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Glu Mobile Inc. (NASDAQ:GLUU)

Q2 2012 Earnings Call

August 2, 2012 4:30 PM ET

Executives

Greg Cannon – VP, Finance

Niccolo de Masi – President and CEO

Eric Ludwig – EVP and CFO

Analysts

Darren Aftahi – Northland Securities

Atul Bagga – Lazard Capital

Michael Graham – Canaccord

Mike Hickey – National Alliance

Mark Argento – Craig-Hallum

Adam Krejcik – ROTH Capital Partners

Operator

Good afternoon, my name is Selena (ph) and I will be your conference operator today. At this time, I would like to welcome everyone to the Glu Mobile 2Q 2012 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator Instructions) I will now turn today’s conference call over to Mr. Greg Cannon. Please go ahead, sir.

Greg Cannon

Good afternoon, everyone and thank you for joining us on the Glu Mobile second quarter 2012 financial results conference call. This is Greg Cannon, VP Finance from Glu Mobile. On the call today we have CEO Niccolo de Masi and CFO Eric Ludwig.

During the course of this call, we will make forward-looking statements regarding future events and the future financial performance of the company. Generally, these statements are identified by the use of words such as expect, believe, anticipate, intend, and other words that denote future events.

These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that can cause actual results to differ materially from those in the forward-looking statements in the press release and in this conference call.

These risk factors are described in our press release and are more fully detailed under the caption Risk Factors on the Form 10-Q filed with the Securities and Exchange Commission on May 10, 2012.

On this call we will present both GAAP and non-GAAP financial measures. Non-GAAP measure exclude the change in deferred revenues and royalties, amortization of in-process development contracts, amortization of intangibles, stock-based compensation charges, restructuring charges, changes in the fair value of the Blammo earn-out, transitional costs, release of tax liabilities, and foreign currency gains and losses primarily related to reevaluation of assets and liabilities.

Additionally, we will be discussing adjusted EBITDA, which is defined as non-GAAP operating income loss, excluding depreciation. These non-GAAP measures are not intended to be considered in isolation from, as substitute for, or superior to our GAAP results, and we encourage investors to consider all measures before making an investment decision.

For complete information regarding our non-GAAP financial information, the most directly comparable GAAP measures, and a quantitative reconciliation of those figures, please refer to today’s press release regarding our second quarter results. The press release has also been furnished to the SEC as part of a Form 8-K.

In addition, please note that the date of this conference call is August 2, 2012, and any forward-looking statements that we may make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of future events.

Lastly, this conference call is the property of Glu Mobile, and any recording, reproduction, or rebroadcast of this conference call without the express written permission of Glu is strictly prohibited.

With that, I’ll turn the call over to Niccolo. Niccolo?

Niccolo de Masi

Good afternoon, and welcome to everyone joining us today. Before I begin, allow me to direct you to the supplemental presentation accompanying today’s earnings. It can be accessed via our investor website, glu.com/investors. In addition to the presentation, you will find two demo videos of our upcoming H-2 titles.

I am pleased to report that in Q2 2012 we delivered $24.2 million of total non-GAAP revenue, and $20.4 million of non-GAAP smart phone revenue, well ahead of expectations. Smart phone revenue growth was 111% over the same period last year, and 17% quarter-on-quarter. Smart phone revenues made up 85% of total non-GAAP revenues in Q2, compared to 54% last year.

During Q2, we continued to invest in the future growth of our business. We were considerably favorable to adjusted EBITDA guidance due to our strength in smart phone revenue and favorable gross margin expansion.

Underpinning these strong results were Deer Hunter Reloaded and Little Kingdom, both from our Griptonite studio that we acquired last August. Deer Hunter Reloaded peaked at number six top grossing and number one top free in the iOS store. Little Kingdom was our first title to launch with seven languages supported in addition to English.

Our acquisition of the Deer Hunter brand allowed us to save over $1.4 million in royalties. We would have otherwise have owed in the quarter. This morning, we consummated a tuck-in technology infrastructure acquisition in the form of GameSpy Technologies, formerly a subsidiary of News Corp’s IGN division.

GameSpy brings a 10 plus year track record providing cross-platform, online, and database services to many of the gaming industry’s largest players.

Glu issued 600,000 shares worth under $3 million at today’s closing for an asset which IGN originally acquired for tens of millions. GameSpy brings Glu a team and technology with which to enhance long-term lifetime value through incorporating robust social functionality, synchronous multiplayer, and asynchronous player versus player mechanics.

Glu has been working with GameSpy operationally since Gun Brothers multiplayer and Death Match went live on Android earlier this year. We’ve continued and expanded the relationship since and are incorporating GameSpy technology in many of our H-2 releases.

GameSpy’s cross-platform pedigree and professional management makes for a strong culture fit with Glu and our growth plan.

In H-1, we launched a total of five new games. In Q3, we have thus far launched Mutant Roadkill and Gears and Guts, which went live this morning. All the rest of our Q3 titles are in live beta refinement.

We expect to launch one further title in August called Dragon Quest. In mid to late September, we anticipate seven more launches including our first sequel title. These are, My Pet Dragon, Ham on the Run (ph), Death’s Dome, Bombshells, Hell’s Bells, Enchant You, Campers (ph), and Eternity Warriors Two.

The majority of our H-2 launches will be between September and December. This will allow us to capitalize on consumer adoption of new hardware and favorable advertising seasonality. It also affords us additional live beta refinement time on a greater social and multiplayer functionalities that integration with GameSpy’s technology will bring.

