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Overview and Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2019

The accompanying interim consolidated financial statements are presented in accordance with United States generally accepted accounting principles (“U.S. GAAP”). The interim consolidated financial statements include the operations of the Company and its owned subsidiaries. All significant intercompany balances and transactions have been eliminated in the consolidation.

The accompanying interim consolidated financial statements and these related notes should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2018.

Unaudited Interim Financial Information

The accompanying interim consolidated balance sheets as of June 30, 2019 and December 31, 2018, the interim consolidated statements of operations, statements of comprehensive income (loss) and statements of stockholders’ equity for the three and six months ended June 30, 2019 and 2018, the statements of cash flows for the six months ended June 30, 2019 and 2018 and the notes to interim consolidated financial statements are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with U.S. GAAP. In management’s opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s statement of financial position and operating results for the periods presented. The results for the three and six months ended June 30, 2019 are not necessarily indicative of the results expected for the full fiscal year or any other future period.

Use Of Estimates

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts in the interim consolidated financial statements and notes thereto. Significant estimates and assumptions reflected in the financial statements include, but are not limited to, the estimated average playing period of payers that we use for revenue recognition, useful lives of property and equipment and intangible assets, accrued liabilities, income taxes, the fair value of assets and liabilities acquired through business combinations, contingent consideration obligations, the discount rate used in discounting our operating lease liabilities, the interest rate used in present valuing the initial liability component of our convertible notes, stock-based compensation expense and evaluation of recoverability of goodwill, intangible assets, and long-lived assets. Actual results could differ materially from those estimates.

For the three and six months ended June 30, 2019, there was no significant impact from discontinued games or from changes in our estimated average playing period of payers that required adjusting the recognition period of deferred revenue generated in prior periods.

For the three and six months ended June 30, 2018, we recognized $0.5 million and $0.9 million, respectively, of online game revenue and income from operations from games that have been discontinued as there is no further performance obligation. This change in estimate did not impact our reported earnings per share in three months ended June 30, 2018 but had a $0.01 per share impact on our reported earnings per share in the six months ended June 30, 2018. For the three and six months ended June 30, 2018, there were no changes in our estimated average playing period of payers that required adjusting the recognition period of deferred revenue generated in prior periods.

Recent Accounting Pronouncements

Issued But Not Yet Adopted

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”, which aligns the accounting for implementation costs incurred with a cloud computing arrangement accounted for as a service arrangement with the guidance in ASC Topic 350-40, Internal-Use Software to determine which implementation costs should be capitalized. The ASU permits either a prospective or retrospective transition approach and is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. The Company is currently assessing this standard’s impact on its consolidated financial statements.

Issued And Adopted

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASC Topic 842”) which requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. For lessors, accounting for leases remains substantially the same as in prior periods. We adopted ASC Topic 842 on January 1, 2019 using the alternative transition approach provided in ASU 2018-11, “Leases (Topic 842) – Targeted Improvements”, which allows initial application of the new standard by recognizing a cumulative-effect adjustment on the adoption date.

Adoption Impact – Lessee Accounting

The adoption of ASC Topic 842 on January 1, 2019 resulted in the recognition of right-of-use assets of $9.1 million, which includes the elimination of our remaining prepaid rent and deferred rent balances, current operating lease liabilities of $7.6 million and non-current operating lease liabilities of $12.4 million. The adoption of ASC Topic 842 did not impact our consolidated statement of operations or consolidated statement of cash flows.

ASC Topic 842 also amends the provisions of ASC Topic 420 – Exit or Disposal Obligations to eliminate the concept of cease-use lease liabilities and instead, requires companies to evaluate leases for impairment in accordance ASC 360 – Property, Plant, and Equipment. Accordingly, upon adoption, we derecognized our $10.9 million restructuring cease-use liability related to our Q2 2015 restructuring plan and simultaneously recognized an operating lease liability for an equal amount, with no associated right-of-use asset.

As part of the adoption, the new standard allows a number of practical expedients and exemptions. At transition, we elected the following:

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The package of practical expedients, which allows us to carryforward our historical lease classification, assessment of whether a contract is or contains a lease and initial direct costs for any leases that exist prior to adoption of the new standard;

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The practical expedient to not separate non-lease components from the related lease components; and

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The exemption to not apply the balance sheet recognition requirements for leases with a lease term of 12 months or less and instead, expense those costs on a straight-line basis over the lease term, or in the period in which the obligation is incurred, if such costs are variable.

