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GLUU > SEC Filings for GLUU > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for GLU MOBILE INC


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S 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 (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). 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 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 our freemium games for smartphones and tablets;

our expectation that substantially all of the freemium games that we are developing for smartphones and tablets will be based on our own intellectual property, which we believe will significantly enhance our margins and long-term value;

our expectations regarding our revenues, including the expected continued decline in revenues from games we distribute for feature phones in our carrier-based business and our belief that our smartphone revenues will continue to increase as a percentage of our total revenues during each quarter of 2012;

our expectation that the revenues that we derive from in-app purchases, advertisements and offers in our freemium games will grow for the remainder of 2012;

our expectation that our gross margin will remain relatively flat for the remainder of 2012 due to the fact that although we will continue to generate an increasing percentage of our total revenues from games based upon original intellectual property, such reduction to our cost of revenues will be generally offset by an expected increase in our hosting costs related to our freemium games;

our expectations regarding our operating expenses, including anticipated increased spending on sales and marketing and research and development initiatives during 2012 compared with 2011, as well as the anticipated impact that our acquisitions of Blammo Games Inc. ("Blammo"), Griptonite, Inc. ("Griptonite") and GameSpy Industries, Inc. ("GameSpy") will have on our operating expenses;

our belief that our GameSpy acquisition will position us to generate additional revenues and increase the lifetime value of our users by enabling us to increase the number of community features in our games;

our intention to increasingly develop titles that incorporate more connected, community-based gameplay, such as player versus player functionality;

our expectation that we will finish 2012 with more than $21.5 million in cash;

our assumptions regarding the impact of Recent Accounting Pronouncements applicable to us;

our expectation that we will incur additional termination costs of approximately $850,000 in the fourth quarter of 2012 in order to better align sales and marketing and research and development expenses with our current business strategy;

our assessments and estimates that determine our effective tax rate and valuation allowance, and our expectation that the liability for uncertain tax positions, excluding interest and penalties, could decrease by approximately $714,000 within the next twelve months due to the expiration of certain statutes of limitation in foreign jurisdictions in which we do business;

our belief that our cash and cash equivalents and cash flows from operations will be sufficient to meet our cash needs for at least the next 12 months; and

our assessments and beliefs regarding the outcome of pending litigation proceedings and the liability, if any, that we may incur as a result of those proceedings.


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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 report 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 unaudited condensed consolidated financial statements and related notes contained elsewhere in this report. Our Management's 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.

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 three and nine months ended September 30, 2012, 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 September 30, 2012 were $21.3 million, a 26% increase compared to the three months ended September 30, 2011 in which we reported revenues of $16.9 million. Revenues for the nine months ended September 30, 2012 were $66.5 million, a 30% increase compared to the nine months ended September 30, 2011, in which we reported revenues of $51.0 million. These increases in revenues were primarily due to a significant increase in our revenues that we generated from games for smartphones, such as Apple's iPhone and mobile phones utilizing Google's Android operating system. We believe that the migration of users from feature phones to smartphone devices, which offer enhanced functionality, will continue during the fourth quarter of 2012 and for the foreseeable future as consumers increasingly upgrade their mobile phones. Accordingly, we have concentrated our product development efforts exclusively towards developing new titles for smartphones and tablet devices, such as Apple's iPad and tablets utilizing Google's Android operating system, such as Amazon's Kindle Fire, and intend to continue to devote significantly fewer resources towards selling games for feature phones in future periods.