Q4 will see four sequel titles from our most successful 2010 and 2011 franchises: Blood and Glory Legends, Gun Bros Two, Contract Killer Two, and Contract Killer Zombies: Evelyn’s Story.

There will also be another five new franchise titles launched in Q4. Our sequels, Q4 release volume, and later launch of Q3 titles combine to position us for an exceptionally strong Q4 2012 and Q1 2013.

We are increasing full-year expectations and now anticipate delivering $83 million at the midpoint of guidance in 2012 non-GAAP smart phone revenue. This equates to 98% year-over-year growth.

With seven quarters of history of premium smart phone product performance, we head into future quarters with better visibility, and predictability.

New launch timing and integration of GameSpy technology will lead to an adjusted EBITDA loss in Q3. However, for Q4 and the full year 2012, we expect to be adjusted EBITDA positive.

We finish Q2 2012 debt-free with a net cash balance of over $24 million. We expect to be free cash flow positive in Q4 and have finished the year with a net cash balance of approximately $21 million.

Amazon and Microsoft have both already taken a page out of the Apple playbook and produced a vertically integrated tablet under their own brand with control of its operating system, hardware, and storefront. Google has the capability to do the same with its Motorola acquisition and its seen success with the Nexus 7 Google Experience tablet by Asus.

We view this vertical integration to be a favorable development for Glu as we have already seen revenues disproportionately derived from consumers using such devices.

Glu has been focused on a premium smart phone strategy since my arrival in January 2010. They say emulation is the greatest form of flattery. Over the past six to nine months, many of our competitors, both private and public, have deemphasized or even abandoned Facebook web in order to pivot to mobile.

It is extremely validating where Glu has been for ten quarters now to see others adopt such similar strategies. We have indeed been skating to where the puck is going.

Facebook itself has publicly recognized that the majority of its traffic will be mobile in the long-term and incorporated discovery of mobile games is a centerpiece of its new app center.

We’ve designed and built a business centered around arguably the most attractive long-term macro growth trend, throughout the technology, media and gaming growth sectors, 1 billion smart phones and tablets, growing to 6 billion.

I would also point out that the growth in the tablet markets provides a wonderful tailwind for a smart phone-focused company such as Glu. With no Facebook web dependence to our revenues, tablets expand our addressable audience rather than cannibalize it. With a larger foreign factor of tablets, we expect to see higher average ECPMs (ph) as well as higher paying ARPDOW (ph) over the longer term.

In summary, we have beaten top and bottom line guidance for H-1, and are raising top and bottom line guidance for H-2. As we have evidenced, our global reach, studio scale, male-oriented gaming prowess, and cross-platform efficiency is driving consistency in our progress and results. We look forward to H-2 with confidence.

I now hand you over to Eric Ludwig for analysis of our financial results and operating metrics.

Eric Ludwig

Thank you, Niccolo. I’m very pleased with our strong results for the second quarter of 2012, which exceeded our expectations on every measure.

On the second to last page of the supplemental presentation, you will find a key operating metrics slide. This slide includes the last six quarters of metrics for the items I will refer to during this call. As such I will not reference every quarter-over-quarter and year-over-year number when reviewing our results.

I will first provide some details on the company’s financial results for the second quarter as well as certain operating metrics. I will then conclude by reviewing our outlook for the third quarter and increase guidance for the second half and full year 2012.

Summarizing some of our key financial highlights for the second quarter of 2012, as we mentioned in our pre announcement last week, total non-GAAP smart phone revenues of $20.4 million were up 111% on a year-over-year basis and beat our earlier guidance. Non-GAAP smart phone revenues accounted for 85% of total non-GAAP revenues, up from 81% in the prior quarter.

Original IP accounted for 83% of our total non-GAAP revenues. More importantly, original IP comprised 95% of total non-GAAP smart phone revenues in the second quarter. Both these percentages were up quarter-over-quarter and year-over-year.

Non-GAAP gross profit margins reached a record 91%. We had 45.9 million downloads of our titles on Apple, Android, and other platforms during the quarter and our cumulative downloads are now at 277 million. Our daily active users in the month of June 2012 were 3.4 million users, while our monthly active users were 29 million.

Our outperformance on revenues and gross margin resulted in our ability to report $1.2 million of adjusted EBITDA in Q2. We also generated non-GAAP net income of $199,000, which was significantly above our guidance. And lastly, we generated $1.6 million of cash from operations and ended the second quarter with $24 million of cash on our balance sheet, which is better than our expectations.

I now take a moment to drill down on our second quarter revenues, and highlight how we delivered against our prior guidance. During the second quarter, total non-GAAP revenue was $24.2 million, which exceeded our guidance range of $20.5 to $21.5 million and was up 35% from the same period last year.

Consistent with prior quarters, the overall revenue growth was driven by the increase in non-GAAP smart phone revenues, which grew to $20.4 million, and was above the high end of our guidance range of $18.5 million.

A strong year-over-year sequential growth in smart phone revenues reflects the success of our recently launched titles, in addition to the continued momentum of our previously released titles. The two titles we launched during the second quarter of 2012 accounted for 22% of our non-GAAP smart phone revenues during the quarter.

Within our earlier games, Q1 2012 titles accounted for 13% and Q4 2011 releases accounted for 39% of total non-GAAP smart phone revenues. Our five largest revenue-generating titles during the second quarter represented 59% of total non-GAAP smart phone revenues.

