Item 1A.
Risk Factors
Our business is subject to many risks and uncertainties, which may affect our future financial performance. If any of the events or
circumstances described below occurs, our business and financial performance could be harmed, our actual results could differ materially from our expectations and the market value of our stock could decline. The risks and uncertainties discussed
below are not the only ones we face. There may be additional risks and uncertainties not currently known to us or that we currently do not believe are material that may harm our business and financial performance. Because of the risks and
uncertainties discussed below, as well as other variables affecting our operating results, past financial performance should not be considered as a reliable indicator of future performance and investors should not use historical trends to anticipate
results or trends in future periods.
We have a history of net losses, may incur substantial net losses in the future and may not achieve
profitability.
We have incurred significant losses since inception, including a net loss of $20.5 million in 2012, a net loss of
$19.9 million in 2013 and a net loss of $3.6 million for the six months ended June 30, 2014. As of June 30, 2014, we had an accumulated deficit of $255.8 million. We expect our costs in 2014 to increase in absolute dollars over 2013 levels
as we implement additional initiatives designed to increase revenues, such as developing games with greater complexity and higher production values, making investments related to our continued transition to becoming a GaaS company, increasing the
amount we spend in acquiring new players and otherwise marketing our new titles (which costs are expected to increase over last year, particularly since advertising costs in our industry have generally been rising), and paying upfront license fees
or minimum guarantees to secure licenses to third party intellectual property, including in connection with our Glu Publishing business. If our revenues do not increase to offset these additional expenses, if we experience unexpected increases in
operating expenses or if we are required to take additional charges related to impairments or restructurings, we will continue to incur losses and will not become profitable on a sustained basis. If we are unable to significantly increase our
revenues or reduce our expenses, it will continue to negatively affect our operating results and our ability to achieve and sustain profitability.
We have a relatively new and evolving business model.
In early 2010, we changed our business model to focus on becoming a leading developer and publisher of free-to-play games for
smartphones, tablets and other next-generation platforms. 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 revenues for us. We launched our first free-to-play titles in the fourth quarter of 2010, so we have a relatively short history operating under this business model. This limits the experience upon which we can
draw when making operating decisions. In addition, part of our strategy is to continue transitioning towards becoming a GaaS company in which the majority of our future free-to-play games will be playable online, and we may not successfully execute
this transition. Our efforts to develop free-to-play games and transition towards becoming a GaaS company may prove unsuccessful or, even if successful, it may take more time than we anticipate to achieve significant revenues because, among other
reasons:
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we may have difficulty optimizing the monetization of our games due to our relatively limited experience creating games that include micro-transaction capabilities, advertising and offers, as well as our limited
experience in offering the features that are often associated with free-to-play games published by GaaS companies, such as tournaments, live events and more frequent content updates;
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we intend to continue to develop the majority of our games based upon our own intellectual property, rather than well-known licensed brands, and we may encounter difficulties in generating sufficient consumer interest
in and downloads of our games, particularly since we have had relatively limited success generating significant revenues from games based on our own intellectual property;
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many well-funded public and private companies have released, or plan to release, free-to-play games, including those provided under the GaaS model, and this competition will make it more difficult for us to
differentiate our games and derive significant revenues from them;
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free-to-play games, including those delivered as a service, have a relatively limited history, and it is unclear how popular this style of game will become or remain or its revenue potential;
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our free-to-play 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 poor consumer reviews or other negative publicity, ineffective or insufficient marketing efforts, lack of sufficient community features, lack of prominent storefront featuring and the relatively large
file size of some of our gamesour thick-client games often utilize a significant amount of the available memory on a users device, and due to the inherent limitations of the smartphone platforms and telecommunications networks, which at
best only allow applications that are less than 100 megabytes to be downloaded over a carriers wireless network, players must download one of our thick-client games either via a wireless Internet (wifi) connection or initially to their
computer and then side-loaded to their device;
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even if our games are widely downloaded, we may fail to retain users or optimize the monetization of these games for a variety of reasons, including poor game design or quality, lack of 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, or our failure to effectively respond and adapt to changing user preferences through game updates;
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we may have difficulty hiring the additional monetization, live operations, server technology, user experience and product management personnel that we require to support our continued transition to becoming a GaaS
company, or may face difficulties in developing our GaaS technology platform and incorporating it into our products;
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we will 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;
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the billing and provisioning capabilities of some smartphones and tablets are currently not optimized to enable users to purchase games or make in-app purchases, which make it difficult for users of these devices to
purchase our games or make in-app purchases and could reduce our addressable market, at least in the short term; and
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the Federal Trade Commission has 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 on this issue), and the commission might issue rules significantly restricting or even prohibiting in-app purchases or name us as a defendant in a future class-action lawsuit.