For us to succeed in the remainder of 2012 and beyond, we believe that we must increasingly publish mobile games that are widely accepted and commercially successful on smartphone and tablet digital storefronts, which include Apple's App Store, the Google Play Store, Amazon's Appstore and Microsoft's XBOX Live marketplace. Our smartphone revenues accounted for approximately 86% and 57% of our revenues for the three months ended September 30, 2012 and September 30, 2011, respectively, and 84% and 49% of our revenues for nine months ended September 30, 2012 and September 30, 2011, respectively. Our strategy for increasing our revenues from smartphones and tablets involves becoming the leading publisher of mobile "freemium" games-games that are downloadable without an initial charge, but which enable a variety of additional content and features to be accessed for a fee or otherwise monetized through various advertising and offer techniques. Because our games can be downloaded and played for free, we are able to more quickly build a significantly larger customer base than we could if we charged users an upfront fee for downloading our games. In addition, our freemium games are generally designed to be persistent experiences maintained through content updates. We believe this approach will enable us to build and grow a longer lasting and more direct relationship with our customers, which will assist us in our future sales and marketing efforts. We intend to continue to have substantially all of our freemium games be based upon our own intellectual property, which we believe will significantly enhance our margins and long-term value.


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Our smartphone revenues surpassed our feature phone revenues for the first time on a quarterly basis in the second quarter of 2011 and continued to grow in each succeeding quarter through the second quarter of 2012. However, our smartphone revenues declined to $18.4 million in the third quarter of 2012 compared to $19.9 million in the second quarter of 2012. This was primarily due to the fact that the new titles that we launched during the third quarter generated less revenue than we expected based on our historical averages. As a result, our new title launches did not offset the revenue declines in our catalog titles. In addition, our revenues for the third quarter of 2012 were negatively impacted due to the fact that many consumers held off on upgrading their existing devices during the summer in anticipation of new hardware launches, and advertising budgets were likewise scaled back due to the reduced consumer demand.

Significantly growing our revenues from smartphones and tablets in the fourth quarter of 2012 and beyond may be challenging for us for several reasons, including: (1) we have encountered difficulties in retaining users of our games for any significant length of time after they initially download our games and only a very small percentage of users ever purchase virtual goods and currency in our games, and these factors have combined to produce a relatively low overall average lifetime value of our users; (2) the open nature of many of the smartphone and tablet storefronts substantially increases the number of competitive products and competitors to produce them, many of which may devote large marketing budgets to promoting their titles, thereby reducing the likelihood of consumer discovery of our titles; (3) we have only relatively recently concentrated our efforts on developing and marketing freemium games;
(4) our relatively limited experience creating games that include micro-transaction capabilities, advertising and offers has caused us, and may continue to cause us, to have difficulty optimizing the monetization of our freemium games; and (5) our freemium games may not be widely downloaded by consumers for a variety of reasons, including poor consumer reviews or other negative publicity, ineffective or insufficient marketing efforts, a failure to achieve prominent storefront featuring for such games or as a result of the large file sizes of many of our games. In addition, as part of our efforts to improve the monetization of our games, we intend to increasingly develop titles that incorporate more connected, community-based gameplay, such as player versus player functionality, and have hired a new President of Studios to oversee this evolution of our product portfolio. We have delayed the expected launch date of several of our new connected, community-based games from the fourth quarter of 2012 to the first quarter of 2013 to provide our new President of Studios sufficient time to refine these titles, which will negatively impact our fourth quarter revenues. We have limited experience with creating connected, community-based games, and if we are not successful in these efforts, it will negatively impact our revenues in the fourth quarter of 2012 and beyond.

In addition, our revenues will continue to depend significantly on growth in the mobile games market, our ability to continue to attract new end users in that market and the overall strength of the economy, particularly in the United States. Our revenues may also be adversely impacted by decisions by digital storefront owners or our carriers to alter their terms of service. For example, Apple has since the second quarter of 2011 made several changes to its app store developer agreement relating to privacy and our ability to include certain types of third party advertising in our games. These changes have in the past, and may in the future, negatively impact our smartphone revenues. Most recently, Apple informed us early in the fourth quarter of 2012 that we could no longer include links to Tapjoy's HTML5 website in our games, which will negatively impact our ability to generate smartphone revenue through incented offers in the fourth quarter of 2012 and beyond. Our revenues depend on a variety of other factors, including our relationships with digital storefront owners, carriers, other distributors and our licensors. The loss of any of our key relationships could adversely impact our revenues in the future.

