Zeroing in on Zynga's Zag and Its New S-1 Filing

Sharp-eyed reporters immediately jumped on a newly amended S-1 Zynga filed with the SEC to report that its growth has slowed and that the odds of an IPO were now 75 percent, down from 80 percent. Average daily users dropped 3 million to 59 million. Some reacted to a "90-percent plummet in profit in the June quarter on Wednesday that raised fresh questions about whether the company can sustain its growth ahead of its much-anticipated IPO."

Oh, what's the fun of writing about business without crisis? Granted, there's plenty of real problems to see. But much of the new round of Zynga coverage seems to have read numbers shallowly and out of context.

The users are schmoozers
Slow-downs in the number of users could clearly be a big issue. But looking at a single point with a year-over-year comparison misses the pattern in how Zynga's traffic behaves. Here are the quarterly numbers in a table from page 4 (click to enlarge):

Yes, there's a 3 million person drop in the average number of daily active users between the quarter that ended in March and the one that ended in June. But that's hardly a first. It dropped 7 million between the same two quarters in 2010. It also dropped 1 million between the third and fourth quarters in 2010. A similar pattern exists in average monthly active users.

Yes, as some point out, Zynga faces increased competition in social gaming. But think about the timing. Things slow down between June and September -- which is when people are generally spending more time outside. And there's a bit of a slowdown in the fourth quarter, during the holidays. Sounds like seasonality to me. One reason 2009 didn't show similar behavior may be that rapid business growth swamped the seasonal pattern.

Interestingly, the average monthly unique users increased, which suggests that the company is laying the groundwork for more expansion. (Assuming that demographics hold up and something-under-5-percent of new users continue to pay to play.)

Who grabbed the profit?
In terms of falling net income, there are a number of reasons the number dropped. One big one? Uncle Sam. In the first six months of 2010, revenue was $231 million and provision for income tax was $1.5 million. In the same period this year, revenue was $522 million -- 2.25 times as much -- and provision for income tax was ... $31.5 million, a jump of more than 20 times.

If income tax represented the same percentage this year as last, it would have been about $3.4 million. That would have boosted net income by $28.1 million for a total of $46.2 million, or about the same percentage of revenue as in the first six months of 2010.

In addition to not releasing new games, which the company acknowledged, the new hiring -- probably to get ready for a new expansion -- was significant. However, Zynga lowered its sales and marketing expenses as a percentage of revenue. Cost of revenue dropped to 28 percent, from 32 percent, meaning that gross margins were up significantly. That offset increased R&D expenses.

As a result, total costs and expenses for the first six months of 2010 and 2011 were both about 91 percent. Even though $10 million of general and administrative costs were for stock-based compensation.

Frankly, if the company can keep everything balanced, it sounds like smart management. Another quarter or two of information will help us all better understand Zynga, as it's only a few years old.

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