FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended June 30, 2009
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 |
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
(State or Other Jurisdiction of
Incorporation or Organization)
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91-2143667
(I.R.S. Employer
Identification No.) |
2207 Bridgepointe Parkway, Suite 250
San Mateo, California 94404
(Address of Principal Executive Offices, including Zip Code)
(650) 532-2400
(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 has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the Registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o (Do not check if a smaller reporting company)
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Smaller reporting company o
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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, $0.0001 par value per share, outstanding as of July
31, 2009: 29,633,413 shares.
GLU MOBILE INC.
FORM 10-Q
Quarterly Period Ended June 30, 2009
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GLU MOBILE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except per share data)
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June 30, |
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December 31, |
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2009 |
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2008 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
12,811 |
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$ |
19,166 |
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Accounts receivable, net |
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16,910 |
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19,826 |
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Prepaid royalties |
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13,013 |
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15,298 |
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Prepaid expenses and other |
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2,557 |
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2,704 |
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Total current assets |
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45,291 |
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56,994 |
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Property and equipment, net |
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4,014 |
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4,861 |
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Prepaid royalties |
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4,483 |
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4,349 |
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Other long-term assets |
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1,074 |
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930 |
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Intangible assets, net |
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16,014 |
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20,320 |
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Goodwill |
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4,603 |
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4,622 |
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Total assets |
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$ |
75,479 |
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$ |
92,076 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
3,806 |
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$ |
6,569 |
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Accrued liabilities |
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816 |
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686 |
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Accrued compensation |
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2,732 |
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2,184 |
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Accrued royalties |
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14,483 |
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18,193 |
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Accrued restructuring |
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962 |
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1,000 |
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Deferred revenues |
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562 |
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727 |
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Current portion of long-term debt |
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14,975 |
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14,000 |
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Total current liabilities |
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38,336 |
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43,359 |
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Other long-term liabilities |
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10,498 |
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11,798 |
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Long-term debt, less current portion |
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6,125 |
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10,125 |
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Total liabilities |
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54,959 |
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65,282 |
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Commitments and contingencies (Note 6) |
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Stockholders equity: |
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Preferred stock, $0.0001 par value; 5,000 shares authorized at June 30, 2009 and December 31, 2008;
no shares issued and outstanding at June 30, 2009 and December 31, 2008 |
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Common stock, $0.0001 par value: 250,000 shares authorized at June 30, 2009 and December 31, 2008;
29,633 and 29,584 shares issued and outstanding at June 30, 2009 and December 31, 2008, respectively |
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3 |
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3 |
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Additional paid-in capital |
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186,296 |
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184,757 |
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Deferred stock-based compensation |
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(11 |
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Accumulated other comprehensive income |
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641 |
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1,170 |
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Accumulated deficit |
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(166,420 |
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(159,125 |
) |
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Total stockholders equity |
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20,520 |
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26,794 |
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Total liabilities and stockholders equity |
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$ |
75,479 |
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$ |
92,076 |
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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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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2009 |
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2008 |
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2009 |
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2008 |
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Revenues |
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$ |
19,872 |
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$ |
23,704 |
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$ |
40,647 |
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$ |
44,296 |
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Cost of revenues: |
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Royalties |
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5,667 |
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5,633 |
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11,480 |
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11,123 |
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Impairment of prepaid royalties and guarantees |
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589 |
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589 |
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Amortization of intangible assets |
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1,412 |
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3,135 |
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4,260 |
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4,842 |
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Total cost of revenues |
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7,668 |
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8,768 |
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16,329 |
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15,965 |
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Gross profit |
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12,204 |
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14,936 |
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24,318 |
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28,331 |
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Operating expenses: |
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Research and development |
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6,648 |
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8,861 |
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13,045 |
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15,381 |
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Sales and marketing |
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3,546 |
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6,042 |
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7,658 |
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11,824 |
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General and administrative |
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3,905 |
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6,096 |
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8,390 |
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11,491 |
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Amortization of intangible assets |
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51 |
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69 |
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102 |
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137 |
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Restructuring charge |
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513 |
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86 |
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513 |
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161 |
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Acquired in-process research and development |
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71 |
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1,110 |
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Total operating expenses |
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14,663 |
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21,225 |
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29,708 |
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40,104 |
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Loss from operations |
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(2,459 |
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(6,289 |
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(5,390 |
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(11,773 |
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Interest and other income/(expense), net: |
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Interest income |
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61 |
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189 |
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79 |
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717 |
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Interest expense |
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(365 |
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(11 |
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(729 |
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(21 |
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Other income/(expense), net |
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761 |
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(277 |
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300 |
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(183 |
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Interest and other income/(expense), net |
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457 |
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(99 |
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(350 |
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513 |
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Loss before income taxes |
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(2,002 |
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(6,388 |
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(5,740 |
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(11,260 |
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Income tax benefit/(provision) |
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464 |
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(213 |
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(1,555 |
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(1,343 |
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Net loss |
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$ |
(1,538 |
) |
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$ |
(6,601 |
) |
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$ |
(7,295 |
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$ |
(12,603 |
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Net loss per share basic and diluted: |
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$ |
(0.05 |
) |
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$ |
(0.23 |
) |
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$ |
(0.25 |
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$ |
(0.43 |
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Weighted average common shares outstanding basic and diluted |
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29,621 |
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29,317 |
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29,608 |
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29,231 |
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Stock-based compensation expense included in: |
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Research and development |
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$ |
200 |
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$ |
174 |
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$ |
380 |
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$ |
250 |
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Sales and marketing |
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159 |
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1,303 |
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310 |
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2,605 |
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General and administrative |
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405 |
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554 |
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838 |
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1,148 |
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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)
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Six Months Ended June 30, |
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2009 |
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2008 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(7,295 |
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$ |
(12,603 |
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Adjustments to reconcile net loss to net cash provided by/(used in) operating
activities: |
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Depreciation and accretion |
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1,178 |
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1,361 |
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Amortization of intangible assets |
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4,360 |
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5,050 |
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Stock-based compensation |
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1,528 |
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4,003 |
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MIG earnout expense |
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875 |
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Interest expense on debt |
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606 |
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Amortization of loan agreement costs |
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75 |
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20 |
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Non-cash foreign currency remeasurement gain |
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(317 |
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(384 |
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Acquired in-process research and development |
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1,110 |
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Impairment of prepaid royalties and guarantees |
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234 |
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Write down of auction-rate securities |
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470 |
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Changes in allowance for doubtful accounts |
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17 |
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86 |
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Changes in operating assets and liabilities, net of effect of acquisitions: |
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Accounts receivable |
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2,904 |
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1,342 |
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Prepaid royalties |
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2,390 |
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(1,926 |
) |
Prepaid expenses and other assets |
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84 |
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(463 |
) |
Accounts payable |
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(2,846 |
) |
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(543 |
) |
Other accrued liabilities |
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47 |
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|
834 |
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Accrued compensation |
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492 |
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1,171 |
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Accrued royalties |
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(3,886 |
) |
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57 |
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Deferred revenues |
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(213 |
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183 |
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Accrued restructuring charge |
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(75 |
) |
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(1,568 |
) |
Other long-term liabilities |
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(1,358 |
) |
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1,665 |
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Net cash provided by/(used in) operating activities |
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(1,434 |
) |
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99 |
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Cash flows from investing activities: |
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Purchase of property and equipment |
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(375 |
) |
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(3,357 |
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Acquisition of Superscape, net of cash acquired |
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(30,008 |
) |
Acquisition of MIG, net of cash acquired |
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(693 |
) |
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Net cash used in investing activities |
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(375 |
) |
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(34,058 |
) |
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Cash flows from financing activities: |
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Proceeds from line of credit |
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31,025 |
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Payments on line of credit |
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(26,514 |
) |
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MIG loan payments |
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(9,000 |
) |
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Proceeds from exercise of stock options |
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20 |
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158 |
|
Proceeds from exercise of stock warrants |
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101 |
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Net cash provided by/(used in) financing activities |
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(4,469 |
) |
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|
259 |
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Effect of exchange rate changes on cash |
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(77 |
) |
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17 |
|
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Net decrease in cash and cash equivalents |
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|
(6,355 |
) |
|
|
(33,683 |
) |
Cash and cash equivalents at beginning of period |
|
|
19,166 |
|
|
|
57,816 |
|
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Cash and cash equivalents at end of period |
|
$ |
12,811 |
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|
$ |
24,133 |
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Supplemental disclosure of non-cash activities |
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Accrued acquisition costs |
|
$ |
|
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|
$ |
340 |
|
Accrued interest on MIG loan payments |
|
$ |
552 |
|
|
$ |
|
|
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 in Nevada in May 2001 and
reincorporated in the state of Delaware in March 2007. The Company creates mobile games and related
applications based on third-party licensed brands and other intellectual property, as well as its
own original intellectual property.
Basis of Presentation
The accompanying unaudited 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
Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 13, 2009. In
the opinion of management, the accompanying unaudited 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 June 30, 2009
and its results of operations for the three months and six months ended June 30, 2009 and 2008,
respectively. These unaudited condensed consolidated financial statements are not necessarily
indicative of the results to be expected for the entire year. The unaudited consolidated balance
sheet presented as of December 31, 2008 has been derived from the audited consolidated financial
statements as of that date, and the consolidated balance sheet presented as of June 30, 2009 has
been derived from the unaudited condensed consolidated financial statements as of that date.
The Company had $12,811 of cash and cash equivalents as of June 30, 2009. During the six
months ended June 30, 2009, the Company used $1,434 of cash in operating activities, $375 of cash
in investing activities and $4,469 of cash in financing activities. The Company expects to continue
to fund its operations and satisfy its contractual obligations for the remainder of 2009 primarily
through its cash and cash equivalents, borrowings under the Companys revolving credit facility and
cash generated by operations during the second half of 2009. However, there can be no assurances
that the Company will be able to generate positive operating cash flow during the second half of
2009 or beyond. The Company believes its cash and cash equivalents, together with cash flows from
operations and borrowings under its credit facility, will be sufficient to meet its anticipated
cash needs for at least the next 12 months. However, the Companys cash requirements for the next
12 months may be greater than anticipated due to, among other reasons, lower than expected cash
generated from operating activities including the impact of foreign currency rate changes, revenues
that are lower than currently anticipated, greater than expected operating expenses, usage of cash
to fund its foreign operations, unanticipated limitations or timing restrictions on its ability to
access funds that are held in its non-U.S. subsidiaries, a deterioration of the quality of the
Companys accounts receivable, which could lower the borrowing base under its credit facility, and
any failure on the Companys part to remain in compliance with the covenants under the revolving
credit facility. The Companys expectations regarding cash sufficiency assume that its operating
results will be sufficient to enable it to comply with the credit facility EBITDA-related covenant.
If revenues are lower than anticipated, the Company will be required to reduce its operating
expenses to remain in compliance with this financial covenant. However, further reducing operating
expenses could be very challenging for the Company, since it undertook operating expense reductions
and restructuring activities in the third and fourth quarters of 2008 that reduced operating
expenses significantly from second quarter of 2008 levels. However, the Company expects to continue
its efforts to reduce operating expenses during the second half of 2009. Reducing operating
expenses further than the Company currently anticipates could have the effect of reducing revenues.
The Companys ability to comply with the EBITDA-related covenant will be further challenged due to
the approximately $800 in costs it expects to incur during the second half of 2009 related to the
transition of its Chief Executive Officer, any additional restructuring charges that it may incur
as the Company continues its efforts to reduce operating expenses and the adverse impact of recent
foreign currency movements on its operating results. The Company currently believes that it will be
able to comply with the EBITDA-related covenant in the third quarter
of 2009, but, due primarily to the unanticipated restructuring charges
and negative foreign currency movements
described in the preceding sentence, will likely not
be able to comply with this covenant in the fourth quarter of 2009 unless one or more of the
following occurs: (1) the Companys revenues significantly exceed its expectations, (2) the Company
is able to significantly reduce its operating expenses after taking into account restructuring charges and foreign
currency movements, (3) foreign currency exchange rates move in
a manner that significantly and positively affect the Companys operating results or (4) the lender
agrees either to amend the credit facility in a manner that enables the Companys compliance with
this covenant or grant the Company a waiver for any non-compliance with the covenant.
The Company is currently engaged in discussions with the lender regarding amending
the credit facility to enable its prospective compliance with the EBITDA-related covenant and
believes that it will enter into such an amendment in the near future.
6
If the Companys cash sources are insufficient to satisfy the Companys cash requirements, the
Company may be required to sell convertible debt or equity securities to raise additional capital
or seek to increase the amount available to the Company for borrowing under the Companys credit
facility and/or restructure the MIG earnout and bonus payments. The Company may be unable to raise
additional capital through the sale of securities, or to do so on terms that are favorable to it,
particularly given current capital market and overall economic conditions. Any sale of convertible
debt securities or additional equity securities could result in substantial dilution to the
Companys stockholders. The holders of new securities may also receive rights, preferences or
privileges that are senior to those of existing holders of the Companys common stock, all of which
is subject to the provisions of the credit facility. Additionally, the Company may be unable to
increase the size of the Companys credit facility, or to do so on terms that are acceptable to it,
particularly in light of the current credit market conditions. Similarly, the Company maybe unable
to restructure the MIG earnout and bonus payments. If the amount of cash that the Company generates
from operations is less than anticipated, it could also be required to extend the term beyond its
December 2010 expiration date (or replace it with an alternate loan arrangement), and resulting
debt payments thereunder could further inhibit the Companys ability to achieve profitability in
the future.
If the liquidity matters discussed above are not adequately addressed by the Company, the
audit report included in the Companys Form 10-K for the year
ending December 31, 2009 may include an explanatory paragraph regarding the Companys ability to continue as a going concern.
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
U.S. and other locations outside of the U.S. The Company performs ongoing credit evaluations of its
customers financial condition and currently does not require any 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 collectability on a monthly basis and 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 that accounted for in excess of 10%
of the Companys revenues for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Verizon Wireless |
|
|
20.8 |
% |
|
|
21.9 |
% |
|
|
21.3 |
% |
|
|
21.1 |
% |
China Mobile |
|
|
* |
|
|
|
13.7 |
|
|
|
10.2 |
|
|
|
11.3 |
|
|
|
|
* |
|
Revenues from the customer were less than 10% during the period. |
At June 30, 2009, Verizon Wireless accounted for 25.3% of total accounts receivable. At
December 31, 2008, Verizon Wireless accounted for 25.7% of total accounts receivable. No other
carrier represented more than 10% of our total accounts receivable as of these dates.
Net Loss Per Share
The Company computes basic net loss per share attributable to common stockholders by dividing
its net loss for the period by the weighted average number of common shares outstanding during the
period less the weighted average number of unvested common shares subject to repurchase by the
Company.
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Net loss |
|
$ |
(1,538 |
) |
|
$ |
(6,601 |
) |
|
$ |
(7,295 |
) |
|
$ |
(12,603 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted shares: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding |
|
|
29,622 |
|
|
|
29,350 |
|
|
|
29,609 |
|
|
|
29,269 |
|
Weighted average unvested common shares subject to repurchase |
|
|
(1 |
) |
|
|
(33 |
) |
|
|
(1 |
) |
|
|
(38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares used to compute basic and diluted net loss per share |
|
|
29,621 |
|
|
|
29,317 |
|
|
|
29,608 |
|
|
|
29,231 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per share basic and diluted |
|
$ |
(0.05 |
) |
|
$ |
(0.23 |
) |
|
$ |
(0.25 |
) |
|
$ |
(0.43 |
) |
The following weighted average options to purchase common stock, 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 |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Warrants to purchase common stock |
|
|
106 |
|
|
|
106 |
|
|
|
106 |
|
|
|
131 |
|
Unvested common shares subject to repurchase |
|
|
1 |
|
|
|
33 |
|
|
|
1 |
|
|
|
38 |
|
Options to purchase common stock |
|
|
5,063 |
|
|
|
4,720 |
|
|
|
5,036 |
|
|
|
4,390 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,170 |
|
|
|
4,859 |
|
|
|
5,143 |
|
|
|
4,559 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification and the Hierarchy
of Generally Accepted Accounting Principles. This standard replaces SFAS No. 162, The Hierarchy of
Generally Accepted Accounting Principles, and establishes only two levels of U.S. generally
accepted accounting principles (GAAP), authoritative and nonauthoritative. The FASB Accounting
Standards Codification (the Codification) will become the source of authoritative,
nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of
authoritative GAAP for SEC registrants. All other non-grandfathered, non-SEC accounting literature
not included in the Codification will become non-authoritative. This standard is effective for
financial statements for interim or annual reporting periods ending after September 15, 2009. The
Company will begin to use the new guidelines and numbering system prescribed by the Codification
when referring to GAAP in the third quarter of fiscal 2009. As the Codification was not intended to
change or alter existing GAAP, it should not have any impact on the Companys consolidated
financial statements.
Effective April 1, 2009, the Company adopted the FASB issued SFAS No. 165, Subsequent Events.
The standard modifies the names of the two types of subsequent events either as recognized
subsequent events (previously referred to in practice as Type I subsequent events) or
non-recognized subsequent events (previously referred to in practice as Type II subsequent
events). In addition, the standard modifies the definition of subsequent events to refer to events
or transactions that occur after the balance sheet date, but before the financial statements are
issued (for public entities) or available to be issued (for nonpublic entities). It also requires
the disclosure of the date through which subsequent events have been evaluated. The standard did
not result in significant changes in the practice of subsequent event disclosures or the related
accounting thereof, and therefore the adoption did not have any impact on the Companys
consolidated financial statements.
Effective April 1, 2009, the Company adopted three FASB staff positions (FSPs) related to
fair value measurements, disclosures and other-than-temporary impairments. FSP FAS 157-4,
Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly, provides additional
guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of
activity for an asset or liability have significantly decreased. FSP FAS 157-4 also includes
guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 115-2 and
SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, amends the
other-than-temporary impairment guidance in U.S. GAAP to make the guidance more operational and to
improve the presentation of other-than-temporary impairments in the financial statements. Finally,
FSP FAS 107-1 and Accounting Principles Board (APB) 28-1, Interim
Disclosures About Fair Value of Financial Instruments, amends SFAS No. 107, Disclosures about
Fair Value of Financial Instruments, to require disclosures about fair value of financial
instruments in interim financial statements as well as in annual financial statements and also
amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in all interim
financial statements. The adoption of these FSPs did not have a material impact on the Companys
consolidated results of operations and financial position.
8
Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (SFAS
No. 157). In February 2008, the FASB issued FSP No. 157-2, which delays the effective date of SFAS
No. 157 for all non-financial assets and liabilities except for those recognized or disclosed in
the financial statements at fair value at least annually. The Company adopted the
provisions of SFAS No. 157 for non-financial assets and non-financial liabilities effective January
1, 2009. However, the adoption of SFAS No. 157 for non-financial assets and non-financial
liabilities did not have an impact on the Companys consolidated results of operations or financial
condition.
Effective January 1, 2009, the Company adopted SFAS No. 141R, Business Combinations (SFAS No.