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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.
We rely on a very small portion of our total players for nearly all of
our revenues that we derive from in-app purchases.
Since our free-to-play games can be downloaded and played for free, we have
succeeded in generating a significant number of game installations and significant user-base growth. However, we rely on a very small portion of our total players for nearly all of our revenues derived from in-app purchases (as opposed to
advertisements and incentivized offers). Since the launch of our first free-to-play titles in the fourth quarter of 2010, the percentage of unique paying players for our largest revenue-generating free-to-play games has typically been less than 1%,
when measured as the number of unique paying users on a given day divided by the number of unique users on that day. To significantly increase our revenues, we must increase the number of players who convert into a paying player by making in-app
purchases, 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 have to date encountered difficulties with game monetization (for example, developing a sufficient
quantity and variety of virtual goods to enable a relatively large scale of in-app purchases by an individual user). We might not succeed in our efforts to increase the monetization rates of our users, particularly if we do not succeed in our
transition to becoming a GaaS company. If we are unable to convert non-paying players into paying players, if we are unable to retain our paying players or if the average amount of revenues 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.
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We derive the majority of our revenues from Apples 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 revenues is derived from Apples iOS platform, which accounted for 59.1% of our total revenues for the six
months ended June 30, 2014 compared with 58.8% of our total revenues for the six months ended June 30, 2013. We generated the majority of these iOS-related revenues from the Apple App Store, which represented 47.2% and 50.4% of our total
revenues for the six months ended June 30, 2014 and 2013, respectively, with the significant majority of such revenues derived from in-app purchases. We generated the balance of our iOS-related revenues 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 derived approximately 37.0% and 28.6% of our total revenues for the six months ended June 30, 2014 and 2013, respectively, from the Android
platform. We generated the majority of our Android-related revenues from the Google Play Store, which represented 25.7% and 18.7% of our total revenues for the six months ended June 30, 2014 and 2013, respectively, with the significant majority
of such revenues derived from in-app purchases. We believe that we have good relationships with each of Apple and Google, which has contributed to the majority of our games released in 2013 and the first six months of 2014 being featured on their
storefronts when they were commercially released. If we do not continue to receive prominent featuring, users may find it more difficult to discover our games and we may not generate significant revenues from them. We may also be required to spend
significantly more on marketing campaigns to generate substantial revenues on these platforms. In addition, currently neither Apple nor Google charges 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 either of these events recurs on a prolonged basis or other similar issues arise that impact our ability to generate
revenues from these storefronts, it would have a material adverse effect on our revenues and operating results. In addition, if these 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.
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 Apples and Googles 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 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 second quarter of 2011, Apple began prohibiting certain types of virtual currency-incented advertising offers in games sold on the Apple App Store. These offers
accounted for approximately one-third of our smartphone revenues during the three months ended June 30, 2011, and our inability to subsequently use such offers negatively impacted our smartphone revenues thereafter. In addition, Apple informed
us early in the fourth quarter of 2012 that we could no longer include links to Tapjoys HTML5 website in our games, which has since negatively impacted our ability to generate revenue through incented offers. Most recently, in the second
quarter of 2014, Apple changed its game rating methodology which has resulted in all of our games that include gun violence receiving a 17+ rating, which could potentially negatively impact the number of people playing these shooter
games and the revenues we generate from these games. In addition, during the second quarter of 2014, there were reports that Apple was considering prohibiting certain types of virtual currency-incented video advertising in games sold on the Apple
App Store. These incented video advertisements generate a meaningful percentage of our overall smartphone revenues, and any prohibition of these advertisements would have had a negative impact on our smartphone revenues. 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.
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In addition, in the first quarter of 2014, Facebook prohibited HasOffers, whose software
development kit we had incorporated into our games to track advertising metrics, from participating in Facebooks mobile measurement program because Facebook asserted that HasOffers had violated its agreement with Facebook. As a result, we
removed HasOffers software development kit from our games and replaced them with a new vendor. While this change did not adversely impact our revenues or operations, any similar changes or prohibitions in the future could negatively impact our
revenues or otherwise materially harm our business, and we may not receive significant or any advance warning of such change.
The markets in which
we operate are highly competitive, and many of our competitors have significantly greater resources than we do.
