contribution from Game of Thrones: Slots Casino and Merge Magic! The net increase in deferred revenue of $21 million was driven primarily by bookings from Empires & Puzzles and Merge Magic! While the release of this GAAP deferral will have a positive impact on revenue and profitability in future periods and represented a $21 million reduction in revenue, gross profit, net income and adjusted EBITDA in Q1, on a year-over-year basis, it represented a $73 million increase in the year-over-year change in revenue, gross profit, net income and adjusted EBITDA. We ended Q1 with a deferred revenue balance of $453 million versus $287 million a year ago.

Turning to Q1 operating expenses. GAAP operating expenses were $349 million, up $64 million or 22% year-over-year. This was primarily driven by a higher contingent consideration expense and increased marketing investments versus the prior year. Given the strength in engagement and monetization in Empires & Puzzles, Merge Dragons! and Merge Magic!, our acquisitions of Small Giant Games and Gram Games continue to perform ahead of our expectations, resulting in a $120 million contingent consideration expense, up $35 million year-over-year and $95 million ahead of our guidance. The increase in marketing was primarily due to investments against our live services, in particular Merge Magic!, Words With Friends, Game of Thrones: Slots Casino and Merge Dragons! Year-over-year GAAP operating expenses decreased from 108% to 86% of revenue. This was a function of the lower net increase in deferred revenue partially offset by the increases in contingent consideration expense and marketing investments. Non-GAAP operating expenses were $208 million, up $25 million or 14% year-over-year primarily due to the increase in marketing investments. Non-GAAP operating expenses represented 49% of bookings, down from 51% of bookings in the prior year. This was primarily due to improved operating leverage in R&D.

We reported a net loss of $104 million, $78 million below our guidance and an improvement of $25 million versus our net loss of $129 million a year ago. The variance to guidance was driven primarily by the higher level of contingent consideration expense and higher net increase in deferred revenue, partially offset by the better-than-expected operating performance. The variance to prior year is heavily influenced by the lower net increase in deferred revenue, our improved operating performance partially offset by the increase in contingent consideration expense.

Our adjusted EBITDA was $68 million, $11 million better than our guidance and an improvement of $87 million versus our negative adjusted EBITDA of $19 million in the prior year. The variance to guidance was driven by better-than-expected operating performance partially offset by the higher net build in deferred revenue. The variance to prior year was driven by the lower net build in deferred revenue as well as our improved operating performance.

We had a net operating cash outflow of $35 million versus a net operating cash inflow of $2 million in the prior year quarter. In Q1 2020, we executed the first of 3 annual installments to acquire the remaining 20% share interest in Small Giant Games, paying $122 million for an additional 6.7% interest. $74 million of this cash investment was classified as a use of operating cash flow and $48 million as net cash used in financing activities. We expect to acquire the remaining shares ratably in Q1 2021 and in Q1 2022. As of March 31, we had approximately $1.43 billion of cash and investments, which we expect to use primarily to fund future acquisitions to further accelerate our growth and the payment of existing contingent consideration obligations. We also had $150 million available under our credit facility, which had no amounts outstanding as of March 31.

Turning to guidance. We are living in unprecedented times with the COVID-19 pandemic already having a profound impact on how we live, work and play. In this environment, we have developed our Q2 and full year 2020 guidance based on the information available to us as of today, May 6, 2020, and using similar methodologies to prior quarters. Given the higher level of uncertainty around the COVID-19 crisis, there is the potential for a wider range of outcomes, both positive and negative, as it relates to our ultimate business results. That said, let's discuss our Q2 and 2020 guidance.

Guidance for Q2 is as follows: revenue of $400 million, up $94 million or 31% year-over-year, a net increase in deferred revenue of $60 million; bookings of $460 million, up $84 million or 22% year-over-year; a net loss of $60 million versus $56 million in the prior year quarter; adjusted EBITDA of $32 million versus $3 million in the prior year quarter. Some factors to consider in assessing our Q2 guidance include: Our live services will drive our top line performance, led by our forever franchise as well as year-over-year additions of Merge Magic! and Game of Thrones: Slots Casino. This overall momentum will be partially offset by the year-over-year declines in older mobile and web titles. We expect that user pay will be the driver of growth, with advertising down year-over-year as we continue to lap prior year advertising network optimizations and due to the recent pressure on advertising yields. Our top line guidance does not assume the launch of any new titles in Q2. We are experiencing elevated levels of engagement across our live service portfolio as people continue to shelter in place. In the current environment, it is hard to predict how events will unfold, but as shelter-in-place rules begin to be lifted, we expect trends to normalize. Our guidance assumes that this normalization will begin in the second half of Q2.

