Glu_Current folio_10K

Table of Contents

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the fiscal year ended December 31, 2018

 

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 001-33368

 

Glu Mobile Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware

91-2143667

(State or Other Jurisdiction of

(IRS Employer

Incorporation or Organization)

Identification No.)

 

 

875 Howard Street, Suite 100

94103

San Francisco, California

(Zip Code)

(Address of Principal Executive Offices)

 

 

(415) 800-6100

 (Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Title of Each Class

Name of Each Exchange on Which Registered

Common Stock, par value $0.0001 per share

Nasdaq Global Select Market

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐     No ☑

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐     No ☑

 

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 ☑     No ☐

 

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 Regulation S-T (§ 232.405 of this chapter during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☑     No ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

Large accelerated filer ☑          

 

Accelerated filer ☐

Non-accelerated filer ☐         

 

Smaller reporting company ☐

 

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐     No ☑

 

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2018, the last business day of the registrant’s most recently completed second fiscal quarter, based upon the closing price of such stock on such date as reported by The Nasdaq Global Select Market, was approximately $713,370,079. Shares of common stock held by each executive officer and director of the registrant and by each person who owns 10% or more of the registrant’s outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The number of outstanding shares of the registrant’s common stock as of February 15, 2019 was 144,120,408.  

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for registrant’s 2019 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A within 120 days after registrant’s fiscal year ended December 31, 2018 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

 

 


 

Table of Contents

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

    

 

    

Page

 

 

 

PART I

 

 

 

 

 

 

 

 

 

Item 1. 

 

Business

 

3

 

Item 1A. 

 

Risk Factors

 

16

 

Item 1B. 

 

Unresolved Staff Comments

 

40

 

Item 2. 

 

Properties

 

40

 

Item 3. 

 

Legal Proceedings

 

41

 

Item 4. 

 

Mine Safety Disclosures

 

41

 

 

 

PART II

 

 

 

 

 

 

 

 

 

Item 5. 

 

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

41

 

Item 6. 

 

Selected Financial Data

 

42

 

Item 7. 

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

44

 

Item 7A. 

 

Quantitative and Qualitative Disclosures About Market Risk

 

67

 

Item 8. 

 

Financial Statements and Supplementary Data

 

69

 

Item 9. 

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

116

 

Item 9A. 

 

Controls and Procedures

 

116

 

Item 9B. 

 

Other Information

 

117

 

 

 

PART III

 

 

 

 

 

 

 

 

 

Item 10. 

 

Directors, Executive Officers and Corporate Governance

 

117

 

Item 11. 

 

Executive Compensation

 

117

 

Item 12. 

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

117

 

Item 13. 

 

Certain Relationships and Related Transactions, and Director Independence

 

118

 

Item 14. 

 

Principal Accounting Fees and Services

 

118

 

 

 

PART IV

 

 

 

 

 

 

 

 

 

Item 15. 

 

Exhibits, Financial Statement Schedules

 

118

 

Item 16. 

 

Form 10-K Summary

 

118

 

Signatures 

 

 

 

123

 

 

 

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Forward-Looking Statements

 

The information in this Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or 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 facts may be deemed to be forward-looking statements. For example, words such as “may,” “will,” “should,” “estimates,” “predicts,” “potential,” “continue,” “strategy,” “believes,” “anticipates,” “plans,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements.  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 or contribute to such differences include, but are not limited to, those discussed elsewhere in this report, particularly in the section titled “Risk Factors,” and the risks discussed in our other Securities and Exchange Commission, or SEC, filings.  We undertake no obligation to update the forward-looking statements after the date of this report, except as required by law.

 

PART I

 

Item 1.  Business

 

General

 

Glu Mobile develops, publishes and markets a portfolio of free-to-play mobile games designed to appeal to a broad cross section of users who download and make purchases within our games through direct-to-consumer digital storefronts, such as the Apple App Store, Google Play Store, and others.   Free-to-play games are games that a player can download and play for free, but which allow players to access a variety of additional content and features for a fee and to engage with various advertisements and offers that generate revenue for us.   We have a portfolio of compelling games based on our own intellectual property such as Cooking Dash,  Covet Fashion,  Deer Hunter,  Design Home and QuizUp, as well as games based on or significantly incorporating third party licensed brands including Kim Kardashian: Hollywood,  MLB Tap Sports Baseball and Restaurant Dash with Gordon Ramsay.  We are headquartered in San Francisco, California, with another U.S. office in San Mateo, California, and international locations in Toronto, Canada and Hyderabad, India.   

 

We were incorporated in Nevada in May 2001 as Cyent Studios, Inc. and changed our name to Sorrent, Inc. later that year.  In November 2001, we incorporated a wholly owned subsidiary in California, and, in December 2001, we merged the Nevada corporation into this California subsidiary to form Sorrent, Inc., a California corporation.  In May 2005, we changed our name to Glu Mobile Inc.  In March 2007, we completed our initial public offering and our common stock is traded on the Nasdaq Global Select Market under the symbol “GLUU.”   Except where the context requires otherwise, in this Annual Report on Form 10-K, references to “Company,” “Glu,” “Glu Mobile,” “we,” “us” and “our” refer to Glu Mobile Inc., and where appropriate, its subsidiaries.

 

Available Information

 

We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other reports, and amendments to these reports, required of public companies with the SEC.  The public can read and copy the materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549 and can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.  We make available free of charge on the Investor Relations section of our corporate website all of the reports we file with the SEC as soon as reasonably practicable after they are filed.  Our internet website is located at www.glu.com and our Investor Relations website is located at www.glu.com/investors.  The information on our website is not incorporated into this report, unless otherwise expressly stated. Copies of our Annual Report on Form 10-K for the year ended December 31, 2018 may also be obtained, without charge, by contacting Investor Relations, Glu Mobile Inc., 875 Howard Street, Suite 100, San Francisco, California 94103 or by emailing IR@glu.com.

 

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Strategy and Business Developments

 

Our Strategy

 

Our goal is to become the leading developer and publisher of free-to-play mobile games. Our strategy for achieving this goal is comprised of three parts:

 

·

Building Growth Games and Maximizing the Value of Evergreen Games;

 

·

Attracting and Fostering Creative Leaders; and

 

·

Cultivating Highly Creative Environments.

 

Building Growth Games and Maximizing the Value of Evergreen Games

 

The first prong of our strategy is to build growth games for smartphones and tablets as well as maximize the value we derive from our evergreen games. Growth games are titles that we continue to update with additional content and features and which grow revenue year over year. We believe a key component of driving revenue growth year over year from a growth game is the inclusion of community features which may involve users competing with each other, forming clubs or groups to cooperate in completing goals or events, or contributing their own original content to the game.  Covet Fashion,  Design Home and MLB Tap Sports Baseball are our existing growth games.  We are focused on building growth games in what we refer to as “blue oceans,” meaning that we seek to identify genres that are not oversaturated with competitive titles and where we believe we can become the leader in that genre.  We currently publish titles primarily in four genres: home décor, sports and action, fashion and celebrity, and time management. We believe these are genres in which we have already established a leadership position, are otherwise aligned with our strengths or are conducive to the establishment of a growth game. 

 

Evergreen games are similar to growth games in that we continue to update them with additional content and features, but differ from growth games in that our focus is to reduce and potentially reverse their year over year revenue declines; to the extent that we succeed in our efforts to grow annual revenue from an evergreen game and expect such title’s revenues to continue to grow on an annual basis, we would then consider such evergreen game to be a growth game.  For example, we succeeded in growing annual revenues from 2017 to 2018 for Kim Kardashian: Hollywood, a title that we first released in June 2014, though we do not expect revenues from this title to continue to grow in 2019. Cooking Dash,  Deer Hunter 2018,  Kim Kardashian: Hollywood and Restaurant Dash with Gordon Ramsay are examples of our existing evergreen games.

 

While we have generally designed our games to incorporate social features that enhance the user’s gameplay experience, as part of our product strategy we are emphasizing adding new social and community-based features, systems, and modes into our growth games.  For example, Covet Fashion allows users to join “Fashion Houses” with other users and then borrow each others’ clothes, receive advice on their looks, chat and work together to unlock additional rewards in special style challenges, and our Tap Sports Baseball franchise allow players to challenge their friends to head-to-head matchups and to join clubs that compete in daily events against other clubs.  We intend to continue to innovate to further enable our titles’ ability to function as successful growth or evergreen titles. For example, we plan to introduce a new meta game experience to Design Home during 2019 which is designed to deepen the experience for the game’s long-term players.   

 

We have begun to emphasize developing new titles based on original intellectual property.  Reflecting this strategy, revenue from games based on our own intellectual property increased from 59.1% of our total revenues in 2017 to 65.7% of our total revenues in 2018. However, we also seek to selectively license and utilize key brands within our titles if we believe this will maximize their consumer appeal and revenue potential. For example, in 2017, we added content from Major League Baseball, or MLB, for the first time in our Tap Sports Baseball franchise, which helped us to meaningfully grow revenue from this franchise year over year. In addition, in 2019 we intend to release WWE Universe, a title featuring WWE Superstars, logos and marks, and Disney Sorcerer’s Arena in collaboration with Disney Consumer Products and Interactive Media.  We have also worked with our celebrity licensors to engage their social media audiences

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and build games that will resonate with their unique fan bases.  In particular, Kim Kardashian: Hollywood utilizes transmedia storytelling, leveraging Ms. Kardashian West’s built-in social media fan base to drive installs and awareness of the game, and then attempts to surprise and delight those fans with real-world events and other game content based on her life.  Our Restaurant Dash with Gordon Ramsay title utilizes Gordon Ramsay’s personality to guide users to become a restaurateur in the image of Mr. Ramsay. We believe that we can continue to drive installs and awareness of our games through our licensing efforts with recognized brands, celebrities and social influencers that resonate with potential players of our games.  Partnering with desirable licensing partners and renewing our existing licenses requires that we continue to develop successful games based on licensed content and are able to compete with other mobile gaming companies on financial and other terms in signing such partners.  We also plan to continue introducing third-party licensed brands, properties and personalities into our games as additional licensed content, for cameo appearances or for limited time events in order to drive awareness and monetization.

 

We also plan to continue monitoring the successful aspects of our games to drive downloads and enhance monetization and retention as part of our product strategy, whether by optimizing advertising revenue within each title, including deeper meta game features, building enhanced and more complex core gameplay, adding additional social features, tournaments and events or otherwise. 

 

Attracting and Fostering Creative Leaders

 

The second prong of our strategy is to attract, cultivate and retain proven creative leaders who will develop and update our growth and evergreen games.  Each creative leader is responsible for the long-term planning of his or her titles and to identify and invest in long-term opportunities and concepts that have the potential to become growth games. Our talent model is to attract the industry’s finest and provide them with world-class infrastructure, tools, funding and the support to create hit games. We have made, and plan to make, significant investment in our creative leaders. 

 

We have worked with our creative leaders to instill financial discipline and operational excellence in our organization by revamping our prototyping and greenlight processes. Prior to developing a new game, a creative leader works with a small team to rapidly prototype new ideas that have the potential to become growth games. We expect our creative leaders to fail fast and to either continue to iterate on a game concept or to move on to rapidly prototyping a new concept. Once the creative leader and his or her team have sufficiently iterated on their concept and are satisfied that their game has the potential to be a growth game, the creative leader will submit a playable version of the game for greenlighting. If the game is greenlit, we then commit larger investments in terms of headcount and resources.

 

Cultivating Highly Creative Environments

 

We believe a key part of building growth games and attracting and cultivating creative leaders is providing them with highly creative environments that are optimal for creating hit games. In December 2017, we moved into our new headquarters in San Francisco that were designed to foster collaboration among our game teams and focus the company around our core values and creative-led vision.   Creative environments that support our creative leaders and other game development personnel are also needed to attract the level of talent that will support our growth and evergreen games.  We not only consolidated our studio footprint by moving into our creative center in San Francisco and relocating our Burlingame studio to our San Francisco headquarters, but have also significantly increased our investment in our low-cost, scaled center in Hyderabad, India which provides live operations for some of our evergreen games, insourced art, quality assurance and low cost repeatable sales, marketing and general and administrative functions.  As part of this consolidation, in the last several years, we closed or sold development studios in Beijing, China; Bellevue, Washington; Portland, Oregon; San Mateo and Long Beach, California; and Moscow, Russia.   

 

Business Developments

 

Since January 1, 2018, we have taken the following actions to support our business:

 

·

We continued to focus our efforts on developing and publishing games for smartphones and tablet devices. 

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Our significant achievements related to these efforts include the following:

 

·

We generated total revenue of $366.6 million for the year ended December 31, 2018, a 27.8% increase compared to total revenue of $286.8 million for the year ended December 31, 2017.

 

·

In December 2018, we had approximately 3.2 million daily active users and 21.1 million monthly active users of our games on our primary distribution platforms, including Apple’s App Store and the Google Play Store. 

 

·

As of December 31, 2018, we had approximately 1.9 billion cumulative installs of our games on our primary distribution platforms, including approximately 29.0 million installs during the fourth quarter of 2018.

 

We grew revenues on an annual basis from each of our growth games, as follows:

 

·

Revenues from Design Home increased from $71.4 million in 2017 to $145.7 million in 2018;

 

·

Revenues from Covet Fashion increased from $35.7 million in 2017 to $49.0 million in 2018; and

 

·

Revenues from our Tap Sports Baseball franchise increased from $42.1 million in 2017 to $69.1 million in 2018.

 

·

In February 2018, we announced that we are collaborating with Disney Consumer Products and Interactive Media (“Disney”) on the development of an upcoming mobile game that is expected to include characters and stories from across Disney and Pixar franchises.

 

Across the globe our industry is experiencing a trend where hit titles generally remain higher in the top grossing charts for longer.  We believe this is due to the continued specialization and investment of teams and companies in their hit titles, and the live, social nature of certain games.  Our strategy and the measures we have implemented to support our business position us to take advantage of these trends.  We plan to continue to regularly update and otherwise support our growth and evergreen games in order to ensure that those games monetize and retain users for even longer periods of time.  In addition, we plan to continue to invest in our creative leaders and the creative environments in which they and their teams work to increase our likelihood of creating significant hit growth games in 2019 and beyond.

 

Our Products

We develop and publish a portfolio of mobile games designed to appeal to a broad cross section of the users of smartphones and tablet devices. Our portfolio of growth and evergreen games is spread across the following genres:

o

Home Décor

o

Design Home, which launched in November 2016 and was acquired as part of our acquisition of Crowdstar, has become our most successful growth game. Design Home allows users to participate in daily Design Challenges in which they style three dimensional spaces with real, high-end furniture and décor.  We are planning key updates for Design Home in 2019, including the introduction of a deeper meta loop and e-commerce functionality.

o

Sports and Action

 

o

MLB Tap Sports Baseball 2018, which launched in March 2018, was the fifth installment in our popular Tap Sports Baseball franchise in which we partnered with the MLB, MLBPA and MLBPAA to include real-world baseball stars from each of the MLB’s 30 teams. MLB Tap Sports Baseball 2018 was our second largest revenue contributor and the highest ranked baseball title in the Apple App Store’s U.S.

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iPhone top grossing games rankings during 2018. We expect to launch MLB Tap Sports Baseball 2019 in March 2019.

o

Deer Hunter 2018, originally launched in September 2015 as Deer Hunter 2016, remained as one of our top action titles during 2018. We released a new Hunting Tournament feature in 2018 along with three major updates to this title in 2016 and 2017, which updates have helped slow the annual revenue declines from this title. 

o

We expect to add to our portfolio of sports and action titles through the worldwide release of WWE Universe in 2019 and the next iteration of our Deer Hunter franchise in 2020.

o

Fashion and Celebrity

o

Covet Fashion, which we acquired as part of our acquisition of Crowdstar, is a top grossing fashion title that was our third largest revenue contributor during 2018.  Covet Fashion features continually changing content and daily Style Challenges to help drive engagement and monetization of its users.  During 2018, we entered into an agreement with Disney which has enabled us to introduce a series of Disney-themed Style Challenges. 

o

Kim Kardashian: Hollywood is a narrative role playing game featuring Kim Kardashian-West’s likeness, voice and creative influence as she guides players on their journey to success in Hollywood. We globally launched Kim Kardashian: Hollywood in June 2014, and it continues to be one of our top revenue-generating titles on an annual basis. In fact, we grew revenue from this title on an annual basis from $26.6 million in 2017 to $34.0 million in 2018.

o

Time Management

o

Cooking Dash, while launched in June 2015, continued to be one of our top revenue-generating titles during 2018.  We released a significant update to this title at the end of 2017 and have continued to introduce new cooking venues through regular content updates, which we believe will maintain this title’s position as one of our top evergreen games into 2019.

o

Restaurant Dash with Gordon Ramsay, launched in June 2016, utilizes Gordon Ramsay’s personality to guide users to become a restaurateur in the image of Mr. Ramsay.  We are no longer developing content updates for this title, but have streamlined our live operations in an effort to maximize revenue and reduce costs from this title in 2019.

o

We expect to add to our portfolio of time management titles with the release of Diner DASH Adventures in 2019. Diner DASH Adventures will offer world decoration, a deep story, and an exciting consolidation of different Dash time-management styles. 

In addition, our portfolio of evergreen games also includes QuizUp, which is a multiplayer trivia game where users can challenge friends to trivia games and create their own trivia competitions.  QuizUp was released in 2013 by Plain Vanilla and acquired by us in December 2016.

Across genres, we view our titles as either growth games or catalog games, and within the catalog group, our titles are either classified as evergreen games or legacy games. Legacy games are those titles that are still published by us and earn revenue, but on which we expend little to no investment in terms of updates and enhancements.

We work to ensure that our games have consistently high production values, are visually appealing and have engaging core gameplay.  These characteristics have typically helped to drive installs and awareness of our games and resulted in highly positive consumer reviews.    

We have continued to improve monetization in our games, with our most popular games remaining successful for longer periods of time. The longevity of our most successful games derives from strong core gameplay, deep meta

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game features, regular content updates and social and community features, such as the ability to join clans or clubs, tournaments, player-versus-player gameplay and live events.

Our games historically have had “thick clients” due to their high production values and, in some cases, 3-D graphics.  A thick client game means that our games have a large file size, often 150 megabytes or more, that resides on the player’s device.  Because of the inherent limitations of the digital platforms and telecommunications networks, which, at best, only allow applications that are less than 150 megabytes to be downloaded over a carrier’s wireless network, users often must download one of our games either via a wireless Internet (wifi) connection or initially to their computer and then load the game to their device. 

Our Revenue

 

We generate the majority of our revenue through “in-app-purchases,” with the balance of our revenue primarily generated by offers and in-game advertising.  When we incorporate licensed content into our games, we share a portion of our revenue with the licensors featured in these titles.

 

In-App Purchases

 

Although users can download and play our games free of charge, they can purchase virtual currency, virtual items, other virtual benefits like time and energy or subscriptions of any of these categories, to enhance their gameplay experience – we refer to these as “in-app purchases” or “micro-transactions.”  Some of the benefits that players receive from their in-app purchases include:

·

Play Longer Through Better Equipment – We generally design our games to become significantly more challenging as the player advances through the game.  For a game like Cooking Dash, players can purchase higher-quality ingredients and various boosts that can help them complete increasingly difficult levels more easily.

·

Play Longer Through Energy Replenishment – We design some of our games, such as Deer Hunter 2018 and Kim Kardashian: Hollywood, to have short playing sessions, the duration of which are limited by the energy available for each session.  Players of Deer Hunter 2018 and Kim Kardashian: Hollywood can use their virtual currency to purchase items that will replenish their energy and enable them to extend their gameplay session.

·

Accelerate Game Progress – Although some players are content to slowly “grind” their way through progressing in a game, others are willing to purchase items to accelerate their progression.  For example, our Tap Sports Baseball titles enable players to spend their virtual currency to upgrade their roster of players and boost the effectiveness of such players, thus allowing the player to more quickly assemble a winning team.

·

Customization – Our games generally enable players to express themselves by customizing their character, the world the character inhabits or a room.  For example, Covet Fashion and Design Home each allow users to customize the look of their avatar or room, respectively, by purchasing clothing or home design elements. While in Covet Fashion users own a clothing or accessory item indefinitely after it is purchased and can use it in multiple events, Design Home limits the player to five uses of any purchased design element.

 

We sell virtual currency to consumers at various prices ranging from $0.99 to $400.00 depending on the available storefront pricing (adjusted for local currencies for sales to players in foreign countries) with the significant majority of player purchases occurring at the lower price points.  The digital storefronts generally share with us 70% of the consumers’ payments for in-app purchases; we do not have any special agreement or arrangement with respect to pricing or terms with any of the digital storefronts.  Consumers may also acquire virtual currency, other virtual items or virtual benefits through gameplay or by completing offers, as described below.