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 promotional and storefront placement based on these factors, as well as our relationship with the digital storefront owner, historical performance, perception of sales potential and relationships with
licensors of brands and other intellectual property. For content and brand licensors, we compete based on royalty and other economic terms, perceptions of development quality, porting abilities, speed of execution, distribution breadth and
relationships with storefront owners or carriers. We also compete for experienced and talented employees.
We compete with a continually
increasing number of companies, including DeNA, Gameloft, GREE, GungHo Online Entertainment, King Digital Entertainment, Nexon and Zynga and many well-funded private companies, including Kabam, Machine Zone, Rovio, Storm 8/Team Lava and Supercell.
We also compete for consumer spending with large companies, such as Activision, Disney, Electronic Arts (EA Mobile), Take-Two Interactive and Warner Brothers, whose games for smartphones and tablets have historically been primarily premium rather
than free-to-play. 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
one million applications, including more than 225,000 active games, were available on Apples U.S. App Store as of July 31, 2014. 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.
Some of our competitors and our potential competitors have one or more advantages over us, either globally or in particular geographic
markets, which include:
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significantly greater financial resources;
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greater experience with the free-to-play games and GaaS business models and more effective game monetization;
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stronger brand and consumer recognition regionally or worldwide;
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greater experience and effectiveness integrating community features into their games, operating as a GaaS company and increasing the revenues derived from their users;
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the capacity to leverage their marketing expenditures across a broader portfolio of mobile and non-mobile products;
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larger installed user bases from their existing mobile games;
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larger installed user bases from related platforms, such as console gaming or social networking websites, to which they can market and sell mobile games;
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more substantial intellectual property of their own from which they can develop games without having to pay royalties;
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lower labor and development costs and better overall economies of scale;
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greater platform-specific focus, experience and expertise; and
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broader global distribution and presence.
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If we are unable to compete effectively or we are not as successful as our competitors in our
target markets, our sales could decline, our margins could decline and we could lose market share, any of which would materially harm our business, operating results and financial condition.
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 revenues 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 revenues or results of operations. We base our current
and future expense levels on our internal operating plans and sales forecasts, and our operating costs are to a large extent fixed. As a result, we may not be able to reduce our costs sufficiently to compensate for an unexpected shortfall in
revenues, and even a small shortfall could disproportionately and adversely affect financial results for that quarter.
In addition to
other risk factors discussed in this section, factors that may contribute to the variability of our quarterly results include:
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our ability to increase the number of our paying players and the amount that each paying player spends in our games;
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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;
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the number and timing of new games released by us and our competitors, particularly those games that may represent a significant portion of revenues in a quarter, which timing can be impacted by internal development
delays, shifts in product strategy and how quickly digital storefront operators review and approve our games for commercial release;
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changes in the prominence of storefront featuring for our games and those of our competitors;
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fluctuations in the size and rate of growth of overall consumer demand for smartphones, tablets, games and related content;
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changes in the mix of revenues derived from games based on original intellectual property versus licensed intellectual property;
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changes in the mix of revenues derived from first party titles versus third party titles;
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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;
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decisions by us to incur additional expenses, such as increases in research and development, or unanticipated increases in vendor-related costs, such as hosting fees;
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the timing of successful mobile device launches;
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the seasonality of our industry;
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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 our games;
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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 2012, we impaired $3.6 million of our goodwill related to our APAC
reporting unit, and in 2013 we impaired $435,000 related to contractual minimum guarantee commitments in our Glu Publishing business; and
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macro-economic fluctuations in the United States and global economies, including those that impact discretionary consumer spending.
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If we fail to develop and publish new mobile games that achieve market acceptance, as well as continue to
enhance our existing games, our revenues 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, analytics and marketing to introduce new games and continue to update our successful free-to-play games, and we
often must make decisions about these matters well in advance of product release to timely implement them. Our success depends, in part, on unpredictable and volatile factors beyond our control, including consumer preferences, competing games, 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. Even if our games are successfully introduced and initially adopted, a failure to continue to 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 revenues and harm our business, operating results and financial condition. Furthermore, we compete for the discretionary spending of consumers, who face a vast array of entertainment choices,
including 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.
If we do not successfully establish and maintain awareness of our brand and games, if we incur excessive expenses promoting
and maintaining our brand or our games or if our games contains 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 a direct relationship with end users who purchase our
products from direct-to-consumer channels and to maintaining our existing relationships with distributors and content licensors, as well as potentially developing new such relationships. 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. 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, particularly as we expand our efforts to
increase awareness of our brand and games among international consumers. 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 increase and maintain brand awareness and consumer recognition of our games, our potential revenues could be limited, our costs could increase and our business, operating results and financial condition could suffer.