We expect a net increase in deferred revenue of $60 million in Q2 2020 versus a net increase of $70 million in Q2 2019. The year-over-year change in this GAAP deferral represents a $10 million year-over-year increase in revenue, gross profit, net income and adjusted EBITDA. We expect gross margins to be up year-over-year primarily due to the lower net increase in deferred revenue in Q2 2020 versus Q2 2019, partially offset by the dilutive impact of the stronger user pay mix in Q2 2020 versus Q2 2019. Given the strong anticipated growth in revenue, we expect our GAAP operating expenses as a percentage of revenue to significantly decrease year-over-year. Outside of these factors, we expect modest year-over-year improvements in operating leverage in R&D and G&A, which should be more than offset by higher sales and marketing. Specifically in Q2, we are seeing unique opportunities to acquire audiences and are ramping our marketing investments across our live service portfolio and our games in test markets.

Turning to 2020. Our revised guidance is as follows: revenue of $1.65 billion, up $328 million or 25% year-over-year and up $50 million versus our prior guidance; a net increase in deferred revenue of $150 million, down $92 million or 38% year-over-year and in line with our prior guidance; bookings of $1.8 billion, up $236 million or 15% year-over-year and up $50 million versus our prior guidance; a net loss of $245 million versus net income of $42 million in 2019 and an increase of $115 million versus our prior guidance. Please note that our net income in 2019 included a onetime gain on the sale of our San Francisco building of $314 million; adjusted EBITDA of $210 million, up $123 million or 141% year-over-year and up $10 million versus our prior guidance. Our guidance assumes that live services will drive the vast majority of our top line performance as we expect our forever franchises to collectively scale throughout 2020 and anticipate initial contributions from new games that are targeted to launch in the second half of the year. In 2020, we also expect year-over-year user pay growth to more than offset the modest declines in advertising due to the recent pressure on advertising yields.

We continue to expect a net increase in deferred revenue of $150 million in 2020 versus a net increase of $242 million in 2019. The year-over-year change in this GAAP deferral represents a $92 million year-over-year increase in revenue, gross profit, net income and adjusted EBITDA. The ultimate outcome for our net increase in deferred revenue in 2020 will be a function of the mix of live services bookings growth as well as the timing and scale of bookings contributions from our new game launches in the second half of the year.

For the full year, we anticipate slight pressure on our gross margins due to a higher mix of user pay versus advertising. Operating leverage on a GAAP basis will be highly influenced by the net increase in deferred revenue and the level of contingent consideration expense. On a non-GAAP basis, we expect to see modest improvement in operating leverage from R&D and G&A, which should be more than offset by increased marketing investments on both our live services and new game launches. Operating leverage will ultimately be a function of our live services performance, user pay versus advertising mix, timing of our new game launches and the level of marketing invested in scaling our live services and new titles. In addition, while we anticipate strong performance in the first half of 2020, it is uncertain how the current COVID-19 crisis will progress as well as how it will affect our business for the remainder of the year. In 2020, we expect a net loss of $245 million, which includes $200 million of contingent consideration expense and $150 million net increase in deferred revenue. Collectively, these will more than offset the strong improvement in operating performance year-over-year. The increase in expected contingent consideration expense for the year is the primary driver of the increase in our net loss versus our prior guidance. Should our recent acquisitions continue to perform ahead of our expectations, we may see further increases in the cumulative contingent consideration accrual. We are raising our adjusted EBITDA guidance to $210 million, representing an increase of $123 million year-over-year primarily due to the lower net increase in deferred revenue and stronger operating performance year-over-year and an increase of $10 million versus our prior guidance driven by a flow-through of the increase in our top line guidance.

