Playtika Holding Corp. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this annual report on Form 10-K. This discussion and analysis contains forward-looking statements that involve certain risks and uncertainties. Our actual results could differ materially from those discussed in these statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this annual report on Form 10-K, particularly under the “Risk Factors” and “Special Note Regarding Forward-Looking Statements” sections. Overview We are one of the world’s leading developers of mobile games creating fun, innovative experiences that entertain and engage our users. We have built best-in-class live game operations services and a proprietary technology platform to support our portfolio of games which enable us to drive strong user engagement and monetization. Our games are free-to-play, and we are experts in providing novel, curated in-game content and offers to our users, at optimal points in their game journeys. Our players love our games because they are fun, creative, engaging, and kept fresh through a steady release of new features that are customized for different player segments. Key Factors Affecting Our Business There are a number of factors that affect the performance of our business, and the comparability of our results from period to period, including: • Conversion of players into paying users and ongoing monetization. While our games are free-to-play, we generate substantially all of our revenues from players’ purchases of in-game virtual items. Our financial performance is dependent, in part, on our ability to convert more active players into paying players and sustainably grow user spend over the long term. Our players’ willingness to consistently make in-app purchases is impacted by our ability to deliver engaging content and personalized user experiences. • Acquisitions of games and new technology . We have grown and expect to continue to grow our business by acquiring games and game studios that we believe can benefit from our live operations services, our Playtika Boost Platform, our design experience, and our scale. When we acquire games and studios, we focus on providing existing audiences with proven content and applying our live operations to create a better game experience for users. We also seek to make acquisitions in technology that enhance our marketing, artificial intelligence and research and development capabilities. • Launch of new games and release of new content, offers, and features . Our revenue growth has been driven by improving the content, offers, and features in our existing games and the release or acquisition of new games. In order to enhance the content, offers, and features in our existing games and to develop or acquire new games, we must invest a significant amount of our technological and creative resources, ensuring that we support a consistent cadence of novel content creation that drives conversion and continued monetization. These expenditures generally occur months in advance of the release of new content or the launch or acquisition of a new game. • User acquisition . We believe that we will be able to continue to grow our user base, including through traditional marketing and advertising, informal marketing campaigns, and cross-promoting between our games, including new games we develop or acquire. We intend to continue to seek new opportunities to enhance and refine these marketing efforts to acquire new users, including identifying potential technologies to enhance our marketing and advertising capabilities. 54 COVID-19 The global pandemic associated with COVID-19 has caused major disruption to all aspects of the global economy and daily life in recent months, particularly as quarantine and stay-at-home orders have been imposed by all levels of government. We have followed guidance by the United States, Israeli and other applicable foreign and local governments to protect our employees and operations during the pandemic and have implemented a remote environment for our business. We cannot predict the potential impacts of the COVID-19 pandemic on our business or operations, but we continuously monitor performance and other industry reports to assess the risk of future negative impacts should the disruptions of the COVID-19 pandemic continue to evolve. Despite the challenges we have faced in light of the COVID-19 pandemic, our revenues and number of DAUs have increased while the stay-at-home orders were in place across the United States. As individuals spend more time at home, we have seen an increase in time spent with digital entertainment, including casual gaming and games involving socially interactive experiences. The COVID-19 pandemic has resulted in and may continue to result in consumers spending a greater portion of their time at home and sustained demand for entertainment options, which may continue to benefit our financial results. However, the COVID-19 pandemic has caused an economic recession, high unemployment rates, and other disruptions, both in the United States and the rest of the world. We cannot predict the potential impacts of the COVID-19 pandemic on our business or operations, and there is no guarantee that these near-term trends will continue, particularly if the COVID-19 pandemic increases and the adverse consequences thereof in severity or continues for a protracted period of time, which could disrupt our operations, or put greater financial pressure on the economy and users’ discretionary income or spending habits. In addition, we could experience a decrease in user activity or spending after the COVID-19 pandemic subsides, which could adversely impact our cash flows, operating results, and financial condition. See “Risk Factors—Risks Related to Our Business—The recent COVID-19 pandemic and similar health epidemics, contagious disease outbreaks and public perception thereof, could significantly disrupt our operations and adversely affect our business, results of operations, cash flows or financial condition” for more information. Consolidated Operating Results of Playtika Holding Corp. Playtika measures the performance of its business by using several key financial metrics, including revenue and operating income, and operating metrics, including Daily Active Users, Average Revenue per Daily Active User, Paying Users, and Average Revenue per Paying User. These operating metrics help Playtika's management to understand and measure the engagement levels of the Company's players, the size of its audience and its reach. Components of our Results of Operations Revenues We primarily derive revenue from the sale of virtual items associated with online games. We distribute our games to the end customer through various web and mobile