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 $13.4 million in 2010, a net loss of $21.1 million in 2011 and a net loss of $13.4 million in the nine months ended
September 30, 2012. As of September 30, 2012, we had an accumulated deficit of $225.2 million. We expect our costs to increase as we implement additional initiatives designed to increase revenues, such as increased sales and marketing
expenses related to our new games designed for smartphones and tablets, such as Apples iPhone and iPad and devices based on Googles Android operating system. In addition, our costs have increased significantly as a result of our
acquisitions of Blammo, Griptonite and GameSpy due to the addition of approximately 200 employees and independent contractors. 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 significant losses and will not become profitable. In addition, our revenues declined in each of 2009 and 2010 from the
preceding year, and only increased slightly in 2011 from 2010 levels. If we are not able to significantly increase our revenues, we will likely not be able to achieve profitability in the future. Furthermore, during 2010, 2011 and the first nine
months of 2012, we incurred aggregate charges of approximately $4.3 million, $1.1 million and $4.1 million for royalty impairments, goodwill impairments and restructuring activities, and we expect to incur an additional approximately
$850,000 in the fourth quarter of 2012 relating to restructuring activites. If we continue to incur these charges, it will continue to negatively affect our operating results and our ability to achieve profitability.
Our financial results could vary significantly from quarter to quarter and are difficult to predict, particularly in light of the current economic
environment, which in turn could cause volatility in our stock price.
Our revenues and operating results could vary
significantly from quarter to quarter because of a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. In addition, we may not be able to
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.
We are also subject to macroeconomic fluctuations in the United States and global economies, including those that impact discretionary
consumer spending, which have deteriorated significantly in many countries and regions, including the United States and Europe due to the effects of the ongoing sovereign debt crisis, and may remain depressed for the foreseeable future. Some of the
factors that could influence the level of consumer spending include continuing conditions in the residential real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence and other macroeconomic factors
affecting consumer spending. If these issues persist, or if the economy enters a prolonged period of decelerating growth or recession, our results of operations may be harmed.
40
In addition to other risk factors discussed in this section, factors that may contribute to
the variability of our quarterly results include:
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the popularity and monetization rates of our new freemium games released during the quarter and the ability of our games released in prior periods to
sustain their popularity and monetization rates;
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the number of new games released by us and our competitors;
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the timing of release of new games by us and our competitors, particularly those that may represent a significant portion of revenues in a quarter,
which timing can be impacted by internal development delays, shifts in product strategy and how quickly digital storefront operators, such as Apple, review and approve our games for commercial release;
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changes in the prominence of storefront featuring for our leading 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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our ability to increase the daily and monthly active users of our freemium games that we develop for smartphones and tablets, as well as the level of
engagement of these users, the length of time these users continue to play our games and the average revenues we derive from these users;
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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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changes in pricing policies by us, our competitors or our carriers and other distributors, including to the extent that smartphone digital storefront
owners impose a platform tax on our revenues derived from offers;
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the timing of successful mobile device launches;
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the seasonality of our industry;
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strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in
business strategy;
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our ability to successfully migrate talent acquired through our Griptonite transaction to creating successful freemium titles;
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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 impairments of goodwill, intangible assets, prepaid royalties and guarantees; for example, in 2010 and
2011, we impaired $663,000 and $531,000, respectively, of certain prepaid royalties and royalty guarantees, and in the first nine months of 2012, we impaired $3.6 million of our goodwill related to our APAC reporting unit;
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the timing of compensation expense associated with equity compensation grants; and
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decisions by us to incur additional expenses, such as increases in marketing or research and development, or unanticipated increases in vendor-related
costs, such as hosting fees.
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Our strategy to grow our business involves developing a significant number of new titles for
smartphones and tablets rather than for feature phones, which historically comprised a significant majority of our revenues. If we do not succeed in generating considerable revenues and gross margins from smartphones and tablets, our revenues,
financial position and operating results will suffer.
As a result of the continued migration of users from
traditional feature phones to smartphones, we expect our feature phone revenues, which represented 16.2%, 47.0% and 84.7% of our revenues in the nine months ended September 30, 2012 and the years ended December 31, 2011 and 2010,
respectively, to continue to decrease significantly. For us to succeed in 2012 and beyond, we believe that we must increasingly publish mobile games that are widely accepted and commercially successful on the smartphone and tablet digital
storefronts (such as Apples App Store, the Google Play Store, Amazons Appstore and Microsofts XBOX Live marketplace), as well as significantly increase the number of players of our games and the average lifetime value of these
players. Our efforts to continue to significantly increase our revenues derived from games for smartphones and tablets may prove unsuccessful or, even if successful, it may take us longer to achieve the revenue growth that we anticipate because,
among other reasons:
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the open nature of many of these digital storefronts increases substantially the number of our competitors and competitive products and makes it more
difficult for us to achieve prominent placement or featuring for our games;
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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;
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competitors may have substantially greater resources available to invest in developing and publishing products for smartphones and tablets;
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these digital storefronts are relatively new and rapidly evolving markets, for which we are less able to forecast with accuracy revenue levels,
required marketing and developments expenses, and net income or loss;
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we have less experience with open storefront distribution channels than with carrier-based distribution;
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the pricing and revenue models for titles on these digital storefronts are rapidly evolving (for example, the introduction of in-app purchasing
capabilities and the potential introduction of usage-based pricing for games), and have resulted, and may continue to result, in significantly lower average selling prices for our premium games developed for smartphones as compared to games
developed for feature phones, and a lower than expected return on investment for these games;
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many of our content licenses do not grant us the rights to develop games for devices utilizing Apples iOS operating system and certain other
smartphones and tablets; and
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many OEMs and carriers are developing their own storefronts and it may be difficult for us to predict which ones will be successful, and we may expend
time and resources developing games for storefronts that ultimately do not succeed.