In summary, while we're operating in unprecedented times, we remain focused on entertaining and connecting our players through our games. Our business fundamentals are strong and we are continuing to execute our multiyear growth strategy. With that, we would now like to open up the call for live questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Matthew Thornton with SunTrust.

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Matthew Corey Thornton, SunTrust Robinson Humphrey, Inc., Research Division - VP [2]

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In the prepared remarks, you guys talked a little bit about seeing some opportunity to invest or the increased investment in user acquisition here. I'm just curious how that investment that you talked about in the second quarter kind of plays into -- and flows through the guidance for the back half of the year.

And then just secondarily, when you think about the sheltering in place and the impact on the business, I'm just curious if there's any differences or comparing and contrasting you could do in terms of what titles or genres are seeing impact or what regions are seeing impact. Is it more U.S. versus international or fairly balanced? Any color you could provide there.

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

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Matt, thanks for your question. This is Frank, and I will start with the second question first and then hand off to Ger for the first one. In terms of the quarter, Q1 was a fairly normal quarter for us in terms of the performance. The change in dynamics related to COVID shelter in place really started to show up in the second half of March pretty late. It's carried through into April. And what we've seen is frankly a broad-based increase in engagement, audience growth. Folks are playing longer sessions, more sessions. And interestingly, while we've seen new players come into our platform and into our games, we're seeing a tremendous number of reactivations. So when you have brands as old as Zynga Poker and Words With friends, 10 years plus, you're seeing a lot of folks, while they're sheltering in place, go to trusted brands or brands that they know. And in case of Words With Friends, we've seen very positive audience trends overall. It's a game that is highly social in nature, and we're really grateful to see how people are engaging with the game and connecting with friends and loved ones during this time. But in addition to that, we're also seeing Social Casino do well, CSR, our Gram and Small Giant Games. So it really is a case where the entire portfolio since late March has seen the audience and engagement gains. So now I'll hand off to Ger for the first part of your question about UA flow-through.

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

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Yes. Matt, as we said in our prepared remarks and in our letter, our guidance is predicated on -- we've given flow-through in our guidance for what we see as performance through the first half of the year. We are investing obviously in the first half in cohorts of audiences that will monetize -- engage and monetize in the second half. But as it relates to our guidance, the guidance is predicated based on what we've seen through the first 6 months. As we get through Q2, obviously, we'll be giving you guys a more informed position on how we see the second half. As I noted in my prepared remarks, there's a lot of variability at the moment. And while we feel confident in our core business and how our games are operating, we're going to give better color on the second half as we come through Q2.

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Operator [5]

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Our next question comes from Ray Stochel with Consumer Edge Research.

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Raymond Leonard Stochel, Consumer Edge Research, LLC - Analyst of Entertainment [6]

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On advertising bookings, I would love if you could give any incremental details on -- number one, is there any sort of way that we can think about how you're running 2Q to date or what advertising bookings might look like in the second quarter? Is there any way to quantify the gross margin impact from advertising headwinds? And then the last one would be is there any way to quantify what portion of your advertising bookings is from third-party games or other products that are fairly well positioned in this stay-at-home environment.

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

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Ray, thanks for your question. In terms of -- if you think about it from a gross margin perspective, I would look at our gross margin profile this time last year and now. And what you'll see in the gross margin is there's essentially a point of pressure which is -- most of that is down to the mix of user pay and advertising. As it relates to advertising overall, we indicated in our notes that we expect to see advertising down modestly. So that's in the sort of, I would say, the low to mid-single digits. And in terms of the profile, we don't comment on the overall profile, but as you would expect, there is -- in mobile gaming in particular, there is a strong weighting of obviously other entertainment companies and gaming companies advertising in our space given that's where gamers are. What we've seen in Q1 is that side of the business is continuing to obviously perform, and it's one of the reasons why we, as a gaming company, are seeing unique opportunities too on the other side to invest in user acquisition. Where we've seen weakness, which actually are advertisers with stronger yields on the brand side, it's a smaller part of our business but it is definitely a challenging area at the moment given where the world is.

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Operator [8]

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Our next question comes from Matthew Cost with Morgan Stanley.