platforms, such as Apple, Facebook, Google and other web and mobile platforms plus our own proprietary platforms. Through these platforms, users can download our free-to-play games and can purchase virtual items to enhance their game-playing experience. Players can purchase virtual items through various widely accepted payment methods offered in the games. Payments from players for virtual items are non-refundable and relate to non-cancellable contracts that specify our obligations and cannot be redeemed for cash nor exchanged for anything other than virtual items within our games. Our games are played primarily on various third-party platforms for which the platform providers collect proceeds from our customers and pay us an amount after deducting platform fees. We are primarily responsible for fulfilling the virtual items, have the control over the content and functionality of games and have the discretion to establish the virtual items’ prices. Therefore, we are the principal and, accordingly revenues are recorded on a gross basis. Payment processing fees paid to platform providers are recorded within cost of revenue. 55 Cost of revenue Cost of revenue includes payment processing fees, customer support, hosting fees and depreciation and amortization expenses associated with assets directly involved in the generation of revenues, primarily servers. Platform providers (such as Apple, Facebook and Google) charge a transactional payment processing fee to accept payments from our players for the purchase of in-app virtual goods. Payment processing fees and other related expenses for in-app purchases made through our proprietary platforms are typically 3-4%, compared to a 30% platform fee for third party platforms. We generally expect cost of revenue to fluctuate proportionately with revenues. Research and development Research and development consists of salaries, bonuses, benefits, other compensation, including stock-based compensation and allocated overhead, related to engineering, research, and development. In addition, research and development expenses include depreciation and amortization expenses associated with assets associated with our research and development efforts. We expect research and development expenses will increase in absolute dollars as our business expands and as we increase our personnel headcount to support the expected growth in our technical development and operating activities. Sales and marketing Sales and marketing consists of costs related to advertising and user acquisition, including costs related to salaries, bonuses, benefits, and other compensation, including stock-based compensation and allocated overhead. In addition, sales and marketing expenses include depreciation and amortization expenses associated with assets related to our sales and marketing efforts. We plan to continue to invest in sales and marketing to retain and acquire users. However, sales and marketing expenses may fluctuate as a percentage of revenues depending on the timing and efficiency of our marketing efforts. General and administrative General and administrative expenses consist of salaries, bonuses, benefits, and other compensation, including stock-based compensation, for all our corporate support functional areas, including our senior leadership. In addition, general and administrative expenses include outsourced professional services such as consulting, legal and accounting services, taxes and dues, insurance premiums, and costs associated with maintaining our property and infrastructure. General and administrative expenses also include depreciation and amortization expenses associated with assets not directly attributable to any of the expense categories above. We also record adjustments to contingent consideration payable recorded after the acquisition date, and legal settlement expenses, as components of general and administrative expense. We expect general and administrative expenses will increase in absolute dollars due to the additional administrative and regulatory burden of becoming and operating as a public company. Interest expense and other, net We generally did not incur interest expense prior to August 2019. In August 2019, we borrowed $2,583 million under our Bridge Facility, and then subsequently refinanced the borrowings under that facility in December 2019 pursuant to our Credit Agreement, dated as of December 10, 2019. Our interest expense includes amortization of deferred financing costs and is offset by interest income earned on the investment of excess cash and cash equivalents. We expect to continue to incur interest expense under our Credit Agreement, although such interest expense will fluctuate based upon the underlying variable interest rates. Provision for income taxes The provision for income taxes consists of current income taxes in the various jurisdictions where we are subject to taxation, primarily the United States, the United Kingdom and Israel, as well as deferred income taxes reflecting the net tax effects of temporary differences between the carrying amounts of assets and liabilities in each of these jurisdictions for financial reporting purposes and the amounts used for income tax purposes. Under current U.S. tax law, the federal statutory tax rate applicable to corporations is 21%. Our effective tax rate can fluctuate based on various factors, including our financial results 56 and the geographic mix to which they relate, the applicability of special tax regimes, changes in our business or operations, examination-related developments and changes in tax law. Results of Operations The table below shows the results of our key financial and operating metrics for the periods indicated. Unless otherwise indicated, financial metrics are presented in millions of U.S. Dollars, user statistics are presented in millions of users, and ARPDAU is presented in U.S. Dollars. Year ended December 31, (in millions of dollars, except percentages, Average DPUs, and ARPDAU) 2020 2019 2018 Revenues $ 2,371.5 $ 1,887.6 $ 1,490.7 Total cost and expenses $ 1,984.3 $ 1,390.2 $ 1,058.1 Operating income $ 387.2 $ 497.4 $ 432.6 Adjusted EBITDA $ 941.6 $ 712.1 $ 628.9 Non-financial performance metrics Average DAUs 11.2 10.2 6.7 Average DPUs (in thousands) 285 218 150 Average Daily Payer Conversion 2.6 % 2.1 % 2.2 % ARPDAU $ 0.58 $ 0.51 $ 0.61 Average MAUs 34.2 33.3 20.7 Comparison of the year ended December 31, 2020 versus the year ended December 31, 2019 Year ended December 31, (in millions) 2020 2019 Revenues earned through third-party platforms $ 2,048.5 $ 1,693.9 Revenues earned through internal proprietary platforms 323.0 193.7 Revenues $ 2,371.5 $ 1,887.6 Cost of revenue $ 712.2 $ 566.3 Research and development expenses 268.9 210.5 Sales and marketing expenses 502.0 413.7 General and administrative expenses 501.2 199.7 Total costs and expenses $ 1,984.3 $ 1,390.2 Revenues Revenues for the year ended December 31, 2020 increased by $483.9 million when compared to 2019. The increase in revenues was primarily due to the acquisitions of Seriously in July 2019, contributing an aggregate $93.5 of incremental revenues compared to the year ended December 31, 2019, combined with improved monetization and increased revenues from new content and product features across our broader portfolio of games when compared to 2019. The combination of the acquisitions and improvements to monetization, new content and product features drove an increase in both DAUs and DPUs. The increase in revenues generated from internal proprietary platforms as a percentage of total revenues resulted from marketing activities for the games offered through these platforms. 