141R), which replaces SFAS No. 141, Business Combinations (SFAS No. 141) and establishes
principles and requirements for how the acquirer of a business recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed, and any
non-controlling interest in the acquiree. SFAS No. 141R also provides guidance for recognizing and
measuring the goodwill acquired in the business combination and determines what information to
disclose to enable users of the financial statements to evaluate the nature and financial effects
of the business combination. SFAS No. 141R applies prospectively to business combinations for which
the acquisition date is on or after the beginning of the first annual reporting period beginning on
or after December 15, 2008. Although the Company did not enter into any business combinations
during the first six months of 2009, the Company believes SFAS No. 141R may have a material impact
on the Companys future consolidated financial statements if the Company were to enter into any
future business combinations depending on the size and nature of any such future transactions.
Note 2 Acquisitions
Acquisition of Superscape Group plc
On March 7, 2008, the Company declared its cash tender offer for all of the outstanding shares
of Superscape Group plc (Superscape) wholly unconditional in all respects when it had received
80.95% of the issued share capital of Superscape. The Company offered 10 pence (pound sterling) in
cash for each issued share of Superscape (Superscape Shares), valuing the acquisition at
approximately £18,300 (or $36,500) based on 183,099 Superscape Shares outstanding.
The Company acquired the net assets of Superscape in order to deepen and broaden its game
library, gain access to 3-D game development and to augment its internal production and publishing
resources with a studio in Moscow, Russia. These factors contributed to a purchase price in excess
of the fair value of the net tangible and intangible assets acquired, and as a result, the Company
recorded goodwill in connection with this transaction.
On March 21, 2008, the date the recommended cash tender offer expired, the Company owned or
had received valid acceptances representing approximately 93.57% of the Superscape Shares, with an
aggregate purchase price of $34,477. In May 2008, the Company acquired the remaining 6.43% of the
outstanding Superscape shares on the same terms as the recommended cash offer for $2,335.
The Companys consolidated financial statements include the results of operations of
Superscape from the date of acquisition, March 7, 2008. Under the purchase method of accounting,
the Company allocated the total purchase price of $38,810 to the net tangible and intangible assets
acquired and liabilities assumed based upon their respective estimated fair values as of the
acquisition date.
9
The following summarizes the purchase price allocation of the Superscape acquisition:
|
|
|
|
|
Assets acquired: |
|
|
|
|
Cash |
|
$ |
8,593 |
|
Accounts receivable |
|
|
4,353 |
|
Prepaid and other current assets |
|
|
1,507 |
|
Property and equipment |
|
|
182 |
|
Titles, content and technology |
|
|
9,190 |
|
Carrier contracts and relationships |
|
|
7,400 |
|
Trade name |
|
|
330 |
|
In-process research and development |
|
|
1,110 |
|
Goodwill |
|
|
13,432 |
|
|
|
|
|
Total assets acquired |
|
|
46,097 |
|
|
|
|
|
Liabilities assumed: |
|
|
|
|
Accounts payable |
|
|
(2,567 |
) |
Accrued liabilities |
|
|
(585 |
) |
Accrued compensation |
|
|
(367 |
) |
Accrued restructuring |
|
|
(3,768 |
) |
Total current liabilities |
|
|
(7,287 |
) |
|
|
|
|
Total liabilities |
|
|
(7,287 |
) |
|
|
|
|
Net acquired assets |
|
$ |
38,810 |
|
|
|
|
|
The Company recorded an estimate for costs to terminate some activities associated with the
Superscape 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 $3,768 principally related to the termination of 29 Superscape employees of $2,277,
restructuring of facilities of $1,466 and other agreement termination fees of $25.
The valuation of the identifiable intangible assets acquired was based on managements
estimates, currently available information and reasonable and supportable assumptions. The
allocation was generally based on the fair value of these assets determined using the income and
market approaches. Of the total purchase price, $16,920 was allocated to amortizable intangible
assets. The amortizable intangible assets are being amortized using a straight-line method over
their respective estimated useful lives of one to six years.
In conjunction with the acquisition of Superscape, the Company recorded a $1,110 expense for
acquired in-process research and development (IPR&D) within operating expenses during the year
ended December 31, 2008 because feasibility of the acquired technology had not been established and
no future alternative uses existed. As a result of the minority interest ownership during the first
quarter of 2008, only $1,039 of the IPR&D expense was recognized during the three months ended
March 31, 2008. The remainder of the expense was recorded in the second quarter of 2008.
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 22% discount
rate.
The Company allocated the residual value of $13,432 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 142, goodwill will not be amortized but will be tested for
impairment at least annually. Goodwill is not deductible for tax purposes. Based on the Companys
annual and interim goodwill impairment tests, all of the goodwill related to the Superscape
acquisition that had been attributed to the Americas reporting unit was impaired during the year
ended December 31, 2008.
10
Superscapes results of operations have been included in the Companys consolidated financial
statements subsequent to the date of acquisition. The financial information in the table below
summarizes the combined results of operations of the Company and Superscape, on a pro forma basis,
as though the companies had been combined as of the beginning of each of the periods presented, and
includes the IPR&D charge resulting from the acquisition of Superscape:
|
|
|
|
|
|
|
Six |
|
|
Months |
|
|
Ended |
|
|
June 30, |
|
|
2008 |
Total pro forma revenues |
|
$ |
47,009 |
|
Gross profit |
|
|
24,064 |
|
Pro forma net loss |
|
|
(12,962 |
) |
Pro forma net loss per share basic and diluted |
|
$ |
(0.44 |
) |
Note 3 Short-Term Investments and Fair Value Measurements
Short-Term Investments
The Company did not have any marketable securities classified as available-for-sale as of June
30, 2009. The Company had $124 of marketable securities classified as available-for-sale as of
December 31, 2008 which approximated fair value.
Fair Value Measurements
The Companys cash and investment instruments are classified within Level 1 of the fair value
hierarchy because they are valued using quoted market prices, broker or dealer quotations, or
alternative pricing sources with reasonable levels of price transparency. The types of instruments
valued based on quoted market prices in active markets include most U.S. government and agency
securities, sovereign government obligations, and money market securities. Such instruments are
generally classified within Level 1 of the fair value hierarchy. As of June 30, 2009, the Company
had $12,811 in cash and cash equivalents.
11
Note 4 Balance Sheet Components
Accounts Receivable
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
Accounts receivable |
|
$ |
17,395 |
|
|
$ |
20,294 |
|
Less: Allowance for doubtful accounts |
|
|
(485 |
) |
|
|
(468 |
) |
|
|
|
|
|
|
|
|
|
$ |
16,910 |
|
|
$ |
19,826 |
|
|
|
|
|
|
|
|
Accounts receivable includes amounts billed and unbilled as of the respective balance sheet
dates. The Company had no significant write-offs or recoveries during the three or six months ended
June 30, 2009 and 2008.
Property and Equipment
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
Computer equipment |
|
$ |
4,946 |
|
|
$ |
4,644 |
|
Furniture and fixtures |
|
|
422 |
|
|
|
386 |
|
Software |
|
|
2,663 |
|
|
|
2,628 |
|
Leasehold improvements |
|
|
3,181 |
|
|
|
3,055 |
|
|
|
|
|
|
|
|
|
|
|
11,212 |
|
|
|
10,713 |
|
Less: Accumulated depreciation and amortization |
|
|
(7,198 |
) |
|
|
(5,852 |
) |
|
|
|
|
|
|
|
|
|
$ |
4,014 |
|
|
$ |
4,861 |
|
|
|
|
|
|
|
|
Depreciation expense for the three months ended June 30, 2009 and 2008 was $585 and $730,
respectively. Depreciation expense for the six months ended June 30, 2009 and 2008 was $1,178 and
$1,352, respectively
Other Long-Term Liabilities
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
Accrued royalties |
|
$ |
2,000 |
|
|
$ |
3,409 |
|
FIN 48 obligations |
|
|
4,471 |
|
|
|
4,399 |
|
Deferred income tax liability |
|
|
2,450 |
|
|
|
2,461 |
|
Other |
|
|
1,577 |
|
|
|
1,529 |
|
|
|
|
|
|
|
|
|
|
$ |
10,498 |
|
|
|
11,798 |
|
|
|
|
|
|
|
|
12
Note 5 Goodwill and Intangible Assets
The Companys intangible assets were acquired in connection with the acquisitions of
Macrospace in 2004, iFone in 2006, MIG in 2007 and Superscape in 2008. The carrying amounts and
accumulated amortization expense of the acquired intangible assets, including the impact of foreign
currency exchange translation, at June 30, 2009 and December 31, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2009 |
|
|
December 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization |
|
|
|
|
|
|
|
|
|
|
Amortization |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense |
|
|
|
|
|
|
|
|
|
|
Expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Including |
|
|
|
|
|
|
|
|
|
|
(Including |
|
|
|
|
|
|
Estimated |
|
|
Gross |
|
|
Impact of |
|
|
Net |
|
|
Gross |
|
|
Impact of |
|
|
Net |
|
|
|
Useful |
|
|
Carrying |
|
|
Foreign |
|
|
Carrying |
|
|
Carrying |
|
|
Foreign |
|
|
Carrying |
|
|
|
Life |
|
|
Value |
|
|
Exchange) |
|
|
Value |
|
|
Value |
|
|
Exchange) |
|
|
Value |
|
Intangible assets amortized
to cost of revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Titles, content and technology |
|
2.5 yrs |
|
$ |
13,693 |
|
|
$ |
(12,873 |
) |
|
$ |
820 |
|
|
$ |
13,370 |
|
|
$ |
(10,478 |
) |
|
$ |
2,892 |
|
Catalogs |
|
1 yr |
|
|
1,285 |
|
|
|
(1,285 |
) |
|
|
|
|
|
|
1,126 |
|
|
|
(1,126 |
) |
|
|
|
|
ProvisionX Technology |
|
6 yrs |
|
|
212 |
|
|
|
(155 |
) |
|
|
57 |
|
|
|
185 |
|
|
|
(119 |
) |
|
|
66 |
|
Carrier contract and related relationships |
|
5 yrs |
|
|
18,597 |
|
|
|
(5,577 |
) |
|
|
13,020 |
|
|
|
18,463 |
|
|
|
(3,845 |
) |
|
|
14,618 |
|
Licensed content |
|
5 yrs |
|
|
2,758 |
|
|
|
(1,472 |
) |
|
|
1,286 |
|
|
|
2,744 |
|
|
|
(1,029 |
) |
|
|
1,715 |
|
Service provider license |
|
9 yrs |
|
|
431 |
|
|
|
(74 |
) |
|
|
357 |
|
|
|
432 |
|
|
|
(50 |
) |
|
|
382 |
|
Trademarks |
|
3 yrs |
|
|
546 |
|
|
|
(404 |
) |
|
|
142 |
|
|
|
540 |
|
|
|
(285 |
) |
|
|
255 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
37,522 |
|
|
|
(21,840 |
) |
|
|
15,682 |
|
|
|
36,860 |
|
|
|
(16,932 |
) |
|
|
19,928 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other intangible assets amortized
to operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Emux Technology |
|
6 yrs |
|
|
1,370 |
|
|
|
(1,038 |
) |
|
|
332 |
|
|
|
1,201 |
|
|
|
(809 |
) |
|
|
392 |
|
Noncompete agreement |
|
2 yrs |
|
|
600 |
|
|
|
(600 |
) |
|
|
|
|
|
|
525 |
|
|
|
(525 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,970 |
|
|
|
(1,638 |
) |
|
|
332 |
|
|
|
1,726 |
|
|
|
(1,334 |
) |
|
|
392 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total intangibles assets |
|
|
|
|
|
$ |
39,492 |
|
|
$ |
(23,478 |
) |
|
$ |
16,014 |
|
|
$ |
38,586 |
|
|
$ |
(18,266 |
) |
|
$ |
20,320 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions to intangible assets during the year ended December 31, 2008 of $16,920 were the
result of the Superscape acquisition (see Note 2).
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 June 30, 2009 and 2008, the Company recorded amortization
expense in the amounts of $1,412 and $3,135, respectively, in cost of revenues. During the six
months ended June 30, 2009 and 2008, the Company recorded amortization expense in the amounts of
$4,260 and $4,842, respectively, in cost of revenues. During the three months ended June 30, 2009
and 2008, the Company recorded amortization expense in the amounts of $51 and $69, respectively, in
operating expenses. During the six months ended June 30, 2009 and 2008, the Company recorded
amortization expense in the amounts of $102 and $137, respectively, in operating expenses.
As of June 30, 2009, the total expected future amortization related to intangible assets was
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization |
|
|
Amortization |
|
|
|
|
|
|
Included in |
|
|
Included in |
|
|
Total |
|
|
|
Cost of |
|
|
Operating |
|
|
Amortization |
|
Year Ending December 31, |
|
Revenues |
|
|
Expenses |
|
|
Expense |
|
2009 (remaining six months) |
|
$ |
2,819 |
|
|
$ |
114 |
|
|
$ |
2,933 |
|
2010 |
|
|
4,235 |
|
|
|
218 |
|
|
|
4,453 |
|
2011 |
|
|
2,858 |
|
|
|
|
|
|
|
2,858 |
|
2012 |
|
|
2,737 |
|
|
|
|
|
|
|
2,737 |
|
2013 |
|
|
2,669 |
|
|
|
|
|
|
|
2,669 |
|
2014 and thereafter |
|
|
364 |
|
|
|
|
|
|
|
364 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
15,682 |
|
|
$ |
332 |
|
|
$ |
16,014 |
|
|
|
|
|
|
|
|
|
|
|
Goodwill
The Company attributes all of the goodwill resulting from the Macrospace acquisition to its
Europe, Middle East and Africa (EMEA) reporting unit. The goodwill resulting from the iFone
acquisition is evenly attributed to the Americas and EMEA reporting units. The Company attributes
all of the goodwill resulting from the MIG acquisition to its Asia and Pacific (APAC) reporting
unit and all of the goodwill resulting from the Superscape acquisition to the Americas reporting
unit. The goodwill allocated to the Americas reporting unit is denominated in United States Dollars
(USD), the goodwill allocated to the EMEA reporting unit is
13
denominated in Pounds Sterling (GBP) and the goodwill allocated to the APAC reporting unit is denominated in Chinese Renminbi
(RMB). As a result, the goodwill attributed to the EMEA and APAC reporting units are subject to
foreign currency fluctuations.
Goodwill by geographic region for the periods indicated was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effects of |
|
|
|
|
|
|
|
|
|
|
Effects of |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign |
|
|
Impairment |
|
|
|
|
|
|
Foreign |
|
|
|
|
|
|
January 1, |
|
|
Goodwill |
|
|
|
|
|
|
Currency |
|
|
of |
|
|
December 31, |
|
|
Currency |
|
|
June 30, |
|
|
|
2008 |
|
|
Acquired |
|
|
Adjustments |
|
|
Exchange |
|
|
Goodwill |
|
|
2008 |
|
|
Exchange |
|
|
2009 |
|
Americas |
|
$ |
11,426 |
|
|
$ |
13,445 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(24,871 |
) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
EMEA |
|
|
27,860 |
|
|
|
|
|
|
|
|
|
|
|
(2,506 |
) |
|
|
(25,354 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
APAC |
|
|
7,976 |
|
|
|
|
|
|
|
15,510 |
|
|
|
409 |
|
|
|
(19,273 |
) |
|
|
4,622 |
|
|
|
(19 |
) |
|
|
4,603 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
47,262 |
|
|
$ |
13,445 |
|
|
$ |
15,510 |
|
|
$ |
(2,097 |
) |
|
$ |
(69,498 |
) |
|
$ |
4,622 |
|
|
$ |
(19 |
) |
|
$ |
4,603 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill was acquired during 2008 as a result of the Superscape acquisition (see Note 2). The
net adjustment increase to goodwill in 2008 of $15,510 was a result of additional purchase
consideration for MIG of $14,536 due to the restructuring in the fourth quarter of 2008 of the MIG
earnout payments and additional professional fees of $974 related to the MIG acquisition. In 2008,
the Company recorded an aggregate goodwill impairment of $69,498 as the fair values of the
Americas, APAC and EMEA reporting units were determined to be below their respective carrying
values.
Note 6 Commitments and Contingencies
Leases
The Company leases office space under non-cancelable operating facility leases with various
expiration dates through July 2013. Rent expense for the three months ended June 30, 2009 and 2008
was $671 and $998, respectively. Rent expense for the six months ended June 30, 2009 and 2008 was
$1,337 and $1,948 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 $552
and $606 at June 30, 2009 and December 31, 2008, respectively, and was included within other
long-term liabilities.
At June 30, 2009, future minimum lease payments under non-cancelable operating leases were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minimum |
|
|
|
|
|
|
|
|
|
|
Operating |
|
|
|
|
|
|
Net |
|
|
|
Lease |
|
|
Sub-lease |
|
|
Lease |
|
Year Ending December 31, |
|
Payments |
|
|
Income |
|
|
Payments |
|
2009 (remaining six months) |
|
$ |
1,972 |
|
|
$ |
102 |
|
|
$ |
1,870 |
|
2010 |
|
|
2,502 |
|
|
|
|
|
|
|
2,502 |
|
2011 |
|
|
1,920 |
|
|
|
|
|
|
|
1,920 |
|
2012 |
|
|
1,046 |
|
|
|
|
|
|
|
1,046 |
|
2013 |
|
|
176 |
|
|
|
|
|
|
|
176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,616 |
|
|
$ |
102 |
|
|
$ |
7,514 |
|
|
|
|
|
|
|
|
|
|
|
14
Minimum Guaranteed Royalties
The Company has entered into license and development agreements with various owners of brands
and other intellectual property to develop and publish games for mobile handsets. Pursuant to some
of these agreements, the Company is required to pay minimum royalties over the term of the
agreements regardless of actual game sales. Future minimum royalty payments for those agreements as
of June 30, 2009 were as follows:
|
|
|
|
|
|
|
Minimum |
|
|
|
Guaranteed |
|
Year Ending December 31, |
|
Royalties |
|
2009 (remaining six months) |
|
$ |
4,785 |
|
2010 |
|
|
4,058 |
|
2011 |
|
|
348 |
|
2012 |
|
|
217 |
|
2013 |
|
|
|
|
2014 and thereafter |
|
|
50 |
|
|
|
|
|
|
|
$ |
9,458 |
|
|
|
|
|
Commitments in the above table include $9,158 of guaranteed royalties to licensors that are
included in the Companys consolidated balance sheet as of June 30, 2009 because the licensors do
not have any significant performance obligations. These commitments are included in both current
and long-term prepaid and accrued royalties.
Income Taxes
As of June 30, 2009, unrecognized tax benefits and potential interest and penalties are
classified within Other long-term liabilities on the Companys condensed consolidated balance
sheets. As of June 30, 2009, the settlement of the Companys income tax liabilities could not be
determined; however, the liabilities are not expected to become due within the next 12 months.
Indemnification Agreements
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 June 30, 2009 or December 31, 2008.
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 generally 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 June 30, 2009 or December 31, 2008.
Contingencies
From time to time, the Company is subject to various claims, complaints and legal actions in
the normal course of business. For example, the Company is engaged in a contractual dispute with a
licensor, Skinit, Inc., related to, among other claims, alleged
underpayment of royalties and failure to perform under a distribution agreement, pursuant to
which Skinit previously claimed that it is owed approximately $600. On April 21, 2009, Skinit filed
a complaint against the Company and other defendants, seeking unspecified damages plus attorneys
fees and costs. The complaint, filed in the Superior Court of California in Orange County (case
number 30-2009), alleges breach of contract, interference with economic relations, conspiracy and
misrepresentation of fact. On June 25, 2009, the Company filed a motion in the Superior Court in
Orange County requesting an order compelling Skinit to arbitrate its claim against the Company and
requesting that the court stay the action pending the determination of the motion and the
subsequent arbitration. On July 30, 2009, the court granted the Companys motion in its entirety
and the dispute will now proceed to arbitration.