 

Offers and In-Game Advertising

 

In addition to in-app purchases of virtual currency, we also monetize our games through offers and in-game advertising.  Optimizing advertising revenue within our games requires us to continue taking advantage of positive trends

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in the mobile advertising industry, particularly as brands continue to migrate budgets from web to mobile.  Offers enable users to acquire virtual currency without paying cash but by instead taking specified actions, such as downloading another application, watching a short video, subscribing to a service or completing a survey.  We work with third parties to provide these offers to players of our games, and we receive a payment from the third party offer provider based on consumer response to these offers.  We also work with third party advertising aggregators who embed advertising, such as incented video ads, ads appearing within the game between content transitions and as pop-up ads; the aggregators typically pay us based on the number of impressions, which is the number of times an advertisement is shown to a player, or conversions, which is the number of times players complete an advertiser’s desired action. In addition, from time to time we work directly with other application developers to include advertising for their applications in our games, and the developers pay us based on either the number of impressions in our games or the number of users who download the developer’s application.  We also sometimes include virtual product integrations of goods directly into certain of our titles such as Design Home,  Covet Fashion and Kim Kardashian: Hollywood and expect that we may generate increasing advertising revenue from these types of product integrations in the future.

 

Licensed Content

 

Following the success of Kim Kardashian: Hollywood and games incorporating licensed third-party brands and properties, like our Tap Sports Baseball franchise, we increased our licensing efforts, both in terms of securing licenses to develop games based upon or significantly featuring celebrities and other third-party intellectual property and for cameo appearances or to otherwise incorporate third-party intellectual property into our games.  However, we have more recently begun to emphasize developing new titles based on original intellectual property. In 2018, 2017, and 2016, games based on our own intellectual property accounted for approximately 65.7%, 59.1%, and 39.7% of our revenue, respectively. The increase from 2017 to 2018 was due primarily to the success of Design Home, the Tap Sports Baseball franchise, and Covet Fashion, as well as the continued strength of some of our evergreen games, such as Cooking Dash and our Deer Hunter franchise. The increase from 2016 to 2017 was due primarily to the success of Design Home and Covet Fashion as well as the continued strength of Cooking Dash. We expect to launch three new titles in 2019, MLB Tap Sports Baseball 2019,  WWE Universe and Disney Sorcerer’s Arena, each of which will include third-party licensed content.  We intend to continue to selectively license and utilize key brands within our titles if we believe this will maximize their consumer appeal and revenue potential.

 

For games based on or significantly incorporating licensed brands, properties or other content, we share a portion of our revenue with the respective licensors.  The average royalty rate that we paid on games based on licensed content (such as Kim Kardashian: Hollywood and Restaurant Dash with Gordon Ramsay) or significantly incorporating licensed content (such as MLB Tap Sports Baseball 2018) was approximately 20.2% of gross revenue in 2018, 18.2% in 2017, and 21.9% in 2016. However, the individual royalty rates that we pay can be meaningfully above or below the average based on a variety of factors, such as the strength of the licensed brand, our development and porting obligations, and the platforms on which we are permitted to distribute the licensed content.

 

Sales, Marketing and Distribution

 

We market, sell and distribute our games primarily through direct-to-consumer digital storefronts, such as Apple’s App Store and the Google Play Store.  In addition to publishing our smartphone games on direct-to-consumer digital storefronts, we also publish some of our titles on other platforms, such as the Mac App Store and Facebook.  The significant majority of our smartphone revenue has historically been derived from Apple’s iOS platform, which accounted for approximately 63.1%, 63.0%, and 62.4% of our total revenue in 2018, 2017, and 2016, respectively.  We generated the majority of these iOS-related revenue from the Apple App Store, which represented 54.7%, 54.2%, and 52.7% of our total revenue in 2018, 2017, and 2016, respectively, with the significant majority of such revenue derived from in-app purchases.  We generated the balance of our iOS-related revenue from offers and advertisements in games distributed on the Apple App Store and, to a far lesser extent, sales of premium games. In addition, we generated approximately 36.6%, 36.0%, and 36.1% of our total revenue in 2018, 2017, and 2016, respectively, from the Android platform. We generated the majority of our Android-related revenue from in-app purchases and sales of premium games made through the Google Play Store, which represented 31.3%, 30.3%, and 27.6% of our total revenue in 2018, 2017, and 2016, respectively.  No other customer or digital storefront accounted for more than 10% of our total revenue in 2018, 2017, and 2016.     

 

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As part of our efforts to successfully market our games on the direct-to-consumer digital storefronts, we attempt to educate the storefront owners about our title roadmap and seek to have our games featured or otherwise prominently placed within the storefront.  We believe that the featuring or prominent placement of our games facilitates organic user discovery and is likely to result in our games achieving a greater degree of commercial success.  We believe that a number of factors may influence the featuring or placement of a game, including:

 

·

the perceived attractiveness and quality of the title, brand, or licensed intellectual property;

 

·

the level of critical or commercial success of the game or of other games previously introduced by a publisher;

 

·

incorporation of the storefront owner’s latest technology in the publisher’s title;

 

·

how strong the consumer experience is on all of the devices that discover titles using any given digital storefront;

·

the publisher’s relationship with the applicable storefront owner and future pipeline of quality titles for it; and

·

the current market share of the publisher.

 

The majority of our games have been featured on the Apple and Google storefronts when they were commercially released, which we believe is in part due to our efforts to be a consistently good partner with Apple and Google.  In addition to our efforts to secure prominent featuring or placement for our games, we have also undertaken a number of marketing initiatives designed to acquire players and increase downloads of our games and increase sales of virtual currency, including:

 

·

using social networking websites, such as Facebook and Twitter, to build a base of fans and followers to whom we can quickly and easily provide information about our games;

·

paying third parties, including advertising networks, social media channels and social influencers, to advertise or incentivize consumers to download our games through offers or recommendations;

·

using “push” notifications to alert users of sales on virtual currency or items in our games; and

·

cross-promoting our games through banner advertisements in our other games, as well as advertising our games in our competitors’ games;

 

In addition, certain of our games featuring celebrities or other licensed content like Kim Kardashian: Hollywood generate significant attention through word of mouth, particularly through social media channels.  We look to leverage existing social media presences in order to increase the virality and commercial success of our games.    Furthermore, social-based methods for promoting our games include in-game events where players compete with and against each other, in-game social promotions and regular content updates, including in-game content that leverages real world events, such as holiday promotions or current events in the life of our celebrity partners.     

 

We have sought to deepen player engagement by fostering a sense of community in our games.  As part of these efforts, we have organized player councils for certain of our games where we have invited some of our most dedicated players to special events to engage with the development teams and share their feedback about our games.  For example, we held a CovetCon event in 2018 where 10 VIP players were chosen to participate in a multi-day event focusing on Covet Fashion, and we are planning additional CovetCon events in 2019.

 

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Development Studios

Our creative leaders have primary responsibility for overseeing game development for our growth and evergreen games.  The internal studios that develop our games are located in San Francisco and San Mateo, California; and Toronto, Canada.  In addition, as part of our restructuring activities in 2016 and 2017 and the acquisition of QuizUp from Plain Vanilla in December 2016, we moved certain of our catalog games to our Hyderabad, India location to run live operations and produce content updates for these games.

Our studios are generally supported by central services personnel in our San Francisco, California headquarters who provide expertise with respect to areas such as user experience, analytics and marketing, with each studio leveraging these services to varying degrees.  In August 2017, we consolidated certain central technology functions, including analytics and software development kit (SDK) development, under our Chief Revenue Officer’s organization to better align these departments with Glu’s user acquisition and advertising revenue teams. 

 

Our game development process involves a significant amount of creativity, particularly with respect to developing original intellectual property franchises or games in which we license intellectual property from celebrities, Hollywood studios or other owners of brands, properties and other content.  Creative and technical studio expertise is necessary to design games that appeal to players who typically play in short sessions and to develop games that work well on mobile phones and tablets with their inherent limitations, such as small screen sizes and control buttons. During 2019, we plan to hire additional game development personnel and invest in technical studio expertise to drive content and features in our growth games and to prototype ideas that we believe can become hit growth games.

Despite our efforts to reduce our geographical footprint and consolidate studios, our development personnel are located in four cities in three different countries, which results in certain inherent complexities.  To address these issues, we instituted our Glu University training program.  Glu University is designed to increase interaction among our studio teams, including having international studio team members regularly spend time in our U.S. studios.  The goal of this program is to ensure that we increase the uniformity, quality and commercial success of our games.  In addition, we believe that our strategy of focusing our development efforts on building and maintaining growth and evergreen games will help ensure more efficient use of our talent and resources across our studios and further promote the sharing of expertise and best practices.      

 

Product Development

Since the markets for our products are characterized by rapid technological change, particularly in the technical capabilities of mobile phones and tablets, and changing end-user preferences, continuous investment is required to innovate and publish new games, regularly update our games, and modify existing games for distribution on new platforms.   

 

We have continued to utilize measures designed to ensure that we publish and launch games that have a greater likelihood of being commercially successful, while identifying earlier in the development process game concepts and designs that are unlikely to produce hits.  Prior to developing a new game, a creative leader works with a small team to rapidly prototype new ideas that have the potential to become growth games. We expect our creative leaders to fail fast and to either continue to iterate on a game concept or to move on to rapidly prototyping a new concept. Once the creative leader and his or her team have sufficiently iterated on their concept and are satisfied that their game has the potential to be a hit title, the creative leader will submit a playable version of the game for greenlighting. If the game is greenlit, only at that point will we commit larger investments in terms of headcount and resources.

 

In addition, we plan to continue holding detailed post-mortems for all products to review and analyze the positive and negative results from each new game launch.  These are in addition to our Glu University training sessions where we formally share best practices and learnings amongst the leadership of all functions of our global studios.

We use third-party development tools to create our games, including a game development engine licensed from Unity Technologies to create most of our newest games and our games in development.  In addition, we rely on our own servers and third-party infrastructure to operate our games and to maintain and provide our analytics data. In particular, a

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significant portion of game traffic is hosted by Amazon Web Services, which provides us server redundancy by using multiple locations on various distinct power grids, and we expect to continue utilizing Amazon for a significant portion of our hosting services for the foreseeable future.

Furthermore, we have made significant investments in building out a personalization and experimentation engine that seamlessly integrates with our proprietary analytics system, advertisement related activities, and game environment.  We believe this new capability will greatly enhance our ability to segment and personalize our players’ in-game experience with a focus on further monetizing our highest spending and most engaged players. We aim to connect the data, insights and knowledge gained from our analytics and monetization techniques to every element of our business – from marketing to merchandising – in order to improve player retention and monetization.

 

Seasonality

 

Many new smartphones and tablets are released in, or shortly before, the fourth calendar quarter to coincide with the holiday shopping season.  Because many players download our games soon after they purchase or receive their new devices, we generally experience seasonal sales increases based on the holiday selling period.  Although we believe that the majority of this holiday impact occurs during the fourth quarter, some of this seasonality also occurs for us in our first calendar quarter due to some lag between device purchases and game purchases.  However, the impact of this seasonality on our operating results is significantly affected by our title release schedule.  For example, we have historically released each year’s new version of our Tap Sports Baseball franchise late in the first quarter, which has resulted in revenues from this title peaking in the second or third quarter, with declining revenues in the fourth quarter and the first quarter of the following year leading up to the launch of the next version of the title. In addition, companies’ advertising budgets are generally highest during the fourth quarter and decline significantly in the first quarter of the following year, which affects the revenue we derive from advertisements and offers in our games.  Conversely, our marketing expenses also increase in the fourth quarter, since demand for marketing is higher during the holiday season and this increased demand drives up marketing costs.

 

Competition

 

Developing, distributing and selling mobile games is a highly competitive business, characterized by frequent product introductions and rapidly emerging new platforms, technologies and storefronts.  For players, we compete primarily on the basis of game quality, brand and customer reviews.  We compete for space on user’s smartphones and tablet devices in terms of the number of applications on their device and the amount of storage consumed by such applications.  We also compete more generally for the time, attention and discretionary spending of users of smartphones and tablet devices who are spending ever-increasing amounts of time on social media, messaging and music, movie and television streaming applications, personal computer and console games, sports and the Internet. We compete for promotional and digital storefront placement based on our relationship with the digital storefront owner, historical performance, game quality, perception of sales potential, customer reviews and relationships with celebrities and other licensors of brands and other content.  For content licensors, we compete based on royalty and other economic terms, historical financial performance of prior licensed content titles, perceptions of development quality, speed of execution, distribution breadth and relationships with storefront owners.  We also compete for experienced and talented employees.  

We compete with a continually increasing number of companies, including Activision (the parent company of King Digital Entertainment), DeNA, Disney, Electronic Arts (EA Mobile), Gameloft, Gamevil, GREE, GungHo Online Entertainment, Netease, Netmarble, Nexon, Rovio, Warner Brothers, and Zynga and many well-funded private companies, including DoubleDown, Epic Games, Jam City, Machine Zone, Miniclip, Niantic, Peak Games, Playrix, Pocket Gems, Scopely, Storm 8/Team Lava, and Supercell.  We also face competition from online game developers and distributors who are primarily focused on specific international markets.  We could also face increased competition if those companies choose to compete more directly in the United States or the other markets that are significant to us or if large companies with significant online presences such as Apple, Google, Amazon, Facebook, Microsoft or Verizon, choose to enter or expand in the games space or develop competing games.  In addition, we also face competition from mobile applications and websites focused on the home design market, which may include games, e-commerce titles, design applications and others seeking to displace our Design Home title which is a leading title in the currently unsaturated home design application market. Competitors in this space include, or may include, established game

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developers, established real estate companies, interior design companies, e-commerce companies and other well-funded private companies looking to enter the home design market.  

In addition, given the open nature of the development and distribution for smartphones and tablets and the relatively low barriers to entry, we also compete or will compete with a vast number of small companies and individuals who are able to create and launch games and other content for these devices using relatively limited resources and with relatively limited start-up time or expertise.  As an example of the competition that we face, it has been estimated that more than 3.3 million applications, including more than 800,000 active games, were available on Apple’s U.S. App Store as of January 31, 2019.  The proliferation of titles in these open developer channels makes it difficult for us to differentiate ourselves from other developers and to compete for players without substantially increasing our marketing expenses and development costs.

We also compete for downloads and time spent on mobile devices with companies that develop popular social media and messaging applications, such as Facebook (with its Facebook, Facebook Messenger, Instagram, WhatsApp and other applications), Pinterest, Reddit, Snapchat, Twitter, Vevo and YouTube, companies that develop streaming music, movie and television applications, such as Pandora, Spotify, Tidal, HBO Go, Netflix, Amazon Prime and Hulu, and with companies that create other non-gaming related software applications, for example for celebrities, such as Kim Kardashian West’s own personal media application. 

Some of our competitors and our potential competitors have one or more advantages over us, either globally or in particular geographic markets, which include:

·

significantly greater financial resources;

·

greater experience with free-to-play games, building and maintaining growth or evergreen games, and building social and community features into mobile games, as well as more effective game monetization;

·

stronger brand and consumer recognition regionally or worldwide;

·

the capacity to leverage their marketing expenditures across a broader portfolio of mobile and non-mobile products;

·

larger installed user bases from their existing mobile games;

·

larger installed user bases from related platforms, such as console gaming or social networking websites, to which they can market and sell mobile games;

·

more substantial intellectual property of their own from which they can develop games without having to pay royalties;

·

lower labor and development costs and better overall economies of scale;

·

greater platform-specific focus, experience and expertise;

·

broader global distribution and presence; and

·

greater talent, both in overall headcount and in terms of experience in creating successful titles.

 

Intellectual Property

 

Our intellectual property is an essential element of our business.  We use a combination of trademark, copyright, trade secret and other intellectual property laws, confidentiality agreements and license agreements to protect our intellectual property.  Our employees and independent contractors are required to sign agreements acknowledging that all

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inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership that they may claim in those works.  We also vigorously defend our intellectual property. Despite our precautions, it may be possible for third parties to obtain and use without our consent intellectual property that we own or license.  Unauthorized use of our intellectual property by third parties, including piracy, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.  In addition, some of our competitors have in the past 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 competitor’s game to the copycat game.  To the extent that these tactics are employed with respect to any of our games, it could reduce our revenue.

 

Our trademarks that have been registered with the U.S. Patent and Trademark Office include Glu, Crowdstar, our 2-D ‘g’ character logo, our 3-D ‘g’ character logo and several of our game titles, including Blood & Glory, Contract Killer,  Cooking Dash, Deer Hunter, Diner Dash, Eternity Warriors, Frontline Commando, Gun Bros, QuizUp, and Tap Sports.  In addition, we have trademark applications pending with the U.S. Patent and Trademark Office for other of our game titles.  For certain titles we do not yet have, and do not intend to seek, trademark registration.  We also own, or have applied to own, one or more registered trademarks in certain foreign countries, depending on the relevance of each brand to other markets. Registrations of both U.S. and foreign trademarks are renewable every ten years.

 

We have eleven patents issued by the U.S. Patent and Trademark Office and have five patent applications pending.  In addition, we have one international patent issued through the Patent Cooperation Treaty (PCT), which corresponds to one of our pending U.S. patent applications. We also have patent applications in Canada, China, and Europe that correspond to one of our eleven issued U.S. patents, and we also have patent applications pending in Canada and Europe that correspond to another of our eleven issued U.S. patents.

We also use third-party development tools to create many of our games, including a game development engine licensed from Unity Technologies to create most of our newest games. 

From time to time, we encounter disputes over rights and obligations concerning intellectual property.  If we do not prevail in these disputes, we may lose some or all of our intellectual property protection, be enjoined from further sales of our games or other applications determined to infringe the rights of others, and/or be forced to pay substantial royalties to a third party, any of which would have a material adverse effect on our business, financial condition and results of operations.

 

Government Regulation 

We are subject to various federal, state and international laws and regulations that affect our business, including those relating to the privacy and security of customer and employee personal information and those relating to the Internet, behavioral tracking, mobile applications, advertising and marketing activities, sweepstakes and contests, and gambling.  Additional laws in all of these areas are likely to be passed in the future, which could result in significant limitations on or changes to the ways in which we can collect, use, host, store or transmit the personal information and data of our customers or employees, communicate with our customers, and deliver products and services, or may significantly increase our compliance costs.  As our business expands to include new uses or collection of data that are subject to privacy or security regulations, our compliance requirements and costs will increase and we may be subject to increased regulatory scrutiny.

Financial Information about Segments and Geographic Areas

 

We manage our operations and allocate resources as a single reportable segment.  Financial information about our segment and geographic areas is incorporated into this section by reference to Note 13 of Notes to Consolidated Financial Statements contained in Item 8 of this report.  In addition, financial information regarding our operations, assets and liabilities, including our total net revenue and net loss for the years ended December 31, 2018, 2017, and 2016, and our total assets as of December 31, 2018 and 2017, is included in our Consolidated Financial Statements contained in Item 8 of this report.

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Employees

 

As of December 31, 2018, we had 659 employees, of which 425 were based in the United States and Canada, and 234 were based in India. We have not experienced any employment-related work stoppages and consider relations with our employees to be good. We believe that our future success depends in part on our continued ability to hire, assimilate and retain qualified employees.

Executive Officers

 

The following table shows Glu’s executive officers as of February 28, 2019 and their areas of responsibility.  Their biographies follow the table.

