UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Quarterly Period Ended September 30, 2007
OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Transition Period from to
Commission File Number 001-33368
Glu Mobile Inc.
(Exact name of the Registrant as Specified in its Charter)
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Delaware
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91-2143667
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(State or Other Jurisdiction of
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(I.R.S. Employer
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Incorporation or Organization)
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Identification No.)
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1800 Gateway Drive, Second Floor
San Mateo, California 94404
(Address of Principal Executive Offices, including Zip Code)
(650) 571-1550
(Registrants Telephone number, including Area Code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
o
Accelerated Filer
o
Non-accelerated filer
þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes
o
No
þ
Shares of Glu Mobile Inc. common stock, $0.0001 par value per share, outstanding as of
November 9, 2007: 28,971,786 shares.
GLU MOBILE INC.
FORM 10-Q
Quarterly Period Ended September 30, 2007
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GLU MOBILE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except per share data)
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September 30,
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December 31,
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2007
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2006
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ASSETS
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Current assets:
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|
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|
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Cash and cash equivalents
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$
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71,988
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|
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$
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3,823
|
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Short-term investments
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8,750
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Accounts receivable, net
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16,387
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14,448
|
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Prepaid royalties
|
|
|
8,633
|
|
|
|
3,501
|
|
Prepaid expenses and other
|
|
|
1,305
|
|
|
|
853
|
|
|
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|
|
|
|
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Total current assets
|
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98,313
|
|
|
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31,375
|
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Property and equipment, net
|
|
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3,993
|
|
|
|
3,480
|
|
Prepaid royalties
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|
|
2,846
|
|
|
|
1,417
|
|
Other long-term assets
|
|
|
4,010
|
|
|
|
1,826
|
|
Intangible assets, net
|
|
|
3,187
|
|
|
|
4,974
|
|
Goodwill
|
|
|
39,963
|
|
|
|
38,727
|
|
|
|
|
|
|
|
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Total assets
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|
$
|
152,312
|
|
|
$
|
81,799
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|
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|
|
|
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LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS EQUITY/(DEFICIT)
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Current liabilities:
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|
|
|
|
|
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|
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Accounts payable
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|
$
|
6,290
|
|
|
$
|
5,394
|
|
Accrued liabilities
|
|
|
246
|
|
|
|
1,048
|
|
Accrued compensation
|
|
|
1,823
|
|
|
|
2,013
|
|
Accrued royalties
|
|
|
11,239
|
|
|
|
7,030
|
|
Accrued restructuring
|
|
|
|
|
|
|
36
|
|
Deferred revenues
|
|
|
194
|
|
|
|
178
|
|
Current portion of long-term debt
|
|
|
|
|
|
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4,339
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
19,792
|
|
|
|
20,038
|
|
Other long-term liabilities
|
|
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3,286
|
|
|
|
1,343
|
|
Long-term debt, less current portion
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|
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7,245
|
|
Preferred stock warrant liability
|
|
|
|
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|
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1,995
|
|
|
|
|
|
|
|
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Total liabilities
|
|
|
23,078
|
|
|
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30,621
|
|
|
|
|
|
|
|
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Commitments and contingencies (see note 6)
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Redeemable convertible preferred stock, $0.0001 par value: 0 and 17,032 shares authorized; 0 and
15,680 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively
|
|
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76,363
|
|
|
|
|
|
|
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Stockholders equity/(deficit):
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Preferred stock, $0.0001 par value; 5,000 shares authorized; no shares issued and outstanding
|
|
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Common stock, $0.0001 par value; 250,000 shares authorized, 28,958 and 5,457 shares issued and
outstanding at September 30, 2007 and December 31, 2006, respectively
|
|
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3
|
|
|
|
1
|
|
Additional paid-in capital
|
|
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178,856
|
|
|
|
19,894
|
|
Deferred stock-based compensation
|
|
|
(155
|
)
|
|
|
(388
|
)
|
Accumulated other comprehensive income
|
|
|
2,052
|
|
|
|
1,285
|
|
Accumulated deficit
|
|
|
(51,522
|
)
|
|
|
(45,977
|
)
|
|
|
|
|
|
|
|
Total stockholders equity/(deficit)
|
|
|
129,234
|
|
|
|
(25,185
|
)
|
|
|
|
|
|
|
|
Total liabilities, redeemable convertible preferred stock and stockholders equity/(deficit)
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|
$
|
152,312
|
|
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$
|
81,799
|
|
|
|
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|
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The
accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.
3
GLU MOBILE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
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|
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|
|
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Three Months Ended
|
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Nine Months Ended
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September 30,
|
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September 30,
|
|
|
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2007
|
|
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2006
|
|
|
2007
|
|
|
2006
|
|
Revenues
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$
|
16,651
|
|
|
$
|
12,347
|
|
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$
|
48,727
|
|
|
$
|
31,863
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Royalties
|
|
|
4,587
|
|
|
|
3,653
|
|
|
|
13,267
|
|
|
|
9,656
|
|
Impairment of prepaid royalties and guarantees
|
|
|
|
|
|
|
60
|
|
|
|
|
|
|
|
319
|
|
Amortization of intangible assets
|
|
|
483
|
|
|
|
553
|
|
|
|
1,589
|
|
|
|
1,223
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
5,070
|
|
|
|
4,266
|
|
|
|
14,856
|
|
|
|
11,198
|
|
|
|
|
|
|
|
|
|
|
|
|
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Gross profit
|
|
|
11,581
|
|
|
|
8,081
|
|
|
|
33,871
|
|
|
|
20,665
|
|
|
|
|
|
|
|
|
|
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Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
|
5,863
|
|
|
|
4,273
|
|
|
|
16,153
|
|
|
|
11,346
|
|
Sales and marketing
|
|
|
3,326
|
|
|
|
2,989
|
|
|
|
9,532
|
|
|
|
8,316
|
|
General and administrative
|
|
|
4,149
|
|
|
|
3,177
|
|
|
|
12,422
|
|
|
|
7,683
|
|
Amortization of intangible assets
|
|
|
67
|
|
|
|
168
|
|
|
|
200
|
|
|
|
477
|
|
Acquired in-process research and development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,500
|
|
Gain on sale of assets
|
|
|
|
|
|
|
|
|
|
|
(1,040
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
13,405
|
|
|
|
10,607
|
|
|
|
37,267
|
|
|
|
29,322
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Loss from operations
|
|
|
(1,824
|
)
|
|
|
(2,526
|
)
|
|
|
(3,396
|
)
|
|
|
(8,657
|
)
|
Interest and other income/(expense), net:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
956
|
|
|
|
180
|
|
|
|
2,081
|
|
|
|
527
|
|
Interest expense
|
|
|
(14
|
)
|
|
|
(402
|
)
|
|
|
(871
|
)
|
|
|
(675
|
)
|
Other income/(expense), net
|
|
|
357
|
|
|
|
(884
|
)
|
|
|
584
|
|
|
|
(756
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest and other income/(expense), net
|
|
|
1,299
|
|
|
|
(1,106
|
)
|
|
|
1,794
|
|
|
|
(904
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes
|
|
|
(525
|
)
|
|
|
(3,632
|
)
|
|
|
(1,602
|
)
|
|
|
(9,561
|
)
|
Income tax provision
|
|
|
(228
|
)
|
|
|
(192
|
)
|
|
|
(813
|
)
|
|
|
(438
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
(753
|
)
|
|
|
(3,824
|
)
|
|
|
(2,415
|
)
|
|
|
(9,999
|
)
|
Accretion to preferred stock
|
|
|
|
|
|
|
(18
|
)
|
|
|
(17
|
)
|
|
|
(56
|
)
|
Deemed dividend
|
|
|
|
|
|
|
|
|
|
|
(3,130
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss attributable to common stockholders
|
|
$
|
(753
|
)
|
|
$
|
(3,842
|
)
|
|
$
|
(5,562
|
)
|
|
$
|
(10,055
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share attributable to common stockholders basic and diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(0.03
|
)
|
|
$
|
(0.76
|
)
|
|
$
|
(0.11
|
)
|
|
$
|
(2.07
|
)
|
Accretion to preferred stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(0.01
|
)
|
Deemed dividend
|
|
|
|
|
|
|
|
|
|
|
(0.15
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share attributable to common stockholders basic and
diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(0.76
|
)
|
|
$
|
(0.26
|
)
|
|
$
|
(2.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding basic and diluted
|
|
|
28,788
|
|
|
|
5,056
|
|
|
|
21,398
|
|
|
|
4,845
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation included in:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development
|
|
$
|
310
|
|
|
$
|
49
|
|
|
$
|
665
|
|
|
$
|
100
|
|
Sales and marketing
|
|
|
224
|
|
|
|
73
|
|
|
|
498
|
|
|
|
130
|
|
General and administrative
|
|
|
626
|
|
|
|
321
|
|
|
|
1,613
|
|
|
|
735
|
|
The
accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.
4
GLU MOBILE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2007
|
|
|
2006
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(2,415
|
)
|
|
$
|
(9,999
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation and accretion
|
|
|
1,518
|
|
|
|
1,096
|
|
Amortization of intangible assets
|
|
|
1,787
|
|
|
|
1,700
|
|
Stock-based compensation
|
|
|
2,776
|
|
|
|
966
|
|
Change in carrying value of preferred stock warrant liability
|
|
|
10
|
|
|
|
1,052
|
|
Amortization of value of warrants issued in connection with loan
|
|
|
477
|
|
|
|
72
|
|
Amortization of loan agreement costs
|
|
|
91
|
|
|
|
11
|
|
Non-cash foreign currency translation gain
|
|
|
(574
|
)
|
|
|
(295
|
)
|
Acquired in-process research and development
|
|
|
|
|
|
|
1,500
|
|
Impairment of prepaid royalties and guarantees
|
|
|
|
|
|
|
319
|
|
Gain on sale of assets
|
|
|
(1,040
|
)
|
|
|
|
|
Changes in allowance for doubtful accounts
|
|
|
46
|
|
|
|
196
|
|
Changes in operating assets and liabilities, net of effect of acquisitions:
|
|
|
|
|
|
|
|
|
Increase in accounts receivable
|
|
|
(1,584
|
)
|
|
|
(1,995
|
)
|
(Increase)/decrease in prepaid royalties
|
|
|
(776
|
)
|
|
|
138
|
|
Increase in prepaid expenses and other assets
|
|
|
(1,525
|
)
|
|
|
(354
|
)
|
Increase/(decrease) in accounts payable
|
|
|
2,424
|
|
|
|
(2,933
|
)
|
Decrease in other accrued liabilities
|
|
|
(800
|
)
|
|
|
(2,203
|
)
|
Increase/(decrease) in accrued compensation
|
|
|
(215
|
)
|
|
|
524
|
|
Increase/(decrease) in accrued royalties
|
|
|
(245
|
)
|
|
|
745
|
|
Increase/(decrease) in deferred revenues
|
|
|
(9
|
)
|
|
|
197
|
|
Decrease in accrued restructuring
|
|
|
(36
|
)
|
|
|
(1,418
|
)
|
Increase in other long-term liabilities
|
|
|
393
|
|
|
|
127
|
|
|
|
|
|
|
|
|
Net cash provided by/(used in) operating activities
|
|
|
303
|
|
|
|
(10,554
|
)
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchase of short-term investments
|
|
|
(73,600
|
)
|
|
|
(22,550
|
)
|
Sale of short-term investments
|
|
|
79,550
|
|
|
|
32,850
|
|
Purchase of property and equipment
|
|
|
(2,142
|
)
|
|
|
(612
|
)
|
Proceeds from sale of assets, net of selling costs
|
|
|
1,040
|
|
|
|
|
|
Acquisition of iFone, net of cash acquired
|
|
|
|
|
|
|
(7,396
|
)
|
|
|
|
|
|
|
|
Net cash provided by investing activities
|
|
|
4,848
|
|
|
|
2,292
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Proceeds from IPO shares, net of issuance costs
|
|
|
74,758
|
|
|
|
|
|
Proceeds from loan agreement
|
|
|
|
|
|
|
12,000
|
|
Proceeds from exercise of stock options
|
|
|
151
|
|
|
|
127
|
|
Proceeds from exercise of warrants
|
|
|
|
|
|
|
7
|
|
Debt payments
|
|
|
(12,060
|
)
|
|
|
(926
|
)
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
62,849
|
|
|
|
11,208
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash
|
|
|
165
|
|
|
|
122
|
|
Net increase in cash and cash equivalents
|
|
|
68,165
|
|
|
|
3,068
|
|
Cash and cash equivalents at beginning of period
|
|
|
3,823
|
|
|
|
2,416
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
71,988
|
|
|
$
|
5,484
|
|
|
|
|
|
|
|
|
The
accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.
5
GLU MOBILE INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
Note 1 The Company, Basis of Presentation and Summary of Significant Accounting Policies
Glu Mobile Inc. (the Company or Glu) was incorporated as Cyent Studios, Inc. in Nevada on
May 16, 2001 and changed its name to Sorrent, Inc. On November 21, 2001, New Sorrent, Inc., a
wholly owned subsidiary of the Company was incorporated in California. The Company and New Sorrent,
Inc. merged on December 4, 2001 to form Sorrent, Inc., a California corporation. In May 2005, the
Company changed its name to Glu Mobile Inc. Glu acquired Macrospace Limited (Macrospace) in
December 2004 in efforts to develop and secure direct distribution relationships in Europe and Asia
with leading wireless carriers, to deepen and broaden its game library (
e.g.,
more titles and genre
diversification), to acquire access and rights to leading licenses and franchises (including
original intellectual property) and to augment its internal and external production and publishing
capabilities. In March 2006, Glu acquired iFone Holdings Limited (iFone) to continue to broaden
its game library and acquire access and rights to leading licenses.
In March 2007, the Company completed its initial public offering (IPO) of common stock in
which it sold and issued 7,300 shares at an issue price of $11.50 per share. The Company raised a
total of $83,950 in gross proceeds from the IPO, or approximately $74,758 in net proceeds after
deducting underwriting discounts and commissions of $5,877 and other offering costs of $3,315. Upon
the closing of the IPO, all shares of redeemable convertible preferred stock outstanding
automatically converted into 15,680 shares of common stock.
In connection with our IPO, in March 2007, we effected a 3-for-1 reverse stock split of our
outstanding capital stock and derivative securities. All share numbers and exercises prices in
this Form 10-Q give effect to the reverse stock split.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission regarding interim financial
reporting. Accordingly, they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements and should be read in
conjunction with the consolidated financial statements and notes thereto included in the Companys
Registration Statement on Form S-1, File Number 333-139493, filed with the Securities and Exchange
Commission. In the opinion of management, the accompanying condensed consolidated financial
statements contain all adjustments, consisting only of normal recurring adjustments, which the
Company believes are necessary for a fair statement of the Companys financial position as of
September 30, 2007 and its results of operations for the three and nine months ended September 30,
2007 and 2006, respectively. These condensed consolidated financial statements are not necessarily
indicative of the results to be expected for the entire year. The consolidated balance sheet
presented as of December 31, 2006 has been derived from the audited consolidated financial
statements as of that date.
For the three months ended September 30, 2007, the Company recorded adjustments related to
operating expenses. The corrections resulted in the Company reporting $49 of additional losses
before income taxes related to prior quarters. Management and the Audit Committee believe that such
amounts are not material to previously reported financial statements. This adjustment had no impact
on reported net loss per share for any of the periods previously reported or for the period ended
September 30, 2007.
For the nine months ended September 30, 2007, the Company recorded adjustments related to cost
of sales, operating expense and tax expense. The corrections resulted in the Company reporting
approximately $5 of additional losses related to prior fiscal years. Management and the Audit
Committee believe that such amounts are not material to previously reported financial statements.
These adjustments had no impact on reported net loss per share for any of the periods previously
reported or for the period ended September 30, 2007.
Basis of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All material intercompany balances and transactions have been
eliminated.
6
Use of Estimates
The preparation of financial statements and related disclosures in conformity with generally
accepted accounting principles in the United States requires the Companys management to make
judgments, assumptions and estimates that affect the amounts reported in its consolidated financial
statements and accompanying notes. Management bases its estimates on historical experience and on
various other assumptions it believes to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates and these differences may be material.
Revenue Recognition
The Companys revenues are derived primarily by licensing software products in the form of
mobile games. License arrangements with the end user can be on a perpetual or subscription basis. A
perpetual license gives an end user the right to use the licensed game on the registered handset on
a perpetual basis. A subscription license gives an end user the right to use the licensed game on
the registered handset for a limited period of time, ranging from a few days to as long as one
month. The Company distributes its products primarily through mobile telecommunications service
providers (carriers), which market the games to end users. License fees for perpetual and
subscription licenses are usually billed by the carrier upon download of the game by the end user.
In the case of subscriber licenses, many subscriber agreements provide for automatic renewal until
the subscriber opts-out, while the others provide opt-in renewal. In either case, subsequent
billings for subscription licenses are generally billed monthly. The Company applies the provisions
of Statement of Position 97-2,
Software Revenue Recognition
, as amended by Statement of Position
98-9, Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions
,
to all transactions.
Revenues are recognized from our games when persuasive evidence of an arrangement exists, the
game has been delivered, the fee is fixed or determinable, and the collection of the resulting
receivable is probable. For both perpetual and subscription licenses, management considers a signed
license agreement to be evidence of an arrangement with a carrier and a clickwrap agreement to be
evidence of an arrangement with an end user. For these licenses, the Company defines delivery as
the download of the game by the end user. The Company estimates revenues from carriers in the
current period when reasonable estimates of these amounts can be made. Several carriers provide
reliable interim preliminary reporting and others report sales data within a reasonable time frame
following the end of each month, both of which allow the Company to make reasonable estimates of
revenues and therefore to recognize revenues during the reporting period when the end user licenses
the game. Determination of the appropriate amount of revenue recognized involves judgments and
estimates that the Company believes are reasonable, but it is possible that actual results may
differ from the Companys estimates. The Companys estimates for revenues include consideration of
factors such as preliminary sales data, carrier-specific historical sales trends, the age of games
and the expected impact of newly launched games, successful introduction of new handsets,
promotions during the period and economic trends. When the Company receives the final carrier
reports, to the extent not received within a reasonable time frame following the end of each month,
the Company records any differences between estimated revenues and actual revenues in the reporting
period when the Company determines the actual amounts. Historically, the revenues on the final
revenue report have not differed by more than one half of 1% of the reported revenues for the
period, which the Company deemed to be immaterial. Revenues earned from certain carriers may not be
reasonably estimated. If the Company is unable to reasonably estimate the amount of revenues to be
recognized in the current period, the Company recognizes revenues upon the receipt of a carrier
revenue report and when the Companys portion of a games licensed revenues are fixed or
determinable and collection is probable. To monitor the reliability of the Companys estimates,
management, where possible, reviews the revenues by carrier and by game on a weekly basis to
identify unusual trends such as differential adoption rates by carriers or the introduction of new
handsets. If the Company deems a carrier not to be creditworthy, the Company defers all revenues
from the arrangement until the Company receives payment and all other revenue recognition criteria
have been met.
In accordance with Emerging Issues Task Force, or EITF Issue No. 99-19,
Reporting Revenue
Gross as a Principal Versus Net as an Agent
, the Company recognizes as revenue the amount the
carrier reports as payable upon the sale of the Companys games. The Company has evaluated its
carrier agreements and has determined that it is not the principal when selling its games through
carriers. Key indicators that it evaluated to reach this determination include:
|
|
|
wireless subscribers directly contract with the carriers, which have most of the service
interaction and are generally viewed as the primary obligor by the subscribers;
|
|
|
|
|
carriers generally have significant control over the types of games that they offer to
their subscribers;
|
7
|
|
|
carriers are directly responsible for billing and collecting fees from their subscribers,
including the resolution of billing disputes;
|
|
|
|
|
carriers generally pay the Company a fixed percentage of their revenues or a fixed fee
for each game;
|
|
|
|
|
carriers generally must approve the price of the Companys games in advance of their sale
to subscribers, and the Companys more significant carriers generally have the ability to
set the ultimate price charged to their subscribers; and
|
|
|
|
|
the Company has limited risks, including no inventory risk and limited credit risk.
|
Investments in Marketable Securities
The Company invests in auction rate securities that are bought and sold in the marketplace
through a bidding process sometimes referred to as a Dutch Auction. After the initial issuance of
the securities, the interest rate on the securities is reset periodically, at intervals set at the
time of issuance (e.g., every seven, 28 or 35 days or every six months), based on the market demand
at the reset period. The stated or contractual maturities for these securities, however,
generally are 20 to 30 years. Historically, the Company had the ability and intent, if necessary,
to liquidate any of these investments as needed in order to meet the Companys needs within its
normal operating cycles. As of December 31, 2006 all auction rate securities were included in
short-term investments. Due to disruptions of, and the resulting greatly reduced liquidity in
certain financial markets in 2007, two of the Companys AAA rated, corporate asset-backed auction
rate securities totaling $2,800 in purchased cost experienced failed auctions during the three
months ended September 30, 2007. Due to the failed auctions, the Company was unable to sell the
securities at their respective costs, resulting in a decrease in fair value of $259 as of September
30, 2007. Although the Company intends to liquidate these two investments as needed it does not
currently have the same ability to do so and has reclassified these investments to other long-term
assets as of September 30, 2007.
The Company has classified these investments as available-for-sale securities under Statement
of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities (SFAS No. 115). In accordance with SFAS No. 115, these securities are reported at fair
value with any changes in market value reported as a part of comprehensive income/(loss). The
Company has recorded an unrealized loss of $259 during the three and nine months ended September
30, 2007. No unrealized gains or losses were recognized during the three or nine months ended
September 30, 2006.
The Company periodically reviews these investments for impairment. In the event the carrying
value of an investment exceeds its fair value and the decline in fair value is determined to be
other-than-temporary, the Company writes down the value of the investment to its fair value. The
Company recorded the $259 change in fair value as of September 30, 2007 as an unrealized loss
within other comprehensive income/(loss) since the change in fair value was determined to be
temporary.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to a concentration of credit risk
consist of cash, cash equivalents, short-term investments and accounts receivable.
The Company derives its accounts receivable from revenues earned from customers located in the
United States and other locations outside of the United States. The Company performs ongoing credit
evaluations of its customers financial condition and, generally, requires no collateral from its
customers. The Company bases its allowance for doubtful accounts on managements best estimate of
the amount of probable credit losses in the Companys existing accounts receivable. The Company
reviews past due balances over a specified amount individually for collectibility on a monthly
basis. It reviews all other balances quarterly. The Company charges off accounts receivable
balances against the allowance when it determines that the amount will not be recovered.
The following table summarizes the revenues from customers in excess of 10% of the Companys
revenues:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2007
|
|
2006
|
Verizon Wireless
|
|
|
23.3
|
%
|
|
|
21.0
|
%
|
Sprint Nextel
|
|
|
*
|
|
|
|
13.0
|
%
|
Cingular Wireless
|
|
|
*
|
|
|
|
11.5
|
%
|
Vodafone
|
|
|
*
|
|
|
|
10.7
|
%
|
|
|
|
*
|
|
Revenues from the customer were less than 10% during the period.
|
8
At September 30, 2007, Verizon Wireless and Sprint Nextel accounted for 25% and 11%, of total
accounts receivable, respectively. At December 31, 2006, Verizon Wireless, Sprint Nextel and
Vodafone accounted for 21%, 11% and 10% of total accounts receivable, respectively. No other
customer represented greater than 10% of the Companys revenues or accounts receivable in these
periods or as of these dates.
The following table summarizes the revenues from specific titles in excess of 10% of the
Companys revenues for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
Monopoly Here & Now
|
|
|
10.1
|
%
|
|
|
*
|
|
|
|
|
*
|
|
Revenues from the title were less than 10% during the period.
|
Freestanding Preferred Stock Warrants
Freestanding warrants and other similar instruments related to shares that are redeemable are
accounted for in accordance with Statement of Financial Accounting Standards No. 150,
Accounting
for Certain Financial Instruments with Characteristics of Both Liabilities and Equity
(SFAS No.
150). Under SFAS No. 150, the freestanding warrants that were related to the Companys redeemable
convertible preferred stock were recorded as liabilities on the consolidated balance sheet. The
warrants were subject to re-measurement at each balance sheet date and any change in fair value was
recognized as a component of other income (expense), net. Subsequent to the Companys IPO and the
associated conversion of the Companys outstanding redeemable convertible preferred stock into
common stock, the warrants to exercise the redeemable convertible preferred stock converted into
common stock warrants; accordingly, the liability related to the redeemable convertible preferred
stock warrants at the closing of the IPO of $1,985 was transferred to additional paid-in-capital
and the common stock warrants are no longer subject to re-measurement.