The Company does not believe it is party to any currently pending litigation, the outcome of
which will have a material adverse effect on its operations, financial position or liquidity.
However, the ultimate outcome of any litigation is uncertain and, regardless of outcome, litigation
can have an adverse impact on the Company because of defense costs, potential negative publicity,
diversion of management resources and other factors.
15
Note 7 Debt
MIG Notes
In December 2008, the Company amended the MIG merger agreement to acknowledge the full
achievement of the earnout milestones and at the same time entered into secured promissory notes in
the aggregate principal amount of $20,000 payable to the former MIG shareholders (the Earnout
Notes) as full satisfaction of the MIG earnout. The Earnout Notes require that the Company pay off
the principal and interest in installments with aggregate principal payments scheduled as follows:
|
|
|
|
|
January 15, 2009 |
|
$ |
6,000 |
|
April 1, 2009 |
|
$ |
3,000 |
|
July 1, 2009 |
|
$ |
5,000 |
|
March 31, 2010 |
|
$ |
1,500 |
|
June 30, 2010 |
|
$ |
1,500 |
|
September 30, 2010 |
|
$ |
1,500 |
|
December 31, 2010 |
|
$ |
1,500 |
|
|
|
|
|
|
|
|
20,000 |
|
|
|
|
|
The Earnout Notes are secured by a lien on substantially all of the Companys assets and are
subordinated to the Companys obligations to the lender under the Companys Loan and Security
Agreement, dated as of February 15, 2007, as amended (the Credit Facility), and any replacement
credit facility that meets certain conditions. The Earnout Notes began accruing simple interest on
April 1, 2009 at the rate of 7% compounded annually and may be prepaid without penalty. A change of
control of the Company accelerates the payment of principal and interest under the Earnout Notes.
During the six months ended June 30, 2009, the Company paid $9,000 of principal to the MIG
shareholders related to the Earnout Notes. The Company paid an additional $5,000 of principal on
July 1, 2009.
In December 2008, the Company also entered into secured promissory notes in the aggregate
principal amount of $5,000 payable to two former shareholders of MIG (the Special Bonus Notes) as
full satisfaction of the special bonus provisions of their employment agreements. The Special Bonus
Notes provide for cash payments as follows:
|
|
|
|
|
March 31, 2010 |
|
$ |
937 |
|
June 30, 2010 |
|
$ |
937 |
|
September 30, 2010 |
|
$ |
1,563 |
|
December 31, 2010 |
|
$ |
1,563 |
|
|
|
|
|
|
|
|
5,000 |
|
|
|
|
|
The Special Bonus Notes are guaranteed by the Company and the Companys obligations are
secured by a lien on substantially all of the Companys assets. The Special Bonus Notes are
subordinated to the Credit Facility and any replacement credit facility that meets certain
conditions. The Special Bonus Notes began accruing simple interest on April 1, 2009 at the rate of
7% compounded annually, and may be paid off in advance without penalty. A
change of control of the Company accelerates the payment of principal and interest under the
Earnout Notes. The Company has recorded the entire $5,000 of the Special Bonus Notes as of June 30,
2009 as the former MIG shareholders are fully vested in the special bonus.
As of June 30, 2009, the Companys current portion of long-term debt related to the Earnout
and Special Bonus Notes was $10,427 and the long-term portion was $6,125.
Based on the borrowing rates currently available to the Company with similar terms and
maturities, the carrying value of the Earnout and Special Bonus Notes of $16,552 approximates fair
value.
16
Credit Facility
In December 2008, the Company entered into the Credit Facility, which Credit Facility amends
and supersedes the Loan and Security Agreement entered into in February 2007, as amended. The
Credit Facility provides for borrowings of up to $8,000, subject to a borrowing base equal to 80%
of the Companys eligible accounts receivable. The Companys obligations under the Credit Facility
are guaranteed by certain of the Companys domestic and foreign subsidiaries and are secured by
substantially all of the Companys assets, including all of the capital stock of certain of the
Companys domestic subsidiaries and 65% of the capital stock of certain of its foreign
subsidiaries.
The interest rate for the Credit Facility is the lenders prime rate, plus 1.0%, but no less
than 5.0%. Interest is due monthly, with all outstanding obligations due at maturity. The Company
must also pay the lender a monthly unused revolving line facility fee of 0.35% on the unused
portion of the $8,000 commitment. In addition, the Company paid the lender a non-refundable
commitment fee of $55 in December 2008 and will pay an additional $55 in December 2009. The Credit
Facility limits the Company and certain of its subsidiaries ability to, among other things,
dispose of assets, make acquisitions, incur additional indebtedness, incur liens, pay dividends and
make other distributions, and make investments. The Credit Facility requires the Company to
establish a separate account at the lender for collection of its accounts receivables. All deposits
into this account are automatically applied by the lender to the Companys outstanding obligations
under the Credit Facility.
In addition, under the Credit Facility, the Company must comply with the following financial
covenants:
|
(a) |
|
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). The Company
must maintain, measured on consolidated basis as of the end of each of the following
periods, EBITDA of at least the following: |
|
|
|
|
|
January 1, 2009 through June 30, 2009 |
|
$ |
(812 |
) |
April 1, 2009 through September 30, 2009 |
|
$ |
1,572 |
|
July 1, 2009 through December 31, 2009 |
|
$ |
4,263 |
|
October 1, 2009 through March 31, 2010 |
|
$ |
5,092 |
|
January 1, 2010 through June 30, 2010 |
|
$ |
5,257 |
|
April 1, 2010 through September 30, 2010 |
|
$ |
5,298 |
|
July 1, 2010 through December 31, 2010 |
|
$ |
6,073 |
|
For purposes of the above covenant, EBITDA means (a) the Companys consolidated net
income, determined in accordance with U.S. GAAP, plus (b) interest expense, plus (c) to the
extent deducted in the calculation of net income, depreciation expense and amortization
expense, plus (d) income tax expense, plus (e) non-cash stock compensation expense, plus (f)
non-cash goodwill and other intangible assets and royalty impairments, plus (g) non-cash
foreign exchange translation charges, minus (h) all non-cash income of the Company and its
subsidiaries for such period.
|
(b) |
|
Minimum Domestic Liquidity: The Company must maintain at the lender an amount of cash,
cash equivalents and short-term investments of not less than the greater of: (a) 20% of the
Companys total consolidated unrestricted cash, cash equivalents and short-term
investments, or (b) 15% of outstanding obligations under the Credit Facility. |
The Companys failure to comply with the financial or operating covenants in the Credit
Facility would not only prohibit the Company from borrowing under the facility, but would also
constitute a default, permitting the lender to, among other things, declare any outstanding
borrowings, including all accrued interest and unpaid fees, becoming immediately due and payable. A
change in control of the Company (as defined in the Credit Facility) also constitutes an event of
default, permitting the lender to accelerate the indebtedness and terminate the Credit Facility. To
the extent an event of default occurred under the Credit Facility and the lender
accelerated the indebtedness and terminated the Credit Facility, this would also trigger the
cross-default provisions of the Earnout Notes and Special Bonus Notes. The Credit Facility also
contains other customary events of default.
The Credit Facility matures on December 29, 2010, when all amounts outstanding will be due. If
the Credit Facility is terminated prior to maturity by the Company or by the lender after the
occurrence and continuance of an event of default, then the Company will owe a termination fee
equal to $80, or 1.00% of the total commitment.
17
As of June 30, 2009, the Company was in compliance with all covenants of the Credit Facility
and had outstanding obligations of $4,547. Based on the borrowing rates currently available to the
Company with similar terms and maturities, the carrying value approximates fair value.
Note 8 Stockholders Equity
Common Stock
In March 2007, the Company completed its initial public offering (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.
Warrants to Purchase Common Stock
In March 2008, a holder of warrants elected to net exercise warrants to purchase 18 shares of
the Companys common stock, which were converted into 10 shares of common stock. Also in March
2008, a holder of warrants elected to exercise warrants to purchase 53 shares of the Companys
common stock at $1.92 per share for total cash consideration of $101.
Warrants outstanding as of June 30, 2009 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number |
|
|
|
|
|
|
Exercise |
|
of Shares |
|
|
|
|
|
|
Price |
|
Outstanding |
|
|
Term |
|
per |
|
Under |
Issue Date |
|
(Years) |
|
Share |
|
Warrant |
May 2006
|
|
|
7 |
|
|
$ |
9.03 |
|
|
|
106 |
|
Note 9 Stock Option and Other Benefit Plans
2007 Employee Stock Purchase Plan
In January 2007, the Companys Board of Directors adopted, and in March 2007 the Companys
stockholders approved, the 2007 Employee Stock Purchase Plan (the 2007 Purchase Plan). The Company
initially reserved 667 shares of its common stock for issuance under the 2007 Purchase Plan. On
each January 1 for the first eight calendar years after the first offering date, the aggregate
number of shares of the Companys common stock reserved for issuance under the 2007 Purchase Plan
will be increased automatically by the number of shares equal to 1% of the total number of
outstanding shares of the Companys common stock on the immediately preceding December 31, provided
that the Board of Directors may reduce the amount of the increase in any particular year and
provided further that the aggregate number of shares issued over the term of this plan may not
exceed 5,333. The 2007 Purchase Plan permits eligible employees to purchase common stock at a
discount through payroll deductions during defined offering periods. The price at which the stock
is purchased is equal to the lower of 85% of the fair market value of the common stock at the
beginning of an offering period or after a purchase period ends.
In January 2009, the 2007 Purchase Plan was amended to provide that the Compensation Committee
of the Companys Board of Directors may fix a maximum number of shares that may be purchased in the
aggregate by all participants during any single offering period (the Maximum Offering Period Share
Amount). The Committee may later raise or lower the Maximum Offering Period Share Amount. The
Committee has established a Maximum Offering Period Share Amount of 500 shares for the offering
period commencing on February 15, 2009 and ending on August 14, 2009, and a Maximum Offering Period
Share Amount of 200 shares for each offering period thereafter.
18
As of June 30, 2009, 1,012 shares were available for issuance under the 2007 Purchase Plan.
2009 Stock Option Exchange Program
On April 22, 2009, the Company launched a voluntary stock option exchange program (the
Exchange Program) pursuant to which its eligible U.S. and U.K. employees (Eligible Employees)
had the right to exchange all options to purchase shares of its common stock outstanding prior to
the Exchange Program launch date having an exercise price equal to or greater than $1.25 per share
(Eligible Options) granted under the Companys 2007 Equity Incentive Plan (the 2007 Plan) or
the Companys 2001 Stock Option Plan for new nonqualified stock options to be granted under the
2007 Plan (New Options). Eligible Options that were tendered for New Options were cancelled and
returned to the 2007 Plan for re-issuance thereunder. The Companys executive officers and directors were not eligible to participate in the Exchange Program. The Exchange
Program provided that Eligible Employees would receive a New Option for each tendered Eligible
Option, depending on the exercise price of the Eligible Option tendered, in accordance with the
exchange ratios set forth in the table below:
|
|
|
|
|
|
|
Exchange Ratio |
|
|
(New Options-for- |
Exercise Price |
|
Eligible Options) |
$1.25 - $1.99 |
|
1-for-1 |
2.00 - 3.99 |
|
1-for-2 |
4.00 - 5.94 |
|
1-for-3 |
5.95 or greater |
|
1-for-4 |
The Company completed the Exchange Program in the second quarter of 2009. Eligible Employees
tendered options to purchase 821 shares of common stock in exchange for replacement options to
purchase 261 shares of common stock under the Companys 2007 Plan. This resulted in $15 of
incremental stock-based compensation to be amortized over three years in 36 equal monthly
installments with a six-year term. The exercise price of the New Options equals the closing sale
price of the Companys common stock as reported on The NASDAQ Global Market on May 22, 2009.
Stock Option Activity
The following table summarizes the Companys stock option activity for the six months ended
June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Number |
|
|
Average |
|
|
Average |
|
|
Aggregate |
|
|
|
Shares |
|
|
of |
|
|
Exercise |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Available |
|
|
Shares |
|
|
Price |
|
|
Term (Years) |
|
|
Value |
|
Balances at December 31, 2008 |
|
|
935 |
|
|
|
5,130 |
|
|
|
5.18 |
|
|
|
|
|
|
|
|
|
Increase in authorized shares |
|
|
887 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options granted |
|
|
(1,211 |
) |
|
|
1,211 |
|
|
|
0.74 |
|
|
|
|
|
|
|
|
|
Options canceled |
|
|
1,316 |
|
|
|
(1,316 |
) |
|
|
6.87 |
|
|
|
|
|
|
|
|
|
Options exercised |
|
|
|
|
|
|
(49 |
) |
|
|
0.42 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at June 30, 2009 |
|
|
1,927 |
|
|
|
4,976 |
|
|
$ |
3.70 |
|
|
|
5.36 |
|
|
$ |
1,069 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options vested and expected to vest at June 30, 2009 |
|
|
|
|
|
|
4,301 |
|
|
$ |
3.95 |
|
|
|
5.34 |
|
|
$ |
844 |
|
Options exercisable at June 30, 2009 |
|
|
|
|
|
|
1,822 |
|
|
$ |
5.67 |
|
|
|
5.08 |
|
|
$ |
124 |
|
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 $1.25 per share as of June 30, 2009. Consolidated net cash proceeds from option exercises
were $20 and $158 for the six months ended June 30, 2009 and 2008, respectively. The Company
realized no income tax benefit from stock option exercises during the six months ended June 30,
2009 or 2008. 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.
The Company applies the fair value provisions of SFAS No. 123(R), Share-Based Payment (SFAS
No. 123R). 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.
19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Dividend yield |
|
|
|
% |
|
|
|
% |
|
|
|
% |
|
|
|
% |
Risk-free interest rate |
|
|
1.41 |
% |
|
|
2.91 |
% |
|
|
1.42 |
% |
|
|
2.63 |
% |
Expected volatility |
|
|
58.0 |
% |
|
|
44.1 |
% |
|
|
57.7 |
% |
|
|
44.2 |
% |
Expected term (years) |
|
|
3.13 |
|
|
|
4.08 |
|
|
|
3.16 |
|
|
|
4.08 |
|
The Company based its 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 but prior to October 25, 2007 from five to ten years.
Stock options granted on or after October 25, 2007 have a contractual term of six 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. The weighted-average fair value of stock options granted
during the six months ended June 30, 2009 and 2008 was $0.30 and $1.78, respectively.
The Company calculated employee stock-based compensation expense recognized in the three and
six months ended June 30, 2009 and 2008 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Research and development |
|
$ |
200 |
|
|
$ |
174 |
|
|
$ |
380 |
|
|
$ |
250 |
|
Sales and marketing |
|
|
159 |
|
|
|
1,303 |
|
|
|
310 |
|
|
|
2,605 |
|
General and administrative |
|
|
405 |
|
|
|
554 |
|
|
|
838 |
|
|
|
1,148 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation expense |
|
$ |
764 |
|
|
$ |
2,031 |
|
|
$ |
1,528 |
|
|
$ |
4,003 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2009, the Company had $5,827 of total unrecognized compensation expense under
SFAS No. 123R, net of estimated forfeitures, which will be recognized over a weighted average
period of 2.78 years. As permitted by SFAS No. 123R, the Company has deferred the recognition of
its excess tax benefit from non-qualified stock option exercises.
Note 10 Income Taxes
The Company recorded an income tax benefit of $464 and provision of $213 for the three months
ended June 30, 2009 and 2008, respectively, related to foreign withholding taxes and income taxes
in some foreign jurisdictions. The Company recorded an income tax provision of $1,555 and $1,343
for the six months ended June 30, 2009 and 2008, respectively, related to foreign withholding taxes
and income taxes. The income tax rates vary from the Federal and State statutory rates due to the
valuation allowances on the Companys net operating losses, foreign tax rate differences, and
withholding taxes.
On January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48,
Accounting for Uncertainty in Income Tax (FIN 48). The total amount of unrecognized tax benefits
as of the date of adoption was $575. As of June 30, 2009 and December 31, 2008, the total amount of
unrecognized tax benefits was $3,626 and $2,406, respectively. As of June 30, 2009, approximately
$69 of unrecognized tax benefits, if recognized, would impact the Companys effective tax rate. The
remaining balance, if recognized, would adjust the Companys goodwill from acquisitions or would
adjust the Companys deferred tax assets which are subject to a valuation allowance.
The Companys policy is to recognize interest and penalties related to unrecognized tax
benefits in income tax expense. The Company recorded $58 and $47 of interest on uncertain tax
positions during the three months ended June 30, 2009 and 2008, respectively. The Company recorded
$114 and $73 of interest on uncertain tax positions during the six months ended June 30, 2009
and 2008, respectively. As of June 30, 2009, the Company had a liability of $3,159 related to
interest and penalties for uncertain tax positions.
The Company is subject to taxation in the U.S. and various foreign jurisdictions. The material
jurisdictions subject to examination by tax authorities are primarily the U.S., California, United
Kingdom and the Peoples Republic of China (PRC). The Companys
20
Federal tax return is open by statute for tax years 2001 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 2001 and forward. The statute of limitations for the Companys 2006 tax return in the
United Kingdom will close in 2009. The Companys PRC tax returns are open by statute for tax years
2002 and forward.
Note 11 Segment Reporting
SFAS 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 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 Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
United States of America |
|
$ |
9,702 |
|
|
$ |
11,166 |
|
|
$ |
19,725 |
|
|
$ |
20,674 |
|
United Kingdom |
|
|
659 |
|
|
|
1,364 |
|
|
|
1,457 |
|
|
|
2,977 |
|
China |
|
|
1,589 |
|
|
|
3,254 |
|
|
|
4,133 |
|
|
|
5,043 |
|
Americas, excluding the USA |
|
|
2,805 |
|
|
|
2,232 |
|
|
|
4,959 |
|
|
|
4,086 |
|
EMEA, excluding the United Kingdom |
|
|
4,468 |
|
|
|
4,877 |
|
|
|
9,237 |
|
|
|
9,956 |
|
Other |
|
|
649 |
|
|
|
811 |
|
|
|
1,136 |
|
|
|
1,560 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
19,872 |
|
|
$ |
23,704 |
|
|
$ |
40,647 |
|
|
$ |
44,296 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
Americas |
|
$ |
2,690 |
|
|
$ |
3,208 |
|
EMEA |
|
|
685 |
|
|
|
790 |
|
Other |
|
|
639 |
|
|
|
863 |
|
|
|
|
|
|
|
|
|
|
$ |
4,014 |
|
|
$ |
4,861 |
|
|
|
|
|
|
|
|
Note 12 Restructuring
During 2008, the Companys management approved restructuring plans to improve the
effectiveness and efficiency of its business and reduce operating expenses around the world. During
the three months ended June 30, 2009, the Company paid $202 of facility related charges that were
accrued in prior periods. During the six months ended June 30, 2009, the Company paid $100 of
severance and $450 of facility related charges that were accrued in prior periods.
During the three months ended June 30, 2009, the Company recorded a $513 restructuring charge
due to a change in the sublease probability assumption for a vacated facility. Any changes in the
future assumptions used in the Companys vacated facility accrual could result in additional
similar charges or reversals in the future. As of June 30, 2009, the Companys remaining
restructuring liability of $962 was comprised of facility related costs that are expected to be
paid over the remainder of the lease terms of one to three years.