These five titles were Deer Hunter Reloaded, which launched this quarter and generated $3.7 million, fourth quarter 2011 title, Frontline Commando, at $3.5 million, Samurai Vs. Zombies Defense at $1.8 million, a Q1 2012 launch, starred on the A-list at $1.7 million and Contract Killer Zombies at $1.4 million, both Q4 2011 titles.

In addition, it is worth noting that Gun Bros was our eighth largest title this quarter, at nearly $900,000 and has generated $10 million since its launch in October 2010.

Our non-GAAP smart phone revenue by platform for the second quarter 2012 was 64% on the Apple platform, 30% on the Android, and 6% on other smart phone platforms. Revenue on the Android platform grew $1.3 million quarter-over-quarter in absolute dollars, an increase in 247 basis points in overall contribution due to the strength of Deer Hunter Reloaded on Google Play, and our catalogue titles on the Kindle Fire.

Our non-GAAP premium smart phone revenues increased 20% from the first quarter to reach $19.2 million. Non-GAAP premium smart phone revenues increased 20% from the first quarter to reach $19.2 million. Non-GAAP premium smart phone revenues accounted for 94% of our total non-GAAP smart phone revenues during the second quarter.

In Q2, we had $2.5 million in-app purchase billable transactions, flat as compared to the prior quarter. The average revenue per in-app transaction increased from $4.71 in Q1 to $5.06 in Q2. The slight increase quarter-over-quarter in ASPs related to higher price currency packages in Deer Hunter Reloaded.

Our legacy feature phone business declined 10% quarter-over-quarter and 55% over the second quarter a year ago on a non-GAAP basis but was above our guidance. Our feature phone revenues now account for only 15% of total non-GAAP revenues and is still dominated by branded IP titles.

During the second quarter, our non-GAAP gross margin reached a record 91.4% substantially above our guidance. Non-GAAP gross margins were up 300 basis points from 88.4% in the first quarter of 2012 and up 875 basis points from Q2 2011 of 82.7%.

The key driver of the quarter-over-quarter improvements was the success of Deer Hunter Reloaded. As you recall, on April 1st we purchased the Deer Hunter brand from Atari for $5 million.

With the $3.7 million that Deer Hunter Reloaded generated during the quarter and an additional $450,000 of legacy Deer Hunter catalogue titles, we did not have to pay any associated royalties during the quarter.

This drove an incremental $1.4 million in margin contribution in the quarter. Now that we own the Deer Hunter brand, all the premium titles we have released since the launch of Goon Bros in October 2010 are considered to be original IP.

And as a reminder, we include two items in our cost of sales. The first is royalties of third-party license holders, which have been declining, and the second is hosting cost for our premium games, which are increasing due to the increase in our DOW and MOW.

And our second half 2012 titles will have increasing server-based social functionality which will also add to hosting costs.

I will next walk through some additional operating results for our second quarter of 2012. Total non-GAAP operating expenses were $21.5 million in the second quarter and in line with our guidance as we invested in marketing and R&D head count to draw the top line growth.

The combination of the better-than-expected revenue in gross margins, along with OpEx coming in line with our guidance, resulted in our ability to report adjusted EBITDA of $1.2 million during the quarter.

The significant (inaudible) our earlier guidance of adjusted EBITDA loss of $2 million to $2.9 million. And I would point out that this is just an EBITDA profit in the second quarter included all the costs for 10 development teams in Blammo and Griptonite who have yet ever released their first title.

In Slide 27, the supplemental presentation highlights this investment we made over the last year and summarizes at the bottom the number of teams that have yet to release their first game.

As a result, we reported non-GAAP income of $199,000 or EPS of break even, which exceeded our guidance of a loss of $0.04 to $0.06 per basic share. We ended the second quarter with $63.8 million weighted average basic shares.

The full recon of GAAP to non-GAAP financial measures was included in the press release we issued today.

Now turning to the balance sheet, as of June 30, 2012, our cash and cash equivalents totaled $24.5 million, which was down from $28.9 million on March 31, 2012 but still better than our expectations.

During Q2, we generated $1.6 million of cash from operating activities, used $900,000 in capital expenditures primarily on our build-out of a new office facility in Moscow, Russia. We spent $5 million and purchased the Deer Hunter IP from Atari and we experienced foreign exchange adjustments of $300,000.

And lastly, we received $200,000 of cash with stock option exercises and ESPP contributions.

Now before turning to guidance, I wanted to provide a scorecard on the three most recent studio and asset acquisitions we have made over the last 12 months to frame our competence in purchasing GameSpy, which we announced today.

We acquired Blammo and Griptonite one year ago today and I am pleased to announce that both studios were profitable for the entire second quarter of 2012 and we believe we’ll be profitable henceforth.

Blammo launch started in the middle of December 2011 and for every month since it launched has generated positive cash flows with very high profit margins.

Griptonite launched Samurai versus Zombies Defense in Q1 and Little Kingdom and Deer Hunter Reloaded in Q2, in early Q2. Despite only three of 11 development teams generating revenue in Q2, the revenues from those three teams’ titles supported the entire organization during the second quarter for all cost.

Equally exciting is the fact that when we acquired Griptonite last August, part of the purchase price was the addition of $10 million of cash on their balance sheet, of which we only utilized $8 million before they became cash flow positive in May.

