Glu Mobile, Inc.
Annual Report 2007

Plain-text annual report

Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-K(Mark One)  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2007ORoo TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934Commission file number: 001-33368Glu Mobile Inc.(Exact name of registrant as specified in its charter)Delaware(State or Other Jurisdiction ofIncorporation or Organization) 91-2143667(IRS EmployerIdentification No.)2207 Bridgepointe Parkway,Suite 250, San Mateo, California(Address of Principal Executive Offices) 94404(Zip Code)(650) 532-2400(Registrant’s Telephone Number, Including Area Code)Securities registered pursuant to Section 12(b) of the Act:Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, par value $0.0001 per share Nasdaq Global MarketSecurities registered pursuant to Section 12(g) of the Act:None(Title of Class)Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will notbe contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):Large accelerated filer oAccelerated filer oNon-accelerated filer Smaller reporting company o(Do not check if a smaller reporting company)Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of such stock on June 29,2007, the last business day of the registrant’s most recently completed second fiscal quarter, as reported by The Nasdaq Global Market, wasapproximately $251,607,500. Shares of common stock held by each executive officer and director of the registrant and by each person who owns10% or more of the registrant’s outstanding common stock have been excluded in that such persons may be deemed to be affiliates. Thisdetermination of affiliate status is not necessarily a conclusive determination for other purposes.The number of outstanding shares of the registrant’s common stock as of March 21, 2008, was 29,336,465.DOCUMENTS INCORPORATED BY REFERENCEPortions of the definitive proxy statement for registrant’s 2008 Annual Meeting of Stockholders to be held on June 3, 2008 and to be filedpursuant to Regulation 14A within 120 days after registrant’s fiscal year ended December 31, 2007 are incorporated by reference into Part III of thisAnnual Report on Form 10-K. TABLE OF CONTENTS PagePART I Item 1. Business 1 Item 1A. Risk Factors 8 Item 1B. Unresolved Staff Comments 26 Item 2. Properties 26 Item 3. Legal Proceedings 26 Item 4. Submission of Matters to a Vote of Security Holders 26 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities 27 Item 6. Selected Financial Data 29 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 52 Item 8. Financial Statements and Supplementary Data 55 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 95 Item 9A. Controls and Procedures 95 Item 9B. Other Information 95 PART III Item 10. Directors, Executive Officers and Corporate Governance 96 Item 11. Executive Compensation 96 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 96 Item 13. Certain Relationships and Related Transactions, and Director Independence 96 Item 14. Principal Accounting Fees and Services 96 PART IV Item 15. Exhibits and Financial Statement Schedules 96 Signatures 97 EXHIBIT 21.01 EXHIBIT 23.01 EXHIBIT 31.01 EXHIBIT 31.02 EXHIBIT 32.01 EXHIBIT 32.02Table of ContentsForward Looking StatementsThe information in this Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (ExchangeAct). Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that arenot statements of historical facts may be deemed to be forward-looking statements. For example, words such as “may,” “will,” “should,”“estimates,” “predicts,” “potential,” “continue,” “strategy,” “believes,” “anticipates,” “plans,” “expects,” “intends” and similarexpressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differsignificantly from the results discussed in the forward-looking statements. Factors that might cause or contribute to such differencesinclude, but are not limited to, those discussed elsewhere in this Annual Report on Form 10-K in the section titled “Risk Factors” and therisks discussed in our other Securities and Exchange Commission (SEC) filings. We undertake no obligation to publicly release anyrevisions to the forward-looking statements after the date of this Annual Report on Form 10-K.PART IItem 1. BusinessOverviewGlu Mobile is a leading global publisher of mobile games. We have developed and published a portfolio of more than 195 casualand traditional games to appeal to a broad cross section of the subscribers served by our more than 200 wireless carriers and otherdistributors. We create games and related applications based on third-party licensed brands and other intellectual property, as well as onour own original brands and intellectual property. Our games based on licensed intellectual property include Call of Duty 4, Deer Hunter2, Diner Dash 2, Sonic the Hedgehog, Transformers, World Series of Poker and Zuma. Our original games based on our ownintellectual property include Brain Genius, Frantic Factory, My Hangman, Shadowalker, Space Monkey and Super K.O. Boxing.We believe that the rapid growth of the mobile game market has been driven by continued advances in wireless communicationstechnology, proliferation of multimedia-enabled mobile handsets, increasing availability of high-quality mobile games and increasing end-user awareness of, and demand for, mobile games.We seek to attract end users by developing engaging content that is designed specifically to take advantage of the portability andnetworked nature of mobile handsets. We leverage the marketing resources and distribution infrastructure of wireless carriers and thebrands and other intellectual property of third-party content owners, allowing us to focus our efforts on developing and publishing high-quality mobile games. We believe that the quality of our games, the breadth of our distribution and licensing relationships, and theadvantages we gain through our technology will enable us to gain share in this growing market.By using carriers’ distribution infrastructures, we afford end users of our games the convenience of paying through their mobilephone bill, while eliminating for us the traditional publishing costs associated with packaging, shipping, stocking, inventorymanagement and return processing. In 2007, our largest wireless carrier customers in each region by revenues were Verizon Wireless,AT&T, Sprint Nextel and T-Mobile USA in North America; Vodafone, Hutchinson 3G, Orange and O2 in Europe; TelCel, TIM Celularand Vivo in Latin America; and Vodafone and Hutchinson 3G Australia in Asia Pacific. Carriers market and distribute our games,retaining a portion of the gross fee paid by their subscribers for purchasing or accessing our games and paying to us the remainder. Thus,the carriers have the opportunity to increase their average revenue per subscriber.By licensing intellectual property from third-party content owners, we provide end users brands and content with which they arefamiliar, while eliminating for us the need to develop all of our games from our own intellectual property. Our branded content ownersprovide us with well-known consumer brands and other intellectual property on which we have based mobile games. When we uselicensed content in the development of our games, or when we distribute mobile games developed by branded content owners, we sharewith the branded content owner a portion of the amount paid to us by carriers, thereby allowing it to derive incremental revenue from itscontent. We also1Table of Contentsprovide a solution for content owners to the development and distribution challenges associated with creating and distributing their ownmobile games.We believe that our carriers and content owners value our global reach, the consistently high quality of our game portfolio, thecreativity of our development studios, and our mobile-specific development expertise, including our ability to port games to more than1,000 different handset models with various combinations of underlying technologies, user interfaces, keypad layouts, screenresolutions, sound capabilities and other carrier-specific customizations.Our Competitive StrengthsWe believe we have a proven capability to develop high-quality mobile games that engage end users. Our portfolio of more than 195games includes a variety of genres and is designed to appeal to the diverse interests of the broad wireless subscriber population. As themobile entertainment market continues to develop, we believe that wireless carriers and branded content owners will increasingly recognizethe benefits of partnering with independent mobile entertainment publishers that have achieved the scale necessary to develop and publisha consistent portfolio of high-quality games and to distribute them globally. We believe that we will continue to be attractive to carriers,content owners and end users because of the following: • our diverse portfolio of award-winning high quality mobile games; • our global scale in distribution, sales and marketing; • our strong relationships with branded content owners; • our proprietary porting and data mining capabilities; and • our experienced management team.Our StrategyOur goal is to be the leading global publisher of mobile games and other mobile entertainment applications. To achieve this goal, weplan to: • continue to create award-winning games through ongoing investment in our studio and technical development capabilities; • leverage and grow our portfolio of games; • expand and strengthen our distribution; • build up our position as a leading global publisher to strengthen licensing relationships; and • gain scale through select acquisitions.Our ProductsWe design our portfolio of games to appeal to the diverse interests of the broad wireless subscriber population. We believe that thequality of our games, as recognized by numerous industry awards, is key to their repeated success. We focus on developing a portfolio ofgames across a number of genres designed to increase adoption and repeat purchase rates by subscribers. We also develop and publishringtones and wallpaper in coordination with a small number of our games, such as Transformers. Revenues from applications otherthan games have not been material to date.End users typically purchase our games from their wireless carrier and are billed on their monthly phone bill. In the United States,one-time fees for unlimited use generally range between approximately $5.00 and $10.00, and prices for subscriptions generally rangebetween approximately $2.50 and $4.00 per month, typically varying by game and carrier. In Europe, one-time fees for unlimited usegenerally range between approximately $2.50 and $10.00 (at current exchange rates), and prices for subscriptions generally range betweenapproximately $1.50 and $4.00 per month (at current exchange rates), typically varying by game and carrier. Prices in the Asia-Pacificand2Table of ContentsLatin America regions are generally lower than in the United States and Europe. Carriers normally share with us 50% to 70% of theirsubscribers’ payments for our games, which we record as revenues. In the case of games based on licensed brands, we, in turn, sharewith the content licensor a portion of our revenues. The average royalty rate that we paid on games based on licensed intellectual propertywas approximately 34% in 2006 and approximately 31% in 2007. However, the individual royalty rates that we pay can be significantlyabove or below the average because our licenses were signed over a number of years and in many cases were negotiated by one of thecompanies we acquired. The royalty rates also vary based on factors such as the strength of the licensed brand.Our portfolio of games includes original games based on our own intellectual property and games based on brands and otherintellectual property licensed from branded content owners. These latter games are inspired by non-mobile brands and intellectualproperty, including movies, board games, Internet-based casual games and console games. In 2007, Glu-branded original gamesaccounted for approximately 11.9% of our revenues. Games based on licensed content from Hasbro, under agreements coveringTransformers, Monopoly, Game of Life and other titles, accounted for approximately 22.9% of our revenues for this period. Aspreviously disclosed, the license covering the classic Hasbro board game titles terminates at the end of the first quarter of 2008. No otherlicensor represented more than 10.0% of our revenues in 2007. As a result of the ordinary lifecycle of titles and the pending expiration ofvarious agreements, we do not expect any licensor to account for more than 10% of revenues in 2008.Our games typically generate revenues for 18 to 24 months after release. As a result, we generate a significant portion of our revenuesfrom our collection of games that have been in release for more than 12 months, which we sometimes refer to as our catalog. In 2007, wehad more than 195 active titles generating revenues, of which the casual, pop culture, gamer, classic and sports genres each had at least20 titles.Wireless carriers generally control the price charged to end users for our mobile games either by approving or establishing the priceof the games charged to their subscribers. Some of our carrier agreements also restrict our ability to change established prices. In caseswhere carrier approval is required, approvals may not be granted in a timely manner or at all. A failure or delay in obtaining theseapprovals, the prices established by the carriers for our games, or changes in these prices could adversely affect market acceptance ofthose games. Similarly, for the significant minority of our carriers, including Verizon Wireless, when we make changes to a pricing plan(the wholesale price and the corresponding suggested retail price based on our negotiated revenue-sharing arrangement), adjustments to theactual retail price charged to end users may not be made in a timely manner or at all, even though our wholesale price was reduced. Afailure or delay by these carriers in adjusting the retail price for our games could adversely affect sales volume and our revenues for thosegames.Changes in end-user tastes and advances in technology combined with limitations on our ability to introduce additional versions ofgames under many of our license agreements, even those with durations longer than the typical shelf life of our games, mean that we arefrequently evaluating ideas for new potential games and will need to obtain new licenses or develop new original games on an ongoingbasis. We may be unable to obtain new licenses or to obtain them on terms favorable to us. Failure to maintain or renew our existinglicenses or to obtain additional licenses could impair our ability to introduce new mobile games or continue our current games, whichcould materially harm our business, operating results and financial condition. Even if we are successful in gaining new licenses orextending existing licenses, we may fail to anticipate the entertainment preferences of our end users when making choices about whichbrands or other content to license. If the entertainment preferences of end users shift to content or brands owned or developed bycompanies with which we do not have relationships, we may be unable to establish and maintain successful relationships with thesedevelopers and owners, which would materially harm our business, operating results and financial condition.Sales, Marketing and DistributionWe market and sell our games primarily through wireless carriers. Because of our internal development, porting and operationscapabilities, we believe that we have an advantage over our competitors in the ability to execute simultaneous and coordinated“day-and-date” game launches. These coordinated launches typically are used for games associated with other content platforms such asfilms, television and console games. We also coordinate our marketing efforts with carriers and mobile handset manufacturers in thelaunch of new games with new handsets.3Table of ContentsOur sales and marketing organization focuses on increasing end-user awareness, adoption and repeat purchase rates through avariety of programs. We co-market our games with our partners, including carriers, branded content owners and direct-to-consumercompanies. For example, when we create an idea for a game, we discuss the game with carriers early in the development process to gain anunderstanding of the attractiveness of the game to them, to obtain their other feedback regarding the game, and to develop plans for co-marketing and a potential launch strategy. We also coordinate our marketing efforts with those of branded content owners, especiallywhere our games will be launched concurrently with their film, television show or other entertainment product. These programs leveragethe sales and marketing resources of our carriers and content licensors to amplify our own sales and marketing efforts. In addition, wework with our carriers to develop merchandising initiatives that stimulate trial and purchase such as pre-loading of games on handsets,often with free trials, Glu-branded game menus that offer games for trial or sale, and pay-per-play or other alternative billingarrangements.We believe that placement of games on the top level or featured handset menu or toward the top of the genre-specific or other menus,rather than lower down or in sub-menus, is likely to result in games achieving a greater degree of commercial success. We believe that anumber of factors may influence the deck placement of a game including: • the perceived attractiveness of the title or brand; • the past success of the game or of other games previously introduced by a publisher; • the number of handsets for which a version of the game is available; • the relationship with the applicable carrier; • the carrier’s economic incentives with respect to the particular game, such as the revenue split percentage; and • the level of marketing support, including marketing development funds.If carriers choose to give our games less favorable deck placement, our games may be less successful than we anticipate and ourbusiness, operating results and financial condition may be materially harmed.We currently have agreements with more than 200 carriers and other distributors that in the aggregate reach more than one billionsubscribers. End users download our mobile games and related applications to their handsets, and typically their carrier bills them a one-time fee or monthly subscription fee, depending on the end user’s desired payment arrangement and the carrier’s offerings. Our carrierdistribution agreements establish the portion of revenues that will be retained by the carrier for distributing our games and otherapplications. Our carrier agreements do not establish us as the exclusive provider of mobile games with the carriers and typically have aterm of one or two years with automatic renewal provisions upon expiration of the initial term, absent a contrary notice from either party.In addition, the carriers can usually terminate these agreements early and, in some instances, at any time without cause, which could givethem the ability to renegotiate economic or other terms. The agreements generally do not obligate the carriers to market or distribute any ofour games. In many of these agreements, we warrant that our games do not contain libelous or obscene content, do not contain materialdefects or viruses, and do not violate third-party intellectual property rights and we indemnify the carrier for any breach of a third party’sintellectual property.In 2007, Verizon Wireless accounted for 23.0% of our revenues. No other carrier represented more than 10.0% of our revenues in2007. In 2006, Verizon Wireless, Sprint Nextel, AT&T and Vodafone accounted for 20.6%, 12.6%, 11.3% and 10.6%, respectively, ofour revenues. In 2005, those carriers accounted for 24.3%, 11.9%, 11.9% and 6.2%, respectively, of our revenues.Although we intend to continue the primary distribution of our games through carriers, we also market and sell our games throughour own website and various Internet portals. Currently, revenues from these alternative distribution channels are immaterial. However,we believe that these channels increase the exposure of our games and brand to end users and that they may become significant channelsin the future. As with our carriers, we believe that inferior placement of our games in the menus of off-deck distributors will result inlower revenues than might otherwise be anticipated from these alternative sales channels.4Table of ContentsCarriers and other distributors also control billings and collections for our games, either directly or through third-party serviceproviders. We depend on their reports for information regarding the amount of sales of our games and related applications and todetermine the amount of royalties we owe branded content licensors and the amount of our revenues. These reports may not be timely, andin the past they have contained, and in the future they may contain, errors. If our carriers or their third-party service providers causematerial inaccuracies when providing billing and collection services to us, our revenues may be less than anticipated or may be subject torefund at the discretion of the carrier. This could harm our business, operating results and financial condition.SeasonalityMany new mobile handset models are released in the fourth calendar quarter to coincide with the holiday shopping season. Becausemany end users download our games soon after they purchase new handsets, we generally experience seasonal sales increases based onthe holiday selling period. However, due to the time between handset purchases and game purchases, most of this holiday impact occursfor us in our first calendar quarter. In addition, we seek to release many of our games in conjunction with specific events, such as therelease of a related movie. Further, for a variety of reasons, including roaming charges for data downloads that may make purchase of ourgames prohibitively expensive for many end users while they are traveling, we sometimes experience seasonal sales decreases during thesummer, particularly in Europe.StudiosWe have six internal studios that create and develop games and other entertainment products tailored to mobile handsets. Thesestudios, based in San Mateo, California, London, England, Beijing, China, Hefei, China, Sao Paulo, Brazil and Moscow, Russia, havethe ability to design and build products from original intellectual property, based on games originated in other media such as online andgame consoles, or based on other licensed brands and intellectual property.Where we license intellectual property from films or other brands or content not based on games from other media, our gamedevelopment process involves a significant amount of creativity. Even licensed console or Internet games require more than a simple portto the mobile environment; rather, our developers must create games that are inspired by the game play of the original. In each of thesecases, our creative and technical studio expertise is necessary to design games that appeal to end users and work well on handsets withtheir inherent limitations such as small screen sizes and control buttons.In addition, our studios develop games with worldwide appeal such as Transformers as well as games that are regionally andculturally relevant like Pasapalabra. We anticipate expanding our creative and development teams in Asia and Latin America forlocalization and development of culturally attuned games.Product Development and TechnologyWe have developed proprietary technologies and product development processes that are designed to enable us rapidly and costeffectively to develop and publish games that are consistently rated as high quality by industry publications such as IGN Entertainment,Modojo and WGWorld, and that meet the needs of our wireless carriers. These technologies and processes include: • our development platforms; • porting tools and processes; • broad development capabilities; • application hosting; • provisioning and billing capabilities; • merchandising and marketing platform; and • thin client-server platform.5Table of ContentsAs of December 31, 2007, we had 287 employees in research and development, up from 150 as of December 31, 2006. Researchand development expenses were $22.4 million and $16.0 million for 2007 and 2006, respectively. We expect to increase to increase inabsolute dollars spending for research and development activities.CompetitionOur primary competitors include Electronic Arts (EA Mobile) and Gameloft, with Electronic Arts having the largest market share ofany company in the mobile games market. In the future, likely competitors include major media companies, traditional video gamepublishers, content aggregators, mobile software providers and independent mobile game publishers. Wireless carriers may also decide todevelop, internally or through a managed third-party developer, and distribute their own mobile games. If carriers enter the mobile gamemarket as publishers, they might refuse to distribute some or all of our games or might deny us access to all or part of their networks.The development, distribution and sale of mobile games is a highly competitive business. For end users, we compete primarily onthe basis of brand, game quality and price. For carriers, we compete for deck placement based on these factors, as well as historicalperformance and perception of sales potential and relationships with licensors of brands and other intellectual property. For content andbrand licensors, we compete based on royalty and other economic terms, perceptions of development quality, porting abilities, speed ofexecution, distribution breadth and relationships with carriers. We also compete for experienced and talented employees.Some of our competitors’ and our potential competitors’ advantages over us, either globally or in particular geographic markets,include the following: • significantly greater revenues and financial resources; • stronger brand and consumer recognition regionally or worldwide; • the capacity to leverage their marketing expenditures across a broader portfolio of mobile and non-mobile products; • more substantial intellectual property of their own from which they can develop games without having to pay royalties; • pre-existing relationships with brand owners or carriers that afford them access to intellectual property while blocking the accessof competitors to that same intellectual property; • greater resources to make acquisitions; • lower labor and development costs; and • broader global distribution and presence.Further, our capital resources limit the number of games that we can develop and market, and any inability to predict successfullythe appropriate level of marketing investment in each game could result in lower earnings than we anticipate.Intellectual PropertyOur intellectual property is an essential element of our business. We use a combination of trademark, copyright, trade secret andother intellectual property laws, confidentiality agreements and license agreements to protect our intellectual property. Our employees andindependent contractors are required to sign agreements acknowledging that all inventions, trade secrets, works of authorship,developments and other processes generated by them on our behalf are our property, and assigning to us any ownership that they mayclaim in those works. Despite our precautions, it may be possible for third parties to obtain and use without consent intellectual propertythat we own or license. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting ourintellectual property rights, may adversely affect our business.We are the owner of 11 trademarks registered with the U.S. Patent and Trademark office, including Glu, Alpha Wing, AncientEmpires, Super K.O. Boxing and our ’g’ character logo, and have ten trademark applications pending with the U.S. Patent andTrademark Office, including Brain Genius, Frantic Factory, Get Cookin’, Poppin Panda,6Table of ContentsShadowalker, Space Monkey, Vegas Hustler and White House Rumble. We also own one or more registered trademarks in Argentina,Australia, Canada, Chile, Colombia, Dominican Republic, Ecuador, the European Union, Guatemala, Hong Kong, Japan, Mexico, NewZealand, Panama, Peru, Singapore, South Korea, Taiwan, Thailand, the United Kingdom, Uruguay and Venezuela, including thenames Alpha Wing, Ancient Empires, Brain Genius, Super K.O. Boxing, Glu and our ’g’ character logo, and have a number oftrademark applications pending in more than ten other jurisdictions for the same and other trademarks. Registration of both U.S. andforeign trademarks are renewable every ten years.In addition, many of our games and other applications are based on or incorporate intellectual property that we license from thirdparties. We have both exclusive and non-exclusive licenses to use these properties for terms that generally range from two to five years.Our licensed brands include, among others, Age of Empires III, Call of Duty 4, Deer Hunter 2, Diner Dash 2, Sonic the Hedgehog,Transformers, World Series of Poker and Zuma. Our licensors include a number of well-established video game publishers and majormedia companies.From time to time, we may encounter disputes over rights and obligations concerning intellectual property. Although we believe thatour product offerings do not infringe the intellectual property rights of any third party, we cannot be certain that we will prevail in anyintellectual property dispute. If we do not prevail in these disputes, we may lose some or all of our intellectual property protection, beenjoined from further sales of our games or other applications determined to infringe the rights of others, and/or be forced to paysubstantial royalties to a third party, any of which would have a material adverse effect on our business, financial condition and resultsof operations.EmployeesAs of December 31, 2007, we had 417 employees, including 287 in research and product development. Of these employees, 139were in the United States and Canada, 101 were in Europe, 165 were in Asia Pacific and 12 were in Latin America. None of ouremployees is represented by a labor union or is covered by a collective bargaining agreement. We have never experienced any employment-related work stoppages and consider relations with our employees to be good.Corporate History and InformationWe were incorporated in Nevada in May 2001 as Cyent Studios, Inc. and changed our name to Sorrent, Inc. later that year. InNovember 2001, we incorporated a wholly owned subsidiary in California, and, in December 2001, we merged the Nevada corporationinto this California subsidiary to form Sorrent, Inc., a California corporation. In May 2005, we changed our name to Glu Mobile Inc. InMarch 2007, we reincorporated in Delaware and implemented a 1-for-3 reverse split of our common stock and convertible preferred stock.Also in March 2007, we completed our initial public offering. In December 2004, we acquired Macrospace Limited, or Macrospace, acompany registered in England and Wales, in March 2006, we acquired iFone Holdings Limited, or together with its affiliates iFone, acompany registered in England and Wales, in December 2007, we acquired Beijing Zhangzhong MIG Information Technology Co. Ltd.,or together with its affiliates MIG, a domestic limited liability company organized under the laws of China, and in March 2008, weacquired Superscape Group plc, or together with its affiliates Superscape, a company registered in England and Wales with operations inRussia.Available InformationOur Internet address is www.glu.com. There we make available, free of charge, our annual reports on Form 10-K, quarterly reportson Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the SEC. Our SEC reports can be accessed through the Investors section of our Website. The information found on our Web site is not part of this or any other report we file with or furnish to the SEC.7Table of ContentsItem 1A. Risk FactorsOur business is subject to many risks and uncertainties, which may affect our future financial performance. If any of the events orcircumstances described below occurs, our business and financial performance could be harmed, our actual results could differmaterially from our expectations and the market value of our stock could decline. The risks and uncertainties discussed below are not theonly ones we face. There may be additional risks and uncertainties not currently known to us or that we currently do not believe arematerial that may harm our business and financial performance. Because of the risks and uncertainties discussed below, as well as othervariables affecting our operating results, past financial performance should not be considered as a reliable indicator of future performanceand investors should not use historical trends to anticipate results or trends in future periods.Risks Related to Our BusinessWe 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 $17.9 million in 2005, a net loss of $12.3 million in2006 and a net loss of $3.3 million in 2007. As of December 31, 2007, we had an accumulated deficit of $52.4 million. We expect tocontinue to increase expenses as we implement initiatives designed to continue to grow our business, including, among other things, thedevelopment and marketing of new games, further international expansion, expansion of our infrastructure, acquisition of content, andgeneral and administrative expenses associated with being a public company. If our revenues do not increase to offset these expectedincreases in operating expenses, we will continue to incur significant losses and will not become profitable. Our revenue growth in recentperiods should not be considered indicative of our future performance. In fact, in future periods, our revenues could decline. Accordingly,we may not be able to achieve profitability in the future.We have a limited operating history in an emerging market, which may make it difficult to evaluate our business.We were incorporated in May 2001 and began selling mobile games in July 2002. Accordingly, we have only a limited history ofgenerating revenues, and the future revenue potential of our business in this emerging market is uncertain. As a result of our shortoperating history, we have limited financial data that can be used to evaluate our business. Any evaluation of our business and ourprospects must be considered in light of our limited operating history and the risks and uncertainties encountered by companies in ourstage of development. As an early stage company in the emerging mobile entertainment industry, we face increased risks, uncertainties,expenses and difficulties. To address these risks and uncertainties, we must do the following: • maintain our current, and develop new, wireless carrier relationships, particularly in international markets; • maintain and expand our current, and develop new, relationships with third-party branded content owners; • retain or improve our current revenue-sharing arrangements with carriers and third-party branded content owners; • maintain and enhance our own brands; • continue to develop new high-quality mobile games that achieve significant market acceptance; • continue to port existing mobile games to new mobile handsets; • continue to develop and upgrade our technology; • continue to enhance our information processing systems; • increase the number of end users of our games; • maintain and grow our non-carrier, or “off-deck,” distribution, including through our website and third-party direct-to-consumerdistributors; • expand our development capacity in countries with lower costs; • execute our business and marketing strategies successfully;8Table of Contents • respond to competitive developments; and • attract, integrate, retain and motivate qualified personnel.We may be unable to accomplish one or more of these objectives, which could cause our business to suffer. In addition,accomplishing many of these efforts might be very expensive, which could adversely impact our operating results and financialcondition.Our financial results could vary significantly from quarter to quarter and are difficult to predict.Our revenues and operating results could vary significantly from quarter to quarter because of a variety of factors, many of whichare outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. In addition, wemay not be able to predict our future revenues or results of operations. We base our current and future expense levels on our internaloperating 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 costssufficiently to compensate for an unexpected shortfall in revenues, and even a small shortfall in revenues could disproportionately andadversely affect financial results for that quarter. Individual games and carrier relationships represent meaningful portions of our revenuesand net loss in any quarter. We may incur significant or unanticipated expenses when licenses are renewed, or we may experience asignificant reduction in revenue if licenses are not renewed. In addition, some payments from carriers that we recognize as revenue on acash basis may be delayed unpredictably.We are also subject to macroeconomic fluctuations in the U.S. economy, including those that impact discretionary consumerspending. Recent macroeconomic issues such as those involving sub-prime mortgages and liquidity issues, as well as liquidity issues inthe auction rate securities that we invest in, may negatively impact the economy and our growth. If these issues persist, or if the economyenters a prolonged period of decelerating growth or recession, our results of operations may be harmed.In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly resultsinclude: • the number of new mobile games released by us and our competitors; • the timing of release of new games by us and our competitors, particularly those that may represent a significant portion ofrevenues in a period; • the popularity of new games and games released in prior periods; • changes in prominence of deck placement for our leading games and those of our competitors; • the expiration of existing content licenses for particular games; • the timing of charges related to impairments of goodwill, intangible assets, prepaid royalties and guarantees; • changes in pricing policies by us, our competitors or our carriers and other distributors; • changes in the mix of original and licensed games, which have varying gross margins; • the timing of successful mobile handset launches; • the timeliness of reporting from carriers; • the seasonality of our industry; • fluctuations in the size and rate of growth of overall consumer demand for mobile games and related content; • strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments orchanges in business strategy; • our success in entering new geographic markets; • foreign exchange fluctuations; • accounting rules governing recognition of revenue;9Table of Contents • the timing of compensation expense associated with equity compensation grants; and • decisions by us to incur additional expenses, such as increases in marketing or research and development.As a result of these and other factors, our operating results may not meet the expectations of investors or public market analysts whochoose to follow our company. Failure to meet market expectations would likely result in decreases in the trading price of our commonstock.The markets in which we operate are highly competitive, and many of our competitors have significantly greater resources thanwe do.The development, distribution and sale of mobile games is a highly competitive business. For end users, we compete primarily onthe basis of brand, game quality and price. For wireless carriers, we compete for deck placement based on these factors, as well ashistorical performance and perception of sales potential and relationships with licensors of brands and other intellectual property. Forcontent 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 carriers. We also compete for experienced and talented employees.Our primary competitors include Electronic Arts (EA Mobile) and Gameloft, with Electronic Arts having the largest market share ofany company in the mobile games market. In the future, likely competitors include major media companies, traditional video gamepublishers, content aggregators, mobile software providers and independent mobile game publishers. Carriers may also decide to develop,internally or through a managed third-party developer, and distribute their own mobile games. If carriers enter the mobile game market aspublishers, they might refuse to distribute some or all of our games or might deny us access to all or part of their networks.Some of our competitors’ and our potential competitors’ advantages over us, either globally or in particular geographic markets,include the following: • significantly greater revenues and financial resources; • stronger brand and consumer recognition regionally or worldwide; • the capacity to leverage their marketing expenditures across a broader portfolio of mobile and non-mobile products; • more substantial intellectual property of their own from which they can develop games without having to pay royalties; • pre-existing relationships with brand owners or carriers that afford them access to intellectual property while blocking the accessof competitors to that same intellectual property; • greater resources to make acquisitions; • lower labor and development costs; and • broader global distribution and presence.