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Due to the expected
continued decrease in our feature phone revenues, if we do not succeed in generating considerable revenues and gross margins from smartphones and tablets, our operating results will suffer.
We have focused our development efforts for smartphones and tablets on creating freemium games, rather than premium games, and if our freemium strategy is unsuccessful, it will seriously harm our
business.
We expect that substantially all of our development activities for smartphones and tablets in the remainder
of 2012 and beyond will be focused on freemium gamesgames that are downloadable without an initial charge, but which enable a variety of additional content and features to be accessed for a fee or otherwise monetized through various
advertising and offer techniques. Our efforts to develop freemium games for smartphones and tablets may prove unsuccessful or, even if successful, may take us longer to achieve significant revenue than anticipated because, among other reasons:
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we have relatively limited experience in successfully developing and marketing freemium games, having launched our first freemium titles in the fourth
quarter of 2010;
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42
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our relatively limited experience with creating games that include micro-transaction capabilities, advertising and offers may cause us to have
difficulty optimizing the monetization of our freemium games;
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changes in Apples policies that have limited our ability to use certain types of virtual currency-incented advertising offers, third party
advertising and other monetization techniques in our games
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some of our competitors have released a significant number of freemium games on smartphones and tablets, and the number of freemium games available on
the smartphone and tablet digital storefronts has been steadily increasing, and this competition will make it more difficult for us to differentiate our games and derive significant revenues from them;
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we intend to continue to develop substantially all of our freemium games based upon our own intellectual property, rather than well-known licensed
brands, and, as a result, we may encounter difficulties in generating sufficient consumer interest in our games, particularly since prior to 2011, we had relatively limited success in generating significant revenues from games based on our own
intellectual property;
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freemium games 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 strategy with respect to developing freemium games assumes that a large number of consumers will download our games because they are free and that
we will subsequently be able to effectively monetize these games via in-app purchases, offers and advertisements; however, some carriers charge users a fee for downloading content to their smartphones, and users of these smartphones may be reluctant
to download our freemium games because of these fees, which would reduce the effectiveness of our product strategy;
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our freemium games may otherwise not be widely downloaded by consumers for a variety of reasons, including poor consumer reviews or other negative
publicity, ineffective or insufficient marketing efforts, lack of sufficient community features that encourage users to invite their friends to play our games with them, a failure to achieve prominent storefront featuring for such games or the
inconvenience associated with downloading our thick-client 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 freemium games are widely downloaded, we may fail to retain users of these games 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 updates to our games;
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we have encountered difficulties in keeping users engaged in our freemium games for a significant amount of time subsequent to their initial download
of the games, for a variety of reasons, including due to the relative lack of community features in our games compared to those of some of our competitors, and we may have difficulty increasing consumer retention in our games;
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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 (a class action lawsuit has been filed relating to this issue; we have not been named as a party to this lawsuit) and the Federal Trade Commission might issue rules significantly restricting or even prohibiting in-app
purchases or we could potentially be named as a defendant in a future class action lawsuit; and
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because these are effectively new products for us, we are less able to forecast with accuracy revenue levels, required marketing and development
expenses, and net income or loss.
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If we do not achieve a sufficient return on our investment with respect
to developing and selling freemium games, it will negatively affect our operating results and may require us to formulate a new business strategy.
43
We derive the significant majority of our smartphone revenues from Apples iOS and Googles
Android platforms, and if we are unable to maintain a good relationship with each of Apple and Google or if the Apple App Store or the Google Play Store were unavailable for any prolonged period of time, our business will suffer.
The significant majority of our smartphone revenues are derived from Apples iOS and Googles Android platforms, which accounted
for 34% and 11%, respectively, of our total revenues in 2011 and 54% and 24%, respectively, of our total revenues in the nine months ended September 30, 2012. We believe that we have maintained a good relationship with both Apple and Google,
which has contributed to the majority of our games receiving featuring on their storefronts when they are commercially released. Accordingly, any deterioration in our relationship with either Apple or Google would materially harm our business and
likely cause our stock price to decline.
We are subject to each of Apples and Googles standard terms and
conditions for application developers, which govern the promotion, distribution and operation of games and other applications on their respective storefronts. Each of Apple and Google has unilateral discretion to change its standard terms and
conditions. In addition, these standard terms and conditions can be vague and subject to changing interpretations by Apple or Google. 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 nine months ended September 30, 2011, and our inability to subsequently utilize 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 will negatively impact our ability
to generate smartphone revenue through incented offers in the fourth quarter of 2012 and beyond. Any similar changes in the future that impact our freemium revenues could materially harm our business, and we may not receive 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. In the event that either Apple or Google ever
determines that we are in violation of its standard terms and conditions, including by a new interpretation, and prohibits us from distributing our games on its storefront, it would materially harm our business and likely cause our stock price to
significantly decline.
We also rely on the continued function of the Apple App Store and the Google Play Store, as the
majority of our smartphone revenues are derived from these two digital storefronts. There have been occasions in the past when these digital storefronts were unavailable for short periods of time or where there have been issues with the in-app
purchasing functionality within the storefront. In the event that either the Apple App Store or the Google Play Store is unavailable or if in-app purchasing functionality within the storefront is non-operational for a prolonged period of time, it
would have a material adverse effect on our revenues and operating results.
We have a relatively new and evolving business model with a
short operating history and rely on a very small portion of our total players for nearly all of our smartphone revenue that we derive from in-app purchases.
In early 2010, we revised our business model to focus on becoming a leading publisher of mobile freemium games. Our freemium games are provided as a live service and are generally designed to be
persistent experiences maintained through content updates, which requires continuous investment by us. We have a short history operating in this business model, which limits the experience upon which we can draw when making operating decisions, and
we may be less successful executing our new business than we anticipate.