As I have already mentioned, the Deer Hunter brand purchase from Atari has already driven substantial margin improvement to our second quarter results and was clearly an efficient use of capital.

We are pleased with the performance of these acquisitions over the last year and believe their success has proven our ability to acquire and integrate companies and brands, which have resulted in enhancing shareholder value.

We are equally excited to welcome the GameSpy team to the Glu family. The GameSpy acquisition has allowed us to add great talent and a scalable social gaming technology platform for a reasonable price.

GameSpy also affords Glue the ability to temper growth in hosting products for our products. We issued IGN, a division of News Corp’s 600,000 shares at today’s closing price of $4.66 for a gross purchase price of $2.8 million.

However, GameSpy came with $913,000 of cash on the balance sheet, $1.2 million of net accounts receivable Glu will collect and $545,000 of net book value fixed assets pertaining to hardware and software to manage their datacenter, thus that purchase price was essentially zero.

We anticipate that (inaudible) the neutral results for the remainder of 2012. Now turning to guidance, as Niccolo mentioned in his remarks, we are launching nine titles in Q3 and nine titles in Q4, unchanged from our guidance in May.

However, due to the majority of our titles being launched in mid-September and early December, we will have less revenue generating days in Q3 and thus smart phone revenues will decrease in Q3.

For the third quarter of 2012, we currently expect non-GAAP revenues to be in the range of $20,250,000 and $21,250,000 which includes $17.5 million to $18.5 million non-GAAP smart phone revenues and approximately 12% quarter-over-quarter declines at midpoint of the range.

I would highlight that in setting our Q3 revenue guidance, only one of the nine titles we are launching this quarter (Meat and Roadkill), is globally live as of yesterday. We are using our historical batting average as the success and failures to calculate our revenues on those back-end loaded titles.

If these eight, as yes to be launched titles, perform better than our historical averages, then our guidance could prove conservative.

We expect non-GAAP gross margin during the third quarter to be approximately 89%, which is down slightly from the second quarter. This reflects slightly higher hosting costs related to the GameSpy acquisition.

In addition, we will have slightly higher smart phone royalty costs in the third and fourth quarter of 2012 as we will be publishing Call of Duty: Black Op Zombies for Mac edition on the Android devices starting this quarter.

The formal press release will be forthcoming but I wanted to provide a sneak peak today for contextual purposes.

Our non-GAAP OpEx for the third quarter is expected to be approximately $22.6 million, which reflects a small amount of head count growth in R&D and two months of gains by operating expenses.

Given these expectations, adjusted EBITDA loss defined as non-GAAP loss less depreciation of approximately $600,000 is expected to range from a loss of $3.1 million to $4 million.

Our non-GAAP net loss including a $200,000 tax expense will be a loss between $3.9 million and $4.8 million or a loss of between $0.06 and $0.07 per weighted average basic share.

Excluded from guidance for Q3 from the OpEx are $912,000 of amortization of intangibles and cost of sales, $495,000 of amortization in OpEx and $1 million of stock-based compensation. And the $1 million of stock comp excludes any fair value adjustments related to the Blammo earn out.

Weighted average common shares outstanding for the third quarter 2012 are expected to be approximately 64.5 million basic and 70.8 million diluted. Finally, we expect our cash balance to be approximate $21 million at the end of the third quarter.

As we mentioned in our preannouncement last week, we increased our revenue and profitability guidance for the full year of 2012 due to the Q2B and the seasonally strong fourth quarter along with the 18 titles launching in the back half of 2012.

We currently expect total non-GAAP revenues to be in the range of $94.4 million to $96.4 million, which includes $81.9 million to $83.9 million in non-GAAP smart phone revenues.

Our smart phone revenue guidance for the full year of 2012 represents 100% growth on a year-over-year basis at the high end of the range. We now expect to be adjusted EBITDA profitable for both the fourth quarter of 2012 and for the full year 2012. And for the full year of 2012 we expect 64.2 million basic shares and 70.5 million diluted shares.

We expect to be cash flow positive from operations in the fourth quarter and to end the year with more than $21.5 million of cash and no debt. And as a result, we are reiterating again that we will reach full-year adjusted EBITDA profitability for 2012 without needing to ask the capital markets and without taking on any debt.

I will close by saying that we are very pleased with our strong second quarter results and with the increasing guidance for the second half and full-year 2012. Our recent acquisitions of Blammo and Griptonite have been solid contributors to our results and both are expected to remain cash flow positive.

Additionally, the Deer Hunter brand purchase was perfectly timed and was an optimal use of capital. Lastly, I’m very excited to have a GameSpy team and technology under our umbrella and I look forward to a large title release slate with increasing social mobile features.

Glu has been very clear since early 2010 in our vision that social mobile gaming was where the growth was going to be and we never deviated from that course. It appears that the rest of the gaming market is now convinced that mobile is the growth engine and Glu is well positioned as a global leader in the space.

With that, I will wrap up the prepared remarks and turn the call over to the operator for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Darren Aftahi of Northland Securities.

Darren Aftahi – Northland Securities

Hi, guys. Thanks for taking my questions. Just a couple of – for your third quarter guidance Eric on gross margin, I think it’s a 200 basis point sequential drop, why such a big drop if only a small portion of sort of the newer titles are going to have a higher server cost?

Are you fielding anything out? I mean, I assume it’s all variable. It just seems like an abnormally large drop. Second question, what kind of pickup have you seen in terms of revenues from China? And then third, any kind of granularity you can give us on impacts of the quarter from your subscription offering, thanks.