Prepaid or Guaranteed Licensor Royalties
The Companys royalty expenses consist of fees that it pays to branded content owners for the
use of their intellectual property, including trademarks and copyrights, in the development of the
Companys games. Royalty-based obligations are either paid in advance and capitalized on our
balance sheet as prepaid royalties or accrued as incurred and subsequently paid. These
royalty-based obligations are expensed to cost of revenues at the greater of the revenues derived
from the relevant game multiplied by the applicable contractual rate or an effective royalty rate
based on expected net product sales. Advanced license payments that are not recoupable against
future royalties are capitalized and amortized over the lesser of the estimated life of the branded
title or the term of the license agreement.
The Companys contracts with some licensors include minimum guaranteed royalty payments, which
are payable regardless of the ultimate volume of sales to end users. Effective January 1, 2006, the
Company adopted FSP FIN 45-3,
Application of FASB Interpretation No. 45 to Minimum Revenue
Guarantees Granted to a Business or Its Owners.
The Company has recorded a minimum guaranteed
liability of approximately $7,164 as of September 30, 2007. When no significant performance remains
with the licensor, the Company initially records each of these guarantees as an asset and as a
liability at the contractual amount. The Company believes that the contractual amount represents
the fair value of the liability. When significant performance remains with the licensor, the
Company records royalty payments as an asset when actually paid and as a liability when incurred,
rather than upon execution of the contract. The Company classifies minimum royalty payment
obligations as current liabilities to the extent they are contractually due within the next twelve
months.
At each quarterly balance sheet date, the Company evaluates the realization of its royalties
as well as any unrecognized guarantees not yet paid to determine amounts that it deems unlikely to
be realized through product sales. The Company uses estimates of revenues, cash flows and net
margins to evaluate the future realization of prepaid royalties and guarantees. This evaluation
considers multiple factors, including the term of the agreement, forecasted demand, game life cycle
status, game development plans, and current
9
and anticipated sales levels, as well as other qualitative factors such as the success of
similar games and similar genres on mobile devices for the Company and its competitors and/or other
game platforms (e.g., consoles, personal computers and Internet) utilizing the intellectual
property and whether there are any future planned theatrical releases or television series based on
the intellectual property. To the extent that this evaluation indicates that the remaining prepaid
and guaranteed royalty payments are not recoverable, the Company records an impairment charge to
cost of revenues in the period that impairment is indicated. The Company recorded impairment
charges to cost of revenues of $0 and $60 during the three months ended September 30, 2007 and
2006, respectively. The Company recorded impairment charges to cost of revenues of $0 and $319
during the nine months ended September 30, 2007 and 2006, respectively.
Research and Development Costs
The Company charges costs related to research, design and development of products to research
and development expense as incurred. The types of costs included in research and development
expenses include salaries, contractor fees and allocated facilities costs.
Software Development Costs
The Company applies the principles of Statement of Financial Accounting Standards No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed
(SFAS No.
86). SFAS No. 86 requires that software development costs incurred in conjunction with product
development be charged to research and development expense until technological feasibility is
established. Thereafter, until the product is released for sale, software development costs must be
capitalized and reported at the lower of unamortized cost or net realizable value of the related
product. The Company has adopted the tested working model approach to establishing technological
feasibility for its games. Under this approach, the Company does not consider a game in development
to have passed the technological feasibility milestone until the Company has completed a model of
the game that contains essentially all the functionality and features of the final game and has
tested the model to ensure that it works as expected. To date, the Company has not incurred
significant costs between the establishment of technological feasibility and the release of a game
for sale; thus, the Company has expensed all software development costs as incurred. The Company
considers the following factors in determining whether costs can be capitalized: the emerging
nature of the mobile game market; the gradual evolution of the wireless carrier platforms and
mobile phones for which it develops games; the lack of pre-orders or sales history for its games;
the uncertainty regarding a games revenue-generating potential; its lack of control over the
carrier distribution channel resulting in uncertainty as to when, if ever, a game will be available
for sale; and its historical practice of canceling games at any stage of the development process.
Internal Use Software
The Company recognizes internal use software development costs in accordance with the
Statement of Position (SOP) No. 98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use
. Thus, the Company capitalizes software development costs, including
costs incurred to purchase third-party software, beginning when it determines certain factors are
present including, among others, that technology exists to achieve the performance requirements
and/or buy versus internal development decisions have been made. The Company has capitalized
certain internal use software costs totaling approximately $10 and $9 during the three months ended
September 30, 2007 and 2006, respectively. The Company has capitalized certain internal use
software costs totaling approximately $469 and $234 during the nine months ended September 30, 2007
and 2006, respectively. The estimated useful life of costs capitalized is generally three years.
During the three months ended September 30, 2007 and 2006, the amortization of capitalized costs
totaled approximately $192 and $119, respectively. During the nine months ended September 30, 2007
and 2006, the amortization of capitalized costs totaled approximately $483 and $323, respectively.
Capitalized internal use software development costs are included in property and equipment, net.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting
Standards No. 109,
Accounting for Income Taxes
(SFAS No. 109), which requires recognition of
deferred tax assets and liabilities for the expected future tax consequences of events that have
been included in its financial statements or tax returns. Under SFAS No. 109, the Company
determines deferred tax assets and liabilities based on the temporary difference between the
financial statement and tax bases of assets and liabilities using the enacted tax rates in effect
for the year in which it expects the differences to reverse. The Company establishes valuation
allowances when necessary to reduce deferred tax assets to the amount it expects to realize.
10
On January 1, 2007, the Company adopted Financial Accounting Standards Board (FASB)
Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an interpretation of FASB
Statement No. 109
(FIN 48), which supplements SFAS No. 109 by defining the confidence level that
a tax position must meet in order to be recognized in the financial statements. FIN 48 requires
that the tax effects of a position be recognized only if it is more-likely-than-not to be
sustained based solely on its technical merits as of the reporting date. The Company considers many
factors when evaluating and estimating its tax positions and tax benefits, which may require
periodic adjustments and which may not accurately anticipate actual outcomes.
With the adoption of FIN 48, companies are required to adjust their financial statements to
reflect only those tax positions that are more-likely-than-not to be sustained. Any necessary
adjustment would be recorded directly to retained earnings and reported as a change in accounting
principle as of the date of adoption. FIN 48 prescribes a comprehensive model for the financial
statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or
expected to be taken in income tax returns. See Note 11 for additional information, including the
effects of adoption on the Companys consolidated financial position, results of operations and
cash flows.
Stock-Based Compensation
Prior to January 1, 2006, the Company accounted for stock-based employee compensation
arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
(APB No. 25), and related interpretations, and followed
the disclosure provisions of Statement of Financial Accounting Standards No. 123,
Accounting for
Stock-Based Compensation
(SFAS No. 123). Under APB No. 25, compensation expense for an option is
based on the difference, if any, on the date of the grant, between the fair value of a companys
common stock and the exercise price of the option. Employee stock-based compensation determined
under APB No. 25 is recognized using the multiple option method prescribed by the Financial
Accounting Standards Board Interpretation No. 28,
Accounting for Stock Appreciation Rights and
Other Variable Stock Option or Award Plans
(FIN 28), over the option vesting period.
Effective January 1, 2006, the Company adopted the fair value provisions of Statement of
Financial Accounting Standards No. 123(R),
Share-Based Payment
(SFAS No. 123R), which supersedes
its previous accounting under APB No. 25. SFAS No. 123R requires the recognition of compensation
expense, using a fair-value based method, for costs related to all share-based payments including
stock options. SFAS No. 123R requires companies to estimate the fair value of share-based payment
awards on the grant date using an option pricing model. The Company adopted SFAS No. 123R using the
prospective transition method, which requires, that for nonpublic entities that used the minimum
value method for either pro forma or financial statement recognition purposes, SFAS No. 123R shall
be applied to option grants on and after the required effective date. For options granted prior to
the SFAS No. 123R effective date that remain unvested on that date, the Company continues to
recognize compensation expense under the intrinsic value method of APB No. 25. In addition, the
Company continues to amortize those awards valued prior to January 1, 2006 utilizing an accelerated
amortization schedule, while it expenses all options granted or modified after January 1, 2006 on a
straight-line basis.
The Company has elected to use the with and without approach as described in EITF Topic No.
D-32 in determining the order in which tax attributes are utilized. As a result, the Company will
only recognize a tax benefit from stock-based awards in additional paid-in capital if an
incremental tax benefit is realized after all other tax attributes currently available to the
Company have been utilized. In addition, the Company has elected to account for the indirect
effects of stock-based awards on other tax attributes, such as the research tax credit, through its
statement of operations.
The Company accounts for equity instruments issued to non-employees in accordance with the
provisions of SFAS No. 123, EITF Issue No. 96-18,
Accounting for Equity Instruments that are Issued
to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services
, and FIN
28.
Comprehensive Income/(Loss)
Comprehensive income/(loss) consists of two components, net income/(loss) and other
comprehensive income/(loss). Other comprehensive income/(loss) refers to gains and losses that
under generally accepted accounting principles are recorded as an element of stockholders equity
but are excluded from net income/(loss). The Companys other comprehensive income/(loss) includes
foreign currency translation adjustments and unrealized gains/(losses) on available-for-sale
securities. The components of comprehensive income/(loss), net of tax, are as follows:
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Net loss, as reported
|
|
$
|
(753
|
)
|
|
$
|
(3,824
|
)
|
|
$
|
(2,415
|
)
|
|
$
|
(9,999
|
)
|
Other comprehensive income/(loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment, net of tax
|
|
|
504
|
|
|
|
568
|
|
|
|
1,025
|
|
|
|
1,553
|
|
Unrealized loss on investments, net of tax
|
|
|
(259
|
)
|
|
|
|
|
|
|
(259
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
$
|
(508
|
)
|
|
$
|
(3,256
|
)
|
|
$
|
(1,649
|
)
|
|
$
|
(8,446
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loss Per Share
The Company computes basic net loss per share attributable to common stockholders by dividing
its net loss attributable to common stockholders for the period by the weighted-average number of
common shares outstanding during the period less the weighted average unvested common shares
subject to repurchase by the Company. Net loss attributable to common stockholders is calculated
using the two-class method; however, preferred stock dividends were not included in the Companys
diluted net loss per share calculations because to do so would be anti-dilutive for all periods
presented.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Net loss attributable to common stockholders
|
|
$
|
(753
|
)
|
|
$
|
(3,842
|
)
|
|
$
|
(5,562
|
)
|
|
$
|
(10,055
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
28,863
|
|
|
|
5,293
|
|
|
|
21,487
|
|
|
|
5,202
|
|
Weighted average unvested common shares subject to repurchase
|
|
|
(75
|
)
|
|
|
(237
|
)
|
|
|
(89
|
)
|
|
|
(357
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used to compute basic and diluted net loss per share
|
|
|
28,788
|
|
|
|
5,056
|
|
|
|
21,398
|
|
|
|
4,845
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share attributable to common stockholders basic and diluted
|
|
$
|
(0.03
|
)
|
|
$
|
(0.76
|
)
|
|
$
|
(0.26
|
)
|
|
$
|
(2.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following weighted-average number of shares subject to options and warrants to purchase
common stock and unvested shares of common stock subject to repurchase have been excluded from the
computation of diluted net loss per share of common stock for the periods presented because
including them would have had an anti-dilutive effect:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Convertible preferred stock
|
|
|
|
|
|
|
15,680
|
|
|
|
4,936
|
|
|
|
14,577
|
|
Warrants to purchase convertible preferred stock
|
|
|
|
|
|
|
229
|
|
|
|
|
|
|
|
182
|
|
Warrants to purchase common stock
|
|
|
204
|
|
|
|
2
|
|
|
|
221
|
|
|
|
13
|
|
Unvested common shares subject to repurchase
|
|
|
75
|
|
|
|
237
|
|
|
|
89
|
|
|
|
357
|
|
Options to purchase common stock
|
|
|
3,570
|
|
|
|
2,329
|
|
|
|
3,370
|
|
|
|
2,213
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,849
|
|
|
|
18,477
|
|
|
|
8,616
|
|
|
|
17,342
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recent Accounting Pronouncements
In September 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement No. 109
(FIN 48), which clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements in accordance with
SFAS No. 109,
Accounting for Income Taxes
. This Interpretation prescribes a comprehensive model for
how a company should recognize, measure, present and disclose in its financials statements
uncertain tax positions that it has taken or expects to take on a tax return, including a decision
whether to file or not to file a return in a particular jurisdiction. Under the Interpretation, the
financial statements must reflect expected future tax consequences of these positions presuming the
taxing authorities full knowledge of the position and all relevant facts. The Interpretation also
revises disclosure requirements and introduces a prescriptive, annual, tabular roll-forward of the
unrecognized tax benefits. This Interpretation is effective for fiscal years beginning after
December 15, 2006. See Note 11 for additional information, including the effects of adoption on the
Companys consolidated financial position, results of operations and cash flows.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157,
Fair
Value Measurements
(SFAS No. 157). SFAS No. 157 establishes a framework for measuring fair value
and expands disclosures about fair value measurements.
12
The changes to current practice resulting from the application of this statement relate to the
definition of fair value, the methods used to measure fair value, and the expanded disclosures
about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November
15, 2007. Earlier adoption is permitted, provided the company has not yet issued financial
statements, including for interim periods, for that fiscal year. The Company is currently
evaluating the impact of adopting SFAS No. 157 on the Companys consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159,
The
Fair Value Option for Financial Assets and Financial Liabilities
(SFAS No. 159). SFAS No. 159
permits companies to choose to measure at fair value, on an instrument-by-instrument basis, many
financial instruments and certain other assets and liabilities that are not currently required to
be measured at fair value. SFAS No. 159 is effective as of the beginning of a fiscal year that
begins after November 15, 2007. The Company is currently in the process of evaluating the impact
that the adoption of SFAS No. 159 on its financial position, results of operations and cash flows.
Note 2 Investments in Marketable Securities
Marketable securities, which are classified as available-for-sale, are summarized below as of
September 30, 2007, and December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Classified on Balance Sheet
|
|
|
|
Purchased
Cost
|
|
|
Unrealized
Loss
|
|
|
Aggregate
Fair Value
|
|
|
Cash and Cash
Equivalents
|
|
|
Short-term
Investments
|
|
|
Other Long-term
Assets
|
|
As of September 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction rate securities
|
|
$
|
2,800
|
|
|
$
|
(259
|
)
|
|
$
|
2,541
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
2,541
|
|
Money market funds
|
|
|
66,251
|
|
|
|
|
|
|
|
66,251
|
|
|
|
66,251
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
69,051
|
|
|
$
|
(259
|
)
|
|
$
|
68,792
|
|
|
$
|
66,251
|
|
|
$
|
|
|
|
$
|
2,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction rate securities
|
|
$
|
8,750
|
|
|
$
|
|
|
|
$
|
8,750
|
|
|
$
|
|
|
|
$
|
8,750
|
|
|
$
|
|
|
Money market funds
|
|
|
1,489
|
|
|
|
|
|
|
|
1,489
|
|
|
|
1,489
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
10,239
|
|
|
$
|
|
|
|
$
|
10,239
|
|
|
$
|
1,489
|
|
|
$
|
8,750
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2007 the contractual maturities of our remaining two auction rate
securities were 2017. As of December 31, 2006, the contractual maturities of investments held were
greater than five years. There were no gross realized gains or losses from sales or maturities of
securities in the periods presented.
Note 3 Acquisitions
Acquisition of iFone Holdings Limited
On March 29, 2006, the Company acquired the net assets of iFone in order to continue to deepen
and broaden its game library, to acquire access and rights to leading licenses and franchises and
to augment its external production resources. These factors contributed to a purchase price in
excess of the fair value of net tangible and intangible assets acquired, and, as a result, the
Company recorded goodwill in connection with this transaction.
The Company purchased all of the issued and outstanding shares of iFone in exchange for the
issuance of 3,423 shares of Special Junior Preferred Stock of the Company and $3,500 in cash. In
addition, subject to the completion of specified milestones, the Company committed to issue a total
of 871 shares of Special Junior Preferred Stock of the Company and $4,500 in subordinated unsecured
promissory notes to the iFone shareholders. In conjunction with this transaction, the Companys
Board of Directors approved an increase in the number of authorized shares of preferred stock of
Glu to 17,031 shares. The milestones outlined in the purchase agreement for which contingent
consideration was agreed to be issued were not achieved during the period to earn this additional
consideration. As the milestone consideration was not earned, these amounts have not been reflected
in these financial statements.
13
The total purchase price of approximately $23,502 consisted of the following: 3,423 shares of
Special Junior Preferred Stock of the Company (valued at $19,098 based on a weighted income and
market comparable approach), $3,500 of cash and transaction costs of $904.
The Companys consolidated financial statements include the results of operations of iFone
from the date of acquisition. Under the purchase method of accounting, the Company allocated the
total purchase price of $23,502 to the net tangible and intangible assets acquired and liabilities
assumed based upon their respective estimated fair values as of the acquisition date.
|
|
|
|
|
Assets acquired:
|
|
|
|
|
Accounts receivable
|
|
$
|
2,518
|
|
Prepaid and other current assets
|
|
|
2,271
|
|
Property and equipment
|
|
|
89
|
|
Intangible assets (see Note 5):
|
|
|
|
|
Titles, content and technology
|
|
|
2,700
|
|
Carrier contracts and relationships
|
|
|
1,300
|
|
Existing license agreements
|
|
|
400
|
|
Trademarks
|
|
|
100
|
|
In-process research and development
|
|
|
1,500
|
|
Goodwill (see Note 5)
|
|
|
22,828
|
|
|
|
|
|
Total assets acquired
|
|
|
33,706
|
|
Liabilities assumed:
|
|
|
|
|
Accounts payable
|
|
|
(4,247
|
)
|
Accrued liabilities
|
|
|
(4,777
|
)
|
Restructuring liabilities
|
|
|
(1,180
|
)
|
|
|
|
|
Total liabilities acquired
|
|
|
(10,204
|
)
|
|
|
|
|
Net acquired assets
|
|
$
|
23,502
|
|
|
|
|
|
The above table includes reductions to acquired goodwill to reflect adjustments to certain
assumed liabilities upon completion of the purchase price allocation.
The Company has recorded an estimate for costs to terminate certain activities associated with
the iFone operations in accordance with the guidance of Emerging Issues Task Force Issue No. 95-3,
Recognition of Liabilities in Connection with a Purchase Business Combination.
This restructuring
accrual of $1,180 principally related to the termination of 41 iFone employees. At September 30,
2007, no restructuring liabilities related to iFone employees remained accrued.
Of the total purchase price, $4,500 was allocated to amortizable intangible assets. The
amortizable intangible assets are being amortized using a straight-line method over the respective
estimated useful life of two to five years.
In conjunction with the acquisition of iFone, the Company recorded a $1,500 expense for
acquired in-process research and development (IPR&D) during the first quarter of 2006 because
feasibility of the acquired technology had not been established and no future alternative uses
existed. The IPR&D expense is included in operating expenses in its consolidated statements of
operation in the year ended December 31, 2006.
The IPR&D is related to the development of new game titles. The Company determined the value
of acquired IPR&D using the discounted cash flow approach. The Company calculated the present value
of the expected future cash flows attributable to the in-process technology using a 21% discount
rate. This rate takes into account the percentage of completion of the development effort of
approximately 20% and the risks associated with the Companys developing this technology given
changes in trends and technology in the industry. As of December 31, 2006, these acquired IPR&D
projects had been completed at costs similar to the original projections.
The Company based the valuation of identifiable intangible assets and IPR&D acquired on
managements estimates, currently available information and reasonable and supportable assumptions.
The Company based the allocation of the purchase price on the fair value of these net assets
acquired determined using the income and market valuation approaches.
14
The Company allocated the residual value of $22,828 to goodwill. Goodwill represents the
excess of the purchase price over the fair value of the net tangible and intangible assets
acquired. In accordance with SFAS No. 142, goodwill will not be amortized but will be tested for
impairment at least annually. Goodwill is not deductible for tax purposes.
The Company has included the results of operations of iFone in its consolidated financial
statements subsequent to the date of the acquisition. The unaudited financial information in the
table below summarizes the combined results of operations of the Company and iFone, on a pro forma
basis, as though the companies had been combined as of the beginning of the period presented:
|
|
|
|
|
|
|
Nine
|
|
|
Months
|
|
|
Ended
|
|
|
September 30,
|
|
|
2006
|
Total pro forma revenues
|
|
$
|
34,285
|
|
Gross profit
|
|
|
22,481
|
|
Pro forma net loss
|
|
|
(14,233
|
)
|
Pro forma net loss per share basic and diluted
|
|
|
(2.94
|
)
|
The Company is presenting pro forma financial information for informational purposes only, and
this information is not intended to be indicative of the results of operations that would have been
achieved if the acquisitions had taken place at the beginning of 2006. The pro forma financial
information above includes a charge of $1,500 for IPR&D.
Note 4 Balance Sheet Components
Property and Equipment
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Computer equipment
|
|
$
|
2,930
|
|
|
$
|
1,856
|
|
Furniture and fixtures
|
|
|
1,407
|
|
|
|
1,260
|
|
Software
|
|
|
2,183
|
|
|
|
1,714
|
|
Leasehold improvements
|
|
|
1,498
|
|
|
|
1,129
|
|
|
|
|
|
|
|
|
|
|
|
8,018
|
|
|
|
5,959
|
|
Less: Accumulated depreciation and amortization
|
|
|
(4,025
|
)
|
|
|
(2,479
|
)
|
|
|
|
|
|
|
|
|
|
$
|
3,993
|
|
|
$
|
3,480
|
|
|
|
|
|
|
|
|
Depreciation expense for the three months ended September 30, 2007 and 2006 was $582 and $397,
respectively. Depreciation expense for the nine months ended September 30, 2007 and 2006 were
$1,496 and $1,096, respectively.
Accounts Receivable
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Accounts receivable
|
|
$
|
16,895
|
|
|
$
|
14,914
|
|
Less: Allowance for doubtful accounts
|
|
|
(508
|
)
|
|
|
(466
|
)
|
|
|
|
|
|
|
|
|
|
$
|
16,387
|
|
|
$
|
14,448
|
|
|
|
|
|
|
|
|
Accounts receivable includes amounts billed and unbilled as of the respective balance sheet
dates.
15
Note 5 Goodwill and Intangible Assets
The Companys intangible assets were acquired in connection with the acquisitions of
Macrospace and iFone. The carrying amounts and accumulated amortization expense of the acquired
intangible assets at September 30, 2007 and December 31, 2006 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Balance at
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Balance at
|
|
|
|
Useful
|
|
|
Acquisition
|
|
|
|
|
|
|
Amortization
|
|
|
December 31,
|
|
|
Acquisition
|
|
|
|
|
|
|
Amortization
|
|
|
September 30,
|
|
|
|
Life
|
|
|
Amount
|
|
|
Impairment
|
|
|
Expense
|
|
|
2006
|
|
|
Amount
|
|
|
Impairment
|
|
|
Expense
|
|
|
2007
|
|
Intangible assets
amortized to cost
of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Titles, context and
technology
|
|
2.5 yrs
|
|
$
|
5,300
|
|
|
$
|
(1,103
|
)
|
|
$
|
(2,373
|
)
|
|
$
|
1,824
|
|
|
$
|
5,300
|
|
|
$
|
(1,103
|
)
|
|
$
|
(3,523
|
)
|
|
$
|
674
|
|
Catalogs
|
|
1 yr
|
|
|
1,500
|
|
|
|
|
|
|
|
(1,500
|
)
|
|
|
|
|
|
|
1,500
|
|
|
|
|
|
|
|
(1,500
|
)
|
|
|
|
|
Provision X
Technology
|
|
6 yrs
|
|
|
247
|
|
|
|
|
|
|
|
(192
|
)
|
|
|
55
|
|
|
|
247
|
|
|
|
|
|
|
|
(202
|
)
|
|
|
45
|
|
Carrier contract
and related
relationships
|
|
5 yrs
|
|
|
2,200
|
|
|
|
|
|
|
|
(563
|
)
|
|
|
1,637
|
|
|
|
2,200
|
|
|
|
|
|
|
|
(892
|
)
|
|
|
1,308
|
|
Licensed content
|
|
5 yrs
|
|
|
400
|
|
|
|
|
|
|
|
(60
|
)
|
|
|
340
|
|
|
|
400
|
|
|
|
|
|
|
|
(120
|
)
|
|
|
280
|
|
Trademarks
|
|
3 yrs
|
|
|
100
|
|
|
|
|
|
|
|
(37
|
)
|
|
|
63
|
|
|
|
100
|
|
|
|
|
|
|
|
(75
|
)
|
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,747
|
|
|
|
(1,103
|
)
|
|
|
(4,725
|
)
|
|
|
3,919
|
|
|
|
9,747
|
|
|
|
(1,103
|
)
|
|
|
(6,312
|
)
|
|
|
2,332
|
|
Other intangible
assets amortized to
operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Emux Technology
|
|
6 yrs
|
|
|
1,600
|
|
|
|
|
|
|
|
(545
|
)
|
|
|
1,055
|
|
|
|
1,600
|
|
|
|
|
|
|
|
(745
|
)
|
|
|
855
|
|
Non-compete
agreement
|
|
2 yrs
|
|
|
700
|
|
|
|
|
|
|
|
(700
|
)
|
|
|
|
|
|
|
700
|
|
|
|
|
|
|
|
(700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,300
|
|
|
|
|
|
|
|
(1,245
|
)
|
|
|
1,055
|
|
|
|
2,300
|
|
|
|
|
|
|
|
(1,445
|
)
|
|
|
855
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangible
assets
|
|
|
|
|
|
$
|
12,047
|
|
|
$
|
(1,103
|
)
|
|
$
|
(5,970
|
)
|
|
$
|
4,974
|
|
|
$
|
12,047
|
|
|
$
|
(1,103
|
)
|
|
$
|
(7,757
|
)
|
|
$
|
3,187
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company has included amortization of acquired intangible assets directly attributable to
revenue-generating activities in cost of revenues. The Company has included amortization of
acquired intangible assets not directly attributable to revenue-generating activities in operating
expenses. During the three months ended September 30, 2007 and 2006, the Company recorded
amortization expense in the amounts of $483 and $553, respectively, in cost of revenues. During the
nine months ended September 30, 2007 and 2006, the Company recorded amortization expense in the
amounts of $1,589 and $1,223, respectively, in cost of revenues. During the three months ended
September 30, 2007 and 2006, the Company recorded amortization expense in the amounts of $67 and
$168, respectively, in operating expenses. During the nine months ended September 30, 2007 and
2006, the Company recorded amortization expense in the amounts of $200 and $477, respectively, in
operating expenses.