The fact that our freemium games can be downloaded
and played for free has contributed to our success in generating large numbers of installs and significantly growing our user base. However, only a very small portion of our daily and monthly active users ever purchase virtual currency or goods in
our games. In order to significantly increase our smartphone revenues, we must increase the number of users of our games and keep them playing our games for a longer period of time so that we can more effectively monetize these users. To attract and
retain players, we must devote significant resources so that the games they play retain their interest and attract them to our other games. We have to date encountered difficulties in keeping users engaged in our freemium games for a significant
amount of time subsequent to their initial download of the games, and we might not succeed in our efforts to increase the average lifetimes of our users, particularly if we are unable to increase the number of community features in our games. If we
fail to grow our daily and monthly active users, if the rates at which we attract and retain players does not increase or if the average amount our users pay declines, our business may not grow, our financial results will suffer, and our stock price
may decline.
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As part of our efforts to improve the monetization of our games, we intend to increasingly
develop titles that incorporate more connected, community-based gameplay, such as player versus player functionality, and have hired a new President of Studios to oversee this evolution of our product portfolio. We have delayed the expected launch
date of several of our new connected, community-based games from the fourth quarter of 2012 to the first quarter of 2013 to provide our new President of Studios sufficient time to refine these titles, which will negatively impact our fourth quarter
revenues. We have limited experience with creating connected, community-based games, and face significant competition from companies who have achieved significant success in developing and monetizing this style of game. If we are not successful in
these efforts, it will negatively impact our revenues in the first quarter of 2013 and beyond.
Acquisitions could result in operating
difficulties, dilution and other harmful consequences.
In August 2011, we completed the acquisitions of Griptonite and
Blammo, in April 2012, we acquired from Atari, Inc. the Deer Hunter trademark and associated domain names and entered into an exclusive, irrevocable, worldwide, long-term license with Atari with respect to the other intellectual property assets
associated with the Deer Hunter brand, and in August 2012, we completed the acquisition of GameSpy. We expect to continue to evaluate and consider a wide array of potential strategic transactions, including business combinations and acquisitions of
studio teams, technologies, services, products and other assets. At any given time, we may be engaged in discussions or negotiations with respect to one or more of these types of transactions. Any of these transactions could be material to our
financial condition and results of operations. The process of integrating any acquired business, including Griptonite, Blammo and GameSpy, may create unforeseen operating difficulties and expenditures and is itself risky. The areas where we may face
difficulties include:
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diversion of management time and a shift of focus from operating the businesses to issues related to integration and administration;
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declining employee morale and retention issues resulting from changes in compensation, management, reporting relationships, future prospects or the
direction of the business;
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the need to integrate each acquired companys accounting, management, information, human resource and other administrative systems to permit
effective management, and the lack of control if such integration is delayed or not implemented;
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the need to implement controls, procedures and policies appropriate for a larger public company that the acquired companies lacked prior to
acquisition;
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in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic,
currency, political and regulatory risks associated with specific countries; and
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liability for activities of the acquired companies before the acquisition, including violations of laws, rules and regulations, commercial disputes,
tax liabilities and other known and unknown liabilities.
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If the anticipated benefits of any future
acquisitions do not materialize, we experience difficulties integrating businesses acquired in the future, or other unanticipated problems arise, our business, operating results and financial condition may be harmed.
The operation of the GameSpy business, which provides technology and services for multiplayer and server-based gaming, will pose a number
of challenges for us. For example, we do not have a direct contract with the data center in which the GameSpy equipment is located, but instead will receive the services that we will require to support many of our future game launches and service
GameSpys existing customers pursuant to a transition services agreement with IGN Entertainment, Inc., GameSpys former parent corporation. Accordingly, to the extent that IGN does not provide us with transitional data center services in a
timely, reliable and otherwise professional manner, it could (1) adversely impact many of the games we expect to launch in the next twelve months and beyond, which would negatively impact our revenues, and (2) place us in breach with
respect to GameSpys existing customer contracts. In addition, this transition services agreement has a term of no more than two years and is subject to early termination under certain circumstances, including in the event that IGN is no longer
affiliated with its parent corporation, News Corp. Once the transition services agreement terminates, we will need to procure our own data center agreement, which may require us to move the GameSpy equipment to another facility, potentially on short
notice. Such a transition could result in disruption to some of our games, which would likely negatively impact our revenues and reputation. Furthermore, we may encounter difficulties in fulfilling our obligations under the existing GameSpy
contracts, as we have no experience in operating this type of services business.
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The integration of Griptonite has been, and may continue to prove to be, particularly
challenging due to its size, as Griptonite has nearly 200 employees and independent contractors compared with approximately 400 employees at Glu prior to the Blammo and Griptonite acquisitions, as well as the fact that Griptonite had historically
built premium games on a work-for-hire basis for non-smartphone platforms such as Microsofts Xbox 360, Nintendos Wii, Nintendos DS and Sonys PSP. We have invested, and will continue to invest, considerable management time and
resources in order to educate the Griptonite studio personnel with respect to the development of freemium games for smartphone platforms. We cannot yet be sure that these efforts will prove successful since we have encountered significant
development delays with respect to some Griptonite titles and none of the Griptonite titles that we released in the third quarter of 2012 met our revenue expectations. If we are not successful in these efforts, it will adversely impact our operating
results given the significant increase in our operating expenses that have resulted from such acquisition.
In addition, a
significant portion of the purchase price of companies we acquire may be allocated to acquired goodwill and other intangible assets, which must be assessed for impairment at least annually. In the future, if our acquisitions, including the
Griptonite, Blammo, and GameSpy acquisitions and our purchase of the Deer Hunter brand assets from Atari, do not yield expected returns, we may be required to take charges to our earnings based on this impairment assessment process, which would harm
our operating results. For example, during 2008 we incurred an aggregate goodwill impairment charge related to write-downs in the third and fourth quarters of 2008 of $69.5 million as the fair values of our three reporting units were determined
to be below their carrying values. In addition, we had a goodwill impairment charge of $3.6 million during the third quarter of 2012, as we determined that the estimated fair value of our APAC reporting unit was less than its carrying value due to
accelerated declines in our legacy feature phone business and the recent restructuring of our APAC operations. Our APAC reporting unit may be subject to additional charges in the future as we continue to realign the business and deal with the
challenges related to our existing distribution channels in the region in our efforts to improve smartphone revenue growth.