 

 

 

 

 

 

 

 

    

    

    

    

 

Name

 

Age

 

Position

 

 

 

 

 

 

 

Niccolo M. de Masi

 

38

 

Executive Chairman

 

Nick Earl

 

53

 

President and Chief Executive Officer

 

Eric R. Ludwig

 

49

 

Executive Vice President, Chief Operating Officer and Chief Financial Officer

 

Chris Akhavan

 

36

 

Chief Revenue Officer

 

Scott J. Leichtner

 

48

 

Vice President, General Counsel and Corporate Secretary

 

Niccolo M. de Masi has served as our Executive Chairman since November 2016, President and Chief Executive Officer from January 2010 to November 2016, as one of our directors since January 2010, as interim Chairman of our board of directors from July 2014 to December 2014 and as the Chairman of our board of directors since December 2014.  Mr. de Masi served as the President of Essential, a mobile phone hardware company from November 2016 to October 2018. Prior to joining Glu, Mr. de Masi was the Chief Executive Officer and President of Hands-On Mobile, a mobile technology company and developer and publisher of mobile entertainment, from October 2009 to December 2009, and previously served as the President of Hands-On Mobile from March 2008 to October 2009.  Prior to joining Hands-On Mobile, Mr. de Masi was the Chief Executive Officer of Monstermob Group PLC, a mobile entertainment company, from June 2006 to February 2007.  Mr. de Masi joined Monstermob in 2004 and, prior to becoming its Chief Executive Officer, held positions as its Managing Director and as its Chief Operating Officer, where he was responsible for formulating and implementing Monstermob’s growth and product strategy.  Prior to joining Monstermob, Mr. de Masi worked in a variety of corporate finance and operational roles within the technology, media and telecommunications (TMT) sector, beginning his career with JP Morgan on both the TMT debt capital markets and mergers and acquisitions teams in London.  He has also worked as a physicist with Siemens Solar and within the Strategic Planning and Development divisions of Technicolor.  Mr. de Masi has served as a director of Resideo since October 2018 and of Xura, Inc. from November 2015 to August 2016.  Mr. de Masi holds an M.A. degree in Physics and an MSci. degree in Electronic Engineering—both from Cambridge University.

 

Nick Earl has served as our President and Chief Executive officer since November 2016 and prior to that was our President of Global Studios from November 2015 to November 2016.  Before joining us, from November 2014 to September 2015, Mr. Earl served as President of Worldwide Studios at Kabam.  From September 2001 to October 2014, Mr. Earl served in several management positions at Electronic Arts, including most recently as Senior Vice President & General Manager of EA Mobile.  From 1999 to 2001, Mr. Earl served as VP Product Development at Eidos.  From April 1993 to March 1999, Mr. Earl served as an executive producer / GM at The 3DO Company.  Mr. Earl holds a B.A. in Economics from the University of California at Berkeley.

 

Eric R. Ludwig has served as our Chief Operating Officer since October 2014, as our Executive Vice President since October 2011, and as our Chief Financial Officer since August 2008.  Mr. Ludwig previously held the position of Senior Vice President, Chief Financial Officer and Chief Administrative Officer from September 2010 to October 2011.  Prior to becoming our Chief Financial Officer, Mr. Ludwig served as our Vice President, Finance, Interim Chief Financial Officer from May 2008 to August 2008, served as our Vice President, Finance from April 2005 to May 2008 and served as our Director of Finance from January 2005 to April 2005.  In addition, Mr. Ludwig has served as our Assistant Secretary since July 2006.  Prior to joining us, from January 1996 to January 2005, Mr. Ludwig held various positions at Instill Corporation, a software as a service company, most recently as Chief Financial Officer, Vice President, Finance and Corporate Secretary.  Prior to Instill, Mr. Ludwig was Corporate Controller at Camstar Systems, Inc., an enterprise

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manufacturing execution and quality systems software company, from May 1994 to January 1996.  He also worked at Price Waterhouse L.L.P. from May 1989 to May 1994. Mr. Ludwig holds a B.S. in Commerce from Santa Clara University and is a Certified Public Accountant (inactive).

 

Chris Akhavan has served as our Chief Revenue Officer since May 2016.  Prior to this, Mr. Akhavan served as our President of Publishing from April 2013 to May 2016.  Before joining us, from January 2010 to April 2013, Mr. Akhavan served in several management positions at Tapjoy, Inc., a provider of mobile advertising, most recently as Senior Vice President, Partnerships.  From April 2009 to January 2010, Mr. Akhavan was a Manager, Publisher Network at RockYou!, a social gaming company, and from October 2007 to November 2008, he served as a Strategic Partner Manager at VideoEgg (now SAY Media), an advertising inventory and platform provider.  Mr. Akhavan holds a B.A. in Economics from the University of California at Santa Cruz.

 

Scott J. Leichtner has served as our Vice President, General Counsel and Corporate Secretary since September 2010.  Mr. Leichtner joined Glu in June 2009 as our Senior Corporate Counsel.  Prior to joining us, Mr. Leichtner was a corporate attorney at Fenwick & West LLP, a law firm focused on serving technology clients, from October 1997 to May 2009.  Mr. Leichtner holds an A.B. in Political Science from Duke University and a J.D. from the University of Michigan.

 

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.

 

If we fail to develop and timely publish new high-quality, engaging games and continue to enhance our existing games, particularly our most successful games, our revenue would suffer.

Our business depends on developing and publishing mobile games that consumers will download and spend time and money playing.  We must continue to invest significant resources in research and development, technology, analytics and marketing to introduce new games and continue to update our successful growth and evergreen games, and we often must make decisions about these matters well in advance of a product’s release to timely implement them. Our success depends, in part, on unpredictable and volatile factors beyond our control, including consumer preferences and the number of applications they are willing to download to and maintain on their devices, competing gaming and non-gaming related applications, new mobile platforms and the availability of other entertainment activities.  If our games do not meet consumer expectations, or they are not brought to market in a timely and effective manner, our business, operating results and financial condition would be harmed. It can be difficult for us to predict with certainty when we will launch a new game as games may require longer development schedules or beta testing periods to meet our quality standards and our players’ expectations. For example, we experienced delays in the development and commercial release of The Swift Life, and, following global launch, the title did not generate significant revenue. We also decided to delay the worldwide launch dates of WWE Universe and Diner DASH Adventures in order to give the development teams additional time to work on these titles so that they can meet our expectations for a potential growth game. The worldwide launch of these titles might get delayed further than we anticipate, or they may not be successful when and if launched, which would likely harm our business, operating results and financial condition. 

Even if our games are successfully introduced in a timely fashion and initially adopted, a failure to continually update them with compelling content or a subsequent shift in the entertainment preferences of consumers could cause a decline in our games’ popularity that could materially reduce our revenue and harm our business, operating results and financial condition, which effect would be magnified for our most successful games and, in particular, Design Home.  In connection with our product strategy, we have committed significant resources to updating, adding new features to and enhancing our existing titles as opposed to launching as many new titles as we have in prior years.  However, we may not

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be successful in doing so, such as was the case with our update of Covet Fashion in the first quarter of 2017 or as may be the case with our plan to add new features to Design Home, including a deep meta game and e-commerce functionality.  It is difficult to predict when and how quickly the popularity and revenue of one of our games will decline, and if any of our key growth games experience any such unexpected declines, we may not meet our expectations or the expectations of securities analysts or investors for a given quarter.  In addition, our Kim Kardashian: Hollywood game benefitted significantly from awareness of the game through media coverage and social media channels, and such viral success can be difficult to predict or to repeat in the future.  Furthermore, we compete for the discretionary spending of consumers, who face a vast array of entertainment choices, including social media and other non-gaming related apps, games played on personal computers and consoles, television, movies, sports and the Internet.  If we are unable to sustain sufficient interest in our games compared to other forms of entertainment, our business and financial results would be seriously harmed.

In addition to the market factors noted above, our ability to successfully develop and launch games for mobile devices and their ability to achieve and maintain commercial success will depend on our ability to:

·

minimize launch delays and cost overruns on the development of new games and features;

·

successfully enhance and increase the revenue we generate from our existing growth games;

·

effectively market and monetize our games;

·

achieve a positive return on investment from our marketing and user acquisition efforts;

·

sustain sufficient interest in our games compared to other forms of entertainment for our players

·

adapt to new technologies and feature sets for mobile and other devices;

·

attract and retain experienced and talented employees

·

compete successfully against a large growing number of existing market participants;

·

minimize and quickly resolve bugs and outages; and

·

acquire and successfully integrate high quality mobile game assets, personnel or companies

These and other uncertainties make it difficult to know whether we will succeed in continuing to develop, launch and enhance successful mobile games in accordance with our operating plan. If we do not succeed in doing so, our business, financial condition, results of operations and reputation will suffer.

Successfully developing and monetizing free-to-play games is a challenging business model.

We face significant challenges in achieving our goal of become the leading developer and publisher of free-to-play mobile games.  The most successful free-to-play games tend to include socio-competitive gameplay, deep meta game features, player versus player activities, regularly updated content and other complex technological and creative attributes.  While we are working to include such features in our games, we may not successfully update our games to include these features or they may not be well received by our players.  For example, the significant update to Racing Rivals that we released in the fourth quarter of 2016 was poorly received by players, led to a significant decline in revenue and ultimately contributed to our decision to sunset this title. If we are unable to successfully implement our product strategy, or if we incur excessive expenses in this effort, our financial performance and ability to grow revenue would be negatively affected. Additionally, our existing games compete with our new offerings and the offerings of our competitors, and revenue from our existing catalog games have declined over time, a trend that we expect to continue. 

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Our efforts to develop new growth games and enhance our existing growth games may prove unsuccessful or, even if successful, it may take more time than we anticipate to achieve significant revenue because, among other reasons: 

·

our strategy assumes that a large number of players will download our games because they are free and that we will then be able to effectively monetize the games; however, players may not widely download our games for a variety of reasons, including

·

competition for downloads not only with other mobile games but also with social media and other non-gaming related applications;

·

limits on the number of mobile applications players are willing to download to and maintain on their devices;

·

poor consumer reviews or other negative publicity;

·

ineffective or insufficient marketing efforts;

·

lack of sufficient social and community features;

·

lack of prominent storefront featuring;

·

failure to reach and maintain Top Free App Store rankings;

·

the relatively large file size of some of our games, which has been exacerbated due to Apple’s requirement that games released on the Apple App Store include 64-bit support; in particular, our games often utilize a significant amount of the available memory on a user’s device and tend to consume additional space as players advance through our games, which may cause players to delete our games once the file size grows beyond the capacity of their devices’ storage limitations; and

·

the inherent limitations of the smartphone platforms and telecommunications networks, which at most only allow applications that are less than 150 megabytes to be downloaded over a carrier’s wireless network; as a result, players must download our games that exceed 150 megabytes either via a wireless Internet (wifi) connection or initially to their computer and then side-load them to their device;

·

even if our games are widely downloaded, we may fail to retain users or optimize the monetization of these games, such as occurred with our Kendall & Kylie title after its initial global launch in January 2016; this may occur for a variety of reasons, including poor game design or quality, lack of social and community features, gameplay issues such as game unavailability, long load times or an unexpected termination of the game due to data server or other technical issues, lack of differentiation from predecessor games or other competitive games, lack of innovative features that surprise and delight our players, differences in user demographics and purchasing power or our failure to effectively respond and adapt to changing user preferences through game updates;

·

future games that we release may fail to resonate with consumers and games that incorporate licensed property may not be financially successful due to the minimum guaranteed royalty payments to our licensors;

·

we intend to continue to develop games based upon our own intellectual property, in addition to well-known licensed brands and properties, and we may encounter difficulties in generating sufficient consumer interest in and downloads of our original intellectual property games;

·

many well-funded public and private companies have released, or plan to release, games in the same genres as our growth games or games incorporating the same licensed brands that we intend to use in our games

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(e.g., WWE and Disney Sorcerer’s Arena), and this competition will make it more difficult for us to differentiate our games and derive significant revenue from them; 

·

we may have difficulty hiring the experienced monetization, live operations, server technology, user experience and product management personnel that we require to develop our new games and support our existing growth games , or may face difficulties in developing our technology platform and incorporating it into our products or developing unique gameplay;

·

we depend on the proper and continued functioning of our own servers and third-party infrastructure to operate our connected games that are delivered as a service; and

·

the impact of potential regulatory issues, including:

·

the Federal Trade Commission, or the FTC, has previously indicated that it intends to review issues related to in-app purchases, particularly with respect to games that are marketed primarily to minors (for example, the FTC reached a settlement with Apple in January 2014 and with Google in September 2014 on this issue, and in April 2016, a federal court granted summary judgment in favor of the FTC finding Amazon liable for unfairly billing consumers for unauthorized in-app purchases by minors), and the FTC might issue rules significantly restricting or even prohibiting in-app purchases or name us as a defendant in a future class-action lawsuit;

·

various jurisdictions are assessing the legality of “loot boxes,” which are commonly used in some of our top games, and Apple has recently updated its terms of service to require publishers to publish the odds of winning the items contained in loot boxes, which could harm the monetization of our games that utilize loot boxes; and

·

various legislators, administrative bodies and courts, primarily in Europe, have taken actions (including imposing fines) or may be considering taking actions (including antitrust enforcement) against Apple and Google, which are our primary distribution platforms, and Facebook, which is our primary user acquisition channel.

If we do not achieve a sufficient return on our investment with respect to our free-to-play business model, it will negatively affect our operating results and may require us to formulate a new business strategy.

The markets in which we operate are highly competitive, many of our competitors have significantly greater resources than we do and our players may prefer our competitors’ products or competing forms of entertainment.

Developing, distributing and selling mobile games is a highly competitive business, characterized by frequent product introductions and rapidly emerging new platforms, technologies and storefronts.  For players, we compete primarily on the basis of game quality, brand and customer reviews.  We compete for space on user’s smartphones and tablet devices in terms of the number of applications on their device and the amount of storage consumed by such applications.  We also compete more generally for the time, attention and discretionary spending of users of smartphones and tablet devices who are spending ever-increasing amounts of time on social media, messaging and music, movie and television streaming applications, personal computer and console games, sports and the Internet. We compete for promotional and digital storefront placement based on our relationship with the digital storefront owner, historical performance, game quality, perception of sales potential, customer reviews and relationships with celebrities and other licensors of brands and other content.  For content licensors, we compete based on royalty and other economic terms, historical financial performance of prior licensed content titles, perceptions of development quality, speed of execution, distribution breadth and relationships with storefront owners.  We also compete for experienced and talented employees.

 

We compete with a continually increasing number of companies, including Activision (the parent company of King Digital Entertainment), DeNA, Disney, Electronic Arts (EA Mobile), Gameloft, Gamevil, GREE, GungHo Online Entertainment, Netease, Netmarble, Nexon, Nintendo, Rovio, Warner Brothers, and Zynga and many well-funded private companies, including DoubleDown, Epic Games, Jam City, Machine Zone, Miniclip, Niantic, Peak Games, Playrix,

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Pocket Gems, Scopely, Storm 8/Team Lava, and Supercell.  We also face competition from online game developers and distributors who are primarily focused on specific international markets.  We could also face increased competition if those companies choose to compete more directly in the United States or the other markets that are significant to us or if large companies with significant online presences such as Apple, Google, Amazon, Facebook, Microsoft or Verizon, choose to enter or expand in the games space or develop competing games.  In addition, we also face competition from mobile applications and websites focused on the home design market, which may include games, e-commerce titles, design applications and others seeking to displace our Design Home title which is a leading title in the currently unsaturated home design application market. Competitors in this space include, or may include, established game developers, established real estate companies, interior design companies, e-commerce companies and other well-funded private companies looking to enter the home design market.  Given the open nature of the development and distribution for smartphones and tablets and the relatively low barriers to entry, we also compete or will compete with a vast number of small companies and individuals who are able to create and launch games and other content for these devices using relatively limited resources and with relatively limited start-up time or expertise.  As an example of the competition that we face, it has been estimated that more than 3.3 million applications, including more than 800,000 active games, were available on Apple’s U.S. App Store as of January 31, 2019.  The proliferation of titles in these open developer channels makes it difficult for us to differentiate ourselves from other developers and to compete for players without substantially increasing our marketing expenses and development costs.

 

We also compete for downloads and time spent on mobile devices with companies that develop popular social media and messaging applications, such as Facebook (with its Facebook, Facebook Messenger, Instagram, WhatsApp and other applications), Pinterest, Reddit, Snapchat, Twitter, Vevo and YouTube, companies that develop streaming music, movie and television applications, such as Pandora, Spotify, Tidal, HBO Go, Netflix, Amazon Prime and Hulu, and with companies that create other non-gaming related software applications, for example for celebrities, such as Kim Kardashian West’s own personal media application.

Some of our competitors and our potential competitors have one or more advantages over us, either globally or in particular geographic markets, which include:

·

significantly greater financial resources;

·

greater experience with free-to-play games, building and maintaining growth or evergreen games, and building social and community features into mobile games, as well as more effective game monetization;

·

stronger brand and consumer recognition regionally or worldwide;

·

the capacity to leverage their marketing expenditures across a broader portfolio of mobile and non-mobile products;

·

larger installed user bases from their existing mobile games;

·

larger installed user bases from related platforms, such as console gaming or social networking websites, to which they can market and sell mobile games;

·

more substantial intellectual property of their own from which they can develop games without having to pay royalties;

·

lower labor and development costs and better overall economies of scale;

·

greater platform-specific focus, experience and expertise;

·

broader global distribution and presence; and

·

greater talent, both in overall headcount and in terms of experience in creating successful titles.

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If we are unable to compete effectively or we are not as successful as our competitors in our target markets, our sales could decline, our margins could decline and we could lose market share, any of which would materially harm our business, operating results and financial condition.

We rely on a very small portion of our total players for nearly all of our revenue that we derive from in-app purchases.

 

We rely on a very small portion of our total players for nearly all of our revenue derived from in-app purchases (as opposed to advertisements and incentivized offers) and installation rates and user-growth have declined for us with many of our most recent product launches.  The percentage of unique paying players for our largest revenue-generating free-to-play games has typically been less than 5%, when measured as the number of unique paying users on a given day divided by the number of unique users on that day, though this percentage fluctuates, and it may be higher than 5% for some of our games during specific, relatively short time periods, such as immediately following worldwide launch, during special events or following content updates or marketing campaigns.  To significantly increase our revenue, we must increase the number of downloads of our games, increase the number of players who convert into paying players by making in-app purchases or enrolling in subscriptions, increase the amount that our paying players spend in our games and/or increase the length of time our players generally play our games.  We might not succeed in our efforts to increase the monetization rates of our users, particularly if we do not increase the amount of social features in our games or otherwise improve our games though updates and live operations.  If we are unable to convert non-paying players into paying players, or if we are unable to retain our paying players or if the average amount of revenue that we generate from our players does not increase or declines, our business may not grow, our financial results will suffer, and our stock price may decline. 

 

We have depended on a small number of growth games for a significant portion of our revenue in recent fiscal periods.  If these games do not continue to grow or we do not release highly successful new games, our revenue would decline. 

In the mobile gaming 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 revenue comes from a limited number of games, although the games in that group have shifted over time. Our top three titles for 2018, Design Home, the Tap Sports Baseball franchise,  and Covet Fashion, each accounted for greater than 10% of our revenue in 2018 and collectively generated approximately 72.0% of our revenue during the period, compared to 52.0% in 2017; no other game generated more than 10% of our revenue during these respective periods. We expect our dependency on a small number of games for a majority of our revenue will continue for the foreseeable future. In particular, our growth game Design Home has accounted for a successively larger percentage of our revenues since its launch which has increased our reliance on the success of this title. We intend to globally launch WWE Universe,  Diner DASH Adventures and Disney Sorcerer’s Arena in 2019, and if one or more of these titles is unsuccessful, it could result in an overall decline in our revenues and cause us to continue to rely primarily on our existing growth games for a significant majority of revenues during 2019.   

We derive the majority of our revenue from Apple’s App Store and the Google Play Store, and if we are unable to maintain a good relationship with each of Apple and Google or if either of these storefronts were unavailable for any prolonged period of time, our business will suffer.

The majority of our smartphone revenue has historically been derived from Apple’s iOS platform, which accounted for 63.1% of our total revenue for 2018 compared with 63.0% and 62.4% of our total revenue for 2017 and 2016, respectively.  We generated the majority of this iOS-related revenue from the Apple App Store, which represented 54.7%, 54.2% and 52.7%  of our total revenue for 2018, 2017 and 2016, respectively, with the significant majority of such revenue derived from in-app purchases. We generated the balance of our iOS-related revenue from offers and advertisements in games distributed on the Apple App Store. In addition, we derived approximately 36.6%, 36.0% and 36.1% of our total revenue for 2018, 2017 and 2016, respectively, from the Android platform. We generated the majority of our Android-related revenue from the Google Play Store, which represented 31.3%, 30.3% and 27.6% of our total revenue for 2018, 2017 and 2016, respectively, with the significant majority of such revenue derived from in-app purchases. We believe that we have good relationships with each of Apple and Google, which have contributed to the majority of our games released in the last several years being featured on their respective storefronts upon worldwide commercial release.  If we do not continue to receive prominent featuring, users may find it more difficult to discover our

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games and we may not generate significant revenue from them.  We may also be required to spend significantly more on marketing campaigns to generate substantial revenue on these platforms. Additionally, our efforts to advertise through search advertisements in the Apple App Store may not be successful and may not result in additional users or monetization. In addition, currently neither Apple nor Google charge a publisher when it features one of their apps.  If either Apple or Google were to charge publishers to feature an app, it could cause our marketing expenses to increase considerably.  Accordingly, any change or deterioration in our relationship with Apple or Google could materially harm our business and likely cause our stock price to decline.  