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Matthew Andrew Cost, Morgan Stanley, Research Division - Research Associate [9]

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So you mentioned in the press release that you're seeing positive results from Empires & Puzzles in Asia. Obviously, you have a couple of games. Those regions are a little bit ahead of the U.S. in terms of like the time line of COVID-19. So are there any learnings that you've seen from your games overseas, whether that's in Europe where some countries are ahead of the U.S. or Asia, that you're factoring into or thinking about when you're forecasting the United States and the portfolio broadly?

And then just second, on the ad revenue side, just a quick follow-up to what you were just discussing. When you think about sort of those modest declines, it does seem like games like Words With Friends, for example, have seen a big pickup in downloads in the past month or 2. So is it really -- there's impression growth but the declines are driven by CPMs going down. Or what are the puts and takes there?

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

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Thank you, Matt. On the dynamic that we see internationally with countries that are coming out of shelter in place quicker than perhaps some of the countries in Western Europe and North America, we have been observing trends there across our portfolio. I'd say it's a little early right now to really trend it out as something definitive. There's some noise in the data in terms of local conditions or particular dynamics. So you've seen some countries where engagement levels have held and, in fact, increase. And in some, there's been a bit of a dip. So I think it's too early to tell, but we are closely watching that to see if it is indicative of what potentially might occur in some of the other countries that are still currently in shelter in place or are just coming out.

In terms of your second question about ad revenue, when you look at the dynamic inside Words With Friends, the compression that you've seen in CPM starting in late March, one of the reasons why we're down less than the rest of the category in terms of advertising is because of the audience gains and engagement gains. We've been able to create more opportunities to advertise inside the game because engagement rates are higher. There's more impressions generated. And therefore, we've offset some of that decline in CPMs in the early stages here and as we've headed into April.

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Operator [11]

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Our next question comes from Mario Lu with Barclays.

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X. Lu, Barclays Bank PLC, Research Division - Research Analyst [12]

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Great. Congrats on the record for this quarter. So I had a question on Empires & Puzzles and a follow-up. So I understand the reporting has change regarding bookings by franchise, but any color you can provide regarding how impactful the launch of Season 3 and the Path of Valor had on sequential bookings growth.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [13]

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Thank you, Mario. The product has seen a terrific quarter. It was a record quarter coming off of a holiday, which was particularly strong for us. We had a very, very aggressive bold beat calendar in this quarter -- this last quarter driven by the long-anticipated release of Season 3 and then the introduction of Valor Path as well as the different events that we run related to the wardrobes. So you had multiple things happening in the quarter that really benefited the product and drove another record quarter for E&P. In terms of teasing out which element was the most impactful, honestly, they all really contributed and fed off of each other. And so from our perspective, when we look forward into the bold beat calendar for E&P, the rest of the year, the team in Helsinki has really developed a very ambitious calendar. We're obviously into the second season of the Valor Path. You're starting to see some of the heroes come back like Gravemaker this week. And so we're seeing -- we're still continuing to see very good results in the product as we head into Q2.

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X. Lu, Barclays Bank PLC, Research Division - Research Analyst [14]

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Got it. And just a high-level follow-up. With shelter in place still being a fact in most of the world and given Zynga's willingness to develop games for new platforms such as Snapchat and Facebook Instant Games, is there opportunity to leverage Bingo's expertise and social gaming to partner and develop with teleconferencing platforms such as Zoom?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [15]

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Thank you for the question. We're definitely looking at new platforms in terms of development beyond just Snap. We are very active in new game development right now. One of the benefits of mobile development is that it's extremely flexible. And once we were able to redeploy into a work-from-home setting and everybody was safe, our productivity was very strong. We made some adjustments in a couple of areas where we saw some challenges. But in general, we're actively developing games for mobile. We're actually looking at chat platforms, and we are considering video-based social platforms as well in terms of places for us to build games. Our mission is -- we're the first social game company. Our mission is to connect the world through games. And one of the key pillars of what we've been trying to do at Zynga recently is to be platform-agnostic to really go where the audience is, and we have a lot of great brands that we believe could be a benefit there.

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Operator [16]

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Our next question comes from Doug Creutz with Cowen.

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Douglas Lippl Creutz, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [17]

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Yes. You guys have sort of a uniquely broad game portfolio. I'm wondering if the positive impact you've seen from shelter in place, if you're noticing any interesting variances across genre or across demographics, if there are any that are performing exceptionally strongly.