Adoption Impact – Lessor Accounting

There was no impact to our financial statements as a result of adopting ASC Topic 842. ASU 2018-11, “Leases (Topic 842) – Targeted Improvements” also provides lessors with a practical expedient to not separate nonlease components from the associated lease component, similar to the expedient provided for lessees. However, the lessor practical expedient is limited to circumstances in which the nonlease component or components otherwise would be accounted for under the new revenue guidance and both (i) the timing and pattern of transfer are the same for the nonlease component(s) and associated lease component and (ii) the lease component, if accounted for separately, would be classified as an operating lease. We have elected this practical expedient.

Refer to Note 6 – “Leases” for further details on our lease arrangements as a lessee and lessor.

Under the terms of the Gram Games acquisition, contingent consideration may be payable based on the achievement of certain future profitability performance targets during each annual period following the acquisition date for a total of three years, with no maximum limit as to the contingent consideration achievable. We estimated the acquisition date and subsequent reporting period fair values of the contingent consideration obligation using a Monte Carlo simulation. The significant unobservable inputs used in the fair value measurement of the contingent consideration obligation were Gram Games’ projected performance, a risk-adjusted discount rate and performance volatility similar to industry peers. Changes to projected performance of the acquired business could result in a higher or lower contingent consideration obligation in the future. As of December 31, 2018, the estimated fair value of the Gram Games contingent consideration obligation was $49.0 million and as of June 30, 2019, the estimated fair value of the contingent consideration obligation increased to $72.8 million, primarily due to stronger than expected performance and the increased probability of achievement. For six months ended June 30, 2019, we recognized $23.8 million of expense within research and development expenses in our consolidated statement of operations. For the three months ended June 30, 2019, we recognized a $2.7 million benefit within research and development expenses in our consolidated statement of operations, driven by continued refinement of forecasted financial results.

Under the terms of the Small Giant acquisition, contingent consideration may be payable based on the achievement of certain future profitability performance targets during each annual period following the acquisition date for a total of three years, with no maximum limit as to the contingent consideration achievable. We estimated the acquisition date and subsequent reporting period fair values of the contingent consideration obligation using a Monte Carlo simulation. The significant unobservable inputs used in the fair value measurement of the contingent consideration obligation were Small Giant’s projected performance, a risk-adjusted discount rate and performance volatility similar to industry peers. Changes to projected performance of the acquired business could result in a higher or lower contingent consideration obligation in the future. At acquisition, the estimated fair value of the contingent consideration obligation was $98.0 million. As of June 30, 2019, the estimated fair value of the contingent consideration obligation increased to $183.6 million, primarily due to stronger than expected performance and the increased probability of achievement. Accordingly, for the three and six months ended June 30, 2019, we recognized $26.6 million and $85.6 million, respectively, of expense within research and development expenses in our consolidated statement of operations.

Fair Value Measurements Investment

We estimate fair value as the exit price, which represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between knowledgeable and willing market participants.

The valuation techniques used to measure the fair value of the Company’s financial instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model-driven valuations using significant inputs derived from or corroborated by observable market data. We use a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Includes inputs, other than Level 1 inputs, that are directly or indirectly observable in the marketplace.

Level 3 — Unobservable inputs that are supported by little or no market activity.

Lessee Arrangements

We determine if an arrangement is a lease at contract inception. If there is an identified asset in the contract (either explicitly or implicitly) and we have control over its use, the contract is (or contains) a lease. In determining if there is an identified asset, we apply judgment in assessing whether the supplier has a substantive substitution right based on the supplier’s practical ability to substitute the asset and the economic benefit to do so. If it is determined that a substantive substitution right exists, the contract is not a lease and is not accounted for under ASC Topic 842. With the respect to the servers utilized in certain of our hosting and data storage arrangements, the Company determined that a substantive substitution right existed given the location of the servers at the supplier’s premises, a lack of contractual restrictions preventing the supplier from substituting the servers throughout the period of use and the economic incentive for the supplier to substitute the servers as needed in order to efficiently handle varying levels of demand from its various customers.

In determining the present value of lease payments, we discount future lease payments using our incremental borrowing rate since the implicit rate in our various leases is unknown. The incremental borrowing rate is determined at lease commencement for each individual lease and is based on a number of factors, including relevant observable debt transactions, the current economic environment, lease term and currency in which the lease is denominated. As of June 30, 2019, the weighted-average incremental borrowing rate for our operating leases was 5.4%.