Our net loss in the three months ended September 30, 2012 was $3.6 million versus a net loss of $6.2 million in the three months ended September 30, 2011. This decrease in our net loss was primarily due to a $4.4 million increase in revenues due to continued growth in sales of our smartphone games, a decrease in our cost of revenues of $2.5 million due to a decrease in royalty-burdened revenues as we continued to focus on developing and selling games based on our own original intellectual property, and a favorable fair value adjustment associated with the Blammo contingent stock-based compensation expense booked in prior quarters. These favorable factors were partially offset by an increase in operating expenses of $3.8 million which was driven by increased research and development and sales and marketing expenses associated with the development and launch of our freemium titles and goodwill impairment charges on our APAC reporting unit. In addition, we had an increase in our other income and expenses of $799,000 related primarily to unfavorable foreign exchange movements. Our net loss in the nine months ended September 30, 2012 was $13.4 million versus a net loss of $11.1 million in the nine months ended September 30, 2011. This increase in our net loss was primarily due to an increase in operating expenses of $24.1 million driven by additional personnel and facility costs associated with the acquisitions of Griptonite, Blammo and GameSpy, increased research and development and sales and marketing expenses associated with the development and launch of our freemium titles, goodwill impairment charges on our APAC reporting unit and additional contingent consideration expense related to the Blammo acquisition. We also had increased expense in our other income and expenses of $1.5 million related primarily to unfavorable foreign exchange movements in the first nine months of 2012 compared to the comparable period of 2011. These unfavorable factors were partially offset by an $15.5 million increase in revenues due to continued growth in sales of our smartphone games, a decrease in our cost of revenues of $4.6 million due to a decrease in royalty-burdened revenues as we continued to focus on developing and selling games based on our own original intellectual property, and a decrease in our tax provision of $3.1 million due primarily to the expiration of statutes of limitations in certain jurisdictions and the subsequent release of uncertain tax provisions. 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 these currencies fluctuated significantly in 2011 and the first nine months of 2012.


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We significantly increased our spending on sales and marketing initiatives in the first nine months of 2012 as compared with the first nine months of 2011 in connection with the launch and promotion of our freemium games, and we expect our sales and marketing expenditures to continue to increase during the fourth quarter of 2012, particularly due to the increased cost to advertise our games during the fourth quarter holiday season when marketing expenses in our industry generally rise due to increased demand. We also expect that our expenses to develop and port games for smartphones and tablets will increase as we enhance our existing titles and develop new titles to take advantage of the additional functionality offered by these devices. In addition, we expect our overall operating expenses, particularly our research and development expenses, to significantly increase in 2012 compared with 2011 due to our acquisitions of Griptonite, Blammo and GameSpy. We also anticipate incurring additional termination costs during the fourth quarter of 2012 as part of our 2012 restructuring plan. As a result of our recent acquisitions, our planned restructuring measures and the anticipated increased spending on sales and marketing and research and development initiatives, we expect to use cash in operations in 2012.

Our ability to attain and sustain profitability will be affected by our ability to grow our revenues, including our ability to derive significant revenues from the games developed by our Blammo and, in particular, Griptonite, studios. We also believe that our GameSpy acquisition will position us to generate additional revenues and increase the lifetime value of our users by enabling us to add robust multiplayer functionality and increase the number of community features in our games; we expect to release several games that utilize the GameSpy functionality in the first quarter of 2013. Our ability to attain and sustain profitability will also be affected by the extent to which we must incur additional expenses to expand our sales, marketing, development, and general and administrative capabilities to grow our business. The largest component of our recurring expenses is personnel costs, which consist of salaries, benefits and incentive compensation, including bonuses and stock-based compensation, for our employees. We expect that the restructuring measures we implemented during 2010, 2011 and the second and third quarters of 2012, which primarily consisted of headcount reductions, and the additional restructuring measures that we intend to implement in the fourth quarter of 2012, will have a beneficial effect on our overall operating expenses, but will not fully offset the expected increases in our operating expenses. Our business has historically been impacted by seasonality, as many new mobile phones and tablets are released in the fourth calendar quarter to coincide with the holiday shopping season. Because many end users download our games soon after they purchase a new mobile phone or tablet, we generally experience seasonal sales increases based on the holiday selling period. However, due to the time between device purchases and game purchases, some of this holiday impact occurs for us in our first calendar quarter. In addition, companies' advertising budgets are generally highest during the fourth quarter and decline significantly in the first quarter of the following year, which tends to positively affect the smartphone revenues we derive from advertisements in our freemium games. We expect these seasonal trends to continue in the future.