In addition, if a game contains objectionable content, we could experience damage to our reputation and brand. The majority of our
successful free-to-play games are in the action/adventure genre, and we expect that the majority of the games that we will release in 2014 will be in that category. Some of these games contain violence or other content that certain consumers may
find objectionable. For example, Apple has assigned all of our shooter games, including our recently released
Dino Hunter: Deadly Shores
game, 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 certain of our game content and children to whom these games are
not targeted may choose to play them without parental permission nonetheless. In addition, one of our employees or an employee of an outside developer could include hidden features in one of our games without our knowledge, which might contain
profanity, graphic violence, sexually explicit or otherwise objectionable material. If consumers believe that a game we published contains objectionable content, it could harm our brand, consumers could refuse to buy it or demand a refund, and could
pressure the digital storefront operators to no longer allow us to publish the game on their platforms. Similarly, if one of our games is introduced with defects or has playability issues, it could results in negative user reviews and damage our
brand. These issues could be exacerbated if our customer service department does not timely and adequately address issues that our players have encountered with our games.
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We have depended on a small number of games for a significant portion of our revenues in recent fiscal
periods. If these games do not continue to succeed or we do not release highly successful new games, our revenues would decline.
In 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 revenues comes from a limited number of games, although the games in that group have shifted over time.
Deer Hunter 2014
accounted for a significant portion of our revenues for the six
months ended June 30, 2014, and we expect to generate significant revenues from this title as well as
Kim Kardashian: Hollywood
and
Dino Hunter: Deadly Shores
during the remainder of 2014. We expect revenues from these titles to
gradually decline over time in a manner similar manner to our other titles. In addition, revenues from
Kim Kardashian: Hollywood
are in part tied to the continued popularity of Kim Kardashian and her marketing efforts though social media and
other channels, and we have little to no control over these matters. Accordingly, we must continue to launch new games that generate significant revenues to continue to grow revenues in the future, which we have sometimes failed to do. For example,
in the third quarter of 2012, we launched 11 new games, only two of which generated significant revenues, which, in part, contributed to our revenues declining from the second quarter of 2012. Developing and launching our games and providing future
content updates requires us to invest significant time and resources with no guarantee that our efforts will result in significant revenues. If our new games are not successful or if we are not able to cost-effectively extend the lives of our
successful games, our revenues could be limited and our business and operating results would suffer.
We rely on a combination of our own servers
and technology and third party infrastructure to operate our games. If we experience any system or network failures, cyber attacks or any other interruption to our games, it could reduce our sales, increase costs or result in a loss of revenues or
end users of our games.
We rely on digital storefronts and other third-party networks to deliver games to our players and on their
or other third parties billing systems to track and account for our game downloads. We also rely on our own servers and third-party infrastructure to operate our connected games, and our reliance on such third-party infrastructure and our GaaS
technology platform will increase as we continue transitioning to becoming a GaaS company. 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. Amazon experienced a power outage during the second quarter of 2012, which affected the playability of our games for approximately one
day. While this particular event did not adversely impact our business, a similar outage of a longer duration could. In addition, the operation of our online-only games that we began releasing in the fourth quarter of 2013 will depend on the
continued functionality of our GaaS technology platform. As a result, we could experience unexpected technical problems with regard to the operation of our online-only games, particularly if the number of concurrent users playing our games is
significantly more than we anticipate. Any technical problem with, cyber attack on, or loss of access to these third parties or our systems, servers or other technologies, including the GaaS 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 July 2014, users could not play our
Kim Kardashian: Hollywood
game for about six hours due to a problem with one of our servers. In addition, in the fourth quarter
of 2013, our
Eternity Warriors 3
title was inoperable for approximately eight consecutive hours due to technical issues with our GaaS platform. Although these outages did not result in a material loss of revenues, any future incidents,
particularly of longer duration, could damage our brand and reputation and result in a material loss of revenues. Further, if virtual assets are lost, or if users do not receive their purchased virtual currency, we may be required to issue refunds,
we may receive negative publicity and game ratings, we may lose players of our games, 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
harm our reputation or cause us to lose players or revenues or incur substantial repair costs and distract management from operating our business.
If we fail to maintain and enhance our capabilities for porting games to a broad array of mobile devices, particularly those running the Android
operating system, our revenues and financial results could suffer.
