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As filed with the Securities and Exchange Commission on February 14, 2007
Registration No. 333-139493
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
AMENDMENT NO. 4
to
Form S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
 
 
 
 
GLU MOBILE INC.
(Exact name of registrant as specified in its charter)
 
         
Delaware   7371   91-2143667
(State or other jurisdiction of
incorporation or organization)
  (Primary standard industrial
classification code number)
  (I.R.S. employer identification no.)
 
 
 
 
1800 Gateway Drive, Second Floor
San Mateo, CA 94404
(650) 571-1550
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
 
 
 
 
L. Gregory Ballard
Chief Executive Officer and President
Glu Mobile Inc.
1800 Gateway Drive, Second Floor
San Mateo, CA 94404
(650) 571-1550
(Name, address, including zip code, and telephone number, including area code, of agent for service)
 
 
 
 
Copies to:
 
     
David A. Bell, Esq.
Laird H. Simons III, Esq.
Mark C. Stevens, Esq.
Fenwick & West LLP
Silicon Valley Center
801 California Street
Mountain View, CA 94041
(650) 988-8500
  Robert V. Gunderson, Jr., Esq.
Craig M. Schmitz, Esq.
Natalie A. Kaniel, Esq.
Gunderson Dettmer Stough Villeneuve
Franklin & Hachigian, LLP
155 Constitution Drive
Menlo Park, CA 94025
(650) 321-2400
 
Approximate date of commencement of proposed sale to the public:   As soon as practicable after the effective date of this Registration Statement.
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   o
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o   _ _
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o   _ _
 
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o   _ _
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
 


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The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.
 
Subject to Completion. Dated February 14, 2007.
 
          Shares
 
(GLU LOGO)
Glu Mobile Inc.
Common Stock
 
 
 
 
This is an initial public offering of shares of common stock of Glu Mobile Inc. All of the shares of common stock are being sold by Glu Mobile Inc.
 
Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $      and $     . Application has been made for listing on The NASDAQ Global Market under the symbol “GLUU.”
 
See “Risk Factors” on page 8 to read about factors you should consider before buying shares of the common stock.
 
 
 
 
Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
 
 
 
 
 
                 
   
Per Share
    Total  
 
Initial public offering price
  $                $             
Underwriting discount
  $       $    
Proceeds, before expenses, to Glu Mobile
  $       $  
 
 
To the extent that the underwriters sell more than           shares of common stock, the underwriters have the option to purchase up to an additional           shares from Glu Mobile and certain selling stockholders at the initial public offering price less the underwriting discount. We will not receive any proceeds from the sale of the shares being sold by the selling stockholders.
 
 
 
 
The underwriters expect to deliver the shares against payment in New York, New York on          , 2007.
 
 
Goldman, Sachs & Co. Lehman Brothers
Banc of America Securities LLC Needham & Company, LLC
 
 
 
 
 
 
Prospectus dated          , 2007.


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stranded award-winning games world series of poker super k.o. boxing global broad distribution portfolio diner dash deer hunter 2 technology independent expertise pgr mobile centipede get glu’d to mobile glu.com World Series of PokerR, WSOP and related designs are trademarks of Harrah#fs License Company, LLC. Used PlayFirst logo are trademarks of PlayFirst, Inc. c 2005 PlayFirst, Inc. PGR and Project Gotham Corporation. All rights reserved. The trademarks, copyrights and design rights in and associated with AtariR CentipedeR c 2004 Atari, Inc. Super KO Boxing, Stranded and all related characters and elements

 


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PROSPECTUS SUMMARY
 
This summary highlights key information contained elsewhere in this prospectus. You should read the entire prospectus carefully, including the section entitled “Risk Factors” and our consolidated financial statements and related notes included elsewhere in this prospectus, before making an investment in our common stock. Unless otherwise indicated, the terms “Glu Mobile,” “Glu,” “we,” “us” and “our” refer to Glu Mobile Inc., a Delaware corporation, together with its consolidated subsidiaries.
 
Glu Mobile Inc.
 
Glu Mobile is a leading global publisher of mobile games. We have developed and published a portfolio of more than 100 casual and traditional games to appeal to a broad cross section of the over one billion subscribers served by our more than 150 wireless carriers and other distributors. We create games and related applications based on third-party licensed brands and other intellectual property, as well as on our own original brands and intellectual property. Our games based on licensed intellectual property include Deer Hunter , Diner Dash , Monopoly , Sonic the Hedgehog , World Series of Poker and Zuma . Our original games based on our own intellectual property include Alpha Wing , Ancient Empires , Blackjack Hustler , Stranded and Super K.O. Boxing. We were one of the top three mobile game publishers during the fourth quarter of 2006 in terms of mobile game market share in North America, as measured by NPD Group, Inc., a market research firm, in its December 2006 “Mobile Game Track Highlight Report,” and in terms of unit sales volume in North America and Europe among titles tracked by m:metrics, another market research firm.
 
Our business leverages the marketing resources and distribution infrastructures of wireless carriers and the brands and other intellectual property of third-party content owners, allowing us to focus our efforts on developing and publishing high-quality mobile games. For the first nine months of 2006, our largest wireless carrier customers in each region by revenues were Verizon Wireless, Sprint Nextel, Cingular Wireless and T-Mobile USA in North America; Vodafone, Hutchinson 3G, Orange and Telefónica Móviles in Europe; TelCel and Vivo in Latin America; and Vodafone, Hutchinson 3G Australia and Telecom New Zealand in Asia Pacific. Branded content owners, such as Atari, Celador (from which we license the rights to Who Wants To Be A Millionaire? in some European and Asian countries), Fox, PlayFirst, PopCap Games, Sega Europe and Turner Broadcasting, provide us with well-known consumer brands and other intellectual property on which we have based mobile games.
 
Industry Overview
 
Juniper Research, a market research firm, in its June 2006 “Mobile Games: Subscription & Download, 2006-2011” report, estimates that the worldwide market for mobile games will grow from $3.1 billion in 2006 to $10.5 billion in 2009, a compound annual growth rate of 50.2%. We believe that the rapid growth of the mobile game market has been driven by continued advances in wireless communications technology, proliferation of multimedia-enabled mobile handsets, increasing availability of high-quality mobile games and increasing end-user awareness of, and demand for, mobile games.
 
The mobile game market differs substantially from the traditional console game market. Mobile games typically have significantly lower development and distribution costs and longer life cycles than console games. Console game sales depend upon the product cycles of the consoles themselves, with large generational shifts between versions of each of the major console platforms every few years. In contrast, the mobile platform is characterized by a gradual evolution of features and capabilities in the many new handsets introduced each year by a large number of manufacturers and carriers. Consumers typically use their console games within the confines of their homes, while mobile games are available in all the settings where consumers take their mobile phones. Furthermore, console games are usually developed for a few console platforms at most, which means that the development costs are mostly associated with the original creation and development of the game. However, once developed, mobile games, may need to be customized, or ported, to more than 1,000 different handset models, many with different technological requirements. Therefore, the ability to port


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mobile games quickly and cost effectively can be a competitive differentiator among mobile game publishers and a barrier to entry for other potential market entrants.
 
Our Competitive Strengths
 
We believe we have a proven capability to develop high-quality mobile games that engage end users. Our portfolio includes a variety of genres and is designed to appeal to the diverse interests of the broad wireless subscriber population. We believe that we will continue to be attractive to wireless carriers, content owners and end users because of the following strengths:
 
Diverse Portfolio of Award-Winning High-Quality Mobile Games.   We have developed and published more than 100 casual and traditional games across a number of genres, including action, board game, card/casino, puzzle, sports, strategy/role playing games, or RPG, and TV/movie. No single game contributed more than 10% of our revenues in 2005 or in the first nine months of 2006. Based on numerical ratings by industry review websites, IGN Entertainment, Modojo and WGWorld, we ranked first in terms of average game quality for mobile games released in 2006. We have received numerous industry awards for our games, including IGN Entertainment’s Best of 2006 awards for best wireless adventure game — Stranded , best wireless puzzle game — Diner Dash and best wireless fighting game — Super K.O. Boxing , IGN Entertainment’s Best of 2005 award for best wireless puzzle game for Zuma, The Academy of Interactive Arts and Sciences’ 2006 Cellular Game of the Year award for Ancient Empires II , and the 2005 award for Best Mobile Sports Game from CNET’s Gamespot for Deer Hunter.
 
Global Scale in Distribution, Sales and Marketing.   We currently have agreements with more than 150 wireless carriers and other distributors, which together serve more than one billion subscribers worldwide. Our games regularly receive premium placement on these carriers’ game menus, or decks, accessed through mobile handset screens. Given the small size of these screens, there are significant advantages to being placed in the initial list of games that an end user sees on the deck, sometimes referred to as premium deck placement, rather than being placed lower on the list where an end user may need to scroll or search to find a game.
 
Strong Relationships with Branded Content Owners.   We have built relationships with a number of key branded content owners. The content providers that accounted for the largest percentage of our revenues in the first nine months of 2006 were Atari, Celador (from which we license the rights to Who Wants To Be A Millionaire? in some European and Asian countries), Fox, PlayFirst, PopCap Games, Sega Europe and Turner Broadcasting. In addition to these relationships, we have recently licensed brands or other intellectual property from Harrah’s, Hasbro, Microsoft and Sony. We believe that branded content owners increasingly understand the complexities of developing their own internal mobile entertainment capabilities, and therefore increasingly wish to work with publishers with a history of successfully developing and publishing high-quality games, as well as with the carrier relationships and marketing resources to publish their games on a worldwide basis.
 
Proprietary Porting and Data Mining Capabilities.   We have developed proprietary technologies and processes designed to increase the profitability of our games. These technologies and processes include a standardized development process designed to facilitate efficient porting, a tool library covering each handset model and ongoing work flow analysis tools. As of December 31, 2006, we had the capability to port and localize to approximately 40,000 stock keeping units, or SKUs, per month, with each SKU characterized by title per language per handset per carrier. Our data mining capabilities provide us with the ability to analyze the revenue potential of each game and to improve profitability through ongoing decision support for additional porting, pricing and marketing programs. Together, our porting and data mining capabilities help us in our efforts to increase the initial sales of each game and support continuing premium deck placement.
 
Experienced Management Team.   In addition to experience in mobile games, our management team has significant experience in the video game publishing, wireless communications and other technology and media industries. We believe that this broad expertise allows us in a timely


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manner to design, develop and deliver games and other mobile entertainment applications that are designed to address the demands of our market. We believe our management team’s expertise and continuity are significant competitive advantages in the evolving mobile entertainment publishing market.
 
Our Strategy
 
Our goal is to be the leading global publisher of mobile games and other mobile entertainment applications. To achieve this goal, we plan to:
 
Continue to Create Award-Winning Games through Ongoing Investment in Our Studio and Technical Development Capabilities.   Our creative and technical teams are recognized in the industry for creating high-quality, award-winning mobile games. Our technical teams leverage proprietary technologies and standardized automated processes that are designed to enable rapid, timely, high-quality and cost-effective development and porting of mobile games. We believe that this combination provides us with a competitive advantage over other industry participants that have traditionally outsourced porting and development or used more manual processes.
 
Leverage and Grow Our Portfolio of Titles.   We have developed a diverse portfolio of more than 100 games, including perennial titles that we believe can produce revenues for significantly longer than the typical 18 to 24 month revenue lifecycle for mobile games. In addition, successful games give us the potential to develop and publish a series of sequel titles, sometimes referred to as franchise titles. For both perennial and sequel titles, we leverage existing development, porting and marketing investments and broad end-user awareness in order to increase the revenue lifecycle of an existing game or increase the chance of success for new games. Games for the mobile platform also provide potential opportunities for us to publish or license our intellectual property for use on other platforms such as online, console or personal computer games. We plan to continue developing perennial and franchise titles, and believe that our proprietary technology and development process capabilities provide us an advantage over our competitors in the coordinated launches frequently required of multi-platform games.
 
Expand and Strengthen Our Distribution.   We believe that wireless carriers are increasing their focus on the leading mobile game publishers in order to improve the consistency and quality of the games that they offer on their handsets. We intend to take steps to increase our market share with our existing carriers and distributors and add additional relationships, particularly in new geographies. In addition, we have increased and expect to continue to increase our non-carrier distribution capabilities through alternative channels such as Internet portals and “off-deck” aggregators.
 
Build Upon Our Position as a Leading Global Publisher to Strengthen Licensing Relationships.   We believe that, as a leading independent publisher of mobile games, we will continue to benefit from branded content owners’ increasing recognition of the challenges associated with mobile entertainment publishing. As a result of those challenges, some branded content owners are reducing their own internal mobile development efforts. We believe that branded content owners are also becoming more reluctant to contract with smaller mobile game publishers that do not have a reputation for quality development or that do not have the breadth of carrier relationships and technological capabilities necessary to publish a game on a worldwide basis. We intend to capitalize on these trends and on our reputation with owners of non-mobile content as a leading mobile partner to strengthen our existing licensing relationships and develop additional relationships.
 
Gain Scale through Select Acquisitions.   We have acquired and integrated two mobile game companies — Macrospace and iFone. We believe that there may be future opportunities to acquire content developers and publishers in the mobile entertainment or complementary industries and we intend, where appropriate, to take advantage of these opportunities.


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Risks Affecting Us
 
Our business is subject to numerous risks, which are highlighted in the section entitled “Risk Factors” immediately following this prospectus summary. These risks represent challenges to the successful implementation of our strategy and to the growth and future profitability of our business. Some of these risks are:
 
  •  we have incurred significant losses since inception, including a net loss of $17.9 million in 2005 and a net loss of $10.0 million in the first nine months of 2006, and as of September 30, 2006, we had an accumulated deficit of $43.7 million;
 
  •  we have only a limited history of generating revenues, and the future revenue potential of our business in the emerging mobile game market is uncertain;
 
  •  the market in which we operate is highly competitive, and many of our established competitors have significantly greater resources than we do;
 
  •  many of our mobile games are based on or incorporate intellectual property that we license from third parties, and most of our revenues are derived from these games; we may not be able to renew these licenses or obtain additional licenses; and
 
  •  we currently rely on wireless carriers, in particular, Verizon Wireless, Sprint Nextel, Cingular Wireless and Vodafone, to market and distribute our products and thus to generate our revenues, and the loss of or a change in any of these carrier relationships could materially harm our business, operating results and financial condition.
 
Corporate History and Information
 
We were incorporated in Nevada in May 2001 as Cyent Studios, Inc. and changed our name to Sorrent, Inc. later that year. In November 2001, we incorporated a wholly owned subsidiary in California, and, in December 2001, we merged the Nevada corporation into this California subsidiary to form Sorrent, Inc., a California corporation. In May 2005, we changed our name to Glu Mobile Inc. Prior to completion of this offering, we intend to reincorporate in Delaware. In December 2004, we acquired Macrospace Limited, or Macrospace, and in March 2006 we acquired iFone Holdings Limited, or iFone, each a company registered in England and Wales.
 
Our principal executive offices are located at 1800 Gateway Drive, Second Floor, San Mateo, California 94404 and our telephone number is (650) 571-1550. Our website address is www.glu.com. The information on our website is not incorporated by reference into this prospectus and should not be considered to be a part of this prospectus.
 
Alpha Wing is our registered trademark in the United States, and Glu, Glu Mobile, our corporate logo, our ‘g’ character logo, Ancient Empires, Blackjack Hustler, 5 Card Draw Poker, Shark Hunt, Stranded and Super K.O. Boxing are our trademarks. Other trademarks appearing in this prospectus are the property of their respective holders.


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The Offering
 
Common stock offered by us           shares
 
Common stock to be outstanding after this offering           shares
 
Use of proceeds We intend to use approximately $10.9 million of the net proceeds of this offering to repay in full the principal and accrued interest on our outstanding loan from Pinnacle Ventures. We expect to use the remaining net proceeds of this offering for general corporate purposes, including working capital and potential capital expenditures and acquisitions. We will not receive any proceeds from the sale of the shares being sold by the selling stockholders. See “Use of Proceeds.”
 
Proposed NASDAQ Global Market symbol GLUU
 
 
The number of shares of common stock to be outstanding after this offering is based on 63,413,858 shares of our common stock outstanding as of December 31, 2006, and excludes:
 
  •  8,645,992 shares issuable upon the exercise of stock options outstanding as of December 31, 2006 with a weighted average exercise price of $1.68 per share;
 
  •  185,700 shares issuable upon the exercise of stock options granted after December 31, 2006 with a weighted average exercise price of $3.55 per share;
 
  •  687,223 shares issuable upon the exercise of warrants outstanding as of December 31, 2006 with a weighted average exercise price of $1.74 per share; and
 
  •             shares to be reserved for issuance under our 2007 Equity Incentive Plan and our 2007 Employee Stock Purchase Plan, each of which will become effective on the first day that our common stock is publicly traded and contains provisions that will automatically increase its share reserve each year, as more fully described in “Management — Employee Benefit Plans.”
 
 
 
Except as otherwise indicated, all information in this prospectus assumes:
 
  •  the automatic conversion of all outstanding shares of our convertible preferred stock into 47,040,945 shares of our common stock upon the completion of this offering;
 
  •  our reincorporation in Delaware prior to completion of this offering;
 
  •  the filing of our amended and restated certificate of incorporation in Delaware immediately following the completion of this offering; and
 
  •  no exercise by the underwriters of their option to purchase from us and the selling stockholders up to an additional           shares of our common stock in this offering.


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Summary Consolidated Financial Data
 
The following tables present summary consolidated financial data for our business. You should read this information together with “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, each included elsewhere in this prospectus.
 
We derived the statements of operations data for the years ended December 31, 2003, 2004 and 2005 and the nine months ended September 30, 2006 and the balance sheet data as of September 30, 2006 from our audited consolidated financial statements included elsewhere in this prospectus. We derived the statements of operations data for the nine months ended September 30, 2005 from our unaudited consolidated financial statements included elsewhere in this prospectus. We have prepared the unaudited consolidated financial statements on the same basis as the audited consolidated financial statements and have included, in our opinion, all adjustments, consisting only of normal recurring adjustments, that we consider necessary to state fairly the results of operations for the nine months ended September 30, 2005. Our historical results are not necessarily indicative of the results we expect in the future, and our results for the nine months ended September 30, 2006 should not be considered indicative of results we expect for the full fiscal year.
 
The pro forma per share data give effect to the conversion of all our outstanding convertible preferred stock into common stock upon the completion of this offering and adjustments to eliminate accretion to preferred stock and the charges associated with the cumulative effect change and subsequent remeasurement to fair value of our preferred stock warrants. For further information concerning the calculation of pro forma per share information, please refer to note 2 of our notes to consolidated financial statements.
                                         
          Nine Months Ended
 
    Year Ended December 31,     September 30,  
   
2003
   
2004
   
2005
   
2005
   
2006
 
    (In thousands, except per share amounts)  
Consolidated Statements of Operations Data:
                                       
Revenues
  $ 1,790     $ 7,022     $ 25,651     $ 18,871     $ 31,863  
Cost of revenues:
                                       
Royalties
    258       1,359       7,256       5,234       9,750  
Impairment of prepaid royalties and guarantees
          231       1,645       525       224  
Amortization of intangible assets
          126       2,823       2,202       1,224  
Impairment of intangible assets
                1,103              
                                         
Total cost of revenues
    258       1,716       12,827       7,961       11,198  
                                         
Gross profit
    1,532       5,306       12,824       10,910       20,665  
                                         
Operating expenses(1):
                                       
Research and development
    3,352       6,474       14,557       10,775       11,346  
Sales and marketing
    697       3,692       8,515       6,359       8,317  
General and administrative
    1,342       3,468       8,434       5,640       7,684  
Amortization of intangible assets
          26       616       463       476  
Restructuring charge
                450              
Acquired in-process research and development
                            1,500  
                                         
Total operating expenses
    5,391       13,660       32,572       23,237       29,323  
                                         
Loss from operations
    (3,859 )     (8,354 )     (19,748 )     (12,327 )     (8,658 )
Interest and other income (expense), net
    11       (69 )     541       351       (904 )
                                         
Loss before income taxes and cumulative effect of change in accounting principle
    (3,848 )     (8,423 )     (19,207 )     (11,976 )     (9,562 )
Income tax benefit (provision)
          101       1,621       943       (437 )
                                         
Loss before cumulative effect of change in accounting principle
    (3,848 )     (8,322 )     (17,586 )     (11,033 )     (9,999 )
Cumulative effect of change in accounting principle
                (315 )     (315 )      
                                         
Net loss
    (3,848 )     (8,322 )     (17,901 )     (11,348 )     (9,999 )
Accretion to preferred stock
    (533 )     (1,351 )     (63 )     (45 )     (56 )
                                         
Net loss attributable to common stockholders
  $ (4,381 )   $ (9,673 )   $ (17,964 )   $ (11,393 )   $ (10,055 )
                                         
Net loss per share attributable to common stockholders —
basic and diluted
                                       
Loss before cumulative effect of change in accounting principle
  $ (1.23 )   $ (1.85 )   $ (1.46 )   $ (0.94 )   $ (0.69 )


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          Nine Months Ended
 
    Year Ended December 31,     September 30,  
   
2003
   
2004
   
2005
   
2005
   
2006
 
    (In thousands, except per share amounts)  
Cumulative effect of change in accounting principle
                (0.02 )     (0.02 )      
Accretion to preferred stock
    (0.16 )     (0.30 )     (0.01 )     (0.01 )      
                                         
Net loss per share attributable to common stockholders — basic and diluted
  $ (1.39 )   $ (2.15 )   $ (1.49 )   $ (0.97 )   $ (0.69 )
                                         
Weighted average common shares outstanding
    3,141       4,499       12,072       11,774       14,534  
                                         
Pro forma net loss per share — basic and diluted
                  $ (0.39 )           $ (0.15 )
                                         
Pro forma weighted average common shares outstanding
                    45,091               58,266  
                                         
 
 
(1) Includes stock-based compensation expense as follows:
 
                                         
          Nine Months Ended
 
    Year Ended December 31,     September 30,  
   
2003
   
2004
   
2005
   
2005
   
2006
 
    (In thousands)  
 
Research and development
  $     $ 28     $ 158     $ 154     $ 100  
Sales and marketing
          59       132       107       131  
General and administrative
    32       454       987       733       735  
 
 
The balance sheet data as of September 30, 2006 are presented below:
 
  •  on an actual basis;
 
  •  on a pro forma basis to reflect (i) the automatic conversion of all outstanding shares of our preferred stock into 47,040,945 shares of our common stock and (ii) the reclassification of our preferred stock warrant liability to additional paid-in capital upon the conversion of warrants to purchase shares of our convertible preferred stock into warrants to purchase shares of our common stock upon the completion of this offering; and
 
  •  on a pro forma as adjusted basis to reflect (i) the sale by us of the      shares of common stock offered by this prospectus at an assumed initial public offering price of $      per share, after deducting the estimated underwriting discounts and commissions and estimated offering expenses, and (ii) the use of approximately $10.9 million of the net proceeds of this offering to repay in full the principal and accrued interest on our loan from Pinnacle Ventures.
 