Cash and cash equivalents at September 30, 2012 totaled $24.1 million, a decrease of $8.2 million from the $32.2 million balance at December 31, 2011. This decrease was primarily due to the $5.0 million in cash we used for the purchase of Deer Hunter brand assets (see "Significant Transactions" below), $5.1 million of cash used in operations and $1.7 of capital expenditures. These outflows were partially offset by $3.1 million of proceeds received from warrant exercises, option exercises and purchases under our employee stock purchase program and $913,000 of cash received from the GameSpy acquisition. We expect to finish 2012 with more than $21.5 million in cash.

Significant Transactions

Acquisition of GameSpy

On August 2, 2012, we completed the acquisition of GameSpy pursuant to an Agreement and Plan of Merger (the "GameSpy Merger Agreement") by and among Glu, Galileo Acquisition Corp., a California corporation and wholly owned subsidiary of Glu ("Galileo"), IGN Entertainment, Inc., a Delaware corporation ("IGN") and GameSpy. Pursuant to the terms of the GameSpy Merger Agreement, Galileo merged with and into GameSpy in a statutory reverse triangular merger (the "GameSpy Merger"), with GameSpy surviving the GameSpy Merger as a wholly owned subsidiary of Glu.


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In connection with the GameSpy Merger, we issued to IGN, as GameSpy's sole shareholder, in exchange for all of the issued and outstanding shares of GameSpy capital stock, a total of 600,000 shares of our common stock, of which 90,000 shares will be held in escrow until November 2, 2013 as security to satisfy indemnification claims under the GameSpy Merger Agreement. In addition, Glu, GameSpy and IGN entered into a Transition Services Agreement, pursuant to which IGN will provide to Glu and GameSpy certain backend data center transition services related to GameSpy's private cloud storage infrastructure for up to two years following the acquisition.

Deer Hunter Brand Assets

On April 1, 2012, we acquired from Atari, Inc. ("Atari") its Deer Hunter trademark and associated domain names and also took a license to the other intellectual property associated with the Deer Hunter brand for total consideration of $5.0 million in cash (the "Consideration"). This transaction was structured as (i) the assignment of the Deer Hunter trademark and associated domain names (the "Brand Assets") for $1.0 million in cash pursuant to a Trademark and Domain Name Purchase Agreement between Glu and Atari (the "Trademark Purchase Agreement") and (ii) an exclusive, irrevocable, sublicensable and transferable worldwide license to the other intellectual property associated with the Deer Hunter brand (collectively, the "Deer Hunter IP Assets") for $4.0 million in cash pursuant to a License Agreement between Glu and Atari (the "License Agreement" and, together with the Trademark Purchase Agreement, the "Agreements"). The License Agreement has a term equal to the longer of (i) 99 years and ii) the expiration of the copyrights in and copyrightable elements of the Deer Hunter IP Assets. The Agreements were dated as of March 31, 2012 and the transaction closed on April 1, 2012.