57 Cost of revenue Cost of revenue for the year ended December 31, 2020 increased by $145.9 million when compared with the year ended December 31, 2019. The increase in cost of revenue was primarily due to $24.0 million in incremental platform fees incurred by us related to the acquisition of Seriously, combined with increased platform fees that generally correspond with an increase in revenues. The increase in revenues generated from internal proprietary platforms as a percentage of total revenues resulted in a favorable impact on total platform fees, although this favorable impact was more than offset by increased amortization expense for intangible assets resulted from recent acquisitions. Research and development expenses Research and development expenses for the year ended December 31, 2020 increased by $58.4 million when compared with the year ended December 31, 2019. The increase in research and development expenses was primarily due to $11.7 million in incremental expenses incurred by us related to the acquisition of Seriously, as well as increased headcount resulting from newly formed research and development operations in Romania and Switzerland and expansions of our existing research and development operations in the Ukraine, Belarus and Israel. Sales and marketing expenses Sales and marketing expenses for the year ended December 31, 2020 increased by $88.3 million when compared with the year ended December 31, 2019. The increase in sales and marketing expenses was primarily due to approximately $30.8 million in incremental expenses incurred by us related to the acquisition of Seriously, as well as increased marketing expenses related to media buy expenses. General and administrative expenses General and administrative expenses for the year ended December 31, 2020 increased by $301.5 million when compared with the year ended December 31, 2019. The increase in general and administrative expenses was primarily due to $276.0 million in stock-based compensation, a $37.6 million expense related to a litigation settlement, and $5.0 million in incremental expenses incurred by us related to the acquisition of Seriously, all of which have no comparable amounts in the prior period. This increase was partially offset by a $4.0 million lower expense associated with adjusting contingent consideration to fair value and lower recruiting expense in 2020 when compared to 2019. Comparison of the year ended December 31, 2019 versus the year ended December 31, 2018 Year ended December 31, (in millions) 2019 2018 Revenues earned through third-party platforms $ 1,693.9 $ 1,382.3 Revenues earned through internal proprietary platforms 193.7 108.4 Revenues $ 1,887.6 $ 1,490.7 Cost of revenue $ 566.3 $ 437.0 Research and development expenses 210.5 148.3 Sales and marketing expenses 413.7 293.2 General and administrative expenses 199.7 179.6 Total costs and expenses $ 1,390.2 $ 1,058.1 Revenues Revenues for the year ended December 31, 2019 increased by $396.9 million when compared to 2018. The increase in revenues was primarily due to the acquisitions of Wooga in November 2018, Supertreat in January 2019 and Seriously in July 58 2019, contributing an aggregate $240.5 million of incremental revenues compared to the year ended December 31, 2018, combined with improved monetization and increased revenues from new content and product features across our broader portfolio of games when compared to 2018. The combination of the acquisitions and improvements to monetization, new content and product features drove an increase in both DAUs and DPUs. The increase in revenues generated from internal proprietary platforms as a percentage of total revenues resulted from the expansion of our proprietary platforms to include one additional game during 2018, combined with increased marketing activities in the existing games offered through these platforms. Cost of revenue Cost of revenue for the year ended December 31, 2019 increased by $129.3 million when compared with the year ended December 31, 2018. The increase in cost of revenue was primarily due to $64.8 million in incremental platform fees incurred by us related to the acquisitions of Wooga, Supertreat and Seriously, combined with increased platform fees associated with the increase in revenues. The increase in revenues generated from internal proprietary platforms as a percentage of total revenues resulted in a favorable impact on total platform fees, although this favorable impact was more than offset by incremental expense associated with the amortization of intangible assets recorded as part of the acquisitions. Research and development expenses Research and development expenses for the year ended December 31, 2019 increased by $62.2 million when compared with the year ended December 31, 2018. The increase in research and development expenses was primarily due to $34.3 million in incremental expenses incurred by us related to the acquisitions of Wooga, Supertreat and Seriously, as well as increased headcount to support existing operations, including an increase of $12.7 million in costs related to outsourced labor, offset by capitalization of research and development expenses related to platform development. Sales and marketing expenses Sales and marketing expenses for the year ended December 31, 2019 increased by $120.5 million when compared with the year ended December 31, 2018. The increase in sales and marketing expenses was primarily due to approximately $104.1 million in incremental expenses incurred by us related to the acquisitions of Wooga, Supertreat and Seriously, as well as increased marketing expenses related to media buy expenses. General and administrative expenses General and administrative expenses for the year ended December 31, 2019 increased by $20.1 million when compared with the year ended December 31, 2018. The increase in general and administrative expenses was primarily due to $16.6 million in incremental expenses incurred by us related to the acquisitions of Wooga, Supertreat and Seriously, as well as $57.1 million in expense associated with adjusting contingent consideration to fair value and acquisition and related expenses, compared to an aggregate of $28.0 million in the prior period. This increase was partially offset by lower expense associated with the Company’s long-term cash incentive plan when compared to 2018. 