We also rely on the continued functioning of the Apple App Store and the Google Play Store.  In the past these digital storefronts have been unavailable for short periods of time or experienced issues with their in-app purchasing functionality.   If such events recur on a prolonged basis or other similar issues arise that impact our ability to generate revenue from these storefronts, it would have a material adverse effect on our revenue and operating results.  In addition, if the storefront operators fail to provide high levels of service, our players’ ability to access our games may be interrupted or players may not receive the virtual currency or goods for which they have paid, which may adversely affect our brand, revenue and operating results.   

The operators of digital storefronts on which we publish our free-to-play games and the advertising channels through which we acquire some of our players in many cases have the unilateral ability to change and interpret the terms of our and others’ contracts with them.

We distribute our free-to-play games through direct-to-consumer digital storefronts, for which the distribution terms and conditions are often “click through” agreements that we are not able to negotiate with the storefront operator.  For example, we are subject to each of Apple’s and Google’s standard click-through terms and conditions for application developers, which govern the promotion, distribution and operation of apps, including our games, on their storefronts.  Each of Apple and Google can unilaterally change its standard terms and conditions, including platform commission fees, with no prior notice to us.  In addition, the agreement terms can be vague and subject to changing interpretations by the storefront operator.  Further, these storefront operators typically have the right to prohibit a developer from distributing its applications on its storefront if the developer violates its standard terms and conditions.  For example, in the fourth quarter of 2017, Apple updated its terms of service to require publishers to disclose a player’s odds of winning the various items contained within loot boxes.  Glu utilizes loot boxes in many of its current games and the games it intends to release in the future, and it is possible that this new disclosure requirement will negatively impact the monetization of these titles. Furthermore, in January 2018, Apple enforced new guidelines relating to offerwalls which negatively impacted our revenues from offers in Design Home. If Apple or Google, or any other key storefront operator, determines that we or one of our key vendors are violating its standard terms and conditions, by a new interpretation or otherwise, or prohibits us from distributing our games on its storefront, it would materially harm our business and likely cause our stock price to significantly decline.

Furthermore, any changes to the advertising channels through which we acquire some of our players, including any changes by Facebook of its advertising platform, which we rely on for a majority of our user acquisition activities, could negatively impact our revenue or otherwise materially harm our business, and we may not receive significant or any advance warning of such changes.

We have a history of net losses, may incur substantial net losses in the future and may not achieve and sustain profitability or growth in future periods.

We have incurred significant losses since inception, including a net loss of $13.2 million in 2018 and a net loss of $97.6 million in 2017. As of December 31, 2018, we had an accumulated deficit of $440.5 million. While we conducted several restructurings and divested our Moscow game development studio during 2017, which measures were aimed at reducing our fixed costs and operating more efficiently, our costs may continue to rise as we implement additional initiatives designed to increase revenue, potentially including: investing more heavily in our existing titles as part of our product strategy; increasing our spending on user acquisition efforts, particularly for our growth games; hiring additional staff in our San Francisco Bay Area and Hyderabad, India locations; developing new games with greater complexity, higher production values and deeper social features; running live operations on our games; and taking other steps to strengthen our company. We anticipate that the costs of acquiring new players and otherwise marketing our new

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titles will continue to rise, particularly since advertising costs in our industry have generally been rising and we have encountered increasing difficulties in generating downloads of our games as users spend more time on alternative software applications, such as social media, messaging, and streaming applications. We may also continue to incur significant costs to acquire rights to third party intellectual property, including incurring significant minimum guaranteed royalty payments. If our revenue does not increase at a rate sufficient to offset these additional expenses, if the launch dates for our games are delayed, if we do not realize a sufficient return on our user acquisition spending for our growth games, if we experience unexpected significant increases in operating expenses or if we are required to take additional charges related to impairments or restructurings, we will continue to incur losses. For example, during the fiscal years ended December 31, 2018 and 2017, we recorded impairments of $0.7 million and $27.3 million, respectively, related to certain contractual minimum guarantee payments made to certain of our celebrity licensors and other prepaid royalties. Additionally, we have taken restructuring charges in the past, including $6.0 million during 2017 related to headcount reductions and other restructuring activities and a $2.7 million charge relating to impairment of acquired in process research and development during the third quarter of 2018. Furthermore, given the significant amount of time and attention users are dedicating to social media and other non-gaming applications, increasing revenue has been, and may continue to be, challenging. This industry trend has been negatively impacting us, as the number of downloads of sequels to certain of our most successful franchises, including the launch of Deer Hunter 2016 (which we have rebranded Deer Hunter 2018), have downloaded at significantly lower rates as compared to previous new titles, which could negatively impact the success of the next iteration of our Deer Hunter franchise which we expect to launch in 2020.

Our financial results could vary significantly from quarter to quarter and are difficult to predict, which in turn could cause volatility in our stock price.

Our revenue and operating results could vary significantly from quarter to quarter due to 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 accurately predict our future revenue 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 revenue, and even a small shortfall in revenue could disproportionately and adversely affect financial results for that quarter. 

In addition to other factors discussed in this section, factors that may contribute to the variability of our quarterly results and the volatility in our stock price include:

·

our ability to increase the number of our paying players and the amount that each paying player spends in our games;

·

the popularity and monetization rates of our new games released during the quarter and the ability of games released in prior periods to sustain their popularity and monetization rates;

·

the number and timing of new games released by us and our competitors, which timing can be impacted by internal development delays, longer than anticipated beta testing periods, shifts in product strategy and how quickly digital storefront operators review and approve our games for commercial release;

·

changes in the prominence of storefront featuring for our games and those of our competitors;

·

the loss of, or changes to, one of our distribution platforms;

·

changes to the Apple iOS platform or the Google Android platform to which we are not able to adapt our game offerings;

·

fluctuations in the size and rate of growth of overall consumer demand for smartphones, tablets, games and related content;

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·

the amount and timing of charges related to any future impairments of goodwill, intangible assets, prepaid royalties and guarantees; for example, in 2018 and 2017, we impaired $0.7 million and $27.3 million, respectively, related to contractual minimum guarantee royalty payments made to certain celebrity licensors and other prepaid royalties, and in future periods we may be required to impair our goodwill due to further declines in our business and/or stock price, or take additional large impairments related to contractual minimum guarantee commitments if the associated games we are developing are not successful;

·

changes in the mix of revenue derived from games based on original intellectual property versus licensed intellectual property;

·

changes in the mix of revenue derived from in-app purchases, advertisements and offers, which mix often depends on the nature of new titles launched during the quarter;

·

changes in the amount of money we spend marketing our titles in a particular quarter, including the average amount we pay to acquire each new user, as well as changes in the timing of these marketing expenses within the quarter;

·

decisions by us to incur additional expenses, such as increases in research and development, restructuring expenses, or unanticipated increases in vendor-related costs, such as hosting fees;

·

the timing of successful mobile device launches;

·

the seasonality of our industry;

·

changes in accounting rules, such as those governing recognition of revenue, including the period of time over which we recognize revenue for in-app purchases of virtual currency and goods within some of our games, as well as estimates of average playing periods and player life;

·

the activities, announcements and performance of our commercial partners: and

·

macro-economic fluctuations in the United States and global economies, including those that impact discretionary consumer spending.

We may not, or may be unable to, renew our existing content licenses when they expire and may not choose to obtain additional licenses or be able to obtain new licenses on favorable terms, which could negatively impact our revenue if we fail to replace such revenue with revenue from games based on our own intellectual property.

 

In 2018, we generated 34.3% of our revenue from games that are based on or substantially incorporate third-party intellectual property, such as the Tap Sports Baseball franchise, Kim Kardashian: Hollywood, and Restaurant Dash with Gordon Ramsay. We expect to continue to derive significant revenue from these titles in 2019, particularly the Tap Sports Baseball franchise, and expect to continue to develop new titles featuring third-party intellectual property, such as WWE Universe and Disney Sorcerer’s Arena. Certain of our licenses expire at various times during the next several years, and we may be unable to renew these licenses on terms favorable to us or at all, and we may have difficulties obtaining licenses from new content owners on terms acceptable to us, if at all.  In addition, these licensors could decide to license to our competitors or develop and publish their own mobile games, competing with us in the marketplace. We also license certain brands and their assets for our Covet Fashion and Design Home titles without the provision of a license fee or royalty. These licensors could decide to no longer license their assets under the current terms, and to instead charge a one-time payment, ongoing royalty or both, which may adversely affect the profitability of these titles. Failure to maintain or renew our existing licenses or to obtain additional licenses would prevent us from continuing to offer our current licensed games and introducing new mobile games based on such licensed content, which could harm our business, operating results and financial condition.

 

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Securing license agreements to develop, publish and market games based on or significantly incorporating celebrities, third-party licensed brands, properties, and other content typically requires that we make minimum guaranteed royalty and other payments to such licensors, and to the extent such payments become impaired, our operating results would be harmed.

In connection with partnerships with celebrities and other licensors of third-party brands, properties and content, we have incurred and may continue to incur significant minimum guaranteed royalty and other payments.  As a result, we may incur impairments on such payments if our forecasts for these games are lower than we anticipated at the time we entered into the agreements.  For example, in 2018 and 2017, we impaired $0.7 million and $27.3 million, respectively, related to contractual minimum guaranteed royalty payments made to certain of our celebrity licensors and other prepaid royalties; as of December 31, 2018 we had remaining prepaid royalty balances totaling $10.2 million.  We expect to continue to selectively license third-party licensed brands, properties and other content and to pay minimum guaranteed royalty payments in connection with such deals.  As a result, we may be required to take impairments in future periods if the games we are developing that have significant contractual minimum guarantee commitments associated with them are not successful.  

If we do not successfully establish and maintain awareness of our brand and games, if we fail to develop high-quality, engaging games that are differentiated from our prior games, if we incur excessive expenses maintaining and promoting our brand or our games or if our games contain defects or objectionable content, our operating results and financial condition could be harmed. 

We believe that establishing and maintaining our brand is critical to establishing, developing and maintaining favorable relationships with players, distributors, content licensors, platform providers, advertisers and key talent. Increasing awareness of our brand and recognition of our games is particularly important in connection with our strategic focus of developing games based on our own intellectual property.  Our ability to promote the Glu brand and increase recognition of our games depends on our ability to develop high-quality, engaging games, including integrating the level of social and community features appropriate for a game’s target audience and partnering with brands with fan bases that can support successful mobile games.  If consumers, digital storefront owners and branded content owners do not perceive our existing games as high-quality or if we introduce new games that are not favorably received by them, 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 is costly and involves extensive management time to execute successfully.  Although we make significant sales and marketing expenditures in connection with the launch of our games, these efforts may not succeed in increasing awareness of our brand or the new games.  If we fail to maintain and increase brand awareness and consumer recognition of our games, our potential revenue could be limited, our costs could increase and our business, operating results and financial condition could suffer.

In addition, if a game contains objectionable content, we could experience damage to our reputation and brand.  Our games may contain violence or other content that some consumers may find objectionable.  For example, many of our shooter games have a 17-and-older rating due to its violence. In addition, Google required us to submit two versions of our Blood & Glory and Contract Killer:  Zombies games, one of which did not depict blood.  Despite these ratings and precautions, consumers may be offended by some of our game content and children to whom these games are not targeted may choose to play them without parental permission nonetheless.  In addition, our employees or employees of outside developers could include hidden features in our games without our knowledge, which might contain profanity, graphic violence, sexually explicit or otherwise objectionable material.  Users of our games, particularly games with social messaging features, may utilize these features for illegal purposes or target certain users through these features. If consumers believe that a game we published contains objectionable content or may expose them to nefarious individuals, it could harm our brand, consumers could refuse to download it or demand a refund for any in-app purchases and could pressure the digital storefront operators to no longer allow us to publish the game on their platforms.  Similarly, if any of our games are introduced with defects, vulnerabilities or have playability issues, we may receive negative user reviews, our brand may be damaged and our operating results and revenue negatively affected. For example, our Racing Rivals title experienced playability and user interface issues after the release of an update in the fourth quarter of 2016 that introduced new graphics, which particularly affected users of some Android devices and harmed monetization of the game, and our attempt to relaunch the game in the second quarter of 2018 by introducing new features and resetting the economy of the game resulted in the game crashing and not being available to most users for several days. As a result, the daily active users of Racing Rivals and the revenue that we generate from this title significantly decreased from peak levels which

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contributed to our decision to shut down the game effective March 31, 2019. In addition, any issues relating to our games could be exacerbated if our customer service department does not timely and adequately address issues that our players have encountered with our games.

We rely on a combination of our own servers and technology and third party infrastructure to operate our games. A significant portion of our game traffic is hosted by a single vendor and if we experience any system or network failures, unexpected technical problems, cyber attacks or any other interruption to our games, it could reduce our sales, increase costs, or result in a loss of revenue or loss of end users of our games.

We rely on our own servers and third-party infrastructure to operate our games, and we expect that our reliance on such third-party infrastructure and our technology platform will increase as we continue to add additional social features and functionality into our games.  We do not control these third parties and replacing them might require significant time and expense.  In particular, a significant portion of our game traffic is hosted by Amazon Web Services, which service provides server redundancy and uses multiple locations on various distinct power grids.  Amazon may terminate its agreement with us upon 30 days’ notice.  In addition, Amazon has experienced brief power outages on occasion during the past several years that have affected the availability of certain of our games during such outages. While none of these events adversely impacted our business, a similar outage of a longer duration could. Any technical problem with, cyber attack on, or loss of access to these third parties’ or our systems, servers or other technologies, including our technology platform, could result in the inability of end users to download or play our games, cause interruption to gameplay, prevent the completion of billing for a game or result in the loss of users’ virtual currency or other in-app purchases, interfere with access to some aspects of our games or result in the theft of end-user personal information.  For example, in the second quarter of 2018, our efforts to relaunch Racing Rivals resulted in the game crashing and not being available to most users for several days. In addition, in the second quarter of 2017, we experienced technical issues with our Covet Fashion title that caused an extended outage and resulted in certain users receiving in-game currency erroneously. If users are unable to access and play our games for any period of time, if virtual assets are lost, or if users do not receive their purchased virtual currency, we may receive negative publicity and game ratings, we may lose players of our games, we may be required to issue refunds, and we may become subject to regulatory investigation or class action litigation, any of which would negatively affect our business.  Any of these problems could require us to incur substantial repair costs, distract management from operating our business and result in a loss of revenue. Furthermore, our disaster recovery systems and those of third-parties with which we do business may not function as intended or may fail to adequately protect our critical business information in the event of a significant business interruption, which may cause interruption in service of our games, security breaches or the loss of data or functionality, which could negatively affect our business, financial condition or results of operations. 

Cyber attacks, security breaches, and computer viruses could harm our business, reputation, brand and operating results.

Cyber attacks, security breaches, and computer viruses have occurred on our systems in the past and may occur on our systems in the future. We store sensitive information, including personal information about our employees.  In addition, our games involve the storage and transmission of players’ personal information in our facilities and on our equipment, networks and corporate systems run by us or managed by third-parties including Apple, Google, Facebook, Microsoft, and Amazon. Our player data, corporate systems, third-party systems and security measures may be breached due to the actions of outside parties, employee error, malfeasance, a combination of these, or otherwise, and, as a result, an unauthorized party may obtain access to our data, our employees’ data, our players’ data or any third party data we may possess. In addition, outside parties may attempt to fraudulently induce employees to disclose information in order to gain access to this data. For example, in January 2016 a cyber attack caused us to take down our user forums for nearly a week and in May 2016, one of our employees fell victim to a spear phishing attack in which the employee uploaded sensitive employee information to a third party website.   Although these incidents did not result in a material loss of revenue, any future incidents, particularly of longer duration, could damage our brand and reputation and result in a material loss of revenue.  Given the global nature of our business and the low cost, relative ease and proliferation of internet enabled devices, we may be at increased risk for cyber attacks and, specifically, denial of service attacks, such as the denial of service attacks that affected Dyn in October 2016. In addition, as highlighted by reports that ISIS terrorists may have used Sony’s PlayStation 4 network to plan attacks, the chat and other social features in our games could potentially be used by terrorist organizations or other criminals to communicate or for other nefarious purposes, which

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could severely damage our brand and reputation.   If an actual or perceived security breach of our or a third-party system on which we rely occurs, the market perception of the effectiveness of our security measures could be harmed, we could lose players and advertisers, and we could suffer significant legal and financial harm including loss of revenue due to such events or in connection with remediation efforts and costs, investigation costs or penalties, litigation, regulatory and enforcement actions, compliance with notification obligations, changed security and system protection measures. Any of these actions could have a material and adverse effect on our business, reputation and operating results.   

We use a game development engine licensed from Unity Technologies to create many of our games. If we experience any prolonged technical issues with this engine or if we lose access to this engine for any reason, it could delay our game development efforts and cause our financial results to fall below expectations for a quarterly or annual period, which would likely cause our stock price to decline.

We use a game development engine licensed from Unity Technologies to create many of our games, and we expect to continue to use this engine for the foreseeable future. Because we do not own this engine, we do not control its operation or maintenance, nor do we control how the engine is updated or upgraded. As a result, any prolonged technical issues with this engine might not be resolved quickly, despite the fact that we have contractual service level commitments from Unity. In addition, to the extent that we require any functionality that is not offered by Unity we are dependent on Unity to update or upgrade its engine to offer such functionality. Furthermore, although Unity cannot terminate our agreement absent an uncured material breach of the agreement by us, we could lose access to this engine under certain circumstances, such as a natural disaster that impacts Unity or a bankruptcy event.  If we experience any prolonged issues with the operation of the Unity game development engine, if the Unity game development engine does not offer the functionality we require or if we lose access to this engine for any reason, it could delay our game development efforts and cause us to not meet revenue expectations for a quarterly or annual period, which would likely cause our stock price to decline. For example, in the first quarter of 2016, we were unable to implement a significant update to our Racing Rivals title due to programming bugs in the Unity game development engine, which update we believe could have helped to increase revenue for that title during the quarter.  Further, if one of our competitors acquired Unity, the acquiring company would be less likely to renew our agreement, which expires in October 2019, which could impact our game development efforts in the future, particularly with respect to sequels to games that were created on the Unity engine.

We derive a significant portion of our revenue from advertisements and offers that are incorporated into our free-to-play games through relationships with third parties. If we lose the ability to provide these advertisements and offers for any reason, if we become victim to advertising fraud or if any events occur that negatively impact the revenue we receive from these sources, it would negatively impact our operating results.

In addition to in-app purchases, we derive a significant portion of our revenue from our free-to-play games through advertisements and offers. We incorporate advertisements and offers into our games by implementing third parties’ software development kits. In order for us to increase our advertising and offers revenues, we need to continue to demonstrate the reach of our player network and success of our advertising partners.  We rely on these third parties to provide us with a sufficient inventory of advertisements and offers to meet the demand of our user base. If we exhaust the available inventory of these third parties, it will negatively impact our revenue. If our relationship with any of these third parties terminates for any reason, or if the commercial terms of our relationships do not continue to be renewed on favorable terms, we would need to locate and implement other third party solutions, which could negatively impact our revenue, at least in the short term.  We may also be susceptible to various types of advertising fraud, which could reduce the effectiveness of our advertising campaigns or cause us to pay money to advertising firms for installations that were wrongly attributed to such firms.  While we have implemented measures to detect and prevent advertising fraud, such measures may not prove effective, which would harm our user acquisition efforts and could harm our revenues. In addition, internet-connected devices and operating systems controlled by third parties increasingly contain features that allow device users to disable functionality allowing for the delivery of advertising on their devices. If a great number of users elect to utilize this feature, our ability to deliver effective advertising campaigns on behalf of our advertisers and our revenue might suffer. Furthermore, the revenue that we derive from advertisements and offers is subject to seasonality, as companies’ advertising budgets are generally highest during the fourth quarter and decline significantly in the first quarter of the following year, which negatively impacts our revenue in the first quarter (and conversely tends to significantly increase our marketing expenses in the fourth quarter).

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The actions of the storefront operators can also negatively impact the revenue that we generate from advertisements and offers. For example, in January 2018, Apple enforced new guidelines relating to certain types of incented offers which negatively impacted our revenues from offers in Design Home starting the first quarter of 2018.  Any similar changes in the future that impact our revenue that we generate from advertisements and offers could materially harm our business.

We rely on assumptions and estimates to calculate certain of our key metrics, and real or perceived inaccuracies in such metrics may harm our reputation and negatively affect our business.