                         
    September 30, 2006  
                Pro Forma
 
   
Actual
   
Pro Forma
   
As Adjusted(1)
 
    (In thousands)  
 
Consolidated Balance Sheet Data:
                       
Cash, cash equivalents and short-term investments
  $ 14,384     $ 14,384     $          
Working capital
    16,527       16,527          
Total assets
    76,419       76,419          
Preferred stock warrant liability
    2,034              
Long-term debt, including current portion
    11,557       11,557        
Redeemable preferred stock
    76,344              
Total stockholders’ equity (deficit)
    (24,763 )     53,615          
 
 
(1) Each $1.00 increase or decrease in the assumed initial public offering price of $      per share would increase or decrease, respectively, our cash, cash equivalents and short-term investments, working capital, total assets and total stockholders’ equity (deficit) by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions.

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RISK FACTORS
 
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this prospectus before purchasing our common stock. If any of the following risks occurs, our business, financial condition or results of operations could be seriously harmed. In that case, the trading price of our common stock could decline, and you might lose some or all of your investment.
 
Risks Related to Our Business
 
We have a history of net losses, may incur substantial net losses in the future and may not achieve profitability.
 
We have incurred significant losses since inception, including a net loss of $8.3 million in 2004, a net loss of $17.9 million in 2005 and a net loss of $10.0 million in the first nine months of 2006. As of September 30, 2006, we had an accumulated deficit of $43.7 million. We expect to continue to increase expenses as we implement initiatives designed to continue to grow our business, including, among other things, the development and marketing of new games, further international expansion, expansion of our infrastructure, acquisition of content, and general and administrative expenses associated with being a public company. If our revenues do not increase to offset these expected increases in operating expenses, we will continue to incur significant losses and will not become profitable. Our revenue growth in recent periods 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 of generating revenues, and the future revenue potential of our business in this emerging market is uncertain. As a result of our short operating history, we have limited financial data that can be used to evaluate our business. Any evaluation of our business and our prospects must be considered in light of our limited operating history and the risks and uncertainties encountered by companies in our stage 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;
 
  •  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-consumer distributors;


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  •  expand our development capacity in countries with lower costs;
 
  •  execute our business and marketing strategies successfully;
 
  •  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 financial condition.
 
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 which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. In addition, we may not be able to predict our future revenues or results of operations. We base our current and future expense levels on our internal operating plans and sales forecasts, and our operating costs are to a large extent fixed. As a result, we may not be able to reduce our costs sufficiently to compensate for an unexpected shortfall in revenues, and even a small shortfall in revenues could disproportionately and adversely affect financial results for that quarter. Individual games and carrier relationships represent meaningful portions of our revenues and net loss in any quarter. We may incur significant or unanticipated expenses when licenses are renewed. In addition, any payments due to us from carriers for revenues that are recognized on a cash basis may be delayed because of changes or issues with those carriers’ processes.
 
In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly results include:
 
  •  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 of revenues 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 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 or changes in business strategy;
 
  •  our success in entering new geographic markets;
 
  •  foreign exchange fluctuations;


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  •  accounting rules governing recognition of revenue;
 
  •  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 who choose to follow our company. Failure to meet market expectations would likely result in decreases in the trading price of our common stock.
 
The markets in which we operate are highly competitive, and many of our competitors have significantly greater resources than we do.
 
The development, distribution and sale of mobile games is a highly competitive business. For end users, we compete primarily on the basis of brand, game quality and price. For wireless carriers, we compete for deck placement based on these factors, as well as historical performance and perception of sales potential and relationships with licensors of brands and other intellectual property. For content and brand licensors, we compete based on royalty and other economic terms, perceptions of development quality, porting abilities, speed of execution, distribution breadth and relationships with carriers. We also compete for experienced and talented employees.
 
Our primary competitors include Digital Chocolate, Electronic Arts (EA Mobile), Gameloft, Hands-On Mobile, I-play, Namco and THQ, with Electronic Arts having the largest market share of any company in the mobile games market. In the future, likely competitors include major media companies, traditional video game publishers, 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 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.
 
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 access of 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 and financial condition.


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Failure to renew our existing brand and content licenses on favorable terms or at all and to obtain additional licenses would impair 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 licensed from third parties accounted for 77.1% and 85.0% of our revenues in 2005 and the first nine months of 2006, respectively. In the first nine months of 2006, revenues derived from our four largest licensors, Atari, Celador, Fox and PopCap Games, together accounted for approximately 62.3% of our revenues. Even if mobile games based on licensed content or brands remain popular, any of our licensors could decide not to renew our existing license or not to license additional intellectual property and instead license to our competitors or develop and publish its own mobile games or other applications, competing with us in the marketplace. Many of these licensors already develop games for other platforms, and may have significant experience and development resources available to them should they decide to compete with us rather than license to us.
 
We have both exclusive and non-exclusive licenses and both licenses that are global and licenses that are limited to specific geographies, often with other mobile game publishers having rights to geographies not covered by our licenses. Our licenses generally have terms that range from two to five years, with the primary exceptions being our six-year licenses covering World Series of Poker and Deer Hunter 2 and our seven-year license covering Kasparov Chess. Licenses for intellectual property that terminate prior to 2008 and during 2008 represented 55.0% and 18.3%, respectively, of our revenues in the first nine months of 2006. Some of the licenses that we have inherited through acquisitions provide that the licensor owns the intellectual property that we develop in the mobile version of the game and that, when our license expires, the licensor can transfer that intellectual property to a new licensee. Increased competition for licenses may lead to larger guarantees, advances and royalties that we must pay to our licensors, which could significantly increase our cost of revenues and cash usage. We may be unable 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 games or to continue to offer our current games, which would materially harm our business, operating results and financial condition. Some of our existing licenses impose, and licenses that we obtain in the future might impose, development, distribution and marketing obligations on 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 entertainment preferences of our end users when making choices about which brands or other content to license. If the entertainment preferences of end users shift to content or brands owned or developed by companies with which we do not have relationships, we may be unable to establish and maintain successful relationships with these developers and owners, which would materially harm our business, operating results and financial condition. In addition, some rights are licensed from licensors that have or may develop financial difficulties, and may 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.


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We currently rely on wireless carriers to market and distribute our games and thus to generate our revenues. In particular, subscribers of Verizon Wireless, Sprint Nextel, Cingular Wireless and Vodafone collectively represented 56.6% of our revenues in the first nine months of 2006. The loss of or a change in any of these significant carrier relationships 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 we currently work and establishing new carrier relationships in geographies where we have not yet established a significant presence. A significant portion of our revenues is derived from a very limited number of carriers. In the first nine months of 2006, we derived approximately 20.9% of our revenues from subscribers of Verizon Wireless, 13.6% of our revenues from subscribers of Sprint Nextel affiliates, 11.4% of our revenues from subscribers of Cingular Wireless and 10.7% of our revenues from subscribers of Vodafone. During 2005, we derived approximately 24.3%, 11.9%, 11.9% and 6.2%, respectively, of our revenues from subscribers of these carriers. In 2005 and the first nine months of 2006, subscribers from carriers representing the next ten largest sources of our revenues represented 25.6% and 26.4% of our revenues, respectively, although some of the carriers represented in this group varied from period to period. We expect that we will continue to generate a substantial majority of our revenues through distribution relationships with fewer than 20 carriers for the foreseeable future. Our failure to maintain our relationships with these carriers would materially reduce our revenues and thus harm our 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 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 usually can terminate these agreements early and, in some instances, at any time without cause, which could give them the ability to renegotiate economic or other terms. The agreements generally do not obligate the carriers to market or distribute any of our games. In many of these agreements, we warrant that our games do not contain libelous or obscene content, do not contain material defects or viruses, and do not violate third-party intellectual property rights and we indemnify the carrier 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, unit demand for that game might decline, reducing our revenues, without necessarily reducing, and perhaps increasing, the total revenues that the 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; and
 
  •  consolidation among carriers.


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If any of our carriers decides not to market or distribute our games or decides to terminate, not renew or modify the terms of its agreement with us or if there is consolidation among carriers generally, we may be unable to replace the affected agreement with acceptable alternatives, causing us to lose access to that carrier’s subscribers and the revenues they afford us, which could materially harm our business, operating results and financial condition.
 
End user tastes are continually changing and are often unpredictable; if we fail to develop and publish new mobile games that achieve market acceptance, our sales would suffer.
 
Our business depends on developing and publishing mobile games that wireless carriers will place on their decks and end users will buy. We must continue to invest significant resources in licensing efforts, research and development, marketing and regional expansion to enhance our offering of games and introduce new games, and we must make decisions about these matters well in advance of product release in order to implement them in a timely manner. Our success depends, in part, on unpredictable and volatile factors beyond our control, including end-user preferences, competing games and the availability of other entertainment activities. If our games and related applications are not responsive to the requirements of our carriers or the entertainment preferences of end users, or they are not brought to market in a timely and effective manner, our business, operating results and financial condition would be harmed. Even if our games are successfully introduced and initially adopted, a subsequent shift in our carriers or the entertainment preferences of end users could cause a decline in our games’ popularity that could materially reduce our revenues and harm our business, operating results and financial condition.
 
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 mobile handsets. The inherent limitation on the number of games available on the deck is a function of the limited screen size of handsets and carriers’ perceptions of the depth of menus and numbers of choices end users will generally utilize. Carriers typically provide one or more top level menus highlighting games that are recent top sellers, that the carrier believes will become top sellers or that the carrier otherwise chooses to feature, in addition to a link to a menu of additional games sorted by genre. We believe that deck placement on the top level or featured menu or toward the top of genre-specific or other menus, rather than lower down or in sub-menus, is likely to result in games achieving a greater degree of commercial success. If carriers choose to give our games less favorable deck placement, our games may be less successful than we anticipate, our revenues may decline and our business, operating results and financial condition may be materially 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 of industry sales. Similarly, a significant portion of our revenues comes from a limited number of mobile games, although the games in that group have shifted over time. For example, in 2005 and in the first nine months of 2006, we generated approximately 52.8% and 57.0% of our revenues, respectively, from our top ten games, but no individual game represented more than 10% of our revenues in either period. We expect to release a relatively small number of new games each year for the foreseeable future. If these games are not successful, our revenues could be limited and our business and operating results would 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 in the price of our common stock. If our competitors develop more successful games or offer them at lower prices or based on payment models, such as pay-for-play or subscription-based models, perceived as offering a better


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value proposition, or if we do not continue to develop consistently high-quality and well-received games, our revenues would likely decline and our business, operating results and financial condition would be harmed.
 
If we are unsuccessful in establishing and increasing awareness of our brand and recognition of our mobile games or if we incur excessive expenses promoting and maintaining our brand or our games, our potential revenues could be limited, our costs could increase and our operating results and financial condition could be harmed.
 
We believe that establishing and maintaining our brand is critical to retaining and expanding our existing relationships with wireless carriers and content licensors, as well as developing new relationships. Promotion of the Glu brand will depend on our success in providing high-quality mobile games. Similarly, recognition of our games by end users will depend on our ability to develop engaging games 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 access our games may be interrupted, which may adversely affect our brand. If end users, branded content owners and carriers do not perceive our existing games as high-quality or if we introduce new games that are not favorably received by our end users and carriers, then we may be unsuccessful in building brand recognition and brand loyalty in the marketplace. In addition, globalizing and extending our brand and recognition of our games will be costly and will involve extensive management time to execute successfully. Further, the markets in which we operate are highly competitive and some of our competitors, such as Electronic Arts (EA Mobile), already have substantially more brand name recognition and greater marketing resources than we do. If we fail to increase brand awareness and consumer recognition of our games, our potential revenues could be limited, our costs could increase and our business, operating results and financial condition could suffer.
 
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, especially L. Gregory Ballard and Albert A. “Rocky” Pimentel. The loss of the services of any of our executive officers or other key employees could harm our business. All of our U.S. executive officers and key employees are at-will employees, which means they may terminate their employment relationship with us at any time. None of our U.S. employees is bound 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 in enforcing 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 mobile entertainment companies. In addition, competition for qualified personnel is particularly intense in the San Francisco Bay Area, where our headquarters are located. Further, our principal overseas operations are based in London and Hong Kong, cities that, similar to our headquarters 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 capable of meeting our growing creative, operational and managerial requirements, or may be required to pay increased compensation in order to do so. If we are unable to attract and retain the qualified personnel we need to succeed, our business would suffer.
 
Volatility or lack of performance in our stock price may also affect our ability to attract and retain our key employees. Many of our senior management personnel and other key employees have become, or will soon become, vested in a substantial amount of stock or stock options. Employees


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may be more likely to leave us if the shares they own or the shares underlying their options have significantly appreciated in value relative to the original purchase prices of the shares or the exercise prices of the options, or if the exercise prices of the options that they hold are significantly above the market price of our common stock. If we are unable to retain our employees, our business, 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 internal growth and acquisitions. This growth has placed, and may continue to place, significant demands on our management and our operational and financial infrastructure. In particular, we grew from approximately 130 employees at December 31, 2004 to more than 210 employees at December 2005 in anticipation of revenues that did not immediately result. As a consequence, we had to terminate 27 employees in December 2005. 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 the necessary level of efficiency in our organization as it grows, our business, operating results and financial condition would be harmed.
 
The acquisition of other companies, businesses or technologies could result in operating difficulties, dilution and other harmful consequences.
 
We have made recent acquisitions and, although we have no present understandings, commitments or agreements to do so, we may pursue further acquisitions, any of which could be material to our business, operating results and financial condition. Future acquisitions could divert management’s time and focus from operating our business. In addition, integrating an acquired company, business or technology is risky and may result in unforeseen operating difficulties and expenditures. We may also use a portion of the net proceeds of this offering for the acquisition of, or investment in, companies, technologies, products or assets that complement our business. Future acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, including our common stock, or the incurrence of debt, contingent liabilities, amortization expenses or acquired in-process research and development expenses, any of which could harm our financial condition and operating results. Future acquisitions may also require us to obtain additional financing, which may not be available on favorable terms or at all.
 
International acquisitions involve risks related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries.
 
Some or all of these issues may result from our acquisitions of Macrospace in December 2004 and iFone in March 2006, each of which is based in the United Kingdom. If the anticipated benefits of either of these or future acquisitions do not materialize, we experience difficulties integrating iFone or businesses acquired 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 other intangible assets, which must be assessed for impairment at least


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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 operating results.
 
We face added business, political, regulatory, operational, financial and economic risks as a result of our international operations and distribution, any of which could increase our costs and hinder our growth.
 
International sales represented approximately 41.8% and 44.6% of our revenues in 2005 and the first nine months of 2006, respectively. In addition, as part of our international efforts, we acquired U.K.-based Macrospace in December 2004, opened our Hong Kong office in July 2005, expanded our presence in the European market with our acquisition of iFone in March 2006 and opened additional offices in Brazil, France and Germany in the second half of 2006. We expect to open additional international offices, and we expect international sales to continue to be an important component of our revenues. 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 and greater difficulty collecting accounts receivable;
 
  •  protectionist laws and business practices that favor local businesses in some countries;
 
  •  foreign tax consequences;
 
  •  foreign exchange controls that might prevent us from repatriating income earned in countries outside the United States;
 
  •  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 ongoing international expansion efforts may be more costly than we expect. Further, expansion into developing countries subjects us to the effects of regional instability, civil unrest and hostilities, and could adversely affect us by disrupting communications and making travel more difficult.
 
These risks could harm our international expansion efforts, which, in turn, could materially and adversely affect our business, operating results and financial condition.


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If we fail to deliver our games at the same time as new mobile handset models are commercially introduced, our sales may suffer.
 
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 control the 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 those handsets. Some handset manufacturers give us access to their handsets prior to commercial release. If one or more major handset manufacturers were to cease to provide us access to new handset models prior to commercial release, we might be unable to introduce compatible versions of our games for those handsets in coordination with their commercial release, and we might not be able to make compatible versions for a substantial period following their commercial release. If, because of game launch delays, we miss the opportunity to sell games when new handsets are shipped or our end users upgrade to a new handset, or if we miss the key holiday selling period, 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 our mobile 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 games charged to their subscribers. Some of our carrier agreements also restrict our ability to change prices. In cases where carrier approval is required, approvals may not be granted in a timely manner or at all. A failure or delay in obtaining these approvals, the prices established by the carriers for our games, or changes in these prices could adversely affect market acceptance of those 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 the actual retail price charged to end 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 carriers in adjusting the retail price for our games, could adversely affect sales volume and our revenues for those games.
 
Carriers and other distributors also control billings and collections for our games, either directly or through third-party service providers. If our carriers or their third-party service providers cause material inaccuracies when providing billing and collection services to us, our revenues may be less than anticipated or may be subject to refund at the discretion of the carrier. This could harm our business, 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 could harm our brand.
 
The planned timing and introduction of new original mobile games and games based on licensed intellectual property are subject to risks and uncertainties. Unexpected technical, operational, deployment, distribution or other problems could delay or prevent the introduction of new games, which could result in a loss of, or delay in, revenues or damage to our reputation and brand. If any of our games is introduced with defects, errors or failures, we could experience decreased sales, loss of end users, damage to our carrier relationships and damage to our reputation and brand. Our attractiveness to branded content licensors might also be reduced. In addition, new games may not achieve sufficient market acceptance to offset the costs of development, particularly when the introduction of a game is substantially later than a planned “day-and-date” launch, which could materially harm our business, operating results and financial condition.


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If we fail to maintain and enhance our capabilities for porting games to a broad array of mobile handsets, our attractiveness to wireless 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 different handset models, many with different technological requirements. These include handsets with various combinations of underlying technologies, user interfaces, keypad layouts, screen resolutions, sound capabilities and other carrier-specific customizations. If we fail to maintain or enhance our porting capabilities, our sales could suffer, branded content owners might choose not to grant us licenses and carriers 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 cause inefficiencies in our porting process or might result in more labor intensive porting processes. In addition, we anticipate that in the future we will be required to port existing and new games to a broader array of handsets. If we utilize more labor intensive porting processes, our margins 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 comparable replacements, we may have to reduce the number of games that we intend to introduce, delay the introduction of some games or increase our internal development staff, which would be a time-consuming and potentially costly process, and, as a result, our competitive 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 satisfactory manner or at all.
 
If our developers terminate their relationships with us or negotiate agreements with terms less favorable to us, we may have to reduce the number of games that we intend to introduce, delay the introduction of some games or increase our internal development staff, which would be a time-consuming and potentially costly process, and, as a result, our business, operating results and financial condition could be harmed.
 
If one or more of our games were found to contain hidden, objectionable content, our reputation and operating results could suffer.
 
Historically, many video games have been designed to include hidden content and gameplay features that are accessible through the use 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 a certain level of achievement in the game). These features have been common in console and computer games. However, in several recent cases, hidden content or features have been included in other publishers’ products by an employee who was not authorized to do so or by an outside developer without the knowledge of the publisher. From time to time, some of this hidden content and these hidden features have contained profanity, graphic violence and sexually explicit or otherwise objectionable material. Our design and porting process and the constraints on the file size


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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 were found to contain hidden, objectionable content, our wireless carriers and other distributors of our games could refuse to sell it, consumers could refuse to buy it or demand a refund of their money, and, if the game was based on licensed content, the licensor could demand that we incur significant expense to remove the objectionable content from the game and all ported versions of the game. This could have a materially negative impact on our business, operating results and financial condition. In addition, our reputation could be harmed, which could impact sales of other games we sell and our attractiveness to content licensors and carriers or other distributors of our games. If any of 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 or prevent fraud; in that case, our stockholders could lose confidence in our financial reporting, which could negatively impact the price of our stock.
 
Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. In addition, Section 404 of the Sarbanes-Oxley Act of 2002 will require us to evaluate and report on our internal control over financial reporting and have our independent registered public accounting firm attest to our evaluation beginning with our Annual Report on Form 10-K for the year ending December 31, 2008. We are in the process of preparing and implementing an internal plan of action for compliance with Section 404 and strengthening and testing our system of internal controls to provide the basis for our report. The process of implementing our internal controls and complying with Section 404 will be expensive and time consuming, and will require significant attention of management. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Even if we conclude, and our independent registered public accounting firm concurs, that our internal control over financial reporting provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, because of its inherent limitations, internal control over financial reporting may not prevent or detect fraud or misstatements. Failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we or our independent registered public accounting firm discover a material weakness or a significant deficiency in our internal control, the disclosure of that fact, even if quickly remedied, could reduce the market’s confidence in our financial statements and harm our stock price. In addition, a delay in compliance with Section 404 could subject us to a variety of administrative sanctions, including ineligibility for short form resale registration, action by the Securities and Exchange Commission, or SEC, the suspension or delisting of our common stock from The NASDAQ Global Market and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price and could harm our business.
 
If we do not adequately protect our intellectual property rights, it may be possible for third parties to obtain and improperly use our intellectual property and our 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 and other intellectual property laws and restrictions on disclosure to protect our intellectual property rights. To date, we have not sought patent protection. Consequently, we will not be able to protect our technologies from independent invention by third parties. Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to copy or otherwise to obtain and use our technology and games. Monitoring unauthorized use of our games is difficult and costly, and we cannot be certain that the steps we have taken will prevent piracy and other unauthorized distribution and use of our technology and games, particularly internationally where the laws may not protect our intellectual property rights as fully as in the United States. In the future, we


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may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs 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 and acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property and to assign to us any ownership they may have in those works, it may still be possible for third parties to obtain and improperly use our intellectual properties without our consent. This could harm our business, operating results and financial condition.
 
Third parties may sue us for intellectual property infringement, which, if successful, may disrupt our business and could require us to pay significant damage awards.
 
Third parties may sue us for intellectual property infringement or initiate proceedings to invalidate our intellectual property, either of which, if successful, could disrupt the conduct of our business, cause us to pay significant damage awards or require us to pay licensing fees. In the event of a successful claim against us, we might be enjoined from using our or our licensed intellectual property, we might incur significant licensing fees and we might be forced to develop alternative technologies. Our failure or inability to develop non-infringing technology or games or to license the infringed or similar technology or games on a timely basis could force us to withdraw games from the market or prevent us from introducing new games. In addition, even if we are able to license the infringed or similar technology or games, license fees could be substantial and the terms of these licenses could be burdensome, which might adversely affect our operating results. We might also incur substantial expenses in defending against third-party infringement claims, regardless of their merit. Successful infringement or licensing claims against us might result in substantial monetary liabilities and might materially disrupt the 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 indemnification provisions. In these provisions, we agree to indemnify them for losses suffered or incurred in connection with our games, including as a result of intellectual property infringement and damages caused by viruses, worms and other malicious software. The term of these indemnity provisions is generally perpetual after execution of the corresponding license agreement, and the maximum potential amount of future payments we could be required to make under these indemnification provisions is generally unlimited. Large future indemnity payments could harm our business, operating results and financial condition.
 
As a result of a majority of our revenues currently being derived from four wireless carriers, if any one of these carriers were unable to fulfill its payment obligations, our financial condition and results of operations would suffer.
 