We derive the majority of our revenues from the sale of virtual
goods within our games for smartphones and tablets that run Apples iOS or Googles Android operating system. Unlike the Apple ecosystem in which Apple controls both the device (iPhone, iPod Touch and iPad) and the storefront (Apples
App Store), the Android ecosystem is highly fragmented since a large number of OEMs manufacture and sell Android-based devices that run a variety of versions of the Android operating system, and there are many Android-based storefronts in addition
to the Google Play Store. For us to sell our games to the widest possible audience of Android users, we must port our games to a significant portion of the more than 1,000 Android-based devices that are commercially available, many of which have
different technical requirements. Since the number of Android-based smartphones and tablets shipped worldwide is growing significantly, it is important that we maintain and enhance our porting capabilities, which could require us to invest
considerable resources in this area. These additional costs could harm our business, operating results and financial condition. In addition, we must continue to increase the efficiency of our porting processes or it may take us longer to port games
to an equivalent number of devices, which would negatively impact our margins. If we fail to maintain or enhance our porting capabilities, our revenues and financial results could suffer.
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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 us 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. 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, 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 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. Further, if one of our competitors acquired Unity, the acquiring
company would be less likely to renew our agreement, 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 revenues 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, or if any events occur that negatively impact the revenues we receive from these sources, it would negatively impact our operating results.
We derive revenues from our free-to-play games though in-app purchases, advertisements and offers. We incorporate
advertisements and offers into our games by implementing third parties software development kits. 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 revenues. 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 revenues, at least in the short term. Furthermore, the revenues 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 revenues in the first
quarter (and conversely significantly increases our marketing expenses in the fourth quarter).
In addition, the actions of the storefront
operators can also negatively impact the revenues that we generate from advertisements and offers. For example, in the second quarter of 2011, Apple began prohibiting certain types of virtual currency-incented advertising offers in games sold
on the Apple App Store. These offers accounted for approximately one-third of our revenues during the three months ended September 30, 2011, and our inability to use such offers has negatively impacted our revenues. In addition,
during the second quarter of 2014, there were reports that Apple was considering prohibiting certain types of virtual currency-incented video advertising in games sold on the Apple App Store. These incented video advertisements generate a meaningful
percentage of our overall smartphone revenues, and any prohibition of these advertisements would have had a negative impact on our smartphone revenues. Any similar changes in the future that impact our revenues that we generate from advertisements
and offers could materially harm our business
.
We might elect not, or may be unable, to renew our existing brand and content licenses when
they expire and might not choose to obtain additional licenses, which might negatively impact our revenues to the extent that we do not create successful games based on our own intellectual property to replace such revenues.
Although we generated 83.5%, 93.3% and 91.5% of our revenues from games based on our own intellectual property during 2012, 2013 and the first
six months of 2014, respectively, we expect our revenues derived from games based on third party intellectual property to increase significantly in future periods due to the success of
Kim Kardashian: Hollywood
. In addition, we intend to
release games in 2015 based on the
James Bond
and
The Terminator
movie franchises, which, if successful, would further increase the revenues we generate from third party intellectual property. Our key licenses expire at various times
during the next several years, and we may be unable to renew these licenses or to renew them on terms favorable to us. 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. Failure to maintain or renew our existing licenses or to obtain additional licenses would prevent us from continue to offer our current licensed games and introduce new mobile games based on such licensed content, which
would harm our business, operating results and financial condition.
45
We have begun publishing, and intend to continue to publish games developed by third parties which will
expose us to a number of potential operational and legal risks.
We have recently formed Glu Publishing, which is focused on
entering into relationships with developers of games, primarily in Asian and Eastern European markets, where Glu will localize and globally publish those games. Our Glu Publishing business will expose us to a number of potential operational and
legal risks. For example, we may be required to provide third party developers with upfront license fees or non-recoupable minimum guarantees in order to obtain the rights to publish their games, and we may need to spend significant money marketing
these games after they have been commercially launched. If the games are not commercially successful because they do not appeal to a Western audience, because of our limited experience in publishing other developers games or for any other
reason, it will negatively impact our operating results. Further, in the third quarter of 2013, we were required to take an impairment charge of $435,000 related to certain minimum guarantee commitments. In addition, if any of the third party
developers with which we work have created their games by infringing another partys intellectual property or otherwise violating their rights, or if these games violate applicable laws and regulations, such as with respect to data collection
and privacy, we would be exposed to potential legal risks by publishing these games.
Our business and growth may suffer if we are unable to hire
and retain key personnel.
