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 $21.1 million in 2011, a net loss of $20.5 million in fiscal 2012 and a net loss of $5.5 million for the three months ended
March 31, 2013. As of March 31, 2013, we had an accumulated deficit of $237.8 million. We expect our costs in 2013 to increase over 2012 levels as we implement additional initiatives designed to increase revenues, such as developing games
with greater complexity and higher production values and increasing the amount we spend marketing our new titles. 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. In addition, our revenues increased only slightly in each of 2011 and 2012 from the preceding year,
and slightly decreased in the first quarter of 2013 as compared to the first quarter of 2012. 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 with a short operating history.
In early 2010, we changed our business model to focus on becoming a leading publisher of freemium games
for smartphones, tablets and other advanced platforms. Freemium 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 freemium titles in the fourth quarter of 2010, so we have a short history operating in this business model, which limits the experience upon which we can draw when making
operating decisions. In addition, since our acquisition of GameSpy in August 2012, we have been transitioning towards becoming a games-as-a-service company in which the majority of our future freemium games will be only playable online, and we may
not be successful in executing on this transition. Our efforts to develop freemium games and transition towards becoming a games-as-a-service 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 freemium games published by games-as-a-service companies, such as tournaments, live events and more frequent content updates;
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we intend to continue to develop substantially all 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, freemium games, including those provided under the games-as-a-service 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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freemium 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 freemium strategy assumes that a large number of players will download our games because they are free and that we will subsequently 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 only allow applications that are less than 50 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 transition to becoming a games-as-a-service company;
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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 smartphones and tablets 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, 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 freemium 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 freemium 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 users for nearly all of our smartphone revenues derived from in-app
purchases. Since the launch of our first freemium titles in the fourth quarter of 2010, the percentage of unique paying users for our largest revenue-generating freemium games has been approximately 1%; however, in the initial period following the
launch of a game, the percentage may be higher, and the percentage of unique paying users is generally lower than 1% for our less successful titles. To significantly increase our revenues, we must either increase the number of users who make in-app
purchases or increase the amount that our paying players spend in 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 are unsuccessful in our transition to becoming a games-as-a-service company. If we are unable
to convert non-paying players into paying players or if the average amount of revenues that we generate from our users does not increase or declines, our business may not grow, our financial results will suffer, and our stock price may decline.
35
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 have historically been derived from Apples iOS platform, which accounted for 54.9% of our
total revenues for the three months ended March 31, 2013 compared with 54.6% of our total revenues for the three months ended March 31, 2012. We received the majority of these iOS-related revenues directly from Apple, which represented
41.9% of our total revenues for the three months ended March 31, 2013 compared with 37.6% of our total revenues for the three months ended March 31, 2012, with the balance of our iOS-related revenues generated from offers and
advertisements in games distributed on the Apple App Store. In addition, we generated approximately 27.7% and 20.8% of our total revenues for the three months ended March 31, 2013 and 2012, respectively, from the Android platform. We received
the majority of our Android-related revenues directly from Google for distribution of our games through the Google Play store, which represented 17.2% and 15.1% of our total revenues for the three months ended March 31, 2013 and 2012,
respectively. We believe that we have good relationships with each of Apple and Google, which has contributed to the majority of our freemium games being featured on their storefronts when they were commercially released. If we do not 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 either of these customers 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 end users ability to access our games may be interrupted or end users 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 freemium games in many
cases have the unilateral ability to change and interpret the terms of our contract with them.