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

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Doug, the -- again, I'll emphasize the point I might have made a little bit earlier in the call, which is in the -- reactivations is where we're seeing it. And it's not really franchise or demographic-based, but we're seeing a lot of players that have been away from a franchise for a year or more come back into a game. And what's really cool to see is the fact that the games have changed a lot since they potentially lapsed. Part of the benefit of continually updating the games and putting out a lot of bold beats is if you left Words With Friends 2 years ago and came into the game now, it's much improved. It's evolved. There's a lot of new features and a lot of new content to engage in. And so whether it's CSR2, which is more of a male-oriented game, or Words With Friends, which is definitely a majority of the players are women, we're seeing that reactivation element has been the most interesting and -- thing that we've been compelled by. We do see, additionally to that, people coming into mobile games for the first time. And when we talked a little bit earlier about unique opportunities to acquire audiences in this environment, that's some of the things that we're starting to look at. Where we see the opportunity to acquire new players, we're definitely investing. And we believe that for the long term, we'll be able to grow the audiences for our games. And if the engagement curves hold or are even slightly diminished based on this period of time, the overall business is going to be in a very good position.

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Operator [19]

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Our next question comes from Mike Hickey with Benchmark Company.

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Michael Joseph Hickey, The Benchmark Company, LLC, Research Division - Senior Equity Analyst [20]

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First question, just on the -- I guess the virus obviously has been a big boost here on engagement and probably a lot of other metrics you look at. How do you sort of unpack that influence, I guess, when you evaluate the performance of your games and data?

And the second question. It looks like you've successfully here got everybody working from home. It doesn't sound like productivity is an issue. It seems that you should be motivated to sort of accelerate some of the new games or the games you have planned for second half to market sooner or you have your audience sort of captive and looking for new experiences. You also, as you said, have a low UA. So just sort of how you think about maybe getting the games out a little bit faster.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [21]

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Mike, the question as it relates to test market data, pre and post shelter in place, it is definitely something that we're looking at so that we understand if there's any potential wrong reads that you might make because people are in a novel situation where they're at home and they have the ability to play games more often. So it's definitely something that we're considering. The games have been in test launch before that late March time period I highlighted. So we are looking at the data before and after and normalizing and looking at whether or not that's an impact. So far, we do continue to see very positive test results on Farm 3, on puzzle and also with Harry Potter coming. So the data is positive, and we're constantly iterating and adjusting to get the games into position so that they deliver long-term engagement and can be forever franchises for us for many years.

It is a great point about acceleration and trying to bring the games into worldwide sooner. It is something that we've looked at, but we're also staying very patient where if we rush the games and we don't believe that the long-term engagement systems are in place, it's a situation where it won't pay out to the positive. So great points. We're definitely considering them and we're making adjustments accordingly, but right now, we feel good about our stance and our time lines.

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Operator [22]

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Our next question comes from Jeff Cohen with Stephens Inc.

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Jeffrey A. Cohen, Stephens Inc., Research Division - Analyst [23]

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Can you talk about how the current operating environment is impacting your ability to do something strategic on the M&A side? Obviously, it's hard to get deals done when you can't meet people in person, but I imagine the economic environment in the second half of the year might accelerate the number of private companies looking for a stable home within the Zynga portfolio. So any thoughts on that?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [24]

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This is Frank. The M&A environment is still very dynamic. If you look at the number of deals that have been done since January, it's been a pretty active marketplace. And when we think about the types of deals that Zynga looks at, again, we try and build relationships very early on and keep coming back to them. So as we moved into a shelter-in-place environment where we've had to do things more via Zoom or Hangouts, the fact that we actually spent that time together earlier in the industry or no folks earlier has really benefited us. We continue to be active in discussions and evaluations. We're obviously not forecasting any deals at this point in time, but we feel very confident that we will be able to continue to grow the company through M&A activity. The balance sheet is in good shape. And as the year unfolds in the second half and we believe that there's a potential for that M&A activity inside the industry to continue -- and we'll continue to look for great teams, great franchises, opportunities and strategic fit. And Zynga continues to be a place, I think, that is appealing for teams out there to join. So it's kind of a situation where we feel very good about our position, and we'll continue to stay active.