59 Other Factors Affecting Net Income Year ended December 31, (in millions) 2020 2019 2018 Interest expense $ 198.3 $ 61.6 $ 0.5 Interest income (0.1) (1.5) (5.2) Foreign currency translation expense (income), net (5.7) 0.3 5.9 Other 0.3 0.7 0.7 Taxes on income 102.3 147.4 92.7 Interest expense Interest expense in 2020 is related to amount borrowed under the December 2019 Credit Facilities, as defined below. Interest expense in 2019 is primarily related to funds borrowed in August 2019 under the Bridge Facility, also as defined below, and amounts borrowed under the December 2019 Credit Facilities. Prior to the August 2019 Bridge Facility transaction, interest expense was not material to the Company. Taxes on income The provision for income tax was $102.3 million for the year ended December 31, 2020 and the effective income tax rate was 52.6%. The tax rate is affected by recurring items such as tax rates in foreign jurisdictions and the relative amounts of income earned in those jurisdictions, which are expected to be fairly consistent in the near term, and certain tax positions taken in various jurisdictions that do not meet a more likely than not standard. It is also affected by items that are not consistent from year to year. Of these items, the primary difference related to significant non-deductible stock-based compensation expense for certain restricted stock units granted during the year ended December 31, 2020. While stock-based compensation expense will be generated each year, the significant non-deductible amount recorded during the year ended December 31, 2020 is not expected to recur. The provision for income tax was $147.4 million for the year ended December 31, 2019 and the effective income tax rate was 33.8%. The difference between the effective income tax rate and the U.S. statutory tax rate was primarily due to recurring items such as tax rates in foreign jurisdictions and the relative amounts of income earned in those jurisdictions. In addition, the effective tax rate for the year ended December 31, 2019 was affected by the tax effects of the change in reinvestment assertion related to undistributed earnings of certain of our non-U.S. subsidiaries during the year. The provision for income tax was $92.7 million for the year ended December 31, 2018, and the effective income tax rate was 21.5%. The difference between the effective income tax rate and the U.S. statutory tax rate was primarily due to recurring items such as tax rates in foreign jurisdictions and the relative amounts of income earned in those jurisdictions. Prior to the second quarter of 2019, the Company considered the earnings in all its non-U.S. subsidiaries to be indefinitely reinvested and accordingly, recorded no deferred income taxes associated with such earnings. During the second quarter of 2019, the Company reevaluated its historic assertion and no longer considered the earnings of certain of its non-U.S. subsidiaries to be indefinitely reinvested since the cash generated from some of the foreign subsidiaries will be used to service debt in the United States. As a result of the change in assertion, the impact of a repatriation of the undistributed earnings resulted in recording a deferred tax liability consisting of potential withholding and distribution taxes of $41.7 million as of December 31, 2019. For the year ended December 31, 2020, the Company accrued an additional $4.5 million of deferred tax liability. Such deferred taxes were recognized as tax expense. The change in assertion relates both retroactively to historical earnings, as well as prospectively to future earnings, in some of the Company’s non-U.S. subsidiaries. 60 Reconciliation of Adjusted EBITDA to net income Adjusted EBITDA is a non-GAAP financial measure and should not be construed as an alternative to net income as an indicator of operating performance, nor as an alternative to cash flow provided by operating activities as a measure of liquidity, or any other performance measure in each case as determined in accordance with GAAP. Below is a reconciliation of Adjusted EBITDA to net income, the closest GAAP financial measure. We define Adjusted EBITDA as net income before (i) interest expense, (ii) interest income, (iii) provision for income taxes, (iv) depreciation and amortization expense, (v) stock-based compensation, (vi) legal settlements, (vii) contingent consideration, (viii) acquisition and related expenses, (ix) long-term compensation plan, (x) M&A related retention payments, and (xi) certain other items, including impairments. We calculate Adjusted EBITDA Margin as Adjusted EBITDA divided by revenues. We supplementally present Adjusted EBITDA and Adjusted EBITDA Margin because these are key operating measures used by our management to assess our financial performance. Adjusted EBITDA adjusts for items that we believe do not reflect the ongoing operating performance of our business, such as certain noncash items, unusual or infrequent items or items that change from period to period without any material relevance to our operating performance. Management believes Adjusted EBITDA and Adjusted EBITDA Margin are useful to investors and analysts in highlighting trends in our operating performance, while other measures can differ significantly depending on long-term strategic decisions regarding capital structure, the tax jurisdictions in which we operate and capital investments. Management uses Adjusted EBITDA and Adjusted EBITDA Margin to supplement GAAP measures of performance in the evaluation of the effectiveness of our business strategies, to make budgeting decisions, and to compare our performance against other peer companies using similar measures. We evaluate Adjusted EBITDA and Adjusted EBITDA Margin in conjunction with our results according to GAAP because we believe they provide investors and analysts a more complete understanding of factors and trends affecting our business than GAAP measures alone. Adjusted EBITDA and Adjusted EBITDA Margin as calculated herein may not be comparable to similarly titled measures reported by other companies within the industry and are not determined in accordance with GAAP. Our presentation of Adjusted EBITDA and Adjusted EBITDA Margin should not be construed as an inference that our future results will be unaffected by unusual or unexpected items. Year ended December 31, (In millions) 2020 2019 2018 Net income $ 92.1 $ 288.9 $ 338.0 Provision for income taxes 102.3 147.4 92.7 Interest expense and other, net 192.8 61.1 1.9 Depreciation and amortization 119.2 73.0 37.7 EBITDA 506.4 570.4 470.3 Share-based compensation (1) 276.0 — — Legal settlement (2) 37.6 — — Acquisition and related expenses (3) 31.4 57.1 28.0 One-time items, including impairment (4) 7.5 (6.5) 0.8 Long-term cash compensation (5) 67.6 72.7 112.7 M&A related retention payments (6) 15.1 18.4 17.1 Adjusted EBITDA $ 941.6 $ 712.1 $ 628.9 Net income margin 3.9 % 15.3 % 22.7 % Adjusted EBITDA margin 39.7 % 37.7 % 42.2 % __________ (1) Reflects, for the year ended December 31, 2020, stock-based compensation expense related to the issuance of certain equity awards to members of management. 