Unlike our legacy
feature phone business in which we and the wireless carrier or other distributor negotiated the business terms related to the distribution of our feature phone games, we distribute our freemium 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 applications, including our games, on their storefronts. Each of Apple and Google can unilaterally change their 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. 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. Most recently, 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 and will likely continue to negatively impact our revenues in future periods. Any similar changes in the future that impact our revenues could materially harm our business, and we may
not receive significant or any advance warning of such change. In addition, each of Apple and Google have the right to prohibit a developer from distributing its applications on its storefront if the developer violates its standard terms and
conditions. If Apple or Google or any other storefront operator determines that we 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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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 end users, 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 Zynga, DeNA, Gree, Nexon and
many well-funded private companies, including Kabam, Rovio, Storm 8/Team Lava and Supercell. We also compete for consumer spending with large companies, such as Activision, Electronic Arts (EA Mobile), Gameloft and Take-Two Interactive, whose games
for smartphones and tablets are primarily premium rather than freemium. In addition, given the open nature of the development and distribution for smartphones and tablets, 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 140,000 active games were available on Apples App Store as of April 30, 2013. The proliferation of titles in these open developer channels makes it difficult for us to differentiate ourselves from other developers and to
compete for end users 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 freemium games business model and more effective game monetization;
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stronger brand and consumer recognition regionally or worldwide;
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greater experience integrating community features into their games 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 customer 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.
37
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 in revenues 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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decisions by us to incur additional expenses, such as increases in marketing or 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 certain of our games;
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fluctuations in the fair market value of the contingent consideration issued to the Blammo non-employee shareholders, as the fair value of the
contingent consideration will be measured during each reporting period until the end of the earn-out period in March 2015;
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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
2011, we impaired $531,000 of certain prepaid royalties and royalty guarantees, and in 2012, we impaired $3.6 million of our goodwill related to our APAC reporting unit; 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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Consumer tastes are continually changing and are often unpredictable, and we compete for consumer
discretionary spending against other forms of entertainment; if we fail to develop and publish new mobile games that achieve market acceptance, our sales would suffer.
Our business depends on developing and publishing mobile games that consumers will want to 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 freemium 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 and related applications 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. For example, we intend to include new categories of games (such as role-playing games
and real-time strategy games) in our planned 2013 product portfolio that often have higher monetization rates than our single-player focused action/adventure and casual games. We have limited experience creating these types of games, and if we do
not succeed in these efforts, it will negatively impact our revenues and operating results for 2013 and beyond. 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 have significantly increased our 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 freemium games are in the action/adventure genre, and we expect that the majority of the games that we will release in 2013 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 our
Big Time Gangsta
game a 17-and-older rating due to its violence and drug and alcohol references. 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
games and children to whom these games are not targeted may choose to play them 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 platform 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 users 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. Our growth depends on our ability to consistently launch new games that generate significant revenues. 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. This risk will be magnified in 2013 because we expect to launch approximately 18 new freemium games during the year compared with the 21
freemium games that we published in 2012, with six of the 18 new titles being third party games that we anticipate publishing through our Glu Publishing initiative. As a result, if any of the games that we publish in 2013 are not successful, it will
have a larger impact on our overall revenue expectations for the year, and we will need to generate greater revenues from our other games to compensate for unsuccessful titles. 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.
If we fail to maintain and enhance our capabilities for porting games to a broad array of mobile devices, particularly those utilizing the Android
operating system, our revenues and financial results could suffer.
We derive the majority of our revenues from the
sale of games for smartphones and tablets that utilize Apples iOS or Googles Android operating systems. 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 700 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.
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 Glu, 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 regard to 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 freemium 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 freemium 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).
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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 utilize such offers has negatively impacted our revenues. In addition, in the third quarter of 2012, Apple made
changes to its terms and conditions that could, depending on how Apple interprets them, negatively impact the revenues we generate from third-party advertising service providers. Any similar changes in the future that impact our revenues that
we generate from advertisements and offers could materially harm our business
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We intend to publish games developed by third
parties which will expose us to a number of potential operational and legal risks.