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Operator [25]

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Our next question comes from Drew Crum with Stifel.

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Andrew Edward Crum, Stifel, Nicolaus & Company, Incorporated, Research Division - VP [26]

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Some of your competitors have discussed the various challenges with developing games remotely. Curious as to what your experience has been. How does it impact the production and delivery of bold beats? In your preamble, you described the new game pipeline is on schedule. I presume that's '20 only. If prolonged, could this in any way impact the '21 slate?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [27]

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One of the benefits of mobile game development is that the engines, the tools, the processes, they're very well understood. We're not waiting on new hardware to come out. We're not looking for component flows coming in from China in terms of what the supplies are going to be. We're very much working in Unreal. We're working on in Unity. We're working on our own engines. We're using tools that we have already built or are off-the-shelf and very well understood. Our production process and systems that we use have translated very well to the home. If you look at some of the disciplines that are important in the games that we build and the bold beats that we're building, things like environmental artists, modelers, data scientists, product managers, they can do their jobs very effectively in a remote setting. And in fact, in some of our studios, the lack of commute time is one of those things that has really driven some of the folks to have higher job satisfaction because they don't have a 2-hour commute in London, for example.

So our teams are able to collaborate effectively right now. Our bold beats for Q2 are on schedule. The ones that we've been delivering in the last month, in the next couple of months, we feel very good about. And again, when -- if you look at Puzzle Combat or FarmVille 3, these are teams that are very experienced, that have worked together very well. So the transition from being in a collaborative space to having to collaborate from home hasn't been a challenge honestly. We were very paranoid about it. We watched every part of the production process. Early on, we ran into some challenges as it related to QA and customer service, as an example, but we made adjustments very quickly to make sure that we were increasing our QA coverage because one of the things you didn't want to do was induce a bug into a live service at a time where it could be very hard to fix. So in the areas where we want to take extra care in customer service, QA, checking in code, our teams have really risen to the challenge. And the fact that we're operating off of more knowns than unknowns in terms of the development environment, in terms of the platforms, in terms of our processes has allowed us to make the transition.

In terms of the titles that we're working on beyond 2020, the same thing holds. Those game teams are on known tech. They're working on ideas and intellectual properties that are well understood. And given where they are in their production schedules, they're actually, in some cases, being very, very productive in terms of the experimentation that they're doing, the testing as well as development of core assets. So as I said in our remarks, this is a situation where Zynga's deployment into work from home has gone very well. It feels like it's something that we can sustain. And in terms of going back into the offices, we're going to be very careful. And employee safety and team safety is #1. So we're going to take our time in terms of how we get back to that because honestly, our business is in pretty good shape in terms of being able to continue to operate in this configuration.

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Operator [28]

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(Operator Instructions) Our next question comes from Alex Giaimo with Jefferies.

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Alexander Joseph Giaimo, Jefferies LLC, Research Division - Equity Analyst [29]

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Okay. Frank, can you just maybe provide a more detailed update on Puzzle Combat. I know there's no scientific approach to how long a game remains in soft launch, but it seems as if that one is taking a bit longer than others.

And then, Ger, just on the guidance, it looks like the full year EBITDA guide increased by less than the magnitude of the 1Q beat. Is that mainly driven by the headwinds in ad revenue and how that kind of flows through from a profitability standpoint? Or was there anything else to call out there?

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

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Yes. So on Puzzle Combat, we're in soft launch. We're in an expanded test market position right now. The data that we're getting is very informative, and we're iterating accordingly. That's kind of the standard stuff that we would say. I think the thing to think about is Small Giant has created a game in Empires & Puzzles that has done extraordinarily well. It's in the top of the charts. It's a very high-performance game. And if you think about Puzzle Combat coming out, we have very high expectations for that title and so do Small Giant. So we're very much taking our time to make sure that the polish is there, that the systems and long-term engagement are there because there's a follow-on title to Empires & Puzzles that wants to live alongside that game. It's going to have a very high level of quality, and we want to understand how it engages with lots of different cohorts and how it scales over time. And so the guys in Helsinki are going that extra mile over the springtime period where we're putting the game through tests on Android extensively in North America. We're looking at a lot of other markets. We're running a lot of different experiments to see how the title responds, but it will have a lot to do with the fact that Empires & Puzzles is so -- it's such a terrific game that we want to be able to meet those expectations in terms of a follow-on game.