Moreover, the terms of acquisitions may require that we make future cash or stock payments to shareholders of the acquired company, which
may strain our cash resources or cause substantial dilution to our existing stockholders at the time the payments are required to be made. For example, 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. In addition, our merger agreement with Griptonite provides that we may be
required to issue up to 5,301,919 additional shares or in specified circumstances pay additional cash (1) in satisfaction of indemnification obligations in the case of, among other things, breaches of our representations, warranties and
covenants in the merger agreement or (2) pursuant to potential working capital adjustments.
The markets in which we operate are
highly competitive, and many of our competitors have significantly greater resources than we do.
The development,
distribution and sale of mobile games is a highly competitive business, 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, customer reviews and, with respect to our premium products, price. We compete for promotional and storefront or deck placement based on these factors, as well as the relationship with the digital storefront owner or wireless carrier,
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.
With respect to our freemium games that we publish for smartphones and tablets, we compete with a continually increasing number of
companies, including Zynga, DeNA, Gree, Tencent and many well-funded private companies. 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; Electronic Arts and Gameloft have historically been our two primary feature phone competitors with regard to feature phone gaming. 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 mobile devices utilizing 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 125,000 active games were available on Apples App Store as of October 31, 2012.
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 spending to market our products or increasing our
development costs.
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Some of our competitors and our potential competitors advantages over us, either
globally or in particular geographic markets, include the following:
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significantly greater revenues and financial resources;
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stronger brand and consumer recognition regionally or worldwide;
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greater experience with the freemium games business model;
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greater experience in integrating community features into their games and increasing the lifetime value of 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 resources to make acquisitions;
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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.
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, although
we have enjoyed success with respect to a number of our action/adventure freemium games, such as
Big Time Gangsta, Blood & Glory, Contract Killer, Contract Killer: Zombies, Deer Hunter Reloaded, Eternity Warriors, Frontline
Commando, Gun Bros and Samurai vs. Zombies Defense,
we have had more limited success with respect to our casual titles, with only
Bug Village
,
Small Street
and
Stardom: The A-List
generating significant revenues. If we fail
to develop casual titles that achieve broad market acceptance, particularly given the fact that the market size for freemium casual games is currently larger than that for freemium action/adventure games, it could limit our potential revenue growth
and harm our operating results. In addition, many of the current top grossing games on the smartphone digital storefronts are games that incorporate community-based gameplay, such as player versus player functionality, and we intend to shift a
significant portion of our product portfolio towards this style of game. We have limited experience with creating connected, community-based games, and if we are not successful in these efforts, it will negatively impact our revenues in the first
quarter of 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.
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If we are unsuccessful in establishing and increasing awareness of our brand and recognition of our
games or if we incur excessive expenses promoting and maintaining our brand or our games, our potential revenues could be limited, our costs could increase and our operating results and financial condition could be harmed.
We believe that establishing and maintaining our brand is critical to establishing a direct relationship with end users who purchase our
products from direct-to-consumer channels, such as Apples App Store and the Google Play Store, and maintaining our existing relationships with wireless carriers, 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 freemium games based on our own intellectual property. Our ability to promote the Glu brand
depends on our success in providing high-quality games. Similarly, recognition of our games by end users depends on our ability to develop engaging games of high quality with attractive titles. However, our success also depends, in part, on the
services and efforts of third parties, over which we have little or no control. For instance, if digital storefront owners or wireless carriers 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. If end users, digital storefront owners, branded content owners and wireless carriers do not perceive our existing
games as high-quality or if we introduce new games that are not favorably received by our end users, digital storefront owners and wireless carriers, then we may not succeed in building brand recognition and brand loyalty in the marketplace. In
addition, globalizing and extending our brand and recognition of our games will be costly and will involve extensive management time to execute successfully, particularly as we expand our efforts to increase awareness of our brand and games among
international consumers. Moreover, if a game is introduced with defects, errors or failures or unauthorized objectionable content or if a game has playability issues such as game unavailability, long load times or a unexpected termination of the
game due to data server or other technical issues, we could experience damage to our reputation and brand, and our attractiveness to digital storefront owners, wireless carriers, licensors, and end users might be reduced. 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. In addition, although we have significantly increased our sales and marketing-related expenditures in
connection with the launch of our freemium games, these efforts may not succeed in increasing awareness of our brand and 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.
Inferior
storefront featuring or deck placement would likely adversely impact our revenues and thus our operating results and financial condition.
The open nature of the digital storefronts, such as Apples App Store and the Google Play Store, substantially increases the number of our competitors and competitive products, which makes it more
difficult for us to achieve prominent placement or featuring for our games. In addition, neither Apple nor Google will generally feature more than one of our games simultaneously, which resulted in our inability to get optimal featuring for some of
our games in the third quarter of 2012 when we launched 11 games, some of which were launched close in time to each other. We may encounter similar difficulties in the future to the extent that we launch multiple games during a limited period. Our
failure to achieve prominent placement or featuring for our games on the digital storefronts could make it more difficult for users to discover our games and, as a result, cause our games to not generate significant revenues. It may also require us
to expend significantly increased amounts on marketing campaigns in order to generate substantial revenues on these platforms, reducing or eliminating the profitability of publishing games for them. We believe that a number of factors may influence
the featuring or placement of a game in these digital storefronts, including:
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the perceived attractiveness of the title or brand;
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the past critical or commercial success of the game or of other games previously introduced by a publisher;
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the publishers and the publishers employees relationship with the applicable digital storefront owner and future pipeline of quality
titles for it;
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the games inclusion of new features and functionality that highlight the capabilities of new smartphones and tablets; and
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the current market share of the publisher.