We have recently formed our Glu
Publishing department that will initially focus on entering into relationships with developers of successful games in Asian markets where Glu will localize and publish those games in the United States and non-Asian markets. 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 will likely need to spend 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. 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 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. 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, Blammo and GameSpy, our current stockholders percentage ownership and earnings per share would be diluted. For example, our Blammo acquisition agreement provides
that the former Blammo shareholders may earn up to 3,312,937 shares of our common stock if Blammo achieves certain net revenue targets during the years ending March 31, 2013, March 31, 2014 and March 31, 2015; Blammo earned an
estimated 754,297 shares of a possible 909,091 shares for the year ended March 31, 2013. Because acquisitions 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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We rely on a combination of our own servers 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 customers 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 will increase as we transition to
becoming a games-as-a-service 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, we use, or plan to use, GameSpys services and equipment for many of our games, which is subject to a transitional data center services agreement between us and IGN,
GameSpys former parent corporation, that terminates on August 2, 2014, unless IGN or we earlier terminate the agreement. Any technical problem with, cyber attack on, or loss of access to these third parties or our systems, servers
or other technologies could result in the inability of end users to download or play our games, 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, some users of our Android-based games have experienced issues receiving the virtual currency that they purchased and paid for. In addition, 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 users 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 end users or revenues or incur substantial repair costs and distract management from
operating our business.
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 70 countries in more than 20
different currencies, with Pounds Sterling and Euros 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 2011 and 2012, 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 have a negative impact on 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 45.0% and 50.1% of our revenues in 2012 and 2011, 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 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;
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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 sales 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.
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Our business and growth may suffer if we are unable to hire and retain key personnel.
Our future success will depend, to a significant extent, on our ability to retain and motivate our key personnel,
namely our management team, particularly Niccolo de Masi, our President and Chief Executive Officer, as well as experienced game development personnel who may experience uncertainty due to the restructurings we implemented in the fourth quarter of
2012 and first half of 2013, in which we eliminated, in the aggregate, more than 100 positions in our Kirkland, Sao Paolo and San Francisco studios. 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 transition to becoming a games-as-a-service company.
Competition for qualified management, game development and other staff can be 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. In addition, we will have significant difficulty in attracting and retaining key personnel if, at our 2013 Annual Meeting of Stockholders, our stockholders do
not approve the proposed amendment to our equity incentive plan to increase the number of shares reserved for issuance under the plan, as we will otherwise not have sufficient shares available under the plan to grant equity awards to our current
employees or newly hired employees. 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.
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.
We expect to continue to use cash in our operations during 2013 as we seek to grow our business. As of March 31, 2013, we had $21.2
million of cash and cash equivalents. If our cash and cash equivalents and cash inflows are insufficient to meet our cash requirements, we will need to seek additional capital to fund our operations, 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, particularly given our current stock price, 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.
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. 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. 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 freemium 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 freemium gaming and impair our business.
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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 live in the United Kingdom. We intend to
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. 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. 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 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.
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.
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
and Zynga.
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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.
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 at our facilities could be impaired.
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 copyright, trademark, trade secret and other
intellectual property laws and contractual restrictions on disclosure to protect our intellectual property rights. To date, we have not sought patent protection, so, we will not be able to protect our technologies from independent invention by third
parties. Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to copy or otherwise to obtain and use our technology and games, 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.
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 litigation, including intellectual property disputes, which may disrupt our business and require us to pay
significant damage awards.
Third parties may sue us, including for intellectual property infringement, or initiate
proceedings to invalidate our intellectual property, which, if successful, could disrupt 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 have been infringing two of Lodsys patents, and is seeking unspecified damages, including treble
damages for willful infringement, interest, attorneys fees and such other costs at the Court may deem just and proper. In the event of a successful claim against us, 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. 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.
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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 software 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 freemium games, particularly with regard to micro-transactions, is still evolving and, in some cases, uncertain. We currently defer revenues related to virtual
goods and currency over the average playing period of paying users, which approximates the 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 revenue, including
whether we account for revenue on a gross basis or net of the revenue share retained by the operators of the platforms through which we distribute our games, 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.
If we are 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, investor confidence in the accuracy of our financial
reports may be impacted or the market price of our common stock could be negatively impacted.
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. 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 whether or not 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 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.
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Some provisions in our certificate of incorporation and bylaws 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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