On August 6th, 2013, Glu Mobile (NASDAQ:GLUU) announced second-quarter earnings, along with a fairly perplexing decision to completely change the way it has accounted for revenues and cost of goods sold over the past three years. Glu also gave guidance for Q3 and the rest of the year using the newly adjusted accounting methods. In this article I will attempt to explain the changes that Glu made and what it means for the guidance Glu management gave for Full Year 2013.
The Apple (NASDAQ:AAPL) and Android markets have always taken about 30% of the money that Glu's games earn before it ever reaches Glu as their fee for being on their markets. Prior to the 2nd quarter of 2013, Glu did not include the money that went straight to Apple and Google (NASDAQ:GOOG) in its revenue. The change it made is quite simple - it is now including the money that Apple and Google takes and adding it onto its revenue figures, but adding an exactly equal amount to its cost of goods sold.
This change will have no material effect on earnings per share, EBITDA, or net income figures. This change will mostly impact margins as evident when looking at the FY2012 numbers. Before the adjustment Glu recorded a GAAP gross margin of 85%, and this margin fell to 69% after the adjustment. For Q1 2013 GAAP gross margin fell from 85% to 65% after the adjustment. Again, this change will have no impact on the business as a whole or the bottom-line numbers; this is simply a bookkeeping change that adjusts for factors that have always been present.
Q2 Results & Full-Year Guidance
Shortly after announcing the accounting change Glu also released Q2 results and updated guidance for FY2013. Glu reported revenues of $23.2M and adjusted EBITDA of -$2.9M. These results were difficult to immediately interpret given the accounting change, but in Glu's investor presentation it also reported the results using the "old" accounting methods. These results showed that Glu's unadjusted revenue figure was $17.6M while EBITDA was unaffected at -$2.9M. This disappointing figure shows that Glu's revenue beat previous expectations by a measly $0.1M. It may seem good to beat expectations at all, but as I explained in my previous article, the guidance was extremely bad to begin with.
In addition to providing Q2 results Glu gave investors updated guidance for FY2013. Previous unadjusted guidance called for $84-88.5M in revenue. The adjusted guidance Glu released August 6, calls for $96.8-98.9M in total revenues. At first glance this looks decent, but we must remember that the accounting change will inflate revenues by about 30% while having no effect on the bottom line. Thus, in order to be able to compare the new guidance with past guidance, we have to use the figure Glu gives in its investor presentation that does not use the newly-implemented accounting method that inflates revenue and COGS. On a basis that is not adjusted for the new accounting change Glu's guidance calls for revenues of $73-74.5M, or about 14% lower than the previous estimate. Glu attributes this decline to pushing titles slated for Q3 release further back into Q4.
Why The Change?
The obvious question that I and other investors must ask: is why would Glu implement this accounting change when literally nothing about its business has changed and the accounting change itself will have zero impact on the business? Luckily, when Glu opened up its Q2 conference call for questions, this was the first question asked by the first analyst. Glu's response:
That's a great question, Sean. Let me kind of give some thoughts on that. It's a pretty long topic but we felt Pricewaterhouse Coopers is our independent auditors since 2003. And when we went public the industry standard was for feature phone carrier based revenue to be net recognition and when we went public and when JAMDAT went public both have been revived by the SEC.
JAMDAT got bought by EA back in 2005 and Glu used that revenue policy for digital storefront starting when the app store came out in 2008. And Apple and Google became meaningful to us back in 2010. We specifically evaluated that accounting with PWC and jointly determine to continue using net accounting revenue.
Recently this past quarter, as we were getting ready to launch what we believe to be online-only games that we felt should be gross accounting, we went to Pricewaterhouse National to get concurrence on that perspective treatments and during this discussions PWC review our historical accounting, PwC National and that they've previously audited, as well as the Apple and Google contracts. And then we've determined that we should have been doing correct accounting shipment of gross revenue.
So, that's why, we're revising and restating the results. But you're right; there is disparity in the industry, but us being the one mobile company with the most mobile revenue compared to the other public company is that mobile is less. I think we had to take the first step at getting the revenue on a gross basis.
This response essentially equates to "well, we felt like it" in my opinion. I do not like that Glu announced this change on the same day that it significantly reduced revenue guidance because it seems like a subtle way to mask the lowered guidance, which is deceptive to shareholders.
The accounting change Glu announced on August 6, will have no material effect on the business or the bottom-line financial results of the company as a whole. It simply introduces a different method to account for factors that have been in place for the whole of Glu's existence in the smartphone gaming industry. What is worrying to me as an investor is the timing of the release as well as the significantly reduced revenue guidance going forward. Hopefully this article was able to clarify some things for investors confused about the change and what effect it will have on financial results going forward.
Disclosure: I am long GLUU, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.