As of December 31, 2005, our outstanding accounts receivable balances with Verizon Wireless, Sprint Nextel, Cingular Wireless and Vodafone were $1.7 million, $693,000, $581,000 and $277,000, respectively. Similarly, as of September 30, 2006, our outstanding accounts receivable balances with those carriers were $2.5 million, $1.8 million, $809,000 and $1.3 million, respectively. Since 53.5% of our outstanding accounts receivable at September 30, 2006 were with Verizon Wireless, Sprint Nextel, Cingular Wireless and Vodafone, we have a concentration of credit risk. If any of these carriers is unable to fulfill its payment obligations to us under our carrier agreements with them, our revenues could decline significantly and our financial condition might be harmed.


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We may need to raise additional capital to grow our business, and we may not be able to raise capital on terms acceptable to us or at all.
 
The operation of our business and our efforts to grow our business further will require significant cash outlays and commitments. If our cash, cash equivalents and short-term investments balances and any cash generated from operations and from this offering are not sufficient to meet our cash requirements, we will need to seek additional capital, potentially through debt 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, if available, may be on terms that are dilutive or potentially dilutive to our stockholders, and the prices at which new investors would be willing to purchase our securities may be lower than the initial public offering price. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of our common stock. If new sources of financing are required but are insufficient or unavailable, we would be required to modify our growth and operating plans to the extent of available funding, which would harm our ability to grow our business.
 
We face risks associated with currency exchange rate fluctuations.
 
Although we currently transact approximately 60% of our business in U.S. Dollars, we also transact approximately one-third of our business in pounds sterling and Euros and a small portion of our business in other currencies. Conducting business in currencies other than U.S. Dollars subjects us to fluctuations in currency exchange rates that could have a negative impact on our reported operating results. Fluctuations in the value of the U.S. Dollar relative to other currencies impact our revenues, cost of revenues and operating margins 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 exchange rate fluctuations and would involve costs and risks of their own, such as ongoing management time and expertise, external costs to implement the strategies and potential accounting implications.
 
Our business in countries with a history of corruption and transactions with foreign governments, including with government owned 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 that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. and other business entities for the purpose of obtaining or retaining business. We have operations, deal with carriers and make sales in countries known to experience corruption, particularly certain emerging countries in East Asia, Eastern Europe and Latin America, and further international expansion may involve more of these countries. Our activities in these countries create the risk of unauthorized payments or offers of payments by one of our employees, consultants, sales agents or distributors that could be in violation of various laws including the FCPA, even though these parties are not always subject to our control. We have attempted to implement safeguards to discourage these practices by our employees, consultants, sales agents and distributors. However, our existing safeguards and any future improvements may prove to be less than effective, and our employees, consultants, sales agents or distributors may engage in conduct for which we might be held responsible. Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to other 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 to employees, 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 accounting principles are subject to interpretation by the Financial


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Accounting Standards Board, or FASB, the SEC, and various other bodies. A change in those principles could have a significant effect on our reported results and might affect our reporting of transactions completed before a change is announced. For example, we have used stock options as a fundamental component of our employee compensation packages. We believe that stock options directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain in our employ. Several regulatory agencies and entities have made regulatory changes that could make it more difficult or expensive for us to grant stock options to employees. For example, the FASB released Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based Payment , that required us to record a charge to earnings for employee stock option grants beginning in 2006. In addition, regulations implemented by the NASDAQ Stock Market generally require stockholder approval for all stock option plans, which could make it more difficult for us to grant stock options to employees. We may, as a result of these changes, incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, any of which could materially and adversely affect our business, operating results and financial condition.
 
Risks Relating to Our Industry
 
Wireless communications technologies are changing rapidly, and we may not be successful in working with these new technologies.
 
Wireless network and mobile handset technologies are undergoing rapid innovation. New handsets with more advanced processors and supporting advanced programming languages continue to be introduced. In addition, networks that enable enhanced features, such as multiplayer technology, are being developed and deployed. We have no control over the demand for, or success of, these products or technologies. The development of new, technologically advanced games to match the advancements in handset technology is a complex process requiring significant research and development expense, as well as the accurate anticipation of technological and market trends. If we fail to anticipate and adapt to these and other technological changes, the available channels for our games may be limited and our market share and our operating results may suffer. Our future success will depend on our ability to adapt to rapidly changing technologies, develop mobile games to accommodate evolving industry standards and improve the performance and reliability of our games. In addition, the widespread adoption of networking or telecommunications technologies or other technological changes could require 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 implement and take advantage of in order to make our games and other mobile entertainment products competitive in the market. Therefore, we usually start our product development with a range of technical development goals that we hope to be able to achieve. We may not be able to achieve these goals, or our competition may be able to achieve them more quickly and effectively than we can. In either case, our products may be technologically inferior to those of our competitors, less appealing to end users or both. If we cannot achieve our technology goals within 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 the resources employed in research and development in an attempt either to preserve our product launch schedule or to keep up with our competition, which would increase our development expenses. In either case, our business, operating results and financial condition could be materially harmed.
 
The complexity of and incompatibilities among mobile handsets may require us to use additional resources for the development of our games.
 
To reach large numbers of wireless subscribers, mobile entertainment publishers like us must support numerous mobile handsets and technologies. However, keeping pace with the rapid innovation of handset technologies together with the continuous introduction of new, and often incompatible,


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handset models by wireless carriers requires us to make significant investments in research and development, including personnel, technologies and equipment. In the future, we may be required to make substantial investments in our development if the number of different types of handset models continues to proliferate. In addition, as more advanced handsets are introduced that enable more complex, feature rich games, we anticipate that our per-game development costs will increase, which could increase 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 business growth 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 handsets to access data services and, in particular, entertainment applications of the type we develop and distribute. New or different mobile entertainment applications, such as streaming video or music applications, developed by our current or future competitors may be preferred by subscribers to our games. In addition, other mobile platforms such as the iPod and dedicated portable gaming platforms such as the PlayStation Portable and the Nintendo DS may become widespread, and end users may 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 the games and related applications that we publish, or switch to portable gaming platforms or distribution where we do not have comparative strengths, 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 harm our 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 mobile handsets on which they are played; economic conditions that adversely affect discretionary consumer spending; changes in consumer demographics; 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 period for 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-party games and related applications such as ours. Our development resources are concentrated in the BREW and Java platforms, and we have experience developing games for the i-mode, Mophun, Symbian and Windows Mobile Platforms. If one or more of these technologies fall out of favor with handset manufacturers and wireless carriers and there is a rapid shift to a technology platform such as Adobe Flash Lite or a new technology where we do not have development experience or resources, the development period for our games may be lengthened, increasing our costs, and the resulting games may be of lower quality, and may be published later than anticipated. 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’ billing systems to track and account for the downloading of their games. In


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certain circumstances, mobile game publishers may also rely on their own servers to deliver games on demand to end users through their carriers’ networks. In addition, certain subscription-based games such as World Series of Poker and entertainment products such as FOX Sports Mobile require access over the mobile Internet to our servers in order to enable features such as multiplayer modes, high score posting or access to information updates. Any failure of, or technical problem with, carriers’, third parties’ or our billing systems, delivery systems, information systems or communications networks could result in the inability of end users to download our games, prevent the completion of billing for a game, or interfere with access to some aspects 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 time to time, our carriers have experienced failures with their billing and delivery systems and communication networks, including gateway failures that reduced the provisioning capacity of their branded e-commerce system. Any failure of, or technical problem with, the carriers’, other third parties’ or our systems could cause us to lose end users or revenues or incur substantial repair costs and distract management 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. Because many end users download our games soon after they purchase new handsets, we may experience seasonal sales increases based on the holiday selling period. However, due to the time between handset purchases and game purchases, most of this holiday impact occurs for us in our first quarter. In addition, we seek to release many of our games in conjunction with specific events, such as the release of a related movie. If we miss these key selling periods for any reason, our sales will suffer disproportionately. Likewise, if a key event to which our game release schedule is tied were to be delayed or cancelled, our sales would also suffer disproportionately. Further, for a variety of reasons, including roaming charges for data downloads that may make purchase of our games prohibitively expensive for many end users while they are traveling, we may experience seasonal sales decreases during the summer, particularly in Europe. If the level of travel increases or expands to other periods, our operating results and financial condition may be harmed. Our ability to meet game development schedules is affected by a number of factors, including the creative processes involved, the coordination of large and sometimes geographically dispersed development teams required by the increasing complexity of our games, and the need to fine-tune our games prior to their release. Any failure to meet anticipated development or release schedules would likely result in a delay of revenues or possibly 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 States and internationally. This includes deployment and maintenance of reliable next-generation digital networks with the speed, data capacity and security necessary to provide reliable wireless communications services. Wireless communications infrastructure may be unable to support the demands placed on it if the number of subscribers continues to increase, or if existing or future subscribers increase their bandwidth requirements. Wireless communications have experienced a variety of outages and other delays as a result of infrastructure and equipment failures, and could face outages and delays in the future. These outages and delays could reduce the level of wireless communications usage as well as our ability to distribute our games successfully. In addition, changes by a wireless carrier to network infrastructure may interfere with downloads of our games and may cause end users to lose functionality in our games that they have already downloaded. This could harm our business, operating results and financial condition.


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Future mobile handsets may significantly reduce or eliminate wireless carriers’ control over delivery of our games and force us to rely further on alternative sales channels, which, if not successful, could require us to increase our sales and marketing expenses significantly.
 
Substantially all our games are currently sold through carriers’ branded e-commerce services. We have invested significant resources developing this sales channel. However, a growing number of handset models currently available allow wireless subscribers to browse the Internet and, in some cases, download applications from sources other than a carrier’s branded e-commerce service. In addition, the development of other application delivery mechanisms such as premium-SMS may enable subscribers to download applications without having 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 us to increase our sales and marketing expenses significantly. As with our carriers, we believe that inferior placement of our games and other mobile entertainment products in the menus of off-deck distributors will result in lower revenues than might otherwise be anticipated from these alternative sales channels. We may be unable to develop and promote our direct website distribution sufficiently to overcome the limitations 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 groups who develop and deploy viruses, worms and other illicit code or malicious software programs that may attack wireless networks and handsets. 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 do not present an immediate risk to our business, we believe future threats could lead some end users to seek to return our games, reduce or delay future purchases of our games or reduce or delay the use of their handsets. Wireless carriers and handset manufacturers may also increase their expenditures on protecting their wireless networks and mobile phone products from attack, which could delay adoption of new handset models. Any of these activities could adversely affect our revenues and this could harm our business, operating results and financial condition.
 
If a substantial number of the end users that purchase our games by subscription change mobile handsets or if wireless carriers 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 percentage of end users who already own one or more of our subscription games will likely upgrade from their existing handsets. With some wireless carriers, 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 systems that passively renew unless end users take some action to opt-out of their subscriptions. In either case, unless we are able to re-sell subscriptions 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.


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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 media and wireless communications industries, including laws and regulations regarding customer privacy, taxation, content suitability, copyright, distribution and antitrust. Furthermore, the growth and development of the market for electronic commerce may prompt calls for more stringent consumer protection laws that may impose additional burdens on companies such as ours conducting business through wireless carriers. We anticipate that regulation of our industry will increase and that we will be required to devote legal and other resources to address this regulation. Changes in current laws or regulations or the imposition of new laws and regulations in the United States or elsewhere regarding the media and wireless communications industries may lessen the growth of wireless communications services and may materially reduce our ability to increase or maintain sales of our games.
 
A number of studies have examined the health effects of mobile phone use, and the results of some of the studies have been interpreted as evidence that mobile phone use causes adverse health effects. The establishment of a link between the use of mobile phone services and health problems, or any media reports suggesting such a link, could increase government regulation of, and reduce demand for, mobile phones and, accordingly, the demand for our games and related applications, and this could harm our business, operating results and financial condition.
 
Risks Related to Ownership of Our Common Stock
 
There has been no prior market for our common stock, our stock price may be volatile or may decline regardless of our operating performance, and you may not be able to resell your shares at or above the initial public offering price.
 
There has been no public market for our common stock prior to this offering. The initial public offering price for our common stock will be determined through negotiations among the underwriters, the selling stockholders and us. This initial public offering price may vary from the market price of our common stock following this offering. If you purchase shares of our common stock in this offering, you may not be able to resell those shares at or above the initial public offering price. An active or liquid market in our common stock may not develop upon completion of this offering or, if it does develop, it may not be sustainable. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including:
 
  •  price and volume fluctuations in the overall stock market;
 
  •  changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;
 
  •  actual or anticipated fluctuations in our operating results;
 
  •  the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
 
  •  changes in financial estimates by any securities analysts who follow our company, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock;
 
  •  ratings downgrades by any securities analysts who follow our company;
 
  •  announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures or capital commitments;
 
  •  the public’s response to our press releases or other public announcements, including our filings with the SEC;


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  •  market conditions or trends in our industry or the economy as a whole;
 
  •  the loss of key personnel;
 
  •  lawsuits threatened or filed against us;
 
  •  future sales of our common stock by our executive officers, directors and significant stockholders; and
 
  •  other events or factors, including those resulting from war, incidents of terrorism or responses to these events.
 
In addition, the stock markets, and in particular The NASDAQ Global Market on which our common stock will be listed, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could have substantial costs, divert resources and the attention of management from our business and adversely affect our business, operating results and financial condition.
 
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 will be subject to the reporting requirements of the Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of the NASDAQ Stock Market. The requirements of these rules and regulations will increase our legal, accounting and financial compliance costs, will make some activities more difficult, time-consuming and costly and may also place undue strain on our personnel, systems and resources.
 
The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. This can be difficult to do. For example, we depend on the reports of wireless carriers for information regarding the amount of sales of our games and related applications and to determine the amount of royalties we owe branded content licensors and the amount of our revenues. These reports may not be timely, and in the past they have contained, and in the future they may contain, errors.
 
In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we will need to expend significant resources and provide significant management oversight. We have a substantial effort ahead of us to implement appropriate processes, document our system of internal control over relevant processes, assess their design, remediate any deficiencies identified and test their operation. As a result, management’s attention may be diverted from other business concerns, which could harm our business, operating results and financial condition. These efforts will also involve substantial accounting-related costs. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on The NASDAQ Global Market.
 
The Sarbanes-Oxley Act and the rules and regulations of the NASDAQ Stock Market will make it more difficult and more expensive for us to maintain directors’ and officers’ liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to maintain coverage. If we are unable to maintain adequate directors’ and officers’ insurance, our ability to recruit and retain qualified directors, especially those directors who may be considered independent for purposes of the NASDAQ Stock Market rules, and officers will be significantly curtailed.


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Purchasers in this offering will suffer immediate substantial dilution.
 
If you purchase shares of our common stock in this offering, the book value of your shares will immediately be $       less than the price you paid. This effect is known as dilution. If previously granted options or warrants are exercised, additional dilution will occur. As of December 31, 2006, options to purchase 8,645,992 shares of our common stock with a weighted average exercise price of approximately $1.68 per share were outstanding. Subsequent to December 31, 2006, we granted additional options to purchase an aggregate of 185,700 shares of our common stock at a weighted average exercise price of $3.55 per share. In addition, as of the date of this prospectus, warrants to purchase an aggregate of 687,223 shares of our common stock with a weighted average exercise price of $1.74 were outstanding. Exercise of these options and warrants will result in additional dilution to purchasers of our common stock in this offering.
 
A significant portion of our total outstanding shares may be sold into the market in the near future. If there are substantial sales of shares of our common stock, the price of our common stock could decline.
 
The price of our common stock could decline if there are substantial sales of our common stock or if there is a large number of shares of our common stock available for sale. After this offering, we will have outstanding                     shares of our common stock based on the number of shares outstanding as of December 31, 2006 and assuming no exercise of the underwriters’ option to purchase additional shares of our common stock in this offering. This includes the shares that we are selling in this offering, which may be resold in the public market immediately. The remaining 63,413,858 shares, or     % of our outstanding shares after this offering, are currently restricted as a result of market standoff and/or lock-up agreements but will be able to be sold in the near future as set forth below.
 
     
Number of Shares and
  Date Available for Sale
% of Total Outstanding
 
into Public Market
 
61,713,144 shares, or       %
  180 days after the date of this prospectus, sales of 48,548,662 of which will be subject to volume and other limitations.
1,700,714 shares, or       %
  More than 180 days after the date of this prospectus, as restricted stock vests and shares are released from escrow
 
After this offering, the holders of an aggregate of 47,571,918 shares of our common stock or subject to warrants outstanding as of December 31, 2006 will have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders. We also intend to register all of our shares of common stock that we have issued and may issue under our employee equity incentive plans. Once we register these shares, they will be able to be sold freely in the public market upon issuance, subject to existing market standoff and/or lock-up agreements.
 
The market price of the shares of our common stock could decline as a result of sales of a substantial number of our shares in the public market or the perception in the market that the holders of a large number of shares intend to sell their shares.
 
Our directors, executive officers and principal stockholders will continue to have substantial control over us after this offering and could delay or prevent a change in corporate control.
 
After this offering, our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately     % of our outstanding common stock, assuming no exercise of the underwriters’ option to purchase additional shares of our common stock in this offering. As a result, these stockholders, acting together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including


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the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might harm the market price of our common stock by:
 
  •  delaying, deferring or preventing a change in our control;
 
  •  impeding a merger, consolidation, takeover or other business combination involving us; or
 
  •  discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us.
 
We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.
 
We cannot specify with any certainty the particular uses of the net proceeds that we will receive from this offering other than the use of $10.9 million to repay in full the principal and accrued interest on our outstanding loan from Pinnacle Ventures. Our management will have broad discretion in the application of the net proceeds, including working capital, possible acquisitions and other general corporate purposes. Our stockholders may not agree with the manner in which our management chooses to allocate and spend the net proceeds. The failure by our management to apply these funds effectively could harm our business and financial condition. Pending their use, we may invest the net proceeds from this offering in a manner that does not produce income or that loses value.
 
If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
 
The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock would be negatively impacted. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.
 
Some provisions in our restated certificate of incorporation, restated bylaws and Delaware law and the terms of some of our licensing and distribution agreements may deter third parties from acquiring us.
 
The terms of a number of our agreements with branded content owners and wireless carriers effectively provide that, if we undergo a change of control, the applicable content owner or carrier will be entitled to terminate the relevant agreement. In addition, our restated certificate of incorporation and restated bylaws that will become effective immediately following the completion of this offering will contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors, including the following:
 
  •  our board of directors will be classified into three classes of directors with staggered three-year terms;
 
  •  only our chairman of the board, our lead independent director, our chief executive officer, our president or a majority of our board of directors will be authorized to call a special meeting of stockholders;
 
  •  our stockholders will be able to take action only at a meeting of stockholders and not by written consent;


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  •  only our board of directors and not our stockholders will be able to fill vacancies on our board of directors;
 
  •  our restated certificate of incorporation will authorize undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; and
 
  •  advance notice procedures will apply for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders.
 
These provisions and other provisions in our charter documents could discourage, delay or prevent a transaction involving a change in our control. Any delay or prevention of a change of control transaction could cause stockholders to lose a substantial premium over the then-current market price of their shares. These provisions could also discourage proxy contests and could make it more difficult for you and other stockholders to elect directors of your choosing or to cause us to take other corporate actions you desire.
 
In addition, we are subject to Section 203 of the Delaware General Corporation Law, which, subject to some exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock, for a three-year period following the date that the stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change in control that our stockholders might consider to be in their best interests.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
In addition to historical information, this prospectus contains forward-looking statements. We may, in some cases, use words, such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “continue,” “should,” “would,” “could,” “potentially,” “will” or “may,” or other similar words and expressions that convey uncertainty about future events or outcomes to identify these forward-looking statements. Forward-looking statements in this prospectus include statements about:
 
  •  our expectations regarding our revenues, expenses and operations and our ability to achieve and then sustain profitability;
 
  •  our anticipated capital expenditures and cash needs and our estimates regarding our capital requirements;
 
  •  our ability to expand our base of end users and relationships with wireless carriers and branded content owners;
 
  •  our ability to expand our product offerings and our ability to develop games for other platforms;
 
  •  our anticipated growth strategies and sources of new revenues;
 
  •  anticipated trends and challenges in our business and the markets in which we operate;
 
  •  our ability to retain and hire necessary employees and to staff our operations appropriately;
 
  •  the impact of seasonality on our business;
 
  •  the amount of external development resources that we intend to use;
 
  •  our expectations regarding the royalty rates for intellectual property that we license and our publishing of original games;
 
  •  our ability to estimate accurately for purposes of preparing our consolidated financial statements;
 
  •  our ability to find future acquisition opportunities on favorable terms or at all;
 
  •  our intention to license additional brands and other intellectual property;
 
  •  our international expansion plans and our anticipated international revenue growth;
 
  •  our ability to stay abreast of modified or new laws applying to our business; and
 
  •  our spending of the net proceeds from this offering.
 
The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements. These risks, uncertainties and factors include those we discuss in this prospectus under the caption “Risk Factors.” You should read these risk factors and the other cautionary statements made in this prospectus as being applicable to all related forward-looking statements wherever they appear in this prospectus.
 
The forward-looking statements made in this prospectus relate only to events as of the date on which the statements are made. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
 
This prospectus also contains statistical data that we obtained from industry publications and reports. These industry publications generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information. Although we have not independently verified the data contained in these industry publications and reports, based on our industry experience we believe that the publications are reliable and the conclusions contained in the publications and reports are reasonable.


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USE OF PROCEEDS
 
We estimate that we will receive net proceeds from the sale of the            shares of common stock that we are selling in this offering of approximately $      million, based on an assumed initial public offering price of $      per share, after deducting the estimated underwriting discounts and commissions and estimated offering expenses. Each $1.00 increase or decrease in the assumed initial public offering price would increase or decrease, as applicable, the net proceeds to us by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions. If the underwriters’ option to purchase additional shares in this offering is exercised in full, we estimate that our net proceeds will be approximately $      million. We will not receive any proceeds from the sale of shares by the selling stockholders pursuant to the exercise of the underwriters’ option, if it is exercised.
 
The principal purposes of this offering are to obtain additional capital, to create a public market for our common stock and to facilitate our future access to the public equity markets. We intend to use approximately $10.9 million of the net proceeds of this offering to repay in full the principal and accrued interest on our outstanding loan from Pinnacle Ventures, based on amounts accrued as of December 31, 2006. The loan has an interest rate of 11% and has a maturity date of June 2009. We used the net proceeds of this loan for working capital and general corporate purposes. We expect to use the remaining net proceeds of this offering for general corporate purposes, including:
 
  •  expansion of our domestic and international sales and marketing activities, which may include increasing the number of our direct sales and marketing personnel and investing in advertising and marketing to increase brand awareness for specific games and for the Glu brand;
 
  •  expansion of our international development and quality assurance capabilities in Asia Pacific, Latin America and EMEA, which may include hiring additional personnel in current offices and opening new offices to expand development and porting capacity;
 
  •  activities to increase our carrier and other distribution channels;
 
  •  possible advances for license agreements; and
 
  •  other corporate opportunities that may arise in the future.
 