As of September 30, 2007, the total expected future amortization related to intangible assets
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
Amortization
|
|
|
|
|
|
|
Included in
|
|
|
Included in
|
|
|
Total
|
|
|
|
Cost of
|
|
|
Operating
|
|
|
Amortization
|
|
Fiscal Years:
|
|
Revenues
|
|
|
Expenses
|
|
|
Expense
|
|
2007 (remaining three months)
|
|
|
485
|
|
|
|
66
|
|
|
|
551
|
|
2008
|
|
|
883
|
|
|
|
267
|
|
|
|
1,150
|
|
2009
|
|
|
526
|
|
|
|
267
|
|
|
|
793
|
|
2010
|
|
|
354
|
|
|
|
255
|
|
|
|
609
|
|
2011 and thereafter
|
|
|
84
|
|
|
|
|
|
|
|
84
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,332
|
|
|
$
|
855
|
|
|
$
|
3,187
|
|
|
|
|
|
|
|
|
|
|
|
16
At September 30, 2007, the Company performed its annual test for goodwill impairment as
required by SFAS No. 142. The Company determined that it operates three reporting units for the
purposes of SFAS No. 142. The Company attributes its goodwill to both its Americas and Europe,
Middle East and Africa (EMEA) reporting units. The Company concluded that goodwill was not
impaired since the fair value of its reporting units exceeded their respective carrying values,
including goodwill. The primary methods used to determine the fair values for SFAS No. 142
impairment purposes were the discounted cash flow and market methods. The Company determined the
assumptions supporting the discounted cash flow method using its best estimates as of the date of
the impairment review. The Company continuously monitors events and circumstances to determine if a subsequent goodwill impairment review is necessary outside
of the annual impairment review.
The Company attributes all of the goodwill resulting from the Macrospace acquisition to its
EMEA reporting unit. The goodwill resulting from the iFone acquisition is evenly attributed to its
Americas and EMEA reporting units. The goodwill allocated to the Americas reporting unit is
denominated in U.S. Dollars, and the goodwill allocated to the Companys EMEA reporting unit is
denominated in pounds sterling. As a result, the goodwill attributed to the EMEA reporting unit is
subject to foreign currency fluctuations. During the nine months ended September 30, 2007, goodwill
increased by $1,236 due to the U.S. Dollar weakening against the pound sterling. During the year
ended December 31, 2006, goodwill increased by $3,081 due to the U.S. Dollar weakening against the
pound sterling. Goodwill at September 30, 2007 and December 31, 2006 was $39,963 and $38,727,
respectively.
Note 6 Commitments and Contingencies
Leases
The Company leases office space under noncancelable operating facility leases with various
expiration dates through July 2012. Rent expense for the three months ended September 30, 2007 and
2006 was $564 and $438, respectively. Rent expense for the nine months ended September 30, 2007 and
2006 was $1,467 and $1,207, respectively. The terms of the facility leases provide for rental
payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over
the lease period, and has accrued for rent expense incurred but not paid. The deferred rent balance
was $599 and $225 at September 30, 2007 and December 31, 2006, respectively, and was included
within other long-term liabilities.
At September 30, 2007, future minimum lease payments under noncancelable operating leases were
as follows:
|
|
|
|
|
|
|
Minimum
|
|
|
|
Operating
|
|
|
|
Lease
|
|
Fiscal Years:
|
|
Payments
|
|
2007 (remaining three months)
|
|
$
|
701
|
|
2008
|
|
|
2,310
|
|
2009
|
|
|
2,177
|
|
2010
|
|
|
2,056
|
|
2011
|
|
|
1,648
|
|
2012 and thereafter
|
|
|
695
|
|
|
|
|
|
|
|
$
|
9,587
|
|
|
|
|
|
Capital Lease
The Company has one lease that it accounts for as a capital lease. It capitalized a total of
$114 as computer equipment under this lease during the year ended December 31, 2005. The Company
recorded no capital lease obligations during the year ended December 31, 2006 or during the three
and nine months ended September 30, 2007. Accumulated depreciation associated with this capital
lease was $66 and $47 at September 30, 2007 and December 31, 2006, respectively. As of September
30, 2007, the Company had no remaining capital lease obligations.
Minimum Guaranteed Royalties
The Company has entered into license and development agreements with various owners of brands
and other intellectual property so that it could develop and publish games for mobile handsets.
Pursuant to some of these agreements, the Company is required to pay minimal royalties over the
term of the agreements regardless of actual game sales. Future minimum royalty payments for those
agreements as of September 30, 2007 were as follows:
17
|
|
|
|
|
|
|
Minimum
|
|
|
|
Guaranteed
|
|
Fiscal Year:
|
|
Royalties
|
|
2007 (remaining three months)
|
|
$
|
5,554
|
|
2008
|
|
|
4,966
|
|
2009
|
|
|
1,278
|
|
2010
|
|
|
775
|
|
2011
|
|
|
400
|
|
2012 and thereafter
|
|
|
375
|
|
|
|
|
|
|
|
$
|
13,348
|
|
|
|
|
|
Commitments in the above table include $7,164 of guaranteed royalties to licensors that are
included in the Companys consolidated balance sheet as of September 30, 2007 because the licensors
do not have any significant performance obligations. These commitments are included in both current
and long-term prepaid and accrued royalties.
Indemnification Arrangements
The Company has entered into agreements under which it indemnifies each of its officers and
directors during his or her lifetime for certain events or occurrences while the officer or
director is or was serving at the Companys request in that capacity. The maximum potential amount
of future payments the Company could be required to make under these indemnification agreements is
unlimited; however, the Company has a director and officer insurance policy that limits its
exposure and enables the Company to recover a portion of any future amounts paid. As a result of
its insurance policy coverage, the Company believes the estimated fair value of these
indemnification agreements is minimal. Accordingly, the Company had recorded no liabilities for
these agreements as of September 30, 2007 or December 31, 2006.
In the ordinary course of its business, the Company includes standard indemnification
provisions in most of its license agreements with carriers and other distributors. Pursuant to
these provisions, the Company indemnifies these parties for losses suffered or incurred in
connection with its games, including as a result of intellectual property infringement and viruses,
worms and other malicious software. The term of these indemnity provisions is generally perpetual
after execution of the corresponding license agreement, and the maximum potential amount of future
payments the Company could be required to make under these indemnification provisions is generally
unlimited. The Company has never incurred costs to defend lawsuits or settle indemnified claims of
these types. As a result, the Company believes the estimated fair value of these indemnity
provisions is minimal. Accordingly, the Company had recorded no liabilities for these provisions as
of September 30, 2007 and December 31, 2006.
Contingencies
The Company is subject to claims and assessments from time to time in the ordinary course of
business. The Companys management does not believe that any of these matters, individually or in
the aggregate, will have a materially adverse effect on the Companys business, financial condition
or results of operation, and thus no amounts were accrued for these exposures at September 30,
2007.
Note 7 Debt
Loan Agreement
In May 2006, the Company entered into a loan agreement (the Loan) with a principal in the
amount of $12,000. The Loan had an interest rate of 11%. The Company was obligated to pay only
interest through December 31, 2006. Beginning January 1, 2007, the Company became obligated to pay
30 equal payments of principal and accrued interest until the entire principal is paid. All
borrowings were repaid in full in March 2007. As a result of the repayment, the remaining
unamortized debt issuance costs of $66 were amortized to interest expense during the first quarter
of 2007.
In conjunction with the Loan, the Company issued to entities affiliated with the lender
warrants to purchase 106 shares of Series D Preferred Stock with an exercise price of $9.03 per
share and a contractual life of seven years. The Company calculated the fair value of each warrant
using the Black-Scholes option pricing model with the following assumptions: volatility of 73%,
term of seven years, risk-free interest rate of 5.1% and dividend yield of 0%. The Company recorded
the fair value of the warrants of $607 as a discount to the carrying value of the Loan. Upon
repayment of the Loan in March 2007, the remaining unamortized debt discount of $477 was
18
amortized in full to interest expense. These warrants converted into warrants to purchase an
equal number of shares of common stock upon the closing of the IPO and remained outstanding at
September 30, 2007.
Line of Credit Facility
In February 2007, the Company entered into an agreement to secure a revolving line of credit
that allows the Company to borrow up to $8,000. The facility is restricted to 80% of the Companys
eligible domestic accounts receivable. The line carries an interest rate equal to the prime rate
plus 1% and matures in 24 months. Payments on any borrowings would be interest only with any
remaining borrowings due at maturity. The line is collateralized by all of the assets of the
Company, including intellectual property. The Company is required to maintain a minimum tangible
net worth of $3,000. Also, if the Companys net cash balance, excluding any borrowings under this
line of credit, declines below $3,500, then the Companys accounts receivable must be collected by
means of a lock box, the interest rate on any borrowings would be increased to the prime rate plus
2% and the Company would have to pay a one-time fee to the lender of $50. To date, there have been
no borrowings under this facility. The Company was in compliance with all covenants as of September
30, 2007.
Note 8 Sale of ProvisionX Software
In January 2007, the Company signed an agreement with a third party for the sale of its
ProvisionX software for $1,100. Under the terms of the agreement, the Company will co-own the
intellectual property rights to the ProvisionX software, excluding any alterations or modifications
following completion of the sale, by the third party. The Company recognized a net gain on the sale
of assets of $1,040 during the first quarter of 2007 which included approximately $60 of selling
costs incurred during the transition.
Note 9 Stockholders Equity/(Deficit)
Common Stock
In March 2007, the Company completed its IPO of common stock in which it sold and issued 7,300
shares of common stock at an issue price of $11.50 per share. The Company raised a total of $83,950
in gross proceeds from the IPO, or approximately $74,758 in net proceeds after deducting
underwriting discounts and commissions of $5,877 and other offering costs of $3,315. Upon the
closing of the IPO, all shares of redeemable convertible preferred stock outstanding automatically
converted into 15,680 shares of common stock.
In April 2007, the underwriters exercised a portion of the over-allotment option as to 199
shares, all of which were sold by stockholders and not by the Company.
Early Exercise of Employee Options
Stock options granted under the Companys stock option plan provide certain employee option
holders the right to elect to exercise unvested options in exchange for shares of restricted common
stock. Unvested shares, in the amounts of 64 and 108 at September 30, 2007 and December 31, 2006,
respectively, were subject to a repurchase right held by the Company at the original issuance price
in the event the optionees employment is terminated either voluntarily or involuntarily. For
exercises of employee options, this right generally lapses as to 25% of the shares subject to the
option on the first anniversary of the vesting start date and as to 1/48th of the shares monthly
thereafter. These repurchase terms are considered to be a forfeiture provision and do not result in
variable accounting. The restricted shares issued upon early exercise of stock options are legally
issued and outstanding and have been reflected in stockholders equity/(deficit). The Company
treats cash received from employees for exercise of unvested options as a refundable deposit shown
as a liability in its consolidated financial statements. As of September 30, 2007 and December 31,
2006, the Company included cash received for early exercise of options of $56 and $92,
respectively, in accrued liabilities. Amounts from accrued liabilities are transferred into common
stock and additional paid-in capital as the shares vest.
Warrants to Purchase Common Stock
In connection with the issuance of its Series A Preferred Stock, the Company issued warrants
to purchase 20 shares of common stock. These warrants had an exercise price of $0.36 per share and
an expiration date of December 31, 2007. During the year ended December 31, 2006, these warrants
were exercised for gross proceeds of $7.
19
Upon the effective date of the IPO, warrants to purchase 229 shares of redeemable convertible
preferred stock converted into warrants to purchase 229 shares of common stock. As discussed in
Note 1, the Company classified the freestanding redeemable convertible preferred stock warrants as
a liability and adjusted the warrants to fair value at each reporting period until the completion
of the IPO. Upon closing of the IPO, the preferred stock warrant liability of $1,985 was reclassed
to additional paid-in capital. During the three months ended September 30, 2007, a holder of
warrants elected to net exercise warrants to purchase 52 shares of common stock which were
converted to 41 shares of common stock.
In February 2007, the Company issued warrants to purchase an aggregate of 272 shares of common
stock with an exercise price of $0.0003 per share to certain holders of Series D or D-1 redeemable
convertible preferred stock as an inducement for these holders to convert their preferred stock
into common stock upon the consummation of the Companys IPO. These warrants expired 30 days
following the completion of the Companys IPO, and if the date of effectiveness of that offering
did not occur by March 31, 2007 or earlier, the warrants would expire at that time. In connection
with the issuance of the warrants, the Company received an agreement to convert all shares of
preferred stock to common stock upon completion of the Companys IPO from holders of the requisite
number of shares to cause that conversion, provided that the registration statement for the initial
public offering was effective on or before March 31, 2007. The Company recorded a deemed dividend
of $3,100 in connection with the issuance of the warrants during the three months ending March 31,
2007. The deemed dividend represented the fair value of the warrants and was calculated using the
share price at the date of the IPO closing of $11.50 per share and the strike price of the warrants
of $0.0003 per share. These warrants were exercised in April 2007.
As of September 30, 2007, warrants to purchase 177 shares of common stock remained
outstanding.
Note 10 Stock Option Plans and Stock Purchase Plan
2001 Stock Plan
In December 2001, the Company adopted the 2001 Stock Option Plan (the 2001 Plan). The 2001
Plan provides for the granting of stock options to employees, directors, consultants, independent
contractors and advisors of the Company. As of September 30, 2007, the Company had authorized 4,498
shares of common stock for issuance under the 2001 Plan.
2007 Equity Incentive Plan
In January 2007, the Companys Board of Directors adopted, and in March 2007 the stockholders
approved, the 2007 Equity Incentive Plan (the 2007 Plan). The Company has reserved 1,766 shares
of its common stock for grant and issuance under the 2007 Plan. In addition, shares not issued or
subject to outstanding grants under the 2001 Plan on the date of adoption of the 2007 Plan and any
shares issued under the 2001 Plan that are forfeited or repurchased by the Company or that are
issuable upon exercise of options that expire or become unexercisable for any reason without having
been exercised in full, will be available for grant and issuance under the 2007 Plan. At the time
of adoption, there were 1,766 shares of common stock authorized for issuance under the 2007 Plan
plus 195 shares of common stock from the 2001 Plan that were unissued.
The Company may grant options under the 2007 Plan at prices no less than 85% of the estimated
fair value of the shares on the date of grant as determined by its Board of Directors, provided,
however, that (i) the exercise price of an ISO or NSO may not be less than 100% or 85%,
respectively, of the estimated fair value of the underlying shares of common stock on the grant
date, and (ii) the exercise price of an ISO or NSO granted to a 10% stockholder may not be less
than 110% of the estimated fair value of the shares on the grant date.
2007 Employee Stock Purchase Plan
In January 2007, the Companys Board of Directors adopted, and in March 2007 the stockholders
approved, the 2007 Employee Stock Purchase Plan (the 2007 Purchase Plan). The Company has reserved
667 shares of its common stock for issuance under the 2007 Purchase Plan.
Stock Option Activity
The following table summarizes the Companys stock option activity for the nine months ended
September 30, 2007:
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
|
|
|
|
|
Weighted
|
|
|
Weighted
|
|
|
|
|
|
|
Available
|
|
|
Number of
|
|
|
Average
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
for
|
|
|
Options
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Intrinsic
|
|
|
|
Grant
|
|
|
Outstanding
|
|
|
Price
|
|
|
Term (Years)
|
|
|
Value
|
|
Balances, December 31, 2006
|
|
|
476
|
|
|
|
2,882
|
|
|
$
|
5.03
|
|
|
|
|
|
|
|
|
|
Additional authorized
|
|
|
1,766
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
(1,014
|
)
|
|
|
1,014
|
|
|
|
11.50
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
(208
|
)
|
|
|
0.75
|
|
|
|
|
|
|
|
|
|
Forfeited, cancelled or expired
|
|
|
260
|
|
|
|
(260
|
)
|
|
|
9.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, September 30, 2007
|
|
|
1,488
|
|
|
|
3,428
|
|
|
$
|
6.83
|
|
|
|
6.96
|
|
|
$
|
11,052
|
|
Options vested and expected to vest at September 30, 2007
|
|
|
|
|
|
|
2,992
|
|
|
$
|
6.48
|
|
|
|
6.73
|
|
|
$
|
10,217
|
|
Options exercisable at September 30, 2007
|
|
|
|
|
|
|
1,328
|
|
|
$
|
3.74
|
|
|
|
5.09
|
|
|
$
|
7,398
|
|
The aggregate intrinsic value in the preceding table is calculated as the difference between
the exercise price of the underlying awards and the quoted closing price of the Companys common
stock of $9.07 per share as of September 30, 2007. During the nine months ended September 30, 2007,
the aggregate intrinsic value of options exercised under the Companys stock option plans was $159.
As of September 30, 2007, the Company had $8,443 of total unrecognized compensation expense under
SFAS No. 123R, net of estimated forfeitures, that will be recognized over a weighted average period
of 2.68 years. As permitted by SFAS No. 123R, the Company has deferred the recognition of its
excess tax benefit from non-qualified stock option exercises.
Included in the above table are four non-employee stock options granted during the nine months
ended September 30, 2007. The non-employee options outstanding had an exercise price of $11.00 per
share, a remaining contractual term of one year and no intrinsic value at September 30, 2007.
The Company adopted SFAS No. 123R on January 1, 2006. Under SFAS No. 123R, the Company
estimated the fair value of each option award on the grant date using the Black-Scholes option
valuation model and the weighted average assumptions noted in the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
Nine Months
|
|
|
Ended September 30,
|
|
Ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
Risk-free interest rate
|
|
|
4.56
|
%
|
|
|
4.87
|
%
|
|
|
4.70
|
%
|
|
|
4.78
|
%
|
Expected term (years)
|
|
|
6.08
|
|
|
|
6.08
|
|
|
|
6.08
|
|
|
|
6.08
|
|
Expected volatility
|
|
|
52.9
|
%
|
|
|
74.3
|
%
|
|
|
57.84
|
%
|
|
|
75.0
|
%
|
The Company based expected volatility on the historical volatility of a peer group of publicly
traded entities. The expected term of options gave consideration to early exercises, post-vesting
cancellations and the options contractual term, which was extended for all options granted
subsequent to September 12, 2005 from five to ten years. The risk-free interest rate for the
expected term of the option is based on the U.S. Treasury Constant Maturity Rate as of the date of
grant.
SFAS No. 123R requires nonpublic companies that used the minimum value method under SFAS No.
123 to apply the prospective transition method of SFAS No. 123R. Prior to adoption of SFAS No.
123R, the Company used the minimum value method, and it therefore has not restated its financial
results for prior periods. Under the prospective method, stock-based compensation expense for the
year ended December 31, 2006 and the three and nine months ended September 30, 2007 includes
compensation expense for (i) all new stock-based compensation awards granted after January 1, 2006
based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R,
(ii) unmodified awards granted prior to but not vested as of December 31, 2005 accounted for under
APB No. 25 and (iii) awards outstanding as of December 31, 2005 that were modified after the
adoption of SFAS No. 123R.
The Company calculated employee stock-based compensation expense recognized in the three and
nine months ended September 30, 2007 based on awards ultimately expected to vest and reduced it for
estimated forfeitures. SFAS No. 123R requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
The following table summarizes the consolidated stock-based compensation expense by line items
in the consolidated statement of operations:
21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended September 30,
|
|
|
Ended September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Research and development
|
|
$
|
310
|
|
|
$
|
49
|
|
|
$
|
665
|
|
|
$
|
100
|
|
Sales and marketing
|
|
|
224
|
|
|
|
73
|
|
|
|
498
|
|
|
|
130
|
|
General and administrative
|
|
|
626
|
|
|
|
321
|
|
|
|
1,613
|
|
|
|
735
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation expense
|
|
$
|
1,160
|
|
|
$
|
443
|
|
|
$
|
2,776
|
|
|
$
|
965
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated net cash proceeds from option exercises were $151 and $127 for the nine months
ended September 30, 2007 and 2006, respectively. The Company realized no income tax benefit from
stock option exercises during the three months ended September 30, 2007 or 2006. As required, the
Company presents excess tax benefits from the exercise of stock options, if any, as financing cash
flows rather than operating cash flows.
During the nine months ended September 30, 2007, the Company modified one option agreement.
The modification involved the acceleration of the vesting of one grant totaling 1 share of common
stock. The Company recorded a charge of $5 in connection with this modification for the nine months
ended September 30, 2007. During the nine months ended September 30, 2006, the Company modified
four option agreements including grants made to two members of the Companys Board of Directors.
The modifications included the repricing of one option for 50 shares of common stock from $4.80 to
$3.57 per share and accelerating the vesting of two other grants totaling 21 shares of common
stock. The Company recorded a charge of $43 during the nine months ended September 30, 2006 in
connection with these modifications.
Restricted Stock
During the nine months ended September 30, 2007, the Company granted 4 shares of restricted
stock to a director of the Company who had elected to receive restricted stock in lieu of an option
grant. The restricted stock vest as to 50% of the shares after six months and thereafter will vest
pro rata monthly for the next six months. The Company did not grant any restricted stock during the
nine months ended September 30, 2006.
Note 11 Income Taxes
The Company recorded an income tax provision of $228 and $192 for the three months ended
September 30, 2007 and 2006, respectively. The company recorded an income tax provision of $813 and
$438 for the nine months ended September 30, 2007 and 2006, respectively. The income tax rates vary
from the Federal and State statutory rates due to the valuation allowances on our net operating
losses, foreign tax rate differences, and withholding taxes.
The Company adopted the provisions of FIN 48 on January 1, 2007. The total amount of
unrecognized tax benefits as of the date of adoption was $575. As of September 30, 2007, the
recognition of the uncertain tax benefits above would not have an impact to our effective tax rate.
In the absence of a valuation allowance on our deferred tax assets the recognition of these
uncertain tax benefits would have an impact to our effective tax rate.
The Companys policy is to recognize interest and penalties related to unrecognized tax
benefits in income tax expense. The Company does not have any uncertain tax positions that would
result in a payment of cash taxes, and as such, the Company does not have any interest accrued on
uncertain tax positions as of the reporting date. As of September 30, 2007, the Company did not
have any penalties accrued for uncertain tax positions.
The Company is subject to taxation in the United States and various foreign jurisdictions. The
material jurisdictions subject to examination by tax authorities are primarily the State of
California, United States and United Kingdom. The Companys federal tax return is open by statute
for tax years 2003 and forward and could be subject to examination by the tax authorities. The
Companys California income tax returns are open by statute for tax years 2002 and forward. The
statute of limitations for the Companys 2005 tax return in the United Kingdom will close in 2008.
Note 12 Segment Reporting
Statement of Financial Accounting Statements No. 131,
Disclosures about Segments of an
Enterprise and Related Information
, establishes standards for reporting information about operating
segments. It defines operating segments as components of an
22
enterprise about which separate financial information is available that is evaluated regularly
by the chief operating decision-maker, or decision-making group, in deciding how to allocate
resources and in assessing performance. The Companys chief operating decision-maker is its Chief
Executive Officer. The Companys Chief Executive Officer reviews financial information on a
geographic basis, however these aggregate into one operating segment for purposes of allocating
resources and evaluating financial performance. Accordingly, the Company reports as a single
operating segment mobile games. It attributes revenues to geographic areas based on the country
in which the carriers principal operations are located.