Certain of our key metrics, including the number of our daily and monthly active users, our average revenue per daily user and the average useful life of our paying players, is calculated using internal company data from multiple analytics systems that have not been independently verified. The calculation of these metrics is described in detail under the heading titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Operating Metrics.” While these numbers are based on what we believe to be reasonable calculations for the applicable period of measurement, there are inherent challenges in measuring these metrics across our large user base around the world.  We regularly review and may adjust our processes for calculating our internal metrics to improve their accuracy, but these efforts may not prove successful and we may discover material inaccuracies.  In addition, our methodology for calculating these metrics may differ from the methodology used by other companies to calculate similar metrics.  For example, we currently treat an individual who plays two different Glu games on the same day or who plays the same game on two different devices during the same day (e.g., iPhone and an iPad) as two active users for each such day when we average or aggregate active users over time. As such, the calculations of our active users may not precisely reflect the actual number of people using our titles. We may also discover unexpected errors in our internal data that resulted from technical or other errors.  Furthermore, our Crowdstar studio utilizes a separate analytics system from the rest of our company, which could result in internal inconsistencies or errors.  If we determine that any of our metrics are not accurate, we may be required to revise or cease reporting such metrics and it may harm our reputation and business.

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 attract, retain and motivate our key personnel, namely our management team, creative leaders and experienced game development personnel.  In particular, we experienced a change in our management team in November 2016 which included the appointment of Nick Earl as our President and Chief Executive Officer. Mr. Earl is critical to our vision, strategic direction, products and technology, and the continued retention of the other members of our senior management team is important to our continued success. In addition, to grow our business, execute on our business strategy and replace departing employees, we must identify, hire and retain qualified personnel, particularly monetization, live operations, server technology, user experience and product management personnel to develop and support our growth games.  Attracting and retaining key personnel and other staff is difficult in a competitive hiring market, particularly in the San Francisco Bay Area where we are headquartered, and we may not succeed in doing so. The gaming and technology industries are also traditionally male dominated, so it may be difficult for us to recruit and retain talented female personnel who may be needed to help us optimize our games that are targeted to a more female-focused audience, including our games in the home décor, fashion and time management genres.  Volatility of our stock price, changes in our compensation structure for our executive officers that significantly relies on performance linked stock awards, and previous headcount reductions may make it more difficult for us to attract and retain top talent. In particular, should our stock price decline it might be difficult for us to attract and retain qualified personnel, since individuals may elect to seek employment with other companies that they believe have better long-term prospects or that present better opportunities for earning equity-based compensation.  Competitors have in the past and may in the future attempt to recruit our employees, and our management and key employees are not bound by agreements that could prevent them from terminating their employment at any time.  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. 

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Any restructuring actions and cost reduction initiatives that we undertake may not deliver the results we expect, and these actions may adversely affect our business.

During the last several years we have implemented restructuring actions and cost reduction initiatives to streamline operations and improve cost efficiencies.  Our most recent restructurings included reductions in personnel in Bellevue, Washington; San Francisco, California; Long Beach, California; Portland, Oregon; and Beijing, China, as well as the divestiture of our Moscow, Russia game development studio. Any future restructurings or divestitures could result in disruptions to our operations and adversely affect our business.  For example, in connection with the divestiture of our Moscow studio, we transitioned certain titles that were developed or operated by the Moscow studio, including Deer Hunter 2018, to our Hyderabad, India studio.  We have seen a decline in revenues from Deer Hunter 2018, which may in part be related to this transition. In addition, we cannot be sure that the cost reduction and streamlining initiatives will be as successful in reducing our overall expenses as we expect or that additional costs will not offset any such reductions or streamlining.  If our operating costs are higher than we expect or if we do not maintain adequate control of our costs and expenses, our operating results will suffer.

We may not realize the benefits expected through our strategic relationship with Tencent and other aspects of the relationship could have adverse effects on our business.

In April 2015, we entered into a strategic relationship with Tencent, a leading Internet company in China and arguably the world’s largest gaming company.  Tencent, through a controlled affiliate, agreed to invest $126.0 million in exchange for approximately 16.3% of our total outstanding common stock on a post-transaction basis.  In November 2015, we entered into an agreement with an affiliate of Tencent to license and publish its game, WeFire, in the United States and international markets outside of Asia under the name Rival Fire, which we launched in July 2016. In light of the poor performance of the title in terms of monetization and downloads, and the related contractual prepaid royalty commitments and license fees under our agreement with the affiliate of Tencent, we impaired $14.5 million in the third quarter of 2016.  In addition, we may not succeed in entering into any other agreements or operating partnerships with Tencent in the future.  Even if we do enter into additional operational partnerships, it could take months to years to fully realize the benefits of such partnerships and, to the extent such agreements involve publishing our games in China, some of our platform partners in China and other parts of Asia may view such a partnership negatively.

Tencent, through its controlled affiliates, held approximately 19.6% of the aggregate voting power of our common stock as of December 31, 2018, and could acquire up to 25.0% of the voting power through open-market purchases of our common stock. While Tencent has agreed to cause these shares to be voted with the majority recommendation of the independent members of our board of directors on most matters, Tencent could have considerable influence over matters such as approving a potential acquisition of us.  Tencent was also granted the right to designate a member of our board of directors, initially appointing Tencent Senior Vice President, Steven Ma, and in January 2017 appointing Ben Feder, Tencent’s President of International Partnerships (North America), as Mr. Ma’s replacement on our board of directors. Mr. Feder or any future Tencent designee could have an actual or apparent conflict of interest in such matters.  Tencent’s investment in and position with us could also discourage others from pursuing any potential acquisition of us, which could have the effect of depriving the holders of our common stock of the opportunity to sell their shares at a premium over the prevailing market price.

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 accounting standards bodies and the methods, estimates and judgments that we use in applying our accounting policies.  The frequency of accounting policy changes may accelerate, including conversion to unified international accounting standards.  Policies affecting revenue recognition have affected, and could further significantly affect, the way we account for revenue.  For example, the accounting for revenue derived from free-to-play games, particularly with regard to revenue generated from online digital storefronts, is still evolving and, in some cases, uncertain.  In particular, we were required to file an amendment to our Annual Report on Form 10-K for the year ended December 31, 2012 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013 to restate or revise the financial statements contained in those reports (including for the year ended December 31, 2011) because we did not correctly apply the

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applicable revenue recognition accounting guidance relating to our smartphone revenue.  While we believe that we are now correctly accounting for our revenues, this is an area that continues to involve significant discussion among accounting professionals and the future changes to the standard may cause our operating results to fluctuate. In addition, we currently defer revenue related to virtual goods and currency over the average playing period of paying users, which approximates the estimated weighted average useful life of the transaction.  While we believe our estimates are reasonable based on available game player information, we may revise such estimates in the future as our games’ operation periods change.  Any adjustments arising from changes in the estimates of the lives of these virtual items would be applied to the current quarter and prospectively on the basis that such changes are caused by new information indicating a change in the game player behavior patterns of our paying users.  Any changes in our estimates of useful lives of these virtual items may result in our revenue being recognized on a basis different from prior periods’ and may cause our operating results to fluctuate.  As we enhance, expand and diversify our business and product offerings, the application of existing or future financial accounting standards could have a significant adverse effect on our reported results although not necessarily on our cash flows.

If we are unable to maintain effective internal control over financial reporting, the accuracy and timeliness of our financial reporting may be adversely affected.

Maintaining effective internal control over financial reporting is necessary for us to produce reliable financial statements.  If we are unable to maintain such internal controls, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal controls as required pursuant to the Sarbanes-Oxley Act, it could result in a material misstatement of our financial statements that would require a restatement, and investor confidence in the accuracy and timeliness of our financial reports and the market price of our common stock could be negatively impacted.

Conversion of key internal systems and processes, particularly our ERP system, and problems with the design or implementation of these systems and processes could interfere with, and therefore harm, our business and operations.

We recently underwent a multi-phase project to convert certain key internal systems and processes, including our enterprise resource planning, or ERP, system to a cloud based system. In connection with the transition to our new ERP system, we shutdown certain of our legacy ERP systems in the third quarter of 2016, which affected certain of our processes in the second half of 2016 and may continue to impact our processes. While we have transitioned to our new ERP system, we may need to resolve issues that arise in connection with this transition. We have invested, and will continue to invest, significant capital and human resources in the design and implementation of these systems and processes. Any problems in the functioning of the new systems or processes, particularly any that impact our operations, could adversely affect our ability to process payments, record and transfer information in a timely and accurate manner, recognize revenue, file SEC reports in a timely manner, or otherwise run our business. Even if we encounter these adverse effects, as noted above, the design and implementation of these new systems and processes may be more time consuming than we anticipated and could negatively impact our business, financial condition, and results of operations.

Our business will suffer if our acquisition and strategic investment activities are unsuccessful or disrupt our ongoing business, which may involve increased expenses and may present risks not contemplated at the time of the transactions.

We have acquired and invested in, and may continue to acquire and invest in, companies, products and technologies that complement our strategic direction.  Acquisitions and investments involve significant risks and uncertainties, including:

·

diversion of management’s time and a shift of focus from operating the business to issues related to negotiation of acquisition or investment terms, integration and administration;

·

our ability to successfully integrate acquired technologies and operations into our business and maintain uniform standards, controls, policies and procedures;

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·

potential employee morale and retention issues resulting from any changes in compensation, management, reporting relationships, or future prospects;

·

potential product development delays resulting from any changes and disruptions that may follow the acquisition;

·

significant competition from other acquirers and investors as the gaming industry consolidates and challenges in offering attractive consideration given the volatility of our stock price and potential difficulties in obtaining alternative financing;

·

challenges retaining the key employees, customers and other business partners of the acquired or investee business;

·

our ability to realize synergies expected to result from an acquisition or strategic investment;

·

an impairment of acquired goodwill and other intangible assets or investments in future periods would result in a charge to earnings in the period in which the write-down occurs;

·

the internal control environment of an acquired or investee entity may not be consistent with our standards and may require significant time and resources to improve;

·

in the case of foreign acquisitions or strategic investments, 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;

·

liability for activities of the acquired or investee companies before the acquisition or investment, including violations of laws, rules and regulations, commercial disputes, tax liabilities, intellectual property and other litigation claims or disputes, accounting standards and other known and unknown liabilities;

·

harm to our brand and reputation; and

·

harm to our existing business relationships with business partners and advertisers as a result of the acquisition.

In particular, we acquired Crowdstar in the fourth quarter of 2016 in a multi-step transaction that did not involve the cooperation of Crowdstar’s management, where the former Chief Executive Officer of Crowdstar did not continue with the company post-acquisition and where we did not receive customary representations, warranties or indemnities from the acquired company. While we successfully integrated Crowdstar into our company and Crowdstar’s top titles, Covet Fashion and Design Home, are generating significant revenue, we still face risks and uncertainties in connection with this acquisition. For example, we may not be able to retain key Crowdstar employees for a variety of reasons, including the fact that we relocated the Crowdstar team from Burlingame, California to our new San Francisco headquarters during the fourth quarter of 2018, and the loss of key Crowdstar employees, or any disruption to Covet Fashion and Design Home due to this move, could affect revenue derived from Covet Fashion and Design Home.  In addition, we continue to face other risks related to the Crowdstar acquisition, including related to the lawsuit filed by Crowdstar’s former Chief Executive Officer in March 2018. For more information regarding this lawsuit, see Part II, Item 1 “Legal Proceedings.”

 

In addition, if we issue equity securities as consideration in an acquisition or strategic investment, as we did for our acquisitions of Griptonite, Inc., Blammo Games Inc., GameSpy Industries, Inc., PlayFirst, Inc. and Cie Games, Inc., our current stockholders’ percentage ownership and earnings per share would be diluted.  We may also need to raise additional capital in the event we use a significant amount of cash as consideration in an acquisition. Because acquisitions and strategic investments are inherently risky, our transactions may not be successful and may, in some cases, harm our operating results or financial condition. 

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Changes in foreign exchange rates and limitations on the convertibility of foreign currencies could adversely affect our business and operating results.

We currently transact business in more than 100 countries and in dozens of different currencies, with the Euro, Canadian Dollar and Indian Rupee being the primary international currencies in which we transact business.  Conducting business in currencies other than U.S. Dollars subjects us to fluctuations in currency exchange rates that could have a negative impact on our reported operating results.  We experienced significant fluctuations in currency exchange rates in 2016 and 2017, and may experience continued significant fluctuations in the future.  We incur expenses for employee compensation and other operating expenses at our non-U.S. locations in the local currency, and an increasing percentage of our international revenue is from customers who pay us in currencies other than the U.S. Dollar.  Fluctuations in the exchange rates between the U.S. Dollar and those other currencies could result in the U.S. Dollar equivalent of these expenses being higher and/or the U.S. Dollar equivalent of the foreign-denominated revenue being lower than would be the case if exchange rates were stable.  This could negatively impact our operating results. To date, we have not engaged in exchange rate hedging activities, and we do not expect to do so in the foreseeable future.

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 adversely affect our operating results.

International sales represented approximately 23.5%, 24.5%, and 25.7% of our revenue during 2018, 2017 and 2016, respectively.  To target international markets, we develop games that are customized for consumers in those markets.  We have international offices located in Canada and India. We expect to increase our international presence, as we intend to increase the number of our employees in our Hyderabad, India office. Risks affecting our international operations include:

·

our ability to develop games that appeal to the tastes and preferences of consumers in international markets;

·

difficulties developing, staffing, and simultaneously managing a large number of varying foreign operations as a result of distance, language, and cultural differences;

·

multiple and conflicting laws and regulations, including complications due to unexpected changes in these laws and regulations;

·

our ability to develop, customize and localize games that appeal to the tastes and preferences of consumers in international markets;

·

competition from local game developers that have significant market share in certain foreign markets and a better understanding of local consumer preferences;

·

potential violations of the Foreign Corrupt Practices Act and local laws prohibiting improper payments to government officials or representatives of commercial partners;

·

regulations that could potentially affect the content of our products and their distribution, particularly in China where multiple governmental bodies must review and approve of any gaming application before it may be published;

·

foreign exchange controls that might prevent us from repatriating income earned in countries outside the United States;

·

potential adverse foreign tax consequences, since due to our international operations, we must pay income tax in numerous foreign jurisdictions with complex and evolving tax laws;

·

political, economic and social instability;

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·

restrictions on the export or import of technology;

·

trade and tariff restrictions and variations in tariffs, quotas, taxes and other market barriers; and

·

difficulties in enforcing intellectual property rights in certain countries.

These risks could harm our international operations, which, in turn, could materially and adversely affect our business, operating results and financial condition.   

We may also liquidate or cease operating some of our foreign subsidiaries in the future which may raise additional risks. For example, we are in the process of winding down and liquidating our subsidiary in China.  These liquidation efforts will require us to obtain approvals from various government agencies in China, which could impose taxes and penalties upon us related to such liquidations.

If we fail to deliver our games at the same time as new mobile devices are commercially introduced, our revenue may suffer.

Our business depends, in part, on the commercial introduction of new mobile devices with enhanced features, including larger, higher resolution color screens, improved audio quality, and greater processing power, memory, battery life and storage.  For example, the introduction of new and more powerful versions of Apple’s iPhone and iPad and devices based on Google’s Android operating system, have helped drive the growth of the mobile games market.  In addition, consumers generally purchase the majority of content, such as our games, for a new device within a few months of purchasing it.  We do not control the timing of these device launches.  The mobile games market could also be disrupted by new technologies, such as the introduction of next generation virtual reality devices.  Some manufacturers give us access to their new devices prior to commercial release.  If one or more major manufacturers were to stop providing us access to new device models prior to commercial release, we might be unable to introduce games that are compatible with the new device when the device is first commercially released, and we might be unable to make compatible games for a substantial period following the device release.  If we do not adequately build into our title plan the demand for games for a particular mobile device or experience game launch delays, we miss the opportunity to sell games when new mobile devices are shipped or our end users upgrade to a new mobile device, our revenue would likely decline and our business, operating results and financial condition would likely suffer.

If the use of smartphones and tablet devices as game platforms and the proliferation of mobile devices generally do not increase, our business could be adversely affected.

While the number of people using mobile Internet-enabled devices, such as smartphones and tablet devices, has increased dramatically in the past few years, the mobile market, particularly the market for mobile games, is still emerging, and it may not grow as we anticipate. Our future success is substantially dependent upon the continued growth of use of mobile devices for games, as opposed to social media applications or other uses.  The proliferation of mobile devices may not continue to develop at historical rates and consumers may not continue to use mobile Internet-enabled devices as platforms for games.  We believe that historic rates of adoption and download of new applications in the United States will not continue to rise, and will instead decline, as the U.S. mobile application market enters a mature state. In addition, new and emerging technologies could make the mobile devices on which our games are currently released obsolete, requiring us to transition our business model to develop games for other next-generation platforms. 

Changes to digital platforms’ rules relating to “loot boxes,” or the potential adoption of regulations or legislation impacting loot boxes, could require us to make changes to some of our games’ economies or design, which could negatively impact the monetization of these games and harm our revenues.

In December 2017, Apple updated its terms of service to require publishers of applications that include “loot boxes” to disclose the odds of receiving each type of item within the loot box to customers prior to purchase. Loot boxes are a commonly used monetization technique in free-to-play mobile games in which a player can acquire a virtual loot box, typically through game play or by using virtual currency, but the player does not know which virtual item he or she will receive (which may be a common, rare or extremely rare item, and may be a duplicate of an item the player already has in

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his or her inventory) until the loot box is opened.  The player will always receive one or more virtual items when he or she opens the loot box, but the player does not know exactly which item(s) until the loot box is opened. We utilize loot boxes in some of our top games including our Tap Sports Baseball franchise and Kim Kardashian Hollywood, and we intend to use loot boxes in our upcoming WWE Universe title. We have updated our applicable games to comply with Apple’s new rules relating to loot boxes and do not believe that this has had a material impact on the monetization of our games that utilize loot boxes.  However, in the event that Apple changes its terms of service to include more onerous requirements or if Apple (or Google) were to prohibit the use of loot boxes in games distributed on its digital platform, it would require us to redesign the economies of the affected games and would likely cause our revenues generated from these games to decline.  In April 2018, each of the Belgian Gaming Commission and the Dutch Gambling Authority declared that loot boxes as implemented in certain of the games that they reviewed constituted illegal gambling under its respective laws. While neither of these bodies reviewed any of our games, we may be required to modify the implementation of loot boxes to continue utilizing loot boxes in these jurisdictions, remove loot boxes from our games published in these jurisdictions or cease publishing games containing loot boxes in these jurisdictions.  In addition, various other jurisdictions, including Australia, the United Kingdom, and the states of Hawaii, Minnesota and Washington, are reviewing or have indicated that they intend to review the legality of loot boxes and whether they constitute gambling.  To the extent that one or more jurisdictions determine that loot boxes constitute gambling or they otherwise elect to regulate the use of loot boxes, it could require us to stop utilizing loot boxes within our games that are distributed in such territories, which would negatively impact our revenues.   

Our business is subject to increasing governmental regulation. If we do not successfully respond to these regulations, our business may suffer.

We are subject to a number of domestic and foreign laws and regulations that affect our business.  Not only are these laws constantly evolving, which could result in their being interpreted in ways that could harm our business, but legislation is also continually being introduced that may affect both the content of our products and their distribution. 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, 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, for example to comply with labeling requirements for our free-to-play games. Additionally, if the FTC or any other significant regulatory body issues rules significantly restricting or even prohibiting in-app purchases or any other key aspect of our business, it would significantly impact our business strategy.  In addition, two self-regulatory bodies in the United States (the Entertainment Software Rating Board) and in the European Union (Pan European Game Information (PEGI)) 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). Furthermore, the Chinese government has adopted measures designed to eliminate violent or obscene content in games, along with regulations that may require us to obtain approval from certain government agencies in China, including the Ministry of Culture and General Administration of Press and Publication, in order to continue to publish any of our games in China. 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.

 

Furthermore, the growth and development of free-to-play gaming and the sale of virtual goods may prompt calls for more stringent consumer protection laws that may impose additional burdens on companies such as ours.  We anticipate that scrutiny and regulation of our industry will increase and that we will be required to devote legal and other resources to addressing such regulation.  For example, existing laws or new laws regarding the regulation of currency and banking institutions may be interpreted to cover virtual currency or goods.  If that were to occur we may be required to seek licenses, authorizations or approvals from relevant regulators, the granting of which may depend on us meeting certain capital and other requirements and we may be subject to additional regulation and oversight, all of which could significantly increase our operating costs.  Changes in current laws or regulations or the imposition of new laws and regulations in the United States or elsewhere regarding these activities may dampen the growth of free-to-play gaming and impair our business.