We may also use a portion of the net proceeds for the acquisition of, or investment in, companies, technologies, products or assets that complement our business. However, we have no present understandings, commitments or agreements to enter into any acquisitions or make any investments.
 
We have not yet determined our anticipated expenditures and therefore cannot estimate the amounts to be used for each of the purposes discussed above. The amounts and timing of any expenditures will vary depending on the amount of cash generated by our operations, competitive and technological developments and the rate of growth, if any, of our business. Accordingly, our management will have significant flexibility in applying the net proceeds from this offering, and investors will be relying on the judgment of our management regarding the application of these net proceeds. Pending the uses described above, we intend to invest the net proceeds from this offering in short-term, interest-bearing, investment-grade securities. The goal with respect to the investment of these net proceeds will be capital preservation and liquidity so that these funds are readily available to fund our operations.
 
DIVIDEND POLICY
 
We have never declared or paid any cash dividends on our capital stock, and we do not currently intend to pay any cash dividends on our common stock for the foreseeable future. We expect to retain future earnings, if any, to fund the development and growth of our business. Any future determination to pay dividends on our common stock will be at the discretion of our board of directors and will depend upon, among other factors, our financial condition, operating results, current and anticipated cash needs, plans for expansion and other factors that our board of directors may deem relevant. Our existing loan agreement with Pinnacle Ventures prohibits payment of dividends prior to the effective date of the registration statement covering this offering.


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CAPITALIZATION
 
The following table sets forth our capitalization as of September 30, 2006:
 
  •  on an actual basis;
 
  •  on a pro forma basis to reflect (i) the automatic conversion of all outstanding shares of our preferred stock into 47,040,945 shares of our common stock, as if this had occurred as of September 30, 2006, and (ii) the reclassification of our preferred stock warrant liability to additional paid-in capital upon the conversion of warrants to purchase shares of our convertible preferred stock into warrants to purchase shares of our common stock upon the completion of this offering; and
 
  •  on a pro forma as adjusted basis to reflect, in addition, (i) the sale by us of the           shares of common stock offered by us in this offering, excluding the underwriters’ option to purchase additional shares of our common stock in this offering, at an assumed initial public offering price of $      per share, after deducting the estimated underwriting discounts and commissions and estimated offering expenses, (ii) the amendment and restatement of our certificate of incorporation immediately following the completion of this offering and (iii) the use of approximately $10.9 million of the net proceeds of this offering to repay in full the principal and accrued interest on our loan from Pinnacle Ventures.
 
You should read this table together with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.
 
                         
    September 30, 2006  
                Pro Forma
 
   
Actual
   
Pro Forma
   
As Adjusted(1)
 
    (In thousands)  
Current portion of long-term debt
  $ 3,226     $ 3,226     $  
                         
Long-term debt, less current portion
  $ 8,331     $ 8,331     $  
                         
Preferred stock warrant liability
    2,034              
                         
Mandatorily redeemable convertible preferred stock (Series A – D-1), $0.0001 par value per share; 37,639,842 shares authorized, 36,773,066 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma or pro forma as adjusted
    57,246              
                         
Special junior redeemable preferred stock, $0.0001 par value per share; 13,454,516 shares authorized, 10,267,879 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma or pro forma as adjusted
    19,098              
                         
Stockholders’ equity (deficit):
                       
Preferred stock, $0.0001 par value per share; no shares authorized, issued or outstanding, actual or pro forma; 5,000,000 shares authorized, no shares issued or outstanding, pro forma as adjusted
                 
Common stock, $0.0001 par value per share; 100,000,000 shares authorized, 16,128,544 shares issued and outstanding, actual; 100,000,000 shares authorized, 63,169,489 shares issued and outstanding, pro forma; 250,000,000 shares authorized,           shares issued and outstanding, pro forma as adjusted
    2       6          
Additional paid-in capital
    19,234       97,608          
Deferred stock-based compensation
    (562 )     (562 )     (562 )
Accumulated other comprehensive loss
    229       229       229  
Accumulated deficit
    (43,666 )     (43,666 )     (43,666 )
                         
Total stockholders’ equity (deficit)
    (24,763 )     53,615          
                         
Total capitalization
  $ 61,946     $ 61,946     $  
                         
 
 
(1) Each $1.00 increase or decrease in the assumed initial public offering price of $      per share would increase or decrease, respectively, the amount of pro forma as adjusted additional paid-in


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capital, total stockholders’ equity (deficit) and total capitalization by approximately $      million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions. If the underwriters’ option to purchase additional shares of our common stock in this offering is exercised in full, the amount of pro forma as adjusted additional paid-in capital, total stockholders’ equity (deficit) and total capitalization would increase by approximately $       , and we would have           shares of our common stock issued and outstanding.
 
In the table above, the number of shares outstanding as of September 30, 2006 does not include:
 
  •  8,135,394 shares issuable upon the exercise of stock options outstanding as of September 30, 2006 with a weighted average exercise price of approximately $1.45 per share;
 
  •  687,223 shares issuable upon the exercise of warrants outstanding as of September 30, 2006 with a weighted average exercise price of approximately $1.74 per share; and
 
  •             shares to be reserved for issuance under our 2007 Equity Incentive Plan and our 2007 Employee Stock Purchase Plan, each of which will become effective on the first day that our common stock is publicly traded and contains provisions that automatically increase its share reserve each year, as more fully described in “Management — Employee Benefit Plans.”


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DILUTION
 
If you invest in our common stock in this offering, your interest will be diluted to the extent of the difference between the initial public offering price of our common stock and the pro forma net tangible book value of our common stock after this offering. As of September 30, 2006, our pro forma net tangible book value was approximately $10.7 million, or $0.17 per share, based upon 63,169,489 shares outstanding as of this date. Pro forma net tangible book value per share represents the amount of our total tangible assets less our total liabilities, divided by the number of outstanding shares of our common stock, after giving effect to the automatic conversion of all outstanding shares of our preferred stock into shares of our common stock and the reclassification of our preferred stock warrant liability to additional paid-in capital upon the conversion of warrants to purchase shares of our convertible preferred stock into warrants to purchase shares of our common stock upon the completion of this offering.
 
After giving effect to the sale by us of the           shares of common stock offered by us in this offering at an assumed initial public offering price of $      per share, after deducting the estimated underwriting discounts and commissions and the estimated offering expenses, our pro forma as adjusted net tangible book value as of September 30, 2006 would have been approximately $      million, or $      per share. This represents an immediate increase in pro forma net tangible book value of $      per share to existing stockholders and an immediate dilution of $      per share to new investors purchasing shares at the initial public offering price. The following table illustrates this per share dilution:
 
                 
Assumed initial public offering price per share
          $        
Pro forma net tangible book value per share as of September 30, 2006
  $ 0.17          
Increase in pro forma net tangible book value per share attributable to new investors
               
                 
Pro forma as adjusted net tangible book value per share after this offering
               
                 
Dilution in pro forma net tangible book value per share to new investors
          $    
                 
 
A $1.00 increase or decrease in the assumed initial public offering price of $      would increase or decrease our pro forma as adjusted net tangible book value per share after this offering by $      per share and the dilution in pro forma as adjusted net tangible book value to new investors by $      per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions. If the underwriters exercise in full their option to purchase additional shares of our common stock in this offering, the pro forma net tangible book value per share after giving effect to this offering would be $      per share, and the dilution in pro forma net tangible book value per share to investors in this offering would be $      per share.
 
The following table summarizes on the pro forma as adjusted basis described above, the difference between our existing stockholders and the purchasers of shares of our common stock in this offering with respect to the number of shares of common stock purchased from us, the total consideration paid to us and the average price paid per share paid to us, based on an assumed initial public offering price of $      per share, before deducting the estimated underwriting discounts and commissions:
 
                                         
   
Shares Purchased
    Total Consideration     Average Price
 
   
Number
   
Percent
   
Amount
   
Percent
   
Per Share
 
 
Existing stockholders
    63,169,489       %   $ 92,658,374       %   $ 1.47  
New investors
                                           
                                         
Total
            100.0 %             100.0 %        
                                         


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A $1.00 increase or decrease in the assumed initial public offering price of $      per share would increase or decrease, respectively, total consideration paid by new investors and total consideration paid by all stockholders by approximately $      million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.
 
The above discussion and tables assume no exercise of our stock options or warrants outstanding as of September 30, 2006, consisting of 8,135,394 shares of our common stock issuable upon the exercise of stock options with a weighted average exercise price of approximately $1.45 per share and 687,223 shares of our common stock issuable upon the exercise of warrants with a weighted average exercise price of approximately $1.74 per share. If all of these options and warrants were exercised, then:
 
  •  there will be an additional $      per share of dilution to new investors;
 
  •  our existing stockholders, including the holders of these options and warrants, would own  % and our new investors would own  % of the total number of shares of our common stock outstanding upon the completion of this offering; and
 
  •  our existing stockholders, including the holders of these options and warrants, would have paid  % of total consideration, at an average price per share of $     , and our new investors would have paid  % of total consideration.


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SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected consolidated financial data below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, related notes and other financial information included elsewhere in this prospectus. The selected consolidated financial data in this section are not intended to replace the financial statements and are qualified in their entirety by the financial statements and related notes included elsewhere in this prospectus.
The following table presents selected historical financial data. We derived the statements of operations data for the years ended December 31, 2003, 2004 and 2005 and the nine months ended September 30, 2006 and the balance sheet data as of December 31, 2004 and 2005 and September 30, 2006 from our audited consolidated financial statements included elsewhere in this prospectus. We derived the statements of operations data for the period from May 16, 2001 (inception) through December 31, 2001 and the year ended December 31, 2002 and the balance sheet data as of December 31, 2001, 2002 and 2003 from our audited consolidated financial statements that do not appear in this prospectus. We derived the statement of operations data for the nine months ended September 30, 2005 from our unaudited consolidated financial statements included elsewhere in this prospectus. We have prepared the unaudited consolidated financial statements on the same basis as the audited consolidated financial statements and have included, in our opinion, all adjustments, consisting only of normal recurring adjustments, that we consider necessary to state fairly the results of operations for the nine months ended September 30, 2005. Our historical results are not necessarily indicative of the results we expect in the future, and our results for the nine months ended September 30, 2006 should not be considered indicative of results we expect for the full fiscal year.
The pro forma per share data give effect to the conversion of all our outstanding convertible preferred stock into common stock upon the completion of this offering and adjustments to eliminate accretion to preferred stock and the charges associated with the cumulative effect change and subsequent remeasurement to fair value of our preferred stock warrants. For further information concerning the calculation of pro forma per share information, please refer to note 2 of our notes to consolidated financial statements.
                                                         
    May 16, 2001
                                     
    (Inception)
                                     
    Through
                            Nine Months
 
    December 31,
    Year Ended December 31,     Ended September 30,  
   
2001
   
2002
   
2003
   
2004
   
2005
   
2005
   
2006
 
    (In thousands, except per share amounts)  
 
Consolidated Statements of Operations Data:
                                                       
Revenues
  $     $ 22     $ 1,790     $ 7,022     $ 25,651     $ 18,871     $ 31,863  
Cost of revenues:
                                                       
Royalties
          2       258       1,359       7,256       5,234       9,750  
Impairment of prepaid royalties and guarantees
                      231       1,645       525       224  
Amortization of intangible assets
                      126       2,823       2,202       1,224  
Impairment of intangible assets
                            1,103              
                                                         
Total cost of revenues
                258       1,716       12,827       7,961       11,198  
                                                         
Gross profit
          20       1,532       5,306       12,824       10,910       20,665  
                                                         
Operating expenses(1):
                                                       
Research and development
    190       1,623       3,352       6,474       14,557       10,775       11,346  
Sales and marketing
    35       392       697       3,692       8,515       6,359       8,317  
General and administrative
    229       1,015       1,342       3,468       8,434       5,640       7,684  
Amortization of intangible assets
                      26       616       463       476  
Restructuring charge
                            450              
Acquired in-process research and development
                                        1,500  
                                                         
Total operating expenses
    454       3,030       5,391       13,660       32,572       23,237       29,323  
                                                         
Loss from operations
    (454 )     (3,010 )     (3,859 )     (8,354 )     (19,748 )     (12,327 )     (8,658 )
Interest and other income (expense), net
    (4 )     39       11       (69 )     541       351       (904 )
                                                         
Loss before income taxes and cumulative effect of change in accounting principle
    (458 )     (2,971 )     (3,848 )     (8,423 )     (19,207 )     (11,976 )     (9,562 )
Income tax benefit (provision)
                      101       1,621       943       (437 )
                                                         
Loss before cumulative effect of change in accounting principle
    (458 )           (3,848 )     (8,322 )     (17,586 )     (11,033 )     (9,999 )
Cumulative effect of change in accounting principle
                            (315 )     (315 )      
                                                         
Net loss
    (458 )     (2,971 )     (3,848 )     (8,322 )     (17,901 )     (11,348 )     (9,999 )
Accretion to preferred stock
                (533 )     (1,351 )     (63 )     (45 )     (56 )
                                                         
Net loss attributable to common stockholders
  $ (458 )   $ (2,971 )   $ (4,381 )   $ (9,673 )   $ (17,964 )   $ (11,393 )   $ (10,055 )
                                                         
Net loss per share attributable to common stockholders — basic and diluted
                                                       
Loss before cumulative effect of change in accounting principle
  $ (5.21 )   $ (1.36 )   $ (1.23 )   $ (1.85 )   $ (1.46 )   $ (0.94 )   $ (0.69 )
Cumulative effect of change in accounting principle
                            (0.02 )     (0.02 )      
Accretion to preferred stock
                (0.16 )     (0.30 )     (0.01 )     (0.01 )      
                                                         
Net loss per share attributable to common stockholders — basic and diluted
  $ (5.21 )   $ (1.36 )   $ (1.39 )   $ (2.15 )   $ (1.49 )   $ (0.97 )   $ (0.69 )
                                                         
Weighted average common shares outstanding
    88       2,188       3,141       4,499       12,072       11,774       14,534  
                                                         
Pro forma net loss per share — basic and diluted
                                  $ (0.39 )           $ (0.15 )
                                                         
Pro forma weighted average common shares outstanding
                                    45,091               58,266  
                                                         


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(1) Includes stock-based compensation expense as follows:
 
                                                         
    May 16, 2001
                                     
    (Inception)
                            Nine Months
 
    Through
                            Ended
 
    December 31,
    Year Ended December 31,     September 30,  
   
2001
   
2002
   
2003
   
2004
   
2005
   
2005
   
2006
 
    (In thousands)  
 
Research and development
  $     $     $     $ 28     $ 158     $ 154     $ 100  
Sales and marketing
                      59       132       107       131  
General and administrative
                32       454       987       733       735  
 
                                                 
    December 31,     September 30,
 
   
2001
   
2002
   
2003
   
2004
   
2005
   
2006
 
    (In thousands)  
 
Consolidated Balance Sheet Data:
                                               
Cash, cash equivalents and short-term investments
  $ 3,866     $ 813     $ 1,888     $ 8,393     $ 21,616     $ 14,384  
Working capital
    3,748       705       2,252       9,540       21,640       16,527  
Total assets
    3,883       1,023       3,188       37,608       49,498       76,419  
Preferred stock warrant liability
                            374       2,034  
Long-term debt, including current portion
                            102       11,557  
Redeemable preferred stock
    4,208       4,208       10,259       31,495       57,190       76,344  
Total stockholders’ deficit
    (443 )     (3,384 )     (7,836 )     (1,418 )     (17,393 )     (24,763 )


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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.
 
Overview
 
Glu Mobile is a leading global publisher of mobile games. We have developed and published a portfolio of more than 100 casual and traditional games to appeal to a broad cross section of the over one billion subscribers served by our more than 150 wireless carriers and other distributors. We create games and related applications based on third-party licensed brands and other intellectual property, as well as on our own original brands and intellectual property. Our games based on licensed intellectual property include Deer Hunter , Diner Dash , Monopoly , Sonic the Hedgehog , World Series of Poker and Zuma. Our original games based on our own intellectual property include Alpha Wing , Ancient Empires , Blackjack Hustler , Stranded 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 and networked nature of mobile handsets. We leverage the marketing resources and distribution infrastructures of wireless carriers and the brands and other intellectual property of third-party content owners, which allows 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 for mobile games. At the same time, carriers and branded content owners are focusing on a small group of publishers that have the ability to produce 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 of the major carriers. We believe we have created the requisite development and porting technology and have achieved the requisite scale to be in this group. We also believe that leveraging our carrier and content owner relationships will allow us to grow our revenues without corresponding 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 to attract new end users in that market. Our ability to attain profitability will be affected by the extent to which we must incur additional expenses to expand our sales, marketing, development, and general and administrative capabilities to grow our business. The largest component of our expenses is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation, including bonuses and stock-based compensation, for our employees. Our operating expenses will continue to grow in absolute dollars, assuming our revenues continue to grow. As a percentage of revenues, we expect these expenses to decrease.
 
We were incorporated in May 2001 and introduced our first mobile games to the market in July 2002. In December 2004 and in March 2006, we acquired Macrospace and iFone, respectively, each a mobile game developer and publisher based in the United Kingdom. In the third quarter of 2005, we opened a Hong Kong office; in the third quarter of 2006, we opened an office in France; and, in the fourth quarter of 2006, we opened additional offices in Brazil and Germany.
 
We acquired Macrospace in order to continue to develop and secure direct distribution relationships with the leading wireless carriers, to deepen and broaden our game library, to acquire access and rights to leading licenses and franchises (including original intellectual property) and to augment our internal production and publishing resources. We acquired iFone in order to continue to deepen and broaden our game library, to acquire access and rights to leading licenses and franchises and to


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augment our external production resources. These acquisitions were part of our strategy of expanding into Europe to address the desire of wireless carriers to work with publishers that have large and diverse portfolios of high-quality games based on well-known brands and of branded content owners to work with publishers that have global distribution capabilities. These acquisitions:
 
  •  enabled us to port the acquired companies’ games to additional handsets and distribute them in other geographies;
 
  •  enabled us to distribute our original and licensed intellectual property in the geographies where these companies had distribution relationships;
 
  •  provided complementary technical production capabilities that enabled the combined companies to create products superior to those developed by either separately;
 
  •  enabled us to develop games targeted to the European market, and localize our existing games;
 
  •  expanded and deepened our management capacity and capability to conduct business globally; and
 
  •  enabled us to compete for licenses on a broader scale because of enhanced distribution and production capabilities.
 
We believe that these acquisitions, together with our internal growth, have significantly enhanced our attractiveness to wireless carriers and branded content owners, allowing us to pursue our ongoing strategy.
 
Revenues
 
We generate the vast majority of our revenues from wireless carriers that market and distribute our games. These carriers generally charge a one-time purchase fee or a monthly subscription fee on their subscribers’ phone bills when the subscribers download our games to their mobile phones. The carriers perform the billing and collection functions and generally remit to us a contractual fee or a contractual percentage 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 games through 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 have grown more rapidly than our international revenues, and this trend may continue.
 
Cost of Revenues
 
Our cost of revenues consists primarily of royalties that we pay to content owners from which we license brands and other intellectual property and, to a limited extent, to certain external developers. Our cost of revenues also includes noncash expenses — amortization of certain acquired intangible assets, any impairment of those intangible assets, and any impairment of prepaid royalties and guarantees. We record advance royalty payments made to content licensors as prepaid royalties on our balance sheet when payment is made to the licensor. We recognize royalties in cost of revenues based upon the revenues derived from the relevant game multiplied by the applicable royalty rate. If our licensors earn royalties in excess of their advance royalties, we also recognize these excess royalties as cost of revenues in the period they are earned by the licensor. If applicable, we will record an impairment of prepaid royalties or accrue for future guaranteed royalties that are in excess of anticipated demand or net realizable value. At each balance sheet date, we perform a detailed review of prepaid royalties and guarantees that considers multiple factors, including forecasted demand, game life cycle status, game development plans, and current and anticipated sales levels.


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We pay some of our external developers, especially in Europe, royalties in addition to payments for game development costs. We recognize these royalties as cost of revenues in the period the developer earns the royalties based upon the revenues derived from the relevant game multiplied by the applicable royalty rate. We expense the costs for development of our games prior to technological feasibility 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 not been significant, but we expect them to increase in aggregate amount based on our existing contracts with developers.
 
Absent further impairments of existing intangible assets, we expect amortization of intangible assets included in cost of revenues to be $552,000 in the fourth quarter of 2006, $2.1 million in 2007, $883,000 in 2008, $526,000 in 2009, $354,000 in 2010 and $84,000 in 2011. These amounts would likely increase if we make future acquisitions.
 
Gross Margin
 
Our gross margin is determined principally by the mix of games that we license. Our games based on licensed intellectual property require us to pay royalties to the licensor and the royalty rates in our licenses vary significantly; our original Glu-branded games, which are based on our own intellectual property, require no royalty payments to licensors. There are multiple internal and external factors that affect the mix of revenues from licensed games and Glu-branded games, including the overall number of licensed games and Glu-branded games available for sale during a particular period, the extent of our and our carriers’ marketing efforts for each game, and the deck placement of each game on our carriers’ mobile handsets. We believe the success of any individual game during a particular period is affected by its quality and third-party ratings, its marketing and media exposure, its consumer recognizability, its overall acceptance by end 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, such as licensed content, games, trademarks and carrier contracts, that are directly related to revenue-generating activities and by periodic charges for impairment of these assets and of prepaid royalties and guarantees. These charges can cause gross margin variations, particularly from quarter to quarter.
 
Operating Expenses
 
Our operating expenses primarily include research and development expenses, sales and marketing expenses and general and administrative 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 employees working on creating, developing, porting, quality assurance, carrier certification and deployment of our games, on technologies related to interoperating with our various wireless carriers and on our internal platforms, payments to third parties for developing and porting of our games, and allocated facilities costs.
 
We devote substantial resources to the development, porting and quality assurance of our games and expect this to continue in the future. We believe that developing games internally through our own development studios allows us to increase operating margins, leverage the technology we have developed and better control game delivery. During 2006, as a result of our acquisition of iFone, we substantially increased our use of external development resources, but we currently do not expect further significant increases in expenses for external development. Our games generally require six months to one year to produce, based on the complexity and feature set of the game developed, the number of carrier wireless platforms and mobile handsets covered, and the experience of the internal or external developer. We expect our research and development expenses will increase in absolute


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terms as we continue 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 for sales 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 and marketing 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 marketing headcount will not increase as rapidly as revenues and that therefore sales and marketing expenses will continue to decrease as a percentage of revenues.
 