Our future success will depend, to a significant extent, on our ability to retain and motivate our key
personnel, namely our management team, particularly Niccolo de Masi, our President and Chief Executive Officer, as well as experienced game development personnel. In addition, to grow our business, execute on our business strategy and replace
departing employees, we must identify, hire and retain qualified personnel, particularly additional monetization, live operations, server technology, user experience and product management personnel to support our continued transition to becoming a
GaaS company. Competition for qualified management, game development and other staff is intense. Attracting and retaining qualified personnel may be particularly difficult for us if our stock price remains relatively depressed, since individuals may
elect to seek employment with other companies that they believe have better long-term prospects. Competitors have in the past and may in the future attempt to recruit our employees, and our management and key employees are not bound by agreements
that could prevent them from terminating their employment at any time. As we continue to develop expertise in free-to-play mobile gaming, operating a GaaS company and monetization in particular, our competitors may increasingly seek to recruit our
employees, particularly from our development studios. 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.
We may need to raise additional capital or borrow funds to grow our business, and we may not be able to raise capital or borrow funds on terms
acceptable to us or at all.
As of June 30, 2014, we had $71.5 million of cash and cash equivalents, and since that date we
have agreed to pay up to $30.3 million in cash in connection with our pending acquisition of Cie Games, Inc. If our cash and cash equivalents and cash inflows are insufficient to meet our cash requirements or if we wish to strengthen our balance
sheet, including to potentially pursue additional acquisitions, we will need to seek additional capital, potentially pursuant to our recently filed universal shelf registration statement, and we may be unable to do so on terms that are acceptable to
us or at all. Equity financings would dilute our existing stockholders, and the holders of new securities may receive rights, preferences or privileges that are senior to those of existing stockholders. Alternatively, we may wish to enter into a
credit facility or other debt arrangement, and we may be unable to procure one on terms that are acceptable to us, particularly in light of the current credit market conditions. If we require new sources of financing but they are insufficient or
unavailable, we would be required to modify our operating plans to align them with available resources, which would harm our ability to grow our business.
46
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. Due to recent economic events, 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 smartphone platforms and
free-to-play
games, particularly with regard to revenues 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 applicable revenue recognition accounting guidance relating to our smartphone revenues. While we believe that we are now correctly accounting for our smartphone revenues, this is an area that continues to involve significant discussion
among accounting professionals and which is not completely settled. It is possible that the relative application, interpretation and weighting of the factors that relate to whether we should be considered the principal in the sales transaction of
games sold through digital storefronts may evolve, and we may in the future conclude that our new accounting policy for smartphone revenue, as reflected in the restated financial statements, is incorrect, which could result in another restatement of
affected financial statements. In addition, we currently defer revenues 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 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 revenues 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, particularly those relating to the way we account for our smartphone revenues, 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. In connection with the restatement of our financial statements in 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, management, including our Chief Executive Officer and Chief Financial Officer, reassessed the effectiveness of our internal control over financial reporting
as of December 31, 2012. Based on this reassessment using the guidelines established in
Internal Control Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in 1992,
management had concluded that we did not maintain effective internal control over financial reporting as of December 31, 2012 because of a material weakness related to the application of revenue accounting guidance to our revenues for sales
through digital storefronts. This control deficiency resulted in the misstatement of our revenues and cost of revenues, including gross margin percentages, and the related balance sheet accounts and financial disclosures for the years ended
December 31, 2011 and 2012 (and the restatement of unaudited interim condensed consolidated financial statements for the quarters ended March 31, June 30, and September 30 for such years). Although we have remediated this
material weakness, if we are otherwise unable to maintain adequate internal controls for financial reporting, 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 another material misstatement of our financial statements that would require a restatement, investor confidence in the accuracy and timeliness of
our financial reports may be impacted or the market price of our common stock could be negatively impacted.
Our acquisition activities may disrupt
our ongoing business, may involve increased expenses and may present risks not contemplated at the time of the transactions.
We
have acquired, and may continue to acquire, companies, products and technologies that complement our strategic direction, including our recently announced agreement to acquire Cie Games. Acquisitions involve significant risks and uncertainties,
including:
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diversion of management time and a shift of focus from operating the businesses to issues related to integration and administration;
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inability to successfully integrate the acquired technology and operations into our business and maintain uniform standards, controls, policies and procedures;
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challenges retaining the key employees, customers and other business partners of the acquired business;
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inability to realize synergies expected to result from an acquisition;
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an impairment of acquired goodwill and other intangible assets in future periods would result in a charge to earnings in the period in which the write-down occurs;
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the internal control environment of an acquired entity may not be consistent with our standards and may require significant time and resources to improve;
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in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political and regulatory risks associated with specific
countries; and
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liability for activities of the acquired companies before the acquisition, including violations of laws, rules and regulations, commercial disputes, tax liabilities and other known and unknown liabilities.