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 andfinancial condition.Failure to renew our existing brand and content licenses on favorable terms or at all and to obtain additional licenses wouldimpair our ability to introduce new mobile games or to continue to offer our current games based on third-party content.Revenues derived from mobile games and other applications based on or incorporating brands or other intellectual property licensedfrom third parties accounted for 80.5%, 88.4% and 88.1% of our revenues in 2005, 2006 and 2007, respectively. For example, in 2007,revenues derived under various licenses from our four largest licensors, Atari, Harrah’s, Hasbro and PopCap Games, together accountedfor approximately 49.5% of our10Table of Contentsrevenues. Even if mobile games based on licensed content or brands remain popular, any of our licensors could decide not to renew ourexisting license or not to license additional intellectual property and instead license to our competitors or develop and publish its ownmobile games or other applications, competing with us in the marketplace. For example, one of our licenses with Hasbro under which wecreate our Battleship, Clue, Game of Life and Monopoly games, which in the past have accounted for a significant portion of ourrevenue, expired in March 2008. Many of these licensors already develop games for other platforms, and may have significant experienceand development resources available to them should they decide to compete with us rather than license to us. Additionally, licensors mayelect to work with publishers who can develop and publish products across multiple platforms, such as mobile, online and console,which we currently cannot offer.We have both exclusive and non-exclusive licenses and both licenses that are global and licenses that are limited to specificgeographies, often with other mobile game publishers having rights to geographies not covered by our licenses. Our licenses generally haveterms that range from two to five years, with the primary exceptions being our six-year licenses covering World Series of Poker and DeerHunter 2 and our seven-year license covering Kasparov Chess. Some of the licenses that we have inherited through acquisitions providethat the licensor owns the intellectual property that we develop in the mobile version of the game and that, when our license expires, thelicensor can transfer that intellectual property to a new licensee. Increased competition for licenses may lead to larger guarantees, advancesand royalties that we must pay to our licensors, which could significantly increase our cost of revenues and cash usage. We may beunable to renew these licenses or to renew them on terms favorable to us, and we may be unable to secure alternatives in a timely manner.Failure to maintain or renew our existing licenses or to obtain additional licenses would impair our ability to introduce new mobile gamesor to continue to offer our current games, which would materially harm our business, operating results and financial condition. Some ofour existing licenses impose, and licenses that we obtain in the future might impose, development, distribution and marketing obligationson us. If we breach our obligations, our licensors might have the right to terminate the license or change an exclusive license to a non-exclusive license, which would harm our business, operating results and financial condition.Even if we are successful in gaining new licenses or extending existing licenses, we may fail to anticipate the entertainmentpreferences of our end users when making choices about which brands or other content to license. If the entertainment preferences of endusers shift to content or brands owned or developed by companies with which we do not have relationships, we may be unable toestablish and maintain successful relationships with these developers and owners, which would materially harm our business, operatingresults and financial condition. In addition, some rights are licensed from licensors that have or may develop financial difficulties, andmay enter into bankruptcy protection under U.S. federal law or the laws of other countries. If any of our licensors files for bankruptcy,our licenses might be impaired or voided, which could materially harm our business, operating results and financial condition.We currently rely on wireless carriers to market and distribute our games and thus to generate our revenues. In particular,subscribers of Verizon Wireless represented 23.0% of our revenues in 2007. The loss of or a change in any significant carrierrelationships could cause us to lose access to their subscribers and thus materially reduce our revenues.Our future success is highly dependent upon maintaining successful relationships with the wireless carriers with which wecurrently work and establishing new carrier relationships in geographies where we have not yet established a significant presence. Asignificant portion of our revenues is derived from a very limited number of carriers. In 2007, we derived approximately 23.0% of ourrevenues from subscribers of Verizon Wireless. No other carrier represented more than 10.0% of our revenues in 2007. In 2006, wederived approximately 20.6% of our revenues from subscribers of Verizon Wireless, 12.6% of our revenues from subscribers of SprintNextel affiliates, 11.3% of our revenues from subscribers of AT&T and 10.6% of our revenues from subscribers of Vodafone. We expectthat we will continue to generate a substantial majority of our revenues through distribution relationships with fewer than 20 carriers forthe foreseeable future. Our failure to maintain our relationships with these carriers would materially reduce our revenues and thus harmour business, operating results and financial condition.Our carrier agreements do not establish us as the exclusive provider of mobile games with the carriers and typically have a term ofone or two years with automatic renewal provisions upon expiration of the initial term,11Table of Contentsabsent a contrary notice from either party. In addition, the carriers usually can terminate these agreements early and, in some instances, atany time without cause, which could give them the ability to renegotiate economic or other terms. The agreements generally do not obligatethe carriers to market or distribute any of our games. In many of these agreements, we warrant that our games do not contain libelous orobscene content, do not contain material defects or viruses, and do not violate third-party intellectual property rights and we indemnify thecarrier for any breach of a third party’s intellectual property. In addition, our agreements with a substantial minority of our carriers,including Verizon Wireless, allow the carrier to set the retail price at a level different from the price implied by our negotiated revenue split,without a corresponding change to our wholesale price to the carrier. If one of these carriers raises the retail price of one of our games, unitdemand for that game might decline, reducing our revenues, without necessarily reducing, and perhaps increasing, the total revenues thatthe carrier receives from sales of that game.Many other factors outside our control could impair our ability to generate revenues through a given carrier, including the following: • the carrier’s preference for our competitors’ mobile games rather than ours; • the carrier’s decision not to include or highlight our games on the deck of its mobile handsets; • the carrier’s decision to discontinue the sale of our mobile games or all mobile games like ours; • the carrier’s decision to offer games to its subscribers without charge or at reduced prices; • the carrier’s decision to require market development funds from publishers like us; • the carrier’s decision to restrict or alter subscription or other terms for downloading our games; • a failure of the carrier’s merchandising, provisioning or billing systems; • the carrier’s decision to offer its own competing mobile games; • the carrier’s decision to transition to different platforms and revenue models; and • consolidation among carriers.If any of our carriers decides not to market or distribute our games or decides to terminate, not renew or modify the terms of itsagreement with us or if there is consolidation among carriers generally, we may be unable to replace the affected agreement with acceptablealternatives, causing us to lose access to that carrier’s subscribers and the revenues they afford us, which could materially harm ourbusiness, operating results and financial condition.Acquisitions could result in operating difficulties, dilution and other harmful consequences.We have acquired a number of businesses in the past, including, most recently, Superscape, which has a significant presence inRussia, in March 2008 and MIG, which is based in China, in December 2007. We expect to continue to evaluate and consider a widearray of potential strategic transactions, including business combinations and acquisitions of technologies, services, products and otherassets. 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 acquiredbusiness may create unforeseen operating difficulties and expenditures and is itself risky. The areas where we may face difficultiesinclude: • diversion of management time and a shift of focus from operating the businesses to issues related to integration andadministration, particularly given the frequency, size and varying scope of our recent acquisitions of Superscape and MIG; • declining employee morale and retention issues resulting from changes in compensation, management, reporting relationships,future prospects or the direction of the business; • the need to integrate each acquired company’s accounting, management, information, human resource and other administrativesystems to permit effective management, and the lack of control if such integration is delayed or not implemented;12Table of Contents • the need to implement controls, procedures and policies appropriate for a larger public company that the acquired companieslacked prior to acquisition; • in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address theparticular economic, currency, political and regulatory risks associated with specific countries; • 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.Some or all of these issues may result from our acquisitions, including our acquisitions of MIG and Superscape. If the anticipatedbenefits of any of these or future acquisitions do not materialize, we experience difficulties integrating these businesses or businessesacquired in the future, or other unanticipated problems arise, our business, operating results and financial condition may be harmed.In addition, a significant portion of the purchase price of companies we acquire may be allocated to acquired goodwill and otherintangible assets, which must be assessed for impairment at least annually. In the future, if our acquisitions do not yield expected returns,we may be required to take charges to our earnings based on this impairment assessment process, which could harm our operatingresults.End user tastes are continually changing and are often unpredictable; if we fail to develop and publish new mobile games thatachieve market acceptance, our sales would suffer.Our business depends on developing and publishing mobile games that wireless carriers will place on their decks and end users willbuy. We must continue to invest significant resources in licensing efforts, research and development, marketing and regional expansion toenhance our offering of games and introduce new games, and we must make decisions about these matters well in advance of productrelease in order to implement them in a timely manner. Our success depends, in part, on unpredictable and volatile factors beyond ourcontrol, including end-user preferences, competing games and the availability of other entertainment activities. If our games and relatedapplications are not responsive to the requirements of our carriers or the entertainment preferences of end users, or they are not brought tomarket in a timely and effective manner, our business, operating results and financial condition would be harmed. Even if our games aresuccessfully introduced and initially adopted, a subsequent shift in our carriers or the entertainment preferences of end users could causea decline in our games’ popularity that could materially reduce our revenues and harm our business, operating results and financialcondition.Inferior deck placement would likely adversely impact our revenues and thus our operating results and financial condition.Wireless carriers provide a limited selection of games that are accessible to their subscribers through a deck on their mobilehandsets. The inherent limitation on the number of games available on the deck is a function of the limited screen size of handsets andcarriers’ perceptions of the depth of menus and numbers of choices end users will generally utilize. Carriers typically provide one or moretop level menus highlighting games that are recent top sellers, that the carrier believes will become top sellers or that the carrier otherwisechooses 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 orfeatured menu or toward the top of genre-specific or other menus, rather than lower down or in sub-menus, is likely to result in gamesachieving a greater degree of commercial success. If carriers choose to give our games less favorable deck placement, our games may beless successful than we anticipate, our revenues may decline and our business, operating results and financial condition may bematerially harmed.We have depended on no more than ten mobile games for a majority of our revenues in recent fiscal periods.In our industry, new games are frequently introduced, but a relatively small number of games account for a significant portion ofindustry sales. Similarly, a significant portion of our revenues comes from a limited number of mobile games, although the games in thatgroup have shifted over time. For example, in 2006 and 2007, we generated approximately 53.3% and 52.7% of our revenues,respectively, from our top ten games, but no individual13Table of Contentsgame represented more than 10% of our revenues in any of those periods. We expect to release a relatively small number of new games eachyear for the foreseeable future. If these games are not successful, our revenues could be limited and our business and operating resultswould suffer in both the year of release and thereafter.In addition, the limited number of games that we release in a year may contribute to fluctuations in our operating results. Therefore,our reported results at quarter and year end may be affected based on the release dates of our products, which could result in volatility inthe price of our common stock. If our competitors develop more successful games or offer them at lower prices or based on paymentmodels, such as pay-for-play or subscription-based models, perceived as offering a better value proposition, or if we do not continue todevelop consistently high-quality and well-received games, our revenues would likely decline and our business, operating results andfinancial condition would be harmed.If we are unsuccessful in establishing and increasing awareness of our brand and recognition of our mobile games or if weincur excessive expenses promoting and maintaining our brand or our games, our potential revenues could be limited, ourcosts could increase and our operating results and financial condition could be harmed.We believe that establishing and maintaining our brand is critical to retaining and expanding our existing relationships with wirelesscarriers and content licensors, as well as developing new relationships. Promotion of the Glu brand will depend on our success inproviding high-quality mobile games. Similarly, recognition of our games by end users will depend on our ability to develop engaginggames of high quality with attractive titles. However, our success will also depend, in part, on the services and efforts of third parties,over which we have little or no control. For instance, if our carriers fail to provide high levels of service, our end users’ ability to accessour games may be interrupted, which may adversely affect our brand. If end users, branded content owners and carriers do not perceiveour existing games as high-quality or if we introduce new games that are not favorably received by our end users and carriers, then wemay be unsuccessful in building brand recognition and brand loyalty in the marketplace. In addition, globalizing and extending ourbrand and recognition of our games will be costly and will involve extensive management time to execute successfully. Further, themarkets in which we operate are highly competitive and some of our competitors, such as Electronic Arts (EA Mobile), already havesubstantially more brand name recognition and greater marketing resources than we do. If we fail to increase brand awareness andconsumer recognition of our games, our potential revenues could be limited, our costs could increase and our business, operating resultsand financial condition could suffer.Our business and growth may suffer if we are unable to hire and retain key personnel, who are in high demand.We depend on the continued contributions of our senior management and other key personnel. The loss of the services of any of ourexecutive officers or other key employees could harm our business. All of our U.S.-based executive officers and key employees are at-willemployees, which means they may terminate their employment relationship with us at any time. None of our U.S.-based employees isbound by a contractual non-competition agreement, which could make us vulnerable to recruitment efforts by our competitors.Internationally, while some employees and contractors are bound by non-competition agreements, we may experience difficulty inenforcing these agreements. We do not maintain a key-person life insurance policy on any of our officers or other employees.Our future success also depends on our ability to identify, attract and retain highly skilled technical, managerial, finance,marketing and creative personnel. We face intense competition for qualified individuals from numerous technology, marketing and mobileentertainment companies. In addition, competition for qualified personnel is particularly intense in the San Francisco Bay Area, where ourheadquarters are located. Further, two of our principal overseas operations are based in London and Hong Kong, cities that, similar to ourheadquarters region, have high costs of living and consequently high compensation standards. Qualified individuals are in high demand,and we may incur significant costs to attract them. We may be unable to attract and retain suitably qualified individuals who are capableof meeting our growing creative, operational and managerial requirements, or may be required to pay increased compensation in order todo so. If we are unable to attract and retain the qualified personnel we need to succeed, our business would suffer.14Table of ContentsVolatility or lack of performance in our stock price may also affect our ability to attract and retain our key employees. Many of oursenior management personnel and other key employees have become, or will soon become, vested in a substantial amount of stock orstock options. Employees may be more likely to leave us if the shares they own or the shares underlying their options have significantlyappreciated in value relative to the original purchase prices of the shares or the exercise prices of the options, or if the exercise prices of theoptions that they hold are significantly above the market price of our common stock. If we are unable to retain our employees, ourbusiness, operating results and financial condition would be harmed.Growth may place significant demands on our management and our infrastructure.We operate in an emerging market and have experienced, and may continue to experience, growth in our business through internalgrowth and acquisitions. This growth has placed, and may continue to place, significant demands on our management and ouroperational and financial infrastructure. Continued growth could strain our ability to: • develop and improve our operational, financial and management controls; • enhance our reporting systems and procedures; • recruit, train and retain highly skilled personnel; • maintain our quality standards; and • maintain branded content owner, wireless carrier and end-user satisfaction.Managing our growth will require significant expenditures and allocation of valuable management resources. If we fail to achieve thenecessary level of efficiency in our organization as it grows, our business, operating results and financial condition would be harmed.We face added business, political, regulatory, operational, financial and economic risks as a result of our internationaloperations and distribution, any of which could increase our costs and hinder our growth.International sales represented approximately 44.8% and 46.2% of our revenues in 2006 and 2007, respectively. In addition, as partof our international efforts, we acquired U.K.-based Macrospace in December 2004, opened our Hong Kong office in July 2005, expandedour presence in the European market with our acquisition of iFone in March 2006, opened an office in France in the third quarter of2006, opened additional offices in Brazil and Germany in the fourth quarter of 2006, opened additional offices in China, Italy and Spainin the second quarter of 2007, opened an office in Chile in the fourth quarter of 2007, acquired China-based MIG in December 2007,opened an office in Sweden in the first quarter of 2008 and acquired Superscape, which has a significant presence in Russia, in March2008. We expect to open additional international offices, and we expect international sales to continue to be an important component of ourrevenues. Risks affecting our international operations include: • challenges caused by distance, language and cultural differences; • multiple and conflicting laws and regulations, including complications due to unexpected changes in these laws and regulations; • the burdens of complying with a wide variety of foreign laws and regulations; • higher costs associated with doing business internationally; • difficulties in staffing and managing international operations; • greater fluctuations in sales to end users and through carriers in developing countries, including longer payment cycles andgreater difficulty collecting accounts receivable; • protectionist laws and business practices that favor local businesses in some countries; • potential adverse foreign tax consequences; • foreign exchange controls that might prevent us from repatriating income earned in countries outside the United States;15Table of Contents • price controls; • the servicing of regions by many different carriers; • imposition of public sector controls; • political, economic and social instability; • restrictions on the export or import of technology; • trade and tariff restrictions; • variations in tariffs, quotas, taxes and other market barriers; and • difficulties in enforcing intellectual property rights in countries other than the United States.In addition, developing user interfaces that are compatible with other languages or cultures can be expensive. As a result, our ongoinginternational expansion efforts may be more costly than we expect. Further expansion into developing countries subjects us to the effects ofregional instability, civil unrest and hostilities, and could adversely affect us by disrupting communications and making travel moredifficult. As a result of our international expansion in Asia, Europe and Latin America, we must pay income tax in numerous foreignjurisdictions with complex and evolving tax laws. In the event we become subject to increased taxes or new forms of taxation imposed bygovernmental authorities, our results of operations could be materially and adversely affected.These risks could harm our international expansion efforts, 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 handset models are commercially introduced, our sales maysuffer.Our business is dependent, in part, on the commercial introduction of new handset models with enhanced features, including larger,higher resolution color screens, improved audio quality, and greater processing power, memory, battery life and storage. We do not controlthe timing of these handset launches. Some new handsets are sold by carriers with one or more games or other applications pre-loaded,and many end users who download our games do so after they purchase their new handsets to experience the new features of thosehandsets. Some handset manufacturers give us access to their handsets prior to commercial release. If one or more major handsetmanufacturers were to cease to provide us access to new handset models prior to commercial release, we might be unable to introducecompatible versions of our games for those handsets in coordination with their commercial release, and we might not be able to makecompatible versions for a substantial period following their commercial release. If, because of game launch delays, we miss theopportunity to sell games when new handsets are shipped or our end users upgrade to a new handset, or if we miss the key holiday sellingperiod, either because the introduction of a new handset is delayed or we do not deploy our games in time for the holiday selling season,our revenues would likely decline and our business, operating results and financial condition would likely suffer.Wireless carriers generally control the price charged for our mobile games and the billing and collection for sales of ourmobile games and could make decisions detrimental to us.Wireless carriers generally control the price charged for our mobile games either by approving or establishing the price of the gamescharged to their subscribers. Some of our carrier agreements also restrict our ability to change prices. In cases where carrier approval isrequired, approvals may not be granted in a timely manner or at all. A failure or delay in obtaining these approvals, the prices establishedby the carriers for our games, or changes in these prices could adversely affect market acceptance of those games. Similarly, for thesignificant minority of our carriers, including Verizon Wireless, when we make changes to a pricing plan (the wholesale price and thecorresponding suggested retail price based on our negotiated revenue-sharing arrangement), adjustments to the actual retail price charged toend users may not be made in a timely manner or at all (even though our wholesale price was reduced). A failure or delay by these carriersin adjusting the retail price for our games, could adversely affect sales volume and our revenues for those games.16Table of ContentsCarriers and other distributors also control billings and collections for our games, either directly or through third-party serviceproviders. If our carriers or their third-party service providers cause material inaccuracies when providing billing and collection servicesto us, our revenues may be less than anticipated or may be subject to refund at the discretion of the carrier. This could harm ourbusiness, operating results and financial condition.We may be unable to develop and introduce in a timely way new mobile games, and our games may have defects, which couldharm our brand.The planned timing and introduction of original games and games based on licensed intellectual property are subject to risks anduncertainties. Unexpected technical, operational, deployment, distribution or other problems could delay or prevent the introduction ofnew games, which could result in a loss of, or delay in, revenues or damage to our reputation and brand. If any of our games isintroduced with defects, errors or failures, we could experience decreased sales, loss of end users, damage to our carrier relationships anddamage to our reputation and brand. Our attractiveness to branded content licensors might also be reduced. In addition, new games maynot achieve sufficient market acceptance to offset the costs of development, particularly when the introduction of a game is substantiallylater than a planned “day-and-date” launch, which could materially harm our business, operating results and financial condition.If we fail to maintain and enhance our capabilities for porting games to a broad array of mobile handsets, our attractiveness towireless carriers and branded content owners will be impaired, and our sales could suffer.Once developed, a mobile game may be required to be ported to, or converted into separate versions for, more than 1,000 differenthandset models, many with different technological requirements. These include handsets with various combinations of underlyingtechnologies, user interfaces, keypad layouts, screen resolutions, sound capabilities and other carrier-specific customizations. If we fail tomaintain or enhance our porting capabilities, our sales could suffer, branded content owners might choose not to grant us licenses andcarriers might choose to give our games less desirable deck placement or not to give our games placement on their decks at all.Changes to our game design and development processes to address new features or functions of handsets or networks might causeinefficiencies in our porting process or might result in more labor intensive porting processes. In addition, we anticipate that in the futurewe will be required to port existing and new games to a broader array of handsets. If we utilize more labor intensive porting processes, ourmargins could be significantly reduced and it might take us longer to port games to an equivalent number of handsets. This, in turn,could harm our business, operating results and financial condition.If our independent, third-party developers cease development of new games for us and we are unable to find comparablereplacements, we may have to reduce the number of games that we intend to introduce, delay the introduction of some games orincrease our internal development staff, which would be a time-consuming and potentially costly process, and, as a result, ourcompetitive position may be adversely impacted.We rely on independent third-party developers to develop a few of our games, which subjects us to the following risks: • key developers who worked for us in the past may choose to work for or be acquired by our competitors; • developers currently under contract may try to renegotiate our agreements with them on terms less favorable to us; and • our developers may be unable or unwilling to allocate sufficient resources to complete our games in a timely or satisfactorymanner or at all.If our developers terminate their relationships with us or negotiate agreements with terms less favorable to us, we may have to reducethe number of games that we intend to introduce, delay the introduction of some games or increase our internal development staff, whichwould be a time-consuming and potentially costly process, and, as a result, our business, operating results and financial condition couldbe harmed.17Table of ContentsIf one or more of our games were found to contain hidden, objectionable content, our reputation and operating results couldsuffer.Historically, many video games have been designed to include hidden content and gameplay features that are accessible through theuse of in-game cheat codes or other technological means that are intended to enhance the gameplay experience. For example, Super K.O.Boxing includes additional characters and game modes that are available with a code (usually provided to a player after accomplishing acertain level of achievement in the game). These features have been common in console and computer games. However, in several recentcases, hidden content or features have been included in other publishers’ products by an employee who was not authorized to do so or byan outside developer without the knowledge of the publisher. From time to time, some of this hidden content and these hidden featureshave contained profanity, graphic violence and sexually explicit or otherwise objectionable material. Our design and porting process andthe constraints on the file size of our games reduce the possibility of hidden, objectionable content appearing in the games we publish.Nonetheless, these processes and constraints may not prevent this content from being included in our games. If a game we published werefound to contain hidden, objectionable content, our wireless carriers and other distributors of our games could refuse to sell it, consumerscould refuse to buy it or demand a refund of their money, and, if the game was based on licensed content, the licensor could demand thatwe incur significant expense to remove the objectionable content from the game and all ported versions of the game. This could have amaterially negative impact on our business, operating results and financial condition. In addition, our reputation could be harmed, whichcould impact sales of other games we sell and our attractiveness to content licensors and carriers or other distributors of our games. If anyof these consequences were to occur, our business, operating results and financial condition could be significantly harmed.If we fail to maintain an effective system of internal controls, we might not be able to report our financial results accurately orprevent fraud; in that case, our stockholders could lose confidence in our financial reporting, which could negatively impactthe price of our stock.Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. In addition, Section 404 of theSarbanes-Oxley Act of 2002 will require us to evaluate and report on our internal control over financial reporting and have our independentregistered public accounting firm attest to our evaluation beginning with our Annual Report on Form 10-K for the year endingDecember 31, 2008. We are in the process of preparing and implementing an internal plan of action for compliance with Section 404 andstrengthening and testing our system of internal controls to provide the basis for our report. The process of implementing our internalcontrols and complying with Section 404 will be expensive and time consuming, and will require significant attention of management. Wecannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes andreporting in the future. Even if we conclude, and our independent registered public accounting firm concurs, that our internal control overfinancial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accounting principles, because of its inherent limitations, internal control overfinancial reporting may not prevent or detect fraud or misstatements. Failure to implement required new or improved controls, ordifficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Ifwe 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 market’s confidence in our financial statements and harm our stockprice. In addition, a delay in compliance with Section 404 could subject us to a variety of administrative sanctions, including ineligibilityfor short form resale registration, action by the SEC, the suspension or delisting of our common stock from The Nasdaq Global Marketand the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price andcould harm our business.If we do not adequately protect our intellectual property rights, it may be possible for third parties to obtain and improperly useour intellectual property and our competitive position may be adversely affected.Our intellectual property is an essential element of our business. We rely on a combination of copyright, trademark, trade secret andother intellectual property laws and restrictions on disclosure to protect our intellectual property rights. To date, we have not sought patentprotection. Consequently, we will not be able to protect our18Table of Contentstechnologies from independent invention by third parties. Despite our efforts to protect our intellectual property rights, unauthorizedparties may attempt to copy or otherwise to obtain and use our technology and games. Monitoring unauthorized use of our games isdifficult and costly, and we cannot be certain that the steps we have taken will prevent piracy and other unauthorized distribution and useof our technology and games, particularly internationally where the laws may not protect our intellectual property rights as fully as in theUnited States. In the future, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantialcosts and diversion of our management and resources.In addition, although we require our third-party developers to sign agreements not to disclose or improperly use our trade secrets andacknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalfare 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 andimproperly use our intellectual properties without our consent. This could harm our business, operating results and financial condition.Third parties may sue us for intellectual property infringement, which, if successful, may disrupt our business and couldrequire us to pay significant damage awards.Third parties may sue us for intellectual property infringement or initiate proceedings to invalidate our intellectual property, either ofwhich, if successful, could disrupt the conduct of our business, cause us to pay significant damage awards or require us to paylicensing fees. In the event of a successful claim against us, we might be enjoined from using our or our licensed intellectual property, wemight 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 withdrawgames from the market or prevent us from introducing new games. In addition, even if we are able to license the infringed or similartechnology or games, license fees could be substantial and the terms of these licenses could be burdensome, which might adversely affectour operating results. We might also incur substantial expenses in defending against third-party infringement claims, regardless of theirmerit. Successful infringement or licensing claims against us might result in substantial monetary liabilities and might materially disruptthe conduct of our business.Indemnity provisions in various agreements potentially expose us to substantial liability for intellectual property infringement,damages caused by malicious software and other losses.In the ordinary course of our business, most of our agreements with carriers and other distributors include indemnificationprovisions. In these provisions, we agree to indemnify them for losses suffered or incurred in connection with our games, including as aresult of intellectual property infringement and damages caused by viruses, worms and other malicious software. The term of theseindemnity provisions is generally perpetual after execution of the corresponding license agreement, and the maximum potential amount offuture payments we could be required to make under these indemnification provisions is generally unlimited. Large future indemnitypayments could harm our business, operating results and financial condition.As a result of a substantial portion of our revenues currently being derived from Verizon Wireless and three other wirelesscarriers, if Verizon Wireless or any other significant carrier were unable to fulfill its payment obligations, our financialcondition and results of operations would suffer.As of December 31, 2007, our outstanding accounts receivable balances with Verizon Wireless, Sprint Nextel, Vodafone and AT&Twere $4.3 million, $1.7 million, $0.9 million and $1.0 million, respectively. As of December 31, 2006, our outstanding accountsreceivable balances with those carriers were $3.0 million, $1.5 million, $1.4 million and $1.2 million, respectively. Since 42.9% of ouroutstanding accounts receivable at December 31, 2007 were with Verizon Wireless, Sprint Nextel, AT&T and Vodafone, we have aconcentration of credit risk. If any of these carriers is unable to fulfill its payment obligations to us under our carrier agreements withthem, our revenues could decline significantly and our financial condition might be harmed.We invest in securities that are subject to market risk and fluctuations in interest rates and the recent issues in the financialmarkets could adversely affect the value of our assets.19Table of ContentsAs of December 31, 2007, we had $59.8 million in cash, cash equivalents and short-term investments. We invest our cash in avariety of financial instruments, consisting principally of investments in money market funds and auction-rate securities. Theseinvestments are denominated in U.S. dollars.As of December 31, 2007, we had $2.8 million of principal invested in auction rate securities, all of which were rated AAA at thetime of purchase. Auction-rate securities are long-term variable rate bonds tied to short-term interest rates. After the initial issuance of thesecurities, the interest rate on the securities is reset periodically, at intervals established at the time of issuance (e.g., every seven, 28, or35 days; every six months; etc.), based on market demand for a reset period. The “stated” or “contractual” maturities for these securities,however, generally are 20 to 30 years. Auction-rate securities are bought and sold in the marketplace through a competitive bidding processoften referred to as a “Dutch auction”. If there is insufficient interest in the securities at the time of an auction, the auction may not becompleted and the rates may be reset to predetermined “penalty” or “maximum” rates. The monthly auctions historically have provided aliquid market for these securities. Following a failed auction, we would not be able to access our funds that are invested in thecorresponding auction-rate securities until a future auction of these investments is successful or new buyers express interest in purchasingthese securities in between reset dates.Given the current negative liquidity conditions in the global credit and capital markets, the auction-rate securities held by us atDecember 31, 2007 have experienced multiple failed auctions as the amount of securities submitted for sale has exceeded the amount ofpurchase orders. The underlying assets of our auction-rate securities are corporate bonds. If the underlying issuers are unable tosuccessfully clear future auctions or if their credit rating deteriorates and the deterioration is deemed to be other-than-temporary, we wouldbe required to adjust the carrying value of the auction-rate securities through an impairment charge to earnings. Any of these events couldmaterially affect our results of operations and our financial condition. For example, in the fourth quarter of 2007, we recorded a pre-taximpairment charge of $806,000 reflecting the decrease in estimated value of our auction-rate securities as of December 31, 2007 that weredetermined to be other-than-temporary as a result of two failed auctions.As of December 31, 2007, the contractual maturities of the remaining two auction-rate securities were 2017. Although we may nothave the ability to liquidate these investments within one year of the balance sheet date, we may need to sell the securities within the nextyear to fund operations. Accordingly, the investments are classified as current assets on the December 31, 2007 consolidated balancesheets. In the event we need to access these funds, we could be required to sell these securities at an amount below our original purchasevalue and our current carrying value.Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate debtsecurities may have their market value adversely impacted due to a rise in interest rates, while floating rate securities may produce lessincome than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due tochanges in interest rates or if the decline in fair value of our publicly traded equity investments and auction rate securities is judged to beother-than-temporary. We may suffer losses in principal if we are forced to sell securities that decline in market value due to changes ininterest rates. Recent events in the sub-prime mortgage market and with auction rate securities could negatively impact our return oninvestment for these debt securities and thereby reduce the amount of cash and cash equivalents and long-term investments on our balancesheet.We may need to raise additional capital to grow our business, and we may not be able to raise capital on terms acceptable to usor at all.The operation of our business and our efforts to grow our business further will require significant cash outlays and commitments,such as with our recent acquisitions. If our cash, cash equivalents and short-term investments balances and any cash generated fromoperations and from our IPO are not sufficient to meet our cash requirements, we will need to seek additional capital, potentially throughdebt or equity financings, to fund our growth. We may not be able to raise needed cash on terms acceptable to us or at all. Financings, ifavailable, may be on terms that are dilutive or potentially dilutive to our stockholders, and the prices at which new investors would bewilling to purchase our securities may be lower than the IPO price. The holders of new securities may also receive rights, preferences orprivileges that are senior to those of existing holders of our common stock. If new sources of20Table of Contentsfinancing are required but are insufficient or unavailable, we would be required to modify our growth and operating plans to the extent ofavailable funding, which would harm our ability to grow our business.Changes in foreign exchange rates and limitations on the convertibility of foreign currencies could adversely affect ourbusiness and operating results.Although we currently transact approximately three-fifths of our business in U.S. Dollars, we also transact approximately one-thirdof our business in pounds sterling and Euros and a small portion of our business in other currencies. Conducting business in currenciesother than U.S. Dollars subjects us to fluctuations in currency exchange rates that could have a negative impact on our reported operatingresults. Fluctuations in the value of the U.S. Dollar relative to other currencies impact our revenues, cost of revenues and operatingmargins and result in foreign currency transaction gains and losses. To date, we have not engaged in exchange rate hedging activities.Even were we to implement hedging strategies to mitigate this risk, these strategies might not eliminate our exposure to foreign exchangerate fluctuations and would involve costs and risks of their own, such as ongoing management time and expertise, external costs toimplement the strategies and potential accounting implications. There is also additional risk if the 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 limitationson conversion into other currencies, which can limit our ability to react to rapid foreign currency devaluations.Our business in countries with a history of corruption and transactions with foreign governments, including with governmentowned or controlled wireless carriers, increase the risks associated with our international activities.As we operate and sell internationally, we are subject to the U.S. Foreign Corrupt Practices Act, or the FCPA, and other laws thatprohibit improper payments or offers of payments to foreign governments and their officials and political parties by the United States andother business entities for the purpose of obtaining or retaining business. We have operations, deal with carriers and make sales incountries known to experience corruption, particularly certain emerging countries in East Asia, Eastern Europe and Latin America, andfurther international expansion may involve more of these countries. Our activities in these countries create the risk of unauthorizedpayments or offers of payments by one of our employees, consultants, sales agents or distributors that could be in violation of variouslaws including the FCPA, even though these parties are not always subject to our control. We have attempted to implement safeguards todiscourage these practices by our employees, consultants, sales agents and distributors. However, our existing safeguards and any futureimprovements may prove to be less than effective, and our employees, consultants, sales agents or distributors may engage in conduct forwhich we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject toother liabilities, which could negatively affect our business, operating results and financial condition.Changes to financial accounting standards and new exchange rules could make it more expensive to issue stock options toemployees, which would increase compensation costs and might cause us to change our business practices.We prepare our financial statements to conform with accounting principles generally accepted in the United States. These accountingprinciples are subject to interpretation by the Financial Accounting Standards Board, or FASB, the SEC, and various other bodies. Achange in those principles could have a significant effect on our reported results and might affect our reporting of transactions completedbefore a change is announced. For example, we have used stock options as a fundamental component of our employee compensationpackages. We believe that stock options directly motivate our employees to maximize long-term stockholder value and, through the use ofvesting, encourage employees to remain in our employ. Several regulatory agencies and entities have made regulatory changes that couldmake it more difficult or expensive for us to grant stock options to employees. For example, the FASB released Statement of FinancialAccounting Standards, or SFAS, No. 123R, Share-Based Payment, that required us to record a charge to earnings for employee stockoption grants beginning in 2006. In addition, regulations implemented by The Nasdaq Stock Market generally require stockholderapproval for all stock option plans, which could make it more difficult for us to grant stock options to employees. We may, as a result ofthese changes, incur increased compensation costs, change our equity compensation strategy or find it difficult to21Table of Contentsattract, retain and motivate employees, any of which could materially and adversely affect our business, operating results and financialcondition.Maintaining and improving our financial controls and the requirements of being a public company may strain our resources,divert management’s 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 Securities Exchange Act of 1934, the Sarbanes-Oxley Act of2002 (Sarbanes-Oxley Act), and the rules and regulations of The Nasdaq Stock Market. The requirements of these rules and regulationsincreases our legal, accounting and financial compliance costs, makes some activities more difficult, time-consuming and costly andmay 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 internalcontrol over financial reporting. This can be difficult to do. For example, we depend on the reports of wireless carriers for informationregarding the amount of sales of our games and related applications and to determine the amount of royalties we owe branded contentlicensors and the amount of our revenues. These reports may not be timely, and in the past they have contained, and in the future theymay contain, errors.In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financialreporting, we expend significant resources and provide significant management oversight to implement appropriate processes, documentour system of internal control over relevant processes, assess their design, remediate any deficiencies identified and test their operation. Asa result, management’s attention may be diverted from other business concerns, which could harm our business, operating results andfinancial condition. These efforts also involve substantial accounting-related costs. In addition, if we are unable to continue to meet theserequirements, we may not be able to remain listed on the Nasdaq Global Market.The Sarbanes-Oxley Act and the rules and regulations of The Nasdaq Stock Market make it more difficult and more expensive forus to maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantiallyhigher costs to maintain coverage. If we are unable to maintain adequate directors’ and officers’ insurance, our ability to recruit and retainqualified directors, especially those directors who may be considered independent for purposes of The Nasdaq Stock Market rules, andofficers will be significantly curtailed.Risks Relating to Our IndustryWireless communications technologies are changing rapidly, and we may not be successful in working with these newtechnologies.Wireless network and mobile handset technologies are undergoing rapid innovation. New handsets with more advanced processorsand supporting advanced programming languages continue to be introduced. In addition, networks that enable enhanced features, such asmultiplayer technology, are being developed and deployed. We have no control over the demand for, or success of, these products ortechnologies. The development of new, technologically advanced games to match the advancements in handset technology is a complexprocess requiring significant research and development expense, as well as the accurate anticipation of technological and market trends. Ifwe fail to anticipate and adapt to these and other technological changes, the available channels for our games may be limited and ourmarket share and our operating results may suffer. Our future success will depend on our ability to adapt to rapidly changingtechnologies, develop mobile games to accommodate evolving industry standards and improve the performance and reliability of ourgames. In addition, the widespread adoption of networking or telecommunications technologies or other technological changes couldrequire substantial expenditures to modify or adapt our games.Technology changes in our industry require us to anticipate, sometimes years in advance, which technologies we must implementand take advantage of in order to make our games and other mobile entertainment products competitive in the market. Therefore, weusually start our product development with a range of technical development goals that we hope to be able to achieve. We may not be ableto achieve these goals, or our competition may be able to achieve them more quickly and effectively than we can. In either case, ourproducts may22Table of Contentsbe technologically inferior to those of our competitors, less appealing to end users or both. If we cannot achieve our technology goalswithin the original development schedule of our products, then we may delay their release until these technology goals can be achieved,which may delay or reduce our revenues, increase our development expenses and harm our reputation. Alternatively, we may increase theresources employed in research and development in an attempt either to preserve our product launch schedule or to keep up with ourcompetition, which would increase our development expenses. In either case, our business, operating results and financial condition couldbe materially harmed.The complexity of and incompatibilities among mobile handsets may require us to use additional resources for the developmentof our games.To reach large numbers of wireless subscribers, mobile entertainment publishers like us must support numerous mobile handsetsand technologies. However, keeping pace with the rapid innovation of handset technologies together with the continuous introduction ofnew, and often incompatible, handset models by wireless carriers requires us to make significant investments in research anddevelopment, including personnel, technologies and equipment. In the future, we may be required to make substantial investments in ourdevelopment if the number of different types of handset models continues to proliferate. In addition, as more advanced handsets areintroduced that enable more complex, feature rich games, we anticipate that our per-game development costs will increase, which couldincrease the risks associated with the failure of any one game and could materially harm our operating results and financial condition.If wireless subscribers do not continue to use their mobile handsets to access games and other applications, our businessgrowth and future revenues may be adversely affected.We operate in a developing industry. Our success depends on growth in the number of wireless subscribers who use their handsetsto access data services and, in particular, entertainment applications of the type we develop and distribute. New or different mobileentertainment applications, such as streaming video or music applications, developed by our current or future competitors may bepreferred by subscribers to our games. In addition, other mobile platforms such as the iPod, iPhone and the Google Android platform,and dedicated portable gaming platforms such as the PlayStation Portable and the Nintendo DS, may become widespread, and end usersmay choose to switch to these platforms. If the market for our games does not continue to grow or we are unable to acquire new end users,our business growth and future revenues could be adversely affected. If end users switch their entertainment spending away from thegames and related applications that we publish, or switch to portable gaming platforms or distribution where we do not have comparativestrengths, our revenues would likely decline and our business, operating results and financial condition would suffer.Our industry is subject to risks generally associated with the entertainment industry, any of which could significantly harmour operating results.Our business is subject to risks that are generally associated with the entertainment industry, many of which are beyond our control.These risks could negatively impact our operating results and include: the popularity, price and timing of release of games and mobilehandsets on which they are played; economic conditions that adversely affect discretionary consumer spending; changes in consumerdemographics; the availability and popularity of other forms of entertainment; and critical reviews and public tastes and preferences,which may change rapidly and cannot necessarily be predicted.A shift of technology platform by wireless carriers and mobile handset manufacturers could lengthen the development periodfor our games, increase our costs and cause our games to be of lower quality or to be published later than anticipated.End users of games must have a mobile handset with multimedia capabilities enabled by technologies capable of running third-partygames and related applications such as ours. Our development resources are concentrated in the BREW and Java platforms, and we haveexperience developing games for the i-mode, Mophun, N-Gage, Symbian and Windows Mobile Platforms. If one or more of thesetechnologies fall out of favor with handset manufacturers and wireless carriers and there is a rapid shift to a technology platform such asAdobe Flash Lite,23Table of ContentsiPod, iPhone or Google Android or a new technology where we do not have development experience or resources, the development period forour games may be lengthened, increasing our costs, and the resulting games may be of lower quality, and may be published later thananticipated. In such an event, our reputation, business, operating results and financial condition might suffer.System or network failures could reduce our sales, increase costs or result in a loss of end users of our games.Mobile game publishers rely on wireless carriers’ networks to deliver games to end users and on their or other third parties’ billingsystems to track and account for the downloading of their games. In certain circumstances, mobile game publishers may also rely on theirown servers to deliver games on demand to end users through their carriers’ networks. In addition, certain subscription-based games suchas World Series of Poker and entertainment products such as FOX Sports Mobile require access over the mobile Internet to our serversin order to enable features such as multiplayer modes, high score posting or access to information updates. Any failure of, or technicalproblem with, carriers’, third parties’ or our billing systems, delivery systems, information systems or communications networks couldresult in the inability of end users to download our games, prevent the completion of billing for a game, or interfere with access to someaspects of our games or other products. If any of these systems fails or if there is an interruption in the supply of power, an earthquake,fire, flood or other natural disaster, or an act of war or terrorism, end users might be unable to access our games. For example, from timeto time, our carriers have experienced failures with their billing and delivery systems and communication networks, including gatewayfailures that reduced the provisioning capacity of their branded e-commerce system. Any failure of, or technical problem with, thecarriers’, other third parties’ or our systems could cause us to lose end users or revenues or incur substantial repair costs and distractmanagement from operating our business. This, in turn, could harm our business, operating results and financial condition.The market for mobile games is seasonal, and our results may vary significantly from period to period.Many new mobile handset models are released in the fourth calendar quarter to coincide with the holiday shopping season. Becausemany end users download our games soon after they purchase new handsets, we may experience seasonal sales increases based on theholiday selling period. However, due to the time between handset purchases and game purchases, most of this holiday impact occurs forus in our first quarter. In addition, we seek to release many of our games in conjunction with specific events, such as the release of arelated movie. If we miss these key selling periods for any reason, our sales will suffer disproportionately. Likewise, if a key event towhich our game release schedule is tied were to be delayed or cancelled, our sales would also suffer disproportionately. Further, for avariety of reasons, including roaming charges for data downloads that may make purchase of our games prohibitively expensive formany end users while they are traveling, we may experience seasonal sales decreases during the summer, particularly in Europe. If thelevel of travel increases or expands to other periods, our operating results and financial condition may be harmed. Our ability to meetgame development schedules is affected by a number of factors, including the creative processes involved, the coordination of large andsometimes geographically dispersed development teams required by the increasing complexity of our games, and the need to fine-tune ourgames prior to their release. Any failure to meet anticipated development or release schedules would likely result in a delay of revenues orpossibly a significant shortfall in our revenues and cause our operating results to be materially different than anticipated.Our business depends on the growth and maintenance of wireless communications infrastructure.Our success will depend on the continued growth and maintenance of wireless communications infrastructure in the United Statesand internationally. This includes deployment and maintenance of reliable next-generation digital networks with the speed, data capacityand security necessary to provide reliable wireless communications services. Wireless communications infrastructure may be unable tosupport the demands placed on it if the number of subscribers continues to increase, or if existing or future subscribers increase theirbandwidth requirements. Wireless communications have experienced a variety of outages and other delays as a result of infrastructureand equipment failures, and could face outages and delays in the future. These outages and delays could reduce the level of wirelesscommunications usage as well as our ability to distribute our games successfully. In addition, changes by a wireless carrier to networkinfrastructure may interfere with downloads of our games and may cause end users to24Table of Contentslose functionality in our games that they have already downloaded. This could harm our business, operating results and financialcondition.Future mobile handsets may significantly reduce or eliminate wireless carriers’ control over delivery of our games and force usto rely further on alternative sales channels, which, if not successful, could require us to increase our sales and marketingexpenses significantly.Substantially all our games are currently sold through carriers’ branded e-commerce services. We have invested significant resourcesdeveloping this sales channel. However, a growing number of handset models currently available allow wireless subscribers to browse theInternet and, in some cases, download applications from sources other than a carrier’s branded e-commerce service. In addition, thedevelopment of other application delivery mechanisms such as premium-SMS may enable subscribers to download applications withouthaving to access a carrier’s branded e-commerce service. Increased use by subscribers of open operating system handsets or premium-SMS delivery systems will enable them to bypass carriers’ branded e-commerce services and could reduce the market power of carriers.This could force us to rely further on alternative sales channels where we may not be successful selling our games, and could require usto increase our sales and marketing expenses significantly. As with our carriers, we believe that inferior placement of our games and othermobile entertainment products in the menus of off-deck distributors will result in lower revenues than might otherwise be anticipated fromthese alternative sales channels. We may be unable to develop and promote our direct website distribution sufficiently to overcome thelimitations and disadvantages of off-deck distribution channels. This could harm our business, operating results and financial condition.Actual or perceived security vulnerabilities in mobile handsets or wireless networks could adversely affect our revenues.Maintaining the security of mobile handsets and wireless networks is critical for our business. There are individuals and groupswho develop and deploy viruses, worms and other illicit code or malicious software programs that may attack wireless networks andhandsets. Security experts have identified computer “worm” programs, such as “Cabir” and “Commwarrior.A,” and viruses, such as“Lasco.A,” that target handsets running on the Symbian operating system. Although these worms have not been widely released and donot present an immediate risk to our business, we believe future threats could lead some end users to seek to return our games, reduce ordelay future purchases of our games or reduce or delay the use of their handsets. Wireless carriers and handset manufacturers may alsoincrease their expenditures on protecting their wireless networks and mobile phone products from attack, which could delay adoption ofnew handset models. Any of these activities could adversely affect our revenues and this could harm our business, operating results andfinancial condition.If a substantial number of the end users that purchase our games by subscription change mobile handsets or if wirelesscarriers switch to subscription plans that require active monthly renewal by subscribers, our sales could suffer.Subscriptions represent a significant portion of our revenues. As handset development continues, over time an increasing percentageof end users who already own one or more of our subscription games will likely upgrade from their existing handsets. With some wirelesscarriers, it is not currently feasible for these end users to transfer their existing subscriptions from one handset to another. In addition,carriers may switch to subscription billing systems that require end users to actively renew, or opt-in, each month from current systemsthat passively renew unless end users take some action to opt-out of their subscriptions. In either case, unless we are able to re-sellsubscriptions to these end users or replace these end users with other end users, our sales would suffer and this could harm our business,operating results and financial condition.Changes in government regulation of the media and wireless communications industries may adversely affect our business.It is possible that a number of laws and regulations may be adopted in the United States and elsewhere that could restrict the mediaand wireless communications industries, including laws and regulations regarding customer privacy, taxation, content suitability,copyright, distribution and antitrust. Furthermore, the growth and development25Table of Contentsof the market for electronic commerce may prompt calls for more stringent consumer protection laws that may impose additional burdenson companies such as ours conducting business through wireless carriers. We anticipate that regulation of our industry will increase andthat we will be required to devote legal and other resources to address this regulation. Changes in current laws or regulations or theimposition of new laws and regulations in the United States or elsewhere regarding the media and wireless communications industriesmay lessen the growth of wireless communications services and may materially reduce our ability to increase or maintain sales of ourgames.A number of studies have examined the health effects of mobile phone use, and the results of some of the studies have beeninterpreted as evidence that mobile phone use causes adverse health effects. The establishment of a link between the use of mobile phoneservices and health problems, or any media reports suggesting such a link, could increase government regulation of, and reduce demandfor, mobile phones and, accordingly, the demand for our games and related applications, and this could harm our business, operatingresults and financial condition.Item 1B. Unresolved Staff CommentsNot applicable.Item 2. PropertiesWe lease approximately 52,067 square feet in San Mateo, California for our corporate headquarters, including our operations,studio and research and development facilities, pursuant to a sublease agreement that expires in July 2012. We have a right of first offer tolease additional space on the second floor of our building. We lease approximately 10,608 square feet in London, England for ourprincipal European offices, pursuant to a lease that expires in October 2011. We have an option to extend the London lease for five yearsand a right of first refusal to lease additional space in our building. We lease approximately 16,354 square feet in Beijing, China for ourprincipal Asia Pacific offices and our China studio facilities, pursuant to two leases that both expire in July 2010. We have an option toextend the Beijing leases for two years. We lease approximately 12,800 square feet in Moscow, Russia for our Russia studio facilities,pursuant to a lease that expires in March 2009. We also lease properties in San Clemente, California, Brazil, Chile, Hefei, China, France,Germany, Hong Kong, Italy, Spain and Sweden. We believe our space is adequate for our current needs and that suitable additional orsubstitute space will be available to accommodate the foreseeable expansion of our operations.Item 3. Legal ProceedingsWe are subject to various claims, complaints and legal actions in the normal course of business from time to time. We do not believewe are party to any currently pending legal proceedings the outcome of which will have a material adverse effect on our operations orfinancial position. There can be no assurance that existing or future legal proceedings arising in the ordinary course of business orotherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.Item 4. Submission of Matters to a Vote of Security HoldersNot applicable.26Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket Information for Common StockOur common stock has been listed on The Nasdaq Global Market under the symbol “GLUU” since our initial public offering inMarch 2007. The following table sets forth, for the periods indicated, the high and low intra-day prices for our common stock as reportedon The Nasdaq Global Market. High Low First quarter 2007 (beginning March 22, 2007) $12.29 $10.00 Second quarter 2007 $14.67 $9.78 Third quarter 2007 $14.10 $7.61 Fourth quarter 2007 $10.41 $4.77 First quarter 2008 (through March 21, 2008) $5.48 $3.92 27Table of ContentsStock Price Performance GraphThe following graph shows a comparison from March 22, 2007 (the date our common stock commenced trading on The NasdaqStock Market) through December 31, 2007 of the cumulative total return for an investment of $100 (and the reinvestment of dividends) inour common stock, the Nasdaq Composite Index and the Nasdaq Telecommunications Index. Such returns are based on historical resultsand are not intended to suggest future performance.The above information under the heading “Stock Price Performance Graph” shall not be deemed to be “filed” for purposes ofSection 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section or Sections 11 and12(a)(2) of the Securities Act of 1933, as amended, and shall not be incorporated by reference into any registration statement or otherdocument filed by us with the Securities and Exchange Commission, whether made before or after the date of this Annual Report onForm 10-K, regardless of any general incorporation language in such filing, except as shall be expressly set forth by specific reference insuch filing.StockholdersAs of March 21, 2008, we had approximately 156 record holders of our common stock.Dividend PolicyWe have never declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings and donot expect to pay any dividends in the foreseeable future. Our line of credit facility, entered into in February 2007, prohibits us frompaying any cash dividends without the prior written consent of the bank. Any future determination related to our dividend policy will bemade at the discretion of our Board of Directors.Recent Sales of Unregistered SecuritiesFor the quarter ended December 31, 2007, we did not sell any unregistered securities.Use of Proceeds from Public Offering of Common StockThe Form S-1 Registration Statement (Registration No. 333-139493) relating to our IPO was declared effective by the SEC onMarch 21, 2007, and the offering commenced the following day. Goldman Sachs & Co. acted as the sole book-running manager for theoffering, and Lehman Brothers Inc., Bank of America Securities LLC and Needham & Company, LLC acted as co-managers of theoffering.28Table of ContentsThe net proceeds of our IPO were $74.8 million. Through December 31, 2007, we used approximately $12.0 million of the netproceeds to repay in full the principal and accrued interest on our outstanding loan from the lender and $14.7 million of the net proceedsfor the acquisition of MIG. We intend to use approximately $36.6 million (based on the March 7, 2008 closing exchange rate between theBritish pound sterling and United States dollar of $1.9969) of the net proceeds for the acquisition of Superscape upon completion of ourtender offer in March 2008. We expect to use the remaining net proceeds for general corporate purposes, including working capital andpotential capital expenditures and acquisitions.Our management will retain broad discretion in the allocation and use of the net proceeds of our IPO, and investors will be relying onthe judgment of our management regarding the application of the net proceeds. Pending specific utilization of the net proceeds as describedabove, we have invested the net proceeds of the offering in a variety of financial instruments, consisting principally in money marketfunds and auction-rate securities. The goal with respect to the investment of the net proceeds will be capital preservation and liquidity sothat such funds are readily available to fund our operations.Purchases of Equity Securities by the Issuer and Affiliated PurchasersFor the year ended December 31, 2007, we did not repurchase any equity securities.Item 6. Selected Financial DataThe following selected consolidated financial data should be read in conjunction with Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and29Table of ContentsSupplementary Data,” and other financial data included elsewhere in this Annual Report on Form 10-K. Our historical results ofoperations are not necessarily indicative of results of operations to be expected for any future period. Year Ended December 31, 2007 2006 2005 2004 2003 (In thousands, except per share amounts) Consolidated Statements of Operations Data: Revenues $66,867 $46,166 $25,651 $7,022 $1,790 Cost of revenues: Royalties 18,381 13,713 7,256 1,359 258 Impairment of prepaid royalties and guarantees — 355 1,645 231 — Amortization of intangible assets 2,201 1,777 2,823 126 — Impairment of intangible assets — — 1,103 — — Total cost of revenues 20,582 15,845 12,827 1,716 258 Gross profit 46,285 30,321 12,824 5,306 1,532 Operating expenses(1): Research and development 22,425 15,993 14,557 6,474 3,352 Sales and marketing 13,224 11,393 8,515 3,692 697 General and administrative 16,898 12,072 8,434 3,468 1,342 Amortization of intangible assets 275 616 616 26 — Restructuring charge — — 450 — — Acquired in-process research and development 59 1,500 — — — Gain on sale of assets (1,040) — — — — Total operating expenses 51,841 41,574 32,572 13,660 5,391 Loss from operations (5,556) (11,253) (19,748) (8,354) (3,859)Interest and other income (expense), net 1,965 (872) 541 (69) 11 Loss before income taxes and cumulative effect of change in accounting principle (3,591) (12,125) (19,207) (8,423) (3,848)Income tax benefit (provision) 265 (185) 1,621 101 — Loss before cumulative effect of change in accounting principle (3,326) (12,310) (17,586) (8,322) (3,848)Cumulative effect of change in accounting principle — — (315) — — Net loss (3,326) (12,310) (17,901) (8,322) (3,848)Accretion to preferred stock (17) (75) (63) (1,351) (533)Deemed dividend (3,130) — — — — Net loss attributable to common stockholders $(6,473) $(12,385) $(17,964) $(9,673) $(4,381)Net loss per share attributable to common stockholders — basic and diluted Loss beforecumulative effect of change in accounting principle $(0.14) $(2.48) $(4.37) $(5.45) $(3.68)Cumulative effect of change in accounting principle — — (0.07) — — Accretion to preferred stock — (0.02) (0.02) (0.89) (0.51)Deemed dividend (0.14) — — — — Net loss per share attributable to common stockholders — basic and diluted $(0.28) $(2.50) $(4.46) $(6.34) $(4.19)Weighted average common shares outstanding 23,281 4,954 4,024 1,525 1,047 (1)Includes stock-based compensation expense as follows: Year Ended December 31, 2007 2006 2005 2004 2003 (In thousands) Research and development $939 $207 $158 $28 $— Sales and marketing 674 322 132 59 — General and administrative 2,186 1,211 987 454 32 Total stock-based compensation expense $3,799 $1,740 $1,277 $541 $32 30Table of Contents Year Ended December 31, 2007 2006 2005 2004 2003 (In thousands, except per share amounts) Cash and cash equivalents and short-term investments $59,810 $12,573 $21,616 $8,393 $1,888 Total assets 161,505 81,799 49,498 37,608 3,188 Current portion of long term debt — 4,339 — — — Long-term debt, less current portion — 7,245 — — — Redeemable convertible preferred stock — 76,363 57,190 31,495 10,259 Total stockholder’s equity/(deficit) 129,461 (25,185) (17,393) (1,418) (7,836)Item 7. Management’s Discussion and Analysis of Financial Condition and Results of OperationsThe following discussion and analysis of our financial condition and results of operations should be read in conjunction withthe consolidated financial statements and related notes contained elsewhere in this Annual Report on Form 10-K. The informationin this discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements are based upon currentexpectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may bedeemed to be forward-looking statements. For example, the words “may,” “will,” “believe,” “anticipate,” “plan,” “expect,”“intend,” “could,” “estimate,” “continue” and similar expressions or variations are intended to identify forward-lookingstatements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Risk Factors”elsewhere in this Annual Report on Form 10-K. All forward-looking statements in this document are based on informationavailable to us as of the date hereof and we assume no obligation to update any such forward-looking statements to reflect futureevents or circumstances.OverviewGlu Mobile is a leading global publisher of mobile games. We have developed and published a portfolio of more than 195 casualand traditional games to appeal to a broad cross section of the subscribers served by our more than 200 wireless carriers and otherdistributors. We create games and related applications based on third-party licensed brands and other intellectual property, as well as onour own original brands and intellectual property. Our games based on licensed intellectual property include Call of Duty 4, Deer Hunter2, Diner Dash 2, Sonic the Hedgehog, Transformers, World Series of Poker and Zuma. Our original games based on our ownintellectual property include Brain Genius, Frantic Factory, My Hangman, Shadowalker, Space Monkey and Super K.O. Boxing.We seek to attract end users by developing engaging content that is designed specifically to take advantage of the portability andnetworked nature of mobile handsets. We leverage the marketing resources and distribution infrastructures of wireless carriers and thebrands and other intellectual property of third-party content owners, allowing us to focus our efforts on developing and publishing high-quality mobile games.We believe that improving quality and greater availability of mobile games are increasing end-user awareness of and demand formobile games. At the same time, carriers and branded content owners are focusing on a small group of publishers that have the ability toproduce high-quality mobile games consistently and port them rapidly and cost effectively to a wide variety of handsets. Additionally,branded content owners are seeking publishers that have the ability to distribute games globally through relationships with most or all ofthe major carriers. We believe we have created the requisite development and porting technology and have achieved the requisite scale to bein this group. We also believe that leveraging our carrier and content owner relationships will allow us to grow our revenues withoutcorresponding percentage growth in our infrastructure and operating costs.Our revenue growth rate will depend significantly on continued growth in the mobile game market and our ability to continue toattract new end users in that market. Our ability to attain profitability will be affected by the extent to which we must incur additionalexpenses to expand our sales, marketing, development, and general and31Table of Contentsadministrative capabilities to grow our business. The largest component of our expenses is personnel costs. Personnel costs consist ofsalaries, benefits and incentive compensation, including bonuses and stock-based compensation, for our employees. Our operatingexpenses will continue to grow in absolute dollars, assuming our revenues continue to grow. As a percentage of revenues, we expect theseexpenses to decrease.In March 2007, we completed our initial public offering, or IPO, of common stock in which we sold and issued 7,300,000 shares ofcommon stock at a price of $11.50 per share to the public. We raised a total of $84.0 million in gross proceeds from the IPO, orapproximately $74.8 million in net proceeds after deducting underwriting discounts and commissions of $5.9 million and other offeringcosts of $3.3 million. Upon the closing of the IPO, all shares of redeemable convertible preferred stock outstanding automaticallyconverted into 15,680,292 shares of common stock.We were incorporated in May 2001 and introduced our first mobile games to the market in July 2002. In December 2004 and inMarch 2006, we acquired Macrospace and iFone, respectively, each a mobile game developer and publisher based in the UnitedKingdom. In December 2007, we acquired MIG, a leading publisher of mobile games in China and in March 2008, we acquiredSuperscape, a global publisher of mobile games. We are headquartered in San Mateo, California and have offices in San Clemente,California, Beijing, China, Brazil, Chile, France, Germany, Hefei, China, Hong Kong, Italy, Russia, Spain, Sweden and the UnitedKingdom.RevenuesWe generate the vast majority of our revenues from wireless carriers that market and distribute our games. These carriers generallycharge a one-time purchase fee or a monthly subscription fee on their subscribers’ phone bills when the subscribers download our gamesto their mobile phones. The carriers perform the billing and collection functions and generally remit to us a contractual fee or a contractualpercentage of their collected fee for each game. We recognize as revenues the percentage of the fees due to us from the carrier (see“— Critical Accounting Policies and Estimates — Revenue Recognition” below). End users may also initiate the purchase of our gamesthrough various Internet portal sites or through other delivery mechanisms, with carriers generally continuing to be responsible for billing,collecting and remitting to us a portion of their fees. To date, eliminating the impact of our acquisitions, our domestic revenues havegrown more rapidly than our international revenues, and this trend may continue.Cost of RevenuesOur cost of revenues consists primarily of royalties that we pay to content owners from which we license brands and otherintellectual property and, to a limited extent, to certain external developers. Our cost of revenues also includes non-cash expenses —amortization of certain acquired intangible assets, any impairment of those intangible assets, and any impairment of prepaid royalties andguarantees. We record advance royalty payments made to content licensors as prepaid royalties on our balance sheet when payment ismade to the licensor. We recognize royalties in cost of revenues based upon the revenues derived from the relevant game multiplied by theapplicable royalty rate. If our licensors earn royalties in excess of their advance royalties, we also recognize these excess royalties as cost ofrevenues in the period they are earned by the licensor. If applicable, we will record an impairment of prepaid royalties or accrue for futureguaranteed royalties that are in excess of anticipated demand or net realizable value. At each balance sheet date, we perform a detailedreview of prepaid royalties and guarantees that considers multiple factors, including forecasted demand, game life cycle status, gamedevelopment plans, and current and anticipated sales levels.We pay some of our external developers, especially in Europe, royalties in addition to payments for game development costs. Werecognize these royalties as cost of revenues in the period the developer earns the royalties based upon the revenues derived from therelevant game multiplied by the applicable royalty rate. We expense the costs for development of our games prior to technologicalfeasibility as we incur them throughout the development process, and we include these costs in research and development expenses (see“— Critical Accounting Policies and Estimates — Software Development Costs” below). To date, royalties paid to developers have notbeen significant, but we expect them to increase in aggregate amount based on our existing contracts with developers.32Table of ContentsAbsent further impairments of existing intangible assets, we expect amortization of intangible assets included in cost of revenues tobe $3.5 million in 2008, $3.1 million in 2009, $2.6 million in 2010, $1.6 million in 2011, $1.5 million in 2012 and $1.5 millionthereafter. These amounts would likely increase if we make future acquisitions.Gross MarginOur gross margin is determined principally by the mix of games that we license. Our games based on licensed intellectual propertyrequire us to pay royalties to the licensor and the royalty rates in our licenses vary significantly; our original Glu-branded games, whichare based on our own intellectual property, require no royalty payments to licensors. There are multiple internal and external factors thataffect the mix of revenues from licensed games and Glu-branded games, including the overall number of licensed games and Glu-brandedgames available for sale during a particular period, the extent of our and our carriers’ marketing efforts for each game, and the deckplacement of each game on our carriers’ mobile handsets. We believe the success of any individual game during a particular period isaffected by its quality and third-party ratings, its marketing and media exposure, its consumer recognizability, its overall acceptance byend users and the availability of competitive games. If our product mix shifts more to licensed games or games with higher royalty rates,our gross margin would decline. Our gross margin is also adversely affected by ongoing amortization of acquired intangible assets, suchas licensed content, games, trademarks and carrier contracts that are directly related to revenue-generating activities and by periodiccharges for impairment of these assets and of