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James Gerard Griffin, Zynga Inc. - CFO [31]

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It's Ger. In terms of the full year guide, it was basically as binary as taking the $50 million and flowing it through at 20%. That's how we sort of thought it through in terms of just upgrading the full year. So you're correct in saying that we held on to some of the EBITDA, and we'll see how we flow that through as we get through Q2.

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Operator [32]

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Our next question comes from Michael Ng with Goldman Sachs.

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Michael Ng, Goldman Sachs Group Inc., Research Division - Research Analyst [33]

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Great. I just have 2. My first question is on some prepared remarks that you made in the letter. You guys talked about assuming a normalization in the second half of 2Q. Could you just clarify what does that mean? Are you assuming some of the titles will return to February bookings levels? And is there anything that you're seeing in the marketplace today that would suggest that normalization? Or is that just simply conservatism?

And then my second question is just on new games and the guidance. You guys said there were some new game contributions to the 2020 guidance. How many of the 3 soft launch games are you assuming get launched in the second half? And if you could just quantify what the contribution from new is.

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James Gerard Griffin, Zynga Inc. - CFO [34]

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Mike, it's Ger. I'll deal with the second part first because it's fairly straightforward. We -- historically, we've said roughly around 5% of our overall guide. And it's still, broadly speaking, 5%. As I've said in the past, that doesn't really give you an indication of when in the second half or how many games will turn up. What it does tell you is we set up our guide for the year and we're continuing to hold that guide given what I've said previously about the second half to be primarily a live service delivery with new games in the second half starting to turn up.

In terms of the Q2 guide normalization. Yes, as we said in the letter, we started to see the uptick in engagement in our games coming into March just like a lot of our peers, and we've continued to see that as we go through April and into the month of May. It's debatable when it's actually going to normalize, but our guidance was predicated on it normalizing in the second half of the quarter. And to your point, that's going back to sort of a pre-cohort level. So you're talking sort of February time frame. The other thing, as it relates to normalization, we're also obviously watching how the channels are operating from a user acquisition perspective. And as we've said in the past, we've seen unique opportunities to invest against our audiences, but as you also know, we've got a very talented data science and UA team that continually monitor the value of those channels and the cohorts coming in, in terms of lifetime value. And depending on how CPIs evolve over the quarter, we'll obviously course-correct our strategy around that.

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Operator [35]

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Our next question comes from Ryan Gee with Bank of America.

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Ryan Gee, BofA Merrill Lynch, Research Division - VP of US Equity Research [36]

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I guess a follow-up for Frank. You mentioned a couple of times on the call strong reactivation. I was looking at the mobile DAUs. Those were up only about $1 million quarter-over-quarter, I believe. So does the $21 million DAU metric maybe not tell the whole story about reactivation? Is there another metric we should be looking at to see how the audience is tracking maybe in April as a better gauge of the uplift in your player base?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [37]

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Yes. Thanks for the question. In Q1, that $21 million quarter-over-quarter lift in terms of DAU and MAUs, it really doesn't reflect much of the shelter in place at all. Again, like I said before, it's the last 2 weeks or 10 days of March. So you're really going to see that impact in momentum more so in our Q2 results later this summer. So as you think about the broad-based lift across the portfolio, anticipate that, that impact starts really taking hold in April.

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Operator [38]

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Our next question comes from David Beckel with Berenberg Capital.

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David James Beckel, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [39]

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I have 2 questions, if I could. First one, being maybe it's a little bit early, but have you seen any signals about retention and payer conversion rates that perhaps differ from what you're normally used to since the end of March? And relatedly, is there any reason to believe that since a lot of your new users are reactivations that they wouldn't be more likely to stick around than a typical new player?

And then secondly, kind of a broad-based question, but I was hoping if you could just comment on the potential effects of a recession. Obviously, economic activity is sharply down, but there are a lot of stimulus payments hitting the market. If that were to recede and customer spend sort of wane, do you expect that to affect your business in any meaningful way?