21
Note 13 Subsequent Events
Management has reviewed and evaluated material subsequent events from the balance sheet date
of June 30, 2009 through the financial statements issue date of August 10, 2009. All appropriate
subsequent event disclosures, have been made in notes to our unaudited Condensed Consolidated
Financial Statements.
On July 8, 2009, the Company announced that L. Gregory Ballard, the Companys President and
Chief Executive Officer, had indicated his intention to transition his role with the Company to new
leadership. Mr. Ballard has agreed pursuant to a Transitional Employment Agreement to remain as
the Companys President and Chief Executive Officer for a transition period until the earlier of
the date a new Chief Executive Officer commences employment with the Company or January 1, 2010.
The Company anticipates incurring approximately $800 in costs associated with the Transitional
Employment Agreement and the search for Mr. Ballards successor during the second half of 2009.
22
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information in this discussion and elsewhere in this report contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon current
expectations that involve risks and uncertainties. Any statements contained herein that are not
statements of historical fact may be deemed to be forward-looking statements. For example, the
words may, will, believe, anticipate, plan, expect, intend, could, estimate,
continue and similar expressions or variations are intended to identify forward-looking
statements. In this report, forward-looking statements include, without limitation, the following:
|
|
|
our expectations and beliefs regarding the future conduct and growth of our
business; |
|
|
|
|
our expectations regarding competition and our ability to compete effectively; |
|
|
|
|
our expectations regarding the development of future products, including those for
next-generation platforms and social networking websites; |
|
|
|
|
our expectations regarding our revenues and expenses for the second half of 2009; |
|
|
|
|
our assumptions regarding the impact of Recent Accounting Pronouncements applicable to
us; |
|
|
|
|
our assessments and estimates that determine our effective tax rate and valuation
allowance; |
|
|
|
|
our belief that our cash and cash equivalents, borrowings under our revolving credit
facility and cash flows from operations will be sufficient to meet our working capital needs,
contractual obligations, debt service obligations, capital expenditure requirements and similar
commitments; |
|
|
|
|
our expectation that we will generate cash from operations in the second half of 2009; |
|
|
|
|
our expectation regarding the costs that will be associated with the transition of our
Chief Executive Officer and our ability to effect a smooth transition; |
|
|
|
|
our expectation regarding our ability to maintain
compliance with or amend the financial and
other covenants in our credit facility; and |
|
|
|
|
our assessments and beliefs regarding the future outcome of pending legal proceedings
and the liability, if any, that we may incur as a result of those proceedings. |
Our actual results and the timing of certain events may differ significantly from the results
discussed in the forward-looking statements. Factors that might cause such a discrepancy include,
but are not limited to, those discussed in Risk Factors elsewhere in this report. All
forward-looking statements in this document are based on information available to us as of the date
hereof, and we assume no obligation to update any such forward-looking statements to reflect future
events or circumstances.
The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the consolidated financial statements and related notes
contained elsewhere in this report. Our Managements Discussion and Analysis of Financial Condition
and Results of Operations (MD&A) includes the following sections:
|
|
An Overview that discusses at a high level our operating results and some of the trends
that affect our business; |
|
|
|
Critical Accounting Policies and Estimates that we believe are important to understanding
the assumptions and judgments underlying our financial statements; |
|
|
|
Recent Accounting Pronouncements; |
|
|
|
Results of Operations, including a more detailed discussion of our revenues and expenses;
and |
|
|
|
Liquidity and Capital Resources, which discusses key aspects of our statements of cash
flows, changes in our balance sheets and our financial commitments. |
23
Overview
This overview provides a high-level discussion of our operating results and some of the trends
that affect our business. We believe that an understanding of these trends is important to
understand our financial results for the second quarter and first six months of 2009, as well as
our future prospects. This summary is not intended to be exhaustive, nor is it intended to be a
substitute for the detailed discussion and analysis provided elsewhere in this report, including
our unaudited consolidated financial statements and accompanying notes.
Financial Results and Trends
Revenues for the three months ended June 30, 2009 were $19.9 million, a 16% decrease compared
to the three months ended June 30, 2008, in which we reported revenues of $23.7 million. Revenues
for the six months ended June 30, 2009 were $40.6 million, an 8% decrease compared to the six
months ended June 30, 2008, in which we reported revenues of $44.3 million. These decreases were
primarily driven by a decrease in handset unit sales in our traditional carrier business, which in
turn led to a decrease in the number of games that we sold, and the impact of foreign currency
exchange rates, which had a greater positive impact on our 2008 revenues compared to our 2009
revenues. Our revenues will continue to depend significantly on growth in the mobile games market
and our ability to continue to attract new end users in that market, purchases of new mobile
handsets and the overall strength of the economy, particularly in the U.S. Our future revenues
would be adversely affected if there were a continued slowdown in our carrier business, which we
expect will generate the vast majority of our revenues in 2009. Revenues from our traditional
carrier business will be affected by the overall strength of the global economy, the extent to
which consumers continue to migrate to next-generation platforms, such as the Apple App
Store, that enable the download of applications from sources other than a carriers branded
e-commerce service and whether the lower average prices for games on the next-generation platforms
will eventually result in lower average prices for games in our carrier business. In addition,
despite the movement by a growing number of consumers to these next generation platforms, to date,
next generation platforms have not been as significant a source of revenue for us and the market as
a whole as we expected. Our revenues may also be adversely impacted by decisions by our carriers to
alter their customer terms for downloading our games. For example, Verizon Wireless, our largest
carrier, imposes a data surcharge to download content on those Verizon customers who have not
otherwise subscribed to a data plan. Our revenues depend on a variety of other factors, including
our relationships with our carriers and licensors. Even if mobile games based on licensed content
or brands remain popular with end users, any of our licensors could decide not to renew our
existing license or not to license additional intellectual property to us and instead license to
our competitors or develop and publish their own mobile games or other applications, competing with
us in the marketplace. The loss of any key relationships with our carriers, other distributors or
licensors could impact our revenues in the future. We expect our 2009 revenues to be lower than our
2008 revenues, and in future periods, our revenues could continue to decline.
Our net loss in the three months ended June 30, 2009 was $1.5 million versus a net loss of
$6.6 million in the three months ended June 30, 2008. This decrease was driven primarily by a
decrease in operating expenses of $6.6 million, a decrease in costs of revenues of $1.1 million, an
increase in income tax benefit of $677,000 and an increase in interest and other income of
$556,000, which was partially offset by a $3.8 million reduction in revenues. Our net loss in the
six months ended June 30, 2009 was $7.3 million versus a net loss of $12.6 million in the six
months ended June 30, 2008. This decrease was driven primarily by a decrease in operating expenses
of $10.4 million, which was partially offset by a $3.6 million reduction in revenues, a decrease in
interest and other income of $863,000 and an increase in cost of revenues of $364,000. The
decreases in our operating expenses in the three and six months ended June 30, 2009 compared with
the corresponding periods in 2008 were in part due to the headcount reductions and related measures
that we took in connection with the restructurings that we implemented in the third and fourth
quarters of 2008 and the restructuring that we implemented in connection with our acquisition of
Superscape. Our operating results are also affected by fluctuations in foreign currency exchange
rates of the currencies in which we incur meaningful operating expenses
(principally the British Pound Sterling, Chinese Renminbi, Brazilian
Real and Russian Ruble) and our customers reporting currencies, as we transact business in more than 70 countries in
more than 20 different currencies, and in 2008 and the first six months of 2009, some of these
currencies fluctuated by up to 40%.
We expect that our expenses to develop and port games for new mobile platforms will increase
as we enhance our existing titles and develop new titles to take advantage of the additional
functionality offered by these platforms. In addition, we expect to incur additional expenses in
connection with our recently announced intention to increase our focus on developing games for
social networking websites. Our ability to attain profitability will be affected by our ability to
grow our revenues and 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 recurring expenses is personnel costs, which consist of salaries, benefits
and incentive
24
compensation, including bonuses and stock-based compensation, for our employees. We expect that our
cash expenses will remain relatively constant compared to the second quarter of 2009 in terms of
absolute dollars for the balance of the year.
Cash and cash equivalents at June 30, 2009 totaled $12.8 million, a decrease of $6.4 million
from $19.2 million at December 31, 2008. This decrease was primarily due to $9.0 million paid
during 2009 with respect to the promissory notes that we issued to the MIG shareholders that are
discussed in further detail in Significant Transactions below. In addition, we paid an additional
$5.2 million on July 1, 2009 with respect to the promissory notes issued to the MIG shareholders.
We also recognized a $3.9 million decrease in our accrued royalties and a $2.8 million reduction in
our accounts payables. These cash outflows were partially offset by net proceeds of $4.5 million
from the borrowings under our credit facility and a $2.9 million decrease in accounts receivable,
which was partially due to better than expected collections. We believe our cash and cash
equivalents, together with cash flows from operations and borrowings under our credit facility,
will be sufficient to meet our anticipated cash needs for at least the next 12 months.
Our expectations regarding cash sufficiency assume that our operating results will be
sufficient to enable us to continue to comply with the financial covenants contained in our
revolving credit facility. However, if our revenues are lower than we anticipate, we will be
required to further reduce our operating expenses to remain in compliance with these covenants.
Reducing our operating expenses could be very challenging for us, since we undertook operating
expense reductions and restructuring activities in the third and fourth quarters of 2008 that
reduced our operating expenses significantly from second quarter of 2008 levels. However, we expect
to continue our efforts to reduce operating expenses during the second half of 2009. Reducing our
operating expenses further than we currently anticipate could have the effect of reducing our
revenues. Our ability to comply with the EBITDA-related covenant will be further challenged due to
the approximately $800,000 in costs we expect to incur during the second half of 2009 related to
the transition of our Chief Executive Officer, any additional restructuring charges that we may
incur as we continue our efforts to reduce operating expenses and the adverse impact of recent
foreign currency movements on our operating results. We currently believe that we will be able to
comply with the EBITDA-related covenant in the third quarter of 2009,
but, due primarily to the unanticipated restructuring charges and
negative foreign currency movements
described in the preceding sentence, will likely not be able
to comply with this covenant in the fourth quarter of 2009 unless one or more of the following
occurs: (1) our revenues significantly exceed our expectations, (2) we are able to significantly
reduce our operating expenses after taking into account
restructuring charges and foreign currency movements, (3) foreign currency exchange rates move in a manner that
significantly and positively affect our operating results or (4) Silicon Valley Bank agrees either
to amend the credit facility in a manner that enables our compliance with this covenant or grant us
a waiver for any non-compliance with the covenant. We are currently
engaged in discussions with Silicon Valley Bank regarding amending
the credit facility to enable our prospective compliance with the EBITDA-related covenant and
believe that we will enter into such an amendment in the near future.
Significant Transactions
In December 2008, we renegotiated and extended our credit facility. The credit facility
provides for borrowings of up to $8.0 million, subject to a borrowing base equal to 80% of our
eligible accounts receivable.
In March 2008, we acquired Superscape, a global publisher of mobile games, to deepen and
broaden our game library, gain access to 3-D game development resources and to augment our internal
production and publishing resources with a studio in Moscow, Russia. We paid 10 pence (pound
sterling) in cash for each issued share of Superscape for a total purchase price of $38.8 million,
consisting of cash consideration of $36.8 million and transaction costs of $2.0 million. Due to
decreases in our long-term forecasts and current market capitalization, the entire goodwill
resulting from the Superscape acquisition was impaired during the year ended December 31, 2008.
In December 2007, we acquired MIG to accelerate our presence in China, deepen our relationship
with China Mobile, the largest wireless carrier in China, acquire access and rights to leading
franchises for the Chinese market, and augment our internal production and publishing resources
with a studio in China. We purchased all of MIGs then outstanding shares for a total purchase
price of $30.5 million, consisting of cash consideration to MIG shareholders of $14.7 million and
transaction costs of $1.3 million. As a result of the attainment of the revenue and operating
income milestones in 2008 by MIG, we were committed to pay the $20.0 million in additional
consideration to the MIG shareholders and the $5.0 million of bonuses to two officers of MIG. In
December 2008, we restructured the timing and nature of these payments and issued to former
shareholders of MIG an aggregate of $25.0 million in promissory notes, which are due in 2009 and
2010. Due to decreases in our long-term forecasts and current market capitalization, a portion of
the goodwill resulting from the MIG acquisition was impaired during the year ended December 31,
2008.
Critical Accounting Policies and Estimates
There were no significant changes in our Critical Accounting Policies and Estimates during the
six months ended June 30, 2009 as compared to the Critical Accounting Policies and Estimates
disclosed in Managements Discussion and Analysis of Financial Condition and Results of Operations
included in our Annual Report on Form 10-K for the year ended December 31, 2008.
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 report, which information is
incorporated herein by reference.
25
Results of Operations
Comparison of the Three Months Ended June 30, 2009 and 2008
Revenues
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Revenues |
|
$ |
19,872 |
|
|
$ |
23,704 |
|
Our revenues decreased $3.8 million, or 16.2%, from $23.7 million for the three months ended
June 30, 2008 to $19.9 million for the three months ended June 30, 2009, due primarily to a
decrease in handset unit sales in our traditional carrier business, which in turn led to a decrease
in the number of games that we sold. Foreign currency exchange rates also had a greater positive
impact on our revenues for the three months ended June 30, 2008 compared to the three months ended
June 30, 2009. In addition, our revenues for the three months ended June 30, 2008 benefitted as a
result of the transition to accrual accounting for China Mobile, as we recognized additional
revenues of $697,000 from China Mobile during the three months ended June 30, 2008 that would
otherwise have been recognized during the three months ended September 30, 2008. International
revenues (defined as revenues generated from carriers whose principal operations are located
outside the United States) decreased by $2.3 million, from $12.5 million in the three months ended
June 30, 2008 to $10.2 million in the three months ended June 30, 2009. The decrease in
international revenues was primarily a result of decreased unit sales in China and EMEA, which was
partially offset by increased unit sales in Latin America. We expect our 2009 revenues to be lower
than our 2008 revenues as a result of the decrease in growth of our carrier-based business,
primarily as a result of the overall decline in the strength of the economy and declines in the
rate of purchases of new mobile handsets.
Cost of Revenues
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
Cost of revenues: |
|
|
|
|
|
|
|
|
Royalties |
|
$ |
5,667 |
|
|
$ |
5,633 |
|
Impairment of prepaid royalties and guarantees |
|
|
589 |
|
|
|
|
|
Amortization of intangible assets |
|
|
1,412 |
|
|
|
3,135 |
|
|
|
|
|
|
|
|
Total cost of revenues |
|
$ |
7,668 |
|
|
$ |
8,768 |
|
|
|
|
|
|
|
|
Revenues |
|
$ |
19,872 |
|
|
$ |
23,704 |
|
|
|
|
|
|
|
|
Gross margin |
|
|
61.4 |
% |
|
|
63.0 |
% |
Our cost of revenues decreased $1.1 million, or 12.5%, from $8.8 million in the three months
ended June 30, 2008 to $7.7 million in the three months ended June 30, 2009. The decrease was due
to a $1.7 million reduction in amortization for titles and content associated with intangible
assets acquired from Superscape that were fully amortized in the first quarter of 2009, which was
partially offset by a $589,000 charge associated with the impairment of certain royalty guarantees.
Revenues attributable to games based upon branded intellectual property increased as a percentage
of revenues from 72.4% in the three months ended June 30, 2008 to 79.2% in the three months ended
June 30, 2009, primarily due to a decrease in sales of games developed by MIG and Superscape based
on their original intellectual property. The average royalty rate that we paid on games based on
licensed intellectual property increased from 32.8% in the three months ended June 30, 2008 to
36.0% in the three months ended June 30, 2009 due to increased sales of titles with higher royalty
rates. Overall royalties, including impairment of prepaid royalties and guarantees, as a percentage
of total revenues increased from 23.8% in the three months ended June 30, 2008 to 31.5% in the
three months ended June 30, 2009.
26
Research and Development Expenses
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Research and development expenses |
|
$ |
6,648 |
|
|
$ |
8,861 |
|
Percentage of revenues |
|
|
33.5 |
% |
|
|
37.4 |
% |
Our research and development expenses decreased $2.2 million, or 25.0%, from $8.9 million in
the three months ended June 30, 2008 to $6.6 million in the three months ended June 30, 2009. The
decrease in research and development costs was primarily due to decreases in salaries and benefits
of $1.0 million, outside services costs of $567,000 and facility and overhead costs of $478,000 due
to reduced headcount in higher cost locations and a reduction in third-party outside services costs
for porting and external development.
Research and development staff decreased from 444 employees at June 30, 2008 to 413 as of June
30, 2009, and salaries and benefits decreased as a result. As a percentage of revenues, research
and development expenses declined to 33.5% for the three months ended June 30, 2009 compared to
37.4% for the three months ended June 30, 2008. Research and development expenses included $200,000
of stock-based compensation expense in the three months ended June 30, 2009 and $174,000 in the
three months ended June 30, 2008.
Sales and Marketing Expenses
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Sales and marketing expenses |
|
$ |
3,546 |
|
|
$ |
6,042 |
|
Percentage of revenues |
|
|
17.8 |
% |
|
|
25.5 |
% |
Our sales and marketing expenses decreased $2.5 million, or 41.3%, from $6.0 million in the
three months ended June 30, 2008 to $3.5 million in the three months ended June 30, 2009. The
decrease was primarily due to a decrease in stock-based compensation of $1.1 million primarily
related to the MIG stock-based compensation earnout no longer being recorded, a $700,000 decrease
in salaries, benefits, variable compensation and expatriate costs as we reduced our sales and
marketing headcount from 76 at June 30, 2008 to 67 at June 30, 2009, a $403,000 decrease in the MIG
earnout expense due to lower amortization associated with reaching the end of the vesting terms and
conditions, a $134,000 decrease in travel and entertainment and a $102,000 decrease in marketing
and promotion costs. As a percentage of revenues, sales and marketing expenses decreased from 25.5%
in the three months ended June 30, 2008 to 17.8% in the three months ended June 30, 2009. Sales and
marketing expenses included $159,000 of stock-based compensation expense in the three months ended
June 30, 2009 and $1.3 million in the three months ended June 30, 2008.
General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
General and administrative expenses |
|
$ |
3,905 |
|
|
$ |
6,096 |
|
Percentage of revenues |
|
|
19.7 |
% |
|
|
25.7 |
% |
Our general and administrative expenses decreased $2.2 million, or 35.9%, from $6.1 million in
the three months ended June 30, 2008 to $3.9 million in the three months ended June 30, 2009. The
decrease in general and administrative expenses was primarily due to a $912,000 decrease in
salaries and benefits, an $830,000 decrease in professional and consulting fees and a $149,000
decrease in stock-based compensation. We decreased our general and administrative
headcount from 84 at June 30, 2008 to 68 at June 30, 2009 and salaries and benefits and stock-based compensation
decreased as a result. As a percentage of revenues, general and administrative
27
expenses decreased from 25.7% in the three months ended June 30, 2008 to 19.7% in the three months ended June 30,
2009. General and administrative expenses included $405,000 of stock-based compensation expense in
the three months ended June 30, 2009 and $554,000 in the three months ended June 30, 2008.