The Company generates its revenues in the following geographic regions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
|
Ended September 30,
|
|
|
Ended September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
United States of America (USA)
|
|
$
|
9,161
|
|
|
$
|
6,763
|
|
|
$
|
26,350
|
|
|
$
|
17,631
|
|
United Kingdom
|
|
|
1,682
|
|
|
|
1,117
|
|
|
|
5,130
|
|
|
|
2,760
|
|
Americas, excluding USA
|
|
|
1,464
|
|
|
|
712
|
|
|
|
3,545
|
|
|
|
1,796
|
|
EMEA, excluding the United Kingdom
|
|
|
3,464
|
|
|
|
3,039
|
|
|
|
10,989
|
|
|
|
7,976
|
|
Other
|
|
|
880
|
|
|
|
716
|
|
|
|
2,713
|
|
|
|
1,700
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
16,651
|
|
|
$
|
12,347
|
|
|
$
|
48,727
|
|
|
$
|
31,863
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The company attributes its long-lived assets, which primarily consist of property and
equipment, to a country primarily based on the physical location of the assets. Property and
equipment, net of accumulated depreciation and amortization, summarized by geographic location was
as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
Americas
|
|
$
|
1,985
|
|
|
$
|
1,956
|
|
EMEA
|
|
|
1,295
|
|
|
|
1,407
|
|
Other
|
|
|
713
|
|
|
|
117
|
|
|
|
|
|
|
|
|
|
|
$
|
3,993
|
|
|
$
|
3,480
|
|
|
|
|
|
|
|
|
23
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion an analysis of our financial condition and results of operations should be
read in conjunction with the unaudited condensed consolidated financial statements and the related
notes thereto included elsewhere in this Report on Form 10-Q and the audited consolidated financial
statements and notes thereto and managements discussion and analysis of financial condition and
results of operations for the year ended December 31, 2006 included in the final prospectus for our
IPO dated March 21, 2007, filed with the Securities and Exchange Commission, or SEC, on March 22,
2007. This quarterly report on Form 10-Q contains forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934, as amended. These statements are often
identified by the use of words such as may, will, expect, believe, anticipate, intend,
could, estimate, or continue, and similar expressions or variations. Such forward-looking
statements are subject to risks, uncertainties and other factors that could cause actual results
and the timing of certain events to differ materially from future results expressed or implied by
such forward-looking statements. Factors that could cause or contribute to such differences
include, but are not limited to, those identified below, and those discussed in the section titled
Risk Factors, set forth in Part II, Item 1A of this Form 10-Q and in our other SEC filings,
including our final prospectus dated March 21, 2007, which we filed in connection with our IPO. We
disclaim any obligation to update any forward-looking statements to reflect events or circumstances
after the date of such statements.
Overview
Glu Mobile Inc. (the Company or Glu) is a leading global publisher of mobile games. We
have developed and published a portfolio of more than 100 casual and traditional games to appeal to
a broad cross section of the over one billion subscribers served by our more than 150 wireless
carriers and other distributors. We create games and related applications based on third-party
licensed brands and other intellectual property, as well as on our own original brands and
intellectual property. Our games based on licensed intellectual property include
Deer Hunter
,
Diner
Dash
,
Monopoly
,
Sonic the Hedgehog
,
Transformers
,
World Series of Poker
and
Zuma.
Our original
games based on our own intellectual property include
Alpha Wing
,
Ancient Empires
,
Blackjack
Hustler
,
Brain Genius
,
My Hangman
,
Stranded
and
Super K.O. Boxing
.
We seek to attract end users by developing engaging content that is designed specifically to
take advantage of the portability and networked nature of mobile handsets. We leverage the
marketing resources and distribution infrastructures of wireless carriers and the brands and other
intellectual property of third-party content owners, which allows us to focus our efforts on
developing and publishing high-quality mobile games.
We believe that improving quality and greater availability of mobile games are increasing
end-user awareness of and demand for mobile games. At the same time, carriers and branded content
owners are focusing on a small group of publishers that have the ability to produce high-quality
mobile games consistently and port them rapidly and cost effectively to a wide variety of handsets.
Additionally, branded content owners are seeking publishers that have the ability to distribute
games globally through relationships with most or all of the major carriers. We believe we have
created the requisite development and porting technology and have achieved the requisite scale to
be in this group. We also believe that leveraging our carrier and content owner relationships will
allow us to grow our revenues without corresponding percentage growth in our infrastructure and
operating costs.
Our revenue growth rate will depend significantly on continued growth in the mobile game
market and our ability to continue to attract new end users in that market. Our ability to attain
profitability will be affected by the extent to which we must incur additional expenses to expand
our sales, marketing, development, and general and administrative capabilities to grow our
business. The largest component of our expenses is personnel costs. Personnel costs consist of
salaries, benefits and incentive compensation, including bonuses and stock-based compensation, for
our employees. Our operating expenses will continue to grow in absolute dollars, assuming our
revenues continue to grow. As a percentage of revenues, we expect these expenses to decrease.
We were incorporated in May 2001 and introduced our first mobile games to the market in July
2002. In December 2004 and in March 2006, we acquired Macrospace and iFone, respectively, each a
mobile game developer and publisher based in the United Kingdom. In the third quarter of 2005, we
opened a Hong Kong office; in the third quarter of 2006, we opened an office in France; in the
fourth quarter of 2006, we opened offices in Brazil and Germany; in the second quarter of 2007, we
opened offices in China, Italy and Spain; and in the fourth quarter of 2007 we opened an office in
Chile.
24
We acquired Macrospace to continue to develop and secure direct distribution relationships
with the leading wireless carriers, to deepen and broaden our game library, to acquire access and
rights to leading licenses and franchises (including original intellectual property) and to augment
our internal production and publishing resources. We acquired iFone to continue to deepen and
broaden our game library, to acquire access and rights to leading licenses and franchises and to
augment our external production resources. These acquisitions were part of our strategy of
expanding into Europe to address the desire of wireless carriers to work with publishers that have
large and diverse portfolios of high-quality games based on well-known brands and of branded
content owners to work with publishers that have global distribution capabilities. These
acquisitions:
|
|
|
enabled us to port the acquired companies games to additional handsets and distribute
them in other geographies;
|
|
|
|
|
enabled us to distribute our original and licensed intellectual property in the
geographies where these companies had distribution relationships;
|
|
|
|
|
provided complementary technical production capabilities that enabled the combined
companies to create products superior to those developed by either separately;
|
|
|
|
|
enabled us to develop games targeted to the European market, and localize our existing
games;
|
|
|
|
|
expanded and deepened our management capacity and capability to conduct business
globally; and
|
|
|
|
|
enabled us to compete for licenses on a broader scale because of enhanced distribution
and production capabilities.
|
In March 2007, we completed our initial public offering, or IPO, of common stock in which we
sold and issued 7,300,000 shares of common stock at a price of $11.50 per share to the public. We
raised a total of $83,950,000 in gross proceeds from the IPO, or approximately $74,758,000 in net
proceeds after deducting underwriting discounts and commissions of $5,877,000 and other offering
costs of $3,315,000. Upon the closing of the IPO, all shares of redeemable convertible preferred
stock outstanding automatically converted into 15,680,292 shares of common stock.
Revenues
We generate the vast majority of our revenues from wireless carriers that market and
distribute our games. These carriers generally charge a one-time purchase fee or a monthly
subscription fee on their subscribers phone bills when the subscribers download our games to their
mobile phones. The carriers perform the billing and collection functions and generally remit to us
a contractual fee or a contractual percentage of their collected fee for each game. We recognize as
revenues the percentage of the fees due to us from the carrier (see Critical Accounting Policies
and Estimates Revenue Recognition below). End users may also initiate the purchase of our games
through various Internet portal sites or through other delivery mechanisms, with carriers generally
continuing to be responsible for billing, collecting and remitting to us a portion of their fees.
To date, eliminating the impact of our acquisitions, our domestic revenues have grown more rapidly
in absolute dollars and as a percentage of total revenue than our international revenues, and we
expect that this trend will continue in fiscal 2008.
Cost of Revenues
Our cost of revenues consists primarily of royalties that we pay to content owners from which
we license brands and other intellectual property and, to a limited extent, to certain external
developers. Our cost of revenues also includes non-cash expenses amortization of certain acquired
intangible assets, any impairment of those intangible assets, and any impairment of prepaid
royalties and guarantees. We record advance royalty payments made to content licensors as prepaid
royalties on our balance sheet when payment is made to the licensor. We recognize royalties in cost
of revenues based upon the revenues derived from the relevant game multiplied by the applicable
royalty rate. If our licensors earn royalties in excess of their advance royalties, we also
recognize these excess royalties as cost of revenues in the period they are earned by the licensor.
If applicable, we will record an impairment of prepaid royalties or accrue for future guaranteed
royalties that are in excess of anticipated demand or net realizable value. At each balance sheet
date, we perform a detailed review of prepaid royalties and guarantees that considers multiple
factors, including forecasted demand, game life cycle status, game development plans, and current
and anticipated sales levels.
25
We pay some of our external developers, especially in Europe, royalties in addition to
payments for game development costs. We recognize these royalties as cost of revenues in the period
the developer earns the royalties based upon the revenues derived from the relevant game multiplied
by the applicable royalty rate. We expense the costs for development of our games prior to
technological feasibility as we incur them throughout the development process, and we include these
costs in research and development expenses (see Critical Accounting Policies and Estimates
Software Development Costs below). To date, royalties paid to developers have not been
significant, but we expect them to increase in aggregate amount based on our existing contracts
with developers.
Absent further impairments of existing intangible assets, we expect amortization of intangible
assets included in cost of revenues to be $485,000 for the remaining three months of 2007, $883,000
in 2008, $526,000 in 2009, $354,000 in 2010 and $84,000 in 2011. These amounts would likely
increase if we make future acquisitions.
Gross Margin
Our gross margin is determined principally by the mix of games that we license to our
customers. Our games based on licensed intellectual property require us to pay royalties to the
licensor and the royalty rates in our licenses vary significantly; our original Glu-branded games,
which are based on our own intellectual property, require no royalty payments to licensors. There
are multiple internal and external factors that affect the mix of revenues from licensed games and
Glu-branded games, including the overall number of licensed games and Glu-branded games available
for sale during a particular period, the extent of our and our carriers marketing efforts for each
game, and the deck placement of each game on our carriers mobile handsets. We believe the success
of any individual game during a particular period is affected by its quality and third-party
ratings, its marketing and media exposure, its consumer recognizability, its overall acceptance by
end users and the availability of competitive games. If our product mix shifts more to licensed
games or games with higher royalty rates, our gross margin would decline. Our gross margin is also
adversely affected by ongoing amortization of acquired intangible assets, such as licensed content,
games, trademarks and carrier contracts, that are directly related to revenue-generating activities
and by periodic charges for impairment of these assets and of prepaid royalties and guarantees.
These charges can cause gross margin variations, particularly from quarter to quarter.
Operating Expenses
Our operating expenses primarily include research and development expenses, sales and
marketing expenses and general and administrative expenses. They have in the past also included
amortization of acquired intangible assets not directly related to revenue-generating activities
and, in the first quarter of fiscal 2006, a restructuring charge and a charge for acquired
in-process research and development.
Research and Development.
Our research and development expenses consist primarily of salaries
and benefits for employees working on creating, developing, porting, quality assurance, carrier
certification and deployment of our games, on technologies related to interoperating with our
various wireless carriers and on our internal platforms, payments to third parties for developing
and porting of our games, and allocated facilities costs.
We devote substantial resources to the development, porting and quality assurance of our games
and expect this to continue in the future. We believe that developing games internally through our
own development studios allows us to increase operating margins, leverage the technology we have
developed and better control game delivery. During 2006, as a result of our acquisition of iFone,
we substantially increased our use of external development resources, but we currently do not
expect further significant increases in expenses for external development. Our games generally
require six months to one year to produce, based on the complexity and feature set of the game
developed, the number of carrier wireless platforms and mobile handsets covered, and the experience
of the internal or external developer. We expect our research and development expenses will
increase in absolute terms as we continue to create new games and technologies.
Sales and Marketing.
Our sales and marketing expenses consist primarily of salaries, benefits
and incentive compensation for sales and marketing personnel, expenses for advertising, trade
shows, public relations and other promotional and marketing activities, expenses for general
business development activities, travel and entertainment expenses and allocated facilities costs.
We expect sales and marketing expenses to increase in absolute terms with the growth of our
business and as we further promote our games and the Glu brand. Although we expect our variable
marketing expenses to increase at least as rapidly as our revenues, we expect that our sales and
marketing headcount will not increase as rapidly as revenues and that therefore sales and marketing
expenses will continue to decrease as a percentage of revenues.
26
General and Administrative.
Our general and administrative expenses consist primarily of
salaries and benefits for general and administrative personnel, consulting fees, legal, accounting
and other professional fees, information technology costs and allocated facilities costs. We expect
that general and administrative expenses will increase in absolute terms as we hire additional
personnel and incur costs related to the anticipated growth of our business and our operation as a
public company. We also expect that these expenses will increase because of the additional costs to
comply with the Sarbanes-Oxley Act and related regulation, our efforts to expand our international
operations and, in the near term, additional accounting costs related to the public offering of our
common stock. However, we expect these expenses to continue to decrease as a percentage of
revenues.
Based on our current revenue and expense projections, we expect that our various operating
expense categories will decline as a percentage of revenues. We could fail to increase our revenues
as anticipated, and we could decide to increase expenses in one or more categories to respond to
competitive pressures or for other reasons. In these cases and others, it is possible that one or
more of our operating expense categories would not decline as a percentage of revenues.
Amortization of Intangible Assets.
We record amortization of acquired intangible assets that
are directly related to revenue-generating activities as part of our cost of revenues and
amortization of the remaining acquired intangible assets, such as non-compete agreements, as part
of our operating expenses. We record intangible assets on our balance sheet based upon their fair
value at the time they are acquired. We determine the fair value of the intangible assets using a
discounted cash flows approach. We amortize the amortizable intangible assets using the
straight-line method over their estimated useful lives of two to six years. Absent impairments of
existing intangible assets, we expect amortization of existing intangible assets to be $66,000 for
the remaining three months of 2007, $267,000 in 2008, $267,000 in 2009 and $255,000 in 2010. These
amounts would likely increase if we make future acquisitions.
Acquired In-Process Research and Development.
We classify all development projects acquired in
business combinations as acquired in-process research and development, or IPR&D, if the feasibility
of the acquired technology has not been established and no future alternative uses exist. We
expense the fair value of IPR&D at the time it is acquired. We determine the fair value of the
IPR&D using a discounted cash flows approach. In estimating the appropriate discount rate, we
consider, among other things, the risks to developing technology given changes in trends and
technology in our industry. In 2006, we expensed the fair value of IPR&D acquired in the iFone
transaction.
Gain on Sale of Assets.
Our gain on sale of assets relates entirely to the net proceeds from
the sale of our ProvisionX software to a third party. We do not anticipate additional gains on
asset sales in the future.
Interest and Other Income/(Expense), Net
Interest and other income/(expense), net, includes interest income, interest expense,
accretion of the debt discount related to the warrants issued to the lender in conjunction with its
March 2006 loan to us, changes in our preferred stock warrant liability and foreign currency
transaction gains and losses. Following the completion of the IPO our outstanding warrants to
purchase redeemable convertible preferred stock converted into warrants to purchase common stock,
and we are no longer required to record changes in our preferred stock warrant liability under
Staff Position No. 150-5,
Issuers Accounting under FASB Statement No. 150 for Freestanding
Warrants and Other Similar Instruments on Shares That Are Redeemable
, or FSP 150-5, or accretion in
the debt discount related to the lenders warrants. Following the IPO, we had additional cash, cash
equivalents and short-term investments of approximately $74.8 million resulting from the net
proceeds of the IPO, based on the price to the public of $11.50 per share and after deducting the
underwriting discounts and estimated offering expenses. This will cause a substantial increase in
our interest income.
Accounting for Income Taxes
We are subject to tax in the United States as well as other jurisdictions in which we conduct
business. Earnings from our non-U.S. activities are subject to local country income tax and may be
subject to current United States income tax under U.S. income tax based upon U.S. anti-deferral
rules, such as Subpart F of the Internal Revenue Code, or the Code. In addition, some revenues
generated outside of the United States may be subject to withholding taxes. In some cases, these
withholding taxes may be deductible on a current basis or may be available as a credit carryforward
to offset future income taxes.
We record a valuation allowance to reduce any deferred tax asset to the amount that is more
likely than not to be realized. We consider historical levels of income, expectations and risks
associated with estimates of future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for a valuation allowance. If we were to determine that we would
be able to realize deferred tax assets in the future in excess of the net recorded amount, we would
adjust the deferred tax asset valuation allowance. Such an adjustment would increase our income in
the period the determination is made. Historically, we have incurred
27
operating losses and have generated significant net operating loss carryforwards. At December
31, 2006, we had net operating loss carryforwards of approximately $28.5 million and $28.7 million
for federal and state tax purposes, respectively. These carryforwards will expire from 2011 to
2026. Our ability to use our net operating loss carryforwards to offset any future taxable income
may be subject to restrictions attributable to equity transactions that result in changes of
ownership as defined by Section 382 of the Code.
On January 1, 2007 we adopted the provisions of FIN 48, which clarifies the accounting for
uncertainty in income taxes recognized in financial statements in accordance with SFAS No. 109,
Accounting for Income Taxes.
FIN 48 prescribes a recognition threshold and measurement attribute
of tax positions taken or expected to be taken on a tax return. The interpretation also provides
guidance on de-recognition, classification, interest and penalties, accounting in interim periods,
disclosure and transition. We do not expect that the amount of unrecognized tax benefits will
change significantly within the next 12 months.
Accretion of Preferred Stock and Deemed Dividend
Our Series A, B, C, D and D-1 mandatorily redeemable convertible preferred stock, which were
converted into common stock in connection with our IPO, had a mandatory redemption provision. In
each quarterly and annual period, we accreted the amount that is necessary to adjust the recorded
balance of this preferred stock to an amount equal to its estimated redemption value at its
redemption date using the effective interest method. The redemption value is the par value of the
preferred stock plus any dividends declared and unpaid. Each share of our outstanding preferred
stock was converted into common stock upon completion of the IPO, and we ceased accreting upon this
conversion. In February 2007, the requisite holders of our preferred stock agreed to convert all
shares of our preferred stock into common stock upon completion of our IPO as long as the
registration statement was effective on or prior to March 31, 2007. In connection with this
agreement, we issued warrants to purchase an aggregate of 272,204 shares of common stock at an
exercise price of $0.0003 per share exercisable for a period of 30 days following completion of our
IPO, provided that the registration statement was effective on or prior to March 31, 2007. We
recorded a deemed dividend related to these warrants in the three months ending March 31, 2007 of
$3.1 million as a charge to net loss attributable to common stockholders. The deemed dividend
represented the fair value of the warrants and was calculated using the share price at the date of
the IPO closing of $11.50 per share and the strike price of the warrants of $0.0003 per share.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with United States generally
accepted accounting principles, or GAAP. These accounting principles require us to make certain
estimates and judgments that can affect the reported amounts of assets and liabilities as of the
dates of the consolidated financial statements, the disclosure of contingencies as of the dates of
the consolidated financial statements, and the reported amounts of revenues and expenses during the
periods presented. Although we believe that our estimates and judgments are reasonable under the
circumstances existing at the time these estimates and judgments are made, actual results may
differ from those estimates, which could affect our consolidated financial statements.
We believe the following to be critical accounting policies because they are important to the
portrayal of our financial condition or results of operations and they require critical management
estimates and judgments about matters that are uncertain:
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revenue recognition;
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investments in marketable securities;
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advance or guaranteed licensor royalty payments;
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software development costs;
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stock-based compensation;
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comprehensive income/(loss); and
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income taxes.
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28
Revenue Recognition
We derive our revenues primarily by licensing software products in the form of mobile games.
License arrangements with our end users can be on a perpetual or subscription basis. A perpetual
license gives an end user the right to use the licensed game on the registered mobile handset on a
perpetual basis. A subscription license gives an end user the right to use the licensed game on the
registered handset for a limited period of time, ranging from a few days to as long as one month.
We distribute our products primarily through wireless carriers, which market our games to end
users. Carriers usually bill license fees for perpetual and subscription licenses upon download of
the game software by the end user. In the case of subscription licenses, many subscriber agreements
provide for automatic renewal until the subscriber opts-out, while the others provide for opt-in
renewal. In either case, subsequent billings for subscription licenses are generally billed
monthly. We apply the provisions of Statement of Position 97-2,
Software Revenue Recognition
, as
amended by Statement of Position 98-9,
Modification of SOP 97-2
,
Software Revenue Recognition, With
Respect to Certain Transactions
, to all transactions.
We recognize revenues from our games when persuasive evidence of an arrangement exists, the
game has been delivered, the fee is fixed or determinable, and the collection of the resulting
receivable is probable. For both perpetual and subscription licenses, we consider a signed license
agreement to be evidence of an arrangement with a carrier and a clickwrap agreement to be
evidence of an arrangement with an end user. For these licenses, we define delivery as the download
of the game by the end user.
We estimate revenues from carriers in the current period when reasonable estimates of these
amounts can be made. Several carriers provide reliable interim preliminary reporting and others
report sales data within a reasonable time frame following the end of each month, both of which
allow us to make reasonable estimates of revenues and therefore to recognize revenues during the
reporting period when the end user licenses the game. Determination of the appropriate amount of
revenue recognized involves judgments and estimates that we believe are reasonable, but it is
possible that actual results may differ from our estimates. Our estimates for revenues include
consideration of factors such as preliminary sales data, carrier-specific historical sales trends,
the age of games and the expected impact of newly launched games, successful introduction of new
handsets, promotions during the period and economic trends. When we receive the final carrier
reports, to the extent not received within a reasonable time frame following the end of each month,
we record any differences between estimated revenues and actual revenues in the reporting period
when we determine the actual amounts. Historically, the revenues on the final revenue report have
not differed by more than one-half of 1% of the reported revenues for the period, which we deemed
to be immaterial. Revenues earned from certain carriers may not be reasonably estimated. If we are
unable to reasonably estimate the amount of revenue to be recognized in the current period, we
recognize revenues upon the receipt of a carrier revenue report and when our portion of a games
licensed revenues is fixed or determinable and collection is probable. To monitor the reliability
of our estimates, our management, where possible, reviews the revenues by carrier and by game on a
weekly basis to identify unusual trends such as differential adoption rates by carriers or the
introduction of new handsets. If we deem a carrier not to be creditworthy, we defer all revenues
from the arrangement with that carrier until we receive payment and all other revenue recognition
criteria have been met.
In accordance with Emerging Issues Task Force, or EITF, Issue No. 99-19,
Reporting Revenue
Gross as a Principal Versus Net as an Agent
, we recognize as revenues the amount the carrier
reports as payable to us upon the sale of our games. We have evaluated our carrier agreements and
have determined that we are not the principal when selling our games through carriers. Key
indicators that we evaluated in reaching this determination included:
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wireless subscribers directly contract with their carriers, which have most of the
service interaction and are generally viewed as the primary obligor by the subscribers;
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carriers generally have significant control over the types of games that they offer to
their subscribers;
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carriers are directly responsible for billing and collecting fees from their subscribers,
including the resolution of billing disputes;
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carriers generally pay us a fixed percentage of their revenues or a fixed fee for each
game;
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carriers generally must approve the price of our games in advance of their sale to
subscribers, and our more significant carriers generally have the ability to set the
ultimate price charged to their subscribers; and
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we have limited risks, including no inventory risk and limited credit risk.
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29
Investments in Marketable Securities
We invest in auction rate securities that are bought and sold in the marketplace through a
bidding process sometimes referred to as a Dutch Auction. After the initial issuance of the
securities, the interest rate on the securities is reset periodically, at intervals set at the time
of issuance (e.g., every seven, 28 or 35 days or every six months), based on the market demand at
the reset period. The stated or contractual maturities for these securities, however, generally
are 20 to 30 years. Historically, we had the ability and intent, if necessary, to liquidate any of
these investments as needed in order to meet our needs within our normal operating cycles. As of
December 31, 2006 all auction rate securities were included in short-term investments. Due to the
disruptions of, and the resulting greatly reduced liquidity in certain financial markets in 2007,
two of the Companys AAA rated, corporate asset-backed auction rate securities totaling $2.8
million in purchased cost experienced failed auctions during the three months ended September 30,
2007. Due to the failed auctions, we were unable to sell the securities at their respective costs,
resulting in a decrease in fair value of $259,000 as of September 30, 2007. Although we intend to
liquidate these two investments as needed we do not currently have the same ability to do so and
have reclassified these investments to other long-term assets as of September 30, 2007.