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In addition, if we issue equity securities as consideration in an acquisition, as we did for our acquisitions of
Griptonite, Inc., Blammo Games Inc., GameSpy Industries, Inc. and PlayFirst, Inc., and as we plan to do for our pending acquisition of Cie Games, Inc., our current stockholders percentage ownership and earnings per share would be diluted.
Because acquisitions are inherently risky, our transactions may not be successful and may, in some cases, harm our operating results or financial condition.
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 90 countries in more than 28 different currencies, with Pounds Sterling, Euros and
Chinese Renminbi 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 2013 and the first six months of 2014, and expect to 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 dollar equivalent of these expenses being higher and/or the 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 additional risk if a currency is not freely or actively traded. Some currencies, such as the Chinese Renminbi in which our Chinese
operations principally transact business, are subject to limitations on conversion into other currencies, which can limit our ability to react to rapid foreign currency devaluations and to repatriate funds to the United States should we require
additional working capital.
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 53.9% and 46.6% of our revenues in 2013 and 2012, respectively. To target international markets,
we develop games that are customized for consumers in those markets. We have international offices located in a number of foreign countries including Canada, China, India, Japan, Korea and Russia. We expect to maintain our international presence,
and we expect international sales will continue to be an important component of our revenues, particularly in APAC markets. Risks affecting our international operations include:
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our ability to develop games that appeal to the tastes and preferences of consumers in international markets;
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difficulties developing, staffing, and simultaneously managing a large number of varying foreign operations as a result of distance, language, and cultural differences;
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multiple and conflicting laws and regulations, including complications due to unexpected changes in these laws and regulations;
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our ability to develop, customize and localize games that appeal to the tastes and preferences of consumers in international markets;
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competition from local game developers that have significant market share in certain foreign markets and a better understanding of local consumer preferences;
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potential violations of the Foreign Corrupt Practices Act and local laws prohibiting improper payments to government officials or representatives of commercial partners;
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regulations that could potentially affect the content of our products and their distribution, particularly in China;
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foreign exchange controls that might prevent us from repatriating income earned in countries outside the United States, particularly China;
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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;
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political, economic and social instability, including the current hostilities in the Ukraine and related economic sanctions that the United States and other countries have imposed upon Russia, which events could
potentially negatively impact us given that we have a development studio in Moscow;
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restrictions on the export or import of technology;
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trade and tariff restrictions and variations in tariffs, quotas, taxes and other market barriers; and
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difficulties in enforcing intellectual property rights in certain countries.
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These risks
could harm our international operations, which, in turn, could materially and adversely affect our business, operating results and financial condition.
If we fail to deliver our games at the same time as new mobile devices are commercially introduced, our revenues 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 Apples iPhone and iPad and devices based on Googles 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. Some manufacturers give us access to their mobile 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 revenues would likely
decline and our business, operating results and financial condition would likely suffer.
49
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, the United Kingdoms Office of Fair
Trading issued new principles in January 2014 relating to in-app purchases in free-to-play games that are directed towards children 16 and under, which principles became effective in April 2014. In addition, in response to a request made by the
European Commission, Google has announced that it will no longer label free-to-play games as free in European Union countries. The Federal Trade Commission has also indicated that it intends to review issues related to in-app purchases, particularly
with respect to games that are marketed primarily to minors; the Federal Trade Commission recently reached a settlement agreement with Apple on this subject. If the Federal Trade Commission issues rules significantly restricting or even prohibiting
in-app purchases, it would significantly impact our business strategy. In addition, two self-regulatory bodies in the United States (the Entertainment Software Rating Board) and the European Union (Pan European Game Information) provide consumers
with rating information on various products such as entertainment software similar to our products based on the content (for example, violence, sexually explicit content, language). Furthermore, the Chinese government has adopted measures designed
to eliminate violent or obscene content in games. In response to these measures, some Chinese telecommunications operators have suspended billing their customers for certain mobile gaming platform services, including those services that do not
contain offensive or unauthorized content, which could negatively impact our revenues 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.