prepaid royalties and guarantees. These charges can cause gross margin variations,particularly from quarter to quarter.Operating ExpensesOur operating expenses primarily include research and development expenses, sales and marketing expenses and general andadministrative expenses. They have in the past also included amortization of acquired intangible assets not directly related to revenue-generating activities and, in one period, a restructuring charge and a charge for acquired in-process research and development.Research and Development. Our research and development expenses consist primarily of salaries and benefits for employeesworking on creating, developing, porting, quality assurance, carrier certification and deployment of our games, on technologies related tointeroperating with our various wireless carriers and on our internal platforms, payments to third parties for developing and porting of ourgames, and allocated facilities costs.We devote substantial resources to the development, porting and quality assurance of our games and expect this to continue in thefuture. We believe that developing games internally through our own development studios allows us to increase operating margins, leveragethe technology we have developed and better control game delivery. Our games generally require six months to one year to produce, basedon the complexity and feature set of the game developed, the number of carrier wireless platforms and mobile handsets covered, and theexperience of the internal or external developer. We expect our research and development expenses will increase in absolute terms as wecontinue to create new games and technologies, but that these expenses will continue to decline as a percentage of revenues.Sales and Marketing. Our sales and marketing expenses consist primarily of salaries, benefits and incentive compensation forsales and marketing personnel, expenses for advertising, trade shows, public relations and other promotional and marketing activities,expenses for general business development activities, travel and entertainment expenses and allocated facilities costs. We expect sales andmarketing expenses to increase in absolute terms with the growth of our business and as we further promote our games and the Glu brand.Although we expect our variable marketing expenses to increase at least as rapidly as our revenues, we expect that our sales and marketingheadcount will not increase as rapidly as revenues and that therefore sales and marketing expenses will continue to decrease as apercentage of revenues.General and Administrative. Our general and administrative expenses consist primarily of salaries and benefits for general andadministrative personnel, consulting fees, legal, accounting and other professional fees, information technology costs and allocatedfacilities costs. We expect that general and administrative expenses will increase in absolute terms as we hire additional personnel andincur costs related to the anticipated growth of our33Table of Contentsbusiness, integration of our recent acquisitions and our operation as a public company. We also expect that these expenses will increasebecause of the additional costs to comply with the Sarbanes-Oxley Act and related regulation and our efforts to expand our internationaloperations. However, we expect these expenses to continue to decrease as a percentage of revenues.Based on our current revenue and expense projections, we expect that our various operating expense categories will decline as apercentage of revenues. We could fail to increase our revenues as anticipated, and we could decide to increase expenses in one or morecategories to respond to competitive pressures or for other reasons. In these cases and others, it is possible that one or more of ouroperating expense categories would not decline as a percentage of revenues.Amortization of Intangible Assets. We record amortization of acquired intangible assets that are directly related to revenue-generating activities as part of our cost of revenues and amortization of the remaining acquired intangible assets, such as noncompetitionagreements, as part of our operating expenses. We record intangible assets on our balance sheet based upon their fair value at the time theyare acquired. We determine the fair value of the intangible assets using a discounted cash flows approach. We amortize the amortizableintangible assets using the straight-line method over their estimated useful lives. Absent impairments of existing intangible assets, weexpect amortization of existing intangible assets to be $276,000 in 2008, $276,000 in 2009 and $264,000 in 2010. These amounts wouldlikely increase if we make future acquisitions.Restructuring Charge. In 2005, we undertook restructuring activities to reduce our ongoing operating expenses. The resultingrestructuring charge principally consisted of costs associated with employee termination benefits. We recorded these costs as an operatingexpense when we communicated the benefit arrangement to the employee and no significant future services, other than a minimumretention period, were required of the employee in order to earn the termination benefits.Acquired In-Process Research and Development. We classify all development projects acquired in business combinations asacquired in-process research and development, or IPR&D, if the feasibility of the acquired technology has not been established and nofuture alternative uses exist. We expense the fair value of IPR&D at the time it is acquired. We determine the fair value of the IPR&D usinga discounted cash flows approach. In estimating the appropriate discount rate, we consider, among other things, the risks to developingtechnology given changes in trends and technology in our industry. In 2006, we expensed the fair value of IPR&D acquired in the iFonetransaction and in 2007, we expensed the fair value of IPR&D acquired in the MIG transaction. In 2008, we will expense the fair value ofIPR&D as a result of our acquisition of Superscape.Gain on Sale of Assets. Our gain on sale of assets relates entirely to the net proceeds from the sale of our ProvisionX software to athird party. We do not anticipate additional gains on asset sales in the future.Interest and Other Income (Expense), NetInterest and other income (expense), net, includes interest income, interest expense, accretion of the debt discount related to thewarrants issued to Pinnacle Ventures in conjunction with its March 2006 loan to us, changes in our preferred stock warrant liability,foreign currency transaction gains and losses and the write down of certain auction rate securities to their respective fair values. Followingthe completion of our initial public offering our outstanding warrants to purchase redeemable convertible preferred stock converted intowarrants to purchase common stock and we are no longer required to record changes in our preferred stock warrant liability under StaffPosition No. 150-5, Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instrumentson Shares That Are Redeemable, or FSP 150-5, or accretion in the debt discount related to the Pinnacle Ventures warrants.Accounting for Income TaxesWe are subject to tax in the United States as well as other tax jurisdictions or countries in which we conduct business. Earningsfrom our non-U.S. activities are subject to local country income tax and may be subject to current United States income tax depending onwhether these earnings are subject to U.S. income tax based upon U.S. anti-deferral rules, such as Subpart F of the Internal Revenue Codeof 1986, as amended, or the Code. In addition, some34Table of Contentsrevenues generated outside of the United States and the United Kingdom may be subject to withholding taxes. In some cases, thesewithholding taxes may be deductible on a current basis or may be available as a credit to offset future income taxes depending on a varietyof factors.We record a valuation allowance to reduce any deferred tax asset to the amount that is more likely than not to be realized. We considerhistorical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible taxplanning strategies in assessing the need for a valuation allowance. If we were to determine that we would be able to realize deferred taxassets in the future in excess of the net recorded amount, we would record an adjustment to the deferred tax asset valuation allowance.Such an adjustment would increase our income or goodwill in the period the determination is made. Historically, we have incurredoperating losses and have generated significant net operating loss carryforwards. During the fourth quarter of 2007, we finalized certaintransfer pricing studies and as a result, we adjusted the federal and state net operating losses and reduced the corresponding valuationallowance. At December 31, 2007, we had net operating loss carryforwards of approximately $23.8 million and $23.3 million for federaland state tax purposes, respectively. These carryforwards will expire from 2011 to 2026. Our ability to use our net operating losscarryforwards to offset any future taxable income may be subject to restrictions attributable to equity transactions that result in changes ofownership as defined by section 382 of the Code. As of December 31, 2007, total net operating losses of $5.9 million are available in theUnited Kingdom, however, $5.1 million of those losses are limited and can only offset a portion of the annual combined profits in theUnited Kingdom until the net operating losses are fully utilized.On January 1, 2007, we adopted the provisions of FIN 48, which clarifies the accounting for uncertainty in income taxes recognizedin financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold andmeasurement attribute of tax positions taken or expected to be taken on a tax return. The interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The total amount ofunrecognized tax benefits as of the adoption date was $575,000. Our policy is to recognize interest and penalties related to unrecognizedtax benefits in income tax expense.Cumulative Effect of Change in Accounting PrincipleOn June 29, 2005, the FASB issued FSP 150-5. FSP 150-5 affirms that freestanding warrants to purchase shares that areredeemable are subject to the requirements in SFAS No. 150, regardless of the redemption price or the timing of the redemption feature.Therefore, under SFAS No. 150, the outstanding freestanding warrants to purchase our convertible preferred stock are liabilities thatmust be recorded at fair value each quarter, with the changes in estimated fair value in the quarter recorded as other expense or income inour statement of operations. We adopted FSP 150-5 as of July 1, 2005 and recorded an expense of $315,000 for the cumulative effect ofthe change in accounting principle to reflect the estimated fair value of these warrants as of that date.Following the completion of the IPO, our outstanding warrants to purchase redeemable convertible preferred stock converted intowarrants to purchase common stock, and we are no longer required to record changes in our preferred stock warrant liability underFSP 150-5.Critical Accounting Policies and EstimatesOur consolidated financial statements are prepared in accordance with United States generally accepted accounting principles, orGAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets andliabilities as of the dates of the consolidated financial statements, the disclosure of contingencies as of the dates of the consolidatedfinancial statements, and the reported amounts of revenues and expenses during the periods presented. Although we believe that ourestimates and judgments are reasonable under the circumstances existing at the time these estimates and judgments are made, actualresults may differ from those estimates, which could affect our consolidated financial statements.35Table of ContentsWe believe the following to be critical accounting policies because they are important to the portrayal of our financial condition orresults of operations and they require critical management estimates and judgments about matters that are uncertain: • revenue recognition; • advance or guaranteed licensor royalty payments; • short-term investments; • long-lived assets; • goodwill; • software development costs; • stock-based compensation; and • income taxes.Revenue RecognitionWe derive our revenues primarily by licensing software products in the form of mobile games. License arrangements with our endusers can be on a perpetual or subscription basis. A perpetual license gives an end user the right to use the licensed game on the registeredmobile handset on a perpetual basis. A subscription license gives an end user the right to use the licensed game on the registered handsetfor a limited period of time, ranging from a few days to as long as one month. All games that require ongoing delivery of content from usor connectivity through our network for multi-player functionality are only billed on a monthly subscription basis. We distribute ourproducts primarily through wireless carriers, which market our games to end users. Carriers usually bill license fees for perpetual andsubscription licenses upon download of the game software by the end user. In the case of subscription licenses, many subscriberagreements provide for automatic renewal until the subscriber opts-out, while the others provide for opt-in renewal. In either case,subsequent billings for subscription licenses are generally billed monthly. We apply the provisions of Statement of Position 97-2,Software Revenue Recognition, as amended by Statement of Position 98-9, Modification of SOP 97-2, Software RevenueRecognition, With Respect to Certain Transactions, to all transactions.We recognize revenues from our games when persuasive evidence of an arrangement exists, the game has been delivered, the fee isfixed or determinable, and the collection of the resulting receivable is probable. For both perpetual and subscription licenses, we consider asigned license agreement to be evidence of an arrangement with a carrier and a “clickwrap” agreement to be evidence of an arrangementwith an end user. For these licenses, we define delivery as the download of the game by the end user.We estimate revenues from carriers in the current period when reasonable estimates of these amounts can be made. Several carriersprovide reliable interim preliminary reporting and others report sales data within a reasonable time frame following the end of each month,both of which allow us to make reasonable estimates of revenues and therefore to recognize revenues during the reporting period when theend user licenses the game. Determination of the appropriate amount of revenue recognized involves judgments and estimates that webelieve are reasonable, but it is possible that actual results may differ from our estimates. Our estimates for revenues includeconsideration of factors such as preliminary sales data, carrier-specific historical sales trends, the age of games and the expected impactof newly launched games, successful introduction of new handsets, promotions during the period and economic trends. When we receivethe final carrier reports, to the extent not received within a reasonable time frame following the end of each month, we record anydifferences between estimated revenues and actual revenues in the reporting period when we determine the actual amounts. Historically, therevenues on the final revenue report have not differed by more than one-half of 1% of the reported revenues for the period, which wedeemed to be immaterial. Revenues earned from certain carriers may not be reasonably estimated. If we are unable to reasonably estimatethe amount of revenue to be recognized in the current period, we recognize revenues upon the receipt of a carrier revenue report and whenour portion of a game’s licensed revenues is fixed or determinable and collection is probable. To monitor the reliability of our estimates,our management, where possible, reviews the36Table of Contentsrevenues by carrier and by game on a weekly basis to identify unusual trends such as differential adoption rates by carriers or theintroduction of new handsets. If we deem a carrier not to be creditworthy, we defer all revenues from the arrangement with that carrier untilwe receive payment and all other revenue recognition criteria have been met.In accordance with Emerging Issues Task Force, or EITF, Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Netas an Agent, we recognize as revenues the amount the carrier reports as payable to us upon the sale of our games. We have evaluated ourcarrier agreements and have determined that we are not the principal when selling our games through carriers. Key indicators that weevaluated in reaching this determination included: • wireless subscribers directly contract with their carriers, which have most of the service interaction and are generally viewed asthe primary obligor by the subscribers; • carriers generally have significant control over the types of games that they offer to their subscribers; • carriers are directly responsible for billing and collecting fees from their subscribers, including the resolution of billing disputes; • carriers generally pay us a fixed percentage of their revenues or a fixed fee for each game; • carriers generally must approve the price of our games in advance of their sale to subscribers, and our more significant carriersgenerally have the ability to set the ultimate price charged to their subscribers; and • we have limited risks, including no inventory risk and limited credit risk.Advance or Guaranteed Licensor Royalty PaymentsOur royalty expenses consist of fees that we pay to branded content owners for the use of their intellectual property, includingtrademarks and copyrights, in the development of our games. Royalty-based obligations are either paid in advance and capitalized on ourbalance sheet as prepaid royalties or accrued as incurred and subsequently paid. These royalty-based obligations are expensed to cost ofrevenues at the greater of the revenues derived from the relevant game multiplied by the applicable contractual rate or an effective royaltyrate based on expected net product sales. Advanced license payments that are not recoupable against future royalties are capitalized andamortized over the lesser of the estimated life of the branded title or the term of the license agreement.Our contracts with some licensors include minimum guaranteed royalty payments, which are payable regardless of the ultimatevolume of sales to end users. Effective January 1, 2006, we adopted FSP FIN 45-3, Application of FASB Interpretation No. 45 toMinimum Revenue Guarantees Granted to a Business or Its Owners. As a result, we recorded a minimum guaranteed liability ofapproximately $7.9 million as of December 31, 2007. When no significant performance remains with the licensor, we initially recordeach of these guarantees as an asset and as a liability at the contractual amount. We believe that the contractual amount represents the fairvalue of our liability. When significant performance remains with the licensor, we record royalty payments as an asset when actually paidand as a liability when incurred, rather than upon execution of the contract. We classify minimum royalty payment obligations as currentliabilities to the extent they are contractually due within the next twelve months.Each quarter, we also evaluate the realization of our royalties as well as any unrecognized guarantees not yet paid to determineamounts that we deem unlikely to be realized through product sales. We use estimates of revenues, cash flows and net margins to evaluatethe future realization of prepaid royalties and guarantees. This evaluation considers multiple factors, including the term of the agreement,forecasted demand, game life cycle status, game development plans and current and anticipated sales levels. To the extent that thisevaluation indicates that the remaining prepaid and guaranteed royalty payments are not recoverable, we record an impairment charge inthe period such impairment is indicated. Subsequently, if actual market conditions are more favorable than anticipated, amounts ofprepaid royalties previously written down may be utilized, resulting in lower cost of revenues and higher income from operations thanpreviously expected in that period. In 2007, our cost of revenues was reduced by $75,000 as a result of selling games on which theprepaid royalties had previously been impaired. During 2007, 2006 and 2005, we recorded impairment charges of zero, $355,000 and$1.6 million, respectively. We believe that the combination of the evolving market for licensing other companies’ intellectual property andour37Table of Contentsimproved license pre-qualification process will reduce risk of future impairments. The impairments that we have recorded to date arepredominantly related to license agreements entered into prior to 2005 and had significant guarantees for which the success was tied to athird-party product release. In 2005, 2006 and 2007, the market for licensed intellectual property stabilized, resulting in lower upfrontcommitment fees. We believe our improved visibility regarding forecasted demand and gaming trends supports our ability to reasonablydetermine the realizibility of the assets on our consolidated balance sheet.Short-Term InvestmentsWe have invested in auction-rate securities that are bought and sold in the marketplace through a bidding process sometimes referredto as a “Dutch Auction.” After the initial issuance of the securities, the interest rate on the securities is reset periodically, at intervals set atthe time of issuance (e.g., every seven, 28 or 35 days or every six months), based on the market demand at the reset period. The “stated”or “contractual” maturities for these securities, however, generally are 20 to 30 years. As of December 31, 2007, we had $2.8 million ofprincipal invested in two auction-rate securities, each of which were rated AAA as of the date of this report, with contractual maturities of2017.We have classified these investments as available-for-sale securities under Statement of Financial Accounting Standards No. 115,Accounting for Certain Investments in Debt and Equity Securities (“SFAS 115”). In accordance with SFAS 115, these securities arereported at fair value with any changes in market value reported as a part of comprehensive income/(loss). No unrealized gains or losseswere recognized during the years ended December 31, 2007, 2006 or 2005.We periodically review these investments for impairment. In the event the carrying value of an investment exceeds its fair value andthe decline in fair value is determined to be other-than-temporary, we write down the value of the investment to its fair value. We recordedan $806,000 write down due to a decline in fair value of two failed auctions as of December 31, 2007 that was determined to be other-than-temporary based on quantitative and qualitative assumptions and estimates using valuation models including a firm liquidationquote provided by the sponsoring broker and an analysis of other-than-temporary impairment factors including the use of cash for thetwo recent acquisitions, the ratings of the underlying securities, our intent to continue to hold these securities and the continued andfurther deterioration in the auction-rate securities market. No realized gains or losses were recognized during the years ended December 31,2006 or 2005.Long-Lived AssetsWe evaluate our long-lived assets, including property and equipment and intangible assets with finite lives, for impairment wheneverevents or changes in circumstances indicate that the carrying value of these assets may not be recoverable in accordance withSFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Factors considered important that could result in animpairment review include significant underperformance relative to expected historical or projected future operating results, significantchanges in the manner of use of the acquired assets, significant negative industry or economic trends, and a significant decline in ourstock price for a sustained period of time. We recognize impairment based on the difference between the fair value of the asset and itscarrying value. Fair value is generally measured based on either quoted market prices, if applicable, or a discounted cash flow analysis.GoodwillIn accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), we do not amortize goodwill or otherintangible assets with indefinite lives but rather test them for impairment. SFAS 142 requires us to perform an impairment review of ourgoodwill balance at least annually, which we do as of September 30 each year, and also whenever events or changes in circumstancesindicate that the carrying amount of these assets may not be recoverable. In our impairment review as of September 30, 2007, we looked attwo of our reporting units — the United States and EMEA - since none of our goodwill was attributable to our third operating unit, therest of the world, as of that date. We compare the fair value of each unit to its carrying value, including goodwill. The primary methodsused to determine the fair values for SFAS 142 impairment purposes were the discounted cash flow and38Table of Contentsmarket methods. We determined the assumptions supporting the discounted cash flow method, including the assumed 25% and 27%discount rates for the Americas and EMEA reporting units, respectively, as of September 30, 2007, using our best estimates as of the dateof the impairment review. If the carrying value, including goodwill, exceeds the fair value, we perform an allocation of the unit’s fair valueto its identifiable tangible and nongoodwill intangible assets and liabilities. This allows us to determine an implied fair value for the unit’sgoodwill. We then compare the implied fair value of the unit’s goodwill with the carrying value of the unit’s goodwill. If the carrying valueof the unit’s goodwill is greater than its implied fair value, we would recognize an impairment charge for the difference. To date, no unit’scarrying value has exceeded its fair value, and thus we have taken no goodwill impairment charges. We believe that, as a result of ourrecent revenue growth, operating results and use of cash, we will begin generating cash flows from operating activities in the latter half of2008.Application of the goodwill impairment test requires judgment, including the identification of the reporting units, the assigning ofassets and liabilities to reporting units, the assigning of goodwill to reporting units and the determining of the fair value of each reportingunit. Significant judgments and assumptions include the forecast of future operating results used in the preparation of the estimated futurecash flows, including forecasted revenues and costs based on current titles under contract, forecasted new titles that we expect to release,timing of overall market growth and our percentage of that market, discount rates and growth rates in terminal values. The marketcomparable approach estimates the fair value of a company by applying to that company market multiples of publicly traded firms insimilar lines of business. The use of the market comparable approach requires judgments regarding the comparability of companies withlines of business similar to ours. This process is particularly difficult in a situation where no domestic public mobile games companiesexist. The factors used in the selection of comparable companies include growth characteristics as measured by revenue or other financialmetrics; margin characteristics; product-defined markets served; customer-defined markets served; the size of a company as measuredby financial metrics such as revenue or market capitalization; the competitive position of a company, such as whether it is a marketleader in terms of indicators like market share; and company-specific issues that suggest appropriateness or inappropriateness of aparticular company as a comparable. We weighted the income and market comparable valuations equally as we did not believe that eithermethod was more appropriate. Further, the total gross value calculated under each method was not materially different, and therefore if theweighting were different we do not believe that this would have significantly impacted our conclusion. If different comparable companieshad been used, the market multiples and resulting estimates of the fair value of our stock would also have been different. Changes inthese estimates and assumptions could materially affect the determination of fair value for each reporting unit, which could triggerimpairment.Software Development CostsWe apply the principles of SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or OtherwiseMarketed (“SFAS 86”). SFAS 86 requires that software development costs incurred in conjunction with product development be chargedto research and development expense until technological feasibility is established. Thereafter, until the product is released for sale,software development costs must be capitalized and reported at the lower of unamortized cost or net realizable value of the related product.We have adopted the “tested working model” approach to establishing technological feasibility for our games. Under this approach, we donot consider a game in development to have passed the technological feasibility milestone until we have completed a model of the game thatcontains essentially all the functionality and features of the final game and have tested the model to ensure that it works as expected. Todate, we have not incurred significant costs between the establishment of technological feasibility and the release of a game for sale; thus,we have expensed all software development costs as incurred. We also will consider the following factors in determining whether costsshould be capitalized: the emerging nature of the mobile game market; the gradual evolution of the wireless carrier platforms and mobilehandsets for which we develop games; the lack of pre-orders or sales history for our games; the uncertainty regarding a game’s revenue-generating potential; our lack of control over the carrier distribution channel resulting in uncertainty as to when, if ever, a game will beavailable for sale; and our historical practice of canceling games at any stage of the development process.39Table of ContentsStock-Based CompensationPrior to January 1, 2006, we accounted for stock-based employee compensation arrangements in accordance with the provisions ofAccounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB No. 25, and related interpretations,and followed the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Under APB No. 25,compensation expense for an option was based on the difference, if any, on the date of the grant between the fair value of a company’scommon stock and the exercise price of the option. APB No. 25 required companies to record deferred stock-based compensation on theirbalance sheets and amortize it to expense over the vesting periods of the individual options. We amortize deferred stock-basedcompensation using the multiple option method as prescribed by FASB Interpretation No. 28, Accounting for Stock Appreciation Rightsand Other Variable Stock Option or Award Plans, or FIN 28, over the option vesting period using an accelerated amortization schedule.We expensed employee stock-based compensation of $1.3 million in 2005.Effective January 1, 2006, we adopted the fair value provisions of SFAS No. 123R, Share-Based Payment (“SFAS 123R”), whichsupersedes our previous accounting under APB No. 25. SFAS 123R requires the recognition of compensation expense, using a fair-valuebased method, for costs related to all share-based payments including stock options. SFAS 123R requires companies to estimate the fairvalue of share-based payment awards on the grant date using an option pricing model. We adopted SFAS 123R using the prospectivetransition method, which required us to apply SFAS 123R to option grants on and after the required effective date. For options grantedprior to the January 1, 2006 effective date that remained unvested on that date, we continue to recognize compensation expense under theintrinsic value method of APB No. 25. In addition, we are continuing to amortize those awards granted prior to January 1, 2006 utilizingan accelerated amortization schedule, while we will expense all options granted or modified on and after January 1, 2006 on a straight-linebasis. To value awards granted on or after January 1, 2006, we used the Black-Scholes option pricing model, which requires, amongother inputs, an estimate of the fair value of the underlying common stock on the date of grant and assumptions as to volatility of ourstock over the term of the related options, the expected term of the options, the risk-free interest rate and the option forfeiture rate. Wedetermined the assumptions used in this pricing model at each grant date. We concluded that it was not practicable to calculate thevolatility of our share price since our securities have been publicly traded for a limited period of time. Therefore, we based expectedvolatility on the historical volatility of a peer group of publicly traded entities. We determined the expected term of our options based uponhistorical exercises, post-vesting cancellations and the options’ contractual term. We based the risk-free rate for the expected term of theoption on the U.S. Treasury Constant Maturity Rate as of the grant date. We determined the forfeiture rate based upon our historicalexperience with option cancellations adjusted for unusual or infrequent events.In 2007, we recorded total employee non-cash stock-based compensation expense of $3.8 million, of which $412,000 representedcontinued amortization of deferred stock-based compensation for options granted prior to 2006 and $3.4 million represented expenserecorded in accordance with SFAS 123R with an expected term of approximately 5.24 years. In 2006, we recorded total employee non-cash stock-based compensation expense of $1.7 million, of which $863,000 represented continued amortization of deferred stock-basedcompensation for options granted prior to 2006 and $877,000 represented expense recorded in accordance with SFAS 123R based on2006 options grants with an expected term of approximately 6.07. In future periods, stock-based compensation expense may increase aswe issue additional equity-based awards to continue to attract and retain key employees. Additionally, SFAS 123R requires that werecognize compensation expense only for the portion of stock options that are expected to vest. If the actual number of forfeitures differsfrom that estimated by management, we may be required to record adjustments to stock-based compensation expense in future periods.As a result of adopting SFAS 123R, our net loss in 2006 and 2007 was higher by $877,000 and $3.4 million, net of tax effect, thanif we had continued to account for stock-based compensation under APB No. 25. Basic and diluted net loss per share in 2006 wouldhave been $0.18 and $0.15 per share lower than if we had not adopted SFAS 123R.We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123, EITF IssueNo. 96-18 and FIN 28.40Table of ContentsIncome TaxesWe account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. As part of the process of preparingour consolidated financial statements, we are required to estimate our income tax benefit (provision) in each of the jurisdictions in whichwe operate. This process involves estimating our current income tax benefit (provision) together with assessing temporary differencesresulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities,which are included within our consolidated balance sheet using the enacted tax rates in effect for the year in which we expect thedifferences to reverse.We record a valuation allowance to reduce our deferred tax assets to an amount that more likely than not will be realized. As ofDecember 31, 2007 and 2006, our valuation allowance on our net deferred tax assets was $14.3 million and $14.4 million, respectively.While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for thevaluation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of ournet recorded amount, we would need to make an adjustment to the allowance for the deferred tax asset, which would increase income inthe period that determination was made.On January 1, 2007 we adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — anInterpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized infinancial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold andmeasurement attribute of tax positions taken or expected to be taken on a tax return. The interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The total amount ofunrecognized tax benefits as of the adoption date was $575,000. Our policy is to recognize interest and penalties related to unrecognizedtax benefits in income tax expense. We do not expect that the amount of unrecognized tax benefits will change significantly within the next12 months.We have not provided federal income taxes on the unremitted earnings of foreign subsidiaries because these earnings are intended tobe reinvested permanently.Results of OperationsThe following sections discuss and analyze the changes in the significant line items in our statements of operations for thecomparison periods identified.Comparison of the Years Ended December 31, 2007 and 2006Revenues Year Ended December 31, 2007 2006 (In thousands) Revenues $66,867 $46,166 Our revenues increased $20.7 million, or 44.8%, from $46.2 million in 2006 to $66.9 million in 2007, due primarily to increasedrevenue per title, including our top ten titles, new titles, our growing catalog of titles, broader international distribution reach and increasedadoption rates for mobile game users. The increase resulted from sales of games that we have released in 2007, including Centipede,Project Gotham Racing, Sonic Jump and Transformers as well as the continued success of titles released in prior years including DeerHunter 2, World Series of Poker and Zuma. Revenues in 2007 from games released in 2007 were $12.7 million. Revenues from our topten titles increased from $24.6 million in 2006 to $35.2 million in 2007. International revenues, defined as revenues generated fromcarriers whose principal operations are located outside the United States, increased $10.2 million from $20.7 million in 2006 to$30.9 million in 2007.41Table of ContentsCost of Revenues Year Ended December 31, 2007 2006 (In thousands) Cost of revenues: Royalties $18,381 $13,713 Impairment of prepaid royalties and guarantees — 355 Amortization of intangible assets 2,201 1,777 Total cost of revenues $20,582 $15,845 Revenues $66,867 $46,166 Gross margin 69.2% 65.7%Our cost of revenues increased $4.7 million, or 29.9%, from $15.8 million in 2006 to $20.6 million in 2007. The increase resultedfrom an increase in royalties due to higher sales volumes and an increase in amortization of acquired intangible assets, which was offsetby a decrease in impairment of prepaid royalties and guarantees. Royalties increased $4.7 million principally because of higher revenueswith associated royalties. Revenues attributable to games based upon branded intellectual property decreased as a percentage of revenuesfrom 88.4% in 2006 to 88.1% in 2007. The average royalty rate that we paid on games based on licensed intellectual property decreasedfrom 34% in 2006 to 31% in 2007. As a result of the decreases in average royalty rate from branded titles and impairment of prepaidroyalties and guarantees, overall royalties, including impairment of prepaid royalties and guarantees, as a percentage of total revenuesdecreased from 30% to 27%. Amortization of intangible assets increased by $0.4 million primarily as a result of a full year of amortizationfor iFone acquired intangible assets during 2007 compared to only nine months of amortization of these assets during 2006.Gross MarginOur gross margin increased from 65.7% in 2006 to 69.2% in 2007 because of the decreased royalty rate paid on games based onlicensed intellectual property and the decrease in impairment of prepaid royalties and guarantees but offset by the increase in amortizationof intangible assets.Research and Development Expenses Year Ended December 31, 2007 2006 (In thousands) Research and development expenses $22,425 $15,993 Percentage of revenues 33.5% 34.6%Our research and development expenses increased $6.4 million, or 40.2%, from $16.0 million in 2006 to $22.4 million in 2007.The increase in research and development costs was primarily due to increases in salaries and benefits of $2.7 million, facility costs of$1.5 million to support additional headcount, outside services costs of $1.2 million for external development and porting projects, andstock-based compensation of $732,000.Research and development headcount increased from 150 to 287 in 2007 and salaries and benefits increased as a result. The growthin headcount was due primarily to expanding our studio capacity in China as well as the research and development employees resultingfrom our December 2007 acquisition of MIG. Research and development expenses included $207,000 of stock-based compensationexpense in 2006 and $939,000 in 2007. As a percentage of revenues, research and development expenses declined from 34.6% in 2006 to33.5% in 2007 due to an increase in revenues.42Table of ContentsSales and Marketing Expenses Year Ended December 31, 2007 2006 (In thousands) Sales and marketing expenses $13,224 $11,393 Percentage of revenues 19.8% 24.7%Our sales and marketing expenses increased $1.8 million, or 16.1%, from $11.4 million in 2006 to $13.2 million in 2007. Most ofthe increase was attributable to a $1.0 million increase in salaries and benefits, as we increased our sales and marketing headcount from41 to 63 in 2007, a $810,000 increase in marketing and sales programs, and a $352,000 increase in stock-based compensation. Weincreased staffing to expand our marketing efforts for our games and the Glu brand, to increase sales efforts to our new and existingwireless carriers and to expand our sales and marketing operations into the Asia-Pacific and Latin America regions. As a percentage ofrevenues, sales and marketing expenses declined from 24.7% in 2006 to 19.8% in 2007 as our sales and marketing activities generatedmore revenues across a greater number of carriers and mobile handsets. Sales and marketing expenses included stock-basedcompensation expense of $322,000 in 2006 and $674,000 in 2007.General and Administrative Expenses Year Ended December 31, 2007 2006 (In thousands) General and administrative expenses $16,898 $12,072 Percentage of revenues 25.3% 26.1%Our general and administrative expenses increased $4.8 million, or 40.0%, from $12.1 million in 2006 to $16.9 million in 2007.The increase in general and administrative expenses was primarily the result of a $2.0 million increase in salaries and benefits, increaseof stock compensation of $975,000, a $558,000 increase in allocated facility and depreciation expense due to increased headcount, a$447,000 increase in directors’ and officers’ insurance, a $394,000 increase in IT support and maintenance fees of, a $232,000 increasein business and franchise taxes and a $154,000 increase in travel and entertainment expenses. We increased our general andadministrative headcount from 43 to 67 in 2007 to support our continued growth and expansion. As a percentage of revenues, general andadministrative expenses declined from 26.1% in 2006 to 25.3% in 2007 as a result of the overall growth of our revenues, which resultedin