61 (2) Reflects a legal settlement expense of $37.6 million for the year ended December 31, 2020. See Note 12 of our audited financial statements included in this document for additional information. (3) Includes (i) contingent consideration payments with respect to our acquisitions of Seriously and Supertreat in 2019, and (ii) third-party fees for actual or planned acquisitions, including related legal, consulting and other expenditures. (4) Primarily reflects business optimization expenses during the year December 31, 2020, income from an early termination of a license agreement during the year ended December 31, 2019, and impairment charges on specific game assets recorded during the years ended December 31, 2018. (5) Includes expenses recognized for grants of annual cash awards to employees pursuant to our Retention Plans, which awards are incremental to salary and bonus payments, and which plans expire in 2024. For more information, see Note 14 of our audited financial statements included in this document. (6) Includes retention awards to key individuals associated with acquired companies as an incentive to retain those individuals on a long-term basis. For more information, see Note 14 of our audited financial statements included in this document. Liquidity and Capital Resources Capital spending We incur capital expenditures in the normal course of business and perform ongoing enhancements and updates to our social and mobile games to maintain their quality standards. Cash used for capital expenditures in the normal course of business is typically made available from cash flows generated by operating activities. We may also pursue acquisition opportunities for additional businesses or social or mobile games that meet our strategic and return on investment criteria. Capital needs are evaluated on an individual investment basis and may require significant capital commitments. Liquidity Our primary sources of liquidity are the cash flows generated from our operations, currently available unrestricted cash and cash equivalents, and borrowings under our credit facility and revolver. Our cash and cash equivalents totaled $520.1 million and $266.8 million at December 31, 2020 and December 31, 2019, respectively. Our primary contractual obligations are our debt obligations. Payments of short-term debt obligations and other commitments are expected to be made from cash on the balance sheet and operating cash flows. Long-term obligations are expected to be paid through operating cash flows, borrowings under our December 2019 Revolving Credit facility or, if necessary, additional term loans or issuances of equity. In February 2021, the Company began exploring potential alternatives to refinance its Term Loan, although the Company does not have any agreements or commitments for such refinancing at this time. Our restricted cash totaled $3.5 million and $5.2 million at December 31, 2020 and December 31, 2019, respectively. Restricted cash primarily consists of deposits to secure obligations under our operating lease agreements and to secure company-issued credit cards. The classification of restricted cash as current and long-term is dependent upon the intended use of each particular reserve. Our ability to fund our operations, pay our debt obligations and fund planned capital expenditures depends, in part, upon economic and other factors that are beyond our control, and disruptions in capital markets could impact our ability to secure additional funds through financing activities. We believe that our cash and cash equivalents balance and our cash flows from operations will be sufficient to meet our normal operating requirements during the next 12 months and the foreseeable future and to fund capital expenditures. In addition, at December 31, 2020, we had capacity under our revolving credit facility to borrow $350 million. In January 2021, we increased the borrowing capacity of the Revolving Credit Facility from $350 million to $550 million. 62 Cash flows The following tables present a summary of our cash flows for the periods indicated (in millions): Year ended December 31, 2020 2019 2018 Net cash flows provided by operating activities $ 517.7 $ 491.9 $ 452.8 Net cash flows used in investing activities (98.1) (516.5) (141.9) Net cash flows used in financing activities (181.3) (6.6) (337.4) Effect of foreign exchange rate changes on cash and cash equivalents 13.3 (2.4) (2.5) Net change in cash, cash equivalents and restricted cash $ 251.6 $ (33.6) $ (29.0) Operating activities Net cash flows provided by operating activities for the year ended December 31, 2020 increased $25.8 million when compared with the year ended December 31, 2019. Net cash flows provided by operating activities for the year ended December 31, 2019 increased $39.1 million when compared with the year ended December 31, 2018 and for the year ended December 31, 2018 increased $83.8 million compared with the year ended December 31, 2017. Net cash flow provided by operating activities for each period primarily consisted of net income generated during the period, exclusive of non-cash expenses such as depreciation, amortization and stock-based compensation, with changes in working capital impacted by normal timing differences. Investing activities Net cash flows used in investing activities for the year ended December 31, 2020 decreased $418.4 million when compared to the year ended December 31, 2019 mainly due to $422.7 million of consideration paid for the acquisition of Supertreat and Seriously in 2019. Net cash flows used in investing activities for the year ended December 31, 2019 increased $374.6 million when compared to the year ended December 31, 2018, due to $422.7 million of consideration paid for the acquisition of Supertreat and Seriously and $92.4 million related to the purchase and