General and Administrative.   Our general and administrative expenses consist primarily of salaries and benefits for general and administrative personnel, consulting fees, legal, accounting and other professional fees, information technology costs and allocated facilities costs. We expect that general and administrative expenses will increase in absolute terms as we hire additional personnel and incur costs related to the anticipated growth of our business and our operation as a public company. We also expect that these expenses will increase because of the additional costs to comply with the Sarbanes-Oxley Act and related regulation, our efforts to expand our international operations and, in the near term, additional accounting costs related to the public offering of our common stock. 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 a percentage of revenues. We could fail to increase our revenues as anticipated, and we could decide to increase expenses in one or more categories to respond to competitive pressures or for other reasons. In these cases and others, it is possible that one or more of our operating 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 noncompetition agreements, as part of our operating expenses. We record intangible assets on our balance sheet based upon their fair value at the time they are acquired. We determine the fair value of the intangible assets using a discounted cash flows approach. We amortize the amortizable intangible assets using the straight-line method over their estimated useful lives of two to six years. Absent impairments of existing intangible assets, we expect amortization of existing intangible assets to be $140,000 in the fourth quarter of 2006, $266,000 in 2007, $267,000 in 2008, $267,000 in 2009 and $256,000 in 2010. These amounts would likely increase if we make future acquisitions.
 
Restructuring Charge.   In 2005, we undertook restructuring activities to reduce our ongoing operating expenses. The resulting restructuring charge principally consisted of costs associated with employee termination benefits. We recorded these costs as an operating expense when we communicated the benefit arrangement to the employee and no significant future services, other than a minimum retention 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 as acquired in-process research and development, or IPR&D, if the feasibility of the acquired technology has not been established and no future 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 using a discounted cash flows approach. In estimating the appropriate discount rate, we consider, among other things, the risks to developing technology given changes in trends and technology in our industry. In 2006, we expensed the fair value of IPR&D acquired in the iFone transaction.


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Interest and Other Income (Expense), Net
 
Interest and other income (expense), net, includes interest income, interest expense, accretion of the debt discount related to the warrants issued to Pinnacle Ventures in conjunction with its March 2006 loan to us, changes in our preferred stock warrant liability and foreign currency transaction gains and losses. Following the completion of this offering when our outstanding warrants to purchase redeemable convertible preferred stock convert into warrants to purchase common stock, we will no longer be required to record changes in our preferred stock warrant liability under Staff Position No. 150-5, Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable , or FSP 150-5, or accretion in the debt discount related to the Pinnacle Ventures warrants. Following this offering, we will have additional cash, cash equivalents and short-term investments of approximately $           resulting from the net proceeds of this offering. This will likely cause a substantial increase in our interest income.
 
Accounting for Income Taxes
 
We are subject to tax in the United States as well as other tax jurisdictions or countries in which we conduct business. Earnings from our non-U.S. activities are subject to local country income tax and may be subject to current United States income tax depending on whether these earnings are subject to U.S. income tax based upon U.S. anti-deferral rules, such as Subpart F of the Internal Revenue Code of 1986, as amended, or the Code. In addition, some revenues generated outside of the United States and the United Kingdom may be subject to withholding taxes. In some cases, these withholding taxes may be deductible on a current basis or may be available as a credit to offset future income taxes depending on a variety of 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 consider historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we were to determine that we would be able to realize deferred tax assets 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 in the period the determination is made. Historically, we have incurred operating losses and have generated significant net operating loss carryforwards. At September 30, 2006, we had net operating loss carryforwards of approximately $28.5 million and $28.6 million for federal and state tax purposes, respectively. These carryforwards will expire from 2011 to 2025. Our ability to use our net operating loss carryforwards to offset any future taxable income may be subject to restrictions attributable to equity transactions that result in changes of ownership as defined by section 382 of the Code.
 
As of December 31, 2005, the federal research and development credit expired. Therefore, the 2006 tax calculations only reflect the California research and development credit. In late December 2006, Congress passed legislation that reinstated the federal credit retroactively to January 1, 2006. As a result, we will recognize an additional credit in the fourth quarter of 2006.
 
Beginning on January 1, 2007, we will be accounting for uncertainty in income taxes in accordance with FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 . As of September 30, 2006, we have not determined what the cumulative impact of adopting this change in accounting method will be.
 
Cumulative Effect of Change in Accounting Principle
 
On June 29, 2005, the FASB issued FSP 150-5. FSP 150-5 affirms that freestanding warrants to purchase shares that are redeemable 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 that must


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be recorded at fair value each quarter, with the changes in estimated fair value in the quarter recorded as other expense or income in our statement of operations.
 
We adopted FSP 150-5 as of July 1, 2005 and recorded an expense of $315,000 for the cumulative effect of the change in accounting principle to reflect the estimated fair value of these warrants as of that date. We recorded income of $85,000 and expense of $1.1 million in other income (expense), net, for the remainder of 2005 and the first nine months of 2006, respectively, to reflect further increases or decreases in the estimated fair value of the warrants. The pro forma effect of the adoption of FSP 150-5 on our results of operations for 2004 and 2005, if applied retroactively as if SFAS No. 150 had been adopted in those years, was not material. We estimated the fair value of these warrants at the respective balance sheet dates using the Black-Scholes option valuation model. This model utilizes as inputs the estimated fair value of the underlying convertible preferred stock at the valuation measurement date, the remaining contractual term of the warrant, risk-free interest rates, expected dividends and expected volatility of the price of the underlying convertible preferred stock.
 
Our management considered the capital structure analysis utilized in the common stock valuations prepared by Duff & Phelps, LLC, an independent valuation firm, as of September 30, 2005, December 31, 2005, March 31, 2006, June 30, 2006, September 7, 2006 and December 31, 2006 in determining the preferred stock value.
 
Accretion of Preferred Stock
 
Our Series A, B, C, D and D-1 mandatorily redeemable convertible preferred stock has a mandatory redemption provision. In each quarterly and annual period, we accrete the amount that is necessary to adjust the recorded balance of this preferred stock to an amount equal to its estimated redemption value at its redemption date using the effective interest method. The redemption value is the greater of the par value of the preferred stock plus any dividends declared and unpaid or its estimated fair value using the effective interest method. Each share of our outstanding preferred stock will automatically convert to common stock if this offering is completed, results in proceeds of at least $50 million and has an offering price in excess of $4.50 per share, and we will cease accreting upon this conversion.
 
Critical Accounting Policies and Estimates
 
Our consolidated financial statements are prepared in accordance with United States generally accepted accounting principles, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the dates of the consolidated financial statements, the disclosure of contingencies as of the dates of the consolidated financial statements, and the reported amounts of revenues and expenses during the periods presented. Although we believe that our estimates and judgments are reasonable under the circumstances existing at the time these estimates and judgments are made, actual results may differ from those estimates, which could affect our consolidated financial statements.
 
We believe the following to be critical accounting policies because they are important to the portrayal of our financial condition or results of operations and they require critical management estimates and judgments about matters that are uncertain:
 
  •  revenue recognition;
 
  •  advance or guaranteed licensor royalty payments;
 
  •  long-lived assets;
 
  •  goodwill;
 
  •  software development costs;


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  •  stock-based compensation; and
 
  •  income taxes.
 
Revenue Recognition
 
We derive our revenues primarily by licensing software products in the form of mobile games. License arrangements with our end users can be on a perpetual or subscription basis. A perpetual license gives an end user the right to use the licensed game on the registered mobile handset on a perpetual basis. A subscription license gives an end user the right to use the licensed game on the registered handset for a limited period of time, ranging from a few days to as long as one month. We distribute our products primarily through wireless carriers, which market our games to end users. Carriers usually bill license fees for perpetual and subscription licenses upon download of the game software by the end user. In the case of subscription licenses, many subscriber agreements 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 Revenue Recognition, 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 is fixed or determinable, and the collection of the resulting receivable is probable. For both perpetual and subscription licenses, we consider a signed license agreement to be evidence of an arrangement with a carrier and a “clickwrap” agreement to be evidence of an arrangement with 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 carriers provide 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 the end user licenses the game. Determination of the appropriate amount of revenue recognized involves judgments and estimates that we believe are reasonable, but it is possible that actual results may differ from our estimates. Our estimates for revenues include consideration of factors such as preliminary sales data, carrier-specific historical sales trends, the age of games and the expected impact of newly launched games, successful introduction of new handsets, promotions during the period and economic trends. When we receive the final carrier reports, to the extent not received within a reasonable time frame following the end of each month, we record any differences between estimated revenues and actual revenues in the reporting period when we determine the actual amounts. Historically, the revenues on the final revenue report have not differed by more than one-half of 1% of the reported revenues for the period, which we deemed to be immaterial. Revenues earned from certain carriers may not be reasonably estimated. If we are unable to reasonably estimate the amount of revenue to be recognized in the current period, we recognize revenues upon the receipt of a carrier revenue report and when our 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 the revenues by carrier and by game on a weekly basis to identify unusual trends such as differential adoption rates by carriers or the introduction of new handsets. If we deem a carrier not to be creditworthy, we defer all revenues from the arrangement with that carrier until we 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 Net as an Agent , we recognize as revenues the amount the carrier reports as payable to us upon the sale of our games. We have evaluated our carrier agreements and


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have determined that we are not the principal when selling our games through carriers. Key indicators that we evaluated in reaching this determination included:
 
  •  wireless subscribers directly contract with their carriers, which have most of the service interaction and are generally viewed as the 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 carriers generally 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 Payments
 
Our royalty expenses consist of fees that we pay to branded content owners for the use of their intellectual property, including trademarks and copyrights, in the development of our games. Royalty-based obligations are either paid in advance and capitalized on our balance sheet as prepaid royalties or accrued as incurred and subsequently paid. These royalty-based obligations are expensed to cost of revenues at the greater of the revenues derived from the relevant game multiplied by the applicable contractual rate or an effective royalty rate based on expected net product sales. Advanced license payments that are not recoupable against future royalties are capitalized and amortized 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 ultimate volume of sales to end users. When no significant performance remains with the licensor, we initially record each of these guarantees as an asset and as a liability at the contractual amount. When significant performance remains with the licensor, we record royalty payments as an asset when actually paid and as a liability when incurred, rather than upon execution of the contract. We classify minimum royalty payment obligations as current liabilities 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 determine amounts that we deem unlikely to be realized through product sales. We use estimates of revenues, cash flows and net margins to evaluate the 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 this evaluation indicates that the remaining prepaid and guaranteed royalty payments are not recoverable, we record an impairment charge in the period such impairment is indicated. Subsequently, if actual market conditions are more favorable than anticipated, amounts of prepaid royalties previously written down may be utilized, resulting in lower cost of revenues and higher income from operations than previously expected in that period. For example, in the first nine months of 2006, our cost of revenues was reduced by $95,000 as a result of selling games on which the prepaid royalties had previously been impaired. During 2003, 2004 and 2005 and the nine months ended September 30, 2006, we recorded impairment charges of $0, $231,000, $1.6 million and $224,000, respectively.
 
Long-Lived Assets
 
We evaluate our long-lived assets, including property and equipment and intangible assets with finite lives, for impairment whenever events or changes in circumstances indicate that the carrying


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value of these assets may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Factors considered important that could result in an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets, significant negative industry or economic trends, and a significant decline in our stock price for a sustained period of time. We recognize impairment based on the difference between the fair value of the asset and its carrying value. Fair value is generally measured based on either quoted market prices, if applicable, or a discounted cash flow analysis.
 
Goodwill
 
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets , we do not amortize goodwill or other intangible assets with indefinite lives but rather test them for impairment. SFAS No. 142 requires us to perform an impairment review of our goodwill balance at least annually, which we do as of September 30 each year, and also whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. In our impairment review, we look at two of our reporting units — the United States and EMEA — since none of our goodwill is attributable to our third operating unit, the rest of the world. We compare the fair value of each unit to its carrying value, including goodwill. The primary methods used to determine the fair values for SFAS No. 142 impairment purposes were the discounted cash flow and market methods. We determined the assumptions supporting the discounted cash flow method, including the assumed 18% discount rate as of September 30, 2006, using our best estimates as of the date of the impairment review. If the carrying value, including goodwill, exceeds the fair value, we perform an allocation of the unit’s fair value to its identifiable tangible and nongoodwill intangible assets and liabilities. This allows us to determine an implied fair value for the unit’s goodwill. We then compare the implied fair value of the unit’s goodwill with the carrying value of the unit’s goodwill. If the carrying value of the unit’s goodwill is greater than its implied fair value, we would recognize an impairment charge for the difference. To date, no unit’s carrying value has exceeded its fair value, and thus we have taken no goodwill impairment charges.
 
Application of the goodwill impairment test requires judgment, including the identification of the reporting units, the assigning of assets and liabilities to reporting units, the assigning of goodwill to reporting units and the determining of the fair value of each reporting unit. Significant judgments and assumptions include the forecast of future operating results used in the preparation of the estimated future cash 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 market comparable approach estimates the fair value of a company by applying to that company market multiples of publicly traded firms in similar lines of business. The use of the market comparable approach requires judgments regarding the comparability of companies with lines of business similar to ours. If different comparable companies had been used, the market multiples and resulting estimates of the fair value of our stock would also have been different. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit, which could trigger impairment.
 
Software Development Costs
 
We apply the principles of SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed. SFAS No. 86 requires that software development costs incurred in conjunction with product development be charged to 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 do not consider a game in development to have passed the technological feasibility milestone until we have completed a model of the


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game that contains essentially all the functionality and features of the final game and have tested the model to ensure that it works as expected. To date, 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. In the future, we will consider the following factors in determining whether costs should be capitalized: the emerging nature of the mobile game market; the gradual evolution of the wireless carrier platforms and mobile handsets 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 be available for sale; and our historical practice of canceling games at any stage of the development process.
 
Stock-Based Compensation
 
The following table summarizes by grant date the number of shares subject to options granted between April 26, 2004 and September 30, 2006 and the per share exercise price, deemed fair value and resulting intrinsic value.
 
                                 
    Number of
          Per Share
       
    Shares
    Per Share
    Deemed
    Per Share
 
Grant Date
 
Granted
   
Exercise Price
   
Fair Value
   
Intrinsic Value
 
 
April 26, 2004
    250,000     $ 0.10     $ 0.16     $ 0.06  
May 6, 2004
    209,000       0.10       0.22       0.12  
June 30, 2004
    345,100       0.25       0.39       0.14  
July 28, 2004
    35,800       0.25       0.53       0.28  
September 8, 2004
    195,900       0.25       1.05       0.80  
November 3, 2004
    1,565,624       0.25       1.58       1.33  
December 8, 2004
    169,500       0.50       1.88       1.38  
January 26, 2005
    193,000       0.50       1.88       1.38  
January 27, 2005
    222,500       0.75       1.88       1.13  
March 1, 2005
    550,000       0.75       1.88       1.13  
March 18, 2005
    105,725       1.00       1.88       0.88  
April 28, 2005
    970,476       1.50       1.49        
June 22, 2005
    13,850       1.50       1.47        
July 27, 2005
    516,824       1.60       1.24        
September 12, 2005
    971,975       1.60       1.24        
September 15, 2005
    253,500       1.60       1.24        
December 15, 2005
    393,775       1.18       1.03        
February 2, 2006
    190,000       1.19       1.09        
March 9, 2006
    372,600       1.19       1.09        
July 20, 2006
    1,742,450       1.30       1.25        
September 7, 2006
    1,804,350       3.51       3.51        
 
Prior to January 1, 2006, we accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting 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’s common stock and the exercise price of the option. APB No. 25 required companies to record deferred stock-based compensation on their balance sheets and amortize it to expense over the vesting periods of the individual options. We recorded deferred stock-based compensation of $2.6 million and $1.1 million related to employee stock options granted in 2004 and 2005, respectively. We amortize deferred stock-based compensation using the multiple option method as prescribed by FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans , or FIN 28, over the option vesting period using an accelerated


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amortization schedule. We expensed employee stock-based compensation of $0, $288,000, $1.5 million and $1.0 million in 2003, 2004 and 2005 and the nine months ended September 30, 2005, respectively.
 
Effective January 1, 2006, we adopted the fair value provisions of SFAS No. 123R, Share-Based Payment , which supersedes our previous accounting under APB No. 25. SFAS No. 123R requires the recognition of compensation expense, using a fair-value based method, for costs related to all share-based payments including stock options. SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the grant date using an option pricing model. We adopted SFAS No. 123R using the prospective transition method, which required us to apply SFAS No. 123R to option grants on and after the required effective date. For options granted prior to the January 1, 2006 effective date that remained unvested on that date, we continue to recognize compensation expense under the intrinsic value method of APB No. 25. In addition, we are continuing to amortize those awards granted prior to January 1, 2006 utilizing an accelerated amortization schedule, while we will expense all options granted or modified on and after January 1, 2006 on a straight-line basis. To value awards granted on or after January 1, 2006, we used the Black-Scholes option pricing model, which requires, among other inputs, an estimate of the fair value of the underlying common stock on the date of grant and assumptions as to volatility of our stock over the term of the related options, the expected term of the options, the risk-free interest rate and the option forfeiture rate. We determined the assumptions used in this pricing model at each grant date. We concluded that it was not practicable to calculate the volatility of our share price since our securities are not publicly traded and therefore there is no readily determinable market value for our stock. Therefore, we based expected volatility on the historical volatility of a peer group of publicly traded entities. We determined the expected term of our options based upon historical exercises, post-vesting cancellations and the options’ contractual term. We based the risk-free rate for the expected term of the option on the U.S. Treasury Constant Maturity Rate as of the grant date. We determined the forfeiture rate based upon our historical experience with option cancellations adjusted for unusual or infrequent events.
 
In the first nine months of 2006, we recorded total employee non-cash stock-based compensation expense of $962,000, of which $713,000 represented continued amortization of deferred stock-based compensation for options granted prior to 2006 and $249,000 represented expense recorded in accordance with SFAS 123R based on 2006 options grants with an expected term of approximately 6.08 years. In future periods, stock-based compensation expense may increase as we issue additional equity-based awards to continue to attract and retain key employees. Additionally, SFAS 123R requires that we recognize compensation expense only for the portion of stock options that are expected to vest. Our estimated forfeiture rate in the first nine months of 2006 was 12%. If the actual number of forfeitures differs from that estimated by management, we may be required to record adjustments to stock-based compensation expense in future periods.
 
Given the absence of an active market for our common stock, our board of directors, the members of which we believe had extensive business, finance and venture capital experience, was required to estimate the fair value of our common stock for purposes of determining exercise prices for the options it granted. Through the first half of 2005, it determined the estimated fair value of our common stock, based in part on a market capitalization analysis of comparable public companies and other metrics, including revenue multiples and price/earning multiples, as well as the following:
 
  •  the prices for our convertible preferred stock sold to outside investors in arms-length transactions;
 
  •  the rights, preference and privileges of that convertible preferred stock relative to those of our common stock;
 
  •  our operating and financial performance;
 
  •  the hiring of key personnel;
 
  •  the introduction of new products;


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  •  our stage of development and revenue growth;
 
  •  the fact that the options grants involved illiquid securities in a private company; 
 
  •  the risks inherent in the development and expansion of our services; and
 
  •  the likelihood of achieving a liquidity event, such as an initial public offering or sale of the company, for the shares of common stock underlying the options given prevailing market conditions.
 
In February 2005, we engaged an independent third-party valuation firm, Duff & Phelps, to perform valuations of our common stock and convertible preferred stock at least quarterly. We obtained estimates of the respective then-current fair values of our stock prepared by Duff & Phelps as of December 2004, March 2005, April 2005, June 2005, September 2005, December 2005, March 2006, June 2006 and September 2006. The first valuation report, as of December 2004, was delivered in June 2005. We endeavor to obtain these estimates as quickly as possible and recently have received a draft within one month and a final report within two months of the valuation date. These valuations used a probability-weighted combination of the market comparable approach and the income approach to estimate our aggregate enterprise value at each valuation date. The market comparable approach estimates the fair value of a company by applying to that company market multiples of publicly traded firms in similar lines of business. The use of the market comparable approach requires judgments regarding the comparability of companies with lines of business similar to ours. If different comparable companies had been used, the market multiples and resulting estimates of the fair value of our stock would also have been different. The income approach involves applying appropriate risk-adjusted discount rates to estimated debt-free cash flows, based on forecasted revenue and costs. The projections used in connection with this valuation were based on our expected operating performance over the forecast period. There is inherent uncertainty in these estimates. If different discount rates or other assumptions had been used, the valuations would have been different.
 
Duff & Phelps applied a 50% weighting to the market comparable approach and a 50% weighting to the income approach in its valuations. It allocated the aggregate implied enterprise value that it estimated to the shares of preferred and common stock using the option-pricing method at each valuation date. The option-pricing method involves making assumptions regarding the anticipated timing of a potential liquidity event, such as an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing was based on the plans of our board of directors and management. Estimating the volatility of the share price of a privately held company is complex because there is no readily available market for the shares. Duff & Phelps estimated the volatility of our stock based on available information on the volatility of stocks of publicly traded companies in our industry. Had different estimates of volatility and anticipated timing of a potential liquidity event been used, the allocations between the shares of preferred and common stock would have been different and would have resulted in a different value being determined for our common stock as of each valuation date. Due to the contemplated timing of a potential public offering, we reduced the non-marketability discount applied to our stock from 25% at September 30, 2005 to 11% at September 30, 2006.
 
Since October 1, 2005, we have granted options as described below. On December 15, 2005, we granted options with an exercise price of $1.18 per share. The fair value of our common stock as of September 30, 2005 was $1.03 per share based upon Duff & Phelps’ retrospectively prepared valuation report, which was finalized on April 18, 2006. The fair value of our common stock as of December 31, 2005 changed minimally to $1.09 per share based upon Duff & Phelps’ retrospectively prepared valuation report, which was also finalized on April 18, 2006. Thus, the exercise price of the options granted on December 15, 2005 was above the fair value of our common stock on the grant date.
 
On February 2, 2006 and March 9, 2006, we granted options with an exercise price of $1.19 per share. The fair value of our common stock as of March 31, 2006 was determined to be $1.19 per share based upon Duff & Phelps’ retrospectively prepared valuation report, which was finalized on


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June 22, 2006. Also, on April 12, 2006, a sale of common stock was made by an existing stockholder to a sophisticated independent third-party investor, who was not an existing stockholder, for $1.19 per share. Thus, the exercise price of the options granted on February 2, 2006 and March 9, 2006 was also above the fair value of our common stock on the grant dates. The increase in the estimated fair value of our common stock from $1.09 at December 31, 2005 to $1.19 at March 31, 2006 was primarily the result of the following events during the intervening period, as well as a decrease in the non-marketability discount from 25% to 14%:
 
  •  in December 2005, we reduced our work force by 27 employees, or approximately 12%, to bring our expenses in line with our anticipated revenues;
 
  •  in the first quarter of 2006, we terminated our relationship with our newly hired executive vice president of publishing and our chief information officer resigned;
 
  •  in early February and early March 2006, the iFone acquisition continued to progress, but it did not close until March 29, 2006; and
 
  •  our revenues during the first quarter of 2006 increased 19% over our revenues for the fourth quarter of 2005.
 