continued economies of scale in our general and administrative expenses. General and administrative expenses included stock-basedcompensation expense in 2007 and 2006 of $2.2 million and $1.2 million, respectively.Other Operating ExpensesOur amortization of intangible assets, such as non-competition agreements, acquired from Macrospace and iFone was $275,000 in2007 and $616,000 in 2006. The decrease was due to the full amortization of certain intangibles during 2006.Our acquired in-process research and development decreased from $1.5 million in 2006 to $59,000 in 2007. The IPR&D chargerecorded in 2006 was related to the development of new games by iFone and the IPR&D charge recorded in 2007 was related to thedevelopment of new games by MIG. We determined the value of acquired IPR&D from iFone and MIG using a discounted cash flowsapproach taking into account the percentage of completion of the development effort and the risks associated with our developingtechnology given changes in trends and technology in our industry.In 2007, we recorded a one time gain on sale of assets of $1.0 million related to the sale of ProvisionX software to a third party inFebruary 2007. Under the terms of the agreement, we will co-own the intellectual property rights to the ProvisionX software, excluding anyalterations or modifications following the sale, by the third party.43Table of ContentsOther Income (Expense), netInterest and other income (expense), net, increased from expense of $872,000 in 2006 to income of $2.0 million in 2007. Thisincrease was primarily due to an increase of $2.3 million of interest income resulting from the investment of proceeds from our IPO, and adecrease of mark-to-market expense on our warrants to purchase preferred stock of $1.0 million offset by an $806,000 write-down ofcertain auction rate securities in the fourth quarter of 2007.Income Tax Benefit (Provision)Income tax benefit (provision) increased from a provision of $185,000 in 2006 to a benefit of $265,000 in 2007 as a result of ourdecision to monetize research and development expenditures in the United Kingdom that would have otherwise given rise to net operatingloss carryforwards offset by an increase in withholding taxes due to higher revenues in countries with withholding tax requirements.Comparison of the Years Ended December 31, 2006 and 2005Revenues Year Ended December 31, 2006 2005 (In thousands) Revenues $46,166 $25,651 Our revenues increased $20.5 million, or 80.0%, from $25.7 million in 2005 to $46.2 million in 2006, almost entirely as a resultof volume increases. The increase resulted from sales of games that we have released in 2006, including Ice Age 2, Diner Dash andSuper K.O. Boxing, and sales of games acquired from iFone. Revenues in 2006 from games released in 2006 were $12.6 million.Revenues from iFone games from March 29, 2006, when we acquired iFone, to December 31, 2006 totaled approximately $8.7 million,primarily in Europe and the United States. Revenues in 2006 from games released prior to 2006 declined by $767,000 from the revenuesderived from those games in 2005. By utilizing our carrier relationships and our marketing and development resources, we were able toincrease worldwide distribution and handset porting of iFone games and thus to increase significantly the revenues derived from thelicenses that we acquired from iFone. Revenues from our top ten games increased from $13.5 million in 2005 to $24.6 million in 2006.International revenues, defined as revenues generated from carriers whose principal operations are located outside the United States,increased $10.0 million from $10.7 million in 2005 to $20.7 million in 2006. A majority of this increase resulted from the acquisition ofiFone in 2006.Cost of Revenues Year Ended December 31, 2006 2005 (In thousands) Cost of revenues: Royalties $13,713 $7,256 Impairment of prepaid royalties and guarantees 355 1,645 Amortization of intangible assets 1,777 2,823 Impairment of intangible assets — 1,103 Total cost of revenues $15,845 $12,827 Revenues $46,166 $25,651 Gross margin 65.7% 50.0%Our cost of revenues increased $3.0 million, or 23.5%, from $12.8 million in 2005 to $15.8 million in 2006. The increase resultedfrom an increase in royalties, which was offset by a decrease in impairment of prepaid royalties and guarantees, a decrease in impairmentof intangible assets, and a decrease in amortization of acquired44Table of Contentsintangible assets. Royalties increased $6.5 million principally because of higher revenues with associated royalties, including thoseacquired from iFone. Revenues attributable to games based upon branded intellectual property increased as a percentage of revenues from80.5% in 2005 to 88.4% in 2006. The average royalty rate that we paid on games based on licensed intellectual property decreased from35% in 2005 to 34% in 2006. As a result of the increase in revenues from branded titles, overall royalties as a percentage of total revenuesincreased from 28% to 30%. Royalties incurred related to games acquired from iFone totaled $2.7 million in 2006. Amortization ofintangible assets decreased by $1.0 million as completion of amortization in 2006 for certain intangible assets acquired from Macrospacewas only partially offset by the commencement of amortization of intangible assets acquired in 2006 from iFone.Gross MarginOur gross margin increased from 50.0% in 2005 to 65.7% in 2006 because of the decreased amortization of intangible assets andthe decreased impairment of prepaid royalties and intangible assets in 2006 partially offset by the increase in royalties. Without the effectof amortization and impairment of acquired intangible assets, our gross margin would have been 65% and 70% in 2005 and 2006,respectively.Research and Development Expenses Year Ended December 31, 2006 2005 (In thousands) Research and development expenses $15,993 $14,557 Percentage of revenues 34.6% 56.8%Our research and development expenses increased $1.4 million, or 9.9%, from $14.6 million in 2005 to $16.0 million in 2006.The increase in research and development costs was primarily due to increases in allocated facilities costs of $1.0 million, salaries andbenefits of $267,000 and outside services costs of $117,000.A restructuring that we effected in the fourth quarter of 2005 resulted in the elimination of 17 research and development employees,but by December 31, 2006 our research and development staff had increased by 28 employees from a year earlier and salaries andbenefits had increased as a result. Research and development expenses included stock-based compensation expense in 2005 of $158,000and $207,000 in 2006. As a percentage of revenues, research and development expenses declined from 56.8% in 2005 to 34.6% in 2006.Sales and Marketing Expenses Year Ended December 31, 2006 2005 (In thousands) Sales and marketing expenses $11,393 $8,515 Percentage of revenues 24.7% 33.2%Our sales and marketing expenses increased $2.9 million, or 33.8%, from $8.5 million in 2005 to $11.4 million in 2006. Most ofthe increase was attributable to a $1.7 million increase in salaries and benefits, as we maintained our sales and marketing headcount at 32in 2005 and increased our sales and marketing headcount from 32 to 41 in 2006, a $909,000 increase in allocated facilities costs and a$190,000 increase in stock-based compensation. We increased staffing to expand our marketing efforts for our games and the Glu brand,to increase sales efforts to our new and existing wireless carriers and to expand our sales and marketing operations into the Asia-Pacificand Latin America regions. Aside from the increase in headcount in our sales and marketing functions, the increase in salaries andbenefits cost was due to an increase in variable compensation of $391,000, primarily an increase in commissions paid to our salesemployees as a result of higher revenue attainment, and $316,000 in compensation for transitional employees from iFone who wereterminated throughout the second and third quarters of 2006. As a percentage of revenues, sales and marketing expenses declined from33.2% in 2005 to 24.7% in 2006 as our sales45Table of Contentsand marketing activities generated more revenues across a greater number of carriers and mobile handsets. Sales and marketing expensesincluded $132,000 of stock-based compensation expense in 2005 and $322,000 in 2006.General and Administrative Expenses Year EndedDecember 31, 2006 2005 (In thousands) General and administrative expenses $12,072 $8,434 Percentage of revenues 26.1% 32.9%Our general and administrative expenses increased $3.6 million, or 43.1%, from $8.4 million in 2005 to $12.1 million in 2006. Theincrease in general and administrative expenses was primarily the result of a $2.0 million increase in salaries and benefits and a$1.9 million increase in consulting and professional fees partially offset by a reduction in allocated facilities costs of $298,000. Weincreased our general and administrative headcount from 13 to 37 in 2005 and from 37 to 43 in 2006. Aside from the increase inheadcount in our general and administrative functions, the increase in salaries and benefits costs was due to $234,000 in compensationfor transitional employees from iFone, most of whom were terminated during the second and third quarters of 2006. As a percentage ofrevenues, general and administrative expenses declined from 32.9% in 2005 to 26.1% in 2006 as a result of the overall growth of ourrevenues, which resulted in economies of scale in our general and administrative expenses. General and administrative expenses includedstock-based compensation expense of $1.0 million in 2005 and $1.2 million in 2006.Other Operating ExpensesOur amortization of intangible assets, such as non-competition agreements, acquired from Macrospace and iFone was $616,000 inboth 2005 and 2006.We had no restructuring charge in 2006; our 2005 restructuring charge was $450,000. In December 2005, we undertookrestructuring activities in order to reduce operating expenses. We eliminated 27 positions, of which 17 were in research and development,four were in sales and marketing and six were in general and administrative. Of the total restructuring charge recorded, $225,000 wasrecorded in the United States and $225,000 was recorded in Europe. These restructuring costs were paid in full by March 31, 2006.Our acquired in-process research and development increased from $0 in 2005 to $1.5 million in 2006. The IPR&D charge recordedin 2006 was related to the development of new games. We determined the value of acquired IPR&D using a discounted cash flowsapproach. We calculated the present value of expected future cash flows attributable to the in-process technology using a 21% discountrate. This rate took into account the percentage of completion of the development effort of approximately 20% and the risks associatedwith our developing technology given changes in trends and technology in our industry. As of December 31, 2006, all acquired IPR&Dprojects had been completed at a cost similar to the original projections.Other Income (Expense), netInterest and other income (expense), net, decreased from income of $541,000 in 2005 to expense of $872,000 in 2006. This decreasewas primarily due to a $1.0 million expense resulting from an increase in the estimated fair value of warrants issued to Pinnacle Venturesin conjunction with our loan from them in May 2006 and $1.0 million of interest expense on that loan in 2006. The warrants are subjectto revaluation at each balance sheet date and any changes in estimated fair value will be recorded as a component of other income(expense). The increase in the estimated fair value of the warrant was due to an increase in the estimated fair value of the underlyingpreferred stock in 2006. These expenses were partially offset by increased foreign currency transaction gains of $584,000 and byincreased interest income of $82,000 in 2006.46Table of ContentsIncome Tax Benefit (Provision)Income tax benefit (provision) decreased from a benefit of $1.6 million in 2005 to a provision of $185,000 in 2006 as a result ofchanges in the valuation allowance.Quarterly Results of OperationsThe following table sets forth unaudited quarterly consolidated statements of operations data for 2007 and 2006. We derived thisinformation from unaudited consolidated financial statements, which we prepared on the same basis as our audited consolidated financialstatements contained in this prospectus. In our opinion, these unaudited statements include all adjustments, consisting only of normalrecurring adjustments, that we consider necessary for a fair statement of that information when read in conjunction with the consolidatedfinancial statements and related notes included elsewhere in this Annual Report on Form 10-K. The operating results for any quartershould not be considered indicative of results for any future period. For the Three Months Ended 2007 2006 March 31 June 30 September 30 December 31(1) March 31 June 30 September 30 December 31 (In thousands) Revenues $15,698 $16,377 $16,651 $18,141 $8,073 $11,443 $12,347 $14,303 Cost of revenues: Royalties 4,292 4,388 4,587 5,114 2,538 3,465 3,653 4,057 Impairment of prepaid royalties andguarantees — — — — 60 198 60 37 Amortization of intangible assets 552 553 483 613 118 553 553 553 Total cost of revenues 4,844 4,941 5,070 5,727 2,716 4,216 4,266 4,647 Gross profit 10,854 11,436 11,581 12,414 5,357 7,227 8,081 9,656 Operating expenses: Research and development 4,713 5,577 5,863 6,272 3,189 3,884 4,273 4,647 Sales and marketing 3,075 3,131 3,326 3,692 2,202 3,126 2,989 3,076 General and administrative 4,009 4,263 4,149 4,477 1,852 2,655 3,177 4,388 Amortization of intangible assets 67 67 67 74 154 154 168 140 Acquired in-process research anddevelopment — — — 59 1,500 — — — Gain on sale of assets (1,040) — — — — — — — Total operating expenses 10,824 13,038 13,405 14,574 8,897 9,819 10,607 12,251 Loss from operations 30 (1,602) (1,824) (2,160) (3,540) (2,592) (2,526) (2,595)Interest and other income (expense), net (522) 1,017 1,299 171 152 50 (1,106) 32 Loss before income taxes (492) (585) (525) (1,989) (3,388) (2,542) (3,632) (2,563)Income tax benefit (provision) (272) (313) (228) 1,078 (106) (139) (192) 252 Net loss $(764) $(898) $(753) $(911) $(3,494) $(2,681) $(3,824) $(2,311)(1)We acquired iFone on March 29, 2006 and MIG on December 19, 2007, and our results of operations include the results ofoperations of iFone and MIG after those dates.47Table of ContentsThe following table sets forth our historical results, for the periods indicated, as a percentage of our revenues. For the Three Months Ended 2007 2006 March 31 June 30 September 30 December 31 March 31 June 30 September 30 December 31 Revenues 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of revenues: Royalties 27.3 26.8 27.5 28.2 31.4 30.3 29.6 28.4 Impairment of prepaid royalties andguarantees — — — — 0.7 1.7 0.5 0.3 Amortization of intangible assets 3.5 3.4 2.9 3.4 1.5 4.8 4.5 3.9 Total cost of revenues 30.9 30.2 30.4 31.6 33.6 36.8 34.6 32.5 Gross profit 69.1 69.8 69.6 68.4 66.4 63.2 65.4 67.5 Operating expenses: Research and development 30.0 34.1 35.2 34.6 39.5 33.9 34.6 32.5 Sales and marketing 19.6 19.1 20.0 20.4 27.3 27.3 24.2 21.5 General and administrative 25.5 26.0 24.9 24.7 22.9 23.2 25.7 30.7 Amortization of intangible assets 0.4 0.4 0.4 0.4 1.9 1.3 1.4 1.0 Acquired in-process research anddevelopment — — — 0.3 18.6 — — — Gain on sale of assets (6.6) — — — — — — — Total operating expenses 69.0 79.6 80.5 80.3 110.2 85.8 85.9 85.7 Loss from operations 0.2 (9.8) (11.0) (11.9) (43.8) (22.7) (20.5) (18.1)Interest and other income/(expense), net (3.3) 6.2 7.8 0.9 1.9 0.4 (9.0) 0.2 Loss before income taxes (3.1) (3.6) (3.2) (11.0) (42.0) (22.2) (29.4) (17.9)Income tax benefit (provision) (1.7) (1.9) (1.4) 5.9 (1.3) (1.2) (1.6) 1.8 Net loss (4.9)% (5.5)% (4.5)% (5.0)% (43.3)% (23.4)% (31.0)% (16.2)%Our revenues generally increased in conjunction with the introduction of new games, the expansion of our wireless carrierdistribution channel and the porting of our games to additional mobile handsets. Revenues in the second, third and fourth quarters of2006 were favorably impacted by revenues generated from increased porting and distribution of games acquired from iFone in late March2006.Many new mobile handset models are released in the fourth calendar quarter to coincide with the holiday shopping season. Becausemany end users download our games soon after they purchase new handsets, we may experience seasonal sales increases based on thiskey holiday selling period. However, due to the time between handset purchases and game purchases, most of this holiday impact occursfor us in our first quarter. For a variety of reasons, we may experience seasonal sales decreases during the summer, particularly inEurope, which is predominantly reflected in our third quarter. In addition to these possible seasonal patterns, we seek to release many ofour games in conjunction with specific events, such as the release of a movie or console game. Initial spikes in revenues as a result ofsuccessful new releases may create further aberrations in our revenue patterns.Our cost of revenues increased over the above periods as a result of increased royalty payments to licensors and developers causedby increased revenues. However, our cost of revenues did not increase consistently in all quarters of 2006 because of periodic impairmentcharges and, in the first quarter of 2006, a significant reduction in amortization of intangible assets because a substantial part of theintangible assets acquired from Macrospace became fully amortized in December 2005. Amortization of intangible assets increased in thesecond quarter of 2006 following the acquisition of iFone and in the fourth quarter of 2007 following the acquisition of MIG.Our quarterly research and development, sales and marketing and general administrative expenses generally increased sequentiallyin all quarters as we continued to add headcount and related costs to accommodate the growing business on a quarterly basis.48Table of ContentsOur acquired in-process research and development expense in the first quarter of 2006 related to in-process projects assumed in the2006 acquisition of iFone for which feasibility had not been established and no future alternative uses existed. Our acquired in-processresearch and development expense in the fourth quarter of 2007 related to certain in-process projects assumed in the 2007 acquisition ofMIG.Our gain on sale of assets in the first quarter of 2007 related to the net proceeds from the sale of our ProvisionX software to a thirdparty.We adopted FSP 150-5 in July 2005 and thus, we recorded the change in estimated fair value of our outstanding warrants topurchase preferred stock as part of interest and other income (expense), net during all quarters of 2006 and the first quarter of 2007 untilthe warrants automatically converted into warrants to purchase common stock upon the completion of our IPO and therefore, the warrantswere no longer subject to remeasurement. Additionally, we entered into a loan agreement in May 2006 recording the amortization of interestexpense and debt issuance costs in all subsequent quarters until the loan was repaid in the first quarter of 2007. In March 2007, we raised$74.8 million of net proceeds from our IPO resulting in increased quarterly interest income due to higher cash and short-term investmentbalances. In the fourth quarter of 2007, we recorded a write-down of $806,000 related to auction-rate securities that we determined had another-than-temporary decline in fair value.During the fourth quarter of 2007, we recognized a tax benefit of approximately $1.5 million relating to monetized research anddevelopment expenditures in the United Kingdom that would otherwise give rise to net operating loss carryforwards. During the fourthquarter of 2006, we recognized a tax benefit of approximately $300,000 relating to an adjustment to the Macrospace acquired balancesheet, which increased the amount of deferred tax liabilities recorded in connection with this acquisition. This benefit should have beenrecorded in the first quarter of 2006. There was no impact of this out-of-period adjustment on our 2006 results of operations. Managementhas determined that this correction was immaterial to all periods impacted.During the fourth quarter of 2007, we recorded adjustments related to cost of revenues and operating expenses. The correctionsresulted in a net $191,000 reduction to loss before income taxes related to prior quarters. These adjustments would have decreased thereported net loss per share for the three months ended September 30, 2007 ($0.03 per share) by $0.01 per share (to $0.02 per share). Weand the audit committee of our board of directors believe that such amounts are not material to previously reported financial statements.These adjustments had an immaterial impact on the reported net loss for the years end December 31, 2007, 2006 and 2005.Liquidity and Capital Resources Year Ended December 31, 2007 2006 2005 (In thousands) Consolidated Statement of Cash Flows Data: Capital expenditures $2,343 $2,047 $3,006 Cash flows used in operating activities (951) (11,018) (10,339)Cash flows (used in) provided by investing activities (8,227) 1,007 (16,706)Cash flows provided by financing activities 62,923 11,252 26,692 Since our inception, we have incurred recurring losses and negative annual cash flows from operating activities, and we had anaccumulated deficit of $52.4 million as of December 31, 2007. Our primary sources of liquidity since our inception through our IPO inMarch 2007 have historically been private placements of shares of our preferred stock with aggregate proceeds of $57.4 million andborrowings under our credit facilities with aggregate proceeds of $12.0 million.In March 2007, we completed our IPO of common stock in which we sold and issued 7,300,000 shares at an issue price of $11.50per share. We raised a total of $83.9 million in gross proceeds from our IPO, or approximately $74.8 million in net proceeds afterdeducting underwriting discounts and commissions of $5.9 million and other offering costs of $3.3 million.49Table of ContentsOperating ActivitiesIn 2007, we used $1.0 million of net cash in operating activities as compared to $11.0 million in 2006. This decrease was primarilydue to a reduction in our net loss by $9.0 million and increases in accounts payable and stock-based compensation of $3.5 million and$2.1 million, respectively. Cash used for prepaid and accrued royalties increased from 2006 to 2007 by $1.8 million and $1.9 million,respectively. We expect to continue to use cash in our operating activities during at least the first half of 2008 because of anticipated netlosses and expected growth in our accounts receivable balance due to the expected growth in our revenues. Additionally, we may decide toenter into new licensing arrangements for existing or new licensed intellectual properties that may require us to make royalty payments atthe outset of the agreement. If we do sign these agreements, this could significantly increase our future use of cash in operating activities.In 2006, we used $11.0 million of net cash in operating activities as compared to $10.3 million in 2005. This increase wasprimarily due to increased payments of our current liabilities. Cash used for accounts payable, accrued liabilities, accrued royalties andaccrued restructuring charge increased from 2005 to 2006 by $3.4 million, $1.5 million, $963,000 and $1.7 million, respectively. Thisincrease was due primarily to the payment of liabilities assumed as a part of the iFone acquisition and more timely payment of our third-party royalties in 2006. This increase was offset in part by a decline in our net loss of $5.6 million from 2005 to 2006, a charge foracquired in-process research and development of $1.5 million in 2006 and a decline in our deferred income tax of $1.5 million from2005 to 2006. We expect to continue to use cash in our operating activities during at least the first half of 2008 because of anticipated netlosses and expected growth in our accounts receivable balance due to the expected growth in our revenues. Additionally, we may decide toenter into new licensing arrangements for existing or new licensed intellectual properties that may require us to make royalty payments atthe outset of the agreement. If we do sign these agreements, this could significantly increase our future use of cash in operating activities.Investing ActivitiesOur primary investing activities have consisted of purchases and sales of short-term investments, purchases of property andequipment and, in 2007 and 2006, the acquisitions of MIG and iFone, respectively. We expect to use more cash in investing activities in2008 including $36.6 million (based on the March 7, 2008 closing exchange rate between British pound sterling and United States dollarof $1.9969) for the acquisition of Superscape as well as amounts for property and equipment related to the moving of our companyheadquarters in March 2008. We expect to fund these investments with our existing cash, cash equivalents and short-term investments.In 2007, we used $8.2 million of cash in investing activities. This net use of cash resulted from the acquisition of MIG, net of cashacquired, of $12.9 million, the purchase of property and equipment of $2.3 million offset by the net sales of short-term investments of$6.0 million and proceeds from the sale of ProvisionX software of $1.0 million.In 2006, we generated $1.0 million as net cash from investing activities. This net cash resulted from net sales of short-terminvestments of $10.5 million, partially offset by the acquisition of iFone for cash and stock, net of cash acquired, of $7.4 million andpurchases of property and equipment of $2.0 million.In 2005, we used $16.7 million of net cash in investing activities, $13.7 million of which represented net purchases of short-terminvestments and the remaining $3.0 million of which represented purchases of property and equipment, such as our enterprise resourceplanning, or ERP, system and our revenue data warehouse.Financing ActivitiesPrior to our IPO in March 2007, substantially all of our financing came from sales of preferred stock or loans.In 2007, we generated $62.9 million of net cash from financing activities, substantially all of which came from the net proceeds ofour IPO of $74.8 million offset by the repayment of a loan from Pinnacle Ventures of $12.1 million.In 2006, we generated $11.3 million of net cash from financing activities, substantially all of which came from the proceeds of aloan from Pinnacle Ventures.50Table of ContentsIn 2005, we generated $26.7 million of net cash from financing activities, substantially all of which came from the issuance andsale of our preferred stock. We used $1.1 million to repay debt issued in connection with the Macrospace acquisition.Sufficiency of Current Cash, Cash Equivalents and Short-Term InvestmentsOur cash, cash equivalents and short-term investments were $59.8 million as of December 31, 2007. We believe that our cash, cashequivalents and short-term investments and any cash flow from operations will be sufficient to meet our anticipated cash needs, includingfor working capital purposes, capital expenditures and various contractual obligations, for at least the next 12 months. We may, however,require additional cash resources due to changed business conditions or other future developments, including any investments oracquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirements, we may seek to sell debtsecurities or additional equity securities or to obtain a credit facility. The sale of convertible debt securities or additional equity securitiescould result in additional dilution to our stockholders. The incurrence of indebtedness would result in debt service obligations and couldresult in operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additionalfinancing will be available on acceptable terms, if at all.We anticipate that, from time to time, we may evaluate acquisitions of complementary businesses, technologies or assets. We arecurrently are in the process of acquiring all outstanding shares of Superscape. Upon completion of the tender offer for all outstandingshares, we will be required to pay approximately $36.6 million (based on the March 7, 2008 closing exchange rate between British poundsterling and United States dollar of $1.9969) in cash to its shareholders.Contractual ObligationsThe following table is a summary of our contractual obligations as of December 31, 2007: Payments Due by Period Less than Total 1 Year 1-3 Years 3-5 Years Thereafter (In thousands) Operating lease obligations $9,570 $2,637 $6,238 $695 — Guaranteed royalties(1) 11,507 7,655 3,427 425 — FIN 48 obligations, including interest and penalties(2) 3,918 — — — 3,918 (1)We have entered into license and development arrangements with various owners of brands and other intellectual property so thatwe can create and publish games for mobile handsets based on that intellectual property. Pursuant to some of these agreements, weare required to pay guaranteed royalties over the term of the contracts regardless of actual game sales. Certain of these minimumpayments totaling $7.9 million have been recorded as liabilities in our consolidated balance sheet because payment is notcontingent upon performance by the licensor.(2)As of December 31, 2007, unrecognized tax benefits and potential interest and penalties are classified within “Other long-termliabilities” on our consolidated balance sheets. As of December 31, 2007, the settlement of our income tax liabilities cannot bedetermined, however, the liabilities are not expected to become due within the next twelve months.Off-Balance Sheet ArrangementsAt December 31, 2007 and 2006, we did not have any relationships with unconsolidated entities or financial partners, such asentities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowingsor debt, and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market orcredit risk that could arise if we had engaged in such relationships.51Table of ContentsRecent Accounting PronouncementsIn September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, Fair Value Measurements(“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but providesguidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. SFAS 157 iseffective for fiscal years beginning after November 15, 2007. However, on February 12, 2008, the FASB issued FSP FAS 157-2 whichdelays the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosedat fair value in the financial statements on a recurring basis (at least annually). This FSP partially defers the effective date of Statement157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of thisFSP. Effective for 2008, we will adopt SFAS 157 except as it applies to those non-financial assets and non-financial liabilities as noted inFSP FAS 157-2. The partial adoption of SFAS 157 is not expected to have a material impact on our consolidated financial position,results of operations or cash flows.In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for FinancialAssets and Financial Liabilities — Including an amendment of FASB Statement No. 11 (“SFAS 159”). SFAS 159 expands the use offair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. The objective ofSFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earningscaused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. UnderSFAS 159, a company may elect to use fair value to measure eligible items at specified election dates and report unrealized gains andlosses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Eligible items include butare not limited to, accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accountspayable, guarantees, issued debt and firm commitments. If elected, SFAS 159 is effective beginning January 1, 2008. We are currentlyevaluating whether we will elect to adopt SFAS 159 and if elected to adopt, the impact of the adoption of the provisions of SFAS 159 onour financial position, results of operations and cash flows.In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141Restablishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. SFAS 141R also establishesdisclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141R is effective asof the beginning of an entity’s fiscal year that begins after December 15, 2008, and will be adopted by us in the first quarter of fiscal2009. We are currently evaluating the impact, if any, of the adoption of the provisions of SFAS 141R on our financial position, results ofoperations and cash flows.Item 7A. Quantitative and Qualitative Disclosures about Market RiskInterest Rate and Credit RiskWe have exposure to interest rate risk that relates primarily to our investment portfolio. All of our current investments are classifiedas cash equivalents or short-term investments. We do not currently use or plan to use derivative financial instruments in our investmentportfolio. The risk associated with fluctuating interest rates is limited to our investment portfolio, and we do not believe that a 10% changein interest rates would have a significant impact on our interest income, operating results or liquidity.As of December 31, 2007, we had $2.8 million of principal invested in auction-rate securities, all of which were rated AAA at thetime of purchase. Auction-rate securities are long-term variable rate bonds tied to short-term interest rates. After the initial issuance of thesecurities, the interest rate on the securities is reset periodically, at intervals established at the time of issuance (e.g., every seven, 28, or35 days; every six months; etc.), based on market demand for a reset period. The “stated” or “contractual” maturities for these securities,however, generally are 20 to 30 years. Auction-rate securities are bought and sold in the marketplace through a competitive bidding processoften referred to as a “Dutch auction”. If there is insufficient interest in the securities at the time of an52Table of Contentsauction, the auction may not be completed and the rates may be reset to predetermined “penalty” or “maximum” rates. The monthlyauctions historically have provided a liquid market for these securities. Following a failed auction, we would not be able to access ourfunds that are invested in the corresponding auction-rate securities until a future auction of these investments is successful or new buyersexpress interest in purchasing these securities in between reset dates.Given the current negative liquidity conditions in the global credit and capital markets, the auction-rate securities held by us atDecember 31, 2007 have experienced multiple failed auctions as the amount of securities submitted for sale has exceeded the amount ofpurchase orders. The underlying assets of our auction-rate securities are corporate bonds. If the underlying issuers are unable tosuccessfully clear future auctions or if their credit rating deteriorates and the deterioration is deemed to be other-than-temporary, we wouldbe required to adjust the carrying value of the auction-rate securities through an impairment charge to earnings. Any of these events couldmaterially affect our results of operations and our financial condition. For example, in the fourth quarter of 2007, we have recorded a pre-tax impairment charge of $806,000 reflecting the decrease in estimated value of our auction-rate securities as of December 31, 2007 thatwere determined to be other-than-temporary as a result of two failed auctions.As of December 31, 2006, the contractual maturities of investments held were greater than five years. However, we had the abilityand intent, if necessary, to liquidate any of these investments as needed in order to meet our needs within our normal operating cycles.Accordingly, all investments were classified as current assets on the consolidated balance sheets. As of December 31, 2007 and 2006, allauction rate securities were included in short-term investments. As of December 31, 2007, the contractual maturities of our remaining twoauction rate securities were 2017. Although we may not have the ability to liquidate these investments within one year of the balance sheetdate, we may need to sell the securities within the next year to fund operations. Accordingly, the investments were classified as currentassets on the consolidated balance sheets.The credit and capital markets have continued to deteriorate in 2008. If uncertainties in these markets continue, these marketsdeteriorate further or we experience any additional ratings downgrades on any investments in its portfolio (including on auction-ratesecurities), we may incur additional impairments to our investment portfolio, which could negatively affect our financial condition, cashflow and reported earnings.As of December 31, 2007 and 2006, our cash and cash equivalents were maintained by financial institutions in the United States,the United Kingdom, Brazil, Chile, China, France, Germany, Hong Kong, Italy and Spain and our current deposits are likely in excessof insured limits. We believe that the financial institutions that hold our investments are financially sound and, accordingly, minimalcredit risk exists with respect to these investments.Our accounts receivable primarily relate to revenues earned from domestic and international wireless carriers. We perform ongoingcredit evaluations of our carriers’ financial condition but generally require no collateral from them. As of December 31, 2007, VerizonWireless accounted for 23.5% of our total accounts receivable and no other carrier represented more than 10% of our total accountsreceivable. As of December 31, 2006, Verizon Wireless, Sprint Nextel and Vodafone accounted for 20.8%, 10.5% and 9.5% of our totalaccounts receivable, respectively.Foreign Currency RiskThe functional currencies of our United States and United Kingdom operations are the United States Dollar, or USD, and thepound sterling, respectively. A significant portion of our business is conducted in currencies other than the USD or the pound sterling.Our revenues are usually denominated in the functional currency of the carrier. Operating expenses are usually in the local currency of theoperating unit, which mitigates a portion of the exposure related to currency fluctuations. Intercompany transactions between our domesticand foreign operations are denominated in either the USD or the pound sterling. At month-end, foreign currency-denominated accountsreceivable and intercompany balances are marked to market and unrealized gains and losses are included in other income (expense), net.53Table of ContentsOur foreign currency exchange gains and losses have been generated primarily from fluctuations in the pound sterling versus theUSD and in the Euro versus the pound sterling. It is uncertain whether these currency trends will continue. In the future, we mayexperience foreign currency exchange losses on our accounts receivable and intercompany receivables and payables. Foreign currencyexchange losses could have a material adverse effect on our business, operating results and financial condition.There is also additional risk if the currency is not freely or actively traded. Some currencies, such as the Chinese Renminbi, inwhich our Chinese operations principally transact business, are subject to limitations on conversion into other currencies, which canlimit out ability to react to foreign currency devaluations.InflationWe do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costswere to become subject to significant inflationary pressures, we might not be able to offset these higher costs fully through price increases.Our inability or failure to do so could harm our business, operating results and financial condition.54Table of ContentsItem 8. Financial Statements and Supplementary DataGLU MOBILE INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageGlu Mobile Inc. Consolidated Financial Statements Report of Independent Registered Public Accounting Firm 56 Consolidated Balance Sheets 57 Consolidated Statements of Operations 58 Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity/(Deficit) 59 Consolidated Statements of Cash Flows 60 Notes to Consolidated Financial Statements 61 55Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and StockholdersGlu Mobile Inc.:In our opinion, the consolidated balance sheets and the related consolidated statements of operations, of redeemable convertiblepreferred stock and stockholder’s equity/(deficit) and of cash flows present fairly, in all material respects, the financial position of GluMobile Inc. and its subsidiaries at December 31, 2007 and 2006, and the results of their operations and their cash flows for each of thethree years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States ofAmerica. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion onthese financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits providea reasonable basis for our opinion.As discussed in Note 3 to the consolidated financial statements, the Company adopted FASB Staff Position 150-5 (“FSP 150-5”)Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That AreRedeemable, during the year ended December 31, 2005. As discussed in Note 13 to the consolidated financial statements, effectiveJanuary 1, 2006, the Company adopted SFAS No. 123(R), Share Based Payment. As discussed in Note 14 to the consolidated financialstatements, effective January 1, 2007, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes./s/ PricewaterhouseCoopers LLPSan Jose, CaliforniaMarch 31, 200856Table of ContentsGLU MOBILE INC.CONSOLIDATED BALANCE SHEETS As of December 31, 2007 2006 (In thousands, except pershare data) ASSETSCurrent assets: Cash and cash equivalents $57,816 $3,823 Short-term investments 1,994 8,750 Accounts receivable, net of allowance of $368 and $466 at December 31, 2007 and 2006, respectively 18,369 14,448 Prepaid royalties 10,643 3,501 Prepaid expenses and other 2,589 853 Total current assets 91,411 31,375 Property and equipment, net 3,817 3,480 Prepaid royalties 2,825 1,417 Other long-term assets 1,593 1,826 Intangible assets, net 14,597 4,974 Goodwill 47,262 38,727 Total assets $161,505 $81,799 LIABILITIES, REDEEMABLE CONVERTIBLE PREFERREDSTOCK AND STOCKHOLDERS’ EQUITY/(DEFICIT)Current liabilities: Accounts payable $6,427 $5,394 Accrued liabilities 217 1,048 Accrued compensation 2,322 2,013 Accrued royalties 12,759 7,030 Deferred revenues 640 178 Accrued restructuring charge — 36 Current portion of long-term debt — 4,339 Total current liabilities 22,365 20,038 Other long-term liabilities 9,679 1,343 Long-term debt, less current portion — 7,245 Preferred stock warrant liability — 1,995 Total liabilities 32,044 30,621 Commitments and contingencies (Note 8) Mandatorily Redeemable Convertible Preferred Stock (Series A — D-1), $0.0001 par value: 0 and 12,547 shares authorizedat December 31, 2007 and 2006; 0 and 12,258 shares issued and outstanding at December 31, 2007 and 2006,(aggregate liquidation value at December 31, 2006: $57,447) — 57,265 Special Junior Redeemable Preferred Stock, $0.0001 par value: 0 and 4,485 shares authorized at December 31, 2007 and2006; 0 and 3,423 shares issued and outstanding at December 31, 2007 and 2006 (liquidation value at December 31,2006: $9,782) — 19,098 — 76,363 Stockholders’ equity/(deficit); Preferred stock, $0.001 par value; 5,000 and 0 shares authorized at December 31, 2007 and 2006; no shares issued andoutstanding at December 31, 2007 and 2006 Common stock, $0.0001 par value: 250,000 and 33,333 shares authorized at December 31, 2007 and 2006; 29,023 and5,457 shares issued and outstanding at December 31, 2007 and 2006 3 1 Additional paid-in capital 179,924 19,894 Deferred stock-based compensation (113) (388)Accumulated other comprehensive income/(loss) 2,080 1,285 Accumulated deficit (52,433) (45,977)Total stockholders’ equity/(deficit) 129,461 (25,185)Total liabilities, redeemable convertible preferred stock and stockholders’ equity/(deficit) $161,505 $81,799 The accompanying notes are an integral part of these consolidated financial statements.57Table of ContentsGLU MOBILE INC.CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, 2007 2006 2005 (In thousands, except per share data) Revenues $66,867 $46,166 $25,651 Cost of revenues: Royalties 18,381 13,713 7,256 Impairment of prepaid royalties and guarantees — 355 1,645 Amortization of intangible assets 2,201 1,777 2,823 Impairment of intangible assets — — 1,103 Total cost of revenues 20,582 15,845 12,827 Gross profit 46,285 30,321 12,824 Operating expenses: Research and development 22,425 15,993 14,557 Sales and marketing 13,224 11,393 8,515 General and administrative 16,898 12,072 8,434 Amortization of intangible assets 275 616 616 Restructuring charge — — 450 Acquired in-process research and development 59 1,500 — Gain on sale of assets (1,040) — — Total operating expenses 51,841 41,574 32,572 Loss from operations (5,556) (11,253) (19,748)Interest and other income/(expense), net: Interest income 2,953 682 600 Interest expense (880) (1,063) (77)Other income/(expense), net (108) (491) 18 Interest and other income/(expense), net 1,965 (872) 541 Loss before income taxes and cumulative effect of change in accounting principle (3,591) (12,125) (19,207)Income tax benefit/(provision) 265 (185) 1,621 Loss before cumulative effect of change in accounting principle (3,326) (12,310) (17,586)Cumulative effect of change in accounting principle — — (315)Net loss (3,326) (12,310) (17,901)Accretion to preferred stock (17) (75) (63)Deemed dividend (3,130) — — Net loss attributable to common stockholders $(6,473) $(12,385) $(17,964)Net loss per share attributable to common stockholders — basic and diluted: Loss before cumulative effect of change in accounting principle $(0.14) $(2.48) $(4.37)Cumulative effect of change in accounting principle — — (0.07)Accretion to preferred stock — (0.02) (0.02)Deemed dividend (0.14) — — Net loss per share attributable to common stockholders — basic and diluted $(0.28) $(2.50) $(4.46)Weighted average common shares outstanding 23,281 4,954 4,024 The accompanying notes are an integral part of these consolidated financial statements.58Table of ContentsGLU MOBILE INC.CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK ANDSTOCKHOLDERS’ EQUITY/(DEFICIT) Accumulated Redeemable Convertible Additional Deferred Other Total Preferred Stock Common Stock Paid-In Stock-based Comprehensive Accumulated Stockholders’ Comprehensive Shares Amount Shares Amount Capital Compensation Income (Loss) Deficit Equity/(Deficit) Loss (In thousands, except per share data) Balances at December 31, 2004 9,193 $31,495 4,704 1 17,177 (2,366) 8 (16,238) (1,418) Net loss — — — — — — — (17,901) (17,901) (17,901)Issuance of Series D Preferred Stock for cash at $9.03 pershare, net of issuance costs of $141 2,234 20,031 — — — — — — — — Issuance of Series D-1 Preferred Stock for cash at $9.03 pershare, net of issuance costs of $79 831 7,421 — — — — — — — — Issuance of common stock upon exercise of stock options — — 294 — 68 — — — 68 — Issuance of common stock — — 83 — 249 — — — 249 — Deferred stock-based compensation from options granted atbelow deemed fair value — — — — 1,129 (1,129) — — — — Amortization of employee deferred stock-based compensation — — — — — 1,487 — — 1,487 — Adjustment to deferred stock-based compensation forterminated employees — — — — (351) 351 — — — — Cancellation of unvested stock option issued to consultants — — — — (210) — — — (210) — Vesting of early exercised options — — — — 51 — — — 51 — Accretion to preferred stock redemption value — 63 — — (63) — — — (63) — Capital contribution — (1,820) — — 1,348 — — 472 1,820 — Reclassification of preferred stock warrants to liability uponadoption of FSP 150-5 — — — — (144) — — — (144) — Foreign currency translation adjustment — — — — — — (1,332) — (1,332) (1,332)Comprehensive loss — — — — — — — — — $(19,233)Balances at December 31, 2005 12,258 $57,190 5,081 $1 $19,254 $(1,657) $(1,324) $(33,667) $(17,393) Net loss — — — — — — — (12,310) (12,310) (12,310)Issuance of Special Junior Preferred Stock for iFone acquisition 3,423 19,098 — — — — — — — — Issuance of common stock upon exercise of stock options — — 342 — 194 — — — 194 — Issuance of common stock for no consideration — — 14 — 152 — — — 152 — Issuance of common stock upon exercise of warrants — — 20 — 7 — — — 7 — Elimination of deferred stock-based compensation on modifiedoptions — — — — (578) 578 — — — — Adjustment to deferred stock-based compensation forterminated employees — — — — (153) 153 — — — — Stock-based compensation expense — — — — 1,050 538 — — 1,588 — Vesting of early exercised options — — — — 43 — — — 43 — Accretion to preferred stock redemption value — 75 — — (75) — — — (75) — Foreign currency translation adjustment — — — — — — 2,609 — 2,609 2,609 Comprehensive loss — — — — — — — — — $(9,701)Balances at December 31, 2006 15,681 $76,363 5,457 $1 $19,894 $(388) $1,285 $(45,977) $(25,185) Net loss — — — — — — — (3,326) (3,326) (3,326)Proceeds from initial public offering of common stock, net ofissuance costs of $3,315 — — 7,300 — 74,758 — — — 74,758 — Automatic conversion of preferred stock to common stockupon completion of initial public offering (15,681) (76,380) 15,681 2 76,378 — — — 76,380 — Transfer of preferred stock warrant liability to additional paid-incapital — — — — 1,985 — — — 1,985 — Deemed dividend related to issuance of common stockwarrants — — — — 3,130 — — (3,130) — — Issuance of restricted stock — — 4 — 1 — — — 1 — Adjustment to deferred stock-based compensation forterminated employees — — — — (17) 17 — — — — Stock-based compensation expense — — — — 3,541 258 — — 3,799 — Vesting of early exercised options — — — — 46 — — — 46 — Accretion to preferred stock redemption value — 17 — — (17) — — — (17) — Issuance of common stock upon exercise of stock options — — 268 — 225 — — — 225 — Issuance of common stock upon exercise of warrants — — 313 — — — — — — — Foreign currency translation adjustment — — — — — — 795 — 795 795 Comprehensive loss — — — — — — — — — $(2,531)Balances at December 31, 2007 — — 29,023 $3 $179,924 $(113) $2,080 $(52,433) $129,461 The accompanying notes are an integral part of these consolidated financial statements.59Table of ContentsGLU MOBILE INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2007 2006 2005 (In thousands) Cash flows from operating activities: Net loss $(3,326) $(12,310) $(17,901)Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 2,116 1,503 816 Amortization of intangible assets 2,476 2,393 3,439 Stock-based compensation 3,799 1,740 1,277 Change in carrying value of preferred stock warrant liability 10 1,014 (85)Amortization of value related to warrants issued in connection with line of credit — — 20 Amortization of value of warrants issued in connection with loan 477 122 — Amortization of loan agreement costs 101 18 — Non-cash foreign currency remeasurement (gain)/loss (690) (522) (61)Acquired in-process research and development 59 1,500 — Impairment of prepaid royalties and guarantees — 355 1,645 Impairment of intangible assets — — 1,103 Write down of auction rate securities 806 — — Gain on sale of assets (1,040) — — Decrease in deferred income tax — (352) (1,863)Changes in allowance for doubtful accounts (94) 230 228 Changes in operating assets and liabilities, net of effect of acquisitions: Increase in accounts receivable (2,672) (4,176) (3,549)Increase in prepaid royalties (2,039) (258) (1,714)Decrease/(increase) in prepaid expenses and other assets (2,598) (1,497) 305 Increase/(decrease) in accounts payable 1,555 (1,982) 1,387 Increase/(decrease) in other accrued liabilities (1,270) (1,285) 182 Increase in accrued compensation 166 1,037 295 Increase in accrued royalties 642 2,505 3,468 Increase/(decrease) in deferred revenues 436 181 (75)Increase/(decrease) in accrued restructuring charge (36) (1,418) 273 Decrease in other long-term liabilities 171 184 471 Net cash used in operating activities (951) (11,018) (10,339)Cash flows from investing activities: Purchase of short-term investments (73,600) (24,850) (54,100)Sale of short-term investments 79,550 35,300 40,400 Purchase of property and equipment (2,343) (2,047) (3,006)Proceeds from sale of assets, net of delivery costs 1,040 — — Acquisition of MIG, net of cash acquired (12,874) — — Acquisition of iFone, net of cash acquired — (7,396) — Net cash provided by/(used in) investing activities (8,227) 1,007 (16,706)Cash flows from financing activities: Proceeds from issuance of preferred stock — — 27,672 Preferred stock issuance costs — — (220)Proceeds from loan agreement — 12,000 — Proceeds from issuance of common stock — — 249 Proceeds from initial public offering, net 74,758 — — Proceeds from exercise of stock options 225 194 69 Proceeds from exercise of stock warrants — 7 — Debt payments (12,060) (949) (1,078)Net cash provided by financing activities 62,923 11,252 26,692 Effect of exchange rate changes on cash 248 166 (124)Net increase/(decrease) in cash and cash equivalents 53,993 1,407 (477)Cash and cash equivalents at beginning of period 3,823 2,416 2,893 Cash and cash equivalents at end of period $57,816 $3,823 $2,416 Supplemental disclosures of cash flow information Interest paid $361 $912 $56 Income taxes paid $835 $487 $137 Supplemental disclosure of non-cash investing and financing activities Acquisition of iFone net assets — 19,018 — Demed dividend related to issuance of common stock warrants 3,130 — — Accretion of preferred stock to redemption value 17 75 63 Capital contribution — — 1,820 Fixed asset purchases financed through capital lease — — 114 Reclassification of preferred stock warrants to (from) liability from (to) additional paid-in capital (1,985) — 144 The accompanying notes are an integral part of these consolidated financial statements.60Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(In thousands, except per share data)NOTE 1 — THE COMPANYGlu Mobile Inc. (the “Company” or “Glu”) was incorporated as Cyent Studios, Inc. in Nevada on May 16, 2001 and changed itsname to Sorrent, Inc. On November 21, 2001, New Sorrent, Inc., a wholly owned subsidiary of the Company was incorporated inCalifornia. The Company and New Sorrent, Inc. merged on December 4, 2001 to form Sorrent, Inc., a California corporation. In May2005, the Company changed its name to Glu Mobile Inc. The Company is a leading global publisher of mobile games. Glu has developedand published a portfolio of more than 195 casual and traditional games to appeal to a broad cross section of subscribers served by theCompany’s more than 200 wireless carriers and other distributors. Glu creates games and related applications based on third-partylicensed brands and other intellectual property, as well as developing its own original brands and intellectual property.In March 2007, the Company completed its initial public offering (“IPO”) of common stock in which it sold and issued7,300 shares at an issue price of $11.50 per share. The Company raised a total of $83,950 in gross proceeds from the IPO, orapproximately $74,758 in net proceeds after deducting underwriting discounts and commissions of $5,877 and other offering costs of$3,315. Upon the closing of the IPO, all shares of redeemable convertible preferred stock outstanding automatically converted into15,680 shares of common stock.In connection with the IPO, in March 2007, the Company affected a 3-for-1 reverse stock split of its outstanding capital stock andderivative securities. All share numbers and exercises prices in these financial statements give effect to the reverse stock split.NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBasis of PresentationThe Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted inthe United States of America.Basis of ConsolidationThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All materialintercompany balances and transactions have been eliminated.Use of EstimatesThe preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principlesrequires the Company’s management to make judgments, assumptions and estimates that affect the amounts reported in its consolidatedfinancial statements and accompanying notes. Management bases its estimates on historical experience and on various other assumptionsit believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying valuesof assets and liabilities. Actual results may differ from these estimates and these differences may be material.Revenue RecognitionThe Company’s revenues are derived primarily by licensing software products in the form of mobile games. License arrangementswith the end user can be on a perpetual or subscription basis. A perpetual license gives an end user the right to use the licensed game onthe registered handset on a perpetual basis. A subscription license gives an end user the right to use the licensed game on the registeredhandset for a limited period of time, ranging from a few days to as long as one month. All games that require ongoing delivery of contentfrom the Company or connectivity through its network for multi-player functionality are only billed on a monthly subscription basis.The Company distributes its products primarily through mobile telecommunications service providers (“carriers”), which market61Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)the games to end users. License fees for perpetual and subscription licenses are usually billed by the carrier upon download of the gameby the end user. In the case of subscriber licenses, many subscriber agreements provide for automatic renewal until the subscriber opts-out, while the others provide opt-in renewal. In either case, subsequent billings for subscription licenses are generally billed monthly. TheCompany applies the provisions of Statement of Position 97-2, Software Revenue Recognition, as amended by Statement of Position98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions, to all transactions.Revenues are recognized from our games when persuasive evidence of an arrangement exists, the game has been delivered, the fee isfixed or determinable, and the collection of the resulting receivable is probable. For both perpetual and subscription licenses, managementconsiders a signed license agreement to be evidence of an arrangement with a carrier and a “clickwrap” agreement to be evidence of anarrangement with an end user. For these licenses, the Company defines delivery as the download of the game by the end user. TheCompany estimates revenues from carriers in the current period when reasonable estimates of these amounts can be made. Several carriersprovide reliable interim preliminary reporting and others report sales data within a reasonable time frame following the end of each month,both of which allow the Company to make reasonable estimates of revenues and therefore to recognize revenues during the reporting periodwhen the end user licenses the game. Determination of the appropriate amount of revenue recognized involves judgments and estimates thatthe Company believes are reasonable, but it is possible that actual results may differ from the Company’s estimates. The Company’sestimates for revenues include consideration of factors such as preliminary sales data, carrier-specific historical sales trends, the age ofgames and the expected impact of newly launched games, successful introduction of new handsets, promotions during the period andeconomic trends. When the Company receives the final carrier reports, to the extent not received within a reasonable time frame followingthe end of each month, the Company records any differences between estimated revenues and actual revenues in the reporting period whenthe Company determines the actual amounts. Historically, the revenues on the final revenue report have not differed by more than one halfof 1% of the reported revenues for the period, which the Company deemed to be immaterial. Revenues earned from certain carriers maynot be reasonably estimated. If the Company is unable to reasonably estimate the amount of revenues to be recognized in the currentperiod, the Company recognizes revenues upon the receipt of a carrier revenue report and when the Company’s portion of a game’slicensed revenues are fixed or determinable and collection is probable. To monitor the reliability of the Company’s estimates, management,where possible, reviews the revenues by carrier and by game on a weekly basis to identify unusual trends such as differential adoptionrates by carriers or the introduction of new handsets. If the Company deems a carrier not to be creditworthy, the Company defers allrevenues from the arrangement until the Company receives payment and all other revenue recognition criteria have been met.In accordance with Emerging Issues Task Force, or EITF Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Netas an Agent, the Company recognizes as revenues the amount the carrier reports as payable upon the sale of the Company’s games. TheCompany has evaluated its carrier agreements and has determined that it is not the principal when selling its games through carriers. Keyindicators that it evaluated to reach this determination include: • wireless subscribers directly contract with the carriers, which have most of the service interaction and are generally viewed as theprimary obligor by the subscribers; • carriers generally have significant control over the types of games that they offer to their subscribers; • carriers are directly responsible for billing and collecting fees from their subscribers, including the resolution of billing disputes; • carriers generally pay the Company a fixed percentage of their revenues or a fixed fee for each game; • carriers generally must approve the price of the Company’s games in advance of their sale to subscribers, and the Company’smore significant carriers generally have the ability to set the ultimate price charged to their subscribers; and • the Company has limited risks, including no inventory risk and limited credit risk.62Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Cash and Cash EquivalentsThe Company considers all investments purchased with an original maturity of three months or less to be cash equivalents. TheCompany deposits cash and cash equivalents with financial institutions that management believes are of high credit quality. Depositsheld with financial institutions are likely to exceed the amount of insurance on these deposits.Short-Term InvestmentsThe Company invests in auction-rate securities that are bought and sold in the marketplace through a bidding process sometimesreferred to as a “Dutch Auction.” After the initial issuance of the securities, the interest rate on the securities is reset periodically, atintervals set at the time of issuance (e.g., every seven, 28 or 35 days or every six months), based on the market demand at the resetperiod. The “stated” or “contractual” maturities for these securities, however, generally are 20 to 30 years.The Company has classified these investments as available-for-sale securities under Statement of Financial Accounting StandardsNo. 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS No. 115”). In accordance with SFAS No. 115,these securities are reported at fair value with any changes in market value reported as a part of comprehensive income/(loss). Nounrealized gains or losses were recognized during the years ended December 31, 2007, 2006 or 2005.The Company periodically reviews these investments for impairment. In the event the carrying value of an investment exceeds itsfair value and the decline in fair value is determined to be other-than-temporary, the Company writes down the value of the investment toits fair value. The Company recorded an $806 write down due to a decline in fair value of two failed auctions as of December 31, 2007that was determined to be other-than-temporary based on quantitative and qualitative assumptions and estimates using valuation modelsincluding a firm liquidation quote provided by the sponsoring broker and an analysis of other-than-temporary impairment factorsincluding the use of cash for the two recent acquisitions, the ratings of the underlying securities, the Company’s intent to continue to holdthese securities and further deterioration in the auction-rate securities market. No realized gains or losses were recognized during the yearsended December 31, 2006 or 2005.Concentration of Credit RiskFinancial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, short-term investments and accounts receivable.The Company derives its accounts receivable from revenues earned from customers located in the U.S. and other locations outsideof the U.S. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateralfrom its customers. The Company bases its allowance for doubtful accounts on management’s best estimate of the amount of probablecredit losses in the Company’s existing accounts receivable. The Company reviews past due balances over a specified amountindividually for collectibility on a monthly basis. It reviews all other balances quarterly. The Company charges off accounts receivablebalances against the allowance when it determines that the amount will not be recovered.The following table summarizes the revenues from customers in excess of 10% of the Company’s revenues: Year Ended December 31, 2007 2006 2005 Verizon Wireless 23.0% 20.6% 24.3%Sprint Nextel * 12.6 11.9 AT&T * 11.3 11.9 Vodafone * 10.6 * *Revenues from the customer were less than 10% during the period.63Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)At December 31, 2007, Verizon Wireless accounted for 23.5% of total accounts receivable and no other customer represented morethan 10% of total accounts receivable. At December 31, 2006, Verizon Wireless, Sprint Nextel and Vodafone accounted for 20.8%, 10.5%and 9.5% of total accounts receivable, respectively. No other customer represented greater than 10% of the Company’s revenues oraccounts receivable in these periods or as of these dates.Fair Value of Financial InstrumentsFor certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payableand other current liabilities, the carrying amounts approximate their fair value due to their relatively short maturity. Based on theborrowing rates available to the Company for loans with similar terms, the carrying value of borrowings outstanding approximates theirfair value.Prepaid or Guaranteed Licensor RoyaltiesThe Company’s royalty expenses consist of fees that it pays to branded content owners for the use of their intellectual property,including trademarks and copyrights, in the development of the Company’s games. Royalty-based obligations are either paid in advanceand capitalized on our balance sheet as prepaid royalties or accrued as incurred and subsequently paid. These royalty-based obligationsare expensed to cost of revenues at the greater of the revenues derived from the relevant game multiplied by the applicable contractual rateor an effective royalty rate based on expected net product sales. Advanced license payments that are not recoupable against future royaltiesare capitalized and amortized over the lesser of the estimated life of the branded title or the term of the license agreement.The Company’s contracts with some licensors include minimum guaranteed royalty payments, which are payable regardless of theultimate volume of sales to end users. Effective January 1, 2006, the Company adopted FSP FIN 45-3, Application of FASBInterpretation No. 45 to Minimum Revenue Guarantees Granted to a Business or Its Owners. As a result, the Company recorded aminimum guaranteed liability of approximately $7,876 and $1,366 as of December 31, 2007 and 2006, respectively. When nosignificant performance remains with the licensor, the Company initially records each of these guarantees as an asset and as a liability atthe contractual amount. The Company believes that the contractual amount represents the fair value of the liability. When significantperformance remains with the licensor, the Company records royalty payments as an asset when actually paid and as a liability whenincurred, rather than upon execution of the contract. The Company classifies minimum royalty payment obligations as current liabilitiesto the extent they are contractually due within the next twelve months.Each quarter, the Company evaluates the realization of its royalties as well as any unrecognized guarantees not yet paid to determineamounts that it deems unlikely to be realized through product sales. The Company uses estimates of revenues, cash flows and netmargins to evaluate the future realization of prepaid royalties and guarantees. This evaluation considers multiple factors, including theterm of the agreement, forecasted demand, game life cycle status, game development plans, and current and anticipated sales levels, aswell as other qualitative factors such as the success of similar games and similar genres on mobile devices for the Company and itscompetitors and/or other game platforms (e.g., consoles, personal computers and Internet) utilizing the intellectual property and whetherthere are any future planned theatrical releases or television series based on the intellectual property. To the extent that this evaluationindicates that the remaining prepaid and guaranteed royalty payments are not recoverable, the Company records an impairment charge tocost of revenues in the period that impairment is indicated. The Company did not incur impairment charges to cost of revenues in the yearended December 31, 2007 but recorded impairment charges to cost of revenues of $355 and $1,645 during the years ended December 31,2006 and 2005, respectively.64Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Goodwill and Intangible AssetsIn accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”),the Company’s goodwill is not amortized but is tested for impairment on an annual basis or whenever events or changes in circumstancesindicate that the carrying amount of these assets may not be recoverable. Under SFAS 142, the Company performs the annualimpairment review of its goodwill balance as of September 30. This impairment review involves a two-step process as follows:Step 1 — The Company compares the fair value of each of its reporting units to the carrying value including goodwill of that unit.For each reporting unit where the carrying value, including goodwill, exceeds the unit’s fair value, the Company moves on to step 2. If aunit’s fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary. To date, the fair valuesof the Company’s reporting units have exceeded their carrying values and thus no goodwill impairment charges have been recorded.Step 2 — The Company performs an allocation of the fair value of the reporting unit to its identifiable tangible and intangible assets(other than goodwill) and liabilities. This allows the Company to derive an implied fair value for the unit’s goodwill. The Company thencompares the implied fair value of the reporting unit’s goodwill with the carrying value of the unit’s goodwill. If the carrying amount of theunit’s goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess.Purchased intangible assets with finite lives are amortized using the straight-line method over their useful lives ranging from one tosix years and are reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.Long-Lived AssetsThe Company evaluates its long-lived assets, including property and equipment and intangible assets with finite lives, forimpairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable inaccordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-LivedAssets. Factors considered important that could result in an impairment review include significant underperformance relative to expectedhistorical or projected future operating results, significant changes in the manner of use of acquired assets, significant negative industryor economic trends, and a significant decline in the Company’s stock price for a sustained period of time. The Company recognizesimpairment based on the difference between the fair value of the asset and its carrying value. Fair value is generally measured based oneither quoted market prices, if available, or a discounted cash flow analysis.Property and EquipmentThe Company states property and equipment at cost. The Company computes depreciation or amortization using the straight-linemethod over the estimated useful lives of the respective assets or, in the case of leasehold improvements, the lease term of the respectiveassets, whichever is shorter.The depreciation and amortization periods for the Company’s property and equipment are as follows:Computer equipment Three yearsComputer software Three yearsFurniture and fixtures Three yearsLeasehold improvements Shorter of the estimated useful life or remaining term of lease65Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Research and Development CostsThe Company charges costs related to research, design and development of products to research and development expense asincurred. The types of costs included in research and development expenses include salaries, contractor fees and allocated facilities costs.Software Development CostsThe Company applies the principles of Statement of Financial Accounting Standards No. 86, Accounting for the Costs ofComputer Software to Be Sold, Leased, or Otherwise Marketed (“SFAS 86”). SFAS 86 requires that software development costsincurred in conjunction with product development be charged to research and development expense until technological feasibility isestablished. Thereafter, until the product is released for sale, software development costs must be capitalized and reported at the lower ofunamortized cost or net realizable value of the related product. The Company has adopted the “tested working model” approach toestablishing technological feasibility for its games. Under this approach, the Company does not consider a game in development to havepassed the technological feasibility milestone until the Company has completed a model of the game that contains essentially all thefunctionality and features of the final game and has tested the model to ensure that it works as expected. To date, the Company has notincurred significant costs between the establishment of technological feasibility and the release of a game for sale; thus, the Company hasexpensed all software development costs as incurred. The Company considers the following factors in determining whether costs can becapitalized: the emerging nature of the mobile game market; the gradual evolution of the wireless carrier platforms and mobile phones forwhich it develops games; the lack of pre-orders or sales history for its games; the uncertainty regarding a game’s revenue-generatingpotential; its lack of control over the carrier distribution channel resulting in uncertainty as to when, if ever, a game will be available forsale; and its historical practice of canceling games at any stage of the development process.Internal Use SoftwareThe Company recognizes internal use software development costs in accordance with the Statement of Position (SOP) No. 98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Thus, the Company capitalizes softwaredevelopment costs, including costs incurred to purchase third-party software, beginning when it determines certain factors are presentincluding, among others, that technology exists to achieve the performance requirements and/or buy versus internal development decisionshave been made. The Company has capitalized certain internal use software costs totaling approximately $482, $394 and $1,283 duringthe years ended December 31, 2007, 2006 and 2005, respectively. The estimated useful life of costs capitalized is generally three years.During the years ended December 31, 2007, 2006 and 2005, the amortization of capitalized costs totaled approximately $663, $457 and$121, respectively. Capitalized internal use software development costs are included in property and equipment, net.Income TaxesThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, Accounting forIncome Taxes (“SFAS 109”), which requires recognition of deferred tax assets and liabilities for the expected future tax consequences ofevents that have been included in its financial statements or tax returns. Under SFAS 109, the Company determines deferred tax assetsand liabilities based on the temporary difference between the financial statement and tax bases of assets and liabilities using the enactedtax rates in effect for the year in which it expects the differences to reverse. The Company establishes valuation allowances whennecessary to reduce deferred tax assets to the amount it expects to realize.On January 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting forUncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”), which supplements SFAS 109 by definingthe confidence level that a tax position must meet in order to be66Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)recognized in the financial statements. FIN 48 requires that the tax effects of a position be recognized only if it is “more-likely-than-not” tobe sustained based solely on its technical merits as of the reporting date. The Company considers many factors when evaluating andestimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actualoutcomes.With the adoption of FIN 48, companies are required to adjust their financial statements to reflect only those tax positions that aremore-likely-than-not to be sustained. Any necessary adjustment would be recorded directly to retained earnings and reported as a changein accounting principle as of the date of adoption. FIN 48 prescribes a comprehensive model for the financial statement recognition,measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The total amountof unrecognized tax benefits as of the adoption date was $575. The Company’s policy is to recognize interest and penalties related tounrecognized tax benefits in income tax expense. See Note 14 for additional information, including the effects of adoption on theCompany’s consolidated financial position, results of operations and cash flows.RestructuringThe Company accounts for costs associated with employee terminations and other exit activities in accordance with Statement ofFinancial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The Company recordsemployee termination benefits as an operating expense when it communicates the benefit arrangement to the employee and it requires nosignificant future services, other than a minimum retention period, from the employee to earn the termination benefits.Stock-Based CompensationPrior to January 1, 2006, the Company accounted for stock-based employee compensation arrangements in accordance with theprovisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and relatedinterpretations, and followed the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). Under APB No. 25, compensation expense for an option is based on the difference, if any, on thedate of the grant, between the fair value of a company’s common stock and the exercise price of the option. Employee stock-basedcompensation determined under APB No. 25 is recognized using the multiple option method prescribed by the Financial AccountingStandards Board Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans(“FIN 28”), over the option vesting period.Effective January 1, 2006, the Company adopted the fair value provisions of Statement of Financial Accounting StandardsNo. 123(R), Share-Based Payment (“SFAS 123R”), which supersedes its previous accounting under APB No. 25. SFAS 123R requiresthe recognition of compensation expense, using a fair-value based method, for costs related to all share-based payments including stockoptions. SFAS 123R requires companies to estimate the fair value of share-based payment awards on the grant date using an optionpricing model. The Company adopted SFAS 123R using the prospective transition method, which requires, that for nonpublic entitiesthat used the minimum value method for either pro forma or financial statement recognition purposes, SFAS 123R shall be applied tooption grants on and after the required effective date. For options granted prior to the SFAS 123R effective date that remain unvested onthat date, the Company continues to recognize compensation expense under the intrinsic value method of APB No. 25. In addition, theCompany continues to amortize those awards valued prior to January 1, 2006 utilizing an accelerated amortization schedule, while itexpenses all options granted or modified after January 1, 2006 on a straight-line basis.The Company has elected to use the “with and without” approach as described in EITF Topic No. D-32 in determining the order inwhich tax attributes are utilized. As a result, the Company will only recognize a tax benefit from stock-based awards in additional paid-incapital if an incremental tax benefit is realized after all other tax attributes currently available to the Company have been utilized. Inaddition, the Company has elected to account67Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)for the indirect effects of stock-based awards on other tax attributes, such as the research tax credit, through its statement of operations.The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123, EITFIssue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction withSelling, Goods or Services, and FIN 28.Advertising ExpensesThe Company expenses the production costs of advertising, including direct response advertising, the first time the advertisingtakes place. Advertising expense was $1,000, $970 and $476 in the years ended December 31, 2007, 2006 and 2005, respectively.Comprehensive Income/(Loss)Comprehensive income/(loss) consists of two components, net income/(loss) and other comprehensive income/(loss). Othercomprehensive income/(loss) refers to gains and losses that under generally accepted accounting principles are recorded as an element ofstockholders’ equity but are excluded from net income/(loss). The Company’s other comprehensive income/(loss) currently includes onlyforeign currency translation adjustments.Foreign Currency TranslationIn preparing its consolidated financial statements, the Company translated the financial statements of its foreign subsidiaries fromtheir functional currencies, the local currency, into United States Dollars. This process resulted in unrealized exchange gains and losses,which are included as a component of accumulated other comprehensive loss within stockholders’ deficit.Cumulative foreign currency translation adjustments include any gain or loss associated with the translation of a subsidiary’sfinancial statements when the functional currency of a subsidiary is the local currency. However, if the functional currency is deemed tobe the United States Dollar, any gain or loss associated with the translation of these financial statements would be included within theCompany’s statements of operations. If the Company disposes of any of its subsidiaries, any cumulative translation gains or losseswould be realized and recorded within the Company’s statement of operations in the period during which the disposal occurs. If theCompany determines that there has been a change in the functional currency of a subsidiary relative to the United States Dollar, anytranslation gains or losses arising after the date of change would be included within the Company’s statement of operations.68Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Net Loss per ShareThe Company computes basic net income/(loss) per share attributable to common stockholders by dividing its net loss attributableto common stockholders for the period by the weighted average number of common shares outstanding during the period less the weightedaverage unvested common shares subject to repurchase by the Company. Net loss attributable to common stockholders is calculatedusing the two-class method; however, preferred stock dividends were not included in the Company’s diluted net loss per sharecalculations because to do so would be anti-dilutive for all periods presented. Year Ended December 31, 2007 2006 2005 Net loss attributable to common stockholders $(6,473) $(12,385) $(17,964)Basic and diluted shares: Weighted average common shares outstanding 23,263 5,260 4,988 Weighted average unvested common shares subject to repurchase (82) (306) (964)Weighted average shares used to compute basic and diluted net loss per share 23,281 4,954 4,024 Net loss per share attributable to common stockholders — basic and diluted $(0.28) $(2.50) $(4.46)The following weighted average convertible preferred stock, warrants to purchase convertible preferred stock, options and warrantsto purchase common stock and unvested shares of common stock subject to repurchase have been excluded from the computation ofdiluted net loss per share of common stock for the periods presented because including them would have had an anti-dilutive effect: Year Ended December 31, 2007 2006 2005 Convertible preferred stock upon conversion to common stock 3,702 14,853 11,006 Warrants to purchase convertible preferred stock — 194 123 Warrants to purchase common stock 210 20 20 Unvested common shares subject to repurchase 81 306 964 Options to purchase common stock 3,436 2,135 2,026 7,429 17,508 14,139 Recent Accounting PronouncementsIn September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value,establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair valuemeasurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value byproviding a fair value hierarchy used to classify the source of the information. SFAS 157 is effective for fiscal years beginning afterNovember 15, 2007. However, on February 12, 2008, the FASB issued FSP FAS 157-2 which delays the effective date of SFAS 157 forall non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statementson a recurring basis (at least annually). This FSP partially defers the effective date of Statement 157 to fiscal years beginning afterNovember 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective for 2008, theCompany will adopt SFAS 157 except as it applies to those non-financial assets and non-financial liabilities as noted in FSP FAS 157-2.The partial adoption of SFAS 157 is not69Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for FinancialAssets and Financial Liabilities — Including an amendment of FASB Statement No. 11 (“SFAS 159”). SFAS 159 expands the use offair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. The objective ofSFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earningscaused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. UnderSFAS 159, a company may elect to use fair value to measure eligible items at specified election dates and report unrealized gains andlosses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Eligible items include butare not limited to, accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accountspayable, guarantees, issued debt and firm commitments. If elected, SFAS 159 is effective beginning January 1, 2008. The Company iscurrently evaluating whether it will elect to adopt SFAS 159 and if elected to adopt, the impact of the adoption of the provisions ofSFAS 159 on its financial position, results of operations and cash flows.In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141Restablishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. SFAS 141R also establishesdisclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141R is effective asof the beginning of an entity’s fiscal year that begins after December 15, 2008, and will be adopted by us in the first quarter of fiscal2009. The Company is currently evaluating the impact, if any, of the adoption of the provisions of SFAS 141R on its financial position,results of operations and cash flows.NOTE 3 — CHANGE IN ACCOUNTING POLICYOn June 29, 2005, the FASB issued Staff Position 150-5, Issuer’s Accounting under FASB Statement No. 150 for FreestandingWarrants and Other Similar Instruments on Shares That Are Redeemable (“FSP 150-5”). FSP 150-5 affirms that warrants of thistype are subject to the requirements in SFAS No. 150, regardless of the redemption price or the timing of the redemption feature.Therefore, under SFAS No. 150, the freestanding warrants to purchase the Company’s convertible preferred stock are liabilities thatmust be recorded at fair value.The Company adopted FSP 150-5 and accounted for the cumulative effect of the change in accounting principle as of July 1, 2005.For the year ended December 31, 2005, the impact of the change in accounting principle was to increase net loss by $315, or $0.07 pershare. There was $85 of income recorded in other income/(expense), net to reflect the decrease in fair value between July 1, 2005 andDecember 31, 2005. In the year ended December 31, 2006, the Company recorded $1,014 of additional expense in other income/(expense),net, to reflect the increase in fair value between January 1, 2006 and December 31, 2006. In the year ended December 31, 2007, theCompany recorded $10 of additional expense in other income/(expense), net, to reflect the increase in fair value between January 1, 2007and March 21, 2007.Subsequent to the Company’s IPO and the associated conversion of the Company’s outstanding redeemable convertible preferredstock into common stock, the warrants to exercise the redeemable convertible preferred stock converted into common stock warrants;accordingly, the liability related to the redeemable convertible preferred stock warrants at the closing of the IPO of $1,985 was transferredto additional paid-in-capital and the common stock warrants are no longer subject to re-measurement.70Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)NOTE 4 — ACQUISITIONSAcquisition of Beijing Zhangzhong MIG Information Technology Co. Ltd.On December 19, 2007, the Company acquired the net assets of Awaken Limited group affiliates. Awaken Limited’s principaloperations are through Beijing Zhangzhong MIG Information Technology (“MIG”), a domestic limited liability company organized underthe laws of the People’s Republic of China (the “PRC”). The Company will refer to the acquired companies collectively as “MIG”. TheCompany acquired MIG in order to accelerate the Company’s presence in China, to deepen Glu’s relationship with China Mobile, thelargest wireless carrier in China, to acquire access and rights to leading franchises for the Chinese market, and to augment its internalproduction and publishing resources with a studio in China. These factors contributed to a purchase price in excess of the fair value ofnet tangible and intangible assets acquired, and, as a result, the Company recorded goodwill in connection with this transaction.The Company purchased all of the issued and outstanding shares of MIG for a total purchase price of $15,228 which consisted ofcash consideration paid to MIG shareholders of $14,655 and transaction costs of $573. In addition, subject to MIG’s achievement ofrevenue and operating income milestones for the year ended December 31, 2008, the Company committed to pay additional considerationof $20,000 to the MIG shareholders and bonus payment of $5,000 to two officers of MIG, who are also shareholders. If earned, one halfof the bonus (or $2,500) will be paid on the earn-out payment date and one half will be paid on December 31, 2009, if the officerscontinue their employment with the Company. As of the acquisition date, these two officers owned 27% of the outstanding shares of MIG.Per their employment agreements, these two shareholders will be entitled to one half of their proportionate share of the earned additionalconsideration (or $2,700) on the earn-out payment date and one half of their proportionate share of the earned additional consideration onDecember 31, 2009, if they continue their employment with the Company. In accordance with Statement of Financial AccountingStandards No. 141, Business Combinations (“SFAS 141”), the Company has not recorded the additional consideration or bonus in theinitial purchase price as these amounts are contingent on MIG’s future earnings. In accordance with Emerging Issues Task Force IssueNo. 