capitalization of assets during the year ended December 31, 2019. Net cash flows used in investing activities for the year ended December 31, 2018 included $179.2 million of consideration paid for the acquisition of Wooga and $57.0 million related to the purchase and capitalization of assets. Financing activities Net cash flows used in financing activities for the year ended December 31, 2020 increased $174.7 million when compared to the year ended December 31, 2019. Net cash flows used in financing activities for the year ended December 31, 2020 included $250.0 million in borrowings on our Revolving Credit Facility, and $283.3 million in repayments on our Revolving Credit Facility Term Loan pursuant to the Credit Agreement. Net cash flows used in financing activities for the year ended December 31, 2019 included borrowings on our Bridge Facility of $2.6 billion offset by a distribution to our stockholder of $2.4 billion and $89.6 million in repayments on our short-term bank credit. Net cash flows used in financing activities for the year ended December 31, 2019 decreased $330.8 million when compared with the year ended December 31, 2018. Financing activities for the year ended December 31, 2019, included a dividend distribution to our stockholder of $2.4 billion, proceeds of $2.6 billion from our Bridge Facility and $2.5 billion from our Term Loan, and repayment of our Bridge Facility of $2.6 billion. Financing activities for the year ended December 31, 2018, included a distribution to our stockholder of $400.0 million. 63 Capital resources On August 20, 2019, we entered into the $2,583 million Bridge Facility. On December 10, 2019, we entered into the Credit Agreement, as amended, which included $2,750 million in Credit Facilities, consisting of a $250 million Revolving Credit Facility, and a $2,500 million Term Loan, which was used to repay all borrowings under the Bridge Facility. On June 15, 2020, we received $100 million of incremental revolving commitments in order to increase the capacity of the Revolving Credit Facility to $350 million. In January 2021, we increased the borrowing capacity of the Revolving Credit Facility from $350 million to $550 million. Credit Agreement The Term Loan matures on December 10, 2024 and the Revolving Credit Facility matures on September 10, 2024 and includes a letter of credit sub-facility. The Term Loan requires scheduled quarterly principal payments in amounts equal to 1.25% of the original aggregate principal amount of the Term Loan, with the balance due at maturity. The Credit Agreement allows us to request one or more incremental term loan facilities, incremental revolving credit facilities and/or increases to the Term Loan or the Revolving Credit Facility in an aggregate amount of up to the sum of (w) $100 million plus (x) the amount of certain voluntary prepayments plus (y) such additional amount so long as, (i) in the case of incremental credit facilities that rank pari passu with the liens on the collateral securing the Credit Facilities, our senior secured net leverage ratio on a pro forma basis would not exceed 2.75 to 1.00, (ii) in the case of incremental credit facilities that rank junior to the liens on the collateral securing the Credit Agreement, our total secured net leverage ratio on a pro forma basis would not exceed 2.75 to 1.00 and (iii) in the case of incremental credit facilities that are unsecured, our total net leverage ratio on a pro forma basis would not exceed 2.75 to 1.00 plus (z) $200 million of incremental revolving commitments from and after the occurrence of a qualified initial public offering, in each case, subject to certain conditions and receipt of commitments by existing or additional financial institutions or institutional lenders. All future borrowings under the Credit Agreement are subject to the satisfaction of customary conditions, including the absence of a default and the accuracy of representations and warranties, subject to certain exceptions. Interest and fees Borrowings under the Credit Agreement bear interest at a rate equal to, at our option, either (a) LIBOR determined by reference to the cost of funds for Eurodollar deposits for the interest period relevant to such borrowing, adjusted for certain additional costs, subject to a floor of (i) in the case of the Term Loan, 1.0% and (ii) in the case of the Revolving Credit Facility, 0.0% or (b) a base rate determined by reference to the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate as determined by the administrative agent and (iii) the one-month adjusted LIBOR rate plus 1.00%, in each case plus an applicable margin. Such applicable margin shall be (a) with respect to the Term Loan, 6.00% per annum in the case of any LIBOR loan or 5.00% per annum in the case of any base rate loan and (b) in the case of the Revolving Credit Facility, 3.25% per annum in the case of any LIBOR loan and 2.25% per annum in the case of any base rate loan, subject in the case of the Revolving Credit Facility to two 0.25% step-downs based on our senior secured net leverage ratio. In addition, on a quarterly basis, we are required to pay each lender under the Revolving Credit Facility a commitment fee in respect of any unused commitments under the Revolving Credit Facility in the amount of 0.50% of the principal amount of the daily unused commitments of such lender, subject to step-downs to 0.375% and 0.25% based upon our senior secured net leverage ratio. We are also required to pay customary agency fees as well as letter of credit participation fees on outstanding letters of credit. The Credit Agreement permits voluntary prepayments and requires mandatory prepayments in certain events including among others, certain net cash proceeds from non-ordinary asset sale transactions (subject to reinvestment rights, except in the case of certain material intellectual property and material games), 100% of net proceeds of any issuance of debt (except for debt permitted to be incurred by the Credit Agreement), and 75% (subject to three 25% step-downs based on our senior secured net leverage ratio) of our excess cash flow to the extent such amount exceeds $10 million. Based upon our financial 64 results for the year ending December 31, 2020, we expect to offer to purchase approximately $105.1 million of our outstanding debt pursuant to the excess cash flow provisions. Some or all of these offers may be refused by the holders of the debt. To the extent the offers are accepted by the holders of the debt, we will use these funds to prepay our debt at its face value. Collateral and guarantors The borrowings under the Credit Agreement are guaranteed by certain of our material, wholly-owned restricted subsidiaries that are incorporated under the laws of