Acquisition of Griptonite

On August 2, 2011, we completed the acquisition of Griptonite pursuant to an Agreement and Plan of Merger, as amended (the "Merger Agreement"), by and among Glu, Granite Acquisition Corp., a Washington corporation and wholly owned subsidiary of Glu ("Sub"), Foundation 9 Entertainment, Inc., a Delaware corporation ("Foundation 9"), and Griptonite. Pursuant to the terms of the Merger Agreement, Sub merged with and into Griptonite in a statutory reverse triangular merger (the "Merger"), with Griptonite surviving the Merger as a wholly owned subsidiary of Glu.

In connection with the Merger, we issued to Foundation 9, as Griptonite's sole shareholder, in exchange for all of the issued and outstanding shares of Griptonite capital stock, a total of 6,106,015 shares of our common stock, of which 600,000 shares were held in escrow until November 2, 2012 as security to satisfy indemnification claims under the Merger Agreement. In addition, we may be required to issue additional shares (not to exceed 5,301,919 shares) or in specified circumstances pay additional cash (i) in satisfaction of indemnification obligations in the case of, among other things, breaches of our representations, warranties and covenants in the Merger Agreement or
(ii) pursuant to potential working capital adjustments.

Acquisition of Blammo

On August 1, 2011, we completed the acquisition of Blammo by entering into a Share Purchase Agreement (the "Share Purchase Agreement") by and among Glu, Blammo and each of the owners of the outstanding share capital of Blammo (the "Sellers").

Pursuant to the terms of the Share Purchase Agreement, we purchased from the Sellers all of the issued and outstanding share capital of Blammo (the "Share Purchase"), and in exchange for such Blammo share capital, we (i) issued to the Sellers, in the aggregate, 1,000,000 shares of our common stock (the "Initial Shares") and (ii) agreed to issue to the Sellers, in the aggregate, up to an additional 3,312,937 shares of our common stock (the "Additional Shares") if Blammo achieves certain Net Revenue targets during the years ending March 31, 2013, March 31, 2014 and March 31, 2015, as more fully described below. 100,000 of the Initial Shares that were held in escrow to satisfy potential indemnification claims under the Share Purchase Agreement were released on August 1, 2012.


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The Additional Shares will be issued to the Sellers if, and to the extent that, Blammo achieves certain Net Revenue (as such term is defined in the Share Purchase Agreement) performance targets as follows: (i) for fiscal 2013 (April 1, 2012 through March 31, 2013), (a) 227,273 Additional Shares will be issued to the Sellers if, and only in the event that, Blammo meets its Baseline Net Revenue goal for such fiscal year, and (b) up to an additional 681,818 Additional Shares will be issued to the Sellers to the extent that Blammo exceeds its Baseline Net Revenue goal and meets its Upside Net Revenue goal for such fiscal year, (ii) for fiscal 2014 (April 1, 2013 through March 31, 2014),
(a) 416,667 Additional Shares will be issued to the Sellers if, and only in the event that, Blammo meets its Baseline Net Revenue goal for such fiscal year, and
(b) up to an additional 833,333 Additional Shares will be issued to the Sellers to the extent that Blammo exceeds its Baseline Net Revenue goal and meets its Upside Net Revenue goal for such fiscal year, and (iii) for fiscal 2015 (April 1, 2014 through March 31, 2015), (a) no Additional Shares will be issued to the Sellers if Blammo does not meet its Baseline Net Revenue goal for such fiscal year and (b) up to 1,153,846 Additional Shares will be issued to the Sellers to the extent that Blammo exceeds its Baseline Net Revenue goal and meets its Upside Net Revenue goal for such fiscal year. To the extent that Blammo meets its Baseline Net Revenue goal for a fiscal year but does not meet its Upside Net Revenue goal for such fiscal year, Additional Shares will be issued to the Sellers on a straight-line basis based on the amount by which Blammo exceeded the Baseline Net Revenue goal. Blammo's Baseline and Upside Net Revenue goals for fiscal 2013, 2014 and 2015 are as follows:

                                   Baseline Net       Upside Net
                    Fiscal Year      Revenue           Revenue
. . .
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