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48
Conversely, wireless carriers provide a limited selection of games that are accessible to
their subscribers through a deck on their mobile handsets. The inherent limitation on the number of games available on the deck is a function of the limited screen size of handsets and carriers perceptions of the depth of menus and numbers of
choices end users will generally utilize. Carriers typically provide one or more top-level menus highlighting games that are recent top sellers, that the carrier believes will become top sellers or that the carrier otherwise chooses to feature, in
addition to a link to a menu of additional games sorted by genre. We believe that deck placement on the top-level or featured menu or toward the top of genre-specific or other menus, rather than lower down or in sub- menus, is likely to result in
higher game sales. If carriers choose to give our games less favorable deck placement, our games may be less successful than we anticipate and our feature phone revenues will decline more steeply than we anticipate.
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 our industry, new games are
frequently introduced, but a relatively small number of games account for a significant portion of industry sales. Similarly, a significant portion of our revenues comes from a limited number of mobile games, although the games in that group have
shifted over time. For example, in 2011 and 2010, we generated approximately 49.5% and 41.6% of our revenues, respectively, from our top ten games. However, other than
Gun Bros
, which generated 11.1% of our total revenues in 2011, no
individual game represented more than 10% of our revenues in either of those years. Our growth depends on our ability to consistently launch new freemium 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 helped contribute to our revenues declining sequentially from the second quarter of 2012. In addition, we seek to extend the lives of our successful freemium games
through regular content updates. The development and launch of our new freemium games and regular content updates require the investment of significant time and resources with no guarantee that they will result in significant revenues. If our new
freemium games are not successful or if we are not able to cost-effectively extend the lives of our successful freemium games, our revenues could be limited and our business and operating results would suffer in both the year of release and
thereafter.
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 smartphone revenues and financial results could suffer.
The majority
of our smartphone revenues are derived 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), there is a high-degree of fragmentation with respect to Android, as a large number of OEMs manufacture and sell Android-based devices with a variety of versions of the Android operating
system, and there are many Android-based storefronts in addition to the Google Play Store. In order for us to sell our games to as wide as possible an audience of Android users, we must port, or convert into separate versions, our games to a
significant percentage of the numerous Android-based devices that are commercially available, many of which have different technological requirements. These include devices with various combinations of underlying technologies, Android operating
system version, user interfaces, keypad layouts, screen resolutions, sound capabilities and other OEM-specific customizations. 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 smartphone
revenues and financial results could suffer.
We utilize a game development engine licensed from Unity Technologies to create many of
our freemium games. If we experience any prolonged issues with regard to the operation of this 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.
We utilize a game development engine
licensed from Unity Technologies to create many of our freemium games, including our 3D games, and expect to continue to utilize this engine for the foreseeable future. Because we do not own this game development engine, we do not control its
operation or maintenance. As a result, if we were to experience any issues with regard to the operation of this engine, these issues might not be resolved as quickly as if it were an internally developed engine, despite the fact that we have
contractual service level commitments from Unity. In addition, although Unity does not have the right to 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. Furthermore, in the event that Unity were to be acquired by one of our
competitors, it would be less likely that our agreement would be renewed, which could impact our game development efforts in the future, particularly with respect to the development of sequels to games that were developed on the Unity engine.
49
We derive a significant portion of our smartphone revenues from advertisements and offers that are
incorporated into our 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 sufficient inventory of advertisements and
offers to meet the demand of our active user base. If we exhaust the available inventory of these third parties, it will negatively impact our smartphone revenues. In addition, a large amount of consolidation has occurred, and will likely
continue to occur, in the mobile gaming space, including with respect to companies that provide advertisements and offers. If our relationship with any of the companies that we work with (including Tapjoy, which accounted for 13% and 13% of our
total revenues in 2011 and the nine months ended September 30, 2012, respectively) terminates for any reason, including due to acquisition, 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 would negatively impact our revenues, at least in the short term. Furthermore, the revenue 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 quarter.
The actions of the operators of the platforms on which we distribute our games 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 smartphone revenues during the three months ended September 30, 2011, and our inability to subsequently utilize such offers negatively impacted our smartphone revenues thereafter. In addition, in the third
quarter of 2012, Apple made changes to its terms and conditions which could negatively impact the revenues we generate from third party advertisers. Any similar changes in the future that impact our revenues that we generate from advertisements
and offers could materially harm our business, and we may not receive any advance warning of such change
.
If sales of feature
phones in our carrier-based business or the average selling prices of our games sold through wireless carriers decline more rapidly than we currently expect, it could have a material adverse impact on our revenues, financial position and results of
operations.
We currently derive a significant portion of our revenues from sales of our games on feature phones
through wireless carriers. However, our feature phone revenues declined from $54.5 million in 2010 to $31.1 million in 2011 and from $26.0 million for the nine months ended September 30, 2011 to $10.8 million for the nine months ended
September 30, 2012, which was primarily due to the continuing migration of consumers from feature phones to smartphones. We believe that the decline in the sales of feature phones and the transition of consumers to smartphones will continue
during the remainder of 2012 and beyond. In addition, due to the continuing decline in the sales of feature phones, we intend to distribute significantly fewer games for feature phones in future periods, which will further reduce our revenues that
we derive from feature phones. However, if our feature phone revenues decline more rapidly than we currently anticipate, it would negatively impact our overall revenues and cash flows from operations, which could in turn negatively impact our
ability to invest resources in developing and marketing our freemium games for smartphone platforms. In addition, premium games sold on smartphones typically have lower average prices than our games sold on feature phones, and as consumers continue
to migrate to smartphones, it could result in lower average prices for our games sold on feature phones. Any unexpected acceleration in the slowdown in revenues generated from feature phones, or any reduction in the average prices of our games sold
through our wireless carriers, could have a material adverse impact on our revenues, financial position and results of operations.