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We sometimes offer our players various types of sweepstakes, giveaways and promotional opportunities, and have allowed players to compete against each other in tournaments for cash prizes.  We have also in the past through a partnership with Probability PLC offered a suite of Glu branded mobile slots games in the United Kingdom and might continue to explore opportunities with respect to social casino games.  We are subject to laws in a number of jurisdictions concerning the operation and offering of such activities and games, many of which are still evolving and could be interpreted in ways that could harm our business.  For example, a March 2018 ruling from the 9th Circuit found that the mobile social casino game Big Fish Casino constituted gambling under Washington state law, which ruling could impact our ability to publish a planned social casino game in Washington state. Any future court ruling or other governmental action that imposes liability on providers of online services could result in criminal or civil liability and could harm our business.

In addition, because our services are available worldwide, certain foreign jurisdictions and others may claim that we are required to comply with their laws, including in jurisdictions where we have no local entity, employees or infrastructure.

The laws and regulations concerning data privacy and data security are continually evolving, and our actual or perceived failure to comply with these laws and regulations could harm our business.

We are subject to federal, state and foreign laws regarding privacy and the protection of the information that we collect regarding our users, which laws are currently in a state of flux and likely to remain so for the foreseeable future.  The U.S. government, including the FTC and the Department of Commerce, is continuing to review the need for greater regulation over collecting information concerning consumer behavior on the Internet and on mobile devices.  The European Union’s General Data Protection Regulation, which became effective in May 2018, the California Consumer Privacy Act of 2018, which will become effective in January 2020, and other laws, like the Brazilian Personal Data Protection Bill of Law, create new individual privacy rights and impose worldwide obligations on companies handling personal data, which has resulted, or will result, in a greater compliance burden for us and other companies and could result in us incurring substantial monetary penalties if we are found to be in violation of these laws and regulations. Various U.S. state and federal regulators have also continued to expand the scope of data elements worthy of, and subject to, privacy protections, creating a multi-layered regulation regime that may be applicable to our business and will require time and resources to address.  Additionally, the Children’s Online Privacy Protection Act requires companies to obtain parental consent before collecting personal information from children under the age of 13. In January 2014, the FTC announced a settlement with Apple related to in-app purchases made by minors.  In April 2016, the FTC was also successful in a lawsuit against Amazon, with a Federal District Court granting summary judgment in favor of the FTC, finding Amazon liable for unfairly billing consumers for unauthorized in-app purchases by minors.  If we do not follow existing laws and regulations, as well as the rules of the smartphone platform operators, with respect to privacy-related matters, or if consumers raise any concerns about our privacy practices, even if unfounded, it could damage our reputation and operating results. Furthermore, new or the interpretation of existing laws, policies, or industry codes could prevent us from offering, or make it costlier or more difficult to offer services in certain jurisdiction. 

All of our games are subject to our privacy policy and our terms of service located on our corporate website.  If we fail to comply with our posted privacy policy, terms of service or privacy-related laws and regulations, including with respect to the information we collect from users of our games, it could result in proceedings against us by governmental authorities or others, which could harm our business.  In addition, interpreting and applying data protection laws to the mobile gaming industry is often unclear.  These laws may be interpreted and applied in conflicting ways from state to state, country to country, or region to region, and in a manner, that is not consistent with our current data protection practices.  Complying with these varying requirements could cause us to incur additional costs and change our business practices. Additionally, a violation of applicable data privacy or data security laws by third parties we work with might also have an adverse effect on our business, financial condition or results of operations. Further, if we fail to adequately protect our users’ privacy and data, it could result in a loss of player confidence in our services and ultimately in a loss of users, which could adversely affect our business.

In the area of information security and data protection, many states and foreign jurisdictions have passed laws requiring notification to users when there is a security breach for personal data or requiring the adoption of minimum information security standards that are often vaguely defined and difficult to implement.  Costs to comply with these laws

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may increase as a result of changes in interpretation.  Furthermore, any failure on our part to comply with these laws may subject us to significant liabilities.  The security measures we have in place to protect our data and the personal information of our employees, customers and partners could be breached due to cyber-attacks initiated by third party hackers, employee error or malfeasance, fraudulent inducement of our employees to disclose sensitive information or otherwise.  Because the techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures.  Any breach or unauthorized access could materially interfere with our operations or our ability to offer our services or result in significant legal and financial exposure, damage to our reputation and a loss of confidence in the security of our data, which could have an adverse effect on our business and operating results.

 

“Cheating” programs, scam offers, black-markets and other offerings or actions by unrelated third parties that seek to exploit our games and players affect the game-playing experience and may lead players to stop playing our games or divert revenue to unrelated third parties.

Unrelated third parties have developed, and may continue to develop, “cheating” programs, scam offers, black-markets and other offerings that may decrease our revenue generated from our virtual economies, divert our players from our games or otherwise harm us.  Cheating programs enable players to exploit vulnerabilities in our games to obtain virtual currency or other items that would otherwise generate in-app purchases for us, play the games in automated ways or obtain unfair advantages over other players who do play fairly.  Unrelated third parties attempt to scam our players with fake offers for virtual goods or other game benefits.  We devote resources to discover and disable these programs and activities, but if we are unable to do so in a prompt and timely manner, our operations may be disrupted, our reputation damaged and players may play our games less frequently or stop playing our games altogether.  This may lead to lost revenue from paying players, increased cost of developing technological measures to combat these programs and activities, legal claims, and increased customer service costs needed to respond to disgruntled players.

Some of our players may make sales or purchases of virtual goods used in our games through unauthorized or fraudulent third-party websites, which may reduce our revenue.

Virtual goods in our games have no monetary value outside of our games. Nonetheless, some of our players may make sales and/or purchases of our virtual goods, such as virtual currency for our Tap Sports Baseball games, through unauthorized third-party sellers in exchange for real currency. These unauthorized or fraudulent transactions are usually arranged on third-party websites and the virtual goods offered may have been obtained through unauthorized means such as exploiting vulnerabilities in our games, from scamming our players with fake offers for virtual goods or other game benefits, or from credit card fraud. We do not generate any revenue from these transactions. These unauthorized purchases and sales from third-party sellers could reduce our revenues by, among other things:

 

·

decreasing revenue from authorized transactions;

 

·

creating downward pressure on the prices we charge players for our virtual currency;

 

·

increasing chargebacks from unauthorized credit card transactions;

 

·

causing us to lose revenue from dissatisfied players who stop playing a particular game;

 

·

increasing costs we incur to develop technological measures to curtail unauthorized transactions;

 

·

resulting in negative publicity or harm our reputation with players and partners; and

 

·

increasing customer support costs to respond to dissatisfied players.

 

To discourage unauthorized purchases and sales of our virtual goods, we state in our terms of service that the buying or selling of virtual currency and virtual goods from unauthorized third party sellers may result in bans from our games or legal action. We have banned players as a result of such activities. We have also employed technological

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measures to help detect unauthorized transactions and continue to develop additional methods and processes by which we can identify unauthorized transactions and block such transactions. However, there can be no assurance that our efforts to prevent or minimize these unauthorized or fraudulent transactions will be successful.

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 essential to our business.  We rely on a combination of patent, copyright, trademark, trade secret and other intellectual property laws and contractual restrictions on disclosure to protect our intellectual property rights.  To date, we have only eleven issued U.S. patents and five U.S. patent applications currently outstanding, including two that we inherited through acquisitions, so we will not be able to protect the majority of our technologies from independent invention by third parties.  In addition, we have filed foreign patent applications on two of the issued U.S. patents.   

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, and some parties have distributed “jail broken” versions of our games where all of the content has been unlocked and made available for free.  Further, some of our competitors 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 competitor’s game to the copycat game.   To the extent third parties copy our games, it could reduce the amount of revenue we are able to generate from any infringed 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 in certain international jurisdictions, such as China, where the laws may not protect our intellectual property rights as fully as in the United States.   We may institute litigation to enforce our intellectual property rights, which could result in substantial costs and divert our management’s 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, to acknowledge 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 brand, business, operating results and financial condition.

We are, and in the future may become, involved in intellectual property disputes, which may disrupt our business, require us to pay significant damage awards and could limit our ability to use certain technologies in the future.  

Third parties may sue us for intellectual property infringement, or initiate proceedings to invalidate our intellectual property, which, if successful, could disrupt our business, cause us to pay significant damage awards or require us to pay licensing fees.  For example, in July 2018, SwiftLife, Inc. filed a complaint in the U.S. District Court for the Eastern District of New York against us, our wholly owned subsidiary Glu Games Inc., and Taylor Swift, Taylor Swift Productions, Inc. and TAS Rights Management, LLC. The complaint alleges eight causes of action, including that Glu and the other defendants infringe the plaintiff’s federally registered trademark, SwiftLife. While we believe that the allegations asserted against us are without merit and we intend to vigorously defend ourselves in this matter, the 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. In addition, any claims brought against us in the future could result in our being enjoined from using our intellectual property or licensed intellectual property, and we might incur significant licensing fees and could be forced to develop alternative technologies.  We may also be required to pay penalties, judgments, royalties or significant settlement costs.  If we fail or are unable to develop non-infringing technology or games or to license the infringed or similar technology or games on a timely basis, we may be forced to withdraw games from the market or be prevented from introducing new games. We might also incur substantial expenses in defending against third-party claims, regardless of their merit.

In addition, we use open source software in some of our games and expect to continue to use open source software in the future.  We may face claims from companies that incorporate open source software into their products, claiming ownership of, or demanding release of, the source code, the open source software and/or derivative works that

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were developed using such software, or otherwise seeking to enforce the terms of the applicable open source license.  These claims could also result in litigation, require us to purchase a costly license or require us to devote additional research and development resources to change our games, any of which would have a negative effect on our business and operating results.

We are, and in the future may become a party to litigation and regulatory inquiries, which could result in an unfavorable outcome and have an adverse effect on our business, financial condition, results of operation and cash flows.

We are, and may become in the future, subject to various legal proceedings, claims and regulatory inquiries that arise out of the ordinary conduct of our business. For example, on March 14, 2018, Jeffrey Tseng, the former Chief Executive Officer of Crowdstar, filed a complaint in the Superior Court of the State of California for the County of Santa Clara against Glu and other defendants alleging certain claims arising out of our acquisition of Crowdstar.  Mr. Tseng is seeking compensatory damages and exemplary damages, each in an amount to be determined at trial, along with costs of suit, reasonable attorneys’ fees and such other relief as the Court may deem proper.  While we believe that the allegations asserted against us are without merit and we intend to vigorously defend ourselves in this matter, the 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. In addition, events may occur that give rise to a potential risk of litigation.  The number and significance of regulatory inquiries have increased as our business has grown and evolved.  Any proceedings, claims or inquiries initiated by or against us, whether successful or not, may be time consuming; result in costly litigation, damage awards, consent decrees, injunctive relief or increased costs of doing business, require us to change our business practices or products, require significant amounts of management time, result in diversion of significant operations resources or otherwise harm our business and future financial results.

Unanticipated changes in our income tax rates or exposure to additional tax liabilities may affect our future financial results.

 

Our future effective income tax rates may be favorably or unfavorably affected by unanticipated changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or their interpretation. Determining our worldwide provision for income taxes requires significant judgments. The estimation process and applicable laws are inherently uncertain, and our estimates are not binding on tax authorities.  Our effective tax rate could also be adversely affected by a variety of factors, many of which are beyond our control.  Recent and contemplated changes to U.S. tax laws, including limitations on a taxpayer’s ability to claim and utilize foreign tax credits and defer certain tax deductions until earnings outside of the United States are repatriated to the United States, could impact the tax treatment of our foreign earnings. Further, the taxing authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, including our transfer pricing, or determine that the manner in which we operate our business is not consistent with the manner in which we report our income to the jurisdictions, which could increase our worldwide effective tax rate and harm our financial position and results of operations. Foreign tax authorities may also interpret or change tax regulations such that we may be subject to tax liabilities upon closure or liquidation of a foreign subsidiary. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine if our provision for income taxes is adequate. These continuous examinations may result in unforeseen tax-related liabilities, which may harm our future financial results.

 

We must charge, collect and/or pay taxes other than income taxes, such as payroll, value-added, sales and use, net worth, property and goods and services taxes, in both the United States and foreign jurisdiction.  If tax authorities assert that we have taxable nexus in a jurisdiction, they may seek to impose past as well as future tax liability and/or penalties.  Any such impositions could also cause significant administrative burdens and decrease our future sales.  Moreover, state and federal legislatures have been considering various initiatives that could change our tax position regarding sales and use taxes.

 

Finally, as we change 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, our tax expense could increase.  

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Our facilities are located near known earthquake fault zones, and the occurrence of an earthquake or other natural disaster could damage our facilities and equipment, which could require us to curtail or cease operations.

Our principal offices are located in the San Francisco Bay Area, an area known for earthquakes.  We are also vulnerable to damage from other types of disasters, including power loss, fires, explosions, floods, communications failures, terrorist attacks and similar events.  If any natural or other disaster were to occur, our ability to operate our business could be impaired. 

Our stock price has fluctuated and declined and may continue to do so. Our stock price may be affected by third party data regarding our games. 

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 changes in the operating performance and stock market valuations of other technology companies generally, or those in our industry in particular, such as Activision, Electronic Arts and Zynga.  We also experience stock price volatility as security analysts or investors base their views and monitor the performance of our games on third party data, like App Annie, AppData, comScore or SensorTower.  Third parties publish daily data about us and other mobile gaming companies with respect to downloads of our games, daily and monthly active users and estimated revenue generated by our games.  These metrics can be volatile, particularly for specific games, and in many cases do not accurately reflect the actual levels of usage of our games across all platforms or the revenue generated by our games. 

In addition, the Nasdaq Global Select Market on which our common stock is listed has 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 their operating performance.  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 company’s 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 management’s attention and resources.

If securities or industry analysts do not publish research about our business, or publish negative or misinformed reports about our business, our share price and trading volume could decline and/or become more volatile.

The trading market for our common stock is affected by the research and reports that securities or industry analysts publish about our business.  We do not have any control over these analysts.  If one or more of the analysts who cover us downgrade our shares or lower their opinion of our shares, our share price would likely decline.  If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our share price or trading volume to decline.  In addition, our share price and the volatility of our shares can be affected by misinformed or mistaken research reports on our business.

Sales of substantial amounts of our common stock in the public markets, or the perception that such sales might occur, could reduce the price that our common stock might otherwise attain and may dilute existing stockholders’ voting power and ownership interest in us.  

The market price of shares of our common stock could decline as a result of substantial sales of our common stock, particularly sales by our directors and their affiliates, executive officers, employees and significant stockholders, under our current shelf registration statements, through a large number of shares of our common stock becoming available for sale, or the perception in the market that holders of a large number of shares intend to sell their shares.  For example, Tencent is free to sell the 21,000,000 shares it acquired from us in the second quarter of 2015 on the open-market, subject only to our black-out periods and other limitations under our insider trading policy. 

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Some provisions in our certificate of incorporation and bylaws, as well as Delaware law, 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:

·

our board of directors is classified into three classes of directors with staggered three-year terms;

·

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;

·

our stockholders are able to take action only at a meeting of stockholders and not by written consent;

·

only our board of directors and not our stockholders is able to fill vacancies on our board of directors;

·

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

·

advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before a meeting of stockholders.

In addition, as a Delaware corporation, we are subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents certain stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of at least two-thirds of our outstanding common stock not held by such 15% or greater stockholder, although our board of directors waived this provision with respect to Tencent’s potential acquisition of greater than 15% of our shares in connection with the transaction in which we initially sold shares of our common stock to an affiliate of Tencent.

We have no plans to pay dividends for the foreseeable future.

We have never declared or paid any cash dividends on our common stock and do not have any plans to pay cash dividends in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.

 

Item 1B.  Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

We lease our San Francisco, California corporate headquarters, an office building of approximately 57,000 square feet. The San Francisco facility currently accommodates our principal executive, marketing, business development, human resources, finance, legal, information technology and administrative activities, two of our development studios, and other development activities.

We lease additional domestic office space in Burlingame and San Mateo, California. We lease offices for our foreign operations in: Toronto, Canada and Hyderabad, India. These additional domestic and international facilities primarily accommodate development studios, and customer care activities, and total approximately 61,000 square feet.

 

We believe our space is adequate for our current needs and that suitable additional or substitute space will be available to accommodate the foreseeable expansion of our operations. See Note 9 of the Notes to Consolidated Financial Statements in Item 8 of this report for more information about our lease commitments.

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Item 3.  Legal Proceedings

 

On March 14, 2018, Jeffrey Tseng, the former Chief Executive Officer of Crowdstar, filed a complaint in the Superior Court of the State of California for the County of Santa Clara against Time Warner Inc., Rachel Lam, Intel Capital Corporation, Middlefield Ventures Inc. and Jose Blanc (collectively, the “Non-Glu Defendants”), Glu and additional yet-to-be-named defendants.  The complaint alleges (i) breach of fiduciary duty by the Non-Glu Defendants, (ii) aiding and abetting breach of fiduciary duty by Glu and (iii) intentional interference with contract, intentional interference with prospective economic advantage, negligent interference with prospective economic advantage and unfair competition by each of the defendants, in each case relating to circumstances arising from our acquisition of Crowdstar and the events leading up to the acquisition.  Mr. Tseng is seeking compensatory damages and exemplary damages, each in an amount to be determined at trial, along with costs of suit, reasonable attorneys’ fees and such other relief as the Court may deem proper.  The first Case Management Conference, was held on July 20, 2018. Glu and the Non-Glu Defendants filed demurrers in response to Mr. Tseng’s complaint on August 17, 2018, Mr. Tseng filed responses to these demurrers on September 17, 2018, and Glu and the Non-Glu Defendants filed reply briefs in support of their demurrers on October 15, 2018. A hearing with respect to the demurrers was held on November 30, 2018.  On January 24, 2019, the judge issued an order sustaining the demurrers on all six claims and gave Mr. Tseng 10 days’ leave to amend his complaint. We believe that the allegations against us are without merit and intend to continue to vigorously defend ourselves in this matter. 

From time to time, we are subject to various claims, complaints and legal actions in the normal course of business.  We are not currently party to any 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 4.  Mine Safety Disclosures

 

Not applicable.

 

PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information for Common Stock

 

Our common stock has been listed on The Nasdaq Global Select Market under the symbol “GLUU” since our initial public offering in March 2007.

 

Stock Price Performance Graph

 

The following graph shows a comparison from December 31, 2013 through December 31, 2018 of the cumulative total return for an investment of $100 (and the reinvestment of dividends) in our common stock, the Nasdaq Composite Index, NASDAQ Telecommunications Index, S&P 500 Index, and RDG Technology Composite Index. Such returns are based on historical results and are not intended to suggest future performance. We have historically utilized the NASDAQ Telecommunications Index in our stock price performance graph.  However, we believe the RDG Technology Composite Index is a better indicator of how Glu’s stock price performance compares to other companies in the overall

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technology industry and, as a result, intend to no longer utilize the NASDAQ Telecommunications Index in our stock price performance graph in future Annual Reports on Form 10-K.

 

Picture 1

 

The information under the heading “Stock Price Performance Graph” shall not be deemed “soliciting material” or to be “filed” for purposes of Section 18 of the Exchange Act of 1934, and shall not be incorporated by reference into any registration statement or other document filed by us with the SEC, whether made before or after the date of this report, regardless of any general incorporation language in such filing, except as expressly set forth by specific reference in such filing.

 

Stockholders

 

As of February 15, 2019, we had approximately 46 record holders of our common stock and thousands of additional beneficial holders.

 

Dividend Policy

 

We have never declared or paid any cash dividends on our capital stock.  We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any future determination related to our dividend policy will be made at the discretion of our Board of Directors.

 

Recent Sales of Unregistered Securities

 

None.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

None.