Eric Ludwig

Great. I’ll take the first two and Niccolo can probably talk about the subscriptions. So on the cogs drop for our guidance for Q3, there’s two components. One is some incremental hosting costs with GameSpy as well as the titles that we’re launching at the back half of September will have significantly more server connectivity than our prior titles. So that’s probably the primary driver.

Secondly, we did just – I just announced today that we will be launching in this quarter a distribution deal with a very high royalty cost but with no effort on Glu’s part for Call of Duty: Black Ops Zombies from Mac edition (ph). So just for Android devices but we’ll be launching that and that will be a – if it’s a one-off title, one-off deal for us to leverage Glu’s distribution heft on Android but will be paying us a sizeable percentage of that revenue back as a royalty. So it’s a bit of a hit to the gross margin from that transaction.

And then in terms of China, we haven’t broken out China, Japan, Korea from our numbers yet but we have been very focused on execution in the Asian countries, in the Asian languages and we have seen nice quarter-over-quarter in absolute dollars revenue growth.

And that whole Asian region is becoming a relatively decent size of revenue. We haven’t broken it out yet, so it’s clearly below 10% for all three of them combined. But it’s getting pretty close to 10%.

Niccolo de Masi

OK, on subscriptions, Darren, it’s early days. There are still some teething challenges with Google’s billing system. We were obviously the trail blazing partner for them.

So I think our confidence hasn’t changed with regards to the long-term positive impact of being the first person to have a universal currency and the first to have subscriptions on Google.

But it’s not likely to be impacting us significantly positively until we figure out how to maximize our marketing of the club as well as maximize and optimize the placement of the club within our games.

And that’s on top of the sort of Google teething challenges that still are being worked through. So it’s probably neutral-ish at the moment. We’re just starting to see, for example, what the rebill rate will be on subscriptions and I think we’ll have an update for you probably every quarter but starting later in the year.

Operator

Your next question comes from the line of Atul Bagga of Lazard Capital.

Atul Bagga – Lazard Capital

Hey, guys. Congratulations on the quarter and thanks for taking my call. A few questions for you, Niccolo, you talked about a strong tail end in the space but if we look at the usage, I mean, ARPDOW it seems like MAU (ph) has been declining for the last two quarters and DAU (ph) is kind of flattish. Can you talk about what’s going on there?

Niccolo de Masi

Sure. So for Glu, we haven’t launched a lot of games in the first half of the year, right. So I think if you look at the slide I put in the earnings presentation that’s on our website, it details ARPDOW and percent to pain in something like our top five or six games.

You can see that while DAU and MAU have not been climbing and, in fact, our DAU, MAU ratio has increased, ARPDOW has climbed and that is how largely we’ve been able to power such good Q2 results on the back of really just one or two titles that came out in spring.

Atul Bagga – Lazard Capital

So looking ahead, I mean, do you expect to see continued growth from better monetization or is it going to be a combination of – where do you see the bigger part of growth coming from? Is it usage or monetization?

Niccolo de Masi

I’m consistent on that one, Atul. You’ve asked me that for 10 quarters in a row and I still believe that it’s more DAU than it is ARPDOW at this phase of the market’s growth and is also this phase of Glu’s scaling.

So we doubled studio capacity in the last year. We have a lot more titles coming out in the second half of this year than last year. So we think that there is room for ARPDOW (ph) expansion slowly but surely and we’ve been evidencing that, right, because you can see that we used to average $0.05 ARPDOW but we’re showing you here our top six titles are averaging $0.085.

So it is moving slowly but surely even though the overall average is not moving that quickly. The newer tittles are moving and I think that there’s room for a little bit steady expansion there in addition to the DAU moving upwards in the coming quarters.

Atul Bagga – Lazard Capital

Fair enough. And then second on competition, you talked about some of the bigger companies now they are trying to pivot the business and focusing more on mobile. Can you talk about how do you see this changing landscape over the next six months (inaudible) especially with the iOS six (ph)?

Do you see – is there any concern with competition coming from bigger companies that might have substantially larger base that’s still on Facebook?

Niccolo de Masi

So we think that iOS six (ph) and integrating Facebook like they have with Twitter is a great tailwind for Glu, right. We were a company that didn’t – wasn’t really able to take advantage of Facebook virality in previous quarters and years.

We’re a company that started off on the strategy of ours without tablets. So those are those things that are really positive market expanding tools for Glu as opposed to risking cannibalization of any kind.

So when you think about what is still going to drive the majority of discovery, we still believe that it’s going to be Apple featuring and Google featuring are going to be highly important items in that chain of events that leads to a user finding your game.

And this is incremental to that. This will not replace the importance of our technology roadmap matching Apple’s and Google’s and Amazon’s and Microsoft and getting that feature placement.

So net positive and it’s not only companies larger than us, Atul, that are pivoting. It’s companies smaller than us as well. So I think it’s pretty much everybody’s recognizing that the mobile ecosystem is certainly one which is a little more democratic. There’s no company that has a market share over probably 10% right now and so that leaves a lot more room for people like ourselves to grow and it also is an ecosystem where discovery is a lot more evenly handed out by the Apples and Googles than it was certainly on Facebook web for example.

Atul Bagga – Lazard Capital

And last, very quick on GameSpy, can you talk about your decision to buy versus partner with them? Is it any indication on long-term direction of Glu as the platform business? Thank you.