Other Operating Expenses
Our restructuring charge increased from $86,000 during the three months ended June 30, 2008 to
$513,000 during the three months ended June 30, 2009. This was due to an additional $513,000
restructuring charge due to a change in the sublease probability assumption for a vacated facility.
Our in-process research and development (IPR&D) was $71,000 in the three months ended June
30, 2008; there was no charge in the three months ended June 30, 2009. The IPR&D charge recorded in
2008 related to the in-process development of new 2D and 3D games by Superscape at the date of
acquisition. We determined the value of acquired IPR&D from Superscape using a discounted cash
flows approach. We calculated the present value of expected future cash flows attributable to the
in-process technology using a 22% discount rate. This rate took into account the percentage of
completion of the development effort ranging from approximately 20% to 50% and the risks associated
with our developing technology given changes in trends and technology in our industry. As of
December 31, 2008, all acquired IPR&D projects had been completed at a cost similar to the original
projections.
Other Expenses
Interest and other income/(expense), net, increased from a net expense of $99,000 during the
three months ended June 30, 2008 to a net income of $457,000 in the three months ended June 30,
2009. This change was primarily due to an increase in foreign currency gains of $825,000 related to
the revaluation of certain assets and liabilities, partially offset by a decrease in interest
income of $128,000 resulting from lower cash balances as a result of the MIG and Superscape
acquisitions and an increase of $354,000 in interest expense related to the MIG notes and
borrowings under our credit facility. We expect to generate minimal interest income during 2009 as
a result of lower cash balances and lower yields on our investments, which are predominately in
cash or cash equivalent securities bearing minimal interest. We also expect to incur interest
expense on the MIG notes and borrowings under our credit facility through 2010.
Income Tax Provision
Income tax provision decreased from $213,000 in the three months ended June 30, 2008 to an
income tax benefit of $464,000 in the three months ended June 30, 2009 primarily as a result of the
interim period tax allocation and changes in income tax in certain foreign entities. We expect our
effective tax rate in 2009 to fluctuate on a quarterly basis. The effective tax rate could be
affected by changes in the valuation of our deferred tax assets, changes in actual results versus
our estimates, or by changes in tax laws, regulations, accounting principles, or interpretations
thereof.
Comparison of the Six Months Ended June 30, 2009 and 2008
Revenues
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Revenues |
|
$ |
40,647 |
|
|
$ |
44,296 |
|
Our revenues decreased $3.6 million, or 8.2%, from $44.3 million for the six months ended June
30, 2008 to $40.6 million for the six months ended June 30, 2009, due primarily to a decrease in
handset unit sales in our traditional carrier business, which in turn led to a decrease in the number of games that we sold. Foreign currency exchange rates also had a
greater positive impact on our revenues for the six months ended June 30, 2008 compared to the six
months ended June 30, 2009. In addition, our revenues for the six months ended June 30, 2008
benefitted as a result of the transition to accrual accounting for China Mobile, as we recognized
additional revenues of $697,000 from China Mobile during the three months ended June 30, 2008 that
would otherwise have been recognized during the three months ended September 30, 2008. Our revenues
for the six months ended June 30, 2009 were positively impacted
by $700,000 of one-time revenue
from an APAC customer. International revenues decreased by $2.7 million, from $23.6 million in the
28
six months ended June 30, 2008 to $20.9 million in the six months ended June 30, 2009. The decrease
in international revenues was primarily a result of decreased unit sales in China and EMEA, which
was partially offset by increased unit sales in Latin America.
Cost of Revenues
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
|
2009 |
|
|
2008 |
|
|
|
(in thousands) |
|
Cost of revenues: |
|
|
|
|
|
|
|
|
Royalties |
|
$ |
11,480 |
|
|
$ |
11,123 |
|
Impairment of prepaid royalties and guarantees |
|
|
589 |
|
|
|
|
|
Amortization of intangible assets |
|
|
4,260 |
|
|
|
4,842 |
|
|
|
|
|
|
|
|
Total cost of revenues |
|
$ |
16,329 |
|
|
$ |
15,965 |
|
|
|
|
|
|
|
|
Revenues |
|
$ |
40,647 |
|
|
$ |
44,296 |
|
|
|
|
|
|
|
|
Gross margin |
|
|
59.8 |
% |
|
|
64.0 |
% |
Our cost of revenues increased $364,000, or 2.3%, from $16.0 million in the six months ended
June 30, 2008 to $16.3 million in the six months ended June 30, 2009. This increase was due to a
$589,000 charge associated with the impairment of certain royalty guarantees and a $357,000
increase in royalties, which was partially offset by a $582,000 reduction in amortization for
titles and content associated with intangible assets acquired from Superscape that were fully
amortized in the first quarter of 2009. Revenues attributable to games based upon branded
intellectual property increased as a percentage of revenues from 76.1% in the six months ended June
30, 2008 to 77.5% in the six months ended June 30, 2009, primarily due to a decrease in sales of
games developed by MIG and Superscape based on their original intellectual property. The average
royalty rate that we paid on games based on licensed intellectual property increased from 33.0% in
the six months ended June 30, 2008 to 36.5% in the six months ended June 30, 2009 due to increased
sales of titles with higher royalty rates. Overall royalties, including impairment of prepaid
royalties and guarantees, as a percentage of total revenues increased from 25.1% in the six months
ended June 30, 2008 to 29.7% in the six months ended June 30, 2009.
Research and Development Expenses
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Research and development expenses |
|
$ |
13,045 |
|
|
$ |
15,381 |
|
Percentage of revenues |
|
|
32.1 |
% |
|
|
34.7 |
% |
Our research and development expenses decreased $2.3 million, or 15.2%, from $15.4 million in
the six months ended June 30, 2008 to $13.0 million in the six months ended June 30, 2009. The
decrease in research and development costs was primarily due to decreases in salaries and benefits
of $892,000, outside services costs of $675,000 and facility and overhead costs of $670,000 due to
reduced headcount in higher cost locations and a reduction in third-party outside services costs
for porting and external development.
Research and development staff decreased from 444 employees at June 30, 2008 to 413 as of June
30, 2009, and salaries and benefits decreased as a result. As a percentage of revenues, research
and development expenses declined to 32.1% for the six months ended June 30, 2009 compared to 34.7%
for the six months ended June 30, 2008. Research and development expenses included $380,000 of
stock-based compensation expense in the six months ended June 30, 2009 and $250,000 in the six
months ended June 30, 2008.
29
Sales and Marketing Expenses
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Sales and marketing expenses |
|
$ |
7,658 |
|
|
$ |
11,824 |
|
Percentage of revenues |
|
|
18.8 |
% |
|
|
26.7 |
% |
Our sales and marketing expenses decreased $4.2 million, or 35.2%, from $11.8 million in the
six months ended June 30, 2008 to $7.6 million in the six months ended June 30, 2009. The decrease
was primarily due to a decrease in stock-based compensation of $2.3 million primarily related to
the MIG stock-based compensation earnout no longer being recorded, a $1.1 million decrease in
salaries and benefits as we reduced our sales and marketing headcount from 76 at June 30, 2008 to
67 at June 30, 2009, a $368,000 decrease in the MIG earnout expense due to lower amortization
associated with reaching the end of the vesting terms and conditions, a $266,000 decrease in travel
and entertainment and a $183,000 decrease in facility and overhead costs due to reduced headcount.
As a percentage of revenues, sales and marketing expenses decreased from 26.7% in the six months
ended June 30, 2008 to 18.8% in the six months ended June 30, 2009. Sales and marketing expenses
included $310,000 of stock-based compensation expense in the six months ended June 30, 2009 and
$2.6 million in the six months ended June 30, 2008.
General and Administrative Expenses
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
General and administrative expenses |
|
$ |
8,390 |
|
|
$ |
11,491 |
|
Percentage of revenues |
|
|
20.6 |
% |
|
|
25.9 |
% |
Our general and administrative expenses decreased $3.1 million, or 27.0%, from $11.5 million
in the six months ended June 30, 2008 to $8.4 million in the six months ended June 30, 2009. The
decrease in general and administrative expenses was primarily due to a $1.5 million decrease in
salaries and benefits, a $991,000 decrease in professional and consulting fees, a $310,000 decrease
in stock-based compensation and a $129,000 decrease in travel and entertainment costs. We decreased
our general and administrative headcount from 84 at June 30, 2008 to 68 at June 30, 2009 and
salaries and benefits and stock-based compensation decreased as a result. As a percentage of
revenues, general and administrative expenses decreased from 25.9% in the six months ended June 30,
2008 to 20.6% in the six months ended June 30, 2009. General and administrative expenses included
$838,000 of stock-based compensation expense in the six months ended June 30, 2009 and $1.1 million
in the six months ended June 30, 2008.
Other Operating Expenses
Our restructuring charge increased from $161,000 during the six months ended June 30, 2008 to
$513,000 during the six months ended June 30, 2009. This was primarily due to an additional
$513,000 restructuring charge due to a change in the sublease probability assumption for a vacated
facility.
Our IPR&D charge was $1.1 million in the six months ended June 30, 2008; there was no charge
in the six months ended June 30, 2009. The IPR&D charge recorded in 2008 related to the in-process
development of new 2D and 3D games by Superscape at the date of acquisition.
Other Expenses
Interest and other income/(expense), net, decreased from a net income of $513,000 during the
six months ended June 30, 2008 to a net expense of $350,000 in the six months ended June 30, 2009.
This change was primarily due to an increase of $708,000 in interest expense related to the MIG
notes and borrowings under our credit facility, a decrease in interest income of $638,000 resulting
from lower cash balances as a result of the MIG and Superscape acquisitions, and offset by a
$483,000 decrease in other expense due to lower mark to market charges for long-term investments
during 2009.
Income Tax Provision
Income tax provision increased from $1.3 million in the six months ended June 30, 2008 to $1.6
million in the six months ended June 30, 2009 primarily as a result of the interim period tax
allocation and changes in income tax in certain foreign entities.
30
Liquidity and Capital Resources
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30, |
|
|
2009 |
|
2008 |
|
|
(in thousands) |
Consolidated Statement of Cash Flows Data: |
|
|
|
|
|
|
|
|
Capital expenditures |
|
$ |
375 |
|
|
$ |
3,357 |
|
Depreciation and amortization |
|
|
5,538 |
|
|
|
6,411 |
|
Cash flows provided by/(used in) operating activities |
|
|
(1,434 |
) |
|
|
99 |
|
Cash flows used in investing activities |
|
|
(375 |
) |
|
|
(34,058 |
) |
Cash flows provided by/(used in) financing activities |
|
|
(4,469 |
) |
|
|
259 |
|
Since our inception, we have incurred recurring losses and negative annual cash flows from
operating activities, and we had an accumulated deficit of $166.4 million and $159.1 million as of
June 30, 2009 and December 31, 2008, respectively. Prior to our initial public offering, our
primary sources of liquidity had 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 quarter ended March 31, 2007, we raised $74.8 million of
proceeds, net of underwriting discounts and estimated expenses, in our initial public offering. In
the future, we anticipate that our primary sources of liquidity will be our cash and cash
equivalents, cash generated from our operating activities and borrowing under our revolving credit
facility.
Operating Activities
For the six months ended June 30, 2009, net cash used in operating activities was $1.4
million, primarily due to our net loss of $7.3 million, the net change in our operating assets and
liabilities of $2.5 million, and non-cash foreign currency translation gain of $317,000, which was
partially offset by adjustments for non-cash items including amortization expense of $4.4 million,
stock-based compensation expense of $1.5 million, depreciation expense of $1.2 million, MIG earnout
expense of $875,000 and interest expense on debt of $606,000.
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
used in operating activities.
Investing Activities
In the six months ended June 30, 2009, we used $375,000 of cash for investing activities
resulting primarily from purchases of property and equipment, all of which related to additional
network and server equipment.
In the six months ended June 30, 2008, we used $34.1 million of cash for investing activities.
This net cash usage resulted from the acquisition of Superscape, net of cash acquired, of $30.0
million, additional cash payments of $693,000 for professional fees related to the acquisition of
MIG and purchases of property and equipment of $3.4 million primarily related to moving our
corporate headquarters.
Financing Activities
In the six months ended June 30, 2009, net cash used in financing activities which was $4.5
million due to the payment of $9.0 million related to the MIG notes, which was partially offset by
the net proceeds from borrowings under our credit facility of $4.5 million. In addition, we paid an
additional $5.2 million on July 1, 2009 with respect to the promissory notes issued to the MIG
shareholders.
In the six months ended June 30, 2008, net cash provided by financing activities was $259,000,
substantially all of which came from the proceeds from the exercise of stock options and warrants.
31
Sufficiency of Current Cash and Cash Equivalents
Our cash and cash equivalents were $12.8 million as of June 30, 2009. During the six months
ended June 30, 2009, we used $6.4 million of cash. We expect to continue to fund our operations and
satisfy our contractual obligations for the remainder of 2009 primarily through our cash and cash
equivalents, borrowings under our revolving credit facility and cash generated by operations during
the second half of 2009. However, there can be no assurances that we will be able to generate
positive operating cash flow during the second half of 2009 or beyond. We believe our cash and cash
equivalents, together with cash flows from operations and borrowings under our credit facility,
will be sufficient to meet our anticipated cash needs for at least the next 12 months. However, our
cash requirements for the next 12 months may be greater than we anticipate due to, among other
reasons, lower than expected cash generated from operating activities including the impact of
foreign currency rate changes, revenues that are lower than we currently anticipate, greater than
expected operating expenses, usage of cash to fund our foreign operations, unanticipated
limitations or timing restrictions on our ability to access funds that are held in our non-U.S.
subsidiaries, a deterioration of the quality of our accounts receivable, which could lower the
borrowing base under our credit facility, and any failure on our part to remain in compliance with
the covenants under our revolving credit facility. Our expectations regarding cash sufficiency
assume that our operating results will be sufficient to enable us to comply with our credit
facilitys EBITDA-related covenant discussed below. If our revenues are lower than we anticipate, we
will be required to reduce our operating expenses to remain in compliance with this financial
covenant. Reducing our operating expenses could be very challenging for us, since we undertook
operating expense reductions and restructuring activities in the third and fourth quarters of 2008
that reduced our operating expenses significantly from second quarter of 2008 levels. However, we
expect to continue our efforts to reduce operating expenses during the second half of 2009.
Reducing operating expenses further than we currently anticipate could have the effect of reducing
our revenues. Our ability to comply with the EBITDA-related financial covenant will be further
challenged due to the approximately $800,000 in costs we expect to incur during the second half of
2009 related to the transition of our Chief Executive Officer, any additional restructuring charges
that we may incur as we continue our efforts to reduce operating expenses and the adverse impact of
recent foreign currency movements on our operating results.
Our cash needs include our requirement to repay $11.0 million of principal under the MIG notes
as of June 30, 2009, $5.0 million of which we repaid on July 1, 2009 and $6.0 million of which is
payable in 2010, as well as $5.0 million of principal under promissory notes issued to two former
shareholders of MIG which is payable in 2010. (See Note 7 of Notes to Unaudited Consolidated
Financial Statements included in Part I, Item I of this report for more information regarding our debt.)
Our anticipated cash requirements during 2009 also include payments for prepaid royalties and
guarantees, of which a portion is related to anticipated new license agreements (for
which there is no existing contractual commitment), which amount we may elect to reduce if we
require more working capital than we currently anticipate. (See Note 6 of Notes to Unaudited
Consolidated Financial Statements included in Part I, Item I of this report for more information regarding
our contractual commitments.) However, this reduced spending on new licenses and any additional
reduction in spending may adversely impact our title plan for 2010 and beyond, and accordingly our
ability to generate revenues in future periods. Conversely, if cash available to us is greater than
we currently anticipate, we may elect to increase prepaid royalties above currently anticipated
levels if we believe it will contribute to enhanced revenue growth and profitability.
We currently have an $8.0 million credit facility, which expires in December 2010. Our credit
facility contains financial covenants and restrictions that limit our ability to draw down the
entire $8.0 million. These covenants are as follows:
|
|
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). We must
maintain, measured on a consolidated basis at the end of each of the following periods, EBITDA
of at least the following: |
|
|
|
|
|
January 1, 2009 through June 30, 2009 |
|
$ |
(812,000 |
) |
April 1, 2009 through September 30, 2009 |
|
$ |
1,572,000 |
|
July 1, 2009 through December 31, 2009 |
|
$ |
4,263,000 |
|
October 1, 2009 through March 31, 2010 |
|
$ |
5,092,000 |
|
January 1, 2010 through June 30, 2010 |
|
$ |
5,257,000 |
|
April 1, 2010 through September 30, 2010 |
|
$ |
5,298,000 |
|
July 1, 2010 through December 31, 2010 |
|
$ |
6,073,000 |
|
For purposes of the above covenant, EBITDA means (a) our consolidated net income, determined in
accordance with U.S. generally accepted accounting principles, plus (b) interest expense, plus (c)
to the extent deducted in the calculation of net income, depreciation expense and amortization
expense, plus (d) income tax expense, plus (e) non-cash stock compensation expense, plus (f)
non-cash
32
goodwill and other intangible assets and royalty impairments, plus (g) non-cash foreign
exchange translation charges, minus (h) all of our non-cash income and the non-cash income of our
subsidiaries for such period.
|
|
Minimum Domestic Liquidity: We must maintain at the lender an amount of cash, cash
equivalents and short-term investments of not less than the greater of: (a) 20% of our total
consolidated unrestricted cash, cash equivalents and short-term investments, or (b) 15% of
outstanding obligations under the credit facility. |
Our credit facility is collateralized by eligible customer accounts receivable balances, as
defined by the lender. There can be no assurances that our eligible accounts receivable balances
will be adequate to allow us to draw down on the entire $8.0 million credit facility particularly
if any of our larger customers creditworthiness deteriorates. In addition, among other things, the
credit facility limits our ability to dispose of certain assets, make acquisitions, incur
additional indebtedness, incur liens, pay dividends and make other distributions, and make
investments. Further, the credit facility requires us to maintain a separate account with the
lender for collection of our accounts receivables. All deposits into this account will be
automatically applied by the lender to our outstanding obligations under the credit facility.
As of June 30, 2009, we had outstanding borrowings of $4.5 million under our credit facility.
Our failure to comply with the financial or operating covenants in the credit facility would not
only prohibit us from borrowing under the facility, but would also constitute a default, permitting
the lender to, among other things, declare any outstanding borrowings, including all accrued
interest and unpaid fees, immediately due and payable. A change in control of Glu also constitutes
an event of default, permitting the lender to accelerate the indebtedness and terminate the credit
facility. The credit facility also contains other customary events of default. To the extent an
event of default occurred under the credit facility and the lender accelerated the indebtedness and
terminated the credit facility, this would also trigger the cross-default provisions of the MIG
notes. Utilizing our credit facility results in debt payments that bear interest at the lenders
prime rate plus 1.0%, but no less than 5.0%, which adversely impacts our cash position and result
in operating and financial covenants that restrict our operations. See Note 7 of Notes to Unaudited
Consolidated Financial Statements included in Part I, Item 1 of this report for more information
regarding our credit facility.
The credit facility matures on December 29, 2010, when all amounts outstanding will be due. If
the credit facility is terminated prior to maturity by us or by the lender after the occurrence and
continuance of an event of default, then we will owe a termination fee equal to $80,000, or 1.00%
of the total commitment.