We have classified these investments as available-for-sale securities under Statement of
Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity
Securities (SFAS No. 115). In accordance with SFAS No. 115, these securities are reported at fair
value with any changes in market value reported as a part of comprehensive income/(loss). We have
recorded an unrealized loss of $259,000 during the three and nine months ended September 30, 2007.
No unrealized gains or losses were recognized during the three or nine months ended September 30,
2006.
We periodically review these investments for impairment. In the event the carrying value of an
investment exceeds its fair value and the decline in fair value is determined to be
other-than-temporary, we write down the value of the investment to its fair value. We recorded the
$259,000 change in fair value as of September 30, 2007 as an unrealized loss within other
comprehensive income/(loss) since the change in fair value was determined to be temporary.
Advance or Guaranteed Licensor Royalty Payments
Our royalty expenses consist of fees that we pay to branded content owners for the use of
their intellectual property, including trademarks and copyrights, in the development of our games.
Royalty-based obligations are either paid in advance and capitalized on our balance sheet as
prepaid royalties or accrued as incurred and subsequently paid. These royalty-based obligations are
expensed to cost of revenues at the greater of the revenues derived from the relevant game
multiplied by the applicable contractual rate or an effective royalty rate based on expected net
product sales. Advanced license payments that are not recoupable against future royalties are
capitalized and amortized over the lesser of the estimated life of the branded title or the term of
the license agreement.
Our contracts with some licensors include minimum guaranteed royalty payments, which are
payable regardless of the ultimate volume of sales to end users. Effective January 1, 2006, we
adopted FSP FIN 45-3,
Application of FASB Interpretation No. 45 to Minimum Revenue Guarantees
Granted to a Business or Its Owners.
As a result, we recorded a minimum guaranteed liability of
approximately $7.2 million at September 30, 2007 and $1.4 million as of December 31, 2006. When no
significant performance remains with the licensor, we initially record each of these guarantees as
an asset and as a liability at the contractual amount. We believe that the contractual amount
represents the fair value of our liability. When significant performance remains with the licensor,
we record royalty payments as an asset when actually paid and as a liability when incurred, rather
than upon execution of the contract. We classify minimum royalty payment obligations as current
liabilities to the extent they are contractually due within the next twelve months.
Each quarter, we also evaluate the realization of our royalties as well as any unrecognized
guarantees not yet paid to determine amounts that we deem unlikely to be realized through product
sales. We use estimates of revenues, cash flows and net margins to evaluate the future realization
of prepaid royalties and guarantees. This evaluation considers multiple factors, including the term
of the agreement, forecasted demand, game life cycle status, game development plans and current and
anticipated sales levels. To the extent that this evaluation indicates that the remaining prepaid
and guaranteed royalty payments are not recoverable, we record an impairment charge in the period
such impairment is indicated. Subsequently, if actual market conditions are more favorable than
anticipated, amounts of prepaid royalties previously written down may be utilized, resulting in
lower cost of revenues and higher income from operations than previously expected in that period.
We believe that the combination of the evolving market for licensing other companies intellectual
property and our improved license pre-qualification process will reduce risk of future impairments.
The impairments that we have recorded to date are predominantly related to license agreements
entered into prior to 2005 and had significant guarantees for which the success was tied to a
third-party product release. In 2005 and 2006, the market for licensed
30
intellectual property stabilized, resulting in lower upfront commitment fees. We believe our
improved visibility regarding forecasted demand and gaming trends supports our ability to
reasonably determine the realizibility of the assets on our consolidated balance sheet.
Software Development Costs
We apply the principles of SFAS No. 86,
Accounting for the Costs of Computer Software to Be
Sold, Leased, or Otherwise Marketed.
SFAS No. 86 requires that software development costs incurred
in conjunction with product development be charged to research and development expense until
technological feasibility is established. Thereafter, until the product is released for sale,
software development costs must be capitalized and reported at the lower of unamortized cost or net
realizable value of the related product. We have adopted the tested working model approach to
establishing technological feasibility for our games. Under this approach, we do not consider a
game in development to have passed the technological feasibility milestone until we have completed
a model of the game that contains essentially all the functionality and features of the final game
and have tested the model to ensure that it works as expected. To date, we have not incurred
significant costs between the establishment of technological feasibility and the release of a game
for sale; thus, we have expensed all software development costs as incurred. We also will consider
the following factors in determining whether costs should be capitalized: the emerging nature of
the mobile game market; the gradual evolution of the wireless carrier platforms and mobile handsets
for which we develop games; the lack of pre-orders or sales history for our games; the uncertainty
regarding a games revenue-generating potential; our lack of control over the carrier distribution
channel resulting in uncertainty as to when, if ever, a game will be available for sale; and our
historical practice of canceling games at any stage of the development process.
Stock-Based Compensation
Prior to January 1, 2006, we accounted for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock
Issued to Employees
, or APB No. 25, and related interpretations, and followed the disclosure
provisions of SFAS No. 123,
Accounting for Stock-Based Compensation.
Under APB No. 25, compensation
expense for an option was based on the difference, if any, on the date of the grant between the
fair value of a companys common stock and the exercise price of the option. APB No. 25 required
companies to record deferred stock-based compensation on their balance sheets and amortize it to
expense over the vesting periods of the individual options. We amortize deferred stock-based
compensation using the multiple option method as prescribed by FASB Interpretation No. 28,
Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans
, or FIN 28,
over the option vesting period using an accelerated amortization schedule.
Effective January 1, 2006, we adopted the fair value provisions of SFAS No. 123R,
Share-Based
Payment
, which supersedes our previous accounting under APB No. 25. SFAS No. 123R requires the
recognition of compensation expense, using a fair-value based method, for costs related to all
share-based payments including stock options. SFAS No. 123R requires companies to estimate the fair
value of share-based payment awards on the grant date using an option pricing model. We adopted
SFAS No. 123R using the prospective transition method, which required us to apply SFAS No. 123R to
option grants on and after the required effective date. For options granted prior to the January 1,
2006 effective date that remained unvested on that date, we continue to recognize compensation
expense under the intrinsic value method of APB No. 25. In addition, we are continuing to amortize
those awards granted prior to January 1, 2006 utilizing an accelerated amortization schedule, while
we will expense all options granted or modified on and after January 1, 2006 on a straight-line
basis. To value awards granted on or after January 1, 2006, we used the Black-Scholes option
pricing model, which requires, among other inputs, an estimate of the fair value of the underlying
common stock on the date of grant and assumptions as to volatility of our stock over the term of
the related options, the expected term of the options, the risk-free interest rate and the option
forfeiture rate. We determined the assumptions used in this pricing model at each grant date. We
concluded that it was not practicable to calculate the volatility of our share price since our
securities are not publicly traded and therefore there is no readily determinable market value for
our stock. Therefore, we based expected volatility on the historical volatility of a peer group of
publicly traded entities. We determined the expected term of our options based upon historical
exercises, post-vesting cancellations and the options contractual term. We based the risk-free
rate for the expected term of the option on the U.S. Treasury Constant Maturity Rate as of the
grant date. We determined the forfeiture rate based upon our historical experience with option
cancellations adjusted for unusual or infrequent events.
In the three months ended September 30, 2007, we recorded total employee non-cash stock-based
compensation expense of $1.2 million of which $72,000 represented continued amortization of
deferred stock-based compensation for options granted prior to 2006
31
and $1.1 million represented expense recorded in accordance with SFAS 123R. In the nine months
ended September 30, 2007, we recorded total employee non-cash stock-based compensation expense of
$2.8 million, of which $218,000 represented continued amortization of deferred stock-based
compensation for options granted prior to 2006 and $2.6 million represented expense recorded in
accordance with SFAS 123R. In future periods, stock-based compensation expense may increase as we
issue additional equity-based awards to continue to attract and retain key employees. Additionally,
SFAS 123R requires that we recognize compensation expense only for the portion of stock options
that are expected to vest. Our estimated forfeiture rate for the nine months ended September 30,
2007 was 12%. If the actual number of forfeitures differs from that estimated by management, we
will be required to record adjustments to stock-based compensation expense in future periods.
Given the absence of an active market for our common stock prior to our IPO, our board of
directors, the members of which we believe had extensive business, finance and venture capital
experience, was required to estimate the fair value of our common stock for purposes of determining
exercise prices for the options it granted based in part on a market capitalization analysis of
comparable public companies and other metrics, including revenue multiples and price/earning
multiples, as well as the following:
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the prices for our convertible preferred stock sold to outside investors in arms-length
transactions;
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the rights, preference and privileges of that convertible preferred stock relative to
those of our common stock;
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our operating and financial performance;
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the hiring of key personnel;
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the introduction of new products;
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our stage of development and revenue growth;
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the fact that the options grants involved illiquid securities in a private company;
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the risks inherent in the development and expansion of our services; and
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the likelihood of achieving a liquidity event, such as an IPO or sale of the company, for
the shares of common stock underlying the options given prevailing market conditions.
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At September 30, 2007, we had $8.4 million of total unrecognized compensation expense under
SFAS No. 123R, net of estimated forfeitures, that will be recognized over a weighted average period
of 2.68 years. Based on the market closing price on September 30, 2007 of $9.07 per share, the
aggregate intrinsic value of outstanding options and exercisable options at September 30, 2007, was
$11.1 million and $7.4 million, respectively.
Comprehensive Income/(Loss)
Comprehensive income/(loss) consists of two components, net income/(loss) and other
comprehensive income/(loss). Other comprehensive income/(loss) refers to gains and losses that
under generally accepted accounting principles are recorded as an element of stockholders equity
but are excluded from net income/(loss). Our other comprehensive income/(loss) includes foreign
currency translation adjustments and unrealized gains/(losses) on available-for-sale securities.
Income Taxes
We account for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes
. As
part of the process of preparing our consolidated financial statements, we are required to estimate
our income tax benefit (provision) in each of the jurisdictions in which we operate. This process
involves estimating our current income tax benefit (provision) together with assessing temporary
differences resulting from differing treatment of items for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included within our
consolidated balance sheet using the enacted tax rates in effect for the year in which we expect
the differences to reverse.
We record a valuation allowance to reduce our deferred tax assets to an amount that more
likely than not will be realized. As of December 31, 2006, our valuation allowance on our net
deferred tax assets was $14.4 million. While we have considered future
32
taxable income and ongoing prudent and feasible tax planning strategies in assessing the need
for the valuation allowance, in the event we were to determine that we would be able to realize our
deferred tax assets in the future in excess of our net recorded amount, we would need to make an
adjustment to the allowance for the deferred tax asset, which would increase income or reduce the
loss in the period that determination was made.
On January 1, 2007, we adopted Financial Accounting Standards Board (FASB) Interpretation No.
48,
Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109
(FIN
48), which supplements SFAS No. 109 by defining the confidence level that a tax position must meet
in order to be recognized in the financial statements. FIN 48 requires that the tax effects of a
position be recognized only if it is more-likely-than-not to be sustained based solely on its
technical merits as of the reporting date. We consider many factors when evaluating and estimating
its tax positions and tax benefits, which may require periodic adjustments and which may not
accurately anticipate actual outcomes.
We have not provided for federal income taxes on the unremitted earnings of foreign
subsidiaries because these earnings are intended to be reinvested permanently.
Results of Operations
Comparison of the Three Months Ended September 30, 2007 and 2006
Revenues
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Three Months Ended
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September 30,
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2007
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2006
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(in thousands)
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Revenues
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$
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16,651
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$
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12,347
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Our revenues increased $4.3 million, or 34.9%, from $12.3 million for the three months ended
September 30, 2006 to $16.7 million for the three months ended September 30, 2007, due primarily to
increased revenue per title, including our top ten titles, new titles, our growing catalog of
titles, broader international distribution reach and increased adoption rates for mobile game
users. Revenues from our top ten games increased from $7.1 million in the three months ended
September 30, 2006 to $9.8 million in the three months ended September 30, 2007. The increase also
resulted from sales of new titles, defined as games that have been in release for twelve months or
less, including
Transformers
,
Monopoly Here and Now, World Series of Poker
and
Deer Hunter 2
.
Revenues for the three months ended September 30, 2007 from our catalog, defined as games that have
been in release for more than twelve months, increased by $2.2 million from the revenues derived
from those games in the three months ended September 30, 2006. We increased worldwide distribution
of iFone games and thus increased significantly the revenues derived from the licenses that we
acquired from iFone. International revenues, defined as revenues generated from carriers whose
principal operations are located outside the United States, increased $1.9 million from $5.6
million in the three months ended September 30, 2006 to $7.5 million in the three months ended
September 30, 2007. The impact to revenues for the three months ended September 30, 2007 due to
changes in foreign exchange results was immaterial.
Cost of Revenues
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Three Months Ended
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September 30,
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2007
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2006
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(In thousands)
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Cost of revenues:
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Royalties
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$
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4,587
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$
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3,653
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Impairment of prepaid royalties and guarantees
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60
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Amortization of intangible assets
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483
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553
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Total cost of revenues
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$
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5,070
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|
$
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4,266
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|
|
|
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Revenues
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$
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16,651
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|
$
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12,347
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Gross margin
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69.6
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%
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65.4
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%
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Our cost of revenues increased $804,000, or 18.8%, from $4.3 million in the three months ended
September 30, 2006 to $5.1 million in the three months ended September 30, 2007. The increase
resulted from an increase in royalties, which was offset by a decrease in impairment of prepaid
royalties and guarantees and amortization of intangible assets. Royalties increased $934,000
principally because of higher revenues with associated royalties, including those acquired from
iFone. Revenues attributable to games based upon branded intellectual property increased as a
percentage of revenues from 86.5% in the three months ended September 30, 2006 to 88.6% in the
three months ended September 30, 2007. The average royalty rate that we paid on games based on
licensed intellectual property decreased from 34.8% in the three months ended September 30, 2006 to
31.1% in the three months ended September 30, 2007. As a result of the decreases in average royalty
rate from branded titles and impairment of prepaid royalties and guarantees, overall royalties,
including impairment of prepaid royalties and guarantees, as a percentage of total revenues
decreased from 30.1% to 27.5%.
Gross Margin
Our gross margin increased from 65.4% in the three months ended September 30, 2006 to 69.6% in
the three months ended September 30, 2007 because of the decrease in royalty rates, higher
percentage of Glu-branded games being sold, decreased impairment of prepaid royalties and decreased
amortization of intangible assets.
Research and Development Expenses
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Three Months Ended
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September 30,
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|
2007
|
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2006
|
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|
(In thousands)
|
Research and development expenses
|
|
$
|
5,863
|
|
|
$
|
4,273
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Percentage of revenues
|
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|
35.2
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%
|
|
|
34.6
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%
|
Our research and development expenses increased $1.6 million, or 37.2%, from $4.3 million in
the three months ended September 30, 2006 to $5.9 million in the three months ended September 30,
2007. The increase in research and development costs was primarily due to increases in salaries and
benefits of $775,000, facility and overhead costs to support increased headcount of $617,000 and
stock based compensation of $261,000 offset by a decrease in outside services costs for porting and
external development of $147,000.
Research and development staff increased from 140 at September 30, 2006 to 212 at September
30, 2007 and salaries and benefits increased as a result. The growth in headcount was due primarily
to expanding our studio capacity in China. Research and development expenses included $49,000 of
stock-based compensation expense in the three months ended September 30, 2006 and $310,000 in the
three months ended September 30, 2007. As a percentage of revenues, research and development
expenses increased from 34.6% in the three months ended September 30, 2006 to 35.2% in the three
months ended September 30, 2007.
Sales and Marketing Expenses
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Three Months Ended
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September 30,
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2007
|
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2006
|
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|
(In thousands)
|
Sales and marketing expenses
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|
$
|
3,326
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|
|
$
|
2,989
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Percentage of revenues
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|
20.0
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%
|
|
|
24.2
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%
|
Our sales and marketing expenses increased $337,000, or 11.3%, from $3.0 million in the three
months ended September 30, 2006 to $3.3 million in the three months ended September 30, 2007. The
increase in sales and marketing expenses was primarily due to an increase in salaries and benefits,
excluding variable compensation, of $455,000 and an increase in stock-based compensation of
$151,000. We increased our sales and marketing headcount from 44 at September 30, 2006 to 51 at
September 30, 2007 to expand our marketing efforts for our games and to develop further market
awareness of the Glu brand, to increase sales efforts to our new and existing wireless carriers and
to expand our sales and marketing operations in the Asia-Pacific and Latin America regions. The
increases in expenses was offset by a $80,000 decrease in variable compensation due to a decrease
in commissions paid to our sales employees and a $109,000 decrease in expenses associated with
marketing programs. As a percentage of revenues, sales and marketing expenses declined from 24.2%
in the three months ended September 30, 2006 to 20.0% in the three months ended September 30, 2007
as our sales and marketing activities generated more revenues across a greater number of carriers
and mobile
34
handsets. Sales and marketing expenses included $73,000 of stock-based compensation expense in
the three months ended September 30, 2006 and $224,000 in the three months ended September 30,
2007.
General and Administrative Expenses
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Three Months Ended
|
|
|
September 30,
|
|
|
2007
|
|
2006
|
|
|
(In thousands)
|
General and administrative expenses
|
|
$
|
4,149
|
|
|
$
|
3,177
|
|
Percentage of revenues
|
|
|
24.9
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%
|
|
|
25.7
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%
|
Our general and administrative expenses increased $972,000, or 30.6%, from $3.2 million in the
three months ended September 30, 2006 to $4.1 million in the three months ended September 30, 2007.
The increase in general and administrative expenses was primarily the result of a $313,000 increase
in salaries and benefits, $305,000 increase in stock based compensation, $147,000 increase in D&O
insurance costs, $87,000 increase in franchise taxes and $50,000 increase in travel and
entertainment expenses. We increased our general and administrative headcount from 42 at September
30, 2006 to 57 at September 30, 2007 to support our continued growth and expansion. As a percentage
of revenues, general and administrative expenses decreased from 25.7% in the three months ended
September 30, 2006 to 24.9% in the three months ended September 30, 2007. General and
administrative expenses included $321,000 of stock-based compensation expense in the three months
ended September 30, 2006 and $626,000 in the three months ended September 30, 2007.
Other Operating Expenses
Our amortization of intangible assets, such as non-competition agreements, acquired from
Macrospace and iFone was $168,000 in the three months ended September 30, 2006 and $67,000 in the
three months ended September 30, 2007. The decrease was due to the full amortization of certain
intangibles during 2006.
Other Expenses
Interest and other income/(expense), net, increased $2.4 million from a net other expense of
$1.1 million in the three months ended September 30, 2006 to a net other income of $1.3 million in
the three months ended September 30, 2007. This increase was primarily due to an increase of
$776,000 in interest income resulting from the investment of proceeds from the IPO, a reduction of
$388,000 of interest expenses in conjunction with a loan that was paid in full with proceeds from
the IPO, an increase of $244,000 due to foreign currency transaction gains and an increase in the
change in the fair value of the preferred stock warrants of $998,000 prior to their conversion to
common stock warrants on the closing of the IPO. The warrants were subject to revaluation at each
balance sheet date and changes in estimated fair value were recorded as a component of other
income/(expense). Subsequent to the IPO and the associated conversion of the outstanding redeemable
convertible preferred stock into common stock, the warrants to exercise the redeemable convertible
preferred stock converted into common stock warrants; accordingly, the liability related to the
redeemable convertible preferred stock warrants was transferred to additional paid-in-capital and
the common stock warrants are no longer subject to re-measurement.
Income Tax Provision
Income tax provision increased from $192,000 in the three months ended September 30, 2006 to
$228,000 in the three months ended September 30, 2007 primarily as a result of increased foreign
withholding taxes.
Comparison of the Nine Months Ended September 30, 2007 and 2006
Revenues
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2007
|
|
2006
|
|
|
(in thousands)
|
Revenues
|
|
$
|
48,727
|
|
|
$
|
31,863
|
|
35
Our revenues increased $16.9 million, or 52.9%, from $31.9 million for the nine months ended
September 30, 2006 to $48.7 million for the nine months ended September 30, 2007, due primarily to
increased revenue per title, including our top ten titles, new titles, our growing catalog of
titles, broader international distribution reach and increased adoption rates for mobile game
users. Revenues from our top ten games increased from $18.9 million in the nine months ended
September 30, 2006 to $27.4 million in the nine months ended September 30, 2007. The increase also
resulted from sales of new titles, defined as games that have been in release for less than twelve
months or less, including
Transformers, Monopoly Here and Now, World Series of Poker, Who Wants to
be a Millionaire (2nd Edition)
and
Deer Hunter 2
. Revenues for the nine months ended September 30,
2007 from our catalog, defined as games that have been in release for more than twelve months,
increased by $6.9 million from the revenues derived from those games in the nine months ended
September 30, 2006. By utilizing our carrier relationships and our marketing and development
resources, we were able to increase worldwide distribution of iFone games and thus to increase
significantly the revenues derived from the licenses that we acquired from iFone. International
revenues, defined as revenues generated from carriers whose principal operations are located
outside the United States, increased $8.1 million from $14.2 million in the nine months ended
September 30, 2006 to $22.4 million in the nine months ended September 30, 2007. The benefit to
revenues for the nine months ended September 30, 2007 due to changes in foreign exchange rates was
$1.1 million.
Cost of Revenues
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
Royalties
|
|
$
|
13,267
|
|
|
$
|
9,656
|
|
Impairment of prepaid royalties and guarantees
|
|
|
|
|
|
|
319
|
|
Amortization of intangible assets
|
|
|
1,589
|
|
|
|
1,223
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
$
|
14,856
|
|
|
$
|
11,198
|
|
|
|
|
|
|
|
|
Revenues
|
|
$
|
48,727
|
|
|
$
|
31,863
|
|
|
|
|
|
|
|
|
Gross margin
|
|
|
69.5
|
%
|
|
|
64.9
|
%
|
Our cost of revenues increased $3.7 million, or 32.7%, from $11.2 million in the nine months
ended September 30, 2006 to $14.9 million in the nine months ended September 30, 2007. The increase
resulted from an increase in royalties and amortization of acquired intangible assets, which was
offset by a decrease in impairment of prepaid royalties and guarantees. Royalties increased $3.6
million principally because of higher revenues with associated royalties, including those acquired
from iFone. Revenues attributable to games based upon branded intellectual property decreased as a
percentage of revenues from 88.4% in the nine months ended September 30, 2006 to 87.6% in the nine
months ended September 30, 2007. The average royalty rate that we paid on games based on licensed
intellectual property decreased from 35.4% in the nine months ended September 30, 2006 to 31.1% in
the nine months ended September 30, 2007. As a result of the decreases in average royalty rate from
branded titles and impairment of prepaid royalties and guarantees, overall royalties, including
impairment of prepaid royalties and guarantees, as a percentage of total revenues decreased from
31.3% to 27.2%. Amortization of intangible assets increased by $366,000 due primarily to the
amortization of intangible assets acquired in 2006 from iFone.
Gross Margin
Our gross margin increased from 64.9% in the nine months ended September 30, 2006 to 69.5% in
the nine months ended September 30, 2007 because of the decrease in royalty rates and impairment of
prepaid royalties and guarantees but offset by the increase in the amortization of intangible
assets.
Research and Development Expenses
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2007
|
|
2006
|
|
|
(In thousands)
|
Research and development expenses
|
|
$
|
16,153
|
|
|
$
|
11,346
|
|
Percentage of revenues
|
|
|
33.1
|
%
|
|
|
35.6
|
%
|
36
Our research and development expenses increased $4.8 million, or 42.4%, from $11.3 million in
the nine months ended September 30, 2006 to $16.2 million in the nine months ended September 30,
2007. The increase in research and development costs was primarily due to increases in salaries and
benefits of $2.1 million, outside services costs for porting and external development of $912,000,
facility and overhead costs to support the increased headcount of $988,000, research materials of
$163,000, travel and entertainment of $97,000 and stock based compensation of $565,000.
Research and development headcount increased from 140 at September 30, 2006 to 212 at
September 30, 2007 and salaries and benefits increased as a result. The growth in headcount was due
primarily to expanding our studio capacity in China. Research and development expenses included
$100,000 of stock-based compensation expense in the nine months ended September 30, 2006 and
$665,000 in the nine months ended September 30, 2007. As a percentage of revenues, research and
development expenses declined from 35.6% in the nine months ended September 30, 2006 to 33.1% in
the nine months ended September 30, 2007 due to an increase in revenues.
Sales and Marketing Expenses
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
|
2007
|
|
|
2006
|
|
|
|
(In thousands)
|
|
Sales and marketing expenses
|
|
$
|
9,532
|
|
|
$
|
8,316
|
|
Percentage of revenues
|
|
|
19.6
|
%
|
|
|
26.1
|
%
|
Our sales and marketing expenses increased $1.2 million, or 14.6%, from $8.3 million in the
nine months ended September 30, 2006 to $9.5 million in the nine months ended September 30, 2007.