50
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 2010, 2011 and the first nine months of 2012, and expect to experience continued significant fluctuations in
the future. These issues may continue to negatively impact the economy and our growth. To date, we have not engaged in exchange rate hedging activities, and we do not expect to do so in the foreseeable future. Even if we were to implement hedging
strategies to mitigate this risk, these strategies might not eliminate our exposure to foreign exchange rate fluctuations and would involve costs and risks of their own, such as cash expenditures, ongoing management time and expertise, external
costs to implement the strategies and potential accounting implications.
We face additional risk if 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 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 would negatively impact our feature phone revenues and might negatively impact our smartphone revenues to the
extent that we do not create successful games based on our own intellectual property.
Revenues derived from mobile
games and other applications based on or incorporating brands or other intellectual property licensed from third parties accounted for 50.7% and 78.1% of our revenues in 2011 and 2010, respectively. In 2011, revenues derived under various licenses
from our five largest licensors during that year, Activision, Atari, Caesars, Fremantle Media and 2waytraffic, together accounted for approximately 30.9% of our revenues. Creating games based on well-known, licensed brands has historically
been critical to the success of our feature phone business, as this helped us achieve more prominent placement on our wireless carriers decks and contributed to greater commercial success with feature phone consumers. In addition, the majority
of our premium games that we initially released for smartphones were based on licensed brands. However, we have shifted our business strategy towards becoming the leading publisher of mobile freemium games, and we intend to continue to have the
substantial majority of these freemium games be based upon our own intellectual property. As a result, we have allocated a significantly smaller amount of our operating budget to licensing deals and might elect not to renew our existing brand and
content licenses when they expire. In addition, we intend to only selectively enter into new licensing arrangements in future periods. Our existing licenses expire at various times during the next several years, and our revenues will be negatively
impacted to the extent that we lose the right to distribute games based on licensed content. For example, our right to publish our
World Series of Poker
game for smartphones and tablets expired on March 31, 2012. The expected decline in
the revenues we derive from games based on licensed brands could have an unexpectedly greater impact on our overall revenues and operating results to the extent that we are not successful in significantly increasing our revenues from games developed
for smartphones and tablets based on our own intellectual property.
We rely on a combination of our own servers and third party
infrastructure to operate our freemium games. If we experience any system or network failures, cyber attacks or any other interruption to our freemium games delivered as a live service, 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, wireless carriers 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 the downloading of our games. We also rely on our own servers and third-party infrastructure to operate our freemium games
that are delivered as a live service, to maintain and provide our analytics data and to deliver games on demand to end users through our carriers networks. In particular, a significant portion of our freemium game traffic is hosted by Amazon
Web Services, which service provides server redundancy and uses multiple locations on various distinct power grids; Amazon experienced a power outage during the second quarter of 2012 which affected our games for approximately one day. In addition,
we intend to utilize GameSpys services and equipment, which is housed in an out-of-state data center, for many of our freemium games that we intend to release in the second half of 2012 and beyond, which is subject to a transitional data
center services agreement between us and IGN, GameSpys former parent corporation. 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 or our analytics data, 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, in connection with the release of
our
Gun Bros
game on Apples App Store in the fourth quarter of 2010, we experienced issues with our data servers that resulted in gameplay issues and the loss of some users virtual assets they acquired through in-app purchases. 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. Furthermore, during the fourth quarter of 2010 and first half of 2011, we lost some of our analytics data, including data with respect to our daily and
monthly average users. 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.
51
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 50.1% and 55.1% of our revenues in 2011 and 2010, respectively. To target international markets, we develop games that are localized and customized for
consumers in those markets. We have international offices located in a number of foreign countries including Brazil, Canada, China, England, 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. Risks affecting our international operations include:
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challenges caused by distance, language and cultural differences;
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multiple and conflicting laws and regulations, including complications due to unexpected changes in these laws and regulations;
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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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foreign currency exchange rate fluctuations;
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difficulties in staffing and managing international operations, as well as issues related to having a labor union in our Sao Paulo studio;
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potential violations of the Foreign Corrupt Practices Act or U.K.s Bribery Act, particularly in certain emerging countries in East Asia, Eastern
Europe and Latin America;
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greater fluctuations in sales through storefronts and carriers in developing countries, including longer payment cycles and greater difficulty
collecting accounts receivable;
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protectionist laws and business practices that favor local businesses in some countries;
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regulations that could potentially affect the content of our products and their distribution, particularly in 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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foreign exchange controls that might prevent us from repatriating income earned in countries outside the United States, particularly China;
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the servicing of regions by many different carriers;
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imposition of public sector controls;
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political, economic and social instability;
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restrictions on the export or import of technology;
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trade and tariff restrictions and variations in tariffs, quotas, taxes and other market barriers; and
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difficulties in enforcing intellectual property rights in certain countries.
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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 phone or tablet within a few
months of purchasing the device. We do not control the timing of these mobile device launches. Some manufacturers give us access to their mobile devices prior to commercial release. If one or more major manufacturers were to cease to provide us
access to new mobile device models prior to commercial release, we might be unable to introduce compatible versions of our games for those mobile devices in coordination with their commercial release, and we might not be able to make compatible
versions for a substantial period following their commercial release. If, because we do not adequately build into our title plan the demand for games for a particular 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.
If consumers or digital platform operators believe that our games contain objectionable content, our reputation and operating results could suffer.
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 the remainder of 2012 will be of a similar nature. Some of these games contain violence or other content that certain consumers may find objectionable, particularly with respect to their children. For example, our
Big Time Gangsta
game has been assigned a 17-and-older rating by Apple 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 version which had no depictions of blood. Despite these ratings and precautions, consumers may be offended by certain of the content in our games and children to whom these games are not targeted may choose to play them
anyway. In addition, there is a risk that one of our employees or an employee of an outside developer could include hidden features in one of our games without our knowledge, which hidden features might contain profanity, graphic violence or
sexually explicit or otherwise objectionable material. If consumers believe that a game we published contains objectionable content, consumers could refuse to buy it or demand a refund of their money and they could pressure the digital platform
operators to no longer allow us to publish the game on their platforms. This could have a materially negative impact on our business, operating results and financial condition.