As of June 30, 2009, we were in compliance with all covenants. We currently believe that we
will be able to comply with the EBITDA-related covenant in the third
quarter of 2009, but, due primarily to the unanticipated restructuring charges and negative foreign currency movements
described in the first paragraph of this section,
will
likely not be able to comply with this covenant in the fourth quarter of 2009 unless one or more of
the following occurs: (1) our revenues significantly exceed our expectations, (2) we are able to
significantly reduce our operating expenses after taking into account restructuring charges and foreign currency movements,
(3) foreign currency exchange rates move in a manner
that significantly and positively affect our operating results or (4) Silicon Valley Bank agrees
either to amend the credit facility in a manner that enables our compliance with this covenant or
grant us a waiver for any non-compliance with the covenant. We are
currently engaged in discussions with Silicon Valley Bank regarding amending
the credit facility to enable our prospective compliance with the EBITDA-related covenant and
believe that we will enter into such an amendment in the near future.
Of the $12.8 million of cash and cash equivalents that we held at June 30, 2009, approximately
$4.9 million were held in accounts in China. To fund our operations and repay our debt obligations,
we repatriated approximately $4.0 million of available funds from China to the U.S during the three
months ended June 30, 2009, which was subject to withholding taxes of 5%. In addition, given the
current global economic environment and other potential developments outside of our control, we may
be unable to utilize the funds that we hold in all of our non-U.S. accounts, which funds include
cash and marketable securities, since the funds may be frozen by additional international
regulatory actions, the accounts may become illiquid for an indeterminate period of time or there
may be other such circumstances that we are unable to predict.
In addition, we may require additional cash resources due to changes in business conditions or
other future developments, including any investments or acquisitions we may decide to pursue, and
to defend against, settle or pay damages related to a litigation dispute to which we are currently
a party. We also intend to enter into new licensing arrangements for existing or new licensed
intellectual properties, which may require us to make royalty payments at the outset of the
agreements well before we are able to collect cash payments and/or recognize revenues associated
with the licensed intellectual properties.
If our cash sources are insufficient to satisfy our cash requirements, we may be required to
sell convertible debt or equity securities to raise additional
capital or may need to seek to either increase the amount
available to us for borrowing under our credit facility or
restructure our obligations under the MIG notes. We may be unable to raise additional
capital through the sale of securities, or to do so on terms that are favorable to us, particularly
given current capital market and overall economic conditions. Any sale of convertible debt
securities or additional equity securities could result in substantial dilution to our
stockholders. The holders of new securities may also receive rights, preferences or privileges that
are senior
33
to those of existing holders of our common stock, all of which is subject to the
provisions of the credit facility. Additionally, we may be unable to increase the size of our
credit facility, or to do so on terms that are acceptable to us, particularly in light of the
current credit market conditions. We may also be unable to restructure our obligations under the MIG notes. If the amount of cash that we generate from operations is less
than anticipated, we could also be required to extend the term beyond its December 2010 expiration
date (or replace it with an alternate loan arrangement), and resulting debt payments thereunder
could further inhibit our ability to achieve profitability in the future.
If we do not adequately address the liquidity matters discussed in this section, the audit
report included in our Form 10-K for the year ending December 31, 2009 may include an explanatory
paragraph regarding our ability to continue as a going concern.
Contractual Obligations
The following table is a summary of our contractual obligations as of June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
Total |
|
1 Year* |
|
1-3 Years |
|
3-5 Years |
|
Thereafter |
|
|
(in thousands) |
Operating lease obligations, net of sublease income |
|
$ |
7,514 |
|
|
$ |
1,870 |
|
|
$ |
5,468 |
|
|
$ |
176 |
|
|
$ |
|
|
Guaranteed royalties(1) |
|
|
9,458 |
|
|
|
4,785 |
|
|
|
4,623 |
|
|
|
50 |
|
|
|
|
|
MIG earnout and bonus notes(2) |
|
|
16,552 |
|
|
|
5,192 |
|
|
|
11,360 |
|
|
|
|
|
|
|
|
|
FIN 48 obligations, including interest and penalties(3) |
|
|
4,470 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,470 |
|
Line of credit |
|
|
4,547 |
|
|
|
4,547 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Represents the remaining six months of 2009
|
|
(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. Some of these agreements require us to pay guaranteed
royalties over the term of the contracts regardless of actual game
sales. Some of these minimum payments totaling $9.2 million have been
recorded as liabilities on our unaudited consolidated balance sheet
because payment is not contingent upon performance by the licensor. |
|
(2) |
|
We have issued $25.0 million of notes payable to former shareholders
of MIG, of which we had paid an aggregate principal amount of $14.0
million as of July 31, 2009. The amounts in the table above include
interest accrued through June 30, 2009. See Note 7 of Notes to
Unaudited Consolidated Financial Statements included in Part I, Item 1
of this report for further details. |
|
(3) |
|
As of June 30, 2009, unrecognized tax benefits and potential interest
and penalties were classified within Other long-term liabilities on
our consolidated balance sheets. As of June 30, 2009, the settlement
of our income tax liabilities cannot be determined; however, the
liabilities are not expected to become due within the next twelve
months. |
Off-Balance Sheet Arrangements
At June 30, 2009, we did not have any significant off-balance sheet arrangements, as defined
in Item 303(a)(4)(ii) of Regulation S-K.
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.
34
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate and Credit Risk
Our exposure to interest rate risk relates primarily to (1) our interest payable under our
$8.0 million credit facility and potential increases in our interest payments arising from
increases in interest rates and (2) our investment portfolio and the potential losses arising from
changes in interest rates.
We are exposed to the impact of changes in interest rates as they affect interest payments
under our $8.0 million credit facility. Advances under the credit facility accrue interest at rates
that are equal to our credit facility lenders prime rate, plus 1.0%, but no less than 5.0%.
Consequently, our interest expense will fluctuate with changes in the general level of interest
rates. At June 30, 2009, we had $4.5 million outstanding under the credit facility and our
effective interest rate at that time was approximately 5.0%. We believe that a 10% change in the
lenders prime rate would have a significant impact on our interest expense, results of operations
and liquidity.
We are also potentially exposed to the impact of changes in interest rates as they affect
interest earned on our investment portfolio. As of June 30, 2009, we had no short-term investments
and substantially all $12.8 million of our cash and cash equivalents was held in operating bank
accounts earning nominal interest. Accordingly, we do not believe that a 10% change in interest
rates would have a significant impact on our interest income, operating results or liquidity
related to these amounts.
The primary objectives of our investment activities are, in order of importance, to preserve
principal, provide liquidity and maximize income without significantly increasing risk. We do not
currently use or plan to use derivative financial instruments in our investment portfolio.
As of June 30, 2009 and December 31, 2008, our cash and cash equivalents were maintained by
financial institutions in the United States, the United Kingdom, Brazil, Chile, China, France,
Germany, Hong Kong, Italy, Russia and Spain, and our current deposits are likely in excess of
insured limits.
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. As of June 30, 2009 and December 31, 2008, Verizon
Wireless accounted for 25.3% and 25.7% of our total accounts receivable, respectively, and no other
carrier represented more than 10% of our total accounts receivable as of these dates.
Foreign Currency Exchange Risk
We transact business in more than 70 countries in more than 20 different currencies, and in
2008, some of these currencies fluctuated by up to 40%. Our revenues are usually denominated in the
functional currency of the carrier while the operating expenses of our operations outside of the
United States are maintained in their local currency, with the significant currencies consisting of
British Pound Sterling (GBP), Chinese Renminbi, Brazilian Real and Russian Ruble. Although
recording operating expenses in the local currency of our foreign operations mitigates some of the
exposure of foreign currency fluctuations, variances among the currencies of our customers and our
foreign operations relative to the United States Dollar (USD) could have and have had a material
impact on our results of operations.
Our foreign currency exchange gains and losses have been generated primarily from fluctuations
in GBP versus the USD and in the Euro versus GBP. 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. Translation adjustments arising from the use of
differing exchange rates are included in accumulated other comprehensive income in stockholders
equity. We have in the past experienced, and in the future may experience, foreign currency
exchange gains and losses on our accounts receivable and intercompany receivables and payables.
Foreign currency exchange gains and losses could have a material adverse effect on our business,
operating results and financial condition.
There is also additional risk if the currency is not freely or actively traded. Some
currencies, such as the Chinese Renminbi, in which our Chinese operations principally transact
business, are subject to limitations on conversion into other currencies, which can limit out
ability to react to foreign currency devaluations.
To date, we have not engaged in exchange rate hedging activities and we do not expect to do so
in the foreseeable future.
35
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Based upon an evaluation of the effectiveness of disclosure controls and procedures, our Chief
Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that, as of the end of the
period covered by this report, our disclosure controls and procedures, as defined under Exchange
Act Rule 13a-15(e) and 15d-15(e), were effective to provide reasonable assurance that information
required to be disclosed in our Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified by the SEC and is accumulated and communicated to
management, including the CEO and CFO, as appropriate to allow timely decisions regarding required
disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during
the six months ended June 30, 2009 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
36
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are subject to various claims, complaints and legal actions in the
normal course of business. For example, we are engaged in a contractual dispute with a licensor,
Skinit, Inc., related to, among other claims, alleged underpayment of royalties and failure to
perform under a distribution agreement, pursuant to which Skinit previously claimed that it is owed
approximately $600,000. On April 21, 2009, Skinit filed a complaint against us and other
defendants, seeking unspecified damages plus attorneys fees and costs. The complaint, filed in
the Superior Court of California in Orange County (case number 30-2009), alleges breach of
contract, interference with economic relations, conspiracy and misrepresentation of fact. On June
25, 2009, we filed a motion in the Superior Court in Orange County requesting an order compelling
Skinit to arbitrate its claim against us and requesting that the court stay the action pending the
determination of the motion and the subsequent arbitration. On July 30, 2009, the court granted
our motion in its entirety and the dispute will now proceed to arbitration.
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, financial position or liquidity. However, the
ultimate outcome of any litigation is uncertain and, regardless of outcome, litigation can have an
adverse impact on us because of defense costs, potential negative publicity, diversion of
management resources and other factors.
ITEM 1A. RISK FACTORS
Our business is subject to many risks and uncertainties, which may affect our future financial
performance. If any of the events or circumstances described below occurs, our business and
financial performance could be harmed, our actual results could differ materially from our
expectations and the market value of our stock could decline. The risks and uncertainties discussed
below are not the only ones we face. There may be additional risks and uncertainties not currently
known to us or that we currently do not believe are material that may harm our business and
financial performance. Because of the risks and uncertainties discussed below, as well as other
variables affecting our operating results, past financial performance should not be considered as a
reliable indicator of future performance and investors should not use historical trends to
anticipate results or trends in future periods.
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 $12.3 million in
2006, a net loss of $3.3 million in 2007, a net loss of $106.7 million in 2008 and a net loss of
$7.3 million for the first six months of 2009. As of June 30, 2009, we had an accumulated deficit
of $166.4 million. During 2008, we incurred aggregate charges of approximately $77.6 million for
goodwill, royalty impairments and restructuring activities. We also expect to incur costs of
approximately $800,000 during the second half of 2009 related to the transition of our Chief
Executive Officer. If we continue to incur these charges, it will continue to negatively affect our
operating results. In addition, during 2008, we incurred $25.0 million in indebtedness related to
the restructuring of the MIG earnout and bonus payments, of which we had repaid $14.0 million as of
July 1, 2009, and in the first six months of 2009, we drew down under our revolving credit facility
under which we had $4.5 million outstanding as of June 30, 2009. Furthermore, we may be required to
incur increased costs in order to implement additional initiatives designed to increase revenues,
such as increased marketing for our new games, particularly those designed for next-generation
platforms and social networking websites, and acquiring content. If our revenues do not increase to
offset these additional expenses and debt payments, if we experience unexpected increases in
operating expenses or if we are required to take additional charges related to impairments or
restructurings, we will continue to incur significant losses and will not become profitable.
Finally, we expect our 2009 revenues to be lower than our 2008 revenues, and in future periods, our
revenues could continue to decline. Accordingly, we may not 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:
|
|
|
respond to market developments, including next-generation platforms, technologies and
pricing and distribution models; |
37
|
|
|
maintain and grow our non-carrier, or off-deck, distribution, including through our
website and third-party direct-to-consumer distributors; |
|
|
|
|
maintain our current, and develop new, wireless carrier and other distributor
relationships, particularly in international markets; |
|
|
|
|
maintain and expand our current, and develop new, relationships with third-party branded
content owners; |
|
|
|
|
retain or improve our current revenue-sharing arrangements with carriers, other
distributors and third-party branded content owners; |
|
|
|
|
maintain and develop greater consumer awareness of our games based on our own intellectual
property and the Glu brand; |
|
|
|
|
continue to develop new high-quality mobile games that achieve significant market
acceptance, particularly for new next-generation handsets and social networking websites; |
|
|
|
|
continue to port existing mobile games to new mobile handsets; |
|
|
|
|
continue to develop and upgrade our technology; |
|
|
|
|
continue to enhance our information processing systems; |
|
|
|
|
expand our development capacity in countries with lower costs; |
|
|
|
|
execute our business and marketing strategies successfully; and |
|
|
|
|
attract, integrate, retain and motivate qualified personnel. |
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, particularly in light of the current economic environment, which in turn could cause
volatility in our stock price.
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. This is particularly
true for 2009, as we implemented significant cost-reduction measures in 2008, making it more
difficult for us to further reduce our operating expenses without a material adverse impact on our
prospects in future periods. Individual games and carrier relationships represent meaningful
portions of our revenues and net income or loss in any quarter. We may incur significant or
unanticipated expenses when licenses are added or renewed, we may experience a significant
reduction in revenue if licenses are not renewed or we may incur impairments of prepaid royalty
guarantees if our forecast for games based on licensed intellectual property is lower than we
anticipated at the time we entered into the agreement. For example,
in 2008 and the six months ended June 30, 2009, we impaired $6.3
million and $589,000, respectively of certain prepaid royalties and royalty guarantees primarily due to several distribution
arrangements that we entered into in 2007 and 2008. In addition, some payments from carriers that
we recognize as revenue on a cash basis may be delayed unpredictably.
We are also subject to macroeconomic fluctuations in the U.S. and global economies, including
those that impact discretionary consumer spending, which have recently deteriorated significantly
in many countries and regions, including the U.S., and may remain depressed for the foreseeable
future. Some of the factors that could influence the level of consumer spending include continuing
conditions in the residential real estate and mortgage markets, labor and healthcare costs, access
to credit, consumer confidence and other macroeconomic factors affecting consumer spending. These
issues can also cause foreign currency rates to fluctuate, which can have an adverse impact on our
business since we transact business in more than 70 countries in more than 20 different currencies.
In 2008, some of these currencies fluctuated by up to 40%, and we experienced continued
significant fluctuations in the first six months
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of 2009. These issues may continue to negatively impact the economy and our growth. If these
issues persist, or if the economy enters a prolonged period of decelerating growth or recession,
our results of operations may be harmed. 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. Our failure to meet market expectations would likely result in a decline in the
trading price of our common stock.
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, including those for
next-generation platforms; |
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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 the prominence of deck placement for our leading games and those of our
competitors; |
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the strength or weakness in consumer demand for new mobile devices; |
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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 pricing policies by our carriers related to downloading content, such as our
games, which pricing policies could be influenced by the lower average prices for content on
next-generation platforms; |
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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 timeliness and accuracy of reporting from carriers; |
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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
handsets, mobile games and related content, including the rate of growth of next-generation
platforms; |
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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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changes in accounting rules, such as those 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. |
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 game quality, brand 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
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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 Electronic Arts (EA Mobile) and Gameloft, 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. Wireless 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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the ability or willingness to offer competing products at no charge or supported by
in-game advertising; |
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lower labor and development costs; and |
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broader global distribution and presence. |
In addition, given the open nature of the development and distribution for certain
next-generation platforms, such as the Apple iPhone and Google Android as well as social networking
websites like Facebook for which we plan to develop and market games in the near future, we also
compete or will compete with a vast number of small companies and individuals who are able to
create and launch mobile games and other content for these mobile devices utilizing limited
resources and with limited start-up time or expertise. Many of these smaller developers are able to
offer their games at no cost or substantially reduce prices to levels at which we are unable to
respond competitively and still achieve profitability given their low overhead. In addition,
publishers who create content for traditional gaming consoles and for online play have also begun
developing games for the Apple App Store. It has been estimated that more than 10,000 games have been made
available on the Apple App Store since its launch in July 2008. The proliferation of titles on the
Apple App Store makes it difficult for us to differentiate ourselves from other developers and to
compete for end users purchasing content for their iPhone and iPod Touch devices without
substantially reducing our prices or increasing spending to market our products. Certain of our
large competitors have the right to more licenses to develop titles for the Apple App Store and have
considerably greater resources than we do, enabling them to develop more games than we can and to
do so more quickly, which causes further challenges, especially on the next-generation platforms.
If our industry continues to shift to a sales and distribution model
similar to the Apple App Store our
ability to compete would be further challenged, since the vast majority of our current revenue is
currently derived from our wireless carrier-based distribution channel and not direct-to-consumer
channels.
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.
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We may need to raise additional capital or borrow funds to grow our business, and we may not be
able to raise capital or borrow funds 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. As of June 30, 2009, we had $12.8 million of cash and
cash equivalents, which does not take into account our payment of $5.2 million on July 1, 2009 on
the subordinated notes that we issued in December 2008 in connection with our restructuring of the
MIG earnout and bonus payments (the MIG subordinated notes). In addition to our general operating
expenses and prepaid and guaranteed royalty payments, we had debt service obligations related to
$4.5 million outstanding as of June 30, 2009 under our revolving credit facility and our issuing an
aggregate of $25.0 million in principal amount of the MIG subordinated notes, under which we owed
$11.0 million as of July 1, 2009. If our cash and cash equivalents, together with any cash
generated from operations and borrowings under our credit facility, are insufficient to meet our
cash requirements, we will either need to seek additional capital, potentially through debt or
equity financings or by increasing the amount available to us for borrowing under the credit
facility, to fund our operations and debt repayment obligations or we will need to restructure our
obligations under the MIG subordinated notes. 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, particularly given our current stock 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, all of which is subject to the provisions of our credit
facility. Additionally, we may be unable to increase the size of the credit facility, or to do so
on terms that are acceptable to us, particularly in light of the current credit market conditions.
We also may not be able to access the full amount of our credit facility, as the credit facilitys
borrowing base is based upon our accounts receivable; at our current revenue levels, we are not
able to access the full $8.0 million of the credit facility. If new sources of financing are
required but are insufficient or unavailable, or if we are unable to restructure our obligations
under the MIG subordinated notes, 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. Furthermore, if
we are unable to remain in compliance with the financial or other covenants contained in the credit
facility and do not obtain a waiver from the lender then, subject to applicable cure periods, any
outstanding indebtedness under the credit facility could be declared immediately due and payable,
which would also trigger the cross-default provisions of the MIG subordinated notes. In this
event, we would need to seek additional sources of financing, which would likely have unfavorable
terms, and any failure to do so would have a serious impact on our business, financial position and
liquidity, including potentially forcing us to file for bankruptcy protection. In addition, to the
extent we do not adequately address our liquidity needs (including the matters discussed in this risk factor), the audit
report included in our Form 10-K for the year ending December 31, 2009 may include an explanatory
paragraph regarding our ability to continue as a going concern. See Managements Discussion and
Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources
Sufficiency of Current Cash, and Cash Equivalents.