Niccolo de Masi

Well, it’s an indication of Glu’s long-term product strategy but it’s not an indication of Glu’s interest in being a platform company. We still currently believe that our best strategic positioning is as a pure content developer. Now that’s not to say that we’re not going to have great connected games on all of the multiplayer social PVP, PVE functionality we mentioned.

We think that’s important to being a content producer. We also think it’s important for our games to have their own community and for Glu to be able to make the most of our own community between games.

But we are – we look to this more as a how can we accelerate Glu’s own proprietor IP far more so than whether or not we’d be looking long term to expand into being another platform provider.

We personally think that there many – at the rate we’re going, there will be, and almost probably are, many more people competing to be kind of disintermediators of Apple and Google, Microsoft than are likely to survive.

So you have (inaudible) and EA and probably one or two other people that are all wanting to play some kind of marketing-publishing role. It’s a great place for Glu to be. We are probably the largest-scaled content-only player.

And over time we are going to have a lot of choice and a lot of nice value chain pension around whether we stay working with just ourselves, directly with Apple, Google and other stores or we start to partner here and there.

And we’ll probably test it out like we always do. But fundamentally we think that the most valuable place for us to be for our shareholders and ourselves is exactly where we are right now, albeit with games that have more retentive tools in them and that have more emersion to gaming behavior and by that I mean more user-user interaction overall.

Atul Bagga – Lazard Capital

Perfect. Thank you.

Niccolo de Masi

Thanks, Atul.

Operator

And your next question will come from the line of Michael Graham with Canaccord.

Michael Graham – Canaccord

Thanks. I was – wanted to ask you about two things. One is the beta refinement process that you mentioned, Niccolo. It seemed like the monetization from some of your more recent games is really strong.

And can you talk about really what that beta refinement process is, what it tells you, what it does to your confidence level when you’re releasing a game these days? And then related to that, I think when we entered this year we were talking about roughly 20 games being launched during the year.

And it’s obviously been really backend loaded but you’ve been able to crush numbers with a lot fewer games. Can you keep pushing off these launches? How long can we go in terms of expending some of these launches? Could we – and what’s your philosophy there? Could we get to a point where we’re in Q4 and you still launched a small number of games and you’re sort of holding some back? Just kind of talk us through that. Thanks.

Niccolo de Masi

So we’re still at 23 games for the year that we expect to go live. That’s where we were last quarter. That’s still where we are this quarter. That’s a great question on the beta refinement period and do we view that.

It’s a balance ultimately between looking at the lifetime revenue of a game and trying to maximize that whole call it long S curve. But of course you’re trading off time to market.

So what we look for generally is certain revenue per day per DOW metric, good downloadability, ultimately, and decent retention figures. And ultimately we’re comparing ourselves against other Glu games that have been successful.

So yes, we have – I agree with. We’ve gotten better in the last six months at improving the batting average of title and what we considered in 2010 to be a raging A-quality success is now turning into a B minus for us in terms of sheer dollars.

So the mark is getting bigger. Glu is getting better at what we do. We’re not going to be in a position whereby the 23 titles we have announced this year is going to reduce between now and the end of the year.

Yes, things have moved late in Q3 but it’s really just ended up stacking Q4 where there is optimal advertising dollars and seasonality to take advantage of as well as things like potential launches of iPhone 5s and other exciting new hardware, which tends to get consumers adopting content at a bit of an accelerated rate.

So this is not going to turn into a situation where we go quarter after quarter never putting out more than a game or two. I mean, we have hit the (no-told) number of games number in 2010 and 2011 and we intend to do so in 2012 as well.

Michael Graham – Canaccord

OK, thanks a lot for that.

Operator

Your next question comes from the line of Mike Hickey with National Alliance.

Mike Hickey – National Alliance

Hey, guys, thanks for taking my questions and congratulations on an outstanding quarter. Obviously there’s a lot of exciting hardware introductions coming out within the next six months and you’ve touched on a few of them. But I was hoping that you could kind of map out where you see the most exciting opportunities and potential challenges and if you could speak also specifically to kind of the evolving Amazon ecosystem and how you think that can impact your business medium term. And then I have a follow-up.

Niccolo de Masi

Well, as I said on my prepared comments, I think the most exciting development in the hardware space overall right now is the integration of software, storefront and hardware by Apple, Google, Amazon, Microsoft, etc cetera.

So everyone has recognized Apple’s over-indexing with regards to other strategies for how much money can be generated for publishers and ultimately how much consumer satisfaction there is.

And it comes down to that tight interoperability, right, between the way the store works, the way the building works, the way that it runs on the software without any issues and ultimately where that store is discovered and how well the content runs on specified, defined and controlled hardware parameters.

So I think the long run you’re going to see a continued over-indexing of the percentage of publisher revenues that come from vertically-integrated devices. But I’m not – I don’t rule out continued growth in the core Android strategy of many Hasset (ph) manufacturers utilizing a free operating system. I think you’re going to have a bit of both.

Amazon’s been successful. We’re a close partner of theirs. We just launched – announced that we’re launching with them in Europe. We expect future devices from Amazon to build on what the Kindle Fire has done and we expect the same thing to happen with Google with the Nexus 7 being a success. I’m sure there will be more of those.

In terms of specific hardware, we couldn’t comment on what we’re expecting the second half of the year except to say that like every year, there are significant advances in memory, not only on storage space but also in ram, processing power, screen size and fidelity of screens.