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, including those at GameSpy, Blammo and Griptonite who may experience, or continue to experience, uncertainty due to our acquisition of their companies. In addition, in order to
grow our business, execute on our business strategy and replace departing employees, we must be able to identify, hire and retain qualified personnel. Competition for qualified management, game development and other personnel can be intense, and we
may not be successful in attracting and retaining such personnel. This may be particularly the case for us to the extent our stock price remains at a relatively depressed level, as individuals may elect to seek employment with other companies that
they believe have better long-term prospects. Competitors have in the past and may in the future attempt to recruit our employees, and our management and key employees are not bound by agreements that could prevent them from terminating their
employment at any time. We may also experience difficulty assimilating our newly hired personnel, including those at GameSpy, Blammo and Griptonite, and they may be less effective or productive than we anticipated, which may adversely affect our
business. In addition, we do not maintain a key-person life insurance policy on any of our officers. Our business and growth may suffer if we are unable to hire and retain key personnel.
53
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 a result of our GameSpy, Blammo and
Griptonite acquisitions, as well as our plans to increase our spending on sales and marketing and research and development initiatives in connection with our freemium games, we expect to continue to use cash in our operations during the fourth
quarter of 2012 as we seek to grow our business. As of September 30, 2012, we had $24.1 million of cash and cash equivalents, which were held in operating bank accounts. If our cash and cash equivalents and cash generated from operations are
insufficient to meet our cash requirements, we will need to seek additional capital, potentially through an additional debt or equity financing (potentially pursuant to our effective universal shelf registration statement), procuring a new debt
facility or selling some of our assets, to fund our operations. We may not be able to raise needed cash on terms acceptable to us or at all. Financings, if available, may be on terms that are dilutive or potentially dilutive to our stockholders,
such was the case with respect to the private placement transaction we completed in August 2010 and the underwritten offering of our common stock that we completed in January 2011, particularly given our current stock price. The holders of new
securities may also receive rights, preferences or privileges that are senior to those of existing holders of our common stock. Additionally, our $8.0 million credit facility expired on September 30, 2011, and, if we wish to enter into a
new facility, we may be unable to procure one on terms that are acceptable to us, particularly in light of the current credit market conditions. If new sources of financing are required but are insufficient or unavailable, we would be required to
modify our growth and operating plans to the extent of available funding, which would harm our ability to grow our business.
Our
business is subject to increasing governmental regulation in the key territories in which we conduct business. 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.
54
We sometimes offer our players various types of sweepstakes, giveaways and promotional
opportunities, and in October 2012, we announced a strategic relationship with Probability PLC to offer a suite of Glu-branded mobile slot games in the United Kingdom and Italy. 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 are continuing to review the need for greater regulation for the collection of information concerning consumer behavior on the Internet and on mobile devices, and 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 addition, in October, 2012, the California Attorney General sent a letter to a number
of companies (not including Glu) warning them that they had 30 days to conspicuously post their privacy policies within their mobile applications or they would be in violation of 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 any concerns are raised by consumers about our privacy practices, even if unfounded, it could damage our
reputation and operating results.
We currently collect certain personally identifiable information regarding our customers,
including the unique device identifiers (UDIDs) of our customers smartphones and tablets, and expect in the future to collect additional personally identifiable information regarding our customers. Apple now prohibits applications that access
a users UDID, and this change in policy has required us to modify our business practices. We post our privacy policy and our terms of service on our corporate website. In these policies, we describe our practices concerning the use,
transmission and disclosure of the information that we collect regarding our users. Any failure by us to comply with our posted privacy policy, terms of service or privacy related laws and regulations could result in proceedings against us by
governmental authorities or others, which could harm our business. In addition, the interpretation of data protection laws, and their application to the mobile gaming industry is often unclear. There is a risk that 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 international requirements could cause us to
incur additional costs and change our business practices. Further, any failure by us to adequately protect our users privacy and data 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. The costs of compliance with these laws may increase in the future 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
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The trading price of our common stock has fluctuated in
the past and is expected to continue to fluctuate in the future, as a result of a number of factors, many of which are outside our control, such as:
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price and volume fluctuations in the overall stock market, including as a result of trends in the U.S. or global economy as a whole and the continuing
unprecedented volatility in the financial markets;
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changes in the operating performance and stock market valuations of other technology companies generally, or those in our industry in particular, such
as Electronic Arts and Zynga;
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actual or anticipated fluctuations in our operating results;
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the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
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failure of securities analysts to initiate or maintain coverage of us, changes in financial estimates or ratings by any securities analysts who follow
our company or our industry, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock;
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announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures, capital raising
activities or capital commitments;
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the publics response to our press releases or other public announcements, including our filings with the SEC;
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any significant sales of our stock by our directors, executive officers or large stockholders, including the investors in our 2010 private placement
transaction or by the former stockholders of Blammo and Griptonite, each of whose shares have been registered for resale under the Securities Act and may be freely sold at any time; and
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lawsuits threatened or filed against us.
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In addition, the stock markets, including The NASDAQ Global Market on which our common stock is listed, have recently and in the past, experienced extreme price and volume fluctuations that have affected
the market prices of many companies, some of which appear to be unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our common stock. In the past,
following periods of volatility in the market price of a particular companys securities, securities class action litigation has often been brought against that company. Securities class action litigation against us could result in substantial
costs and divert our managements attention and resources.