The increase was primarily due to an increase of $457,000 for marketing campaigns, $195,000 in
travel and entertainment and $368,000 in stock-based compensation. Salaries and benefits, excluding
variable compensation, increased $541,000. We increased our sales and marketing headcount from 44
at September 30, 2006 to 51 at September 30, 2007 to expand our marketing efforts for our games and
the Glu brand, to increase sales efforts to our new and existing wireless carriers and to expand
our sales and marketing operations in the Asia-Pacific and Latin America regions. The increase in
these costs was offset by a reduction of variable compensation of $142,000 due to a decrease in
commissions paid to our sales employees and a reduction of $115,000 in severance expenses. As a
percentage of revenues, sales and marketing expenses declined from 26.1% in the nine months ended
September 30, 2006 to 19.6% in the nine months ended September 30, 2007 as our sales and marketing
activities generated more revenues across a greater number of carriers and mobile handsets. Sales
and marketing expenses included $130,000 of stock-based compensation expense in the nine months
ended September 30, 2006 and $498,000 in the nine months ended September 30, 2007.
General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2007
|
|
2006
|
|
|
(In thousands)
|
General and administrative expenses
|
|
$
|
12,422
|
|
|
$
|
7,683
|
|
Percentage of revenues
|
|
|
25.5
|
%
|
|
|
24.1
|
%
|
Our general and administrative expenses increased $4.7 million, or 61.7%, from $7.7 million in
the nine months ended September 30, 2006 to $12.4 million in the nine months ended September 30,
2007. The increase in general and administrative expenses was primarily the result of a $2.2
million increase in salaries and benefits, $756,000 increase in professional fees, $878,000
increase in stock based compensation, $353,000 increase in facility and overhead costs to support
additional headcount, $296,000 increase in D&O insurance and $124,000 increase in travel and
entertainment. We increased our general and administrative headcount from 42 at September 30, 2006
to 57 at September 30, 2007 to support our continued growth and expansion. As a percentage of
revenues, general and administrative expenses increased from 24.1% in the nine months ended
September 30, 2006 to 25.5% in the nine months ended September 30, 2007 as a result of increased
salaries and benefits and spending in accounting and legal fees. General and administrative
expenses included $735,000 of stock-based compensation expense in the nine months ended September
30, 2006 and $1.6 million in the nine months ended September 30, 2007.
37
Other Operating Expenses
Our amortization of intangible assets, such as non-competition agreements, acquired from
Macrospace and iFone was $477,000 in the nine months ended September 30, 2006 and $200,000 in the
nine months ended September 30, 2007. The decrease was due to the full amortization of certain
intangibles during 2006.
Our acquired in-process research and development decreased from $1.5 million in the nine
months ended September 30, 2006 to zero in the nine months ended September 30, 2007. The IPR&D
charge recorded in 2006 was related to the development of new games by iFone. We determined the
value of acquired IPR&D using a discounted cash flows approach. We calculated the present value of
expected future cash flows attributable to the in-process technology using a 21% discount rate.
This rate took into account the percentage of completion of the development effort of approximately
20% and the risks associated with our developing technology given changes in trends and technology
in our industry. As of December 31, 2006, all acquired IPR&D projects had been completed at a cost
similar to the original projections.
Our gain on sale of assets increased from zero during the nine months ended September 30, 2006
to $1.0 million during the nine months ended September 30, 2007 due to the sale of ProvisionX
software to a third party in February 2007. Under the terms of the agreement, we will co-own the
intellectual property rights to the ProvisionX software, excluding any alterations or modifications
following the sale, by the third party.
Other Expenses
Interest and other income/(expense), net, increased from a net expense of $904,000 in the nine
months ended September 30, 2006 to income of $1.8 million in the nine months ended September 30,
2007. This increase was primarily due to an increase in interest income of $1.6 million resulting
from the investment of proceeds from the IPO offset by an increase in interest expenses of $196,000
in conjunction with a loan from a lender which included $548,000 of non-cash interest expense
related to the full recognition of the unamortized debt issuance costs and warrant discount on upon
extinguishment of the loan with proceeds from the IPO. Other income also increased due to an
increase in foreign currency transaction gains of $279,000 and by a benefit in the change in the
fair value of the preferred stock warrants of $1.1 million prior to their conversion to common
stock warrants on the closing of the IPO. The warrants were subject to revaluation at each balance
sheet date and changes in estimated fair value were recorded as a component of other
income/(expense). Subsequent to the IPO and the associated conversion of the outstanding redeemable
convertible preferred stock into common stock, the warrants to exercise the redeemable convertible
preferred stock converted into common stock warrants; accordingly, the liability related to the
redeemable convertible preferred stock warrants was transferred to additional paid-in-capital and
the common stock warrants are no longer subject to re-measurement.
Income Tax Provision
Income tax provision increased from $438,000 in the nine months ended September 30, 2006 to
$813,000 in the nine months ended September 30, 2007 primarily as a result of increased foreign
withholding taxes.
Liquidity and Capital Resources
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2007
|
|
2006
|
|
|
(in thousands)
|
Consolidated Statement of Cash Flows Data:
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
$
|
2,142
|
|
|
$
|
612
|
|
Depreciation and amortization
|
|
|
3,305
|
|
|
|
2,796
|
|
Cash flows provided by/(used in) operating activities
|
|
|
303
|
|
|
|
(10,554
|
)
|
Cash flows provided by investing activities
|
|
|
4,848
|
|
|
|
2,292
|
|
Cash flows provided by financing activities
|
|
|
62,849
|
|
|
|
11,208
|
|
Since our inception, we have incurred recurring losses and negative annual cash flows from
operating activities, and we had an accumulated deficit of $51.5 million and $46.0 million as of
September 30, 2007 and December 31, 2006, respectively. Our primary sources of liquidity have
historically been private placements of shares of our preferred stock with aggregate proceeds of
$57.4 million and borrowings under our credit facilities with aggregate proceeds of $12.0 million.
In the nine months ended September 30, 2007, we raised $74.8 million of proceeds, net of
underwriting discounts and expenses, in our IPO. In the future, we anticipate that our primary
sources of liquidity will be cash generated from our operating activities.
38
Operating Activities
In the nine months ended September 30, 2007, net cash provided by operating activities was
$303,000 as compared to $10.6 million of net cash used in operating activities in the nine months
ended September 30, 2006. This increase was primarily due to a decline in our net loss of $7.6
million from the nine months ended September 30, 2007 as compared to the same period in 2006,
decreased payments in accounts payable and accrued liabilities of $6.8 million due primarily to the
payment of liabilities assumed as a part of the iFone acquisition in the nine months ended
September 30, 2006, decreased payments for restructuring of $1.4 million and an increase in
collections from accounts receivables of $411,000. Non-cash items increased for the nine months
ended September 30, 2007 by $422,000, $87,000, $1.8 million, $485,000 and $1.0 million for
depreciation, amortization of intangible assets, stock based compensation, non-cash interest
expense and change in carrying value of preferred stock warrant liability, respectively, as
compared to the same period in 2006.
This was offset by a charge for acquired IPR&D of $1.5 million in the nine months ended
September 30, 2006, the impairment of prepaid royalties and guarantees of $319,000 in the nine
months ended September 30, 2006 and a gain on sale of assets of $1.0 million in the nine months
ended September 30, 2007. Cash used for prepaid expenses and other assets, royalties and accrued
compensation increased by $1.2 million, $1.9 million and $739,000, respectively, in the nine months
ended September 30, 2007 as compared to the same period in 2006.
We expect to use cash in our operating activities during the fourth quarter of 2007 because of
anticipated net losses and expected growth in our accounts receivable balance due to the expected
growth in our revenues. Additionally, we may decide to enter into new licensing arrangements for
existing or new licensed intellectual properties that may require us to make royalty payments at
the outset of the agreement. If we do sign these agreements, this could significantly increase our
future use of cash in operating activities.
Investing Activities
Our primary investing activities have consisted of purchases and sales of short-term
investments, purchases of property and equipment, and, in the nine months ended September 30, 2006,
the acquisition of iFone. We expect to use more cash in investing activities in 2007 as we expand
our internal development capacity in the Asia-Pacific region. We expect to fund this investment
with our existing cash, cash equivalents and short-term investments.
In the nine months ended September 30, 2007, we generated $4.8 million of net cash from
investing activities. This net cash resulted from net sales of short-term investments of $6.0
million and $1.0 million in proceeds from the sale of assets offset by purchases of property and
equipment of $2.1 million.
In the nine months ended September 30, 2006 we generated $2.3 million of net cash from
investing activities. This net cash resulted from net sales of short-term investments of $10.3
million, offset by the acquisition of iFone for cash and stock, net of cash acquired, of $7.4
million and purchases of property and equipment of $612,000.
Financing Activities
In the nine months ended September 30, 2007, our financing activities provided $62.8 million
of cash primarily from $78.1 million of IPO proceeds net of underwriters fees offset by the
payment of the $12.0 million loan from the lender. Additionally, we paid $3.3 million during the
nine months ended September 30, 2007 for the payment of offering costs related to the IPO.
In the nine months ended September 30, 2006, our financing activities provided $11.2 million
of cash primarily from $12.0 million of proceeds from a loan offset by $926,000 in loan payments
substantially all of which came from the payment of a loan assumed in connection with the iFone
acquisition.
Sufficiency of Current Cash, Cash Equivalents and Short-Term Investments
Our cash, cash equivalents and short-term investments were $72.0 million as of September 30,
2007. We believe that our cash, cash equivalents and short-term investments and any cash flow from
operations will be sufficient to meet our anticipated cash needs, including for working capital
purposes, capital expenditures and various contractual obligations, for at least the next 12
months. We may, however, require additional cash resources due to changed business conditions or
other future developments, including any
39
investments or acquisitions we may decide to pursue. If these sources are insufficient to
satisfy our cash requirements, we may seek to sell debt securities or additional equity securities
or to obtain a credit facility. The sale of convertible debt securities or additional equity
securities could result in additional dilution to our stockholders. The incurrence of indebtedness
would result in debt service obligations and could result in operating and financial covenants that
would restrict our operations. In addition, there can be no assurance that any additional financing
will be available on acceptable terms, if at all. We anticipate that, from time to time, we may
evaluate acquisitions of complementary businesses, technologies or assets. However, there are no
current understandings, commitments or agreements with respect to any acquisitions.
Contractual Obligations
The following table is a summary of our contractual obligations as of September 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less than
|
|
|
|
|
|
|
|
|
Total
|
|
1 Year
|
|
1-3 Years
|
|
3-5 Years
|
|
Thereafter
|
|
|
(In thousands)
|
Operating lease obligations
|
|
$
|
9,587
|
|
|
$
|
701
|
|
|
$
|
6,543
|
|
|
$
|
2,343
|
|
|
$
|
|
|
Guaranteed royalties(1)
|
|
|
13,348
|
|
|
|
5,554
|
|
|
|
7,019
|
|
|
|
775
|
|
|
|
|
|
|
|
|
(1)
|
|
We have entered into license and development arrangements with various owners of brands and
other intellectual property so that we can create and publish games for mobile handsets based
on that intellectual property. Pursuant to some of these agreements, we are required to pay
guaranteed royalties over the term of the contracts regardless of actual game sales. Certain
of these minimum payments totaling $7.7 million have been recorded as liabilities in our
condensed consolidated balance sheet because payment is not contingent upon performance by the
licensor.
|
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partners, such as
entities often referred to as structured finance or special purpose entities, which would have been
established for the purpose of facilitating off-balance sheet arrangements or other contractually
narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt, and we
have not entered into any synthetic leases. We are, therefore, not materially exposed to any
financing, liquidity, market or credit risk that could arise if we had engaged in such
relationships.
Recent Accounting Pronouncements
Information with respect to Recent Accounting Pronouncements may be found in Note 1 of Notes
to Unaudited Condensed Consolidated Financial Statements in this quarterly report, which
information is incorporated herein by reference.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate and Credit Risk
We have exposure to interest rate risk that relates primarily to our investment portfolio. We
invest excess cash in money market funds and auction rate securities. We do not currently use or
plan to use derivative financial instruments in our investment portfolio. The risk associated with
fluctuating interest rates is limited to our investment portfolio, and we do not believe that a 10%
change in interest rates would have a significant impact on our interest income, operating results
or liquidity.
As of September 30, 2007 and December 31, 2006, our cash and cash equivalents were maintained
by financial institutions in the United States, the United Kingdom, Hong Kong, Brazil, Germany,
France, Spain and Italy and our current deposits are likely in excess of insured limits. We believe
that the financial institutions that hold our investments are financially sound and, accordingly,
minimal credit risk exists with respect to these institutions. Due to disruptions of, and the
resulting greatly reduced liquidity in certain financial markets in 2007, two of our AAA
rated, corporate asset-backed auction rate securities totaling $2.8 million in purchased cost
experienced failed auctions during the three months ended September 30, 2007. Due to the failed
auctions, we were unable to sell the securities at their respective costs, resulting in a
decrease in fair value of $259,000 as of September 30, 2007. Although we intend to
liquidate these two investments as needed we do not currently have the same ability to do so and
have reclassified these investments to other long-term assets as of September 30, 2007.
40
Our accounts receivable primarily relate to revenues earned from domestic and international
wireless carriers. We perform ongoing credit evaluations of our carriers financial condition but
generally require no collateral from them. At September 30, 2007, Verizon Wireless and Sprint
Nextel accounted for 25% and 11% of our total accounts receivable, respectively. At December 31,
2006, Verizon Wireless, Sprint Nextel and Vodafone accounted for 21%, 11% and 10% of our total
accounts receivable, respectively.
Foreign Currency Risk
The functional currencies of our United States and United Kingdom operations are the U.S.
Dollar, or USD, and the pound sterling, respectively. A significant portion of our business is
conducted in currencies other than the USD or the pound sterling. Our revenues are usually
denominated in the functional currency of the carrier. Operating expenses are usually in the local
currency of the operating unit, which mitigates a portion of the exposure related to currency
fluctuations. Intercompany transactions between our domestic and foreign operations are denominated
in either the USD or the pound sterling. At month-end, foreign currency-denominated accounts
receivable and intercompany balances are marked to market and unrealized gains and losses are
included in other income/(expense), net.
Our foreign currency exchange gains and losses have been generated primarily from fluctuations
in the pound sterling versus the USD and in the Euro versus the pound sterling. It is uncertain
whether these currency trends will continue. In the future, we may experience foreign currency
exchange losses on our accounts receivable and intercompany receivables and payables. Foreign
currency exchange losses could have a material adverse effect on our business, operating results
and financial condition.
Inflation
We do not believe that inflation has had a material effect on our business, financial
condition or results of operations. If our costs were to become subject to significant inflationary
pressures, we might not be able to offset these higher costs fully through price increases. Our
inability or failure to do so could harm our business, operating results and financial condition.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Regulations under the Securities Exchange Act of 1934 (Exchange Act) require public
companies, including our Company to maintain disclosure controls and procedures, which are
defined to mean a companys controls and other procedures that are designed to ensure that
information required to be disclosed in the reports that it files or submits under the Exchange Act
is recorded, processed, summarized and reported, within the time periods specified in the
Commissions rules and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be disclosed in our reports
filed under the Exchange Act is accumulated and communicated to management, including our principal
executive officer and principal financial officer, or persons performing similar functions, as
appropriate to allow timely decisions regarding required or necessary disclosures. Our chief
executive officer and chief financial officer have concluded, based on the evaluation of the
effectiveness of the disclosure controls and procedures by our management as of the end of the
period covered by this report, that our disclosure controls and procedures were effective for this
purpose.
Changes in Internal Control over Financial Reporting
Regulations under the Exchange Act require public companies, including our Company, to
evaluate any change in our internal control over financial reporting as such term is defined in
Rule 13a-15(f) and Rule 15d-15(f) of the Exchange Act. In connection with their evaluation of our
disclosure controls and procedures as of the end of the period covered by this report, our Chief
Executive Officer and Chief Financial Officer did not identify any change in our internal control
over financial reporting during the fiscal quarter covered by this report that materially affected,
or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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From time to time, we are subject to various claims, complaints and legal actions in the
normal course of business. We do not believe we are party to any currently pending litigation, the
outcome of which will have a material adverse effect on our operations or financial position.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
We have a history of net losses, may incur substantial net losses in the future and may not achieve
profitability.
We have incurred significant losses since inception, including a net loss of $8.3 million in
2004, a net loss of $17.9 million in 2005 and a net loss of $12.3 million in 2006. As of December
31, 2006, we had an accumulated deficit of $46.0 million, and as of September 30, 2007, we had an
accumulated deficit of $51.5 million. We expect to continue to increase expenses as we implement
initiatives designed to continue to grow our business, including, among other things, the
development and marketing of new games, further international expansion, expansion of our
infrastructure, acquisition of content, and general and administrative expenses associated with
being a public company. If our revenues do not increase to offset these expected increases in
operating expenses, we will continue to incur significant losses and will not become profitable.
Our revenue growth in recent periods should not be considered indicative of our future performance.
In fact, in future periods, our revenues could decline. Accordingly, we may not be able to achieve
profitability in the future.
We have a limited operating history in an emerging market, which may make it difficult to evaluate
our business.
We were incorporated in May 2001 and began selling mobile games in July 2002. Accordingly, we
have only a limited history of generating revenues, and the future revenue potential of our
business in this emerging market is uncertain. As a result of our short operating history, we have
limited financial data that can be used to evaluate our business. Any evaluation of our business
and our prospects must be considered in light of our limited operating history and the risks and
uncertainties encountered by companies in our stage of development. As an early stage company in
the emerging mobile entertainment industry, we face increased risks, uncertainties, expenses and
difficulties. To address these risks and uncertainties, we must do the following:
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maintain our current, and develop new, wireless carrier relationships, particularly in
international markets;
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maintain and expand our current, and develop new, relationships with third-party branded
content owners;
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retain or improve our current revenue-sharing arrangements with carriers and third-party
branded content owners;
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maintain and enhance our own brands;
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continue to develop new high-quality mobile games that achieve significant market
acceptance;
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continue to port existing mobile games to new mobile handsets;
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continue to develop and upgrade our technology;
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continue to enhance our information processing systems;
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increase the number of end users of our games;
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maintain and grow our non-carrier, or off-deck, distribution, including through our
website and third-party direct-to-consumer distributors;
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expand our development capacity in countries with lower costs;
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execute our business and marketing strategies successfully;
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respond to competitive developments; and
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attract, integrate, retain and motivate qualified personnel.
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We may be unable to accomplish one or more of these objectives, which could cause our business
to suffer. In addition, accomplishing many of these efforts might be very expensive, which could
adversely impact our operating results and financial condition.
Our financial results could vary significantly from quarter to quarter and are difficult to
predict.
Our revenues and operating results could vary significantly from quarter to quarter because of
a variety of factors, many of which are outside of our control. As a result, comparing our
operating results on a period-to-period basis may not be meaningful. In addition, we may not be
able to predict our future revenues or results of operations. We base our current and future
expense levels on our internal operating plans and sales forecasts, and our operating costs are to
a large extent fixed. As a result, we may not be able to reduce our costs sufficiently to
compensate for an unexpected shortfall in revenues, and even a small shortfall in revenues could
disproportionately and adversely affect financial results for that quarter. Individual games and
carrier relationships represent meaningful portions of our revenues and net loss in any quarter. We
may incur significant or unanticipated expenses when licenses are renewed. In addition, some
payments from carriers that we recognize as revenue on a cash basis may be delayed unpredictably.
In addition to other risk factors discussed in this section, factors that may contribute to
the variability of our quarterly results include:
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the number of new mobile games released by us and our competitors;
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the timing of release of new games by us and our competitors, particularly those that may
represent a significant portion of revenues in a period;
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the popularity of new games and games released in prior periods;
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changes in prominence of deck placement for our leading games and those of our
competitors;
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the expiration of existing content licenses for particular games;
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the timing of charges related to impairments of goodwill, intangible assets, prepaid
royalties and guarantees;
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changes in pricing policies by us, our competitors or our carriers and other
distributors;
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changes in the mix of original and licensed games, which have varying gross margins;
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the timing of successful mobile handset launches;
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the seasonality of our industry;
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fluctuations in the size and rate of growth of overall consumer demand for mobile games
and related content;
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strategic decisions by us or our competitors, such as acquisitions, divestitures,
spin-offs, joint ventures, strategic investments or changes in business strategy;
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our success in entering new geographic markets;
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foreign exchange fluctuations;
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accounting rules governing recognition of revenue;
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the timing of compensation expense associated with equity compensation grants; and
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decisions by us to incur additional expenses, such as increases in marketing or research
and development.
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As a result of these and other factors, our operating results may not meet the expectations of
investors or public market analysts who choose to follow our company. Failure to meet market
expectations would likely result in decreases in the trading price of our common stock.
The markets in which we operate are highly competitive, and many of our competitors have
significantly greater resources than we do.
The development, distribution and sale of mobile games is a highly competitive business. For
end users, we compete primarily on the basis of brand, game quality and price. For wireless
carriers, we compete for deck placement based on these factors, as well as historical performance
and perception of sales potential and relationships with licensors of brands and other intellectual
property. For content and brand licensors, we compete based on royalty and other economic terms,
perceptions of development quality, porting abilities, speed of execution, distribution breadth and
relationships with carriers. We also compete for experienced and talented employees.
Our primary competitors include Digital Chocolate, Electronic Arts (EA Mobile), Gameloft,
Hands-On Mobile, I-play, Namco and THQ, with Electronic Arts having the largest market share of any
company in the mobile games market. In the future, likely competitors include major media
companies, traditional video game publishers, content aggregators, mobile software providers and
independent mobile game publishers. Carriers may also decide to develop, internally or through a
managed third-party developer, and distribute their own mobile games. If carriers enter the mobile
game market as publishers, they might refuse to distribute some or all of our games or might deny
us access to all or part of their networks.
Some of our competitors and our potential competitors advantages over us, either globally or
in particular geographic markets, include the following:
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significantly greater revenues and financial resources;
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stronger brand and consumer recognition regionally or worldwide;
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the capacity to leverage their marketing expenditures across a broader portfolio of
mobile and non-mobile products;
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more substantial intellectual property of their own from which they can develop games
without having to pay royalties;
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pre-existing relationships with brand owners or carriers that afford them access to
intellectual property while blocking the access of competitors to that same intellectual
property;
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greater resources to make acquisitions;
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lower labor and development costs; and
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broader global distribution and presence.
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If we are unable to compete effectively or we are not as successful as our competitors in our
target markets, our sales could decline, our margins could decline and we could lose market share,
any of which would materially harm our business, operating results and financial condition.
Failure to renew our existing brand and content licenses on favorable terms or at all and to obtain
additional licenses would impair our ability to introduce new mobile games or to continue to offer
our current games based on third-party content.
Revenues derived from mobile games and other applications based on or incorporating brands or
other intellectual property licensed from third parties accounted for 80.5% and 88.4% of our
revenues in 2005 and 2006, respectively. In 2006, revenues derived from our four largest licensors,
Atari, Fox, PopCap Games and Celador, together accounted for approximately 58.1% of our revenues.
Even if mobile games based on licensed content or brands remain popular, any of our licensors could
decide not to renew our existing license or not to license additional intellectual property and
instead license to our competitors or develop and publish its own mobile
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games or other applications, competing with us in the marketplace. For example, our license
with Hasbro under which we create our
Battleship, Clue, Game of Life
and
Monopoly
games, which in
the past have accounted for a significant portion of our revenue, will expire in December 2007.
Many of these licensors already develop games for other platforms, and may have significant
experience and development resources available to them should they decide to compete with us rather
than license to us.
We have both exclusive and non-exclusive licenses and both licenses that are global and
licenses that are limited to specific geographies, often with other mobile game publishers having
rights to geographies not covered by our licenses. Our licenses generally have terms that range
from two to five years, with the primary exceptions being our six-year licenses covering
World
Series of Poker
and
Deer Hunter 2
and our seven-year license covering
Kasparov Chess.
Some of the
licenses that we have inherited through acquisitions provide that the licensor owns the
intellectual property that we develop in the mobile version of the game and that, when our license
expires, the licensor can transfer that intellectual property to a new licensee. Increased
competition for licenses may lead to larger guarantees, advances and royalties that we must pay to
our licensors, which could significantly increase our cost of revenues and cash usage. We may be
unable to renew these licenses or to renew them on terms favorable to us, and we may be unable to
secure alternatives in a timely manner. Failure to maintain or renew our existing licenses or to
obtain additional licenses would impair our ability to introduce new mobile games or to continue to
offer our current games, which would materially harm our business, operating results and financial
condition. Some of our existing licenses impose, and licenses that we obtain in the future might
impose, development, distribution and marketing obligations on us. If we breach our obligations,
our licensors might have the right to terminate the license or change an exclusive license to a
non-exclusive license, which would harm our business, operating results and financial condition.