On July 20, 2006, we granted options with an exercise price of $1.30 per share. The fair value of our common stock, as of June 30, 2006, was $1.25 per share based upon Duff & Phelps’ retrospectively prepared valuation report, which was finalized on September 7, 2006. The increase in the estimate fair value of our common stock from $1.19 at March 31, 2006 to $1.25 at June 30, 2006 was primarily due to a decrease in the non-marketability discount from 14% to 11%, a reduction in the time to liquidity from 1.00 years to 0.75 years, and the following events during the intervening period:
 
  •  in the second quarter of 2006, we increased 2006 and 2007 forecasted revenues because of the acquisition of iFone;
 
  •  in the second quarter of 2006, we began the integration of iFone, which involved substantially reducing iFone headcount; and
 
  •  in the second quarter of 2006, we spent considerable time with our carrier customers promoting the iFone titles and with our internal and external developers to continue deploying the iFone titles on our carriers.
 
On September 7, 2006, we granted options with an exercise price of $3.51 per share. The fair value of our common stock as of September 7, 2006 was $3.51 per share based upon Duff & Phelps’ retrospectively prepared valuation report, which was finalized on October 25, 2006. The increase in the estimated fair value of our common stock from $1.25 at June 30, 2006 to $3.51 at September 30, 2006 was primarily due to preliminary discussions regarding a potential initial public offering of our common stock, our view of our valuation upon such a potential initial public offering and a reassessment by us and Duff & Phelps of the companies that would be potential comparable public companies based on companies included in the initial presentations to us by investment banks, and the following events during the intervening period:
 
  •  in July and August 2006, we successfully launched three games based on our own original intellectual property;
 
  •  we further increased our revenue forecast for 2007 based on the success of these product introductions and the continued strength of the titles acquired from iFone;
 
  •  in the third quarter of 2006, we began to show the combined leverage of the iFone acquisition both in revenue growth and cost reductions;
 
  •  in the third quarter of 2006, we continued to augment our management team, which included a Vice President and General Counsel, Vice President and Chief Information Officer and the EMEA Marketing Director;


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  •  we formulated and presented for the first time to the investment banks a 2008 forecast;
 
  •  we determined that we should work towards an initial public offering and began assembling an updated forecast for 2006-2010; and
 
  •  the market values of comparable public companies increased.
 
If we had made different assumptions and estimates than those described in the paragraphs above, the amount of our recognized and to be recognized stock-based compensation expense, net loss and net loss per share amounts could have been materially different. We believe that we have used reasonable methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, to determine the fair value of our common stock.
 
In June 2006, we repriced stock options that we had granted to 15 employees in the first quarter of 2005. We changed no terms of the original option grants, other than the exercise price and the term, which we extended from the fifth anniversary to the tenth anniversary of the grant date. This repricing related to vested options to purchase 86,879 shares of our common stock and unvested options to purchase 729,396 shares of our common stock having weighted average original exercise prices of $0.78 and $0.76 per share, respectively. We repriced these options at a new exercise price of $1.30 per share. We accounted for the repricing as a modification under SFAS No. 123R and thus recorded the new incremental fair value related to vested awards as compensation expense on the date of modification. In accordance with SFAS No. 123R, we 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, over the remaining requisite service period of the option holders. Total incremental compensation cost resulting from the modification was $150,000, of which we recorded $59,000 as stock-based compensation expense in the first nine months of 2006. In connection with this repricing, we followed the provisions of SFAS No. 123R and eliminated from our balance sheet the remaining deferred stock-based compensation related to the modified stock options. Future stock-based compensation charges for the modified options will be recorded in accordance with SFAS No. 123R.
 
As a result of adopting SFAS No. 123R, our net loss in the nine months ended September 30, 2006 was higher by $244,000, net of tax effect, than if we had continued to account for stock-based compensation under APB No. 25. Basic and diluted net loss per share in the nine months ended September 30, 2006 would have been $0.02 lower than if we had not adopted SFAS No. 123R. At September 30, 2006, we had $4.0 million of total unrecognized compensation expense under SFAS No. 123R, net of estimated forfeitures, that will be recognized over a weighted average period of 1.77 years. Based on the midpoint of the price range set forth on the cover page of this prospectus, the aggregate intrinsic value of outstanding options and exercisable options was $      million and $      million, respectively.
 
We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123, EITF Issue No. 96-18 and FIN 28. In 2003, 2004, 2005 and the nine months ended September 30, 2006, we granted stock options to non-employees to purchase 49,000, 344,000, 3,500 and 2,000 shares of our common stock, respectively. At December 31, 2003, 2004 and 2005 and September 30, 2006, we had outstanding non-employee stock options to purchase 59,000, 338,000, 34,000 and 2,000 shares of our common stock, respectively, with weighted average exercise prices of $0.06, $0.10, $0.06 and $1.30 per share, respectively. At September 30, 2006, the outstanding non-employee options had an exercise price of $1.30, a remaining contractual term of 9.80 years and no intrinsic value. In 2005, we cancelled certain options issued to consultants in prior years. As these options were not vested at the time of the cancellation, we reversed $227,000 of expense recognized in previous years. Stock-based compensation expense related to options granted to non-employees was $32,000, $253,000, ($210,000) and $4,000 in 2003, 2004, 2005 and the nine months ended September 30, 2006.


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Income Taxes
 
We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes . As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax benefit (provision) in each of the jurisdictions in which we operate. This process involves estimating our current income tax benefit (provision) together with assessing temporary differences resulting 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 the differences 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 of December 31, 2004 and 2005 and September 30, 2006, our valuation allowance on our net deferred tax assets was $6.3 million, $11.4 million and $14.3 million, respectively. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation 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 our net recorded amount, we would need to make an adjustment to the allowance for the deferred tax asset, which would increase income in the period that determination was made.
 
We have not provided federal income taxes on the unremitted earnings of foreign subsidiaries because these earnings are intended to be reinvested permanently.
 
Results of Operations
 
The following sections discuss and analyze the changes in the significant line items in our statements of operations for the comparison periods identified.
 
Comparison of the Nine Months Ended September 30, 2005 and 2006
 
Revenues
 
                 
    Nine Months
 
    Ended September 30,  
   
2005
   
2006
 
    (In thousands)  
 
Revenues by type:
               
Domestic
  $ 10,848     $ 17,651  
International
    8,023       14,212  
                 
Total
  $ 18,871     $ 31,863  
                 
Percentage of revenues by type:
               
Domestic
    57.5 %     55.4 %
International
    42.5       44.6  
                 
Total
    100.0 %     100.0 %
                 
 
Our revenues increased $13.0 million, or 69%, from $18.9 million in the nine months ended September 30, 2005 to $31.9 million in the nine months ended September 30, 2006, almost entirely as a result of volume increases. The increase resulted from sales of games that we have released since September 30, 2005, including Ice Age 2 , Diner Dash and Driver Vegas , and sales of games acquired from iFone. Revenues from games released after September 30, 2005 were $9.9 million in the nine months ended September 30, 2006. Revenues from iFone games from March 29, 2006, when we acquired it, to September 30, 2006 totaled approximately $4.8 million, primarily in Europe and the United States. Revenues in the first nine months of 2006 from games released prior to September 30, 2005 declined by $1.7 million from the revenues derived from those games in the first nine months of 2005. By utilizing our carrier relationships and our marketing and development


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resources, we were able to increase worldwide distribution and handset porting of iFone games and thus to increase significantly the revenues derived from the licenses that we acquired from iFone. Revenues from our top ten games increased from $10.5 million in the nine months ended September 30, 2005 to $18.2 million in the nine months ended September 30, 2006. International revenues, defined as revenues generated from carriers whose principal operations are located outside the United States, increased $6.2 million from $8.0 million in the nine months ended September 30, 2005 to $14.2 million in the nine months ended September 30, 2006. A majority of this increase resulted from the acquisition of iFone in 2006. The following wireless carriers accounted for 10% or more of our revenues in the nine months ended September 30, 2005 or 2006.
 
                                 
    Nine Months Ended
    Nine Months Ended
 
    September 30, 2005     September 30, 2006  
          Percentage of
          Percentage of
 
Name of Wireless Carrier
 
Revenues
   
Our Revenues
   
Revenues
   
Our Revenues
 
    (In thousands)           (In thousands)        
Verizon Wireless
  $ 4,592       24.3 %   $ 6,666       20.9 %
Sprint Nextel
    2,511       13.3       4,318       13.6  
Cingular Wireless
    2,206       11.7       3,646       11.4  
Vodafone
    1,028       5.4       3,419       10.7  
 
Cost of Revenues
 
                 
    Nine Months
 
    Ended September 30,  
   
2005
   
2006
 
    (In thousands)  
 
Cost of revenues:
               
Royalties
  $ 5,234     $ 9,750  
Impairment of prepaid royalties and guarantees
    525       224  
Amortization of intangible assets
    2,202       1,224  
Impairment of intangible assets
           
                 
Total cost of revenues
  $ 7,961     $ 11,198  
                 
Revenues
  $ 18,871     $ 31,863  
                 
Gross margin
    57.8 %     64.9 %
 
Our cost of revenues increased $3.2 million, or 41%, from $8.0 million in the nine months ended September 30, 2005 to $11.2 million in the nine months ended September 30, 2006. The increase resulted from an increase in royalties, which was offset by a decrease in amortization of acquired intangible assets and a decrease in impairment of prepaid royalties and guarantees. Royalties increased $4.5 million principally because of higher revenues with associated royalties, including those acquired from iFone. Revenues attributable to games based upon branded intellectual property increased as a percentage of revenues from 74.8% in the nine months ended September 30, 2005 to 85.0% in the nine months ended September 30, 2006. The average royalty rate that we paid on games based on licensed intellectual property decreased from 37% in the nine months ended September 30, 2005 to 36% in the nine months ended September 30, 2006. As a result of the increase in revenues from branded titles, the overall royalties as a percentage of total revenues increased from 27.7% to 30.6%. Royalties incurred related to games acquired from iFone totaled $1.5 million in the nine months ended September 30, 2006. Amortization of intangible assets decreased by $1.0 million as completion of amortization in 2006 for certain intangible assets acquired


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from Macrospace was only partially offset by the commencement of amortization of intangible assets acquired in 2006 from iFone.
 
Gross Margin
 
Our gross margin increased from 57.8% in the nine months ended September 30, 2005 to 64.9% in the nine months ended September 30, 2006 because of the decreased amortization of intangible assets and the decreased impairment of prepaid royalties in the nine months ended September 30, 2006 partially offset by the increase in royalties. Without the effect of amortization of acquired intangible assets, our gross margin would have been essentially level at 69% in both periods.
 
Research and Development Expenses
 
                 
    Nine Months
 
    Ended September 30,  
   
2005
   
2006
 
    (In thousands)  
 
Research and development expenses
  $ 10,775     $ 11,346  
Percentage of revenues
    57.1 %     35.6 %
 
Our research and development expenses increased $571,000, or 5%, from $10.8 million in the nine months ended September 30, 2005 to $11.3 million in the nine months ended September 30, 2006. The increase in research and development costs was primarily due to increases in allocated facilities costs of $625,000 and salaries and benefits of $182,000, offset by lower outside services costs of $98,000.
 
A restructuring that we effected in the fourth quarter of 2005 resulted in the elimination of 17 research and development employees, but by September 30, 2006 our research and development staff had increased by seven employees from a year earlier and salaries and benefits had increased as a result. Outside services, including fees for third-party development, porting, localization and testing, declined from 10.0% of total research and development expenses in the nine months ended September 30, 2005 to 8.7% in the nine months ended September 30, 2006 because of an increase in internal resources used to design, develop, port and test new games. Research and development expenses included $154,000 of stock-based compensation expense in the nine months ended September 30, 2005 and $100,000 in the nine months ended September 30, 2006. As a percentage of revenues, research and development expenses declined from 57.1% in the nine months ended September 30, 2005 to 35.6% in the nine months ended September 30, 2006.
 
Sales and Marketing Expenses
 
                 
    Nine Months
 
    Ended September 30,  
    2005    
2006
 
    (In thousands)  
 
Sales and marketing expenses
  $ 6,359     $ 8,317  
Percentage of revenues
    33.7 %     26.1 %
 
Our sales and marketing expenses increased $2.0 million, or 31%, from $6.4 million in the nine months ended September 30, 2005 to $8.3 million in the nine months ended September 30, 2006. Most of the increase was attributable to a $1.4 million increase in salaries and benefits, as we increased our sales and marketing headcount from 11 to 37 in the nine months ended September 30, 2005 and from 32 to 44 in the nine months ended September 30, 2006, and a $612,000 increase in


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allocated facilities costs. 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-Pacific region. Aside from the increase in headcount in our sales and marketing functions, the increase in salaries and benefits cost was due to an increase in variable compensation of $369,000, primarily an increase in commissions paid to our sales employees as a result of higher revenue attainment, and $292,000 in compensation for transitional employees from iFone who were terminated throughout the second and third quarters of 2006. As a percentage of revenues, sales and marketing expenses declined from 33.7% in the nine months ended September 30, 2005 to 26.1% in the nine months ended September 30, 2006 as we completed most of our necessary sales and marketing hiring by the end of 2005 and thereafter significantly reduced the rate at which we added personnel. Also, our sales and marketing activities generated more revenues across a greater number of carriers and mobile handsets. Sales and marketing expenses included $107,000 of stock-based compensation expense in the nine months ended September 30, 2005 and $131,000 in the nine months ended September 30, 2006.
 
General and Administrative Expenses
 
                 
    Nine Months
 
    Ended September 30,  
   
2005
   
2006
 
    (In thousands)  
 
General and administrative expenses
  $ 5,640     $ 7,684  
Percentage of revenues
    29.9 %     24.1 %
 
Our general and administrative expenses increased $2.0 million, or 36%, from $5.6 million in the nine months ended September 30, 2005 to $7.7 million in the nine months ended September 30, 2006. The increase in general and administrative expenses was primarily the result of a $1.5 million increase in salaries and benefits and a $975,000 increase in consulting and professional fees. We increased our general and administrative headcount from 13 to 40 in the nine months ended September 30, 2005 and from 37 to 42 in the nine months ended September 30, 2006. Aside from the increase in headcount in our general and administrative functions, the increase in salaries and benefits costs was due to $216,000 in compensation for transitional employees from iFone, most of whom were terminated during the second and third quarters of 2006. As a percentage of revenues, general and administrative expenses declined from 29.9% in the nine months ended September 30, 2005 to 24.1% in the nine months ended September 30, 2006 as a result of the overall growth of our revenues, which resulted in economies of scale in our general and administrative expenses. General and administrative expenses included $733,000 of stock-based compensation expense in the nine months ended September 30, 2005 and $735,000 in the nine months ended September 30, 2006.
 
Other Operating Expenses
 
Our amortization of intangible assets, such as non-competition agreements, acquired from Macrospace and iFone was relatively constant at $463,000 in the nine months ended September 30, 2005 and $476,000 in the nine months ended September 30, 2006.
 
Our acquired in-process research and development increased from $0 in the nine months ended September 30, 2005 to $1.5 million in the nine months ended September 30, 2006. The IPR&D charge recorded in 2006 is related to the development of new games. We determined the value of acquired IPR&D using a discounted cash flows approach. We calculated the present value of expected future cash flows attributable to the in-process technology using a 21% discount rate. This rate took into account the percentage of completion of the development effort of approximately 20% and the risks associated with our developing technology given changes in trends and technology in our industry. As of September 30, 2006, acquired IPR&D projects were approximately 90% completed.


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Management expects that the remaining projects will be completed by the end of 2006 at a cost similar to the original projections.
 
Other Expenses
 
Interest and other income (expense), net, decreased from income of $351,000 in the nine months ended September 30, 2005 to expense of $904,000 in the nine months ended September 30, 2006. This decrease was primarily due to a $1.1 million expense resulting from an increase in the estimated fair value of warrants issued to Pinnacle Ventures in conjunction with our loan from them in May 2006 and $550,000 of interest expense on that loan in the nine months ended September 30, 2006. The warrants are subject to 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 underlying preferred stock in the nine months ended September 30, 2006. These expenses were partially offset by $295,000 of foreign currency transaction gains and by increased interest income of $169,000 in the nine months ended September 30, 2006.
 
Income tax benefit (provision) decreased from a benefit of $943,000 in the nine months ended September 30, 2005 to a provision of $437,000 in the nine months ended September 30, 2006 as a result of changes in the valuation allowance.
 
Comparison of the Years Ended December 31, 2004 and 2005
 
Revenues
 
                 
    Year Ended
 
    December 31,  
   
2004
   
2005
 
    (In thousands)  
 
Revenues by type:
               
Domestic
  $ 6,606     $ 14,917  
International
    416       10,734  
                 
Total
  $ 7,022     $ 25,651  
                 
Percentage of revenues by type:
               
Domestic
    94.1 %     58.2 %
International
    5.9       41.8  
                 
Total
    100.0 %     100.0 %
                 
 
Our revenues increased $18.6 million, or 265%, from $7.0 million in 2004 to $25.7 million in 2005. The increase resulted from sales of games acquired from Macrospace in December 2004, sales of games that we released in 2005, including Deer Hunter , Zuma and FOX Sports Mobile , and an increase in sales from games introduced prior to 2005. Revenues from Macrospace games, primarily from Europe, increased from $65,000 in 2004 to $9.7 million in 2005. Revenues in 2005 from games released in 2005 were $4.9 million. In 2005, revenues from games released prior to 2005 increased $4.0 million compared to 2004. Revenues from our top 10 games increased from $5.6 million in 2004 to $13.5 million in 2005, of which $2.3 million resulted from the acquisition of Macrospace. Our international revenues increased $10.3 million from $416,000 in 2004 to $10.7 million in 2005. Most of this increase in international revenues was due to the acquisition of Macrospace. The following wireless carriers accounted for 10% or more of our revenues in 2004 or 2005.
 


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    Year Ended
    Year Ended
 
    December 31, 2004     December 31, 2005  
          Percentage of
          Percentage of
 
Name of Wireless Carrier
 
Revenues
   
Our Revenues
   
Revenues
   
Our Revenues
 
    (In thousands)           (In thousands)        
 
Verizon Wireless
  $ 2,862       40.8 %   $ 6,244       24.3 %
Cingular Wireless
    438       6.2       3,042       11.9  
Sprint Nextel
    2,485       35.4       3,058       11.9  
 
Cost of Revenues
 
                 
    Year Ended
 
    December 31,  
   
2004
   
2005
 
    (In thousands)  
 
Cost of revenues:
               
Royalties
  $ 1,359     $ 7,256  
Impairment of prepaid royalties and guarantees
    231       1,645  
Amortization of intangible assets
    126       2,823  
Impairment of intangible assets
          1,103  
                 
Total cost of revenues
  $ 1,716     $ 12,827  
                 
Revenues
  $ 7,022     $ 25,651  
                 
Gross margin
    75.6 %     50.0 %
 
Our cost of revenues increased $11.1 million, or 647%, from $1.7 million in 2004 to $12.8 million in 2005. The increase resulted from an increase in royalty payments, an increase in amortization of intangible assets due to the acquisition of Macrospace, an increase in impairment of prepaid royalties and guarantees, and impairment of intangible assets acquired from Macrospace in 2004. Royalties increased $5.9 million primarily because of higher revenues with associated royalties and higher average royalty rates for licensed intellectual property, primarily as a result of the Macrospace acquisition. Although revenues attributable to games based upon licensed intellectual property decreased as a percentage of revenues from 81.9% in 2004 to 77.1% in 2005, revenues attributable to games based upon licensed intellectual property increased by 244% from 2004 to 2005. The average royalty rate that we paid on games based on licensed intellectual property increased from 24% in 2004 to 37% in 2005 primarily as a result of the acquisition of Macrospace. Royalties incurred related to games acquired from Macrospace totaled $2.6 million in 2005, representing a 46% average royalty rate paid on games based on licensed intellectual property acquired from Macrospace.
 
Gross Margin
 
Our gross margin decreased from 75.6% in 2004 to 50.0% in 2005. This decrease was primarily due to increased amortization of intangible assets, higher royalty rates paid on games acquired from Macrospace, an increase in impairment of prepaid royalties and guarantees, and impairment of intangible assets in 2005. Without the effect of amortization and impairment of acquired intangible assets, our gross margin would have decreased by 12 percentage points from 77.4% to 65.3% instead of by 26 percentage points.

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Research and Development Expenses
 
                 
    Year Ended
 
    December 31,  
   
2004
   
2005
 
    (In thousands)  
 
Research and development expenses
  $ 6,474     $ 14,557  
Percentage of revenues
    92.2 %     56.8 %
 
Our research and development expenses increased $8.1 million, or 125%, from $6.5 million in 2004 to $14.6 million in 2005. The increase primarily resulted from a $6.6 million increase in salaries and benefits due to increases in personnel in the United States and the United Kingdom, a $600,000 increase in allocated facilities costs and a $97,000 increase in expenses for outside services. The increase in these costs and expenses was primarily due to the expansion of the London studio with the acquisition of Macrospace in December 2004. We increased our research and development staff from 65 at December 31, 2004 to 122 at December 31, 2005. Despite the absolute increase in expenses for outside services, these expenses declined as a percentage of research and development expenses from 19.9% in 2004 to 9.7% in 2005 because of an increase in internal resources used to design, develop, port and test new games. As a percentage of revenues, our research and development expenses decreased from 92.2% in 2004 to 56.8% in 2005, primarily as a result of growth in revenues. Research and development expenses included $28,000 of stock-based compensation expense in 2004 and $158,000 in 2005.
 
Sales and Marketing Expenses
 
                 
    Year Ended
 
    December 31,  
   
2004
   
2005
 
    (In thousands)  
 
Sales and marketing expenses
  $ 3,692     $ 8,515  
Percentage of revenues
    52.6 %     33.2 %
 
Our sales and marketing expenses increased $4.8 million, or 131%, from $3.7 million in 2004 to $8.5 million in 2005. The increase resulted from a $2.6 million increase in salaries and benefits, a $1.7 million increase in spending on advertising, public relations and corporate branding and a $466,000 increase in travel and entertainment costs. We increased our sales and marketing staff from 11 at December 31, 2004 to 32 at December 31, 2005. We increased sales and marketing spending to expand the marketing efforts for our games, to rebrand the company as Glu Mobile in June 2005 following the acquisition of Macrospace, to expand marketing of the Glu brand in the United States and to increase marketing efforts in various European markets after the acquisition of Macrospace in December 2004. As a percentage of revenues, sales and marketing expenses declined from 52.6% in 2004 to 33.2% in 2005 as our sales and marketing activities generated more revenues across a greater number of carriers and mobile handsets. Sales and marketing expenses included $59,000 of stock-based compensation expense in 2004 and $132,000 in 2005.
 