Our facilities are located near known earthquake fault zones, and the
occurrence of an earthquake or other natural disaster could cause damage to 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, and are thus vulnerable to damage. We are also vulnerable to damage from other types of disasters, including
power loss, fire, explosions, floods, communications failures, terrorist attacks and similar events. If any 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 an essential
element of 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. Consequently, we will not be able to protect our technologies from independent invention by third parties. In addition, there are practical and other limitations to the protection offered by copyright law. 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 in the past released games that are nearly identical to successful games released by their competitors in an effort to confuse the market and divert users from the
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 resort to litigation 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 could require us to pay significant damage awards.
Third parties may sue us, including for intellectual property infringement, or initiate proceedings to invalidate our
intellectual property, which, if successful, could disrupt the conduct of our business, cause us to pay significant damage awards or require us to pay licensing fees. For example, on November 5, 2012, Mobile Transformation LLC filed a complaint
against us in The U.S. District Court for The District of The State of Delaware claiming that we are infringing one of its patents and seeking unspecified damages. In the event of a successful claim against us, whether in the suit brought by Mobile
Transformation LLC or pursuant to a future claim, we might be enjoined from using our or our licensed intellectual property, we might incur significant licensing fees and we might be forced to develop alternative technologies. Our failure or
inability to develop non-infringing technology or games or to license the infringed or similar technology or games on a timely basis could force us to withdraw games from the market or prevent us from introducing new games. 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. From time to time, 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.
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 and could further significantly affect the way we account for revenue related to our products and services. 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, could have a significant adverse effect on our
reported results although not necessarily on our cash flows.
If we fail to maintain an effective system of internal controls, we might
not be able to report our financial results accurately or prevent fraud; in that case, our stockholders could lose confidence in our financial reporting, which could negatively impact the price of our stock.
Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. In addition, Section 404 of
the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal control over financial reporting. We have incurred, and expect to continue to incur, substantial accounting and auditing expenses and expend significant management
time in complying with the requirements of Section 404. Even if we conclude that our internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles, because of its inherent limitations, internal control over financial reporting may not prevent or detect fraud or misstatements. Failure to implement
required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we or our independent registered public accounting firm discover a
material weakness or a significant deficiency in our internal control, the disclosure of that fact, even if quickly remedied, could reduce the markets confidence in our financial statements and harm our stock price. In addition, a delay in
compliance with Section 404 could subject us to a variety of administrative sanctions, including ineligibility for short form resale registration, action by the SEC, the suspension or delisting of our common stock from The NASDAQ Global Market
and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price and could harm our business.
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Maintaining and improving our financial controls and the requirements of being a public company may
strain our resources, divert managements attention and affect our ability to attract and retain qualified members for our board of directors.
As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the rules and
regulations of The NASDAQ Stock Market. The requirements of these rules and regulations has significantly increased our legal, accounting and financial compliance costs, makes some activities more difficult, time-consuming and costly and may also
place undue strain on our personnel, systems and resources.
The Sarbanes-Oxley Act requires, among other things, that we
maintain effective disclosure controls and procedures and internal control over financial reporting. This can be difficult to do. To maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial
reporting, we expend significant resources and provide significant management oversight to implement appropriate processes, document our system of internal control over relevant processes, assess their design, remediate any deficiencies identified
and test their operation. As a result, managements attention may be diverted from other business concerns, which could harm our business, operating results and financial condition. These efforts also involve substantial accounting-related
costs. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on The NASDAQ Global Market.
Changes in our tax rates or exposure to additional tax liabilities could adversely affect our earnings and financial condition.
We are subject to income taxes in the United States and in various foreign jurisdictions. Significant judgment is required in determining
our worldwide provision for income taxes, and, in the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain.
We are also required to estimate what our tax obligations will be in the future. Although we believe our tax estimates are reasonable,
the estimation process and applicable laws are inherently uncertain, and our estimates are not binding on tax authorities. The tax laws treatment of software and internet-based transactions is particularly uncertain and in some cases currently
applicable tax laws are ill-suited to address these kinds of transactions. Apart from an adverse resolution of these uncertainties, our effective tax rate could also be adversely affected by our profit level, by changes in our business or changes in
our structure, changes in the mix of earnings in countries with differing statutory tax rates, changes in the elections we make, changes in applicable tax laws (in the United States or foreign jurisdictions), or changes in the valuation allowance
for deferred tax assets, as well as other factors. For example, the current administration has made public statements indicating that it has made international tax reform a priority, and key members of the U.S. Congress have conducted hearings and
proposed new legislation. Recent changes to U.S. tax laws, including limitations on the ability of taxpayers to claim and utilize foreign tax credits and the deferral of certain tax deductions until earnings outside of the United States are
repatriated to the United States, as well as changes to U.S. tax laws that may be enacted in the future, could impact the tax treatment of our foreign earnings.
We incur certain tax expenses that do not decline proportionately with declines in our consolidated pre-tax income or loss. As a result, in absolute dollar terms, our tax expense will have a greater
influence on our effective tax rate at lower levels of pre-tax income or loss than at higher levels. In addition, at lower levels of pre-tax income or loss, our effective tax rate will be more volatile.
We are also required to charge, collect and/or pay taxes other than income taxes, such as payroll, value-added, sales and use, net worth,
property and goods and services taxes, in both the United States and foreign countries based on our determination of whether we have taxable nexus in the respective jurisdictions. We are subject to examination by tax authorities with respect to
these non-income taxes. The outcomes from examinations, changes in our business or changes in applicable tax rules may have an adverse effect on our earnings and financial condition. If tax authorities assert that we have taxable nexus in the
jurisdiction, those authorities might seek to impose past as well as future liability for taxes and/or penalties. Such impositions could also impose significant administrative burdens and decrease our future sales. Moreover, state and federal
legislatures have been considering various initiatives that could change our position regarding sales and use taxes.
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Furthermore, 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, acquisitions and our current and anticipated business and operational requirements, our tax expense could
increase.
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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