Even if we are successful in gaining new licenses or extending existing licenses, we may fail
to anticipate the entertainment preferences of our end users when making choices about which brands
or other content to license. If the entertainment preferences of end users shift to content or
brands owned or developed by companies with which we do not have relationships, we may be unable to
establish and maintain successful relationships with these developers and owners, which would
materially harm our business, operating results and financial condition. In addition, some rights
are licensed from licensors that have or may develop financial difficulties, and may enter into
bankruptcy protection under U.S. federal law or the laws of other countries. If any of our
licensors files for bankruptcy, our licenses might be impaired or voided, which could materially
harm our business, operating results and financial condition.
We currently rely on wireless carriers to market and distribute our games and thus to generate our
revenues. In particular, subscribers of Verizon Wireless, Sprint Nextel, Cingular Wireless and
Vodafone collectively represented 55.1% of our revenues in 2006. The loss of or a change in any of
these significant carrier relationships could cause us to lose access to their subscribers and thus
materially reduce our revenues.
Our future success is highly dependent upon maintaining successful relationships with the
wireless carriers with which we currently work and establishing new carrier relationships in
geographies where we have not yet established a significant presence. A significant portion of our
revenues is derived from a very limited number of carriers. In 2006, we derived approximately 20.6%
of our revenues from subscribers of Verizon Wireless, 12.6% of our revenues from subscribers of
Sprint Nextel affiliates, 11.3% of our revenues from subscribers of Cingular Wireless and 10.6% of
our revenues from subscribers of Vodafone. During 2005, we derived approximately 24.3%, 11.9%,
11.9% and 6.2%, respectively, of our revenues from subscribers of these carriers. In 2005 and 2006,
subscribers from carriers representing the next ten largest sources of our revenues represented
25.6% and 23.8% of our revenues, respectively, although some of the carriers represented in this
group varied from period to period. We expect that we will continue to generate a substantial
majority of our revenues through distribution relationships with fewer than 20 carriers for the
foreseeable future. Our failure to maintain our relationships with these carriers would materially
reduce our revenues and thus harm our business, operating results and financial condition.
Our carrier agreements do not establish us as the exclusive provider of mobile games with the
carriers and typically have a term of one or two years with automatic renewal provisions upon
expiration of the initial term, absent a contrary notice from either party. In addition, the
carriers usually can terminate these agreements early and, in some instances, at any time without
cause, which could give them the ability to renegotiate economic or other terms. The agreements
generally do not obligate the carriers to market or distribute any of our games. In many of these
agreements, we warrant that our games do not contain libelous or obscene content, do not contain
material defects or viruses, and do not violate third-party intellectual property rights and we
indemnify the carrier for any breach of a third partys intellectual property. In addition, our
agreements with a substantial minority of our carriers, including Verizon Wireless, allow the
carrier to set the retail price at a level different from the price implied by our negotiated
revenue split, without a
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corresponding change to our wholesale price to the carrier. If one of these carriers raises
the retail price of one of our games, unit demand for that game might decline, reducing our
revenues, without necessarily reducing, and perhaps increasing, the total revenues that the carrier
receives from sales of that game.
Many other factors outside our control could impair our ability to generate revenues through a
given carrier, including the following:
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the carriers preference for our competitors mobile games rather than ours;
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the carriers decision not to include or highlight our games on the deck of its mobile
handsets;
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the carriers decision to discontinue the sale of our mobile games or all mobile games
like ours;
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the carriers decision to offer games to its subscribers without charge or at reduced
prices;
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the carriers decision to require market development funds from publishers like us;
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the carriers decision to restrict or alter subscription or other terms for downloading
our games;
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a failure of the carriers merchandising, provisioning or billing systems;
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the carriers decision to offer its own competing mobile games;
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the carriers decision to transition to different platforms and revenue models; and
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consolidation among carriers.
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If any of our carriers decides not to market or distribute our games or decides to terminate,
not renew or modify the terms of its agreement with us or if there is consolidation among carriers
generally, we may be unable to replace the affected agreement with acceptable alternatives, causing
us to lose access to that carriers subscribers and the revenues they afford us, which could
materially harm our business, operating results and financial condition.
End user tastes are continually changing and are often unpredictable; if we fail to develop and
publish new mobile games that achieve market acceptance, our sales would suffer.
Our business depends on developing and publishing mobile games that wireless carriers will
place on their decks and end users will buy. We must continue to invest significant resources in
licensing efforts, research and development, marketing and regional expansion to enhance our
offering of games and introduce new games, and we must make decisions about these matters well in
advance of product release in order to implement them in a timely manner. Our success depends, in
part, on unpredictable and volatile factors beyond our control, including end-user preferences,
competing games and the availability of other entertainment activities. If our games and related
applications are not responsive to the requirements of our carriers or the entertainment
preferences of end users, or they are not brought to market in a timely and effective manner, our
business, operating results and financial condition would be harmed. Even if our games are
successfully introduced and initially adopted, a subsequent shift in our carriers or the
entertainment preferences of end users could cause a decline in our games popularity that could
materially reduce our revenues and harm our business, operating results and financial condition.
Inferior deck placement would likely adversely impact our revenues and thus our operating results
and financial condition.
Wireless carriers provide a limited selection of games that are accessible to their
subscribers through a deck on their mobile handsets. The inherent limitation on the number of games
available on the deck is a function of the limited screen size of handsets and carriers
perceptions of the depth of menus and numbers of choices end users will generally utilize. Carriers
typically provide one or more top level menus highlighting games that are recent top sellers, that
the carrier believes will become top sellers or that the carrier otherwise chooses to feature, in
addition to a link to a menu of additional games sorted by genre. We believe that deck placement on
the top level or featured menu or toward the top of genre-specific or other menus, rather than
lower down or in sub-menus, is likely to
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result in games achieving a greater degree of commercial success. If carriers choose to give
our games less favorable deck placement, our games may be less successful than we anticipate, our
revenues may decline and our business, operating results and financial condition may be materially
harmed.
We have depended on no more than ten mobile games for a majority of our revenues in recent fiscal
periods.
In our industry, new games are frequently introduced, but a relatively small number of games
account for a significant portion of industry sales. Similarly, a significant portion of our
revenues comes from a limited number of mobile games, although the games in that group have shifted
over time. For example, in 2005 and 2006, we generated approximately 52.8% and 53.3% of our
revenues, respectively, from our top ten games, but no individual game represented more than 10% of
our revenues in either period. We expect to release a relatively small number of new games each
year for the foreseeable future. If these games are not successful, our revenues could be limited
and our business and operating results would suffer in both the year of release and thereafter.
In addition, the limited number of games that we release in a year may contribute to
fluctuations in our operating results. Therefore, our reported results at quarter and year end may
be affected based on the release dates of our products, which could result in volatility in the
price of our common stock. If our competitors develop more successful games or offer them at lower
prices or based on payment models, such as pay-for-play or subscription-based models, perceived as
offering a better value proposition, or if we do not continue to develop consistently high-quality
and well-received games, our revenues would likely decline and our business, operating results and
financial condition would be harmed.
If we are unsuccessful in establishing and increasing awareness of our brand and recognition of our
mobile games or if we incur excessive expenses promoting and maintaining our brand or our games,
our potential revenues could be limited, our costs could increase and our operating results and
financial condition could be harmed.
We believe that establishing and maintaining our brand is critical to retaining and expanding
our existing relationships with wireless carriers and content licensors, as well as developing new
relationships. Promotion of the Glu brand will depend on our success in providing high-quality
mobile games. Similarly, recognition of our games by end users will depend on our ability to
develop engaging games of high quality with attractive titles. However, our success will also
depend, in part, on the services and efforts of third parties, over which we have little or no
control. For instance, if our carriers fail to provide high levels of service, our end users
ability to access our games may be interrupted, which may adversely affect our brand. If end users,
branded content owners and carriers do not perceive our existing games as high-quality or if we
introduce new games that are not favorably received by our end users and carriers, then we may be
unsuccessful in building brand recognition and brand loyalty in the marketplace. In addition,
globalizing and extending our brand and recognition of our games will be costly and will involve
extensive management time to execute successfully. Further, the markets in which we operate are
highly competitive and some of our competitors, such as Electronic Arts (EA Mobile), already have
substantially more brand name recognition and greater marketing resources than we do. If we fail to
increase brand awareness and consumer recognition of our games, our potential revenues could be
limited, our costs could increase and our business, operating results and financial condition could
suffer.
Our business and growth may suffer if we are unable to hire and retain key personnel, who are in
high demand.
We depend on the continued contributions of our senior management and other key personnel,
especially L. Gregory Ballard and Albert A. Rocky Pimentel. The loss of the services of any of
our executive officers or other key employees could harm our business. All of our U.S.-based
executive officers and key employees are at-will employees, which means they may terminate their
employment relationship with us at any time. None of our U.S.-based employees is bound by a
contractual non-competition agreement, which could make us vulnerable to recruitment efforts by our
competitors. Internationally, while some employees and contractors are bound by non-competition
agreements, we may experience difficulty in enforcing these agreements. We do not maintain a
key-person life insurance policy on any of our officers or other employees.
Our future success also depends on our ability to identify, attract and retain highly skilled
technical, managerial, finance, marketing and creative personnel. We face intense competition for
qualified individuals from numerous technology, marketing and mobile entertainment companies. In
addition, competition for qualified personnel is particularly intense in the San Francisco Bay
Area, where our headquarters are located. Further, two of our principal overseas operations are
based in London and Hong Kong, cities that, similar to our headquarters region, have high costs of
living and consequently high compensation standards. Qualified individuals are in high demand, and
we may incur significant costs to attract them. We may be unable to attract and retain suitably
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qualified individuals who are capable of meeting our growing creative, operational and
managerial requirements, or may be required to pay increased compensation in order to do so. If we
are unable to attract and retain the qualified personnel we need to succeed, our business would
suffer.
Volatility or lack of performance in our stock price may also affect our ability to attract
and retain our key employees. Many of our senior management personnel and other key employees have
become, or will soon become, vested in a substantial amount of stock or stock options. Employees
may be more likely to leave us if the shares they own or the shares underlying their options have
significantly appreciated in value relative to the original purchase prices of the shares or the
exercise prices of the options, or if the exercise prices of the options that they hold are
significantly above the market price of our common stock. If we are unable to retain our employees,
our business, operating results and financial condition would be harmed.
Growth may place significant demands on our management and our infrastructure.
We operate in an emerging market and have experienced, and may continue to experience, growth
in our business through internal growth and acquisitions. This growth has placed, and may continue
to place, significant demands on our management and our operational and financial infrastructure.
In particular, we grew from approximately 130 employees at December 31, 2004 to more than 210
employees at September 30, 2005 in anticipation of revenues that did not immediately result. As a
consequence, we had to terminate 27 employees in December 2005. Continued growth could strain our
ability to:
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develop and improve our operational, financial and management controls;
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enhance our reporting systems and procedures;
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recruit, train and retain highly skilled personnel;
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maintain our quality standards; and
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maintain branded content owner, wireless carrier and end-user satisfaction.
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Managing our growth will require significant expenditures and allocation of valuable
management resources. If we fail to achieve the necessary level of efficiency in our organization
as it grows, our business, operating results and financial condition would be harmed.
The acquisition of other companies, businesses or technologies could result in operating
difficulties, dilution and other harmful consequences.
We have made recent acquisitions and, although we have no present understandings, commitments
or agreements to do so, we may pursue further acquisitions, any of which could be material to our
business, operating results and financial condition. Future acquisitions could divert managements
time and focus from operating our business. In addition, integrating an acquired company, business
or technology is risky and may result in unforeseen operating difficulties and expenditures. We may
also use a portion of the net proceeds of our IPO for the acquisition of, or investment in,
companies, technologies, products or assets that complement our business. Future acquisitions or
dispositions could result in potentially dilutive issuances of our equity securities, including our
common stock, or the incurrence of debt, contingent liabilities, amortization expenses or acquired
in-process research and development expenses, any of which could harm our financial condition and
operating results. Future acquisitions may also require us to obtain additional financing, which
may not be available on favorable terms or at all.
International acquisitions involve risks related to integration of operations across different
cultures and languages, currency risks and the particular economic, political and regulatory risks
associated with specific countries.
Some or all of these issues may result from our acquisitions of Macrospace in December 2004
and iFone in March 2006, each of which is based in the United Kingdom. If the anticipated benefits
of either of these or future acquisitions do not materialize, we experience difficulties
integrating iFone or businesses acquired in the future, or other unanticipated problems arise, our
business, operating results and financial condition may be harmed.
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In addition, a significant portion of the purchase price of companies we acquire may be
allocated to acquired goodwill and other intangible assets, which must be assessed for impairment
at least annually. In the future, if our acquisitions do not yield expected returns, we may be
required to take charges to our earnings based on this impairment assessment process, which could
harm our operating results.
We face added business, political, regulatory, operational, financial and economic risks as a
result of our international operations and distribution, any of which could increase our costs and
hinder our growth.
International sales represented approximately 41.8% and 44.8% of our revenues in 2005 and
2006, respectively. In addition, as part of our international efforts, we acquired U.K.-based
Macrospace in December 2004, opened our Hong Kong office in July 2005, expanded our presence in the
European market with our acquisition of iFone in March 2006, opened an office in France in the
third quarter of 2006, opened additional offices in Brazil and Germany in the fourth quarter of
2006, opened additional offices in China, Italy and Spain in the second quarter of 2007, and opened
an office in Chile in the fourth quarter of 2007. We expect to open additional international
offices, and we expect international sales to continue to be an important component of our
revenues. Risks affecting our international operations include:
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challenges caused by distance, language and cultural differences;
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multiple and conflicting laws and regulations, including complications due to unexpected
changes in these laws and regulations;
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the burdens of complying with a wide variety of foreign laws and regulations;
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higher costs associated with doing business internationally;
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difficulties in staffing and managing international operations;
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greater fluctuations in sales to end users and through carriers in developing countries,
including longer payment cycles and greater difficulty collecting accounts receivable;
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protectionist laws and business practices that favor local businesses in some countries;
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foreign tax consequences;
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foreign exchange controls that might prevent us from repatriating income earned in
countries outside the United States;
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price controls;
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the servicing of regions by many different carriers;
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imposition of public sector controls;
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political, economic and social instability;
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restrictions on the export or import of technology;
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trade and tariff restrictions;
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variations in tariffs, quotas, taxes and other market barriers; and
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difficulties in enforcing intellectual property rights in countries other than the United
States.
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In addition, developing user interfaces that are compatible with other languages or cultures
can be expensive. As a result, our ongoing international expansion efforts may be more costly than
we expect. Further, expansion into developing countries subjects us
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to the effects of regional instability, civil unrest and hostilities, and could adversely
affect us by disrupting communications and making travel more difficult.
These risks could harm our international expansion efforts, which, in turn, could materially
and adversely affect our business, operating results and financial condition.
If we fail to deliver our games at the same time as new mobile handset models are commercially
introduced, our sales may suffer.
Our business is dependent, in part, on the commercial introduction of new handset models with
enhanced features, including larger, higher resolution color screens, improved audio quality, and
greater processing power, memory, battery life and storage. We do not control the timing of these
handset launches. Some new handsets are sold by carriers with one or more games or other
applications pre-loaded, and many end users who download our games do so after they purchase their
new handsets to experience the new features of those handsets. Some handset manufacturers give us
access to their handsets prior to commercial release. If one or more major handset manufacturers
were to cease to provide us access to new handset models prior to commercial release, we might be
unable to introduce compatible versions of our games for those handsets in coordination with their
commercial release, and we might not be able to make compatible versions for a substantial period
following their commercial release. If, because of game launch delays, we miss the opportunity to
sell games when new handsets are shipped or our end users upgrade to a new handset, or if we miss
the key holiday selling period, either because the introduction of a new handset is delayed or we
do not deploy our games in time for the holiday selling season, our revenues would likely decline
and our business, operating results and financial condition would likely suffer.
Wireless carriers generally control the price charged for our mobile games and the billing and
collection for sales of our mobile games and could make decisions detrimental to us.
Wireless carriers generally control the price charged for our mobile games either by approving
or establishing the price of the games charged to their subscribers. Some of our carrier agreements
also restrict our ability to change prices. In cases where carrier approval is required, approvals
may not be granted in a timely manner or at all. A failure or delay in obtaining these approvals,
the prices established by the carriers for our games, or changes in these prices could adversely
affect market acceptance of those games. Similarly, for the significant minority of our carriers,
including Verizon Wireless, when we make changes to a pricing plan (the wholesale price and the
corresponding suggested retail price based on our negotiated revenue-sharing arrangement),
adjustments to the actual retail price charged to end users may not be made in a timely manner or
at all (even though our wholesale price was reduced). A failure or delay by these carriers in
adjusting the retail price for our games, could adversely affect sales volume and our revenues for
those games.
Carriers and other distributors also control billings and collections for our games, either
directly or through third-party service providers. If our carriers or their third-party service
providers cause material inaccuracies when providing billing and collection services to us, our
revenues may be less than anticipated or may be subject to refund at the discretion of the carrier.
This could harm our business, operating results and financial condition.
We may be unable to develop and introduce in a timely way new mobile games, and our games may have
defects, which could harm our brand.
The planned timing and introduction of new original mobile games and games based on licensed
intellectual property are subject to risks and uncertainties. Unexpected technical, operational,
deployment, distribution or other problems could delay or prevent the introduction of new games,
which could result in a loss of, or delay in, revenues or damage to our reputation and brand. If
any of our games is introduced with defects, errors or failures, we could experience decreased
sales, loss of end users, damage to our carrier relationships and damage to our reputation and
brand. Our attractiveness to branded content licensors might also be reduced. In addition, new
games may not achieve sufficient market acceptance to offset the costs of development, particularly
when the introduction of a game is substantially later than a planned day-and-date launch, which
could materially harm our business, operating results and financial condition.
If we fail to maintain and enhance our capabilities for porting games to a broad array of mobile
handsets, our attractiveness to wireless carriers and branded content owners will be impaired, and
our sales could suffer.
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Once developed, a mobile game may be required to be ported to, or converted into separate
versions for, more than 1,000 different handset models, many with different technological
requirements. These include handsets with various combinations of underlying technologies, user
interfaces, keypad layouts, screen resolutions, sound capabilities and other carrier-specific
customizations. If we fail to maintain or enhance our porting capabilities, our sales could suffer,
branded content owners might choose not to grant us licenses and carriers might choose to give our
games less desirable deck placement or not to give our games placement on their decks at all.
Changes to our game design and development processes to address new features or functions of
handsets or networks might cause inefficiencies in our porting process or might result in more
labor intensive porting processes. In addition, we anticipate that in the future we will be
required to port existing and new games to a broader array of handsets. If we utilize more labor
intensive porting processes, our margins could be significantly reduced and it might take us longer
to port games to an equivalent number of handsets. This, in turn, could harm our business,
operating results and financial condition.
If our independent, third-party developers cease development of new games for us and we are unable
to find comparable replacements, we may have to reduce the number of games that we intend to
introduce, delay the introduction of some games or increase our internal development staff, which
would be a time-consuming and potentially costly process, and, as a result, our competitive
position may be adversely impacted.
We rely on independent third-party developers to develop a few of our games, which subjects us
to the following risks:
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key developers who worked for us in the past may choose to work for or be acquired by our
competitors;
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developers currently under contract may try to renegotiate our agreements with them on
terms less favorable to us; and
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our developers may be unable or unwilling to allocate sufficient resources to complete
our games in a timely or satisfactory manner or at all.
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If our developers terminate their relationships with us or negotiate agreements with terms
less favorable to us, we may have to reduce the number of games that we intend to introduce, delay
the introduction of some games or increase our internal development staff, which would be a
time-consuming and potentially costly process, and, as a result, our business, operating results
and financial condition could be harmed.
If one or more of our games were found to contain hidden, objectionable content, our reputation and
operating results could suffer.
Historically, many video games have been designed to include hidden content and gameplay
features that are accessible through the use of in-game cheat codes or other technological means
that are intended to enhance the gameplay experience. For example,
Super K.O. Boxing
includes
additional characters and game modes that are available with a code (usually provided to a player
after accomplishing a certain level of achievement in the game). These features have been common in
console and computer games. However, in several recent cases, hidden content or features have been
included in other publishers products by an employee who was not authorized to do so or by an
outside developer without the knowledge of the publisher. From time to time, some of this hidden
content and these hidden features have contained profanity, graphic violence and sexually explicit
or otherwise objectionable material. Our design and porting process and the constraints on the file
size of our games reduce the possibility of hidden, objectionable content appearing in the games we
publish. Nonetheless, these processes and constraints may not prevent this content from being
included in our games. If a game we published were found to contain hidden, objectionable content,
our wireless carriers and other distributors of our games could refuse to sell it, consumers could
refuse to buy it or demand a refund of their money, and, if the game was based on licensed content,
the licensor could demand that we incur significant expense to remove the objectionable content
from the game and all ported versions of the game. This could have a materially negative impact on
our business, operating results and financial condition. In addition, our reputation could be
harmed, which could impact sales of other games we sell and our attractiveness to content licensors
and carriers or other distributors of our games. If any of these consequences were to occur, our
business, operating results and financial condition could be significantly harmed.
If we fail to maintain an effective system of internal controls, we might not be able to report our
financial results accurately or prevent fraud; in that case, our stockholders could lose confidence
in our financial reporting, which could negatively impact the price of our stock.
51
Effective internal controls are necessary for us to provide reliable financial reports and
prevent fraud. In addition, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to
evaluate and report on our internal control over financial reporting and have our independent
registered public accounting firm attest to our evaluation beginning with our Annual Report on Form
10-K for the year ending December 31, 2008. We are in the process of preparing and implementing an
internal plan of action for compliance with Section 404 and strengthening and testing our system of
internal controls to provide the basis for our report. The process of implementing our internal
controls and complying with Section 404 will be expensive and time consuming, and will require
significant attention of management. We cannot be certain that these measures will ensure that we
implement and maintain adequate controls over our financial processes and reporting in the future.
Even if we conclude, and our independent registered public accounting firm concurs, that our
internal control over financial reporting provides reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles, because of its inherent limitations,
internal control over financial reporting may not prevent or detect fraud or misstatements. Failure
to implement required new or improved controls, or difficulties encountered in their
implementation, could harm our operating results or cause us to fail to meet our reporting
obligations. If we or our independent registered public accounting firm discover a material
weakness or a significant deficiency in our internal control, the disclosure of that fact, even if
quickly remedied, could reduce the markets confidence in our financial statements and harm our
stock price. For example, our auditors have identified a significant deficiency in that we did not
have sufficient personnel within our accounting function in the United Kingdom. While we believe we
have adequately remediated the deficiency, our remediation may prove inadequate and there can be no
assurance that additional deficiencies will not be identified. In addition, a delay in compliance
with Section 404 could subject us to a variety of administrative sanctions, including ineligibility
for short form resale registration, action by the Securities and Exchange Commission, or SEC, the
suspension or delisting of our common stock from The NASDAQ Global Market and the inability of
registered broker-dealers to make a market in our common stock, which would further reduce our
stock price and could harm our business.
If we do not adequately protect our intellectual property rights, it may be possible for third
parties to obtain and improperly use our intellectual property and our competitive position may be
adversely affected.
Our intellectual property is an essential element of our business. We rely on a combination of
copyright, trademark, trade secret and other intellectual property laws and restrictions on
disclosure to protect our intellectual property rights. To date, we have not sought patent
protection. Consequently, we will not be able to protect our technologies from independent
invention by third parties. Despite our efforts to protect our intellectual property rights,
unauthorized parties may attempt to copy or otherwise to obtain and use our technology and games.
Monitoring unauthorized use of our games is difficult and costly, and we cannot be certain that the
steps we have taken will prevent piracy and other unauthorized distribution and use of our
technology and games, particularly internationally where the laws may not protect our intellectual
property rights as fully as in the United States. In the future, we may have to resort to
litigation to enforce our intellectual property rights, which could result in substantial costs and
diversion of our management and resources.
In addition, although we require our third-party developers to sign agreements not to disclose
or improperly use our trade secrets and acknowledging that all inventions, trade secrets, works of
authorship, developments and other processes generated by them on our behalf are our property and
to assign to us any ownership they may have in those works, it may still be possible for third
parties to obtain and improperly use our intellectual properties without our consent. This could
harm our business, operating results and financial condition.
Third parties may sue us for intellectual property infringement, which, if successful, may disrupt
our business and could require us to pay significant damage awards.
Third parties may sue us for intellectual property infringement or initiate proceedings to
invalidate our intellectual property, either of which, if successful, could disrupt the conduct of
our business, cause us to pay significant damage awards or require us to pay licensing fees. In the
event of a successful claim against us, we might be enjoined from using our or our licensed
intellectual property, we might incur significant licensing fees and we might be forced to develop
alternative technologies. Our failure or inability to develop non-infringing technology or games or
to license the infringed or similar technology or games on a timely basis could force us to
withdraw games from the market or prevent us from introducing new games. In addition, even if we
are able to license the infringed or similar technology or games, license fees could be substantial
and the terms of these licenses could be burdensome, which might adversely affect our operating
results. We might also incur substantial expenses in defending against third-party infringement
claims,
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regardless of their merit. Successful infringement or licensing claims against us might result
in substantial monetary liabilities and might materially disrupt the conduct of our business.