Our stock price has fluctuated and declined significantly since our initial public offering in
March 2007, and may continue to fluctuate, may not rise and may decline further, which could cause
our stock to be delisted from trading on the NASDAQ Global Market.
The trading price of our common stock has fluctuated in the past and is expected to continue
to fluctuate in the future, as a result of a number of factors, many of which are outside our
control, such as:
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price and volume fluctuations in the overall stock market, including as a result of trends
in the economy as a whole, such as the recent and continuing unprecedented volatility in the
financial markets; |
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changes in the operating performance and stock market valuations of other technology
companies generally, or those in our industry in particular; |
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actual or anticipated fluctuations in our operating results; |
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the financial projections we may provide to the public, any changes in these projections
or our failure to meet these projections; |
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failure of securities analysts to initiate or maintain coverage of us, changes in
financial estimates by any securities analysts who follow our company or our industry, our failure
to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock; |
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ratings or other changes by any securities analysts who follow our company or our
industry; |
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announcements by us or our competitors of significant technical innovations, acquisitions,
strategic partnerships, joint ventures, capital raising activities or capital commitments; |
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the publics response to our press releases or other public announcements, including our
filings with the SEC; |
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lawsuits threatened or filed against us; and |
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market conditions or trends in our industry or the economy as a whole. |
In addition, the stock markets, including the NASDAQ Global Market on which our common stock
is listed, have recently and in the past, experienced extreme price and volume fluctuations that
have affected the market prices of many companies, some of which appear to be unrelated or
disproportionate to the operating performance of these companies. These broad market fluctuations
could adversely affect the market price of our common stock. In the past, following periods of
volatility in the market price of a particular companys securities, securities class action
litigation has often been brought against that company. Securities class action litigation against
us could result in substantial costs and divert our managements attention and resources.
Since becoming a publicly traded security listed on the NASDAQ Global Market in March 2007,
our common stock has reached a closing high of $14.67 per share and closing low of $0.23 per share.
Our common stock traded below $1.00 per share from October 30, 2008 until June 12, 2009, and the
last reported sale price of our common stock on August 7, 2009 was $1.07 per share. Under NASDAQs
continued listing standards, if the closing bid price of our common stock is under $1.00 per share
for 30 consecutive trading days, NASDAQ may notify us that it may delist our common stock from the
NASDAQ Global Market. If the closing bid price of our common stock does not thereafter regain
compliance for a minimum of ten consecutive trading days during the 180-days following notification
by NASDAQ, NASDAQ may delist our common stock from trading on the NASDAQ Global Market. While
NASDAQ suspended the minimum bid price and market value requirements through July 31, 2009, we do
not expect that NASDAQ will extend or resume the suspension in the near future. As a result, we
cannot assure you that our common stock will remain eligible for trading on the NASDAQ Global
Market. If our stock were delisted, the ability of our stockholders to sell any of our common stock
at all would be severely, if not completely, limited, causing our stock price to continue to
decline.
We have outstanding debt obligations and may incur additional debt in the future, which could
adversely affect our financial condition and results of operations.
In December 2008, we renegotiated and extended our $8.0 million revolving credit facility,
which is secured by substantially all of our assets, including our intellectual property. As of
June 30, 2009, we had outstanding borrowings of $4.5 million under this credit facility, and we
expect to continue to borrow during the term of the facility for general working capital purposes
and to satisfy our other debt obligations. In addition, in December 2008, we issued an aggregate of
$25.0 million in principal amount of promissory notes to former shareholders of MIG to restructure
the earnout and bonus payments that we owe to them, of which we had repaid $14.0 million as of July
1, 2009. This debt may adversely affect our operating results and financial condition by, among
other things:
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requiring us to dedicate a portion of our expected cash from operations to service our
debt, thereby reducing the amount of expected cash flow available for other purposes, including
funding our operations; |
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increasing our vulnerability to downturns in our business, to competitive pressures and to
adverse economic and industry conditions; |
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limiting our ability to pursue acquisitions that may be accretive to our business; and |
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limiting our flexibility in planning for, or reacting to, changes in our business and our
industry. |
Our credit facility imposes restrictions on us, including restricting our ability to incur
specified liens and sell the company and requiring us to maintain compliance with specified
financial covenants and to maintain a certain level of cash deposits with the lender. Our ability
to comply with certain of these covenants may be affected by events beyond our control. Our
expectations regarding cash sufficiency assume that our operating results will be sufficient to
enable us to comply with the EBITDA-related covenant. Our revenues depend on a number of factors,
including the rate of sales of mobile devices, our relationships with our carriers and licensors,
consumer tastes, competitive pressures, our ability to generate revenues from next-generation
platforms and foreign exchange rate fluctuations. If our revenues are lower than we anticipate, we
will be required to reduce our operating expenses to remain in compliance with this financial
covenant. However, reducing our operating expenses could be very challenging for us, since we
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undertook operating expense reductions and restructuring activities in the third and fourth
quarters of 2008 that reduced our operating expenses significantly from second quarter of 2008
levels. However, we expect to continue our efforts to reduce operating expenses during the second
half of 2009. Reducing operating expenses further than we currently anticipate could have the
effect of reducing our revenues. Our ability to comply with the EBITDA-related covenant will be
further challenged due to the approximately $800,000 in costs we expect to incur during the second
half of 2009 related to the transition of our Chief Executive Officer, any additional restructuring
charges that we may incur as we continue our efforts to reduce operating expenses and the adverse
impact of recent foreign currency movements on our operating results. We currently believe that we
will be able to comply with the EBITDA-related covenant in the third quarter of 2009, but, due
primarily to the unanticipated restructuring charges and negative foreign currency movements
described in the preceding sentence, will
likely not be able to comply with this covenant in the fourth quarter of 2009 unless one or more of
the following occurs: (1) our revenues significantly exceed our expectations, (2) we are able to
significantly reduce our operating expenses after taking into account restructuring charges and foreign currency movements, (3) foreign currency exchange rates move in a manner
that significantly and positively affect our operating results or (4) Silicon Valley Bank agrees
either to amend the credit facility in a manner that enables our compliance with this covenant or
grant us a waiver for any non-compliance with the covenant. While we are currently engaged in discussions with Silicon Valley Bank regarding amending
the credit facility to enable our prospective compliance with the EBITDA-related covenant and
believe that we will enter into such an amendment in the near future,
we cannot assure you that we will be successful in doing so. If we breach any of the covenants under
our credit facility and do not obtain a waiver from the lender, then, subject to applicable cure
periods, any outstanding indebtedness under the credit facility could be declared immediately due
and payable, which would also trigger the cross-default provision of our MIG subordinated notes.
See Managements Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources Sufficiency of Current Cash, Cash Equivalents for additional
information regarding our credit facility and the MIG subordinated notes. Should the lender call
the loan at a time when we did not have or were unable to secure cash to repay it, it would have a
serious impact on our business, financial position and liquidity, including potentially forcing us
to file for bankruptcy protection. For more information about our debt obligations, see Note 7 to
Notes to Unaudited Condensed Consolidated Financial Statements. In addition, to the extent we do
not adequately address our liquidity needs (including the liquidity matters discussed in this risk factor), the audit report
included in our Form 10-K for the year ended December 31, 2009 may include an explanatory paragraph
regarding our ability to continue as a going concern.
A continued slowdown in sales of mobile devices, particularly the devices for our carrier-based
business which represents the vast majority of our revenues, or a decline in the average selling
prices of our games sold through wireless carriers, could have a material adverse impact on our
revenues, financial position and results of operations.
We currently derive the vast majority of our revenues from sales of our games on traditional
mobile devices through our wireless carriers. Our revenues for the
six months ended June 30, 2009 declined from the corresponding period
in 2008 due to a decrease in sales in our
carrier-based business, resulting primarily from a decrease in handset unit sales, which in turn
led to a decrease in the number of games that we sold, as well as movement by a number of consumers
to next-generation platforms that enable the download of applications from sources other than a
carriers branded e-commerce service, such as the Apple App Store. We expect that we
will continue to derive the vast majority portion of our revenues from our carrier-based business
in 2009. The ability of the next-generation platforms or social networking websites to serve as a
source of significant new revenues is uncertain, and we may be unable to generate sufficient
revenues from these platforms to make up for any decline in the traditional carrier business. In
addition, games sold on the next-generation platforms typically have lower average prices than our
games sold through our wireless carriers, and to the extent consumers continue to migrate to
next-generation platforms, it could result in lower average prices for our games in our carrier
business. Any continued slowdown in that business or in sales of handset units for that business,
or any reduction in the average prices of our games sold through our wireless carriers, could have
a material adverse impact on our revenues, financial position and results of operations.
Our strategy to grow our business includes developing titles for next-generation platforms beyond
our wireless carrier channel, which currently comprises the vast majority of our revenues. If we do
not succeed in generating considerable revenues and gross margins from the next-generation
platforms, our revenues, financial position and operating results may suffer.
Growth in our carrier channel, which currently comprises the vast majority of our revenues,
has slowed in recent periods. As part of our strategy to grow our business, we have started to
develop titles for next-generation platforms such as Apples App
Store, Googles
Android Market, Research in Motions Blackberry App World and
Nokias Ovi Store. The introduction of these
next-generation platforms has drawn some of our customers away from our carrier-based business. For
us to succeed, we believe that we must publish mobile games that are widely accepted and
commercially successful on these new platforms. However, our efforts on these platforms may prove
unsuccessful or, even if successful, it may take us longer to achieve meaningful revenue than
anticipated because, among others reasons:
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the open nature of the development and marketing for certain of these next-generation
platforms increases substantially the number of our competitors and competitive products
and makes it more difficult for us to achieve prominence and deck placement for our games; |
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the pricing and revenue models for products on these platforms are rapidly evolving,
and may result in average selling prices for our games developed for these platforms that
are substantially lower than from our traditional carrier channels and a lower than
expected return on investment for these games; |
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the competitive advantage of our porting capabilities may be reduced as these
next-generation platforms become ubiquitous; |
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many of our key licenses do not grant us the rights to develop games for the iPhone; |
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we have relatively little experience with direct-to-consumer distribution channels; |
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these next-generation platforms are effectively new markets, for which we are less able
to forecast with accuracy revenue levels, required marketing and developments expenses,
and net income or loss; |
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many OEMs and carriers are developing next-generation platforms and it may be difficult
for us to predict which ones will be successful, and we may expend time and resources
developing games for next-generation platforms that ultimately do not succeed; and |
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competitors may have substantially greater resources available to invest in development
and publishing of products for next-generation platforms. |
If we do not succeed in generating considerable revenues and gross margins from the next-generation
platforms, our revenues, financial position and operating results may suffer.
If we do not achieve a sufficient return on our investment with respect to our efforts to develop
games for social networking websites, it could negatively affect our operating results.
We have recently announced that we intend to increase our focus on developing games for social
networking websites such as Facebook. We will face a number of challenges in pursuing this
opportunity. For example, we have historically designed, marketed and sold games only for mobile
phones and we have very limited experience developing games for social networking websites. In
order to increase the level of expertise in our company, we will be required to hire additional
personnel with experience in social networking gaming, which could make it more difficult for us
reduce our operating expenses in the event of an unexpected decline in revenues. In addition, we
will need to divert internal resources from other projects to focus on our social networking
initiatives, which could negatively impact our ability to design, market and sell games for mobile
phones and, consequently, reduce our revenues. Social networking websites are effectively new
markets, for which we are less able to forecast with accuracy revenue levels, required marketing
and developments expenses, and net income or loss. We must determine how best to derive revenues
from games for social networking websites, as most games on social networking websites are
available free of charge and users may be reluctant to pay to play our games. Furthermore, the
open nature of the development and marketing platforms for social networking websites will subject
us to significant competition from many additional companies that have greater experience in
developing and monetizing games on social networking websites. The proliferation of games on
social networking websites will make it difficult for us to differentiate ourselves from these
other game developers and to compete for end users, particularly due to the fact that these other
game developers have an established presence and user community for their games on social
networking websites. In addition, some competitors may have substantially greater resources
available to invest in development and publishing of products for social networking websites.
Social networking websites have also been subject to copycat tactics, where some
companies have released games that are nearly identical to successful games released by their
competitors in an effort to confuse the market and divert users from the competitors game to the
copycat game. As a result, even if we succeed in developing and monetizing games for social
networking websites, competitors may produce copycat games that could result in user confusion and
ultimately reduce the success of our games. Finally, many of our key licenses do not grant us the
rights to develop games for social networking websites, which could limit our ability to offer
certain of our games on these websites. If we do not achieve a sufficient return on our investment
with respect to develop games for social networking websites, it could negatively affect our
operating results.
Changes in foreign exchange rates and limitations on the convertibility of foreign currencies could
adversely affect our business and operating results.
Although we currently transact approximately one-half of our business in U.S. Dollars, we also
transact approximately one-fourth of our business in pounds sterling and Euros and the remaining
portion of our business in other currencies. Conducting business in
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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 exchange gains and losses. For example, in 2008, we recorded
a $3.0 million foreign currency exchange loss primarily related to the revaluation of intercompany
balance sheet accounts. To the extent foreign exchange rates continue to negatively affect our
operating results, it will negatively affect our ability to remain in compliance with the
EBITDA-related covenant in our credit facility. To date, we have not engaged in exchange rate
hedging activities, and we do not expect to do so in the foreseeable future. Even if we were 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 cash expenditures, ongoing management time and expertise, external costs to implement the
strategies and potential accounting implications.
We face additional risk if the currency is not freely or actively traded. Some currencies,
such as the Chinese Renminbi, in which our Chinese operations principally transact business, are
subject to limitations on conversion into other currencies, which can limit our ability to react to
rapid foreign currency devaluations and to repatriate funds to the U.S. should we require
additional working capital.
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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 75.0%, 88.1% and 88.4% of our
revenues in 2008, 2007 and 2006, respectively. In 2008, revenues derived under various licenses
from our four largest licensors, Atari, Playfirst, PopCap and Sega, together accounted for
approximately 25% 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 games or other applications, competing with us in the marketplace. For example, one of
our licenses with Hasbro under which we created our Battleship, Clue, Game of Life and Monopoly
games, which in the past had accounted for a significant portion of our revenues, expired in March
2008, and we experienced a decline in revenues as a result. 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. Moreover, many of our
licensors have not granted us the right to develop games for some next-generation platforms, such
as the iPhone, and may instead choose to develop games for the iPhone themselves. Additionally,
licensors may elect to work with publishers who can develop and publish products across multiple
platforms, such as mobile, online and console, which we currently cannot offer.
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. Our budget for new licenses in 2009 is a
substantial reduction from the amount we have spent for new licenses in prior years. Our
anticipated reduced spending on new licenses in 2009, which we may decide to further reduce if we
require more working capital for other purposes than we currently anticipate, may adversely impact
our title plan and our ability to generate revenues in 2010 and future periods. 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.
Even if we succeed 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.
We currently rely primarily on wireless carriers, in particular Verizon Wireless, to market and
distribute our games and thus to generate our revenues. The loss of or a change in any significant
carrier relationship, including their credit worthiness, could materially reduce our revenues and
adversely impact our cash position.
A significant portion of our revenues is derived from a limited number of carriers. In 2008,
we derived approximately 51.4% of our revenues from relationships with five carriers, including
Verizon Wireless, which accounted for 21.4% of our revenues. 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. 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. In addition, having our revenues concentrated among a limited number of
carriers also creates a credit concentration risk for us, and in the event that any significant
carrier were unable to fulfill its payment obligations to us, our operating results and cash
position would suffer. Finally, our credit facilitys borrowing base is tied to our accounts
receivable. If any of our wireless carriers were delinquent in their payments to us, it would
reduce our borrowing base and could require us to immediately repay any borrowings outstanding
related to such carrier. If any of these eventualities come to pass, it could materially reduce our
revenues and otherwise harm our business.
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
research and development, licensing efforts, marketing and regional expansion to enhance our
offering of games and introduce new games, and we must make decisions about these matters well in
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advance of product release to timely implement them. Our success depends, in part, on
unpredictable and volatile factors beyond our control, including end-user preferences, competing
games, new mobile platforms and the availability of other entertainment activities. If our games
and related applications do not respond 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.
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 more recently the Apple
iPhone, Google Android, Blackberry, 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 different 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.
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 result in higher game sales. 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.
Conversely, the open nature of the next-generation platform direct-to-consumer channels, such
as the Apple App Store, allow for vast numbers of applications to be offered to
consumers from a much wider array of competitors than in the traditional carrier channel. This may
reduce the competitive advantage of our established network of relationships with wireless
carriers. It may also require us to expend significantly increased amounts to generate substantial
revenues on these platforms, reducing or eliminating the profitability of publishing games for
them.
We have depended on no more than ten mobile games for a majority of our revenues in recent
fiscal periods. If these games do not continue to succeed or we do not release highly successful
new games, our revenues would decline.
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 2008 and 2007, we generated approximately 30.5% and 52.7% of our
revenues, respectively, from our top ten games, but no individual game represented more than 10% of
our revenues in either of those periods. In addition, our revenues from our top ten games in
absolute dollars have declined in recent periods. 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.
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
such relationships, and is also critical to establishing a direct relationship with end users who
purchase our products from direct-to-consumer channels, such as the Apple App Store,
directly from us and, in the future, social networking websites. Our ability to promote the Glu
brand depends on our success in
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providing high-quality mobile games and, in the future, high-quality games on social
networking websites. Similarly, recognition of our games by end users depends on our ability to
develop engaging games of high quality with attractive titles. However, our success also depends,
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 not succeed 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, particularly as we expand our efforts to increase awareness of our brand and
games among international consumers. Moreover, if a game is introduced with defects, errors or
failures or unauthorized objectionable content, we could experience damage to our reputation and
brand, and our attractiveness to wireless carriers, licensors and end users might be reduced. If we
fail to increase and maintain 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.
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 52.0% and 46.2% of our revenues in 2008 and
2007, respectively. In addition, as part of our international efforts, we acquired U.K.-based
Macrospace in December 2004, UK-based iFone in March 2006, China-based MIG in December 2007 and
Superscape, which has a significant presence in Russia, in March 2008. We have international
offices located in Brazil, Canada, Chile, China, Colombia, England, France, Germany, Italy,
Malaysia, Mexico, Poland, Russia and Spain. We expect to maintain our international presence, and
we expect international sales 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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foreign currency exchange rate fluctuations; |
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difficulties in staffing and managing international operations; |
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potential violations of the Foreign Corrupt Practices Act, particularly in certain
emerging countries in East Asia, Eastern Europe and Latin America; |
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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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potential adverse foreign tax consequences; |
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foreign exchange controls that might prevent us from repatriating income earned in
countries outside the United States, particularly China; |
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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 and variations in tariffs, quotas, taxes and other market
barriers; and |
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difficulties in enforcing intellectual property rights in certain countries. |
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. As a result of our international expansion in Asia, Europe and Latin America, we must
pay income tax in numerous foreign jurisdictions with complex and evolving tax laws. If we become
subject to increased taxes or new forms of taxation imposed by governmental authorities, our
results of operations could be materially and adversely affected.
These risks could harm our international operations, which, in turn, could materially and
adversely affect our business, operating results and financial condition.
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 some 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.
In addition, wireless carriers have the ability to change their pricing policy with their
customers for downloading content, such as our games. For example, Verizon Wireless, our largest
carrier, in 2008 began imposing a data surcharge to download content on those of its customers who
had not otherwise subscribed to a data plan. Such charges have, and could in the future, deter end
users from purchasing our content. Furthermore, a substantial portion of our revenues is derived
from subscriptions. Our wireless carriers have the ability to discontinue offering subscription
pricing, without our approval.