 

Item 6.  Selected Financial Data

 

The following selected consolidated financial data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Item 8, “Financial Statements and

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Supplementary Data,” and other financial data included elsewhere in this report. Our historical results of operations are not necessarily indicative of results of operations to be expected for any future period.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 

 

   

2018

   

2017

   

2016

   

2015

   

2014

 

 

 

(In thousands, except per share amounts)

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

366,561

 

$

286,827

 

$

200,581

 

$

249,900

 

$

223,146

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Platform commissions, royalties and other

 

 

128,445

 

 

103,499

 

 

75,239

 

 

95,682

 

 

80,736

Impairment of prepaid royalties and guarantees

 

 

711

 

 

27,323

 

 

30,107

 

 

2,502

 

 

256

Impairment and amortization of intangible assets

 

 

9,119

 

 

10,331

 

 

14,792

 

 

9,553

 

 

4,767

Total cost of revenue

 

 

138,275

 

 

141,153

 

 

120,138

 

 

107,737

 

 

85,759

Gross profit

 

 

228,286

 

 

145,674

 

 

80,443

 

 

142,163

 

 

137,387

Operating expenses (1):

 

 

 

 

 

 

 

 

 

 

 

                

 

 

                

Research and development

 

 

94,934

 

 

92,420

 

 

81,879

 

 

72,856

 

 

64,284

Sales and marketing

 

 

113,860

 

 

104,356

 

 

48,050

 

 

48,240

 

 

45,076

General and administrative

 

 

31,667

 

 

34,425

 

 

30,225

 

 

26,092

 

 

25,019

Amortization of intangible assets

 

 

 —

 

 

 —

 

 

 —

 

 

201

 

 

508

Restructuring charge

 

 

240

 

 

6,019

 

 

2,279

 

 

1,075

 

 

435

Total operating expenses

 

 

240,701

 

 

237,220

 

 

162,433

 

 

148,464

 

 

135,322

(Loss)/Income from operations

 

 

(12,415)

 

 

(91,546)

 

 

(81,990)

 

 

(6,301)

 

 

2,065

Interest and other expense, net

 

 

(235)

 

 

(6,850)

 

 

(5,751)

 

 

(743)

 

 

(1,472)

(Loss)/Income before income taxes

 

 

(12,650)

 

 

(98,396)

 

 

(87,741)

 

 

(7,044)

 

 

593

Income tax benefit (provision)

 

 

(549)

 

 

826

 

 

301

 

 

(141)

 

 

7,555

Net (loss)/income

 

 

(13,199)

 

 

(97,570)

 

 

(87,440)

 

 

(7,185)

 

 

8,148

Net (loss)/income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.09)

 

$

(0.72)

 

$

(0.66)

 

$

(0.06)

 

$

0.09

Diluted

 

$

(0.09)

 

$

(0.72)

 

$

(0.66)

 

$

(0.06)

 

$

0.08

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

141,402

 

 

135,715

 

 

131,804

 

 

118,775

 

 

91,826

Diluted

 

 

141,402

 

 

135,715

 

 

131,804

 

 

118,775

 

 

96,922

_________

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Includes stock-based compensation expense as follows:

Research and development

 

$

12,807

 

$

6,460

 

$

4,567

 

$

3,563

 

$

7,422

Sales and marketing

 

 

2,795

 

 

1,289

 

 

1,091

 

 

1,082

 

 

701

General and administrative

 

 

8,990

 

 

7,314

 

 

7,605

 

 

7,041

 

 

3,510

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 

 

   

2018

   

2017

   

2016

   

2015

   

2014

 

 

 

(In thousands)

Cash and cash equivalents and short-term investments

 

$

97,834

 

$

63,764

 

$

102,102

 

$

180,542

 

$

70,912

Total assets

 

 

314,433

 

 

299,298

 

 

339,504

 

 

402,986

 

 

251,663

Total long-term liabilities

 

 

7,191

 

 

12,534

 

 

22,350

 

 

25,932

 

 

3,936

Total stockholder's equity

 

$

177,313

 

$

153,860

 

$

232,814

 

$

306,428

 

$

171,706

 

 

Please see Note 1, Note 3 and Note 9 of our Notes to Consolidated Financial Statements for a discussion of factors such as impairment of prepaid royalties and guarantees, divestiture, and any material uncertainties that may materially affect the comparability of the information reflected in selected financial data, described in Item 6 of this report.

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Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included in Item 8, “Financial Statements and Supplementary Data” of this report. In addition to our historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results and the timing of certain events could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in Item 1A, “Risk Factors.”

 

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations, or 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 revenue 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 understanding our financial results for fiscal 2018, 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 consolidated financial statements and accompanying notes.    

 

Financial Results and Trends

 

Revenue for 2018 was $366.6 million, a 27.8% increase compared to 2017, in which we reported revenue of $286.8 million. The increase in total revenue was primarily related to a $71.8 million increase in our revenue from micro-transactions (in-app purchases) and a $9.0 million increase in our revenue from advertisements and offers. The increase was primarily related to an increase in revenue from Design Home,  Covet Fashion, the Tap Sports Baseball franchise and Kim Kardashian: Hollywood. These increases were partially offset by declining revenue on a year over year basis from catalog games such as Restaurant Dash with Gordon Ramsay, Deer Hunter 2018 (originally launched as Deer Hunter 2016), Deer Hunter Classic, Cooking Dash, Kendall & Kylie, Contract Killer Sniper and Racing Rivals.

   

Revenue for 2017 was $286.8 million, a 43.0% increase compared to 2016, in which we reported revenue of $200.6 million. The increase in total revenue was primarily related to a $79.7 million increase in our revenue from micro-transactions (in-app purchases) and a $7.4 million increase in our revenue from advertisements and offers. The increase was primarily related to an increase in revenue from the launch of MLB Tap Sports Baseball 2017 in March 2017, the launch of Restaurant Dash with Gordon Ramsay in June 2016 and the addition of Covet Fashion and Design Home through our acquisition of Crowdstar in November 2016.  This increase was partially offset by declining revenue on a year over year basis from catalog titles such as Tap Sports Baseball 2016, Kendall & Kylie, Kim Kardashian: HollywoodRacing Rivals, and Cooking Dash.   

 

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We have concentrated our product development efforts towards developing games for smartphone and tablet devices.  We generate the majority of our revenue from Apple’s iOS platform, which accounted for 63.1%, 63.0%, and 62.4% of our total revenue for the years ended December 31, 2018, 2017, and 2016, respectively.  We generated the majority of this iOS-related revenue through the Apple App Store, which represented 54.7%, 54.2%, and 52.7% of our total revenue for the years ended December 31, 2018, 2017, and 2016, respectively, with the significant majority of such revenue derived from in-app purchases.  We generated the balance of our iOS-related revenue from offers and advertisements in games distributed on the Apple App Store.  In addition, we generated approximately 36.6%, 36.0%, and 36.1% of our total revenue for the years ended December 31, 2018, 2017, and 2016, respectively, from the Android platform.  We generated the majority of our Android-related revenue through the Google Play Store, which represented 31.3%, 30.3%, 27.6% of our total revenue for the years ended December 31, 2018, 2017, and 2016, respectively, with the significant majority of such revenue derived from in-app purchases.  We generated the balance of our Android-related revenue from other platforms that distribute apps that run the Android operating system (e.g., the Amazon App Store) and through offers and advertisements in games distributed through the Google Play Store and other Android platforms. 

   

We currently publish titles primarily in four genres: home décor, sports and action, fashion and celebrity, and time management. We believe these are genres in which we have already established a leadership position, are otherwise aligned with our strengths or are conducive to the establishment of a strong growth title. Across genres, we view our titles as either growth games or catalog games, and within the catalog group, our titles are either classified as evergreen games or legacy games. Growth games are titles that we continue to update with additional content and features and which grow revenue year over year.  Evergreen games are similar to growth games in that we continue to update them with additional content and features, but differ from growth games in that our focus is to reduce and potentially reverse their year over year revenue declines; to the extent that we succeed in our efforts to grow annual revenue from an evergreen game and expect such title’s revenues to continue to grow on an annual basis, we would then consider such evergreen game to be a growth game. Legacy games are those titles that are still published by us and earn revenue, but on which we expend little to no investment in terms of updates and enhancements.

 

We established our leadership position in the home décor genre with our release of Design Home in November 2016, which was the first title launched by Crowdstar following the acquisition. We introduced key updates for Design Home in 2018, including elite events for elder players, improved series challenges and language localization in German, French and Spanish, and are planning key updates for this title in 2019, including the introduction of a deeper meta loop and e-commerce functionality. Our leadership in the sports and action category remains strong with our Tap Sports Baseball and Deer Hunter franchises, and we furthered our leadership with the launch of MLB Tap Sports Baseball 2018 in March 2018 which includes licensed content from Major League Baseball, or MLB, together with current and former MLB players pursuant to our continuing agreements with the Major League Baseball Players Association, or MLBPA, and Major League Baseball Players Alumni Association, or MLBPAAWe expect to launch MLB Tap Sports Baseball 2019 in March 2019 and expect to add to our portfolio of sports and action titles through the worldwide release of WWE Universe in 2019 and the next iteration of our Deer Hunter franchise in 2020. We established our leadership in the fashion and celebrity gaming genre when we launched Kim Kardashian: Hollywood in June 2014, and extended our leadership position through our acquisition of Crowdstar in November 2016 and its successful Covet Fashion title. The time management genre includes our Cooking Dash and Diner Dash franchises, and our leadership position in this genre was bolstered by our successful release of Restaurant Dash with Gordon Ramsay (which was originally branded as Gordon Ramsay DASH) in June 2016. We expect to add to our portfolio of time management titles through the release of Diner DASH Adventures in 2019.

   

We believe that our games consistently have high production values, are visually appealing and have engaging core gameplay.  These characteristics have typically helped to drive installs and awareness of our games and resulted in highly positive consumer reviews.  The majority of our games have been featured on Apple and Google storefronts when they were commercially released, which we believe is the result of us being a good partner of Apple and Google.   

   

We work closely with our celebrity and brand licensors to engage their social media audiences and build games that will resonate with their unique fan bases.  For example, our Kim Kardashian: Hollywood title utilizes transmedia storytelling, leveraging Ms. Kardashian West’s built-in social media fan base to drive installs and awareness of the game, and then attempting to surprise and delight those fans with real-world events and other game content based on her life.  Our goal is for the game content to become entwined with Ms. Kardashian West’s persona and social media

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presence, and to otherwise enhance interaction with her fans. We also leverage the strength of well-known brands and licensors to provide users with more realistic experiences, such as the case with MLB Tap Sports Baseball 2018 which features all MLB clubs and uniforms and current and former MLB players. We also work to build and nurture social communities in and around the games themselves, creating a new vehicle for strong, personal engagement with the brand or celebrity’s fan base.   

   

For us to continue driving installs and awareness of our games and to improve monetization and retention of our players, we must ensure that each of our games, has compelling gameplay and a core monetization loop that incentivizes players to make in-app purchases.  In addition, we must regularly update our games with compelling new content, deliver socio-competitive features like tournaments, contests, player-versus-player gameplay and live events and build and nurture social media communities around our franchises both in-game and holistically via community features such as dedicated social channels.  

    

We also plan to continue monitoring the successful aspects of our games to drive downloads and enhance monetization and retention as part of our product strategy, whether by optimizing advertising revenue within each title, securing additional compelling licensing arrangements, building enhanced and more complex core gameplay, adding deep meta game features and additional social features, tournaments and events, offering subscriptions for in game durables and consumables to players or otherwise. Optimizing advertising revenue within our games requires us to continue taking advantage of positive trends in the mobile advertising space, particularly as brands continue to migrate budgets from web to mobile.  Continuing to drive installs and awareness of our games through licensing efforts requires that we continue to partner with brands, celebrities, and social influencers that resonate with potential players of our games.  Partnering with desirable licensing partners and renewing our existing licenses with our most successful partners requires that we continue to develop successful games based on licensed content and are able to compete with other mobile gaming companies on financial and other terms in signing such partners.  We also plan to continue introducing third-party licensed brands, properties and personalities into our games as additional licensed content, for cameo appearances or for limited time events in order to drive awareness and monetization.

   

Across the globe our industry is evidencing that hit titles generally remain higher in the top grossing charts for longer.  We believe this is due to the continued specialization and investment of teams and companies in their hit titles, and the live, social nature of certain games. Our strategy and the measures we have implemented to support our business position us to take advantage of these trends, as evidenced by the continued strength of our Design Home,  Covet Fashion, and Kim Kardashian: Hollywood titles and the year over year growth of our Tap Sports Baseball franchise. We continue to regularly update and otherwise support our growth and evergreen games in order to ensure that those games monetize and retain users for even longer periods of time. In addition, we plan to continue to invest in our creative leaders and the creative environments in which they and their teams work to increase our likelihood of creating significant hit growth games in 2019 and beyond. 

   

Our net loss in the year ended December 31, 2018 was $13.2 million versus a net loss of $97.6 million in the year ended December 31, 2017. This change was primarily due to an increase in revenue of $79.7 million, a decrease in cost of sales of $2.9 million, a decrease in general and administrative expense of $2.8 million and a decrease in restructuring charges of $5.8 million. These changes were partially offset by an increase in sales and marketing expense of $9.5 million, an increase in research and development expense of $2.5 million and a decrease in other expense of $6.1 million related to the loss recorded on the divestiture of our Moscow studio in December 2017.  See “—Results of Operations—Comparison of the Years Ended December 31, 2018 and 2017” below for further details. Our operating results were also affected by fluctuations in foreign currency exchange rates of the currencies in which we incurred meaningful operating expenses (principally the Canadian Dollar, and Indian Rupee), and our customers’ reporting currencies. 

 

Our net loss in the year ended December 31, 2017 was $97.6 million versus a net loss of $87.4 million in the year ended December 31, 2016. This change was primarily due to an increase in cost of revenue of $21.0 million, an increase of $56.3 million in sales and marketing expenses and a net increase in interest and other expenses of $1.1 million. These increases were partially offset by an increase in revenue of $86.2 million.  See “—Results of Operations—Comparison of the Years Ended December 31, 2017 and 2016” below for further details. Our operating results were also affected by fluctuations in foreign currency exchange rates of the currencies in which we incurred meaningful operating

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expenses (principally the British Pound Sterling, Euro, Chinese Renminbi, Russian Ruble, Canadian Dollar, and Indian Rupee), and our customers’ reporting currencies, which fluctuated significantly in 2016 and 2017. We expect our sales and marketing expense will slightly decrease as a percent of revenue in 2019.

 

Our ability to achieve and sustain profitability depends not only on our ability to grow our revenue, but also on our ability to manage our operating expenses.  We significantly increased our sales and marketing expenditures beginning in the second quarter of 2017, which was primarily related to Design Home, as we sought to leverage the game’s momentum, and we further increased our overall sales and marketing spending during 2018. The increase in 2018 expense compared to 2017 largely related to higher marketing spend for Covet Fashion, the Tap Sports Baseball franchise and Kim Kardashian: Hollywood, partially offset by lower marketing expense for some of our catalog titles. We expect our sales and marketing expenses to increase in 2019 primarily due to higher user acquisition expenditures, including related to the launch of WWE Universe,  Diner DASH Adventures and Disney Sorcerer’s Arena in 2019.  Additionally, the largest component of our recurring expenses is personnel costs, which consist of salaries, benefits and incentive compensation, including bonuses and stock-based compensation.  We have conducted several restructurings since 2016. However, the cost reductions from these restructurings were largely offset by personnel costs related to our acquisition of Crowdstar in November 2016.  In December 2017, we sold our wholly owned subsidiary in Moscow and transitioned the catalog games developed and/or operated by the Moscow studio to a more cost-effective location in Hyderabad, India. In 2019, we intend to focus on reducing our operating costs to be more efficient. These efforts may be partially offset by our plans to continue hiring additional development personnel in the San Francisco Bay Area and in Hyderabad, India.

 

Cash and cash equivalents at December 31, 2018 totaled $97.8 million, an increase of $34.0 million from the $63.8 million balance at December 31, 2017. This increase was primarily related to $32.3 million of cash generated from operations and $2.2 million of cash generated from financing activities, which was partially offset by $636,000 of cash used in investing activities.

 

Key Operating Metrics

 

We manage our business by tracking various non-financial operating metrics that give us insight into user behavior in our games. The three metrics that we use most frequently are Daily Active Users (DAU), Monthly Active Users (MAU), and Average Revenue Per Daily Active User (ARPDAU).  Our methodology for calculating DAU, MAU, and ARPDAU may differ from the methodology used by other companies to calculate similar metrics.

 

DAU is the number of individuals who played a particular smartphone game on a particular day.  An individual who plays two different games on the same day is counted as two active users for that day when we aggregate DAU across games.  In addition, an individual who plays the same game on two different devices during the same day (e.g., an iPhone and an iPad) is also counted as two active users for each such day when we average or aggregate DAU over time.  Average DAU for a particular period is the average of the DAUs for each day during that period.  We use DAU as a measure of player engagement with the titles that our players have downloaded.

 

MAU is the number of individuals who played a particular smartphone game in the month for which we are calculating the metric.  An individual who plays two different games in the same month is counted as two active users for that month when we aggregate MAU across games.  In addition, an individual who plays the same game on two different devices during the same month (e.g., an iPhone and an iPad) is also counted as two active users for each such month when we average or aggregate MAU over time.  Average MAU for a particular period is the average of the MAUs for each month during that period.  We use the ratio between DAU and MAU as a measure of player retention.

 

ARPDAU is total free-to-play smartphone revenue – consisting of micro-transactions, advertisements and offers – for the measurement period divided by the number of days in the measurement period divided by the DAU for the measurement period. ARPDAU reflects game monetization.  Under our revenue recognition policy, we recognize this revenue over the estimated average playing period of a user, but our methodology for calculating our DAU does not align with our revenue recognition policy for micro-transactions and offers, under which we defer revenue.  For example, if a title is introduced in the last month of a quarter, we defer a substantial portion of the micro-transaction and offer revenue to future months, but the entire DAU for the newly released title is included in the month of launch.

 

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We calculate DAU, MAU and ARPDAU primarily from our main distribution platforms: Apple’s App Store, Google’s Play Store,  and Amazon’s Appstore, as well as from Facebook for certain titles; we are not able to calculate these metrics across all of our distribution channels. In addition, the platforms that we include for purposes of this calculation have changed over time, and we expect that they will continue to change as our business evolves, but we do not expect that we will adjust prior metrics to take any such additions or deletions of distribution platforms into account. We believe that calculating these metrics for only our primary distribution platforms at a given period is generally representative of the metrics for all of our distribution platforms. Moreover, we rely on the data analytics software that we incorporate into our games to calculate and report the DAU, MAU and ARPDAU of our games, and we make certain adjustments to the analytics data to address inconsistencies between the information as reported and our DAU and MAU calculation methodology.

 

We have estimated the DAU and MAU for certain older titles because the analytics tools incorporated into those titles are incompatible with newer device operating systems (e.g., iOS 12), preventing us from collecting complete data. For these titles, we estimate DAU and MAU by extrapolating from each affected title’s historical data using a fixed decay rate in light of the behavior of similar titles for which complete data is available.  The table below sets forth our aggregate DAU, MAU and ARPDAU for all of our then-active smartphone titles for the periods specified, followed by a qualitative discussion of the changes in these metrics. Aggregate DAU and MAU include users of both our free-to-play and premium titles, whereas aggregate ARPDAU is calculated based only on revenue from our free-to-play games. Aggregate DAU and MAU for each period presented represents the aggregate metric for the last month of the period. For example, DAU for the three months ended December 31, 2018 is aggregate daily DAU for the month of December 2018 calculated for all active smartphone free-to-play and premium titles in that month across the distribution platforms for which we calculate the metric.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended,

 

 

2018

  

  

2017

 

 

March 31

    

June 30

    

September 30

    

December 31

  

  

March 31

    

June 30

    

September 30

    

December 31

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aggregate DAU

 

3,585

 

 

3,627

 

 

3,408

 

 

3,214

 

 

 

4,098

 

 

4,627

 

 

3,903

 

 

3,801

 

Aggregate MAU

 

24,787

 

 

22,817

 

 

19,415

 

 

21,113

 

 

 

32,523

 

 

32,192

 

 

27,585

 

 

28,646

 

Aggregate ARPDAU

$

0.25

 

$

0.27

 

$

0.32

 

$

0.32

 

 

$

0.15

 

$

0.16

 

$

0.23

 

$

0.23

 

 

The decrease in aggregate DAU and MAU for the three months ended December 31, 2018 as compared to the same period of the prior year was primarily related to fewer downloads across our portfolio of games.

 

Our aggregate ARPDAU increased for the three months ended December 31, 2018 as compared to the same period of the prior year, as we improved monetization on certain titles, particularly through increased content updates and use of social features in those games. Future increases in our aggregate DAU, MAU and ARPDAU will depend on our ability to retain current players, attract new paying players, launch new games and expand into new markets and distribution platforms.

