In the end the specifics are vague, but it's safe to assume that Nick thought that the show was too adult for their target demographic, which is of course going to lead to censorship by the network and consequently to creative differences. Then, when these issues are piled on top of rising production costs as the show gets a bigger budget, as well as slight decreases in ratings between seasons (as inevitably happens with most shows as they continue on), Nick probably started thinking that it wasn't worth it to keep the show on.
However, an important thing to remember is that Nickelodeon is essentially corporate greed incarnate. Everything about them screams capitalism and exploitation. Many shows have been canceled before their time on Nick, but Nick never gives accurate reasons as to why, and that's because they like to milk a show for all its worth even after its cancellation. Take the Angry Beavers cancellation for example (http://www.youtube.com/watch?v=aNWRQL6Wej4 explains it well, especially if you click the link in the description); as it turns out, when Nick cancels a show they make huge bank by keeping its status vague and then cleaning up on showing reruns and selling merchandise/DVDs/Digital releases, the profit from which people like Vasquez never see any money from. And the messed up part is that after a long break of not showing episodes, people are content just watching these reruns because they get excited about the possibility that Nick might be bringing the show back. Case in point: look at all the posts in this forum of people spreading rumors that Zim is coming back because Nick suddenly started showing reruns again, out of nowhere. Nick is making big money on this mentality, and they foster it.
Bottom line: With the problems Nick was having with both Vasquez and the nature of the show, Zim was worth more canceled than continued, due to the possibilities of DVD re-re-re-releases, merchandising, and reruns. It's just like with artists--once they hit their prime and get famous, they're worth more dead than alive. The "poor ratings going into the 2nd season" excuse is obviously bogus, because Nick canceled the show after the 1st episode of the 2nd season.
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