We sometimes offer our players various types of sweepstakes, giveaways and promotional opportunities, and in October 2012, we entered into a
strategic relationship with Probability PLC to offer a suite of Glu-branded mobile slot games in the United Kingdom and Italy, two of which are currently offered in the United Kingdom. We might continue to explore opportunities with respect to real
money gambling. 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. Any 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 Federal Trade Commission 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. For example, in December 2012, the Federal Trade Commission adopted amendments to the Childrens Online Privacy Protection Act to strengthen privacy
protections for children under age 13, which amendments became effective in July 2013. In addition, the European Union has proposed reforms to its existing data protection legal framework. Various government and consumer agencies have also called
for new regulation and changes in industry practices. For example, in February 2012, the California Attorney General announced a deal with Amazon, Apple, Google, Hewlett-Packard, Microsoft and Research in Motion to strengthen privacy protection for
users that download third-party apps to smartphones and tablet devices. Additionally, in January 2014, the Federal Trade Commission announced a settlement with Apple related to in-app purchases made by minors. In response to developments in the
interpretation and understanding of regulations such as these and guidance and inquiries from the California Attorney General, we released updates to our
My Dragon
and
Deer Hunter Reloaded
games and made changes to our games in
development to make our privacy policy readily accessible to players of these games as required by the California Online Privacy Protection Act. 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.
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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. 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 have passed laws requiring notification to users when there is a security
breach for personal data, such as the 2002 amendment to Californias Information Practices Act, or requiring the adoption of minimum information security standards that are often vaguely defined and difficult to implement. Costs to comply with
these laws 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, 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.
Our stock price has fluctuated and declined significantly since our initial public offering in March 2007,
and may continue to fluctuate, may not rise and may decline further.
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 Electronic Arts, King Digital Entertainment and Zynga.
In addition, The NASDAQ Global
Market on which our common stock is listed has recently and in the past experienced extreme price and volume fluctuations that have affected the market prices of many companies, some of which appear to be unrelated or disproportionate to 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 companys securities, securities class action
litigation has often been brought against that company. Securities class action litigation against us could result in substantial costs and divert our managements attention and resources.
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 filed only two patent applications, so we will
not be able to protect the vast majority of our technologies from independent invention by third parties. Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to copy or otherwise to obtain and use our
technology and games, 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 competitors game to the copycat game. To the extent that these tactics are employed with respect to any of our games, it
could reduce our revenues that we generate from these 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. In the future, we may have to litigate to enforce our
intellectual property rights, which could result in substantial costs and divert our managements attention and our resources.
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In addition, although we require our third-party developers to sign agreements not to disclose or
improperly use our trade secrets and acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property and to assign to us any ownership they may have in those
works, it may still be possible for third parties to obtain and improperly use our intellectual properties without our consent. This could harm our brand, business, operating results and financial condition.
We may become involved in intellectual property disputes, which may disrupt our business and require us to pay significant damage awards.
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, on April 16, 2013, Lodsys Group, LLC, a Texas limited liability company (Lodsys), filed a complaint
in the U.S. District Court for the Eastern District of Texas alleging that we were infringing two of Lodsys patents, and seeking unspecified damages, including treble damages for willful infringement, interest, attorneys fees and such
other costs as the Court may deem just and proper; we settled this matter in December 2013. If there is a successful claim against us in the future, we might be enjoined from using our intellectual property or licensed intellectual property that we
use in our business, we might incur significant licensing fees and we might 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 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 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 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 may become subject to various legal proceedings, claims and
regulatory inquiries that arise out of the ordinary conduct of our business and are not yet resolved and additional claims and inquiries may arise in the future. In addition, events may give occur that give rise to a potential risk of litigation.
The number and significance of regulatory inquiries have increased as our business has 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 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 of 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 taxpayers ability to claim and utilize foreign tax credits and defer certain tax deductions until earnings outside of the U.S. are repatriated to the U.S., 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. 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.
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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 U.S. 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.
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.
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 your voting power and your 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 statement, 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, we plan to issue up to 9,982,886 shares in connection with our
potential acquisition of Cie Games, Inc. We have agreed to prepare and file a Registration Statement on Form S-3 covering the resale of such shares, and assuming the effectiveness of such registration, the shares issued in the Cie Games acquisition
will be subject to only limited re-sale restrictions.
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:
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our board of directors is classified into three classes of directors with staggered three-year terms;
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only our chairman of the board, our lead independent director, our chief executive officer, our president or a majority of our board of directors is authorized to call a special meeting of stockholders;
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our stockholders are able to take action only at a meeting of stockholders and not by written consent;
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only our board of directors and not our stockholders is able to fill vacancies on our board of directors;
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our certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; and
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advance notice procedures apply for stockholders to nominate candidates for election as directors or to bring matters before a meeting of stockholders.
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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.
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