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Frank D. Gibeau, Zynga Inc. - CEO & Director [40]

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Thank you, David. In terms of retention and player conversion rates, we -- again, we mentioned that there have been a lot of reactivations of players that probably understates the fact that a lot of the current players are playing more, and we're seeing all new players come in. It's a situation where we'll see retention -- the earliest retention data we're getting now is measured in just a couple of weeks really if you think about the shelter-in-place effect starting to occur in late March. So I think over time, we'll get a much better read on the retention data. The part that we're optimistic about is that a lot of the reactivations are coming into games that have improved a lot since the last time they were in. And so there's a lot of new things for them to do and a lot of new content for them to consume. So we're optimistic about that component. And in terms of ARPDAUs or player conversions -- payer conversions, we've seen improvements in some franchises, and that's been very encouraging. Some of it's related to bold beat releases. So it's a little noisy right now to trend it across the entire portfolio, but again, we're looking at this data on a daily basis and trying to look forward to see if we've seen a structural shift in the player dynamics or if things will revert back to a normal level later in the quarter like we've included in our guidance. So it's an exciting time to kind of being able to go through and understand how these segments are performing.

In terms of the second question, when you go back and look at recessionary times in the video game industry, some of this predates free-to-play mobile, but video games, interactive entertainment is a very appealing and very efficient way to entertain yourself in a time of economic downturn. If you look at the number of hours that you can play, the amount of money that you would spend relative to other things, like going to movies, going out to a ballgame or other types of discretionary income, you find yourself in a position where games proved to be relatively resilient as you look back at 2008, 2001 and in some of those periods of times or even smaller country-level recessions. The interesting dynamic now is with a platform that's ubiquitous as mobile and a free-to-play business model with highly accessible IP, if you're in a -- if the economy does have an extended downturn, free-to-play mobile games are going to be a pretty efficient way for a person to entertain themselves and to engage with family and friends when times are tough. And so versus other categories of entertainment or higher-priced ticket items inside the entertainment space, I think that free-to-play mobile games, especially ones that are ad-driven, are in a position to be able to reach audiences in a period that could see that type of dynamic.

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Operator [41]

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Our last question comes from Brian Fitzgerald at Wells Fargo.

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Brian Nicholas Fitzgerald, Wells Fargo Securities, LLC, Research Division - Senior Analyst [42]

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A lot of questions answered. Appreciate that. Maybe I'll try a couple. Any evidence of a substitution impact, not cannibalization, but substitution as hardcore gamers. They have a robust experience in front of them in terms of a PC or console. So they're leaning forward to those and expecting a bounce back when we do get back to norm, and there's an offsetting trend there. I'm trying to figure out and whether or not that's offset by just the general acceleration of expansion of demos from -- away from hardcore gamers. So that was the first question.

And then maybe a follow-up to that last question you answered, Frank. And it's -- any potential impacts on the ecosystem from the lengthening or the delaying of hardware or handsets, not the stuff you guys use but, "Hey, I'm not buying a new handset because I'm squeezed." And so maybe I'm not as prone to expand my games -- or my gaming endeavors. So those are the 2 questions.

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Frank D. Gibeau, Zynga Inc. - CEO & Director [43]

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Great. In terms of your first question, most of the people who play Zynga games don't identify as gamers in many ways. They're busy adults who are looking for ways to entertain themselves. You can play anytime, anywhere. You can -- it's highly social. So from the standpoint of switching cost or substitution impact from PC and console, we don't see that really at play here. We have an audience and a demographic that is somewhat counter to that. We have some players that do a lot of cross-platform play, especially in some of our NaturalMotion titles. You see a little bit with E&P. But in general, the bounce back to normalization is probably going to impact us less than console and PC.

In terms of handset generating or driving additional volume inside mobile games, the release of a new iPhone or a new device from Google or Android base is a nice effect inside the marketplace, but it's nowhere near as impactful as the release of a new console or a new set of GPUs for PC games. It -- your phones are pretty high-performance right now. And so if they carry on a few months longer on their 11s or on their Pixels, it doesn't really make that big a difference to our overall business. There is a nice promotional window when you do see new hardware come out in kind of a refresh and a replacement business in the West certainly, but from our perspective, it's not a big tailwind -- or a headwind at all.

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Operator [44]

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Thank you. And I'm showing no further questions at this time. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.