 

We rely on a very small portion of our total users for nearly all of our revenue derived from in-app purchases. Since the launch of our first free-to-play titles in the fourth quarter of 2010, the percentage of unique paying users for our largest revenue-generating free-to-play games has typically been less than 5%, when measured as the number of unique paying users on a given day divided by the number of unique users on that day, though this percentage fluctuates. It may be higher than 5% for some of our games while for certain other games it may be higher during specific, relatively short time periods, such as immediately following worldwide launch, during special events or following content updates, marketing campaigns or certain other events.

 

Significant Transactions

 

Divestiture of Moscow Studio

On December 31, 2017, we entered into the following agreements related to the divestiture of our Moscow-based game development studio (the “Moscow Studio”) through the sale of our wholly-owned UK subsidiary Glu Mobile (Russia) Limited (“GMRL”):

 

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·

Share Purchase Agreement (the “SPA”) between Glu and Saber Interactive (“Saber”);

 

·

Transitional Services Agreement (the “TSA”) among Glu, Saber and MGL. My.com (Cyprus) Limited (“MGL”); and

 

·

Asset Purchase and License Agreement (the “APLA”) between Glu and MGL.

 

Pursuant to the SPA, Saber purchased all the issued and outstanding share capital of GMRL. Saber also assumed all obligations under the office lease for the Moscow Studio.

 

Under the TSA, Saber agreed to transition certain legacy titles from the Moscow Studio to our Hyderabad studio. Upon successful completion of the transition (i) Saber paid the employees of the Moscow Studio and GMRL bonus payments of $500,000 in the aggregate and reduced the cash consideration by the amount of the bonus, and (ii) certain employees of the Moscow Studio and GMRL had the vesting of an aggregate of approximately 147,000 shares subject to equity awards accelerated.

 

Pursuant to the APLA, we sold four mobile games (and related intellectual property and other rights) developed by the Moscow Studio: (i) Last Day Alive, (ii) Heroes of Destiny, (iii) a game that was in development featuring a male celebrity, and (iv) Furiosa.  We transferred all of our rights and obligations under certain contracts related to the game featuring a male celebrity, including, but not limited to, the obligation to pay the remaining approximately $1.5 million in minimum guarantee and other payments under these contracts. We also agreed to provide MGL with a non-exclusive, perpetual, worldwide, irrevocable, non-transferrable, royalty-free license to certain development tools and technology necessary to use, develop, publish, exploit and sell the purchased games and that MGL and/or its affiliates may use for the development of other of its products.

 

The total cash consideration under the SPA and APLA was $3.2 million, of which we received $1.7 million in January 2018. The remaining $1.5 million, net of a transition bonus payment of $500,000, was received in April 2018 upon completion of the transition of the legacy titles from the Moscow Studio to our Hyderabad studio.

 

In connection with the divestiture, we recorded a loss of $6.5 million in the year ended December 31, 2017, which is included in other expense on the consolidated statement of operations. This was primarily comprised of a $10.0 million charge related to the assignment of one of the contracts related to the male celebrity, a $1.2 million charge related to the write-off of goodwill associated with the Moscow Studio and a $0.5 million charge related to the write-off of net assets associated with the Moscow Studio. These charges were partially offset by $3.2 million in cash paid by Saber and MGL, $1.5 million related to the assumption of obligations by MGL under the contract related to the male celebrity, and $0.5 million related to the transition services provided by Saber.

 

In connection with the activities related to the transition under the TSA that occurred in 2018, we recorded the following expenses in the year ended December 31, 2018:

 

·

$500,000 related to bonuses that became due to the employees of the Moscow Studio and GMRL;

·

$514,000 related to the vesting of 147,000 shares subject to equity awards held by certain employees of the Moscow Studio and GMRL; and

·

$515,000 related to the amortization of transition services assets that were capitalized as part of the transaction consideration.

 

Our divestiture of the Moscow studio was part of our efforts to consolidate our studio locations, focusing on a new scaled creative center in San Francisco and a low cost, repeatable location in Hyderabad, India. This divestiture was not presented as discontinued operations in the consolidated statements of operations, because it did not represent a strategic shift in our business and is not expected to have a significant effect on our operations or financial results, as we continued operating similar businesses after the divestiture.

 

Crowdstar Acquisition

 

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On November 2, 2016, we, through a wholly owned subsidiary, acquired shares representing approximately 80.6% of the issued and outstanding voting power of Crowdstar, for consideration of approximately $40.8 million in cash pursuant to a transfer agreement by and among us, Crowdstar and certain stockholders of Crowdstar. Crowdstar, which was based in Burlingame, California, develops fashion and home décor genre games for mobile devices.

 

Following the initial acquisition of shares of Crowdstar by us, we exercised the right, as the holder of a majority of each of the preferred stock and the capital stock of Crowdstar, to appoint each of the five members of the board of directors of Crowdstar.  In addition, certain drag-along provisions specified in a voting agreement by and among Crowdstar and certain stockholders of Crowdstar were triggered.  Pursuant to the drag-along provisions, certain other stockholders of Crowdstar were required to tender their Crowdstar capital stock to us on the same terms as those specified in the transfer agreement. 

 

On December 6, 2016, we acquired the remaining issued and outstanding shares of Crowdstar pursuant to a short-form merger and now have 100% ownership of Crowdstar. We paid an aggregate of approximately $45.5 million of cash ($40.8 million for the initial purchase of shares and an aggregate of $4.7 million in connection with purchasing shares in connection with exercising the drag-along provisions and effecting the short-form merger)  to acquire 100% ownership of Crowdstar. 

 

Our first title created by Crowdstar, Design Home, was released in November 2016.

 

Related Party Transaction

 

In November 2015, we entered into an agreement with an affiliate of Tencent pursuant to which we agreed, subject to certain conditions, to pay in the aggregate, up to $15.0 million in recoupable advanced royalties and non-recoupable license fees. As of December 31, 2016, we had paid the full amount of $15.0 million, as all payment milestones were achieved. 

During the year ended December 31, 2016, we recorded an impairment of approximately $14.5 million for un-recouped advanced royalties and non-recoupable license fees that were paid to an affiliate of Tencent, due to the underperformance of our Rival Fire title which launched during the third quarter of 2016 and the negligible cash flows anticipated for the remaining contractual life of these assets.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements are prepared in accordance with United States generally accepted accounting principles, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the dates of the consolidated financial statements, the disclosure of contingencies as of the dates of the consolidated financial statements, and the reported amounts of revenue and expenses during the periods presented. Although we believe that our estimates and judgments are reasonable under the circumstances existing at the time these estimates and judgments are made, actual results may differ from those estimates, which could affect our consolidated financial statements.

 

We believe the following to be critical accounting policies because they are important to the portrayal of our financial condition or results of operations and they require critical management estimates and judgments about matters that are uncertain:

 

·

revenue recognition;

·

prepaid or guaranteed licensor royalties;

·

business combinations – purchase accounting;

·

goodwill; and

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·

stock-based compensation.

 

Revenue Recognition

 

We generate revenue through in-app purchases within our games on smartphones and tablets, such as Apple’s iPhone and iPad and mobile devices utilizing Google’s Android operating system. Smartphone and tablet games are distributed primarily through Digital Storefronts. We also have relationships with certain advertising service providers for advertisements within smartphone games and revenue from these advertising providers is generated through impressions, clickthroughs, banner ads and offers. 

 

Users can download our free-to-play games within the Digital Storefronts and pay to acquire virtual currency which can be redeemed in the game for virtual goods. We sell both consumable and durable virtual goods and receive reports from the Digital Storefronts, which breakdown the various purchases made from our games over a given time period. We review these reports and determine on a per-item basis whether the purchase was a consumable virtual good or a durable virtual good. Consumable goods are items that can be purchased directly by the player through the Digital Storefront and are consumed at a predetermined time or otherwise have limitations on repeated use, while durable goods are items that remain in the game for as long as the player continues to play. Our revenue from consumable virtual goods has been insignificant. Revenue from durable virtual goods are generated through the purchase of virtual coins by users through a Digital Storefront. Players convert the virtual coins within the game to durable virtual goods such as furniture, clothes, players or other items to enhance their game-playing experience.

 

We adopted ASC 606 and its related amendments effective January 1, 2018 using a modified retrospective method. The reported results for 2018 reflect the application of ASC 606 guidance while the reported results for 2017 were prepared under the guidance of ASC 605, Revenue Recognition (ASC 605), which is also referred to herein as "legacy GAAP" or the "previous guidance". The adoption of ASC 606 represents a change in accounting principle that will more closely align revenue recognition with the delivery of our services and will provide financial statement readers with enhanced disclosures.

 

In accordance with ASC 606, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration we expect to receive in exchange for these services. A contract with a customer exists when (i) we enter into an enforceable contract with a customer that defines each party’s rights regarding the services to be transferred and identifies the payment terms related to these services, (ii) the contract has commercial substance and, (iii) we determine that collection of substantially all consideration for services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. We apply judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer. 

 

Micro-Transactions

 

We distribute our games for smartphones and tablets to the end customer through Digital Storefronts. Within these Digital Storefronts, users can download our free-to-play games and pay to acquire virtual currency which can be redeemed in the game for virtual goods. The initial download of the mobile game from the Digital Storefront does not create a contract under ASC 606 because of the lack of commercial substance; however, the separate election by the player to make an in-application purchase satisfies the criteria thus creating a contract under ASC 606. We have identified the following performance obligations in these contracts:

 

(1)

Ongoing game related services such as hosting of game play, storage of customer content, when and if available content updates, maintaining the virtual currency management engine, tracking gameplay statistics, matchmaking as it relates to multiple player gameplay, etc.

 

(2)

Obligation to the paying player to continue displaying and providing access to the purchased virtual goods within the game.

 

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Neither of these obligations are considered distinct since the actual mobile game and the related ongoing services are both required to purchase and benefit from the related virtual goods. As such, our performance obligations represent a single combined performance obligation which is to make the game and the ongoing game related services available to the players. The transaction price, which is the amount paid for virtual currency/goods by the player, is allocated entirely to this single combined performance obligation. We recognize revenue from in-application purchases of durable virtual currency/goods over the estimated average playing period of paying users. Our revenue from consumable virtual goods has been insignificant over the previous three years. Based on our analysis, the estimated weighted average useful life of a paying user ranges from four to eight months.

 

Advertisements and Offers

 

We have relationships with certain advertising service providers for advertisements within our mobile games. Revenue from these advertising service providers is generated through impressions, clickthroughs, offers and banner ads. Offers are the type of advertisements where the players are rewarded with virtual currency for completing specified actions, such as downloading another application, watching a short video, subscribing to a service or completing a survey. We have determined the advertising buyer to be our customer and displaying the advertisements within the mobile games is identified as the single performance obligation. Revenue from advertisements and offers are recognized at the point-in-time the advertisements are displayed in the game or the offer has been completed by the user as the customer simultaneously receives and consumes the benefits provided from these services.

 

Other Estimates and Judgments

 

We compute our estimated average playing period of paying users at least twice each year. We have examined the playing patterns of paying users across a representative sample of our games across various genres.  

 

We use the “survival analysis” model to estimate the average playing period for paying users. This model provides for a singular approach to estimating the average playing period of paying users on a title by title basis for our diverse portfolio of games. It is a statistical model that analyzes time duration until one or more events happens and is commonly used in various industries for estimating lifespans. We believe this is an appropriate model to estimate the average playing period of paying users for our titles as this model statistically estimates the average playing period of each title by analyzing the historical behavior patterns of paying users.

 

This model requires the stratification of user data into active and inactive monetizing users on a per title basis. Active users are those who are active in the game for the past 30 days as of the evaluation date. The remaining users are considered inactive and deemed to have churned from the game. These users are treated mathematically differently in the model than those who are still active. A distribution curve is then fit to the user data to estimate the average playing period of paying users on a per title basis.

 

We have selected a threshold of 120 days from the commercial launch of a title as the minimum number of days of data required for this model. This threshold was deemed to be appropriate as we tested the model using lower thresholds which resulted in inconsistencies in the estimate of the average playing period of paying users. For new titles with less than 120 days of data that share similar attributes with an existing title and/or prequel titles, the average playing period is determined based on the average playing period of that existing title or prequel title, as applicable. For all other titles with less than 120 days of data, the average playing period is determined based on the average playing period of all other remaining existing titles.   

 

While we believe our estimates to be reasonable based on available game player information, we may revise such estimates in the future if a titles’ user characteristics change. Any adjustments arising from changes in the estimates of the average playing period for paying users would be applied to the current quarter and prospectively on the basis that such changes are caused by new information that indicates a change in user behavior patterns compared to historical titles. Any changes in our estimates of the useful life of virtual goods in a certain title may result in revenue being recognized on a basis different from prior periods’ and may cause our operating results to fluctuate.

 

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Principal Agent Considerations

 

We evaluated our Digital Storefront and advertising service provider agreements under ASC 606 in order to determine if we are acting as the principal or as an agent when selling virtual items or advertisements within our games. We primarily use Digital Storefronts for distributing our smartphone games and for enabling players to purchase virtual items and advertising service providers to serve advertisements within our games. We evaluated the following factors to assess whether we control each specified good or service before that good or service is transferred to the customer:

 

·

the party responsible for the fulfillment of the virtual items, game related services, or serving of advertisements;

·

the party having the discretion to set pricing with the end-users; and

·

the party having inventory risk before the specified good or service have been transferred to a customer.

 

Based on the evaluation of the above indicators, we determined that we have control of the services before they are transferred to the end-user. Thus, we are generally acting as a principal and are the primary obligor to end-users for games distributed through Digital Storefronts and advertisements served through our advertising service providers. Therefore, we recognize revenue related to these arrangements on a gross basis, when the necessary information about the gross amounts or platform fees charged, before any adjustments, are made available by the Digital Storefronts and advertising service providers.  In situations where the price paid by the end-user of the advertising service provider is not known, we account for these transactions on a net basis. 

 

Deferred Platform Commissions and Royalties

 

Digital Storefronts retain platform commissions and fees on each purchase made by the paying players through the Digital Storefront. We are also obligated to pay ongoing licensing fees in the form of royalties related to the games developed based on or significantly incorporating licensed brands, properties or other content, and our plans to incorporate additional licensed content in some of its own originally branded games. As revenue from sales to paying players through Digital Storefronts are deferred, the related direct and incremental platform commissions and fees as well as third-party royalties are also deferred on the consolidated balance sheets. The deferred platform commissions and royalties are recognized in the consolidated statements of operations in “Cost of revenue” in the period in which the related sales are recognized as revenue.

 

Prepaid or Guaranteed Licensor Royalties

 

Our royalty expenses consist of fees that we pay to content owners for the use of their brands, properties and other licensed content, including trademarks and copyrights, in the development of our games. Royalty-based obligations are either paid in advance and capitalized on the balance sheet as prepaid royalties or accrued as incurred and subsequently paid.  These royalty-based obligations are expensed to cost of revenue at the greater of the revenue derived from the relevant game multiplied by the applicable contractual rate or an effective royalty rate based on expected net product sales.

 

Our contracts with certain licensors include minimum guaranteed royalty payments, which are payable regardless of the ultimate volume of sales to end users, in accordance with ASC 440-10, Commitments, or ASC 440.  When no significant performance remains with the licensor, we initially record each of these guarantees as an asset and as a liability at the contractual amount. We believe that the contractual amount represents the fair value of the liability. When significant performance remains with the licensor, we record royalty payments as an asset when actually paid and as a liability when incurred, rather than upon execution of the contract. The classification of minimum royalty payment obligations between long-term and short-term is determined based on the expected timing of recoupment of earned royalties calculated on projected revenue for the games that include content licensed from third parties.

 

Each quarter, we evaluate the realization of our prepaid and guaranteed royalties as well as any unrecognized guarantees not yet paid to determine amounts that we deem unlikely to be realized through product sales.  We use estimates of undiscounted revenue and net margins to evaluate the future realization of prepaid royalties, license fees, and guarantees.  This evaluation is performed at the title level and considers multiple factors, such as, the term of the agreement, forecasted demand, game life cycle status, game development plans, level of social media activity, and current

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and anticipated sales levels, as well as other qualitative factors such as the success of similar games and similar genres on mobile devices published by us and our competitors and/or other game platforms (e.g., consoles and personal computers) utilizing the intellectual property.  To the extent that this evaluation indicates that the remaining prepaid and guaranteed royalty payments are not recoverable, we record an impairment charge to cost of revenue in the period that impairment is indicated.

 

Business Combinations

 

We apply ASC 805, Business Combinations, or ASC 805, which is the accounting guidance related to business combinations. The standard requires:

·

recognition of assets acquired, liabilities assumed, and contingent consideration at their fair value on the acquisition date with subsequent changes recognized in earnings;

·

acquisition-related expenses and restructuring costs to be recognized separately from the business combination and expensed as incurred;

·

in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset until completion or abandonment; and

·

that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes.

 

We account for acquisitions of entities that include inputs and processes and have the ability to create outputs as business combinations. The purchase price of the acquisition is allocated to tangible assets, liabilities, and identifiable intangible assets acquired based on their estimated fair values. The excess of the purchase price over those fair values is recorded as goodwill. Acquisition-related expenses and restructuring costs are expensed as incurred. While we use our best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business combination date, these estimates and assumptions are inherently uncertain and subject to refinement. Our key assumptions used have included projected revenue, cost of goods sold, and operating expenses for our acquired entities, the future amortization tax benefit of legacy titles, and discount rates. As a result, during the preliminary purchase price allocation period, which may be up to one year from the business combination date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. After the preliminary purchase price allocation period, we record adjustments to assets acquired or liabilities assumed subsequent to the purchase price allocation period in our operating results in the period in which the adjustments were determined.

 

Goodwill

 

In accordance with ASC 350, Intangibles – Goodwill and Other, or ASC 350, we do not amortize goodwill or other intangible assets with indefinite lives but rather test them for impairment. We perform our annual impairment test as of September 30th each year, at the reporting unit level, which is at the company level as a whole, since we operate in a single reporting segment. We also perform an evaluation of impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable.

 

We evaluate qualitative factors and overall financial performance to determine whether it is necessary to perform the first step of the two-step goodwill test. This step is referred to as “Step 0.” Step 0 involves, among other qualitative factors, weighing the relative impact of factors that are specific to the reporting unit as well as industry and macroeconomic factors. After assessing those various factors, if it is determined that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity will need to proceed to the first step of the two-step goodwill impairment test. ASC 350 requires a multiple-step approach to testing goodwill for impairment for each reporting unit annually, or whenever events or changes in circumstances indicate the fair value of a reporting unit is below its carrying amount. The first step measures for impairment by applying the fair value-based tests at the reporting unit level. The second step (if necessary) measures the amount of impairment by applying the fair value-based tests to individual assets and liabilities within each reporting unit. The fair value of the reporting units is estimated using a combination of the market approach, which utilizes comparable companies’ data, and/or the income approach, which uses discounted cash flows.

 

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During the third quarters of fiscal 2018 and 2017 we performed a “Step 0” qualitative assessment for our reporting unit.  Based on the assessment, we concluded that it was more likely than not that the fair value of the reporting unit was greater than its carrying amount, and as a result, did not proceed to further impairment testing.  Accordingly, we did not recognize an impairment of goodwill during the years ended December 31, 2018 and December 31, 2017.

 

During the three months ended December 31, 2017, we recorded a prepaid royalty impairment charge of $26.1 million. However, our market capitalization remained well above our carrying value during that period. Based on the results of the interim goodwill impairment test, as of December 31, 2017, we concluded that goodwill was not impaired.

 

We performed our annual goodwill impairment assessment as of September 30, 2016 and determined a Step 1 analysis was necessary due to a significant decline in our market capitalization and the significant impairment of prepaid royalties recorded during the three months ended September 30, 2016. Based on the results of the Step 1 analysis, we concluded that the fair value of the reporting unit was greater than the carrying value of the reporting unit based on a methodology that utilized both an income approach and a market approach. The income approach was based on projected future (debt-free) cash flows that were discounted to present value. For the market approach, we used both the guideline company and similar transaction methods. The guideline company method analyzed market multiples of bookings for a group of comparable public companies. Under the similar transactions method, valuation multiples were calculated utilizing actual transaction prices and revenue/EBITDA data from target companies deemed similar to us. The revenue and profitability forecasts used in valuation considered recent performance and trends, strategic initiatives and relevant industry trends. Assumptions used in the valuation were similar to those that would be used by market participants performing independent valuations of similar businesses.

 

Key assumptions used in the quantitative analysis included:

 

·

4% long-term revenue growth rate and the Gordon Growth model to calculate the terminal value;

 

·

A gradual return to historical profitability rates over the remaining forecast period;

 

·

Royalty rates based on active license agreements of the brand; and

 

·