General and Administrative Expenses
 
                 
    Year Ended
 
    December 31,  
   
2004
   
2005
 
    (In thousands)  
 
General and administrative expenses
  $ 3,468     $ 8,434  
Percentage of revenues
    49.4 %     32.9 %


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Our general and administrative expenses increased $4.9 million, or 143%, from $3.5 million in 2004 to $8.4 million in 2005. The increase was due primarily to an increase of $2.3 million in salaries and benefits resulting from an increase in headcount with the completion of the acquisition of Macrospace in December 2004, an increase of $1.7 million in consulting and professional services costs and an increase of $533,000 in stock-based compensation. We increased our general and administrative staff from 13 at December 31, 2004 to 37 at December 31, 2005. As a percentage of revenues, general and administrative expenses declined from 49.4% in 2004 to 32.9% in 2005 due to the overall growth of our revenues, which allowed economies of scale in our general and administrative expenses. General and administrative expenses included $454,000 of stock-based compensation expense in 2004 and $987,000 in 2005.
 
Other Operating Expenses
 
Our amortization of intangible assets increased from $26,000 in 2004 to $616,000 in 2005. This increase was due to the intangible assets acquired from Macrospace in December 2004.
 
We had no restructuring charge in 2004; our 2005 restructuring charge was $450,000. In December 2005, we undertook restructuring activities in order to reduce operating expenses. We eliminated 27 positions, of which 17 were in research and development, 4 were in sales and marketing and 6 were in general and administrative. Of the total restructuring charge recorded, $225,000 was recorded in the United States and $225,000 was recorded in Europe. These restructuring costs were paid in full by March 31, 2006.
 
Other Expenses
 
Our interest and other income (expense), net was an expense of $69,000 in 2004 and income of $541,000 in 2005. The increase was primarily a result of a $488,000 increase in interest income due to higher average cash and cash equivalent balances in 2005.
 
Our income tax benefit increased from $101,000 in 2004 to $1.6 million in 2005. The increase in the income tax benefit was primarily due to the net operating loss of Macrospace in 2005.
 
Comparison of the Years Ended December 31, 2003 and 2004
 
Revenues
 
                 
    Year Ended
 
    December 31,  
   
2003
   
2004
 
    (In thousands)  
 
Total revenues by type:
               
Domestic
  $ 1,790     $ 6,606  
International
          416  
                 
Total
  $ 1,790     $ 7,022  
                 
Percentage of revenues by type:
               
Domestic
    100.0 %     94.1 %
International
          5.9  
                 
Total
    100.0 %     100.0 %
                 
 
Our revenues increased 292% from $1.8 million in 2003 to $7.0 million in 2004. The increase primarily resulted from sales of games that we released in 2004 such as Driv3r , FOX Sports Football and Yao Ming Basketball. In 2003, we had no international revenues compared to $416,000 of international revenues in 2004.


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Cost of Revenues
 
                 
    Year Ended
 
    December 31,  
   
2003
   
2004
 
    (In thousands)  
 
Cost of revenues:
               
Royalties
  $ 258     $ 1,359  
Impairment of prepaid royalties and guarantees
          231  
Amortization of intangible assets
          126  
Impairment of intangible assets
           
                 
Total cost of revenues
  $ 258     $ 1,716  
                 
Revenues
  $ 1,790     $ 7,022  
                 
Gross margin
    85.6 %     75.6 %
 
Cost of revenues increased $1.5 million, or 565%, from $258,000 in 2003 to $1.7 million in 2004. Royalties increased from $258,000 in 2003 to $1.4 million in 2004 due to higher revenues and higher average royalty rates for licensed properties.
 
Gross Margin
 
Our gross margin as a percentage of revenues decreased from 85.6% in 2003 to 75.6% in 2004. The decrease in our gross profit as a percentage of revenues resulted from higher royalty rates paid to licensors on new games released in 2004, and impairment of prepaid royalties and guarantees and amortization of intangible assets recorded in 2004.
 
Research and Development Expenses
 
                 
    Year Ended
 
    December 31,  
   
2003
   
2004
 
    (In thousands)  
 
Research and development expenses
  $ 3,352     $ 6,474  
Percentage of revenues
    187.3 %     92.2 %
 
Research and development expenses increased 93% from $3.4 million in 2003 to $6.5 million in 2004. The increase primarily resulted from an increase in salaries and benefits and outside services related to porting, localization and certification costs as we increased our development efforts on new games. Outside services represented approximately 20% of total research and development expenses in 2003 and 2004, or $677,000 in 2003 and $1.3 million in 2004. Research and development expenses included stock-based compensation expense of $0 in 2003 and $28,000 in 2004.
 
Sales and Marketing Expenses
 
                 
    Year Ended
 
    December 31,  
   
2003
   
2004
 
    (In thousands)  
 
Sales and marketing expenses
  $ 697     $ 3,692  
Percentage of revenues
    38.9 %     52.6 %


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Sales and marketing expenses increased 430% from $697,000 in 2003 to $3.7 million in 2004. The increase was due to increased salaries and benefits costs and spending on product marketing and corporate branding. As a percentage of revenues, sales and marketing expenses increased from 38.9% in 2003 to 52.6% in 2004 due to our investment in marketing and in sales and marketing personnel. Sales and marketing expenses included stock-based compensation expense of $0 in 2003 and $59,000 in 2004.
 
General and Administrative Expenses
 
                 
    Year Ended
 
    December 31,  
   
2003
   
2004
 
    (In thousands)  
 
General and administrative expenses
  $ 1,342     $ 3,468  
Percentage of revenues
    75.0 %     49.4 %
 
General and administrative expenses increased 158% from $1.3 million in 2003 to $3.5 million in 2004. The increase primarily resulted from increased salaries and benefits and professional fees. As a percentage of revenues, general and administrative expenses declined from 75.0% in 2003 to 49.4% in 2004 due to the overall growth of our revenues, which resulted in economies of scale in our general and administrative costs. General and administrative expenses included stock-based compensation expense of $32,000 in 2003 and $454,000 in 2004.
 
Quarterly Results of Operations
 
The following table sets forth unaudited quarterly consolidated statements of operations data for 2005 and the first three quarters of 2006. We derived this information from unaudited consolidated financial statements, which we prepared on the same basis as our audited consolidated financial statements contained in this prospectus. In our opinion, these unaudited statements include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair statement of that information when read in conjunction with the consolidated financial statements and


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related notes included elsewhere in this prospectus. The operating results for any quarter should not be considered indicative of results for any future period.
 
                                                         
    For the Three Months Ended  
    2005     2006  
   
March 31
   
June 30
   
September 30
   
December 31
   
March 31
   
June 30(1)
   
September 30(1)
 
                      (In thousands)                    
 
Revenues
  $ 4,762     $ 6,984     $ 7,125     $ 6,780     $ 8,073     $ 11,443     $ 12,347  
Cost of revenues:
                                                       
Royalties
    1,158       1,897       2,178       2,023       2,564       3,499       3,687  
Impairment of prepaid royalties and guarantees
    72       453             1,120       34       164       26  
Amortization of intangible assets
    759       759       684       621       118       553       553  
Impairment of intangible assets
                      1,103                    
                                                         
Total cost of revenues
    1,989       3,109       2,862       4,867       2,716       4,216       4,266  
                                                         
Gross profit
    2,773       3,875       4,263       1,913       5,357       7,227       8,081  
                                                         
Operating expenses:
                                                       
Research and development
    3,648       3,374       3,754       3,781       3,189       3,884       4,273  
Sales and marketing
    1,936       2,307       2,116       2,156       2,202       3,126       2,989  
General and administrative
    1,436       1,950       2,254       2,794       1,852       2,655       3,177  
Amortization of intangible assets
    154       154       154       154       154       154       168  
Restructuring charge
                      450                    
Acquired in-process research and development
                            1,500              
                                                         
Total operating expenses
    7,174       7,785       8,278       9,335       8,897       9,819       10,607  
                                                         
Loss from operations
    (4,401 )     (3,910 )     (4,015 )     (7,422 )     (3,540 )     (2,592 )     (2,526 )
Interest and other income (expense), net
    (87 )     100       338       190       152       50       (1,106 )
                                                         
Loss before income taxes and cumulative effect of change in accounting principle
    (4,488 )     (3,810 )     (3,677 )     (7,232 )     (3,388 )     (2,542 )     (3,632 )
Income tax benefit (provision)
    354       274       316       677       (106 )     (139 )     (192 )
                                                         
Loss before cumulative effect of change in accounting principle
    (4,134 )     (3,536 )     (3,361 )     (6,555 )     (3,494 )     (2,681 )     (3,824 )
Cumulative effect of change in accounting principle
                (315 )                        
                                                         
Net loss
  $ (4,134 )   $ (3,536 )   $ (3,676 )   $ (6,555 )   $ (3,494 )   $ (2,681 )   $ (3,824 )
                                                         
 
 
(1) We acquired iFone on March 29, 2006, and our results of operations include the results of operations of iFone after that date.


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The following table sets forth our historical results, for the periods indicated, as a percentage of our revenues.
 
                                                         
    For the Three Months Ended  
    2005     2006  
    March 31     June 30     September 30     December 31     March 31     June 30     September 30  
 
Revenues
    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
Cost of revenues:
                                                       
Royalties
    24.3       27.2       30.6       29.8       31.8       30.6       29.9  
Impairment of prepaid royalties and guarantees
    1.5       6.5             16.5       0.4       1.4       0.2  
Amortization of intangible assets
    16.0       10.8       9.6       9.2       1.5       4.8       4.5  
Impairment of intangible assets
                      16.3                    
                                                         
Total cost of revenues
    41.8       44.5       40.2       71.8       33.6       36.8       34.6  
                                                         
Gross profit
    58.2       55.5       59.8       28.2       66.4       63.2       65.4  
                                                         
Operating expenses:
                                                       
Research and development
    76.6       48.3       52.7       55.8       39.5       33.9       34.6  
Sales and marketing
    40.6       33.0       29.7       31.8       27.3       27.3       24.2  
General and administrative
    30.2       27.9       31.6       41.2       22.9       23.2       25.7  
Amortization of intangible assets
    3.2       2.2       2.2       2.3       2.0       1.3       1.4  
Restructuring charge
                      6.6                    
Acquired in-process research and development
                            18.6              
                                                         
Total operating expenses
    150.6       111.4       116.2       137.7       110.3       85.8       85.9  
                                                         
Loss from operations
    (92.4 )     (55.9 )     (56.4 )     (109.5 )     (43.9 )     (22.6 )     (20.5 )
Interest and other income/(expense), net
    (1.8 )     1.4       4.7       2.8       1.9       0.4       (9.0 )
                                                         
Loss before income taxes and cumulative effect of change in accounting principle
    (94.2 )     (54.5 )     (51.7 )     (106.7 )     (42.0 )     (22.2 )     (29.5 )
Income tax benefit (provision)
    7.4       3.9       4.4       10.0       (1.3 )     (1.2 )     (1.6 )
                                                         
Loss before cumulative effect of change in accounting principle
    (86.8 )     (50.6 )     (47.3 )     (96.7 )     (43.3 )     (23.4 )     (31.1 )
Cumulative effect of change in accounting principle
                (4.4 )                        
                                                         
Net loss
    (86.8 )%     (50.6 )%     (51.7 )%     (96.7 )%     (43.3 )%     (23.4 )%     (31.1 )%
                                                         
 
Our revenues generally increased in conjunction with the introduction of new games, the expansion of our wireless carrier distribution channel and the porting of our games to additional mobile handsets. Revenues in the second and third quarters of 2006 were favorably impacted by revenues generated from increased porting and distribution of games acquired from iFone in late March. Revenues from iFone games in the second and third quarters of 2006 were $1.7 million and $3.1 million, respectively.
 
Many new mobile handset models are released in the fourth calendar quarter to coincide with the holiday shopping season. Because many end users download our games soon after they purchase new handsets, we may experience seasonal sales increases based on this key holiday selling period. However, due to the time between handset purchases and game purchases, most of this holiday impact occurs for us in our first quarter. For a variety of reasons, we may experience seasonal sales decreases during the summer, particularly in Europe, which is predominantly reflected in our third quarter. In addition to these possible seasonal patterns, we seek to release many of our games in conjunction with specific events, such as the release of a movie or console game. Initial spikes in revenues as a result of successful 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 caused by increased revenues. However, our cost of revenues did not


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increase sequentially in all quarters because of periodic impairment charges and, in the first quarter of 2006, a significant reduction in amortization of intangible assets because a substantial part of the intangible assets acquired from Macrospace became fully amortized in December 2005. Amortization of intangible assets increased in the second quarter of 2006 following the acquisition of iFone.
 
Our quarterly research and development expenses were relatively constant in 2005 as we were able to use our technology to create, develop and port a larger number of games without any significant change in staffing. The decrease in research and development expenses from the fourth quarter of 2005 to the first quarter of 2006 was due to a reduction in employee costs resulting from a restructuring initiated in December 2005. A total of 17 research and development employees were terminated as part of this restructuring effort. The increase in research and development expenses from the first quarter of 2006 to the second quarter of 2006 was primarily due to additional research and development activities with the completion of the iFone acquisition. The increase in research and development expenses from the second quarter of 2006 to the third quarter of 2006 was due to an increase in research and development personnel because of the number of games acquired from iFone that we chose to port to additional handsets.
 
Our sales and marketing expenses were relatively constant in 2005 and the first quarter of 2006, with the exception of the second quarter of 2005 when we increased marketing expenses in connection with our corporate name change and rebranding efforts. The increase in sales and marketing expenses from the first quarter of 2006 to the second quarter of 2006 was due to additional sales and marketing activities with the completion of the iFone acquisition.
 
Our general and administrative expenses generally increased each quarter as a result of increased salaries and benefits and consulting fees to support the growth in our business. The decrease in general and administrative expenses from the fourth quarter of 2005 to the first quarter of 2006 was due to a reduction in employee costs (resulting from the restructuring initiated in December 2005), lower professional services fees and lower allocated facilities costs. A total of six general and administrative employees were terminated as part of this restructuring effort. The increase in general and administrative expenses from the first quarter of 2005 to the second quarter of 2006 was due to additional general and administrative activities and personnel with the completion of the iFone acquisition.
 
Our acquired in-process research and development expense in the first quarter of 2006 related to certain in-process projects assumed in the 2006 acquisition of iFone.
 
We adopted FSP 150-5 in July 2005 and thus, in the third quarter of 2005, accounted for the cumulative effect of this change in accounting principle. Thereafter, in each quarter, we recorded the increase in estimated fair value of our outstanding warrants to purchase preferred stock as part of interest and other income (expense), net.


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Liquidity and Capital Resources
 
                                 
                      Nine Months
 
                      Ended
 
    Year Ended December 31,     September 30,
 
   
2003
   
2004
   
2005
   
2006
 
    (In thousands)  
 
Consolidated Statement of Cash Flows Data:
                               
Capital expenditures
  $ 124     $ 253     $ 3,006     $ 612  
Cash flows used in operating activities
    (4,209 )     (9,171 )     (10,339 )     (10,554 )
Cash flows (used in) provided by investing activities
    (124 )     (10,007 )     (16,706 )     2,292  
Cash flows provided by financing activities
    5,408       20,184       26,692       11,208  
 
Since our inception, we have incurred recurring losses and negative annual cash flows from operating activities, and we had an accumulated deficit of $43.7 million as of September 30, 2006. Our primary sources of liquidity have historically been private placements of shares of our preferred stock with aggregate proceeds of $57.4 million and borrowings under our credit facilities with aggregate proceeds of $12.0 million. In the future, we anticipate that our primary sources of liquidity will be cash generated from the proceeds of this offering and our operating activities.
 
Operating Activities
 
In the nine months ended September 30, 2006, we used $10.6 million of net cash in operating activities as compared to $7.3 million in the nine months ended September 30, 2005. This increase was primarily due to increased payments of our current liabilities. Cash used for accounts payable, accrued liabilities, accrued royalties and accrued restructuring charge increased in the nine months ended September 30, 2006 by $2.9 million, $2.2 million, $1.9 million and $1.4 million, respectively, from the nine months ended September 30, 2005. This increase 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 $1.3 million from the nine months ended September 30, 2005 to the nine months ended September 30, 2006, a charge for acquired in-process research and development of $1.5 million in the nine months ended September 30, 2006, no decrease in our deferred income tax liability in the nine months ended September 30, 2006 when it had declined $1.0 million in the nine months ended September 30, 2005, and a smaller increase in our accounts receivable balance of $485,000 in the nine months ended September 30, 2006. We expect to continue to use cash in our operating activities during at least the first half of 2007 because of anticipated net losses and expected growth in our accounts receivable balance due to the expected growth in our revenues. Additionally, we may decide to enter into new licensing arrangements for existing or new licensed intellectual properties that may require us to make royalty payments at the outset of the agreement. If we do sign these agreements, this could significantly increase our future use of cash in operating activities.
 
In 2005, we used $10.3 million of net cash in operating activities as compared to $9.2 million in 2004. This increase was primarily due to the increase in our net loss of $9.6 million and the increase in the growth of our accounts receivable of $2.2 million from 2004 to 2005. The increase in our accounts receivable balance was due to higher revenues in 2005 resulting in part from the acquisition of Macrospace in December 2004. This use of cash was offset in part by the increase in growth of our accrued royalties and accrued liabilities of $3.0 million and $681,000, respectively, increase in depreciation and amortization of $4.0 million and impairments of prepaid royalties and intangible assets of $2.5 million.


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In 2004, we used $9.2 million of net cash in operating activities as compared to $4.2 million in 2003. This increase was primarily due to the increase in our net loss of $4.5 million and the increase in the growth of our prepaid royalties and accounts receivable of $1.7 million and $541,000, respectively, from 2003 to 2004. The increase in our prepaid royalties was due to several licensing arrangements with large initial royalty payments signed in 2004. This use of cash was offset in part by the increase in growth of our accounts payable of $1.5 million.
 
Investing Activities
 
Our primary investing activities have consisted of purchases and sales of short-term investments, purchases of property and equipment, and, in 2004 and 2006, the acquisitions of Macrospace and iFone, respectively. With the exception of 2005, purchases of property and equipment have been less than $1.0 million in each period. We expect to use more cash in investing activities in 2007 as we expect to expand our internal development capacity in the Asia-Pacific region by adding headcount and facilities. We expect to fund this investment with our existing cash, cash equivalents and short-term investments.
 
We generated $2.3 million as net cash from investing activities in the nine months ended September 30, 2006. This net cash resulted from net sales of short-term investments of $10.3 million, partially offset by the acquisition of iFone for cash and stock, net of cash acquired, of $7.4 million and purchases of property and equipment of $612,000.
 
We used $16.7 million of net cash in investing activities in 2005, $13.7 million of which represented net purchases of short-term investments and the remaining $3.0 million of which represented purchases of property and equipment, such as our enterprise resource planning, or ERP, system and our revenue data warehouse.
 
We used $10.0 million of net cash in investment activities in 2004, $5.5 million of which represented purchases of short-term investments and $4.3 million of which represented the acquisition of Macrospace for cash and stock, net of cash acquired.
 
Financing Activities
 
Through 2005, substantially all of our financing came from sales of preferred stock. In 2006, most of our financing came from a loan.
 
We generated $11.2 million of net cash from financing activities in the nine months ended September 30, 2006, substantially all of which came from the proceeds of a loan from Pinnacle Ventures, described below.
 
We generated $26.7 million of net cash from financing activities in 2005, substantially all of which came from the issuance and sale of our preferred stock. We used $1.1 million to repay debt issued in connection with the Macrospace acquisition.
 
We generated $20.2 million of net cash from financing activities in 2004, substantially all of which came from the issuance and sale of our preferred stock.
 
We generated $5.4 million of net cash from financing activities in 2003, $4.5 million of which came from the issuance and sale of our preferred stock and $1.0 million of which came from the issuance and sale of convertible promissory notes, which were later converted into our preferred stock.
 
Sufficiency of Current Cash, Cash Equivalents and Short-Term Investments
 
Our cash, cash equivalents and short-term investments were $21.6 million as of December 31, 2005 and $14.4 million as of September 30, 2006. We believe that our cash, cash equivalents and short-term investments and any cash flow from operations will be sufficient to meet our anticipated cash needs, including for working capital purposes, capital expenditures and various contractual


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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 or acquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirements, we may seek to sell debt securities or additional equity securities or to obtain a credit facility. The sale of convertible debt securities or additional equity securities could result in additional dilution to our stockholders. The incurrence of indebtedness would result in debt service obligations and could result in operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additional financing 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. However, there are no current understandings, commitments or agreements with respect to any acquisitions.
 
Contractual Obligations
 
The following table is a summary of our contractual obligations as of September 30, 2006:
 
                                         
    Payments Due by Period  
          Less than
                   
   
Total
   
1 Year
   
1-3 Years
   
3-5 Years
   
Thereafter
 
    (In thousands)  
 
Long-term debt obligations(1)
  $ 13,985     $ 330     $ 10,924     $ 2,731        
Capital lease obligations
    107       76       31              
Operating lease obligations
    2,141       452       1,689              
Guaranteed royalties(2)
    4,417       581       1,586       1,525       725  
 
 
(1) The amounts in the table include interest payments on the loan. In May 2006, we borrowed $12.0 million from Pinnacle Ventures. This loan has an interest rate of 11% and is collateralized by all of our assets. We were obligated to pay only interest in 2006. Beginning January 1, 2007, we became obligated to pay 30 equal monthly payments of principal and accrued interest. We were in compliance with all covenants under the loan as of September 30, 2006. If we elect to make any advance payments, they would be subject to a premium equal to 3% of the principal amount repaid unless the payments were made in connection with an issuance of shares of stock that would be publicly traded on a national market or exchange, in connection with a change in our control or more than 18 months after the funding of the loan. We intend to repay the entire outstanding principal amount of the loan and all accrued interest from the net proceeds of this offering.
 
(2) We have entered into license and development arrangements with various owners of brands and other intellectual property so that we can create and publish games for mobile handsets based on that intellectual property. Pursuant to some of these agreements, we are required to pay guaranteed royalties over the term of the contracts regardless of actual game sales. Certain of these minimum payments have been recorded as liabilities in our consolidated balance sheet because payment is not contingent upon performance by the licensor.
 
Off-Balance Sheet Arrangements
 
We do not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt, and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.


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Recent Accounting Pronouncements
 
In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 , which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. This Interpretation prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financials statements uncertain tax positions that it has taken or expects to take on a tax return, including a decision whether to file or not to file a return in a particular jurisdiction. Under the Interpretation, the financial statements must reflect expected future tax consequences of these positions presuming the taxing authorities’ full knowledge of the position and all relevant facts. The Interpretation also revises disclosure requirements and introduces a prescriptive, annual, tabular roll-forward of the unrecognized tax benefits. This Interpretation is effective for fiscal years beginning after December 15, 2006. We will adopt this provision in the first quarter of 2007 and are currently evaluating the impact of this provision on our consolidated financial position, results of operations or cash flows.
 
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 establishes a framework for measuring the fair value of assets and liabilities. This framework is intended to provide increased consistency in how fair value determinations are made under various existing accounting standards that permit, or in some cases require, estimates of fair market value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier adoption is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. We are currently in the process of evaluating the impact of SFAS No. 157 on our consolidated financial statements.
 