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.
Our market is experiencing a growth in adoption of smartphones, such as the Apple iPhone and RIM
Blackberry devices. For many of our wireless carriers, these smartphones are not yet directly
integrated into the carriers provisioning infrastructure that would allow them to sell games
directly to consumers, and games are instead sold through third parties, which is a more cumbersome
process for consumers and results in a smaller revenue share for us. These factors could harm 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 depends, 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. For example, some companies have
recently launched new mobile handsets or mobile platforms, including
Apples iPhone and Googles
Android. In addition, consumers generally purchase the majority of content,
such as our games, for a new handset within a few months of purchasing the handset. 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 we do not adequately build
into our title plan the demand for games for a particular handset or platform or experience 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, our revenues would likely decline and our business, operating results and
financial condition would likely suffer.
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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, such
as the Apple App Store. In addition, developing other application delivery mechanisms,
such as premium-SMS or our own direct-to-consumer website, enable subscribers to download
applications without having to access a carriers branded e-commerce service. Increased use by
subscribers of open operating system handsets, premium-SMS delivery systems or our website 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 and our efforts to promote direct distribution
could prove expensive. 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 or change or cease offering subscription plans, 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,
end users are not able 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, or change or cease offering subscription plans
altogether. If our subscription revenues decrease significantly for these or other reasons, our
sales would suffer and this could 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 and financial results could suffer.
To reach large numbers of wireless subscribers, mobile entertainment publishers like us must
support numerous mobile handsets and technologies. 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, in the future we will be required to port existing
and new games to a broader array of handsets and develop versions specific to new next-generation
handsets. If we utilize more labor-intensive porting processes, our margins could be significantly
reduced and it may take us longer to port games to an equivalent number of handsets. For example,
the time required to develop and port games to some of the new advanced mobile handsets, including
the iPhone and those based on the Android platform, is longer and thus developing and
porting for the new platforms is more costly than developing and porting for games for traditional
mobile phones. Since the vast majority of our revenues are currently derived from our carrier
business, it is important that we maintain and enhance our porting capabilities. However, as
additional App Stores are developed and gain market prominence, our porting capabilities represent
less of a business advantage for us, yet we could be required to invest considerable resource in
this area to support our existing business. These additional costs could harm our business,
operating results and financial condition.
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Our industry is subject to risks generally associated with the entertainment industry, any of which
could significantly harm our operating results.
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; the commercial success of any movies upon which one of more of our games are
based; 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.
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, our Super K.O. Boxing game
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. 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.
If we do not effect a smooth transition to a new Chief Executive Officer, our business and
operating results may suffer and our stock price may decline. In addition, the costs associated
with this transition will make it more difficult for us to comply with the financial covenants
contained in our credit facility.
On July 8, 2009, we announced that L. Gregory Ballard, our President and Chief Executive
Officer, had indicated his intention to transition his role with our company to new leadership.
Mr. Ballard has agreed pursuant to a Transitional Employment Agreement to remain as our President
and Chief Executive Officer for a transition period until the earlier of the date a new Chief
Executive Officer commences employment with us or January 1, 2010. However, Mr. Ballard remains an
at-will employee and he may terminate his employment with us at any time for any reason. In the
event that we are unable to identify and retain a new Chief Executive Officer prior to January 1,
2010 or such earlier date as Mr. Ballard may elect to terminate his employment with us, or if we
are otherwise unable to effect a smooth transition to a new Chief Executive Officer, it may result
in uncertainty from our business partners, customers, employees and investors and cause disruptions
to our business, any of which could harm our business and operating results and cause our stock
price to decline. Our new Chief Executive Officer will likely also require a period of time to
assimilate into our company and become fully productive, which could negatively impact our
business, at least in the short term. In addition, we will incur substantial costs in connection
with Mr. Ballards transition, including restructuring costs relating to our financial obligations
to Mr. Ballard under the Transitional Employment Agreement and the fees of the executive search
firm we have retained to assist us in identifying Chief Executive Officer candidates. These costs
will negatively affect our operating results and will make it more difficult for us to comply with
the EBITDA-related covenant contained in our credit facility. The credit facility also provides
that once Mr. Ballard is no longer our Chief Executive Officer, we must obtain the lenders
approval of his replacement within 60 days of his departure. If we breach any of the covenants
under our credit facility and do not obtain a waiver from the lender, then, subject to applicable
cure periods, any outstanding indebtedness could be declared immediately due and payable, which
would also trigger the cross-default provision of our MIG subordinated notes. (See Managements
Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital
Resources Sufficiency of Current Cash, Cash Equivalents for additional information regarding
our debt obligations.) Should the lender call the loan at a time when we did not have or were
unable to secure cash to repay it, it would have a serious impact on our business financial
position and liquidity, including potentially forcing us to file for bankruptcy protection. For
more information about our debt obligations, see Note 7 to Notes to Unaudited Condensed
Consolidated Financial Statements.
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Our business and growth may suffer if we are unable to hire and retain key personnel.
Our future success will depend, to a significant extent, on our ability to retain and motivate
our key personnel, namely our management team and experienced sales and engineering personnel. In
addition, in order to grow our business, succeed on our new business initiatives such as developing
games for social networking websites and replace departing employees, we must be able to identify
and hire qualified personnel. Competition for qualified management, sales, engineering and other
personnel can be intense, and we may not be successful in attracting and retaining such personnel.
This may be particularly the case for us to the extent our stock price remains at a depressed
level, as individuals may elect to seek employment with other companies that they believe have
better long-term prospects. Competitors have in the past and may in the future attempt to recruit
our employees, and our management and key employees that are not bound by agreements that could
prevent them from terminating their employment at any time. We may also experience difficulty
assimilating our newly hired personnel, which may adversely affect our business. In addition, we do
not maintain a key-person life insurance policy on any of our officers. Our business and growth may
suffer if we are unable to hire and retain key personnel.
Acquisitions could result in operating difficulties, dilution and other harmful consequences.
We have acquired a number of businesses in the past, including, most recently, Superscape,
which has a significant presence in Russia, in March 2008 and MIG, which is based in China, in
December 2007. We expect to continue to evaluate and consider a wide array of potential strategic
transactions, including business combinations and acquisitions of technologies, services, products
and other assets. At any given time, we may be engaged in discussions or negotiations with respect
to one or more of these types of transactions. Any of these transactions could be material to our
financial condition and results of operations. The process of integrating any acquired business may
create unforeseen operating difficulties and expenditures and is itself risky. The areas where we
may face difficulties include:
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diversion of management time and a shift of focus from operating the businesses to issues
related to integration and administration; |
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declining employee morale and retention issues resulting from changes in compensation,
management, reporting relationships, future prospects or the direction of the business; |
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the need to integrate each acquired companys accounting, management, information, human
resource and other administrative systems to permit effective management, and the lack of control
if such integration is delayed or not implemented; |
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the need to implement controls, procedures and policies appropriate for a larger public
company that the acquired companies lacked prior to acquisition; |
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in the case of foreign acquisitions, the need to integrate operations across different
cultures and languages and to address the particular economic, currency, political and regulatory
risks associated with specific countries; and |
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liability for activities of the acquired companies before the acquisition, including
violations of laws, rules and regulations, commercial disputes, tax liabilities and other known and
unknown liabilities. |
If the anticipated benefits of any future acquisitions do not materialize, we experience
difficulties integrating businesses acquired in the future, or other unanticipated problems arise,
our business, operating results and financial condition may be harmed.
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. For example, during 2008 we incurred an aggregate goodwill impairment
charge related to write-downs in the third and fourth quarters of 2008 of $69.5 million as the fair
values of our three reporting units were determined to be below their carrying values.
Moreover, the terms of acquisitions may require that we make future cash or stock payments to
shareholders of the acquired company, which may strain our cash resources or cause substantial
dilution to our existing stockholders at the time the payments are required to be made. For
example, pursuant to our merger agreement with MIG, we were required to make $25.0 million in
future cash
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and stock payments to the former MIG shareholders, which payments we renegotiated in
December 2008. Had we paid the MIG earnout and bonus payments on their original terms, we could have experienced cash shortfall
related to the cash payments and our stockholders could have experienced substantial dilution
related to the stock payments.
Our reported financial results could be adversely affected by changes in financial accounting
standards or by the application of existing or future accounting standards to our business as it
evolves.
Our reported financial results are impacted by the accounting policies promulgated by the SEC
and national accounting standards bodies and the methods, estimates, and judgments that we use in
applying our accounting policies. Due to recent economic events, the frequency of accounting policy
changes may accelerate. Policies affecting software revenue recognition have and could further
significantly affect the way we account for revenue related to our products and services. For
example, we recently began developing and selling games for next-generation platforms and are
beginning meaningful development of games for social networking websites, and the accounting for
revenue derived from these platforms is still evolving and, in some cases, uncertain. As we
enhance, expand and diversify our business and product offerings, the application of existing or
future financial accounting standards, particularly those relating to the way we account for
revenue, could have a significant adverse effect on our reported results although not necessarily
on our cash flows.
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.
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 requires 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 this report. We have incurred, and
expect to continue to incur, substantial accounting and auditing expenses and expend significant
management time in complying with the requirements of Section 404. 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. 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 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 business and operating
results may be harmed.
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
divert our managements attention and our 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.
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Our business is subject to increasing regulation of content, consumer privacy, distribution and
online hosting and delivery in the key territories in which we conduct business. If we do not
successfully respond to these regulations, our business may suffer.
Legislation is continually being introduced that may affect both the content of our products
and their distribution. For example, data and consumer protection laws in the United States and
Europe impose various restrictions on our web sites, which will be increasingly important to our
business as we continue to market our products directly to end users. Those rules vary by territory
although the Internet recognizes no geographical boundaries. In the United States, for example,
numerous federal and state laws have been introduced which attempt to restrict the content or
distribution of games. Legislation has been adopted in several states, and proposed at the federal
level, that prohibits the sale of certain games to minors. If such legislation is adopted and
enforced, it could harm our business by limiting the games we are able to offer to our customers or
by limiting the size of the potential market for our games. We may also be required to modify
certain games or alter our marketing strategies to comply with new and possibly inconsistent
regulations, which could be costly or delay the release of our games. In addition, two
self-regulatory bodies in the United States (the Entertainment Software Rating Board) and the
European Union (Pan European Game Information) provide consumers with rating information on various
products such as entertainment software similar to our products based on the content (for example,
violence, sexually explicit content, language). Any one or more of these factors could harm our
business by limiting the products we are able to offer to our customers, by limiting the size of
the potential market for our products, or by requiring costly additional differentiation between
products for different territories to address varying regulations.
Changes in our tax rates or exposure to additional tax liabilities could adversely affect our
earnings and financial condition.
We are subject to income taxes in the United States and in various foreign jurisdictions.
Significant judgment is required in determining our worldwide provision for income taxes, and, in
the ordinary course of our business, there are many transactions and calculations where the
ultimate tax determination is uncertain.
We are also required to estimate what our tax obligations will be in the future. Although we
believe our tax estimates are reasonable, the estimation process and applicable laws are inherently
uncertain, and our estimates are not binding on tax authorities. The tax laws treatment of
software and internet-based transactions is particularly uncertain and in some cases currently
applicable tax laws are ill-suited to address these kinds of transactions. Apart from an adverse
resolution of these uncertainties, our effective tax rate also could be adversely affected by our
profit level, by changes in our business or changes in our structure, changes in the mix of
earnings in countries with differing statutory tax rates, changes in the elections we make, changes
in applicable tax laws (in the United States or foreign jurisdictions), or changes in the valuation
allowance for deferred tax assets, as well as other factors. Further, our tax determinations are
subject to audit by tax authorities which could adversely affect our income tax provision. Should
our ultimate tax liability exceed our estimates, our income tax provision and net income or loss
could be materially affected.
We incur certain tax expenses that do not decline proportionately with declines in our
consolidated pre-tax income or loss. As a result, in absolute dollar terms, our tax expense will
have a greater influence on our effective tax rate at lower levels of pre-tax income or loss than
at higher levels. In addition, at lower levels of pre-tax income or loss, our effective tax rate
will be more volatile.
We are also required to pay taxes other than income taxes, such as payroll, value-added, net
worth, property and goods and services taxes, in both the United States and foreign jurisdictions.
We are subject to examination by tax authorities with respect to these non-income taxes. There can
be no assurance that the outcomes from examinations, changes in our business or changes in
applicable tax rules will not have an adverse effect on our earnings and financial condition. In
addition, we do not collect sales and use taxes since we do not make taxable sales in jurisdictions
where we have employees and/or property or we do not have nexus in the state. If tax authorities
assert that we have taxable nexus in the state, those authorities might seek to impose past as well
as future liability for taxes and/or penalties. Such impositions could also impose significant
administrative burdens and decrease our future sales. Moreover, state and federal legislatures have
been considering various initiatives that could change our position regarding sales and use taxes.
Furthermore, as we expand our international operations, adopt new products and new
distribution models, implement changes to our operating structure or undertake intercompany
transactions in light of changing tax laws, acquisitions and our current and anticipated business
and operational requirements, our tax expense could increase.
54
Third parties may sue us, including 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, including for intellectual property infringement, or initiate
proceedings to invalidate our intellectual property, which, if successful, could disrupt the
conduct of our business, cause us to pay significant damage awards or require us to pay licensing
fees. For example, recently Skinit, Inc. filed a complaint against us and other defendants, seeking
unspecified damages, plus attorneys fees and costs. The complaint alleges breach of contract,
interference with economic relations, conspiracy and misrepresentation of fact. 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 disputes, litigation or
infringement claims, regardless of their merit. Successful claims against us might result in
substantial monetary liabilities, an injunction against us and might materially disrupt the conduct
of our business and harm our financial results.
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 are subject to the reporting requirements of the Securities Exchange
Act of 1934, the Sarbanes-Oxley Act of 2002, and the rules and regulations of the NASDAQ Stock
Market. The requirements of these rules and regulations increases our legal, accounting and
financial compliance costs, makes 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.
To maintain and improve the effectiveness of our disclosure controls and procedures and
internal control over financial reporting, we expend significant resources and provide significant
management oversight 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 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 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.
System or network failures could reduce our sales, increase costs or result in a loss of revenues
or end users of our games.
We rely on wireless carriers and other third-party networks to deliver games to end users and
on their or other third parties billing systems to track and account for the downloading of our
games. In certain circumstances, we also rely on our own servers to deliver games on demand to end
users through our carriers networks. In addition, certain of our subscription-based games, such as
World Series of Poker, require access over the mobile Internet to our servers to enable certain
features. Any technical problem with carriers, third parties or our billing, delivery or
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. 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 such technical problems
could cause us to lose end users or revenues or incur substantial repair costs and distract
management from operating our business.
55
Some provisions in our certificate of incorporation, bylaws and the terms of some of our licensing
and distribution agreements and our credit facility may deter third parties from seeking to acquire
us.
Our certificate of incorporation and bylaws contain provisions that may make the acquisition
of our company more difficult without the approval of our board of directors, including the
following:
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our board of directors is classified into three classes of directors with staggered
three-year terms; |
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only our chairman of the board, our lead independent director, our chief executive
officer, our president or a majority of our board of directors is authorized to call a special
meeting of stockholders; |
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our stockholders are able to take action only at a meeting of stockholders and not by
written consent; |
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only our board of directors and not our stockholders is able to fill vacancies on our
board of directors; |
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our certificate of incorporation authorizes undesignated preferred stock, the terms of
which may be established and shares of which may be issued without stockholder approval; and |
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advance notice procedures apply for stockholders to nominate candidates for election as
directors or to bring matters before a meeting of stockholders. |
In addition, the terms of a number of our agreements with branded content owners and wireless
carriers effectively provide that, if we undergo a change of control, the applicable content owner
or carrier will be entitled to terminate the relevant agreement. Also, our credit facility provides
that a change in control of our company is an event of default, which accelerates all of our
outstanding debt, thus effectively requiring that we or the acquirer be willing to repay the debt
concurrently with the change of control or that we obtain the consent of the lender to proceed with
the change of control transaction. Individually or collectively, these matters may deter third
parties from seeking to acquire us.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Equity Securities
None.
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.
The net proceeds of our IPO were $74.8 million. Through July 1, 2009, we used approximately
$12.0 million of the net proceeds to repay in March 2007 the entire principal and accrued interest
on an outstanding loan from the lender, $13.6 million of the net proceeds for the acquisition of
MIG, net of cash acquired, $30.0 million, net of cash acquired, for the acquisition of Superscape,
and $14.2 million to repay principal and accrued interest on the notes payable to the former MIG
shareholders. We used the remainder of the net proceeds for our operating activities, primarily for
advances for new license agreements.
Repurchases of Common Stock
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
56
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our annual meeting of stockholders on May 29, 2009. At the meeting, our stockholders
voted on the two proposals described below.
Proposal No. 1: The election of two Class II directors to serve on our board of
directors, each to serve until our annual meeting of stockholders to be held in 2012 and until his
or her successor is elected and qualified, or until his or her death, resignation or removal:
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Nominee |
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For |
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Withheld |
Ann Mather |
|
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22,124,811 |
|
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515,278 |
|
Daniel L. Skaff |
|
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22,169,081 |
|
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471,008 |
|
In addition, the following directors term of office continued after the annual meeting: L.
Gregory Ballard, William J. Miller, Richard A. Moran, Henry M. Nada, A. Brooke Seawell and Ellen F.
Siminoff. Messrs. Ballard, Miller and Seawell are Class III directors, whose term of office will
expire at our annual meeting of stockholders to be held in 2010. Messrs. Moran and Nada and Ms.
Siminoff are Class I directors, whose term of office will expire at our annual meeting of
stockholders to be held in 2011.
Proposal No. 2: Ratification of the appointment of PricewaterhouseCoopers LLP as our
independent registered public accounting firm for the fiscal year ending December 31, 2009:
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For |
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Against |
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Abstain |
|
Broker Non-Votes |
22,567,959
|
|
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57,973 |
|
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14,157 |
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0 |
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ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
The exhibits listed on the Exhibit Index (following the Signatures section of this report) are
incorporated by reference into this Item 6.
57
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: August 10, 2009 |
By: |
/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: August 10, 2009 |
By: |
/s/ Eric R. Ludwig
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Eric R. Ludwig |
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Senior Vice President and Chief Financial Officer
(Principal Financial Officer) |
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58
EXHIBIT INDEX
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Incorporated by Reference |
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Exhibit |
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Filing |
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Filed |
Number |
|
Exhibit Description |
|
Form |
|
File No. |
|
Exhibit |
|
Date |
|
Herewith |
|
|
|
|
|
|
|
|
|
|
|
|
|
10.01 |
|
Form of Indemnity Agreement entered into between Glu
Mobile Inc. and each of its directors and executive
officers, effective as of June 15, 2009 |
|
8-K |
|
001-33368 |
|
10.01 |
|
06/15/09 |
|
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|
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31.01 |
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Certification of Principal Executive Officer
Pursuant to Securities Exchange Act Rule
13a-14(a)/15d-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)
/15d-14(a). |
|
|
|
|
|
|
|
|
|
X |
|
|
|
|
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|
|
|
|
|
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|
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32.01 |
|
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 |
|
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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|
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X |
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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. |
59