Leases Income

The original agreement provides for total lease payments of $167.3 million, including escalating lease payments and various lease incentives that are recognized on a straight-line basis over the lease term. In February 2019, the original agreement was amended to provide additional space to the tenant, resulting in an additional $5.1 million of lease payments to be received over the lease term and an additional $0.8 million of lease incentives for tenant improvements.

Debt

We separately accounted for the liability and equity components of the Notes. We determined the initial carrying amount of the $572.0 million liability component by calculating the present value of the cash flows using an effective interest rate of 4.1%. The interest rate was determined based on non-convertible debt offerings of similar sizes and terms by companies with similar credit ratings (Level 2 inputs). The carrying amount of the equity component, representing the conversion option, was $118.0 million and was calculated by deducting the initial carrying value of the liability component from the principal amount of the Notes as a whole. This difference represents a debt discount that is amortized to interest expense over the 5-year contractual term of the Notes using the effective interest rate method. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.

We allocate transaction costs related to the issuance of the Notes to the liability and equity components using the same proportions as the initial carrying value of the Notes. Transaction costs attributable to the liability component were $14.6 million and are being amortized to interest expense using the effective interest method over the term of the Notes. Transaction costs attributable to the equity component were $3.0 million and are accounted for consistently with the equity component of the debt.

As the Capped Calls are considered indexed to our own stock and are equity classified, they are recorded in stockholders’ equity and are not accounted for as derivatives.

Earnings Per Share

On May 2, 2018, our founder, Mark Pincus, elected to convert certain outstanding shares of Class B common stock and all outstanding shares of Class C common stock controlled by Mr. Pincus and an affiliated investment entity into an equivalent number of shares of Class A common stock. As a result of Mr. Pincus’ conversion, the remaining shares of Class B common stock represented less than 10% of the total voting power of all Zynga stockholders and, accordingly, each remaining outstanding share of Class B common stock automatically converted into one share of Class A common stock. Each Zynga stockholder now has one vote per share on all matters subject to stockholder vote. Following the conversion, no shares of Class B or Class C common stock are outstanding and the total number of authorized shares of capital stock will be reduced to account for the elimination of the Class B and Class C common stock. Accordingly, beginning in the second quarter of 2018, the Company calculated basic and dilutive net income (loss) per share under a single-class method.

Prior to the conversion noted above, we computed net income (loss) per share of common stock using the two-class method required for participating securities and multiple classes of common stock. Prior to the date of the initial public offering, we considered all series of our convertible preferred stock to be participating securities due to their non-cumulative dividend rights. Additionally, we considered shares issued upon the early exercise of options subject to repurchase and unvested restricted shares to be participating securities, because the holders of such shares have non-forfeitable dividend rights in the event we declare a dividend for common shares. In accordance with the two-class method, net income allocated to these participating securities, which include participation rights in undistributed net income, is subtracted from net income (loss) to determine total net income (loss) to be allocated to common stockholders.

Basic net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) attributable to common stockholders by the weighted-average number of common shares outstanding, including potential dilutive securities. In computing diluted net income (loss) per share, net income (loss) attributable to common shareholders is re-allocated to reflect the potential impact of dilutive securities, including stock options, unvested ZSUs, unvested performance-based ZSUs and ESPP withholdings. For periods in which we have generated a net loss or there is no income attributable to common stockholders, we do not include dilutive securities in our calculation of diluted net income (loss) per share, as the impact of these awards is anti-dilutive.

Legal Contingencies

The Company is involved in legal and regulatory proceedings on an ongoing basis. Some of these proceedings are in early stages and may seek an indeterminate amount of damages. If the Company believes that a loss arising from such matters is probable and can be reasonably estimated, the Company accrues the estimated liability in its financial statements. If only a range of estimated losses can be determined, the Company accrues an amount within the range that, in its judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, the Company accrues the low end of the range. For proceedings in which an unfavorable outcome is reasonably possible but not probable and an estimate of the loss or range of losses arising from the proceeding can be made, the Company discloses such an estimate, if material. If such a loss or range of losses is not reasonably estimable, the Company discloses that fact. In assessing the materiality of a proceeding, the Company evaluates, among other factors, the amount of monetary damages claimed, as well as the potential impact of non-monetary remedies sought by plaintiffs that may require changes to business practices in a manner that could have a material adverse impact on the Company’s business.

Legal Expenses

Legal expenses are recognized as incurred.