the United States, England and Wales and the State of Israel (subject to exceptions), and are secured by a pledge of substantially all of our existing and future property and assets and the guarantors (subject to exceptions), including a pledge of the capital stock of the domestic subsidiaries held by us and the domestic guarantors and 65% (or 100% in the case of certain of the guarantors) of the capital stock of the first-tier foreign subsidiaries held by us and the domestic guarantors, in each case subject to exceptions. The Credit Agreement requires that we and the guarantors (a) generate at least 80.0% of the EBITDA (as defined in the Credit Agreement) of our and our restricted subsidiaries for the four fiscal quarters most recently ended prior to the end of each fiscal quarter and (b) own all “Material Intellectual Property” (defined as (i) any intellectual property rights consisting of registered trademarks or copyrights subsisting in the name or logo of any game that generates more than 5% of our and our restricted subsidiaries’ EBITDA for the then most recently ended four fiscal quarters and (ii) any intellectual property rights consisting of registered trademarks or copyrights subsisting in the names or logos of certain material games) on the last day of the four fiscal quarters most recently ended prior to the end of each fiscal quarter. If we and the guarantors do not satisfy such requirement, then we must cause sufficient additional subsidiaries (which, subject to certain limitations, may include guarantors located in jurisdictions other than the United States, England and Wales and the State of Israel) to become guarantors in order to satisfy such requirement. As of December 31, 2020, we were in compliance with these requirements. Restrictive covenants The Revolving Credit Facility includes a maximum first-priority senior secured net leverage ratio financial maintenance covenant of 6.25 to 1.00, which is applicable on the last day of any of our fiscal quarters on which the aggregate outstanding amount of the Revolving Credit Facility and letters of credit issued under the Revolving Credit Facility (excluding certain undrawn or cash collateralized letters of credit) exceeds 30% of the aggregate amount of the commitments under the Revolving Credit Facility. At December 31, 2020, our first-priority senior secured net leverage ratio was 2.09 to 1.00. In addition, the Credit Agreement includes negative covenants, subject to certain exceptions, restricting or limiting our ability and the ability of our restricted subsidiaries to, among other things: (i) make non-ordinary course dispositions of assets; (ii) make certain mergers and acquisitions; (iii) complete dividends and stock repurchases and optional redemptions (and optional prepayments) of junior lien debt, unsecured debt and subordinated debt; (iv) incur indebtedness; (v) make certain loans and investments; (vi) incur liens and certain fixed charges; (vii) transact with affiliates; (viii) change our or our restricted subsidiaries’ business; (ix) enter into sale/leaseback transactions; (x) allow limitations on negative pledges and the ability of restricted subsidiaries to pay dividends or make distributions; (xi) change the fiscal year and (xii) modify junior lien debt, unsecured debt and subordinated debt documents. Under the Credit Agreement, we may be required to meet specified leverage ratios in order to take certain actions, such as incurring certain debt or liens or making certain investments. For additional information regarding our indebtedness, see Note 9, Debt to the accompanying consolidated financial statements. Critical accounting policies and estimates We prepare our financial statements in conformity with U.S. GAAP. Certain accounting policies require that we apply significant judgment in defining the appropriate assumptions for calculating financial estimates. By their nature, these judgments will be subject to an inherent degree of uncertainty. Our judgments are based upon our management’s historical experience, terms of existing contracts, observance of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. 65 We consider accounting estimates to be critical accounting policies when: • the estimates involve matters that are highly uncertain at the time the accounting estimate is made; and • different estimates or changes to estimates could have a material impact on the reported financial positions, changes in financial position or results of operations. When more than one accounting principle, or method of its application, is generally accepted, we select the principle or method that we consider to be the most appropriate when given the specific circumstances. Application of these accounting principles requires us to make estimates about the future resolution of existing uncertainties. Due to the inherent uncertainty involving estimates, actual results reported in the future may differ from such estimates. For additional information on our significant accounting policies, please refer to Note 1, Organization and Summary of Significant Accounting Policies to the financial statements included elsewhere in this filing. Business combinations We apply the provisions of ASC 805, Business Combination and allocates the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from customer relationships, acquired technology and acquired trademarks from a market participant perspective, useful lives and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Software development costs We review internal use software development cost associated with infrastructure and new games or updates to existing games to determine if the costs qualify for capitalizing. The development costs incurred during the application development stage that are related to infrastructure are capitalized. Internal use software is included in intangible assets other than goodwill, net in the accompanying consolidated balance sheets. Capitalization of such costs begins when the preliminary project stage is completed and ceases at the point in which the project is substantially complete and is ready for its intended purpose. With respect to new games or updates to existing games, the preliminary project stage remains ongoing until just prior to worldwide launch. The development costs are expensed as incurred to research and development in the consolidated statement of comprehensive income. Goodwill The purchase price of an acquisition is allocated to the underlying assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. We determine the estimated fair values of assets acquired and liabilities assumed after review and consideration of relevant information including discounted cash flows, quoted market prices, and estimates made by management. To the extent the purchase price exceeds the fair value of the net identifiable tangible and intangible assets acquired and liabilities assumed, such excess is recorded as goodwill. Under ASC 350, Intangible—Goodwill and Other , goodwill is not amortized, but rather is subject to an annual impairment test. We test goodwill for impairment as of October 1 st of each year, or more frequently if events or changes in circumstances indicate that this asset may be impaired. For the purposes of impairment testing, we have determined that we have one reporting unit. When performing the annual goodwill impairment testing, we either conducts a qualitative assessment to determine whether it is more likely than not that the asset is impaired, or we elect to bypass this qualitative assessment and perform a quantitative test for impairment. 