And we expect, as with every Christmas, to see Q4 significantly pushing ahead the state of the art. You have a continued diversification of strategies. Zonies (ph) bought the rest of their Sony Ericcson JV and they’re of course going to continue bringing out more game-centric devices on the one hand.

On the other hand, most likely the iPhone ecosystem and whatever new iOS devices come out, we’ll continue to be top of the stack with regards to how we prioritize developments due to revenue opportunity.

Mike Hickey – National Alliance

OK, yes, that was very helpful. Thank you. The press is a bit early but for looking into next year, I know 23 titles expected this year, can you give us any sense of the number of titles you’re thinking for ‘13 and maybe how you expect to pay some of the – just reflect what you did in ‘12?

And then obviously you’ve had some very successful games that I’ve iterated more than once. Thinking into 2013, do you have – can you give us any granularity on how many would be franchises versus new IP?

Niccolo de Masi

So it’s early days to be able to comment on that simply because we don’t know yet what the success percentage will be of new franchises in Q4 and we also don’t know how long we’re going to update the titles that are launching between September and December this year.

However, historically we have about – we have in excess of 20 development teams and sometimes they get bigger. Sometimes they get smaller. Probably next year we’ll see closer to approximately the 20-ish number than it will be to some deviation either side of that.

You’re not going to see a doubling of the number of titles because over time we’re trying to build that more emersion gaming behavior I talked about in the last question. So we want to be supporting deeper, bigger online experiences where consumers are playing against each other, interacting with each other and hence that would lead to more revenue success but fewer new titles would come out over time.

Our franchise strategy is consistent in the sense that we believe we’re building some interesting brands with games like Goon Bros 2, Contract Killer 2. These are games that have had 20 million, 30 million installs globally and we think the sequels will do as well and we think that over time multiyear franchise installs can reach, in a number of cases, perhaps as high as 7500 million. And that’s obviously pretty interesting from a reach and brand equity perspective.

So we’ll continue to follow that strategy. Any candidate and engine that’s done well will, of course, be looked at quite seriously for reuse and for (inaudible). And that’s something that obviously Glu has the breadth and scale and support, quite a substantial year-on-year-out sequel investment because we’ve got a lot of teams.

Mike Hickey – National Alliance

OK. That’s helpful. Last question, obviously the competition is heating up in mobile and you’re seeing resources being (inaudible) into the space that you are – compared to a lot of people that are first to first to market.

How do you think – do you think that’s going to intensify to kind of the M&A landscape over the next six to 12 months as maybe some larger competition tries to acquire market share?

Niccolo de Masi

Well, I think it has to in the long term. I don’t know if I can comment in the next six to 12 months but there’s no doubt longer term in any market, right, when you see more intense competition, you see more players and bigger players. There tends to be a fight for scale.

So Glu continues to believe that we have the scale to be an independent success in the long term but as we’ve always said, we’re aligned with our shareholders and board with regards to a healthy premium for becoming a part of another entity if that’s interesting.

So we’re running this business fundamentally as best we can and ultimately whether or not we stay independent or become part of something else is down to what’s on offer. But I do think that you’ve seen big deal making, small deals in the last two years. You’re likely to continue seeing the same thing in the next two years.

I think there will be lots of small deals. Some players have to – bigger players have to recharge their cash balances at some point. But eventually, as this market becomes $5 billion, $10 billion of potential revenue a year, obviously it’s something that has to be addressed by the very largest players very significantly if they want to continue to power their own growth.

Mike Hickey – National Alliance

Yes, yes, well said. Well, thanks, guys, and good luck on your holiday.

Operator

Your next question comes from the line of Mark Argento with Craig-Hallum.

Mark Argento – Craig-Hallum

Good afternoon, guys. Just some thoughts around the advertising landscape, mobile advertising and any new developments you’ve seen there in terms of that business being able to grow and become more substantial.

And then second question around the whole concept of competition, I know there’s always been concerns about barriers to entry. Anybody can develop a mobile game, hard to do it at scale.

Are you starting to see the number of new games launched in the marketplace out there starting to dwindle? Maybe if you could quantify or you have any thoughts qualitatively about what you’re seeing out in the marketplace on the stores, that would be great.

Eric Ludwig

Yes, sure, Mark. I’ll take the first one on advertising. I think if you look at – there’s a slide in our presentation of the percentage of revenue coming from advertising book incentive, non-incented advertising. We actually saw some pretty sizeable growth this quarter in advertising, so we’ve started now doing a lot of cross promotions of other peoples’ games in our ad network as well as interstitial pop-ups.

So we’ve seen really good growth already this year. I think that will continue obviously in absolute dollars in the growth as we get a bigger footprint of DOW and downloads with reaching other customers. And then in terms of competition I’ll turn it back over to Niccolo.

Niccolo de Masi

Yes, the advertising seems – or as I said in my prepared comments, I mean, it’s long-term positive. We’re seeing progress in video ads. We’re seeing very slow progress, right, from brand advertisers shifting digital dollars from internet to mobile but it’s a steady trend.

In the long term, I suspect that the Proctor & Gamble’s of the world will view mobile and online and web all as one kind of digital bucket and so slowly but surely this tends to favor players like ourselves that have seen low ECPMs and are likely to see higher ECPMs in the long term.

So historic competition, barriers to entry, scale, etc cetera, there is still finite space in the app stores with regard to feature placement. The app stores are designed at the moment – and I believe (inaudible) to be about encouraging content discovery.