Indemnity provisions in various agreements potentially expose us to substantial liability for
intellectual property infringement, damages caused by malicious software and other losses.
In the ordinary course of our business, most of our agreements with carriers and other
distributors include indemnification provisions. In these provisions, we agree to indemnify them
for losses suffered or incurred in connection with our games, including as a result of intellectual
property infringement and damages caused by viruses, worms and other malicious software. The term
of these indemnity provisions is generally perpetual after execution of the corresponding license
agreement, and the maximum potential amount of future payments we could be required to make under
these indemnification provisions is generally unlimited. Large future indemnity payments could harm
our business, operating results and financial condition.
As a result of a majority of our revenues currently being derived from four wireless carriers, if
any one of these carriers were unable to fulfill its payment obligations, our financial condition
and results of operations would suffer.
As of December 31, 2006, our outstanding accounts receivable balances with Verizon Wireless,
Sprint Nextel, Vodafone and Cingular Wireless were $3.0 million, $1.5 million, $1.4 million and
$1.2 million, respectively. As of December 31, 2005, our outstanding accounts receivable balances
with those carriers were $1.7 million, $693,000, $277,000 and $538,000, respectively. Since 49.3%
of our outstanding accounts receivable at December 31, 2006 were with Verizon Wireless, Sprint
Nextel, Cingular Wireless and Vodafone, we have a concentration of credit risk. If any of these
carriers is unable to fulfill its payment obligations to us under our carrier agreements with them,
our revenues could decline significantly and our financial condition might be harmed.
We may need to raise additional capital to grow our business, and we may not be able to raise
capital on terms acceptable to us or at all.
The operation of our business and our efforts to grow our business further will require
significant cash outlays and commitments. If our cash, cash equivalents and short-term investments
balances and any cash generated from operations and from our IPO are not sufficient to meet our
cash requirements, we will need to seek additional capital, potentially through debt or equity
financings, to fund our growth. We may not be able to raise needed cash on terms acceptable to us
or at all. Financings, if available, may be on terms that are dilutive or potentially dilutive to
our stockholders, and the prices at which new investors would be willing to purchase our securities
may be lower than the IPO price. The holders of new securities may also receive rights, preferences
or privileges that are senior to those of existing holders of our common stock. If new sources of
financing are required but are insufficient or unavailable, we would be required to modify our
growth and operating plans to the extent of available funding, which would harm our ability to grow
our business.
We face risks associated with currency exchange rate fluctuations.
Although we currently transact approximately three-fifths of our business in U.S. Dollars, we
also transact approximately one-third of our business in pounds sterling and Euros and a small
portion of our business in other currencies. Conducting business in currencies other than U.S.
Dollars subjects us to fluctuations in currency exchange rates that could have a negative impact on
our reported operating results. Fluctuations in the value of the U.S. Dollar relative to other
currencies impact our revenues, cost of revenues and operating margins and result in foreign
currency transaction gains and losses. To date, we have not engaged in exchange rate hedging
activities. Even were we to implement hedging strategies to mitigate this risk, these strategies
might not eliminate our exposure to foreign exchange rate fluctuations and would involve costs and
risks of their own, such as ongoing management time and expertise, external costs to implement the
strategies and potential accounting implications.
Our business in countries with a history of corruption and transactions with foreign governments,
including with government owned or controlled wireless carriers, increase the risks associated with
our international activities.
As we operate and sell internationally, we are subject to the U.S. Foreign Corrupt Practices
Act, or the FCPA, and other laws that prohibit improper payments or offers of payments to foreign
governments and their officials and political parties by the United States and other business
entities for the purpose of obtaining or retaining business. We have operations, deal with carriers
and make sales in countries known to experience corruption, particularly certain emerging countries
in East Asia, Eastern Europe and Latin America,
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and further international expansion may involve more of these countries. Our activities in
these countries create the risk of unauthorized payments or offers of payments by one of our
employees, consultants, sales agents or distributors that could be in violation of various laws
including the FCPA, even though these parties are not always subject to our control. We have
attempted to implement safeguards to discourage these practices by our employees, consultants,
sales agents and distributors. However, our existing safeguards and any future improvements may
prove to be less than effective, and our employees, consultants, sales agents or distributors may
engage in conduct for which we might be held responsible. Violations of the FCPA may result in
severe criminal or civil sanctions, and we may be subject to other liabilities, which could
negatively affect our business, operating results and financial condition.
Changes to financial accounting standards and new exchange rules could make it more expensive to
issue stock options to employees, which would increase compensation costs and might cause us to
change our business practices.
We prepare our financial statements to conform with accounting principles generally accepted
in the United States. These accounting principles are subject to interpretation by the Financial
Accounting Standards Board, or FASB, the SEC, and various other bodies. A change in those
principles could have a significant effect on our reported results and might affect our reporting
of transactions completed before a change is announced. For example, we have used stock options as
a fundamental component of our employee compensation packages. We believe that stock options
directly motivate our employees to maximize long-term stockholder value and, through the use of
vesting, encourage employees to remain in our employ. Several regulatory agencies and entities have
made regulatory changes that could make it more difficult or expensive for us to grant stock
options to employees. For example, the FASB released Statement of Financial Accounting Standards,
or SFAS, No. 123R,
Share-Based Payment
, that required us to record a charge to earnings for
employee stock option grants beginning in 2006. In addition, regulations implemented by the NASDAQ
Stock Market generally require stockholder approval for all stock option plans, which could make it
more difficult for us to grant stock options to employees. We may, as a result of these changes,
incur increased compensation costs, change our equity compensation strategy or find it difficult to
attract, retain and motivate employees, any of which could materially and adversely affect our
business, operating results and financial condition.
Maintaining and improving our financial controls and the requirements of being a public company may
strain our resources, divert managements attention and affect our ability to attract and retain
qualified members for our board of directors.
As a public company, we will be subject to the reporting requirements of the Securities
Exchange Act of 1934, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and
regulations of the NASDAQ Stock Market. The requirements of these rules and regulations will
increase our legal, accounting and financial compliance costs, will make some activities more
difficult, time-consuming and costly and may also place undue strain on our personnel, systems and
resources.
The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure
controls and procedures and internal control over financial reporting. This can be difficult to do.
For example, we depend on the reports of wireless carriers for information regarding the amount of
sales of our games and related applications and to determine the amount of royalties we owe branded
content licensors and the amount of our revenues. These reports may not be timely, and in the past
they have contained, and in the future they may contain, errors.
In order to maintain and improve the effectiveness of our disclosure controls and procedures
and internal control over financial reporting, we will need to expend significant resources and
provide significant management oversight. We have a substantial effort ahead of us to implement
appropriate processes, document our system of internal control over relevant processes, assess
their design, remediate any deficiencies identified and test their operation. As a result,
managements attention may be diverted from other business concerns, which could harm our business,
operating results and financial condition. These efforts will also involve substantial
accounting-related costs. In addition, if we are unable to continue to meet these requirements, we
may not be able to remain listed on The NASDAQ Global Market.
The Sarbanes-Oxley Act and the rules and regulations of the NASDAQ Stock Market will make it
more difficult and more expensive for us to maintain directors and officers liability insurance,
and we may be required to accept reduced coverage or incur substantially higher costs to maintain
coverage. If we are unable to maintain adequate directors and officers insurance, our ability to
recruit and retain qualified directors, especially those directors who may be considered
independent for purposes of the NASDAQ Stock Market rules, and officers will be significantly
curtailed.
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Risks Relating to Our Industry
Wireless communications technologies are changing rapidly, and we may not be successful in working
with these new technologies.
Wireless network and mobile handset technologies are undergoing rapid innovation. New handsets
with more advanced processors and supporting advanced programming languages continue to be
introduced. In addition, networks that enable enhanced features, such as multiplayer technology,
are being developed and deployed. We have no control over the demand for, or success of, these
products or technologies. The development of new, technologically advanced games to match the
advancements in handset technology is a complex process requiring significant research and
development expense, as well as the accurate anticipation of technological and market trends. If we
fail to anticipate and adapt to these and other technological changes, the available channels for
our games may be limited and our market share and our operating results may suffer. Our future
success will depend on our ability to adapt to rapidly changing technologies, develop mobile games
to accommodate evolving industry standards and improve the performance and reliability of our
games. In addition, the widespread adoption of networking or telecommunications technologies or
other technological changes could require substantial expenditures to modify or adapt our games.
Technology changes in our industry require us to anticipate, sometimes years in advance, which
technologies we must implement and take advantage of in order to make our games and other mobile
entertainment products competitive in the market. Therefore, we usually start our product
development with a range of technical development goals that we hope to be able to achieve. We may
not be able to achieve these goals, or our competition may be able to achieve them more quickly and
effectively than we can. In either case, our products may be technologically inferior to those of
our competitors, less appealing to end users or both. If we cannot achieve our technology goals
within the original development schedule of our products, then we may delay their release until
these technology goals can be achieved, which may delay or reduce our revenues, increase our
development expenses and harm our reputation. Alternatively, we may increase the resources employed
in research and development in an attempt either to preserve our product launch schedule or to keep
up with our competition, which would increase our development expenses. In either case, our
business, operating results and financial condition could be materially harmed.
The complexity of and incompatibilities among mobile handsets may require us to use additional
resources for the development of our games.
To reach large numbers of wireless subscribers, mobile entertainment publishers like us must
support numerous mobile handsets and technologies. However, keeping pace with the rapid innovation
of handset technologies together with the continuous introduction of new, and often incompatible,
handset models by wireless carriers requires us to make significant investments in research and
development, including personnel, technologies and equipment. In the future, we may be required to
make substantial investments in our development if the number of different types of handset models
continues to proliferate. In addition, as more advanced handsets are introduced that enable more
complex, feature rich games, we anticipate that our per-game development costs will increase, which
could increase the risks associated with the failure of any one game and could materially harm our
operating results and financial condition.
If wireless subscribers do not continue to use their mobile handsets to access games and other
applications, our business growth and future revenues may be adversely affected.
We operate in a developing industry. Our success depends on growth in the number of wireless
subscribers who use their handsets to access data services and, in particular, entertainment
applications of the type we develop and distribute. New or different mobile entertainment
applications, such as streaming video or music applications, developed by our current or future
competitors may be preferred by subscribers to our games. In addition, other mobile platforms such
as the iPod and dedicated portable gaming platforms such as the PlayStation Portable and the
Nintendo DS may become widespread, and end users may choose to switch to these platforms. If the
market for our games does not continue to grow or we are unable to acquire new end users, our
business growth and future revenues could be adversely affected. If end users switch their
entertainment spending away from the games and related applications that we publish, or switch to
portable gaming platforms or distribution where we do not have comparative strengths, our revenues
would likely decline and our business, operating results and financial condition would suffer.
Our industry is subject to risks generally associated with the entertainment industry, any of which
could significantly harm our operating results.
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Our business is subject to risks that are generally associated with the entertainment
industry, many of which are beyond our control. These risks could negatively impact our operating
results and include: the popularity, price and timing of release of games and mobile handsets on
which they are played; economic conditions that adversely affect discretionary consumer spending;
changes in consumer demographics; the availability and popularity of other forms of entertainment;
and critical reviews and public tastes and preferences, which may change rapidly and cannot
necessarily be predicted.
A shift of technology platform by wireless carriers and mobile handset manufacturers could lengthen
the development period for our games, increase our costs and cause our games to be of lower quality
or to be published later than anticipated.
End users of games must have a mobile handset with multimedia capabilities enabled by
technologies capable of running third-party games and related applications such as ours. Our
development resources are concentrated in the BREW and Java platforms, and we have experience
developing games for the i-mode, Mophun, Symbian and Windows Mobile Platforms. If one or more of
these technologies fall out of favor with handset manufacturers and wireless carriers and there is
a rapid shift to a technology platform such as Adobe Flash Lite or a new technology where we do not
have development experience or resources, the development period for our games may be lengthened,
increasing our costs, and the resulting games may be of lower quality, and may be published later
than anticipated. In such an event, our reputation, business, operating results and financial
condition might suffer.
System or network failures could reduce our sales, increase costs or result in a loss of end users
of our games.
Mobile game publishers rely on wireless carriers networks to deliver games to end users and
on their or other third parties billing systems to track and account for the downloading of their
games. In certain circumstances, mobile game publishers may also rely on their own servers to
deliver games on demand to end users through their carriers networks. In addition, certain
subscription-based games such as
World Series of Poker
and entertainment products such as
FOX
Sports Mobile
require access over the mobile Internet to our servers in order to enable features
such as multiplayer modes, high score posting or access to information updates. Any failure of, or
technical problem with, carriers, third parties or our billing systems, delivery systems,
information systems or communications networks could result in the inability of end users to
download our games, prevent the completion of billing for a game, or interfere with access to some
aspects of our games or other products. If any of these systems fails or if there is an
interruption in the supply of power, an earthquake, fire, flood or other natural disaster, or an
act of war or terrorism, end users might be unable to access our games. For example, from time to
time, our carriers have experienced failures with their billing and delivery systems and
communication networks, including gateway failures that reduced the provisioning capacity of their
branded e-commerce system. Any failure of, or technical problem with, the carriers, other third
parties or our systems could cause us to lose end users or revenues or incur substantial repair
costs and distract management from operating our business. This, in turn, could harm our business,
operating results and financial condition.
The market for mobile games is seasonal, and our results may vary significantly from period to
period.
Many new mobile handset models are released in the fourth calendar quarter to coincide with
the holiday shopping season. Because many end users download our games soon after they purchase new
handsets, we may experience seasonal sales increases based on the holiday selling period. However,
due to the time between handset purchases and game purchases, most of this holiday impact occurs
for us in our first quarter. In addition, we seek to release many of our games in conjunction with
specific events, such as the release of a related movie. If we miss these key selling periods for
any reason, our sales will suffer disproportionately. Likewise, if a key event to which our game
release schedule is tied were to be delayed or cancelled, our sales would also suffer
disproportionately. Further, for a variety of reasons, including roaming charges for data downloads
that may make purchase of our games prohibitively expensive for many end users while they are
traveling, we may experience seasonal sales decreases during the summer, particularly in Europe. If
the level of travel increases or expands to other periods, our operating results and financial
condition may be harmed. Our ability to meet game development schedules is affected by a number of
factors, including the creative processes involved, the coordination of large and sometimes
geographically dispersed development teams required by the increasing complexity of our games, and
the need to fine-tune our games prior to their release. Any failure to meet anticipated development
or release schedules would likely result in a delay of revenues or possibly a significant shortfall
in our revenues and cause our operating results to be materially different than anticipated.
Our business depends on the growth and maintenance of wireless communications infrastructure.
Our success will depend on the continued growth and maintenance of wireless communications
infrastructure in the United States and internationally. This includes deployment and maintenance
of reliable next-generation digital networks with the speed, data
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capacity and security necessary to provide reliable wireless communications services. Wireless
communications infrastructure may be unable to support the demands placed on it if the number of
subscribers continues to increase, or if existing or future subscribers increase their bandwidth
requirements. Wireless communications have experienced a variety of outages and other delays as a
result of infrastructure and equipment failures, and could face outages and delays in the future.
These outages and delays could reduce the level of wireless communications usage as well as our
ability to distribute our games successfully. In addition, changes by a wireless carrier to network
infrastructure may interfere with downloads of our games and may cause end users to lose
functionality in our games that they have already downloaded. This could harm our business,
operating results and financial condition.
Future mobile handsets may significantly reduce or eliminate wireless carriers control over
delivery of our games and force us to rely further on alternative sales channels, which, if not
successful, could require us to increase our sales and marketing expenses significantly.
Substantially all our games are currently sold through carriers branded e-commerce services.
We have invested significant resources developing this sales channel. However, a growing number of
handset models currently available allow wireless subscribers to browse the Internet and, in some
cases, download applications from sources other than a carriers branded e-commerce service. In
addition, the development of other application delivery mechanisms such as premium-SMS may enable
subscribers to download applications without having to access a carriers branded e-commerce
service. Increased use by subscribers of open operating system handsets or premium-SMS delivery
systems will enable them to bypass carriers branded e-commerce services and could reduce the
market power of carriers. This could force us to rely further on alternative sales channels where
we may not be successful selling our games, and could require us to increase our sales and
marketing expenses significantly. As with our carriers, we believe that inferior placement of our
games and other mobile entertainment products in the menus of off-deck distributors will result in
lower revenues than might otherwise be anticipated from these alternative sales channels. We may be
unable to develop and promote our direct website distribution sufficiently to overcome the
limitations and disadvantages of off-deck distribution channels. This could harm our business,
operating results and financial condition.
Actual or perceived security vulnerabilities in mobile handsets or wireless networks could
adversely affect our revenues.
Maintaining the security of mobile handsets and wireless networks is critical for our
business. There are individuals and groups who develop and deploy viruses, worms and other illicit
code or malicious software programs that may attack wireless networks and handsets. Security
experts have identified computer worm programs, such as Cabir and Commwarrior.A, and viruses,
such as Lasco.A, that target handsets running on the Symbian operating system. Although these
worms have not been widely released and do not present an immediate risk to our business, we
believe future threats could lead some end users to seek to return our games, reduce or delay
future purchases of our games or reduce or delay the use of their handsets. Wireless carriers and
handset manufacturers may also increase their expenditures on protecting their wireless networks
and mobile phone products from attack, which could delay adoption of new handset models. Any of
these activities could adversely affect our revenues and this could harm our business, operating
results and financial condition.
If a substantial number of the end users that purchase our games by subscription change mobile
handsets or if wireless carriers switch to subscription plans that require active monthly renewal
by subscribers, our sales could suffer.
Subscriptions represent a significant portion of our revenues. As handset development
continues, over time an increasing percentage of end users who already own one or more of our
subscription games will likely upgrade from their existing handsets. With some wireless carriers,
it is not currently feasible for these end users to transfer their existing subscriptions from one
handset to another. In addition, carriers may switch to subscription billing systems that require
end users to actively renew, or opt-in, each month from current systems that passively renew unless
end users take some action to opt-out of their subscriptions. In either case, unless we are able to
re-sell subscriptions to these end users or replace these end users with other end users, our sales
would suffer and this could harm our business, operating results and financial condition.
Changes in government regulation of the media and wireless communications industries may adversely
affect our business.
It is possible that a number of laws and regulations may be adopted in the United States and
elsewhere that could restrict the media and wireless communications industries, including laws and
regulations regarding customer privacy, taxation, content suitability, copyright, distribution and
antitrust. Furthermore, the growth and development of the market for electronic commerce may prompt
calls for more stringent consumer protection laws that may impose additional burdens on companies
such as ours conducting business
57
through wireless carriers. We anticipate that regulation of our industry will increase and
that we will be required to devote legal and other resources to address this regulation. Changes in
current laws or regulations or the imposition of new laws and regulations in the United States or
elsewhere regarding the media and wireless communications industries may lessen the growth of
wireless communications services and may materially reduce our ability to increase or maintain
sales of our games.
A number of studies have examined the health effects of mobile phone use, and the results of
some of the studies have been interpreted as evidence that mobile phone use causes adverse health
effects. The establishment of a link between the use of mobile phone services and health problems,
or any media reports suggesting such a link, could increase government regulation of, and reduce
demand for, mobile phones and, accordingly, the demand for our games and related applications, and
this could harm our business, operating results and financial condition.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Equity Securities
During the three months ended September 30, 2007, a holder of warrants elected to net exercise
warrants to purchase 52 shares of common stock which were converted to 41 shares of common stock.
The issuance of these shares upon exercise of the warrants was deemed to be exempt from
registration under Section4(2) of the Securities Act and Rule 506 promulgated thereunder, as a
transaction by an issuer not involving a public offering transaction.
Use of Proceeds from Public Offering of Common Stock
The Form S-1 Registration Statement (Registration No. 333-139493) relating to our IPO was
declared effective by the SEC on March 21, 2007, and the offering commenced the following day.
Goldman Sachs & Co. acted as the sole book-running manager for the offering, and Lehman Brothers
Inc., Bank of America Securities LLC and Needham & Company, LLC acted as co-managers of the
offering.
The net proceeds of our IPO were $74.8 million. Through September 30, 2007, we used
approximately $12.0 million of the net proceeds to repay in full the principal and accrued interest
on our outstanding loan from the lender. We expect to use the remaining net proceeds for general
corporate purposes, including working capital and potential capital expenditures and acquisitions.
Although we may also use a portion of the net proceeds for the acquisition of, or investment in,
companies, technologies, products or assets that complement our business, we have no present
understandings, commitments or agreements to enter into any acquisitions or make any investments.
Our management will retain broad discretion in the allocation and use of the net proceeds of
our IPO, and investors will be relying on the judgment of our management regarding the application
of the net proceeds. Pending specific utilization of the net proceeds as described above, we have
invested the net proceeds of the offering in short-term, interest-bearing obligations, investment
grade instruments, certificates of deposit or direct or guaranteed obligations of the United States
government. The goal with respect to the investment of the net proceeds will be capital
preservation and liquidity so that such funds are readily available to fund our operations.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
58
ITEM 6. EXHIBITS
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Incorporated by Reference
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Exhibit
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Filing
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Provided
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Number
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Exhibit Description
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Form
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File No.
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Exhibit
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Date
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Herewith
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10.01
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Sublease dated as of August 22, 2007, between Oracle
USA, Inc., and Glu Mobile Inc.
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8-K
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001-33368
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10.1
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08/28/07
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10.02+
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Publishing and Distribution Agreement dated as of
October 1, 2004, as amended through July 11, 2007, by
and among PopCap Games, Inc., PopCap Games
International Ltd. and Glu Mobile Inc.
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X
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31.01
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Certification of Principal Executive Officer Pursuant
to Securities Exchange Act Rule 13a-14(a).
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X
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31.02
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Certification of Principal Financial Officer Pursuant
to Securities Exchange Act Rule 13a-14(a).
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X
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32.01
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Certification of Principal Executive Officer Pursuant
to 18 U.S.C. Section 1350 and Securities Exchange Act
Rule 13a-14(b).*
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X
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32.02
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Certification of Principal Financial Officer Pursuant
to 18 U.S.C. Section 1350 and Securities Exchange Act
Rule 13a-14(b).*
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X
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+
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The omitted portions of this exhibit have been filed with the Securities and Exchange
Commission pursuant to a request for confidential treatment under Rule 24b-2 of the Securities
Exchange Act of 1934, as amended.
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*
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This certification is not deemed filed for purposes of Section 18 of the Securities
Exchange Act, or otherwise subject to the liability of that section. Such certification will
not be deemed to be incorporated by reference into any filing under the Securities Act of 1933
or the Securities Exchange Act of 1934, except to the extent that Glu Mobile Inc. specifically
incorporates it by reference.
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59
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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GLU MOBILE INC.
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Date: November 14, 2007
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By:
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/s/ L. Gregory Ballard
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L. Gregory Ballard
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President and Chief Executive Officer
(Principal Executive Officer)
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Date: November 14, 2007
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By:
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/s/ Albert A. Pimentel
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Albert A. Pimentel
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Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
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60
EXHIBIT INDEX
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Incorporated by Reference
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Exhibit
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Filing
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Provided
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Number
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Exhibit Description
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Form
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File No.
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Exhibit
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Date
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Herewith
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10.01
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Sublease dated as of August 22, 2007, between Oracle
USA, Inc., and Glu Mobile Inc.
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8-K
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001-33368
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10.1
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08/28/07
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10.02+
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Publishing and Distribution Agreement dated as of
October 1, 2004, as amended through July 11, 2007, by
and among PopCap Games, Inc., PopCap Games
International Ltd. and Glu Mobile Inc.
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X
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31.01
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Certification of Principal Executive Officer Pursuant
to Securities Exchange Act Rule 13a-14(a).
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X
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31.02
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Certification of Principal Financial Officer Pursuant
to Securities Exchange Act Rule 13a-14(a).
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X
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32.01
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Certification of Principal Executive Officer Pursuant
to 18 U.S.C. Section 1350 and Securities Exchange Act
Rule 13a-14(b).*
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X
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32.02
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Certification of Principal Financial Officer Pursuant
to 18 U.S.C. Section 1350 and Securities Exchange Act
Rule 13a-14(b).*
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X
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+
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The omitted portions of this exhibit have been filed with the Securities and Exchange
Commission pursuant to a request for confidential treatment under Rule 24b-2 of the Securities
Exchange Act of 1934, as amended.
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*
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This certification is not deemed filed for purposes of Section 18 of the Securities
Exchange Act, or otherwise subject to the liability of that section. Such certification will
not be deemed to be incorporated by reference into any filing under the Securities Act of 1933
or the Securities Exchange Act of 1934, except to the extent that Glu Mobile specifically
incorporates it by reference.
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