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements , or SAB No. 108, which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. We will be required to adopt the provisions of SAB No. 108 in our fiscal year 2006. We do not believe the adoption of SAB No. 108 will have a material impact on our consolidated financial position, results of operations or cash flows.
 
Quantitative and Qualitative Disclosures about Market Risk
 
Interest Rate and Credit Risk
 
We have exposure to interest rate risk that relates primarily to our investment portfolio. All of our current investments are classified as cash equivalents or short-term investments and carried at cost, which approximates market value. We do not currently use or plan to use derivative financial instruments in our investment portfolio. The risk associated with fluctuating interest rates is limited to our investment portfolio, and we do not believe that a 10% change in interest rates would have a significant impact on our interest income, operating results or liquidity.
 
As of December 31, 2004 and 2005 and September 30, 2006, our cash and cash equivalents were maintained by financial institutions in the United States, the United Kingdom and Hong Kong, and our current deposits are likely in excess of insured limits. We believe that the financial institutions that hold our investments are financially sound and, accordingly, minimal credit risk exists with respect to these investments.
 
Our accounts receivable primarily relate to revenues earned from domestic and international wireless carriers. We perform ongoing credit evaluations of our carriers’ financial condition but generally require no collateral from them. At December 31, 2004, Verizon Wireless and Sprint Nextel accounted for 30% and 22%, respectively, of our total accounts receivable. At December 31, 2005, Verizon Wireless accounted for 23% of our total accounts receivable. At September 30, 2006, Verizon


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Wireless, Sprint Nextel and Vodafone accounted for 21%, 15% and 11% of our total accounts receivable, respectively.
 
Foreign Currency Risk
 
The functional currencies of our United States and United Kingdom operations are the United States Dollar, or USD, and the pound 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 the operating unit, which mitigates a portion of the exposure related to currency fluctuations. Intercompany transactions between our domestic and foreign operations are denominated in either the USD or the pound sterling. At month-end, foreign currency-denominated accounts receivable and intercompany balances are marked to market and unrealized gains and losses are included in other income (expense), net.
 
Our foreign currency exchange gains and losses have been generated primarily from fluctuations in the pound sterling versus the USD and in the Euro versus the pound sterling. It is uncertain whether these currency trends will continue. In the future, we may experience foreign currency exchange losses on our accounts receivable and intercompany receivables and payables. Foreign currency exchange losses could have a material adverse effect on our business, operating results and financial condition.
 
Inflation
 
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were 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.


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BUSINESS
 
Overview
 
Glu Mobile is a leading global publisher of mobile games. We have developed and published a portfolio of more than 100 casual and traditional games to appeal to a broad cross section of the over one billion subscribers served by our more than 150 wireless carriers and other distributors. We create games and related applications based on third-party licensed brands and other intellectual property, as well as on our own original brands and intellectual property. Our games based on licensed intellectual property include Deer Hunter , Diner Dash , Monopoly , Sonic the Hedgehog , World Series of Poker and Zuma . Our original games based on our own intellectual property include Alpha Wing , Ancient Empires , Blackjack Hustler , Stranded and Super K.O. Boxing. We were one of the top three mobile game publishers during the fourth quarter of 2006 in terms of mobile game market share in North America, as measured by NPD Group, Inc., a market research firm, in its December 2006 “Mobile Game Track Highlight Report,” and in terms of unit sales volume in North America and Europe among titles tracked by m:metrics, another market research firm.
 
Juniper Research, a market research firm, in its June 2006 “Mobile Games: Subscription & Download, 2006-2011” report, estimates that the worldwide market for mobile games will grow from $3.1 billion in 2006 to $10.5 billion in 2009, a compound annual growth rate of 50.2%. We believe that the rapid growth of the mobile game market has been driven by continued advances in wireless communications technology, 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 and networked nature of mobile handsets. We leverage the marketing resources and distribution infrastructure of wireless carriers and the brands 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 the advantages 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 mobile phone bill, while eliminating for us the traditional publishing costs associated with packaging, shipping, stocking, inventory management and return processing. In the first nine months of 2006, our largest wireless carrier customers in each region by revenues were Verizon Wireless, Sprint Nextel, Cingular Wireless and T-Mobile USA in North America; Vodafone, Hutchinson 3G, Orange and Telefónica Móviles in Europe; TelCel and Vivo in Latin America; and Vodafone, Hutchinson 3G Australia and Telecom New Zealand 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 are familiar, while eliminating for us the need to develop all of our games from our own intellectual property. Our branded content owners, such as Atari, Celador (from which we license the rights to Who Wants To Be A Millionaire? in some European and Asian countries), Fox, PlayFirst, PopCap Games, Sega Europe and Turner Broadcasting, provide us with well-known consumer brands and other intellectual property on which we have based mobile games. When we use licensed content in the development of our games, we share with the content owner a portion of the amount paid to us by carriers, thereby allowing it to derive incremental revenue from its content. We also provide a solution for content owners to the development and distribution challenges associated with creating and distributing their own mobile games.


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We believe that our carriers and content owners value our global reach, the consistently high quality of our game portfolio, the creativity of our development studios, and our mobile-specific development expertise, including our ability to port games to more than 1,000 different handset models with various combinations of underlying technologies, user interfaces, keypad layouts, screen resolutions, sound capabilities and other carrier-specific customizations.
 
Industry Background
 
The growth of the mobile entertainment market is being shaped by an intersection of trends in the wireless communications and entertainment industries since wireless carriers provide the primary marketing and distribution channel for mobile games and branded content owners provide the licensing relationships that facilitate creating a large and diverse portfolio of recognizable games. Juniper Research, in its June 2006 “Mobile Games: Subscription & Download, 2006-2011” report, estimates that the percentage of wireless subscribers who download mobile games in our two largest markets, North America and Europe, will increase from 5.5% in 2006 to 14.6% in 2009 and from 5.6% in 2006 to 14.0% in 2009, respectively.
 
The mobile game market differs substantially from the traditional console game market. Mobile games typically have significantly lower development and distribution costs and longer life cycles than console games. Console game sales depend upon the product cycles of the consoles themselves, with large generational shifts between versions of each of the major console platforms every few years. In contrast, the mobile platform is characterized by a gradual evolution of features and capabilities in the many new handsets introduced each year by a large number of manufacturers and carriers. Consumers typically use their console games within the confines of their homes, while mobile games are available in all the settings where consumers take their mobile handsets. Furthermore, console games are usually developed for a few console platforms at most, which means that the development costs are mostly associated with the original creation and development of the game. However, once developed, mobile games may need to be ported to more than 1,000 different handset models, many with different technological requirements. Therefore, the ability to port mobile games quickly and cost effectively can be a competitive differentiator among mobile game publishers and a barrier to entry for other potential market entrants.
 
The networked nature of mobile games allows publishers the opportunity to improve the profitability of a game through decisions on porting, pricing, localization and marketing. Some games, especially those tied to films, television shows or console games with specific “day-and-date” launch requirements, ideally are launched simultaneously on a global basis with a large number of carriers. Other games may be launched in stages by regions or by carriers. These games require initial launch on fewer handsets than games with global “day-and-date” launch requirements. Games released in stages offer the opportunity to improve profitability by adjusting porting and marketing support costs based upon the initial success of the game.
 
We believe that the following trends will continue to shape the growing market for mobile entertainment:
 
Increasing Quality and Broadening Appeal of Mobile Games.   We believe that improving quality and greater availability of mobile games are contributing to increased end-user awareness of and demand for mobile entertainment. Wireless carriers and mobile game publishers now offer games across a diverse range of genres in an effort to appeal to a broad cross section of end users with mobile phones. For example, casual games, such as Diner Dash , are easy to learn and play and therefore well-suited to the mass market demographics of wireless subscribers. Carriers and mobile game publishers also have begun to focus on games where the brand, such as Monopoly , or the name, such as Super K.O. Boxing , clearly communicates the nature of the game within the handset’s game menu and therefore increases the likelihood of purchase or subscription. In addition, mobile entertainment publishers are introducing games, such as Deer Hunter, that are tailored to specific


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regional, age and gender demographics. We believe that these factors will contribute to rapid growth in the percentage of subscribers who download games.
 
Increasing Complexity of Developing and Publishing Mobile Games.   Mobile game publishers have emerged to address the requirements specific to mobile games, such as creating games to operate within the resource constraints of handsets, negotiating the requisite distribution agreements, and developing the technical expertise required to port and customize a game to more than 1,000 handset models and, with regional and language requirements, to create thousands of versions of that game. Some companies in related industries, such as carriers, traditional game publishers and other branded content owners, have established internal mobile game development or publishing capabilities. We believe that these companies are becoming increasingly aware of the complexities of developing mobile games and, as a result, are increasingly partnering with a small group of leading publishers that can manage the complexities specific to mobile games and related applications.
 
Increasing Importance of Scale in Licensing and Wireless Carrier Partnerships.   Carriers increasingly are seeking mobile game publishers with large and diverse portfolios of high-quality games based on well-known brands that are likely to appeal to a large number of the carriers’ subscribers. Branded content owners prefer global distribution in order to match the breadth of distribution of their brands in other entertainment media. Thus, they increasingly are seeking mobile game publishers with a global network of carrier relationships and a history of successfully launching high-quality games with premium deck placement on a number of mobile handsets. As a result, scale in content and carrier relationships is mutually reinforcing and has resulted in increasing differentiation between mobile game publishers that have achieved sufficient scale in licensing and carrier relationships and those that have not. We believe that only a small group of leading mobile entertainment publishers has established the licensing relationships necessary to create large and diverse portfolios of well-known games and the carrier relationships necessary to facilitate global distribution.
 
Continuing Advances in the Multimedia Capabilities of Mobile Handsets.   Mobile games capitalize on the ongoing and accelerating improvement of multimedia capabilities in handsets. The increasing screen resolutions, audio and graphics capabilities, processing power, battery life, memory and storage capabilities, and affordability of these handsets are enabling the delivery of a higher quality visual and audio entertainment experience to a broader group of end users.
 
Accelerating Deployment of Advanced Wireless Networks.   Advances in wireless networks are increasingly enabling convenient and rapid downloads of large files such as mobile games. In addition, these advanced networks have improved merchandising capabilities, as well as flexible provisioning and billing capabilities for data applications such as pay-per-play, that provide the infrastructure necessary for purchasing and downloading mobile games. We believe that incremental revenue from data-centric usages, such as accessing the Internet and downloading mobile games, helps wireless carriers recoup their multi-billion dollar investments in next-generation infrastructure. Juniper Research, in its June 2006 “Mobile Games: Subscription & Download, 2006-2011” report, estimates that the number of wireless subscribers on 2.5G and 3G networks, which facilitate the latest and highest quality mobile games, will grow from 970 million subscribers in 2006 to 1.8 billion subscribers in 2010.
 
Our Competitive Strengths
 
We believe we have a proven capability to develop high-quality mobile games that engage end users. Our portfolio of more than 100 games includes a variety of genres and is designed to appeal to the diverse interests of the broad wireless subscriber population. As the mobile entertainment market continues to develop, we believe that wireless carriers and branded content owners will increasingly recognize the benefits of partnering with independent mobile entertainment publishers that have achieved the scale necessary to develop and publish a consistent portfolio of high-quality games and


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to distribute them globally. We believe that we will continue to be attractive to carriers, content owners and end users because of the following strengths:
 
Diverse Portfolio of Award-Winning High-Quality Mobile Games.   We have developed and published more than 100 casual and traditional games across a number of genres, including action, board games, card/casino, puzzle, sports, strategy/RPG and TV/movie. No single game contributed more than 10% of our revenues in 2005 or the first nine months of 2006. We develop most of our games, including both original games and those based on licensed brands and intellectual property, at our studios in San Mateo, California and London, England. We believe that internal development of our games is a key factor in their consistently high quality. Our games are widely recognized for innovation and quality by industry reviewers. Based on numerical ratings by industry review websites, IGN Entertainment, Modojo and WGWorld, we ranked first in terms of average game quality for mobile games released in 2006. We have received numerous industry awards for our games, including IGN Entertainment’s Best of 2006 awards for best wireless adventure game — Stranded , best wireless puzzle game — Diner Dash and best wireless fighting game — Super K.O. Boxing , IGN Entertainment’s Best of 2005 award for best wireless puzzle game for Zuma, The Academy of Interactive Arts and Sciences’ 2006 Cellular Game of the Year award for Ancient Empires II , and the 2005 award for Best Mobile Sports Game by CNET’s Gamespot for Deer Hunter. Industry awards such as these increase our overall brand recognition and help us to gain premium deck placement with wireless carriers, thereby increasing the likelihood that end users will purchase and play our games.
 
Global Scale in Distribution, Sales and Marketing.   We currently have agreements with more than 150 wireless carriers and other distributors, which together serve more than one billion subscribers worldwide. Our games regularly receive premium placement on these carriers’ game decks accessed through handset screens. Given the small size of these screens, there are significant advantages to being placed in the initial list of games that an end user sees on the deck, rather than being placed lower on the list where an end user may need to scroll or search to find a game. In addition, we have developed closely integrated technical and strategic relationships with many carriers. These relationships typically are available to only a small number of leading publishers and may result in access to carriers’ new handset models for porting and preloading games prior to commercial handset release, self-certification of games with carriers (rather than going through the carriers’ more time-consuming processes for certifying compliance with their network requirements), co-marketing and promotions for new game releases, and end-user market research.
 
Strong Relationships with Branded Content Owners.   We have built relationships with a number of key branded content owners. The content providers that accounted for the largest percentages of our revenues in the first nine months of 2006 were Atari, Celador (from which we license the rights to Who Wants To Be A Millionaire? in some European and Asian countries), Fox, PlayFirst, PopCap Games, Sega Europe and Turner Broadcasting. In addition to these relationships, we have recently licensed brands or other intellectual property from Harrah’s, Hasbro, Microsoft and Sony. We believe that branded content owners increasingly understand the complexities of developing their own internal mobile entertainment capabilities and therefore increasingly wish to work with publishers with a history of successfully developing and publishing high-quality games, the carrier relationships necessary to distribute their games on a worldwide basis, the ability to do global marketing on a localized basis, and independence from a parent that may compete with the content owner in other markets. A number of carriers have reduced the number of mobile game publishers to which they provide access to their networks, and many branded content owners have similarly narrowed the number of mobile game publishers with which they contract. We believe these trends have mutually reinforced each other to the benefit of leading publishers such as Glu Mobile.
 
Proprietary Porting and Data Mining Capabilities.   We have developed proprietary technologies and processes designed to increase the profitability of our games through rapid and cost-effective porting to a broad range of handsets across a number of carriers. Our porting capabilities leverage technology and proprietary standardized processes, such as a development process designed to facilitate efficient porting, a tool library that helps automate some of the repetitive development tasks


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to support new handsets, and ongoing work flow analysis tools to support continuous improvement of our porting and deployment capabilities. Porting and localization result in each game having many stock keeping units, or SKUs, characterized by title, language, handset and carrier. As of December 31, 2006, we had the capability to port and localize games to approximately 40,000 SKUs per month. Our data mining capabilities provide us with the ability to analyze the revenue potential of each game and to improve profitability by adjusting porting and marketing support costs based upon the initial success of the game. Together, our porting and data mining capabilities help us in our efforts to increase initial and subsequent sales of each game and to support continuing premium deck placement.
 
Experienced Management Team.   In addition to experience in mobile games, our management team has significant experience in the video game publishing, wireless communications and other technology and media industries. We believe that this broad expertise allows us in a timely manner to design, develop and deliver games and other mobile entertainment applications that are designed to address the demands of our market. We believe our management team’s expertise and continuity are significant competitive advantages in the evolving mobile entertainment publishing market.
 
Our Strategy
 
Our goal is to be the leading global publisher of mobile games and other mobile entertainment applications. To achieve this goal, we plan to:
 
Continue to Create Award-Winning Games through Ongoing Investment in Our Studio and Technical Development Capabilities.   Our creative and technical teams are recognized in the industry for creating high-quality, award-winning mobile games. Our technical teams leverage proprietary technologies and standardized automated processes that are designed to enable rapid, timely, high-quality and cost-effective development and porting of mobile games. We believe that this combination provides us with a competitive advantage over other industry participants that have traditionally outsourced porting and development or used more manual processes. As a result, we have a record of developing successful mobile games based on licensed brands, as well as our own original brands such as Super K.O. Boxing. Original games result in higher margins, since we do not have to pay royalties to a content licensor. The industry-leading quality of our games, as recognized by industry reviewers, is important to our success, and we intend to continue investing in our studios’ game development capabilities.
 
Leverage and Grow Our Portfolio of Games.   We have developed a diverse portfolio of more than 100 games, including perennial titles that we believe can produce revenues for significantly longer than the typical 18 to 24 month revenue lifecycle for mobile games. In addition, successful games give us the potential to develop and publish a series of sequel titles, sometimes referred to as franchise titles. For both perennial and sequel titles, we leverage existing development, porting and marketing investments and broad end-user awareness in order to increase the revenue lifecycle of an existing game or increase the chance of success for new games. Games for the mobile platform also provide potential opportunities for us to publish or license our intellectual property for use on other platforms such as online, console or personal computer games. For example, casual games are well-suited for both online and mobile platforms, and we may develop or license online versions of some of our casual games. We plan to continue developing perennial and franchise titles, and we believe that our proprietary technology and development process capabilities provide us an advantage over our competitors in the coordinated launches frequently required of multi-platform games.
 
Expand and Strengthen Our Distribution.   We believe that wireless carriers are increasing their focus on the leading mobile game publishers in order to improve the consistency and quality of the games that they offer on their handsets. However, among carriers in the United States, the top five publishers currently account for only approximately 60% of mobile game revenues, according to the December 2006 “Mobile Game Track Highlight Report” of NPD Group, Inc., a market research


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firm. We intend to take steps to increase our market share with our existing carriers and distributors. For example, we plan to leverage increased user awareness of Glu as a brand that stands for high-quality mobile entertainment through the use of Glu-branded game menus on handset decks. We also plan to seek additional carrier relationships in geographic areas where we do not yet have a significant presence. In addition, we have increased and expect to continue to increase our non-carrier distribution capabilities through alternative channels such as Internet portals and “off-deck” aggregators.
 
Build Upon Our Position as a Leading Global Publisher to Strengthen Licensing Relationships.   We believe that, as a leading independent publisher of mobile games, we will continue to benefit from branded content owners’ increasing recognition of the challenges associated with mobile entertainment publishing. As a result of these challenges, some branded content owners are reducing their own internal mobile development efforts. We believe that branded content owners are also becoming more reluctant to contract with smaller mobile game publishers that do not have a reputation for quality development or that do not have the breadth of carrier relationships and technological capabilities necessary to publish a game on a worldwide basis. We intend to capitalize on these trends and on our reputation with non-mobile content owners as a leading mobile partner to strengthen our existing licensing relationships and develop additional relationships.
 
Gain Scale through Select Acquisitions.   We have acquired and integrated two mobile game companies — Macrospace and iFone. We believe that there may be future opportunities to acquire content developers and publishers in the mobile entertainment or complementary industries and we intend, where appropriate, to take advantage of these opportunities.
 
Our Products
 
We design our portfolio of games to appeal to the diverse interests of the broad wireless subscriber population. We believe that the quality of our games, as recognized by numerous industry awards, is key to their repeated success. We focus on developing a portfolio of games across a number of genres designed to increase adoption and repeat purchase rates by subscribers. We also develop and publish ringtones and wallpaper in coordination with a small number of our games, such as Ice Age 2. Revenues from applications other than 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 $8.00, and prices for subscriptions generally range between approximately $2.50 and $3.50 per month, typically varying by game and carrier. In Europe, our subscription prices have a similar range, while one-time fees for unlimited use range both higher and lower, depending on the country. Prices in the Asia-Pacific region are generally lower than in the United States and Europe. Carriers normally share with us 50% to 70% of their subscribers’ payments for our games, which we record as revenues. In the case of games based on licensed brands, we, in turn, share with the content licensor a portion of our revenues. The average royalty rate that we paid on games based on licensed intellectual property was 37% in 2005 and 36% in the first nine months of 2006. However, the individual royalty rates that we pay can be significantly above or below the average because our licenses were signed over a number of years and in many cases were negotiated by one of the companies 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 other intellectual property licensed from branded content owners. These latter games are inspired by non-mobile brands and intellectual property, including movies, board games, Internet-based casual games and console games. In the first nine months of 2006, Glu-branded original games accounted for 15.0% of our revenues. Games based on licensed content from Atari, Fox, PopCap Games and Celador accounted for 23.6%, 17.3%, 11.6% and 9.8%, respectively,


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of our revenues for this period, with the balance coming from games and other applications based on content from other branded content owners.
 
Our games typically generate revenues for 18 to 24 months after release. As a result, we generate a significant portion of our revenues from our collection of games that have been in release for more than 12 months, which we sometimes refer to as our catalog. In the first nine months of 2006, we had 133 active titles generating revenues, of which the sports, TV/movie and action genres each had at least 20 titles.
 
Wireless carriers generally control the price charged to end users for our mobile games either by approving or establishing the price of the games charged to their subscribers. Some of our carrier agreements also restrict our ability to change established prices. In cases where carrier approval is required, approvals may not be granted in a timely manner or at all. A failure or delay in obtaining these approvals, the prices established by the carriers for our games, or changes in these prices could adversely affect market acceptance of those 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 the actual retail price charged to end 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 carriers in adjusting the retail price for our games could adversely affect sales volume and our revenues for those games.


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The following table summarizes a selection of our games by genre:
 
                 
        Year
     
Title   Branded Content Owner   Introduced     Market
 
Action
               
Aqua Teen Hunger Force
  Turner Broadcasting   2005*       Global
Driv3r and Driver Vegas
  Atari     2003/2005     Global
Inuyasha
  Viz Media     2005     Regional
Sonic the Hedgehog Part 1 and Part 2
  Sega Europe   2006*   *   Regional
                 
Board Game
               
Battleship
  Hasbro   2006*   *   Global
Clue
  Hasbro   2006*   *   Global
Game of Life
  Hasbro   2006*   *   Global
Monopoly
  Hasbro   2006*   *   Global
                 
Card/Casino
               
5 Card Draw Poker
  Glu     2004     Global
Blackjack Hustler
  Glu     2005     Global
Hoyle Solitaire Pro
  Encore Software     2006     Global
World Series of Poker Texas Hold ’em
  Harrah’s     2006     Global
                 
Puzzle
               
Astropop
  PopCap Games     2005     Global
Diner Dash
  PlayFirst     2006     Global
Insaniquarium Deluxe
  PopCap Games     2006     Global
Zuma
  PopCap Games     2005     Global
                 
Sports
               
Deer Hunter and Deer Hunter 2 Mobile
  Atari     2004/2006     Global
FOX Sports Mobile
  Fox     2003     Regional
Shark Hunt
  Glu     2003     Global
Super K.O. Boxing
  Glu     2006     Global
                 
Strategy/RPG
               
Ancient Empires I and II
  Glu   2005*       Global
Baldur’s Gate
  Hasbro     2004     Global
Kasparov Chess
  Gary Kasparov