98-5, Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase BusinessCombination, the Company will record the estimated contingent consideration and bonus earned by the two officers (totaling $10,400) ascompensation over the two year vesting period ending December 31, 2009.71Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The Company’s consolidated financial statements include the results of operations of MIG from the date of acquisition. Under thepurchase method of accounting, the Company allocated the total purchase price of $15,228 to the net tangible and intangible assetsacquired and liabilities assumed based upon their respective estimated fair values as of the acquisition date. The following summarizesthe preliminary purchase price allocation of the MIG acquisition:Assets acquired: Cash $1,899 Accounts receivable 848 Prepaid and other current assets 20 Property and equipment 71 Intangible assets: Content and technology 490 Existing Titles 2,200 Carrier contracts and relationships 8,510 Service providers license 400 Trade names 110 In-process research and development 59 Goodwill 7,880 Total assets acquired 22,487 Liabilities assumed: Accounts payable (21)Accrued liabilities (650)Accrued compensation (106)Total current liabilities (777)Long-term deferred tax liabilities (2,652)Other long-term liabilities (3,830)Total liabilities (7,259)Net acquired assets $15,228 The valuation of the identifiable intangible assets acquired was based on management’s estimates, currently available informationand reasonable and supportable assumptions. The allocation was generally based on the fair value of these assets determined using theincome and market approaches. Of the total purchase price, $11,710 was allocated to amortizable intangible assets. The amortizableintangible assets are being amortized over the respective estimated useful life of two to nine years.In conjunction with the acquisition of MIG, the Company recorded a $59 expense for acquired in-process research and development(“IPR&D”) during the fourth quarter of 2007 because feasibility of the acquired technology had not been established and no futurealternative uses existed. The IPR&D expense is included in operating expenses in our consolidated statements of operation in the yearended December 31, 2007.The IPR&D is related to the development of a new title. The Company determined the value of acquired IPR&D using the discountedcash flow approach. The Company calculated the present value of the expected future cash flows attributable to the in-process technologyusing a 21% discount rate. The Company expects the cash flows generated from this new title to begin in 2008. This rate takes intoaccount the percentage of completion of the development effort of approximately 60% and the risks associated with the Company’sdeveloping this technology72Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)given changes in trends and technology in the industry. As of February 29, 2008, this acquired IPR&D project had been completed atcosts similar to the original projections.The Company allocated the residual value of $7,880 to goodwill. Goodwill represents the excess of the purchase price over the fairvalue of the net tangible and intangible assets acquired. Any changes in consideration, transaction costs or fair value of MIG’s net assetsmay change the preliminary purchase price allocation and amount of goodwill recorded by the Company. In accordance withSFAS No. 142, goodwill will not be amortized but will be tested for impairment at least annually. Goodwill is not deductible for taxpurposes.Acquisition of iFone Holdings LimitedOn March 29, 2006, the Company acquired the net assets of iFone in order to continue to deepen and broaden its game library, toacquire access and rights to leading licenses and franchises and to augment its external production resources. These factors contributed toa purchase price in excess of the fair value of net tangible and intangible assets acquired, and, as a result, the Company recorded goodwillin connection with this transaction.The Company purchased all of the issued and outstanding shares of iFone in exchange for the issuance of 3,423 shares of SpecialJunior Preferred Stock of the Company and $3,500 in cash. In addition, subject to the completion of specified milestones, the Companycommitted to issue a total of 871 shares of Special Junior Preferred Stock of the Company and $4,500 in subordinated unsecuredpromissory notes to the iFone shareholders. In conjunction with this transaction, the Company’s Board of Directors approved an increasein the number of authorized shares of preferred stock of Glu to 17,031 shares. The milestones outlined in the purchase agreement forwhich contingent consideration was agreed to be issued were not achieved during the period to earn this additional consideration. As themilestone consideration was not earned, these amounts have not been reflected in these financial statements.The total purchase price of approximately $23,502 consisted of the following: 3,423 shares of Special Junior Preferred Stock of theCompany (valued at $19,098 based on an independent valuation of the preferred stock issued using a weighted income and marketcomparable approach), $3,500 of cash and transaction costs of $904.73Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The Company’s consolidated financial statements include the results of operations of iFone from the date of acquisition. Under thepurchase method of accounting, the Company allocated the total purchase price of $23,502 to the net tangible and intangible assetsacquired and liabilities assumed based upon their respective estimated fair values as of the acquisition date.Assets acquired: Accounts receivable $2,518 Prepaid and other current assets 2,271 Property and equipment 89 Intangible assets: Titles, content and technology 2,700 Carrier contracts and relationships 1,300 Existing license agreements 400 Trademarks 100 In-process research and development 1,500 Goodwill 22,828 Total assets acquired 33,706 Liabilities assumed: Accounts payable (4,247)Accrued liabilities (4,777)Restructuring liabilities (1,180)Total liabilities acquired (10,204)Net acquired assets $23,502 The above table includes reductions to acquired goodwill to reflect adjustments to certain assumed liabilities upon completion of thepurchase price allocation.The Company has recorded an estimate for costs to terminate certain activities associated with the iFone operations in accordancewith the guidance of Emerging Issues Task Force Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase BusinessCombination. This restructuring accrual of $1,180 principally related to the termination of 41 iFone employees. At December 31, 2006, atotal of $36 of restructuring liabilities related to iFone employees remained and is expected to be paid in the first quarter of 2007.Of the total purchase price, $4,500 was allocated to amortizable intangible assets. The amortizable intangible assets are beingamortized using a straight-line method over the respective estimated useful life of two to five years.In conjunction with the acquisition of iFone, the Company recorded a $1,500 expense for acquired in-process research anddevelopment (“IPR&D”) during the first quarter of 2006 because feasibility of the acquired technology had not been established and nofuture alternative uses existed. The IPR&D expense is included in operating expenses in its consolidated statements of operation in the yearended December 31, 2006.The IPR&D is related to the development of new game titles. The Company determined the value of acquired IPR&D using thediscounted cash flow approach. The Company calculated the present value of the expected future cash flows attributable to the in-processtechnology using a 21% discount rate. This rate takes into account the percentage of completion of the development effort of approximately20% and the risks associated with the Company’s developing this technology given changes in trends and technology in the industry. Asof December 31, 2006, these acquired IPR&D projects had been completed at costs similar to the original projections.74Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The Company based the valuation of identifiable intangible assets and IPR&D acquired on management’s estimates, currentlyavailable information and reasonable and supportable assumptions. The Company based the allocation of the purchase price on the fairvalue of these net assets acquired determined using the income and market valuation approaches.The Company allocated the residual value of $22,828 to goodwill. Goodwill represents the excess of the purchase price over the fairvalue of the net tangible and intangible assets acquired. In accordance with SFAS No. 142, goodwill will not be amortized but will betested for impairment at least annually. Goodwill is not deductible for tax purposes.The Company has included the results of operations of MIG and iFone in its consolidated financial statements subsequent to thedates of the respective acquisitions. The unaudited financial information in the table below summarizes the combined results of operationsof the Company, MIG and iFone, on a pro forma basis, as though the companies had been combined as of the beginning of each of theperiods presented: 2007 2006 2005 Total pro forma revenues $69,543 $49,534 $33,686 Gross profit 46,379 29,960 18,754 Pro forma net loss before effect of change in accounting principle (6,596) (21,520) (19,737)Pro forma net loss (6,596) (21,520) (20,052)Pro forma net loss per share — basic and diluted (0.28) (4.34) (4.98)The Company is presenting pro forma financial information for informational purposes only, and this information is not intended tobe indicative of the results of operations that would have been achieved if the acquisitions had taken place at the beginning of each of theperiods presented. The pro forma financial information for each of the periods includes a charge of $1,559 for IPR&D since the abovetable assumes the acquisitions occurred as of the beginning of each period.NOTE 5 — SHORT-TERM INVESTMENTSMarketable securities, which are classified as available-for-sale, are summarized below as of December 31, 2007, and December 31,2006: Classified on Balance Sheet Purchased Realized Aggregate Cash and Cash Short-term Cost Loss Fair Value Equivalents Investments As of December 31, 2007: Auction rate securities $2,800 $(806) $1,994 $— $1,994 Money market funds 50,968 — 50,968 50,968 — $53,768 $(806) $52,962 $50,968 $1,994 As of December 31, 2006: Auction rate securities $8,750 $— $8,750 $— $8,750 Money market funds 1,489 — 1,489 1,489 — $10,239 $— $10,239 $1,489 $8,750 At December 31, 2007, the Company had $2,800 of principal invested in auction-rate securities. The auction-rate securities held bythe Company are private placement securities with long-term nominal maturities for which the interest rates are reset through a Dutchauction each month. The monthly auctions historically have provided a liquid market for these securities. The Company’s investments inauction-rate securities represent interests in corporate bonds.75Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The auction-rate security investments held by the Company all had AAA credit ratings at the time of purchase. With the liquidityissues experienced in global credit and capital markets, the auction-rate securities held by the Company at December 31, 2007 haveexperienced multiple failed auctions as the amount of securities submitted for sale has exceeded the amount of purchase orders.The estimated market value of the Company’s auction-rate securities holdings at December 31, 2007 was $1,994, which reflects a$806 adjustment to the principal value of $2,800. Although the auction-rate securities continue to pay interest according to their statedterms, based on valuation models including a firm liquidation quote provided by the sponsoring broker and an analysis of other-than-temporary impairment factors including the use of cash for the two recent acquisitions and the continued and further deterioration in theauction-rate securities market, the Company has recorded a pre-tax impairment charge of $806 in the fourth quarter of 2007, reflecting theauction-rate securities holdings that the Company has concluded have an other-than-temporary decline in value.As of December 31, 2006, the contractual maturities of investments held were greater than five years. However, the Company hadthe ability and intent, if necessary, to liquidate any of these investments as needed in order to meet the Company’s needs within its normaloperating cycles. Accordingly, all investments were classified as current assets on the consolidated balance sheets. As of December 31,2007 and 2006, all auction-rate securities were included in short-term investments. As of December 31, 2007 the contractual maturities ofthe Company’s remaining two auction-rate securities were 2017. Although the Company may not have the ability to liquidate theseinvestments within one year of the balance sheet date it may need to sell the securities within the next year to fund operations. Accordingly,the investments were classified as current assets on the consolidated balance sheets.NOTE 6 — BALANCE SHEET COMPONENTSProperty and Equipment December 31, 2007 2006 Computer equipment $3,200 $1,856 Furniture and fixtures 1,368 1,260 Software 2,196 1,714 Leasehold improvements 1,694 1,129 8,458 5,959 Less: Accumulated depreciation and amortization (4,641) (2,479) $3,817 $3,480 Depreciation and amortization for the years ended December 31, 2007, 2006 and 2005 were $2,085, $1,503 and $816,respectively.Accounts Receivable December 31, 2007 2006 Accounts receivable $18,737 $14,914 Less: Allowance for doubtful accounts (368) (466) $18,369 $14,448 Accounts receivable includes amounts billed and unbilled as of the respective balance sheet dates.76Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The movement in our allowance for doubtful accounts is as follows: Balance at Balance at Beginning of End of Description Period Additions Deductions Period (In thousands) Year ended December 31, 2005 $— $207 $— $207 Year ended December 31, 2006 $207 $259 $— $466 Year ended December 31, 2007 $466 $64 $162 $368 The Company had no significant write-offs or recoveries during the years ended December 31, 2007, 2006 and 2005.NOTE 7 — GOODWILL AND INTANGIBLE ASSETSIntangible AssetsThe Company’s intangible assets were acquired in connection with the acquisitions of Macrospace in 2004, iFone in 2006 and MIGin 2007. The carrying amounts and accumulated amortization expense of the acquired intangible assets at December 31, 2007 and 2006were as follows: December 31, 2007 December 31, 2006 Accumulated Accumulated Amortization Amortization Expense Expense (Including (Including Estimated Gross Impact of Net Gross Impact of Net Useful Carrying Foreign Carrying Carrying Foreign Carrying Life Value Exchange) Value Value Exchange) Value Intangible assets amortized to cost ofrevenues: Titles, content and technology 2.5 yrs $5,018 $(4,172) $846 $4,197 $(2,372) $1,825 Catalogs 1 yr 1,553 (1,553) — 1,500 (1,500) — ProvisionX Technology 6 yrs 256 (118) 138 247 (192) 55 Carrier contract and related relationships 5 yrs 10,922 (1,117) 9,805 2,200 (563) 1,637 Licensed content 5 yrs 2,651 (183) 2,468 400 (60) 340 Service provider license 9 yrs 404 (2) 402 — — — Trademarks 3 yrs 218 (96) 122 100 (38) 62 21,022 (7,241) 13,781 8,644 (4,725) 3,919 Other intangible assets amortized tooperating expenses: Emux Technology 6 yrs 1,656 (840) 816 1,600 (545) 1,055 Noncompete agreement 2 yrs 725 (725) — 700 (700) — 2,381 (1,565) 816 2,300 (1,245) 1,055 Total intangibles assets $23,403 $(8,806) $14,957 $10,944 $(5,970) $4,974 Additions to intangible assets in 2007 of $11,710 are a result of the MIG acquisition and the additions in 2006 of $4,500 are aresult of the iFone acquisition (see note 4).77Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The Company has included amortization of acquired intangible assets directly attributable to revenue-generating activities in cost ofrevenues. The Company has included amortization of acquired intangible assets not directly attributable to revenue-generating activities inoperating expenses. During the years ended December 31, 2007, 2006 and 2005, the Company recorded amortization expense in theamounts of $2,201, $1,777 and $2,823, respectively, in cost of revenues. During the years ended December 31, 2007, 2006 and 2005,the Company recorded amortization expense in the amounts of $275, $616 and $616, respectively, in operating expenses.During the year ended December 31, 2005, the Company impaired certain titles, content and technology intangible assets as certaintitles were discontinued or their current anticipated cash flows were significantly lower than the estimated cash flows used in the initialvaluation. The Company used a discounted cash flow approach to determine the current fair value of these intangibles. The Companyrecorded a charge of $1,103 for the impairment during the year ended December 31, 2005. It recorded no impairments during the yearsended December 31, 2007 and 2006.As of December 31, 2007, the total expected future amortization related to intangible assets was as follows: Amortization Amortization Included in Included in Total Cost of Operating Amortization Period Ending December 31, Revenues Expenses Expense 2008 $3,494 $276 $3,770 2009 3,097 276 3,373 2010 2,595 264 2,859 2011 1,569 — 1,569 2012 1,478 — 1,478 2013 and thereafter 1,548 — 1,548 $13,781 $816 $14,597 GoodwillAt September 30, 2007, the Company performed its annual test for goodwill impairment as required by SFAS No. 142. TheCompany determined that it operates three reporting units for the purposes of SFAS No. 142. The goodwill as of the assessment date wasattributed to the Americas and Europe, Middle East and Africa (“EMEA”) reporting units. The Company concluded that goodwill wasnot impaired since the fair value of its reporting units exceeded their respective carrying values, including goodwill. The primary methodsused to determine the fair values for SFAS No. 142 impairment purposes were the discounted cash flow and market methods. TheCompany determined the assumptions supporting the discounted cash flow method, including the assumed 25% and 27% discount ratesfor the Americas and EMEA reporting units, respectively, using its best estimates as of the date of the impairment review.The Company attributes all of the goodwill resulting from the Macrospace acquisition to its EMEA reporting unit. The goodwillresulting from the iFone acquisition is evenly attributed to the Americas and EMEA reporting units. The goodwill allocated to theAmericas reporting unit is denominated in United States Dollars, and the goodwill allocated to the EMEA reporting unit is denominated inpounds sterling. As a result, the goodwill attributed to the EMEA reporting unit is subject to foreign currency fluctuations. The Companyattributes all of the goodwill resulting from the MIG acquisition to its APAC reporting unit. The goodwill resulting from the acquisition ofMIG is denominated in Chinese Renminbi (“RMB”) and will be subject to foreign currency fluctuations.78Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Goodwill by geographic region is as follows: Effects of Effects of Foreign Foreign January 1, Goodwill Currency December 31, Goodwill Currency December 31, 2006 Acquired Adjustments Exchange 2006 Acquired Adjustments Exchange 2007 Americas $— $11,414 $— $— $11,414 $— $12 $— $11,426 EMEA 12,467 11,414 351 3,081 27,313 — 13 534 27,860 APAC — — — — — 7,880 — 96 7,976 Total $12,467 $22,828 $351 $3,081 $38,727 $7,880 $25 $630 $47,262 Goodwill was acquired during 2007 as a result of the purchase of MIG and during 2006 as a result of the purchase of iFone (seeNote 4). The net adjustment increase to goodwill in 2007 of $25 was a result of adjustments to iFone’s pre-acquisition and net operatinglosses research and development tax credits. The net adjustment increase to goodwill in 2006 of $351 was a result of adjustments to thenet operating loss carryforwards for Glu Mobile Limited (formerly Macrospace Limited) upon finalization of the 2004 tax returns.NOTE 8 — COMMITMENTS AND CONTINGENCIESLeasesThe Company leases office space under non-cancelable operating facility leases with various expiration dates through July 2012.Rent expense for the years ended December 31, 2007, 2006 and 2005 was $2,092, $1,759 and $1,236, respectively. The terms of thefacility leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over thelease period, and has accrued for rent expense incurred but not paid. The deferred rent balance was $571 and $225 at December 31,2007 and 2006, respectively, and was included within other long-term liabilities.At December 31, 2007, future minimum lease payments under non-cancelable operating leases were as follows: Minimum Operating Lease Period Ending December 31, Payments 2008 $2,637 2009 2,413 2010 2,189 2011 1,636 2012 695 2013 and thereafter — $9,570 Capital LeaseThe Company has one lease that it accounts for as a capital lease. It capitalized a total of $114 as computer equipment under thislease during the year ended December 31, 2005. The Company recorded no capital lease obligations during the year ended December 31,2007 or during the year ended December 31, 2006. Accumulated depreciation associated with this capital lease was $85 and $47 atDecember 31, 2007 and 2006, respectively. As of December 31, 2007, the Company had no remaining capital lease obligations.79Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Minimum Guaranteed RoyaltiesThe Company has entered into license and development agreements with various owners of brands and other intellectual property sothat it could develop and publish games for mobile handsets. Pursuant to some of these agreements, the Company is required to payminimal royalties over the term of the agreements regardless of actual game sales. Future minimum royalty payments for those agreementsas of December 31, 2007 were as follows: Minimum Guaranteed Period Ending December 31, Royalties 2008 $7,655 2009 1,815 2010 1,262 2011 350 2012 425 2013 and thereafter — $11,507 Commitments in the above table include $7,867 of guaranteed royalties to licensors that are included in the Company’s consolidatedbalance sheet as of December 31, 2007 because the licensors do not have any significant performance obligations. These commitments areincluded in both current and long-term prepaid and accrued royalties.Income TaxesAt this time, the settlement of the Company’s income tax liabilities cannot be determined, however, the liabilities are not expected tobecome due within the next twelve months.Indemnification ArrangementsThe Company has entered into agreements under which it indemnifies each of its officers and directors during his or her lifetime forcertain events or occurrences while the officer or director is or was serving at the Company’s request in that capacity. The maximumpotential amount of future payments the Company could be required to make under these indemnification agreements is unlimited;however, the Company has a director and officer insurance policy that limits its exposure and enables the Company to recover a portionof any future amounts paid. As a result of its insurance policy coverage, the Company believes the estimated fair value of theseindemnification agreements is minimal. Accordingly, the Company had recorded no liabilities for these agreements as of December 31,2007 or 2006.In the ordinary course of its business, the Company includes standard indemnification provisions in most of its license agreementswith carriers and other distributors. Pursuant to these provisions, the Company indemnifies these parties for losses suffered or incurredin connection with its games, including as a result of intellectual property infringement and viruses, worms and other malicious software.The term of these indemnity provisions is generally perpetual after execution of the corresponding license agreement, and the maximumpotential amount of future payments the Company could be required to make under these indemnification provisions is generallyunlimited. The Company has never incurred costs to defend lawsuits or settle indemnified claims of these types. As a result, theCompany believes the estimated fair value of these indemnity provisions is minimal. Accordingly, the Company had recorded noliabilities for these provisions as of December 31, 2007 or 2006.80Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)ContingenciesThe Company is subject to claims and assessments from time to time in the ordinary course of business. The Company’smanagement does not believe that any of these matters, individually or in the aggregate, will have a materially adverse effect on theCompany’s business, financial condition or results of operation, and thus no amounts were accrued for these exposures at December 31,2007 or 2006.NOTE 9 — DEBTLoan AgreementIn May 2006, the Company entered into a loan agreement (the “Loan”) with a principal in the amount of $12,000. The Loan had aninterest rate of 11%. The Company was obligated to pay only interest through December 31, 2006. Beginning January 1, 2007, theCompany became obligated to pay 30 equal payments of principal and accrued interest until the entire principal is paid. All borrowingswere repaid in full in March 2007. As a result of the repayment, the remaining unamortized debt issuance costs of $66 were amortized tointerest expense during the first quarter of 2007.In conjunction with the Loan, the Company issued to entities affiliated with the lender warrants to purchase 106 shares of Series DPreferred Stock with an exercise price of $9.03 per share and a contractual life of seven years. The Company calculated the fair value ofeach warrant using the Black-Scholes option pricing model with the following assumptions: volatility of 73%, term of seven years, risk-free interest rate of 5.1% and dividend yield of 0%. The Company recorded the fair value of the warrants of $607 as a discount to thecarrying value of the Loan. Upon repayment of the Loan in March 2007, the remaining unamortized debt discount of $477 was amortizedin full to interest expense. These warrants converted into warrants to purchase an equal number of shares of common stock upon theclosing of the IPO and remained outstanding at December 31, 2007.Line of Credit FacilityIn February 2007, the Company entered into an agreement to secure a revolving line of credit that allows the Company to borrow upto $8,000. The facility is restricted to 80% of the Company’s eligible domestic accounts receivable. The line carries an interest rate equalto the prime rate plus 1% and matures in 24 months. Payments on any borrowings would be interest only with any remaining borrowingsdue at maturity. The line is collateralized by all of the assets of the Company, including intellectual property. The Company is required tomaintain a minimum tangible net worth of $3,000. Also, if the Company’s net cash balance, excluding any borrowings under this line ofcredit, declines below $3,500, then the Company’s accounts receivable must be collected by means of a lock box, the interest rate on anyborrowings would be increased to the prime rate plus 2% and the Company would have to pay a one-time fee to the lender of $50. To date,there have been no borrowings under this facility. The Company was in compliance with all covenants as of December 31, 2007.NOTE 10 — SALE OF PROVISIONX SOFTWAREIn January 2007, the Company signed an agreement with a third party for the sale of its ProvisionX software for $1,100. Under theterms of the agreement, the Company will co-own the intellectual property rights to the ProvisionX software, excluding any alterations ormodifications following completion of the sale, by the third party. The Company recognized a net gain on the sale of assets of $1,040during the year ended December 31, 2007 which included approximately $60 of selling costs incurred during the transition.81Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)NOTE 11 — STOCKHOLDERS’ EQUITY/(DEFICIT)Common StockIn March 2007, the Company completed its IPO of common stock in which it sold and issued 7,300 shares of common stock at anissue price of $11.50 per share. The Company raised a total of $83,950 in gross proceeds from the IPO, or approximately $74,758 innet proceeds after deducting underwriting discounts and commissions of $5,877 and other offering costs of $3,315. Upon the closing ofthe IPO, all shares of redeemable convertible preferred stock outstanding automatically converted into 15,680 shares of common stock.In April 2007, the underwriters exercised a portion of the over-allotment option as to 199 shares, all of which were sold bystockholders and not by the Company.At December 31, 2007, the Company was authorized to issue 250,000 shares of common stock. As of December 31, 2007, theCompany had reserved 817 shares for issuance under its stock plans.Preferred StockAt December 31, 2007, the Company was authorized to issue 5,000 shares of preferred stock.Early Exercise of Employee OptionsStock options granted under the Company’s stock option plan provide certain employee option holders the right to elect to exerciseunvested options in exchange for shares of restricted common stock. Unvested shares, in the amounts of 50 and 108 at December 31,2007 and 2006, respectively, were subject to a repurchase right held by the Company at the original issuance price in the event theoptionees’ employment is terminated either voluntarily or involuntarily. For exercises of employee options, this right generally lapses as to25% of the shares subject to the option on the first anniversary of the vesting start date and as to 1/48th of the shares monthly thereafter.These repurchase terms are considered to be a forfeiture provision and do not result in variable accounting. The restricted shares issuedupon early exercise of stock options are legally issued and outstanding and have been reflected in stockholders’ equity/(deficit). TheCompany treats cash received from employees for exercise of unvested options as a refundable deposit shown as a liability in itsconsolidated financial statements. As of December 31, 2007 and 2006, the Company included cash received for early exercise of optionsof $45 and $92, respectively, in accrued liabilities. Amounts from accrued liabilities are transferred into common stock and additionalpaid-in capital as the shares vest.Warrants to Purchase Common StockIn connection with the issuance of its Series A Preferred Stock, the Company issued warrants to purchase 20 shares of commonstock. These warrants had an exercise price of $0.36 per share and an expiration date of December 31, 2007. During the year endedDecember 31, 2006, these warrants were exercised for gross proceeds of $7.Upon the effective date of the IPO, warrants to purchase 229 shares of redeemable convertible preferred stock converted intowarrants to purchase 229 shares of common stock. As discussed in Note 1, the Company classified the freestanding redeemableconvertible preferred stock warrants as a liability and adjusted the warrants to fair value at each reporting period until the completion ofthe IPO. Upon closing of the IPO, the preferred stock warrant liability of $1,985 was reclassed to additional paid-in capital. During theyear ended December 31, 2007, a holder of warrants elected to net exercise warrants to purchase 52 shares of common stock which wereconverted to 41 shares of common stock.In February 2007, the Company issued warrants to purchase an aggregate of 272 shares of common stock with an exercise price of$0.0003 per share to certain holders of Series D or D-1 redeemable convertible preferred stock as an inducement for these holders toconvert their preferred stock into common stock upon the consummation of the Company’s IPO. These warrants expired 30 daysfollowing the completion of the Company’s IPO, and if the date82Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)of effectiveness of that offering did not occur by March 31, 2007 or earlier, the warrants would expire at that time. In connection with theissuance of the warrants, the Company received an agreement to convert all shares of preferred stock to common stock upon completionof the Company’s IPO from holders of the requisite number of shares to cause that conversion, provided that the registration statement forthe initial public offering was effective on or before March 31, 2007. The Company recorded a deemed dividend of $3,130 in connectionwith the issuance of the warrants during the three months ending March 31, 2007. The deemed dividend represented the fair value of thewarrants and was calculated using the share price at the date of the IPO closing of $11.50 per share and the strike price of the warrants of$0.0003 per share. These warrants were exercised in April 2007.Warrants outstanding at December 31, 2007 were as follows: Number Exercise of Shares Price Outstanding Term per Under Issue Date (Years) Share Warrant March 2003 5 $1.92 71 May 2006 7 9.03 106 177 NOTE 12 — REDEEMABLE CONVERTIBLE PREFERRED STOCKPrior to the IPO in March 2007, the Company’s Certificate of Incorporation authorized the issuance of up to 17,032 shares ofredeemable convertible preferred stock, with $0.0001 par value. Redeemable convertible preferred stock at December 31, 2006 consisted ofthe following: Shares Issued and Liquidation Authorized Outstanding Preference Mandatorily redeemable convertible preferred stock: Series A 2,313 2,313 $4,275 Series B 2,988 2,865 5,500 Series C 4,015 4,015 20,000 Series D 2,400 2,234 20,172 Series D-1 831 831 7,500 Total mandatorily redeemable convertible preferred stock 12,547 12,258 $57,447 Special junior redeemable convertible preferred stock 4,485 3,423 $9,782 The Special Junior Preferred Stock was classified as redeemable due to the deemed liquidation provision in the instrument.Upon closing of the IPO in March 2007, all shares of outstanding redeemable convertible preferred stock automatically convertedinto 15,680 shares of common stock.Warrants for Preferred StockIn 2003, in connection with the execution of a convertible note payable agreement, the Company issued to the lender warrants topurchase 71 shares of Series B Preferred Stock at an exercise price of $1.92. In 2004, in connection with obtaining a line of creditagreement, the Company issued to the lender warrants to purchase 52 shares of Series B Preferred Stock at an exercise price of $1.92. In2006, in connection with the execution of the loan agreement (see Note 8), the Company issued to the lender warrants to purchase106 shares of Series D Preferred Stock at an exercise price of $9.03 per share.83Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Upon the closing of the IPO in March 2007, and the associated conversion of the Company’s outstanding redeemable convertiblepreferred stock to common stock, 229 warrants to purchase shares of redeemable convertible preferred stock were converted to warrantsto purchase an equivalent number of shares of the Company’s common stock.NOTE 13 — STOCK OPTION AND OTHER BENEFIT PLANS2001 Stock PlanIn December 2001, the Company adopted the 2001 Stock Option Plan (the “2001 Plan”). The 2001 Plan provides for the granting ofstock options to employees, directors, consultants, independent contractors and advisors of the Company.As provided by the 2007 Equity Incentive Plan, 195 shares, representing all remaining shares reserved for issuance under the 2001Plan were transferred to the 2007 Plan upon closing of the IPO. However, the plan will continue to govern the terms and conditions of theoutstanding awards previously granted under the 2001 Plan.2007 Equity Incentive PlanIn January 2007, the Company’s Board of Directors adopted, and in March 2007 the stockholders approved, the 2007 EquityIncentive Plan (the “2007 Plan”). The Company has reserved 1,766 shares of its common stock for grant and issuance under the 2007Plan. In addition, shares not issued or subject to outstanding grants under the 2001 Plan on the date of adoption of the 2007 Plan and anyshares issued under the 2001 Plan that are forfeited or repurchased by the Company or that are issuable upon exercise of options thatexpire or become unexercisable for any reason without having been exercised in full, will be available for grant and issuance under the2007 Plan. At the time of adoption, there were 1,766 shares of common stock authorized for issuance under the 2007 Plan plus195 shares of common stock from the 2001 Plan that were unissued.The Company may grant options under the 2007 Plan at prices no less than 85% of the estimated fair value of the shares on the dateof grant as determined by its Board of Directors, provided, however, that (i) the exercise price of an incentive stock option (“ISO”) or non-qualified stock options (“NSO”) may not be less than 100% or 85%, respectively, of the estimated fair value of the underlying shares ofcommon stock on the grant date, and (ii) the exercise price of an ISO or NSO granted to a 10% stockholder may not be less than 110% ofthe estimated fair value of the shares on the grant date. Prior to the Company’s IPO, the Board determined the fair value of common stockin good faith based on the best information available to the Board and Company’s management at the time of the grant. Following the IPO,the fair value of the Company’s common stock is determined by the last sale price of such stock on the Nasdaq Global Market on thedate of determination. The stock options generally vest 25% at one year from the vesting commencement date and an additional 1/48 permonth thereafter. Stock options granted during 2007 prior to October 25, 2007 have a contractual term of ten years and stock optionsgranted on or after October 25, 2007 have a contractual term of six years.The 2007 Plan also provides the Board of Directors the ability to grant restricted stock awards, stock appreciation rights, restrictedstock units, performance shares and stock bonuses.As of December 31, 2007, 817 shares were reserved for future grants under the 2007 Plan.2007 Employee Stock Purchase PlanIn January 2007, the Company’s Board of Directors adopted, and in March 2007 the stockholders approved, the 2007 EmployeeStock Purchase Plan (the “2007 Purchase Plan). The Company has reserved 667 shares of its common stock for issuance under the2007 Purchase Plan. The Company has reserved 667 shares of its common stock for issuance under the plan. On each January 1 for thefirst eight calendar years after the first offering date, the aggregate number of shares of the Company’s common stock reserved forissuance under the plan will be increased84Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)automatically