Hey, Look, Zynga's Only Profitable Because Of A Sneaky Accounting Change

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When Zynga filed its financials for the quarter ended in June, it quickly became obvious why the company has delayed its IPO: The numbers were weak.

"Bookings" and "Daily Average Users," the company's two most meaningful performance metrics, both declined from the March quarter ("Bookings" is the light blue bars in the chart above).

Worse, over the past five quarters, the company's user base has begun to plateau (see chart below).

Image: Business Insider Research

And now Stephen Davidoff at the New York Times has also spotted another issue with Zynga's numbers:

If not for a recent accounting change, the apparently profitable company would be losing money.

Here's the story...

As BI Research analyst Pascal-Emmanuel Gobry explained in a recent note, Zynga discloses two types of revenue metrics:

Of these, "bookings" is actually a more meaningful measure of the company's performance in a given period.  This is because "Bookings" represents the dollar-amount of virtual goods sold to game players in the period, whereas "Revenue" is the amount bought in prior periods amortized over the expected life of the virtual goods.

Got that?

"Bookings" is what Zynga actually sells in the quarter or year. "Revenue" is what Zynga sold over the past 4-6 quarters and then spread over the next year or year-and-a-half.

Anytime a company uses "amortization" to calculate revenue, you need to pay close attention to the amortization schedule--the length of time that the sale is spread over. Because a change in this period will result in an increase or reduction in revenue in a given period, even though the company hasn't actually sold any more or less.

So, here's what happened with Zynga:

Last year, for the first six months of 2010, Zynga amortized revenue from virtual goods using an expected useful life of 14 months. In other words, $5 of fertilizer a Farmville player bought anytime over the past 14 months would be spread over the next 14 months, so that Zynga booked about $0.36 of revenue per month.

But for the first six months of this year, Zynga shortened its amortization schedule to 11 months instead of 14 months. This means that, for every $5 of Farmville fertilizer sold, the company will book $0.45 of revenue per month for 11 months.

And that, in turn, means that Zynga's reported revenue from these sales is considerably higher than it would have been had Zynga left its amortization schedule unchanged. (It also means that revenue in the 5th quarter will be lower, because all of the revenue from today's sale will already have been exhausted).

So, how much revenue has Zynga's accounting change contributed to the company this year?

$27 million!

Zynga has booked $522 million of revenue so far this year, so $27 million might not seem like a big change. But it's big enough to wipe out the company's $18 million of profit for the year.

In other words, had Zynga not changed its accounting, the company would have lost money for the first six months of 2011.

Here's the operative note from the latest SEC filing:

The estimated weighted-average life of durable and consumable virtual goods included in bookings during the six months ended June 30, 2010 was 14 months compared to 11 months for the six months ended June 30, 2011. In the six months ended June 30, 2011, online game revenue increased $27.3 million related to changes in our estimated average life of durable virtual goods.

And there's another point to make about these amortization schedules...

In 2010, Zynga's revenue also benefitted from the company reducing its amortization schedule, this time on a full-year basis. In 2010, the company shortened its amortization schedule to an average of 13 months (full year), from an average of 18 months in 2009. This had the impact of goosing Zynga's 2010 revenue as well.

It may also not be great news from a fundamental perspective that Zynga is shortening these amortization schedules.  Because what it means is that the company now thinks the useful life of the virtual goods it sells is only 11 months instead of 18 months two years ago.

This may be a result of the specific type of virtual goods the company is now selling, or that players consume virtual goods faster than it thought. But it also may mean that, after more history, the company has concluded that its game-players just don't stay as engaged in the games as long as it thought they would. And that, in turn, would force the company to continue to produce mega-hit games every few months just to stay even.

SEE ALSO:
ZYNGA'S Q2: The Numbers Were Even Worse Than They Looked

EXPLAINER: How Zynga Makes Money

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Yes, Microsoft Did Change The World More Than Apple (MSFT, AAPL)

But in terms of sheer impact on the world? Microsoft wins, hands down. 

Microsoft gave the world two things:

Microsoft was the first real software company.Microsoft did put a PC on every desk and in every home. 

At the end of the day, it's that last part that matters. By shifting the value in computing to software, Microsoft commoditized computing hardware and made computing accessible to the masses. If this isn't one of the most significant events in history, nothing is.

Now, some people will say that Microsoft did this by copying Apple's innovations like the graphical user interface. Whatever. First of all, Apple famously copied those from Xerox PARC. Great artists steal. Second of all, by any meaning of the word, the person who changes the world isn't the one who comes up with the idea, it's the one who executes on it, and 1980s Apple failed to execute (a lesson well learned by Apple under Steve Jobs 2.0). 

The original Macintosh did show where the future of computing was headed, but it was also a commercial failure. 1980s Apple failed to understand the value of software, in particular third party software, which was lacking in the Macintosh. (This writer's mother bought two computers in the mid-1980s: the first Macintosh and the first IBM PC. There was a lot more software for the PC. So she kept buying PCs, to this day--though she has an iPhone.)

Microsoft, being a software company, built an operating system platform that let thousands of others innovate which, along with Moore's Law, made PCs cheaper and more valuable every year which meant more and more people could get access to them, in a vicious circle.

Being the first big, viable software company also meant Microsoft cleared the way for thousands of other software innovators, when it was in no way obvious at the start that a company could be viable making just software.

The hardware may have been ugly, and the software clunky (a big reason why Windows is buggy is because of Microsoft's amazing 20 year commitment to backwards compatibility, which makes PC software a cohesive environment, a tremendous service to users and the world, for which it gets no credit. With less software to support, Apple can afford to wipe the slate clean every ten years, a strength born of weakness.), but it was the software that millions of people used, and loved.

Nowadays Apple is so huge and efficient that it can afford to make the best products at the best prices. But when the personal computer revolution happened, the Macintosh was a Mercedes and MS-DOS was the Model T. The Model T might have been ugly, clunky and cheap, but being cheap it also changed the lives of millions and transformed the world in a way that the early auto pioneers, amazing and necessary though they were, didn't.  

Now, Apple may yet get its revenge. The mobile computing revolution, with smartphones and tablets, will be at least as big as the desktop computing revolution, and Apple is seriously taking the lead. Android has a good chance of disrupting iOS, but Apple also has a great chance of remaining the dominant mobile platform. Maybe 20 years from now we'll look back and see Apple had an impact at least as big as Microsoft in the 1980s. 

But if we're looking now, Microsoft clearly had a bigger impact on the world than Apple. The fact that we all love Apple products and they're gorgeous doesn't change the fact that the company that actually made the world realize the magic of software, and made computing accessible to almost everyone on the planet, is Microsoft. 

Related: My Apple Story ?

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15 Irrefutable Signs That Climate Change Is Real

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From rising air and ocean temperatures to shrinking glaciers and widespread melting of snow and ice, evidence of a changing global climate is all around us. 

The Intergovernmental Panel on Climate Change has linked many of these changes in climate to an increase greenhouse gas emissions from human activities, which was documented in a 2007 assessment report compiled by thousands of scientists over decades of research and debate.

Regardless of their causes – whether you believe in anthropogenic drivers, like fossil fuels from power plants and cars or not — the observed changes in climate are scientific facts that have grave implications for the future of natural and human systems.

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