So I don’t believe we will ever reach a situation whereby Apple, Google, Microsoft or Amazon strike a special multiyear contract with any publisher to favor them hitting certain user targets, right.

That has happened in other places on the web but I don’t think it’s going to happen in mobile stores because it largely ruins the ecosystem for new and up and coming developers and it also ruins, frankly, returns for anyone who doesn’t get that contract.

So the sort of demarketization of discovery is likely to be the case for the longer term. That doesn’t mean that there’s going to be demarketization of production values. I think the direction of content creation in the film space and the console gaming space has been very clear for the past two or three decades or more in the case of the film space.

So slowly but surely we believe that whether you build a casual game or whether you build an action title, people are going to need to be hitting the kinds of production values that Glu already has evidenced in the past 12, 18, 24 months. And that’s obviously long term favorable for us.

With regards to other competitors, I think there’s room for more than one strategy to be successful. There are people that are bringing successful card games from Japan to the US and westernizing them and there will be some room for that.

There will be room for some mobile MMOs and there will be room for very light casual games that have high DOW and low ARPDOW. Glu has been a male-centric, high production value, 3D premium leader on mobile devices really since 2010 and we aim to continue that strength.

But we’re also diversifying into some of those other areas and you’re seeing us take some of those shots on goal this year.

Mark Argento – Craig-Hallum

Very helpful, thank you.

Greg Cannon

Thanks, Mark.

Operator

(Operator Instructions) Your final question comes from the line of Adam Krejcik with ROTH Capital Partners.

Adam Krejcik – ROTH Capital Partners

Hi, guys, thanks. Two questions, first, Niccolo, can you just remind us or talk a little bit about the structure you guys have at your studios for some of the older games, the Q1, Q4 releases? How much kind of maintenance costs is associated because it seems like some of these games, the tail end is still doing very well.

So is it safe to assume the profitability from those older games is that much higher than the newer releases?

Niccolo de Masi

Well, look, our business has six numbers of teams approximately and most of our OpEx is in fixed cost overall. And that’s the 600 plus people that we have working for Glu around the world.

If you look at a team like Goon Bros, which is kind of our poster child – it was our first success. It continues to be our first title I think cumulatively. That team has been working almost entirely on Goon Bros to – for most of this year so far.

They’ve done minimal content updates for the title, relatively cost effective tweaks in addition to weapons for holidays and that kind of thing. But if you think about standard team with 15 people on there, there’s probably been two people supporting Goon Bros while the rest are working on the new title.

And when Goon Bros 2 launches, it’s safe to say there will be zero supporting Goon Bros 1 and they’ll be focused on updating Goon Bros 2 for a period of time and then moving on to potentially a sequel or potentially something else that uses their skill set.

Adam Krejcik – ROTH Capital Partners

Got it. And then in terms of marketing dollars, if we’re to break this out, how much of it is geared towards new releases versus older titles? And do you have to really spend much more marketing dollars or is it more you’ve got a loyal player base and content updates?

Eric Ludwig

Yes, sure, Adam. I’ll take that. So if you look at our marketing spend this quarter, a little over $4 million, that’s about 45% of that is people cost. And we’ve been pretty fixed in our head count cost for sale and marketing people. And the balance about $2.7 million this quarter, $2.8 million of that number this quarter was in variable spend.

What you typically see is more of – and that $2.7 million is about 15% of the smart phone revenue, so we’ve been trying to target our variable spend on 14% to 15% of the variable – of the smart phone revenue.

And then you typically see more of that focused on new title launches and that could be current quarter launch or prior quarter. But titles like Contract Killer from a year ago, titles like Goon Bros have a very, very little marketing spend against them unless there’s either a big update to the title where it gets some kind of featuring, in which case we would do some kind of campaign around a no one (ph) update with a no one (ph) featuring. Otherwise, more than 50% of that is usually around the current titles that are launching.

Adam Krejcik – ROTH Capital Partners

Great. And then finally, do you think it’s possible – I know it’s early – but to achieve the, some of the long-term margin metrics that you’ve put out maybe on a quarterly basis in 2013 or is that something you can’t comment on?

Eric Ludwig

Yes, I mean, we haven’t yet done any planning for 2013 that we’re willing to expose yet. So it’s probably too early to talk about that. Though when you look at the implied numbers that we’re giving guidance for in Q4, we’ll have a pretty reasonable margin in the fourth quarter, nowhere near the long-term targets but certainly sizably profitable with the current guidance that we’re giving, so pretty happy about that.

And I think one last thing that I wanted to comment on your first portion of the question was about the teams and updating for the teams. I did highlight in my prepared remarks that the Q2 results that we had, the adjusted EBITDA of $1.2 million, that still had 10 teams from Grip and Blammo that had yet to ever launch their first title.

So we’re still in the investment phase in the first half of this year and now for Q3 and by the end of Q3 and early Q4, all of those teams will have had their first shots on goal, so it’ll be a different profile for delivery of revenue and team absorption of cost.

Adam Krejcik – ROTH Capital Partners

Great, thanks very much.

Eric Ludwig

All right, thanks, Adam.

Operator

There are no further questions at this time.

Niccolo de Masi

All right, well, we’d like to thank our shareholders and board for their support as we continue to build Glu into the leading premium mobile gaming company. Thank you for joining the call and we’ll see you next time.

Eric Ludwig

Thank you.

Operator

Thank you. This will conclude today’s conference call. You may now disconnect your line.

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