by the number of shares equal to 1% of the total number of outstanding shares of the Company’s common stock on theimmediately preceding December 31, provided that the Board of Directors may reduce the amount of the increase in any particular yearand provided further that the aggregate number of shares issued over the term of this plan may not exceed 5,333. The 2007 Purchase Planpermits eligible employees to purchase common stock at a discount through payroll deductions during defined offering periods. The priceat which the stock is purchased is equal to the lower of 85% of the fair market value of the common stock at the beginning of an offeringperiod or after a purchase period ends.Stock Option ActivityThe following table summarizes the Company’s stock option activity: Options Outstanding Weighted Average Shares Number of Exercise Available Shares Price Balances at December 31, 2004 226 1,685 0.42 Increase in authorized shares 1,083 — Options granted (1,397) 1,397 3.94 Options canceled 562 (562) 2.93 Options exercised — (294) 0.24 Balances at December 31, 2005 474 2,226 2.02 Increase in authorized shares 1,000 Options granted (1,653) 1,653 7.30 Options canceled 655 (655) 3.17 Options exercised — (342) 0.61 Balances at December 31, 2006 476 2,882 $5.03 Increase in authorized shares 1,766 Options granted (1,775) 1,775 9.15 Options canceled 350 (350) 9.16 Options exercised — (271) 0.84 Balances at December 31, 2007 817 4,036 $6.75 85Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)At December 31, 2007, the options outstanding and currently exercisable by exercise price were as follows: Options Outstanding Options Exercisable Weighted Weighted Average Average Remaining Weighted Remaining Weighted Range of Contractual Average Aggregate Contractual Average Aggregate Exercise Number Life Exercise Intrinsic Number Life Exercise Intrinsic Prices Outstanding (in Years) Price Value Exercisable (in Years) Price Value $ 0.18 - $ 3.54 621 1.90 $0.84 $2,720 522 1.65 $0.72 $2,347 $ 3.57 - $ 3.90 682 8.08 3.82 953 421 8.10 3.84 581 $ 4.50 - $ 5.57 404 3.12 4.69 214 235 2.63 4.57 153 $ 5.95 - $ 5.95 690 5.91 5.95 — — — — — $ 8.29 - $ 9.64 48 9.52 9.16 — — — — — $10.53 - $10.53 653 8.69 10.53 — 205 8.67 10.53 — $10.65 - $11.88 938 9.21 11.53 — 61 9.18 11.35 — $ 0.18 - $11.88 4,036 6.64 6.75 $3,887 1,444 5.01 4.10 $3,081 The Company has computed the aggregate intrinsic value amounts disclosed in the above table based on the difference between theoriginal exercise price of the options and the fair value of the Company’s common stock of $5.22 at December 31, 2007. The aggregateintrinsic value of awards exercised during the year ended December 31, 2007 and December 31, 2006 was $170 and $119, respectively.As of December 31, 2007, the total stock options vested and expected to vest were 3,397 and had a weighted average exercise price of$6.47 per share, a weighted average contractual term of 6.43 years and a total intrinsic value of $3,707.Included in the above table are non-employee stock options granted in the years ended December 31, 2007, 2006 and 2005 for 4, 1and 1 shares of common stock, respectively. The Company had outstanding non-employee stock options to purchase 4, 1 and 11 sharesof common stock at weighted average exercise prices of $11.00, $3.90 and $0.18 at December 31, 2007, 2006 and 2005, respectively.The non-employee options outstanding had an exercise price of $11.00, a remaining contractual term of 9 years and no intrinsic value atDecember 31, 2007.Prior to the Adoption of SFAS No. 123RPrior to the adoption of SFAS No. 123R, the Company applied SFAS No. 123, as amended by Statement of Financial AccountingStandards No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, which allowed companies to apply theaccounting rules under APB No. 25, and related interpretations.Stock-based compensation expense, under APB No. 25, is recognized for employee stock option grants in those instances in whichthe fair value of the underlying common stock is greater than the exercise price of the stock options at the date of grant. The Companyrecorded deferred stock-based compensation related to employees of $1,129 for stock options granted in the year ended December 31,2005. Stock-based compensation of $863 and $1,487 was expensed during the years ended December 31, 2006 and 2005, respectively,using an accelerated basis over the vesting period of the individual options, in accordance with FIN 28.During the years ended December 31, 2004 and 2005, the Company issued stock options to certain employees with exercise pricesdetermined with hindsight to be below the fair market value of the Company’s common stock at the date of grant. The Companyretrospectively estimated the fair value of its common stock based upon several factors, including its operating and financialperformance, progress and milestones attained in its business, past sales of convertible preferred stock, the results of retrospectiveindependent valuations by a third-party valuation firm, and the expected valuation that the Company would obtain in an initial publicoffering. These retrospective independent valuations utilized the probability-weighted expected return and the option pricing valuationmethodologies. The Company has reviewed these factors and the events that happened between each pair of valuation86Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)dates and has determined that the combination of these factors and events reflect a true measurement of the fair value of the Company’sstock over an extended period of time and believes that the fair value of its common stock is appropriately reflected in the chart below.In June 2006, the Company offered to the employees who were granted options from January 2005 to March 2005 the ability toamend the terms of their options to increase the exercise prices in order to help them avoid potential adverse personal income taxconsequences. The Company repriced certain stock option awards granted to 15 of its employees in the first quarter of 2005. Under theterms of this repricing, no terms of the original option grants were changed other than the exercise price and the term, which was extendedfrom the fifth anniversary to the tenth anniversary of the grant date. The Company repriced vested options to purchase 29 shares andunvested options to purchase 243 shares having weighted average original exercise prices of $2.34 and $2.28, respectively. These optionswere repriced at a new exercise price of $3.90 per share. The Company has accounted for the repricing as a modification underSFAS No. 123R and thus recorded the net incremental fair value related to vested awards as compensation expense on the date ofmodification. In accordance with SFAS No. 123R, the Company will record the incremental fair value related to the unvested awards,together with unamortized stock-based compensation expense associated with the unvested awards as determined under APB No. 25, overthe remaining requisite service period of the option holders. In connection with the repricing, the Company recorded stock compensationexpense of $66 in the year ended December 31, 2006. Total incremental compensation cost resulting from the modification was $150.In connection with the repricing of stock options during 2006, the Company followed the provisions of SFAS No. 123R andeliminated from its balance sheet its remaining deferred stock-based compensation related to modified stock options. Future stock-basedcompensation charges for the modified options will be recorded in accordance with SFAS No. 123R.Stock-based compensation expense recorded under APB No. 25 and SFAS No. 123 for period prior to the adoption ofSFAS No. 123R is allocated as follows: Year Ended December 31, 2005 Research and development $158 Sales and marketing 132 General and administrative 987 Total stock-based compensation expense $1,277 The Company estimates the fair value of each option granted on the date of grant, based on the minimum value method, using theBlack-Scholes option valuation model with the following weighted-average assumptions: Year Ended December 31, 2005 Dividend yield 0%Risk-free interest rate 3.94%Expected term (years) 3.64 The weighted average grant date fair values per share, based on the minimum value method, of options granted during the yearsended December 31, 2005 was $1.05.The weighted average fair value per share, based on the minimum value method, of options granted during the years endedDecember 31, 2005 with exercise prices less than the estimated fair value of the stock at the date of grant was $3.72. The weighted averagefair value per share of options granted during the year ended December 31, 2005 with exercise prices greater than the estimated fair valueof the stock at the date of grant was $0.18.87Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following table illustrates the effects on net loss if the Company had applied the fair value recognition provisions of SFAS 123to all employee stock options: Year Ended December 31, 2005 Net loss, as reported $(17,901)Add: Employee stock-based compensation expense included in reported net loss 1,487 Less: Total employee stock-based compensation expense determined under the fair value method (1,607)Pro forma, net loss $(18,021)Basic and diluted net loss per share As reported $(4.45)Pro forma $(4.48)Adoption of SFAS No. 123RThe Company adopted SFAS No. 123R on January 1, 2006. Under SFAS No. 123R, the Company estimated the fair value of eachoption award on the grant date using the Black-Scholes option valuation model and the weighted average assumptions noted in thefollowing table. Year Ended December 31, 2007 2006 Dividend yield 0% 0%Risk-free interest rate 4.25% 4.77%Expected term (years) 5.24 6.07 Expected volatility 52% 74%The Company based expected volatility on the historical volatility of a peer group of publicly traded entities. The expected term ofoptions gave consideration to early exercises, post-vesting cancellations and the options’ contractual term, ranging from five to ten years.The risk-free interest rate for the expected term of the option is based on the U.S. Treasury Constant Maturity Rate as of the date of grant.SFAS No. 123R requires nonpublic companies that used the minimum value method under SFAS No. 123 to apply the prospectivetransition method of SFAS No. 123R. Prior to adoption of SFAS No. 123R, the Company used the minimum value method, and ittherefore has not restated its financial results for prior periods. Under the prospective method, stock-based compensation expense for theyears ended December 31, 2006 and 2007 includes compensation expense for (i) all new stock-based compensation awards granted afterJanuary 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R, (ii) unmodifiedawards granted prior to but not vested as of December 31, 2005 accounted for under APB No. 25 and (iii) awards outstanding as ofDecember 31, 2005 that were modified after the adoption of SFAS No. 123R.The Company calculated employee stock-based compensation expense recognized during the years ended December 31, 2007 and2006 based on awards ultimately expected to vest and reduced it for estimated forfeitures. SFAS No. 123R requires forfeitures to beestimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.88Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The following table summarizes the consolidated stock-based compensation expense by line items in the consolidated statement ofoperations: Year Ended December 31, 2007 2006 Research and development $939 $207 Sales and marketing 674 322 General and administrative 2,186 1,211 Total stock-based compensation expense $3,799 $1,740 As a result of adopting SFAS No. 123R on January 1, 2006, the Company’s net loss for the years ended December 31, 2006 and2007 was higher by $877 and $3,387, respectively, net of tax effect, than if the Company had continued to account for stock-basedcompensation under APB No. 25. Basic and diluted net loss per share for the years ended December 31, 2006 and 2007 would have been$0.18 and $0.15 lower than if the Company had not adopted SFAS No. 123R.Consolidated net cash proceeds from option exercises were $225 and $194 for the year ended December 31, 2007 and 2006,respectively. The Company realized no income tax benefit from stock option exercises during the year ended December 31, 2007 and2006. As required, the Company presents excess tax benefits from the exercise of stock options, if any, as financing cash flows ratherthan operating cash flows.During 2006, the Company modified five additional option agreements, including grants made to two members of the Company’sBoard of Directors. The modifications included the repricing of one option for 50 shares of common stock from $4.80 per share to $3.57per share and accelerating the vesting of four other grants totaling 27 shares of common stock. The Company recorded a charge of $100in connection with these modifications for the year ended December 31, 2006. Total incremental compensation costs resulting from themodifications were $104. During 2007, the Company modified one option agreement. The modification involved the acceleration of thevesting of one grant totaling 1 share of common stock. The Company recorded a charge of $5 in connection with this modification for theyear ended December 31, 2007.At December 31, 2007, the Company had $8,962 of total unrecognized compensation expense under SFAS No. 123R, net ofestimated forfeitures, related to stock option plans that will be recognized over a weighted-average period of 2.88 years.Non-Employee Stock OptionsDuring the years ended December 31, 2005, 2006 and 2007, the Company granted options to purchase 1, 1 and 4, shares ofcommon stock, respectively, to non-employees at exercise prices ranging from $3.90 to $11.00 and with contractual terms generally offive years. The Company determined estimated fair value on the grant date using the Black-Scholes option pricing model and thefollowing assumptions: dividend yield of 0%, expected volatility of 100%, risk-free interest rate of 3.77% to 4.90% and contractual livesof 5 to 10 years. The Company accounts for stock options, which vest over the service period, using the variable accounting model andre-measures them each accounting period. Compensation expense related to options granted to consultants was $253 during the year endedDecember 31, 2006 and $9 during the year ended December 31, 2007. During the year ended December 31, 2005, the Company cancelledoptions issued to consultants in prior years. As these options were not vested at the time of cancellation, the Company reversed the expenserecognized in previous years totaling $227 relating to the unvested portion of these options. Net compensation expense related to optionsgranted to consultants during the year ended December 31, 2005 was ($210).89Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)Restricted StockDuring the year ended December 31, 2007, the Company granted 4 shares of restricted stock to a director of the Company who hadelected to receive restricted stock in lieu of an option grant. The restricted stock vests as to 50% of the shares after six months andthereafter will vest pro rata monthly for the next six months. The Company did not grant any restricted stock during the years endedDecember 31, 2006 or 2005.401(k) Defined Contribution PlanThe Company sponsors a 401(k) defined contribution plan covering all employees. In December 2007, the Board of Directorsapproved the matching of employee contributions beginning in April 2008. Matching contributions to the plan are in the form of cash andat the discretion of the Company. To date, there have been no employer contributions under this plan.NOTE 14 — INCOME TAXESThe components of loss before income taxes and cumulative effect of change in accounting principle by tax jurisdiction were asfollows: Year Ended December 31, 2007 2006 2005 United States $(1,221) $(5,714) $(12,197)Foreign (2,370) (6,411) (7,010)Loss before income taxes and cumulative effect of change in accounting principle $(3,591) $(12,125) $(19,207)The components of income tax benefit/(provision) were as follows: Year Ended December 31, 2007 2006 2005 Current: Federal $(52) $— $— State (20) (1) (1)Foreign 56 (568) (241) (16) (569) (242)Deferred: Federal — — — State — — — Foreign 281 384 1,863 281 384 1,863 Total: Federal (52) — — State (20) (1) (1)Foreign 337 (184) 1,622 $265 $(185) $1,621 90Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)The difference between the actual rate and the federal statutory rate was as follows: Year Ended December 31, 2007 2006 2005 Tax at federal statutory rate 34.0% 34.0% 34.0%State tax, net of federal benefit (0.6) 1.9 3.7 Foreign rate differential (3.2) (1.6) (1.7)Research and development credit 7.7 2.2 1.9 Acquired in-process research and development (0.6) (4.2) — United Kingdom research and development refund (11.9) — — Withholding taxes (18.0) (3.9) (0.9)Other 1.1 (4.9) (1.8)Valuation allowance (1.1) (25.0) (26.8)Effective tax rate 7.4% (1.5)% 8.4%Deferred tax assets and liabilities consist of the following: December 31, 2007 December 31, 2006 US Foreign Total US Foreign Total Deferred tax assets: Fixed assets $190 $238 $428 $113 $256 $369 Net operating loss carryforwards 9,098 1,659 11,447 11,325 3,176 14,501 Accruals, reserves and other 1,426 146 1,572 424 143 567 Stock-based compensation 979 272 1,251 371 101 472 Research and development credit 753 — 753 954 — 954 Total deferred assets 12,446 2,315 15,451 13,187 3,676 16,863 Deferred tax liabilities: Macrospace and iFone intangible assets — (1,020) (1,020) — (1,735) (1,735)MIG intangible assets — (2,656) (2,656) — — — Other (92) (1) (93) (176) (575) (751)Net deferred tax assets 12,354 (1,362) 11,682 13,011 1,366 14,377 Less valuation allowance (12,354) (1,294) (14,338) (13,011) (1,366) (14,377)Net deferred tax liability $— $(2,656) $(2,656) $— $— $— The Company has not provided deferred taxes on unremitted earnings attributable to foreign subsidiaries because these earnings areintended to be reinvested indefinitely.In accordance with SFAS No. 109 and based on all available evidence on a jurisdictional basis, the Company believes that, it ismore likely than not that its deferred tax assets will not be utilized, and has recorded a full valuation allowance against its net deferred taxassets in each jurisdiction.At December 31, 2007, the Company has net operating loss carryforwards of approximately $23,833 and $23,272 for federal andstate tax purposes, respectively. These carryforwards will expire from 2011 to 2026. In addition, the Company has research anddevelopment tax credit carryforwards of approximately $901 for federal income tax purposes and $915 for California tax purposes. Theresearch and development tax credit carryforwards will begin to expire in 2021. The California state research credit will carry forwardindefinitely. The Company has91Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)approximately $384 of foreign tax credits from the current year that will expire in 2017, and approximately $52 of federal and $20 ofstate alternative minimum tax credits that will carryforward indefinitely. In addition, at December 31, 2007, the Company has netoperating loss carryforwards of approximately $5,923 for United Kingdom tax purposes.The Company’s ability to use its net operating loss carryforwards and federal and state tax credit carryforwards to offset futuretaxable income and future taxes, respectively, may be subject to restrictions attributable to equity transactions that result in changes inownership as defined by Internal Revenue Code Section 382. Total net operating losses of $5,923 are available in the United Kingdom,however, of those losses $5,098 are limited and can only offset a portion of the annual combined profits in the United Kingdom until thenet operating losses are fully utilized.The Company adopted the provisions of FIN 48 on January 1, 2007. The total amount of unrecognized tax benefits as of the date ofadoption was $575. The recognition of the uncertain tax benefits above would not have an impact to our effective tax rate due to thevaluation allowance on our deferred tax assets.The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits in income tax expense. As part ofpurchase accounting for the acquisition of MIG in December 2007, the Company recorded a liability of $2,650 of interest and penalty forthe People’s Republic of China (“PRC”) prior to the acquisition of MIG. The Company did not accrue any additional interest andpenalties on uncertain tax positions during the current period.A reconciliation of the total amounts of unrecognized tax benefits at December 31, 2007 is as follows:Balance at January 1, 2007 $575 Additions based on uncertain tax positions due to acquisitions 1,153 Additions based on uncertain tax positions related to the current period 367 Additions based on uncertain tax positions related to prior periods 113 Balance at December 31, 2007 $2,208 As of December 31, 2007, approximately $135 of unrecognized tax benefits, if recognized, would impact our effective tax rate. Theremaining balance, if recognized, would adjust our goodwill from acquisitions or would adjust our deferred tax assets which are subjectto valuation allowance.The Company is subject to taxation in the United States and various foreign jurisdictions. The material jurisdictions subject toexamination by tax authorities are primarily the State of California, United States, United Kingdom and the PRC. The Company’sfederal tax return is open by statute for tax years 2001 and forward and could be subject to examination by the tax authorities. TheCompany’s California income tax returns are open by statute for tax years 2001 and forward. The statute of limitations for theCompany’s 2005 tax return in the United Kingdom will close in 2008. The Company’s PRC income tax returns are open by statute fortax years 2002 and forward. In practice, a tax audit, examination or tax assessment notice issued by the PRC tax authorities does notrepresent finalization or closure of a tax year.NOTE 15 — SEGMENT REPORTINGStatement of Financial Accounting Statements No. 131, Disclosures about Segments of an Enterprise and Related Information,establishes standards for reporting information about operating segments. It defines operating segments as components of an enterpriseabout which separate financial information is available that is evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision-maker is itsChief Executive Officer. The Company’s Chief Executive Officer reviews financial information on a geographic basis, however theseaggregate into one operating segment for purposes of allocating resources and evaluating financial performance. Accordingly,92Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)the Company reports as a single operating segment — mobile games. It attributes revenues to geographic areas based on the country inwhich the carrier’s principal operations are located.The Company generates its revenues in the following geographic regions: Year Ended December 31, 2007 2006 2005 United States of America $35,997 $25,475 $14,917 United Kingdom 6,813 4,810 3,115 Americas, excluding the USA 5,284 2,704 987 EMEA, excluding the United Kingdom 15,421 10,715 5,542 Other 3,352 2,462 1,090 $66,867 $46,166 $25,651 The company attributes its long-lived assets, which primarily consist of property and equipment, to a country primarily based onthe physical location of the assets. Property and equipment, net of accumulated depreciation and amortization, summarized by geographiclocation was as follows: Year Ended December 31, 2007 2006 2005 Americas $1,806 $1,956 $2,311 EMEA 1,146 1,407 395 Other 865 117 137 $3,817 $3,480 $2,843 NOTE 16 — RESTRUCTURINGDuring December 2005, the Company undertook restructuring activities to reduce operating expenses. The Company eliminated 27positions, of which 17 were in research and development, 4 in sales and marketing and 6 in general and administrative. A restructuringcharge of $450 was recorded in December 2005, including $225 in the United States and $225 in Europe. Of these costs, a total of$177 was paid in December 2005 and the remainder was paid in the first quarter of 2006. No restructuring activities took place duringthe years ended December 31, 2007 or 2006.NOTE 17 — SUBSEQUENT EVENTSIn January 2008, the Company announced a tender offer to purchase all of the outstanding shares of Superscape Group plc(“Superscape”), a leading developer and publisher of mobile games. The acquisition of Superscape will expand Glu’s presence in theUnited States and add significant development and publishing capabilities to the Company’s existing resources. The offer price of 10pence in cash for each Superscape share values Superscape’s entire issued and to be issued share capital at approximately $36.6 million(based on the March 7, 2008 closing exchange rate between British pound sterling and United States dollar of $1.9969). The Companydeclared the tender offer unconditional in March 2008. As of March 21, 2008, the Company owned or had received acceptances in respectof approximately 92.97% of the existing share capital of Superscape. Payment for shares is required to be made within fourteen days ofwhen such shares are tendered.93Table of ContentsGLU MOBILE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)In March 2008, the Company’s Board of Directors adopted the 2008 Equity Inducement Plan (the “Inducement Plan”). TheInducement Plan does not require the approval of the Company’s stockholders. The Company has reserved 600 shares of its commonstock for grant and issuance under the Inducement Plan. The Company may only grant NSOs under the Inducement Plan. Grants ofNSO under the Inducement Plan may only be made to persons not previously an employee or director of the Company, or following abona fide period of non-employment, as an inducement material to such individual’s entering into employment with the Company and toprovide incentives for such persons to exert maximum efforts for the Company’s success. The Company may grant NSOs under theInducement Plan at prices less than 100% of the fair value of the shares on the date of grant, at the discretion of its Board of Directors.The fair value of the Company’s common stock is determined by the last sale price of such stock on the Nasdaq Global Market on thedate of determination. The Inducement Plan does not provide the Board of Directors the ability to grant restricted stock awards, stockappreciation rights, restricted stock units, performance shares and stock bonuses.94Table of ContentsItem 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone.Item 9A. Controls and ProceduresDisclosure Controls and ProceduresOur management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of ourdisclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as amended (the “Exchange Act”).In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the designof disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply itsjudgment in evaluating the benefits of possible controls and procedures relative to their costs.Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of December 31, 2007, ourdisclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance thatinformation we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to ourmanagement, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding requireddisclosure.Internal Control over Financial ReportingBecause we are not an “accelerated filer” or “large accelerated filer” (as those terms are defined in Rule 12b-2 under the SecuritiesExchange Act of 1934, as amended), this Annual Report on Form 10-K does not include a report of management’s assessment regardinginternal control over financial reporting or an attestation report of our independent registered public accounting firm due to a transitionperiod, established by the rules of the SEC for newly public companies.This Annual Report on Form 10-K does not include a report of management’s assessment regarding internal control over financialreporting or an attestation report of the Company’s independent registered public accounting firm due to a transition period established byrules of the Securities and Exchange Commission for newly public companies. At the end of the 2008, Section 404 of the Sarbanes-OxleyAct will require our management to provide an assessment of the effectiveness of our internal control over financial reporting, and ourindependent registered public accounting firm will be required to audit management’s assessment. We are in the process of performing thesystem and process documentation, evaluation and testing required for management to make this assessment and for its independentauditors to provide its attestation report. We have not completed this process or its assessment, and this process will require significantamounts of management time and resources. In the course of evaluation and testing, management may identify deficiencies that will needto be addressed and remediated.Changes in Internal Control over Financial ReportingThere were no changes in our internal control over financial reporting that occurred during our fourth fiscal quarter that havematerially affected, or are reasonably likely to materially affect, our internal control over financial reportingItem 9B. OTHER INFORMATIONNone.95Table of ContentsPART IIIItem 10. Directors, Executive Officers and Corporate GovernanceExcept as set forth below, the information required by this item is incorporated by reference to our Proxy Statement for our 2008Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007.We maintain a Code of Business Conduct and Ethics that incorporates our code of ethics applicable to all employees, including allofficers. Our Code of Business Conduct and Ethics is published on the Investors page of our Web site at www.glu.com. We intend todisclose future amendments to certain provisions of our Code of Business Conduct and Ethics, or waivers of such provisions granted toexecutive officers and directors, on this Web site within four business days following the date of such amendment or waiver.Item 11. Executive CompensationThe information required by this item is incorporated by reference to our Proxy Statement for our 2008 Annual Meeting ofStockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007.Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersThe information required by this item is incorporated by reference to our Proxy Statement for our 2008 Annual Meeting ofStockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007.Item 13. Certain Relationships and Related Transactions, and Director IndependenceThe information required by this item is incorporated by reference to our Proxy Statement for our 2008 Annual Meeting ofStockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007.Item 14. Principal Accounting Fees and ServicesThe information required by this item is incorporated by reference to our Proxy Statement for our 2008 Annual Meeting ofStockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007.PART IVItem 15. Exhibits and Financial Statement Schedules(a)(1) Financial Statements: The financial statements filed as part of this report are listed on the index to financial statements onpage 55.(2) Financial Schedules: No separate “Valuation and Qualifying Accounts” table has been included as the required information hasbeen included in the Consolidated Financial Statements included in this Annual Report on Form 10-K prepared herein.(b) Exhibits. The exhibits listed on the Exhibit Index (following the Signatures section of this report) are included, or incorporated byreference, in this annual report.96Table of ContentsSignaturesPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, on March 31, 2008, the Registrant hasduly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.GLU MOBILE INC. By: /s/ L. Gregory BallardL. Gregory BallardChief Executive Officer/s/ Albert A. PimentelAlbert A. PimentelChief Financial OfficerPOWER OF ATTORNEYKNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appointsAlbert A. Pimentel as his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendmentsto this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with theSecurities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, maydo or cause to be done by virtue hereof.Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons inthe capacities and on the dates indicated.Signature Title Date /s/ L. Gregory Ballard(L. Gregory Ballard) President and Chief Executive Officer (PrincipalExecutive Officer) March 31, 2008 /s/ Albert A. Pimentel(Albert A. Pimentel) Executive Vice President and Chief Financial Officer(Principal Financial Officer) March 31, 2008 /s/ Eric R. Ludwig(Eric R. Ludwig) Vice President, Finance and Assistant Secretary(Principal Accounting Officer) March 31, 2008 /s/ Daniel L. Skaff(Daniel L. Skaff) Director March 31, 2008 /s/ Ann Mather(Ann Mather) Director March 31, 2008 /s/ William J. Miller(William J. Miller) Director March 31, 200897Table of ContentsSignature Title Date /s/ Richard A. Moran(Richard A. Moran) Director March 31, 2008 /s/ Hany M. Nada(Hany M. Nada) Director March 31, 2008 /s/ A. Brooke Seawell(A. Brooke Seawell) Director March 31, 2008 /s/ Sharon L. Wienbar(Sharon L. Wienbar) Director March 31, 200898Table of ContentsExhibit Index Incorporated by Reference Exhibit Filing ProvidedNumber Exhibit Description Form File No. Exhibit Date Herewith2.01 Agreement and Plan of Merger, dated as of November 28,2007, by and among Glu Mobile Inc., Maverick AcquisitionCorp., Awaken Limited, Awaken (Beijing) CommunicationsTechnology Co. Ltd., Beijing Zhangzhong MIG InformationTechnology Co. Ltd., Beijing Qinwang Technology Co. Ltd.,each of Wang Bin, Wang Xin and You Yanli, and Wang Xin,as Representative. 8-K 001-33368 2.01 12/03/07 2.02 Recommended Cash Offer by Glu Mobile Inc. for SuperscapeGroup plc. 8-K 001-33368 2.01 01/25/08 2.03 Form of Acceptance, Authority and Election by Glu MobileInc. for Superscape Group plc. 8-K 001-33368 2.02 01/25/08 3.01 Restated Certificate of Incorporation of Glu Mobile Inc. S-1/A 333-139493 3.02 02/14/07 3.02 Amended and Restated Bylaws of Glu Mobile Inc. S-1/A 333-139493 3.04 02/14/07 4.01 Form of Registrant’s Common Stock Certificate. S-1/A 333-139493 4.01 02/14/07 4.02 Amended and Restated Investors’ Rights Agreement, dated asof March 29, 2006, by and among Glu Mobile Inc. andcertain investors of Glu Mobile Inc. and the Amendment No. 1and Joinder to the Amended and Restated Investor RightsAgreement dated May 5, 2006, by and among Glu MobileInc. and certain investors of Glu Mobile Inc. S-1 333-139493 4.02 12/19/06 10.01 Form of Indemnity Agreement. S-1 333-139493 10.01 12/19/06 10.02 2001 Stock Option Plan, form of option grant used fromDecember 19, 2001 to May 2, 2006, form of option grantused from December 8, 2004 to May 2, 2006 and forms ofoption grant used since May 2, 2006. S-1/A 333-139493 10.02 01/22/07 10.03 2007 Equity Incentive Plan and forms of (a) Notice of StockOption Grant, Stock Option Award Agreement and StockOption Exercise Agreement, (b) Notice of Restricted StockAward and Restricted Stock Agreement, (c) Notice of StockAppreciation Right Award and Stock Appreciation RightAward Agreement, (d) Notice of Restricted Stock Unit Awardand Restricted Stock Unit Agreement and (e) Notice of StockBonus Award and Stock Bonus Agreement. S-1/A 333-139493 10.03 02/16/07 10.04 2007 Employee Stock Purchase Plan. S-1/A 333-139493 10.03 02/16/07 10.05 Lease Agreement at San Mateo Centre II and III dated as ofJanuary 23, 2003, as amended on June 26, 2003,December 5, 2003, October 11, 2004 and May 31, 2005, byand between CarrAmerica Realty, L.P. and Glu Mobile Inc. S-1 333-139493 10.05 12/19/06 10.06 Sublease dated as of August 22, 2007, between Oracle USA,Inc., and Glu Mobile Inc. 8-K 001-33368 10.1 08/28/07 10.07+ BREW Application License Agreement dated as ofFebruary 12, 2002 by and between Cellco Partnership (d.b.a.Verizon Wireless) and Glu Mobile Inc. S-1/A 333-139493 10.11.1 01/10/07 Table of Contents Incorporated by Reference Exhibit Filing ProvidedNumber Exhibit Description Form File No. Exhibit Date Herewith10.08+ BREW Developer Agreement dated as of November 2, 2001,as amended, by and between Qualcomm Inc. and Glu MobileInc. S-1/A 333-139493 10.11.2 01/10/07 10.09 Offer Letter Agreement dated September 17, 2002 by andbetween Alessandro Galvagni and Glu Mobile Inc. S-1 333-139493 10.14 12/19/06 10.10 Offer Letter Agreement dated September 22, 2003 by andbetween L. Gregory Ballard and Glu Mobile Inc. S-1 333-139493 10.15 12/19/06 10.11 Offer Letter Agreement dated December 22, 2003 by andbetween Jill S. Braff and Glu Mobile Inc. S-1 333-139493 10.16 12/19/06 10.12 Offer Letter Agreement dated September 23, 2004 by andbetween Albert A. Pimentel and Glu Mobile Inc. S-1 333-139493 10.17 12/19/06 10.13 Loan and Security Agreement dated as of May 2, 2006 by andbetween Pinnacle Ventures LLC and the Registrant. S-1 333-139493 10.19 12/19/06 10.14 Form of Warrant dated as of May 2, 2006 by and betweenPinnacle Ventures I Equity Holdings LLC and Glu MobileInc., by and between Pinnacle Ventures I Affiliates, L.P. andGlu Mobile Inc., and by and between Pinnacle Ventures IIEquity Holdings, LLC and Glu Mobile Inc. S-1 333-139493 10.20 12/19/06 10.15 Form of Severance and Change in Control Agreement dated asof March 22, 2006 by and between L. Gregory Ballard andGlu Mobile Inc., and by and between Albert A. Pimentel andGlu Mobile Inc. S-1 333-139493 10.23 12/19/06 10.16 Summary of Bonus Plan of Glu Mobile Inc. S-1 333-139493 10.24 12/19/06 10.17 Loan and Security Agreement dated as of February 14, 2007,as amended, by and between Silicon Valley Bank and GluMobile Inc. S-1/A 333-139493 10.28 03/06/07 10.18 Form of Warrant to Purchase Common Stock issuedFebruary 28, 2007 by Glu Mobile Inc. to Granite GlobalVentures II, L.P. and to TWI Glu Mobile Holdings Inc. S-1/A 333-139493 10.31 03/06/07 10.19 Written Consent and Agreement to Convert entered into as ofFebruary 28, 2007 by and among Glu Mobile Inc. and GraniteGlobal Ventures II, L.P. and TWI Glu Mobile Holdings Inc. S-1/A 333-139493 10.32 03/06/07 21.01 List of Subsidiaries of Glu Mobile Inc. X23.01 Consent of PricewaterhouseCoopers LLP, independentregistered public accounting firm. X24.01 Power of Attorney (included on page 97). 31.01 Certification of Principal Executive Officer Pursuant toSecurities Exchange Act Rule 13a-14(a). X31.02 Certification of Principal Financial Officer Pursuant toSecurities Exchange Act Rule 13a-14(a). XTable of Contents Incorporated by Reference Exhibit Filing ProvidedNumber Exhibit Description Form File No. Exhibit Date Herewith32.01 Certification of Principal Executive Officer Pursuant to18 U.S.C. Section 1350 and Securities Exchange ActRule 13a-14(b).* X32.02 Certification of Principal Financial Officer Pursuant to18 U.S.C. Section 1350 and Securities Exchange ActRule 13a-14(b).* X+Confidential treatment has been requested with respect to selected portions of this agreement pursuant to an application forconfidential treatment by Glu Mobile Inc.*This certification is not deemed “filed” for purposes of Section 18 of the Securities Exchange Act, or otherwise subject to theliability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Actof 1933 or the Securities Exchange Act of 1934, except to the extent that Glu Mobile Inc. specifically incorporates it by reference. Exhibit 21.01Subsidiaries of Glu Mobile Inc. Jurisdiction of Name Under Which SubsidiaryName of Subsidiary Incorporation Conducts Business3D Wireless Games, Inc. United States 3D Wireless Games, Inc.Awaken (Beijing) CommunicationsTechnology Co. Ltd. China (PRC) Awaken (Beijing) CommunicationsTechnology Co. Ltd.Awaken Limited British Virgin Islands Awaken LimitedBeijing Qinwang Technology Co. Ltd. China (PRC) Beijing Qinwang Technology Co. Ltd.Beijing Zhangzhong MIG Information TechnologyCo. Ltd. China (PRC) Beijing Zhangzhong MIG Information TechnologyCo. Ltd.Friendly Giants Limited United Kingdom Friendly Giants LimitedGlu Mobile Brasil Ltda Brazil Glu Mobile Brasil LtdaGlu Mobile GmbH Germany Glu Moible GmbHGlu Mobile Limited Hong Kong Glu Mobile LimitedGlu Mobile Limited United Kingdom Glu Mobile LimitedGlu Mobile LLC United States Glu Mobile LLCGlu Mobile S.A. Chile Glu Mobile S.A.Glu Mobile SARL France Glu Mobile SARLGlu Mobile SRL Italy Glu Mobile SARLGlu Mobile S.L. Spain Glu Mobile SLGlu Mobile Technology (Beijing) Co. Litd. China (PRC) Glu Mobile Technology (Beijing) Co. Ltd.iFone Holdings Limited United Kingdom iFone Holdings LimitediFone Limited United Kingdom iFone LimitedMaverick Mobile Entertainment(Beijing) Limited China (PRC) Maverick Mobile Entertainment(Beijing) LimitedPenultimate, Inc. United States Penultimate, Inc.Sorrent Europe Ltd. United Kingdom Sorrent Europe Ltd.Superscape (Russia) Ltd. United Kingdom Superscape (Russia) Ltd.Superscape Group plc United Kingdom Superscape Group plcSuperscape Limited United Kingdom Superscape LimitedSuperscape Technology Limited United Kingdom Superscape Technology LimitedSuperscape Inc. United States Superscape Inc. Exhibit 23.01CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-141487) of Glu Mobile Inc. of our report dated March31, 2008 relating to the financial statements, which appears in this Form 10-K./s/ PricewaterhouseCoopers LLPSan Jose, CaliforniaMarch 31, 2008 EXHIBIT 31.01CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO RULE 13A-14(A) OF THE SECURITIESEXCHANGE ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, L. Gregory Ballard, certify that:1. I have reviewed this Annual Report on Form 10-K of Glu Mobile Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. Date: March 31, 2008 /s/ L. Gregory Ballard L. Gregory Ballard President and Chief Executive Officer(Principal Executive Officer)  EXHIBIT 31.02CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO RULE 13A-14(A) OF THESECURITIES EXCHANGE ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Albert A. Pimentel, certify that:1. I have reviewed this Annual Report on Form 10-K of Glu Mobile Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. Date: March 31, 2008 /s/ Albert A. Pimentel Albert A. Pimentel Executive Vice President and Chief Financial Officer(Principal Financial Officer)  EXHIBIT 32.01CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICERPURSUANT TO 18 U.S.C. §1350The undersigned, L. Gregory Ballard, the President and Chief Executive Officer of Glu Mobile Inc. (the “Company”), pursuant to 18 U.S.C. §1350, herebycertifies that: (i) the Annual Report on Form 10-K for the period ended December 31, 2007 of the Company (the “Report”) fully complies with the requirements of Section13(a) or 15(d) of the Securities Exchange Act of 1934; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 31, 2008 By: /s/ L. Gregory Ballard L. Gregory Ballard President and Chief Executive Officer(Principal Executive Officer)  EXHIBIT 32.02CERTIFICATION OF PRINCIPAL FINANCIAL OFFICERPURSUANT TO §18 U.S.C. SECTION 1350The undersigned, Albert A. Pimentel, the Executive Vice President and Chief Financial Officer of Glu Mobile Inc. (the “Company”), pursuant to 18 U.S.C.§1350, hereby certifies that: (i) the Annual Report on Form 10-K for the period ended December 31, 2007 of the Company (the “Report”) fully complies with the requirements of Section13(a) or 15(d) of the Securities Exchange Act of 1934; and. (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 31, 2008 By: /s/ Albert A. Pimentel Albert A. Pimentel Executive Vice President and Chief Financial Officer(Principal Financial Officer) 

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