66 Under the qualitative assessment, we consider both positive and negative factors, including macroeconomic conditions, industry events, financial performance and other changes, and makes a determination of whether it is more likely than not that the fair value of goodwill is less than its carrying amount. If, after assessing the qualitative factors, we determine it is more likely than not the asset is impaired, we then perform a quantitative test in which the estimated fair value of the reporting unit is compared with its carrying amount, including goodwill. If a quantitative analysis is necessary, we compare the fair value of our reporting unit to our carrying value. We determine the estimated fair value based on a combination of EBITDA and estimated future cash flows discounted at rates commensurate with the capital structure and cost of capital of comparable market participants, giving appropriate consideration to the prevailing borrowing rates within the industry in general. EBITDA multiples and discounted cash flows are common measures used to value businesses in our industry. If the estimated fair value exceeds carrying value, goodwill is considered not to be impaired and no additional steps are necessary. However, if the carrying amount exceeds estimated fair value, an impairment loss is recognized in an amount equal to the excess, limited to the amount of goodwill allocated to the reporting unit. The annual evaluation of goodwill requires the use of estimates about future operating results, valuation multiples, and discount rates to determine their fair value. Changes in these assumptions can materially affect these estimates. Thus, to the extent the revenues volumes deteriorate in the near future, discount rates increase significantly, or we do not meet our projected performance, we could have impairments to record in the next twelve months, and such impairments could be material. Revenue recognition We primarily derive revenues from the sale of virtual items associated with online games. We distribute our games to the end customer through various web and mobile platforms such as Apple, Facebook, Google, and other web and mobile platforms. Through these platforms, users can download our free-to-play games and can purchase virtual currency which is redeemed in the game for virtual goods, or players can purchase virtual goods directly (collectively referred to as virtual items) to enhance their game-playing experience. The initial download of the games does not create a contract under ASC 606, Revenue from Contracts with Customers , or ASC 606; however, the separate election by the player to make an in-application purchase satisfies the ASC 606 criterion for creating a contract. Players can pay for their virtual item purchases through various widely accepted payment methods offered in the games. Payments from players for virtual items are required at the time of purchase, are non-refundable and relate to non-cancellable contracts that specify our obligations and cannot be redeemed for cash nor exchanged for anything other than virtual items within our games. The purchase price is a fixed amount which reflects the consideration that we expect to be entitled to receive in exchange for use of virtual items by our customers. The platform providers collect proceeds from the game players and remit the proceeds to us after deducting their respective platform fees. We are primarily responsible for providing the virtual items, have control over the content and functionality of games and have the discretion to establish the virtual items’ prices. Therefore, we are the principal and, accordingly revenues are recorded on a gross basis. Payment processing fees paid to platform providers are recorded within cost of revenue. Our performance obligation is to display the virtual items within the game over the estimated life of the paying player or until the virtual item is consumed in game play based upon the nature of the virtual item. We categorize our virtual items as either consumable or durable, and the substantial majority of our games sell only consumable virtual items. Consumable virtual items represent items that can be consumed by a specific player action and do not provide the player any continuing benefit following consumption. For the sale of consumable virtual items, we recognize revenues as the items are consumed (i.e. over time) which is usually up to one month. We have determined through a review of game play behavior that players generally do not purchase additional virtual currency until their existing virtual currency balances have been substantially consumed. This review, performed on a game-by-game basis, includes an analysis of game players’ historical play behavior, purchase behavior, and the amount of virtual currency outstanding. Based upon this 67 analysis, we have estimated the rate at which virtual currency is consumed during game play within each game. Accordingly, revenues are recognized using a user-based revenue model using these estimated consumption rates. We monitor our analysis of customer play behavior on a quarterly basis. Durable virtual items represent items that are accessible to the player over an extended period of time. We sell durable virtual items primarily through games acquired in recent acquisitions. We recognize revenues from the sale of durable virtual items ratably over the estimated average life of the paying player, which is estimated on a game-by-game basis and generally ranges from three months up to one year. We estimate the average life of the paying player based on historical paying player patterns and playing behaviors within each of the specific games that offer durable virtual items. We monitor our operational data and player patterns and re-assess our estimates on a quarterly basis. Deferred revenues, which represent a contract liability, represent mostly unrecognized fees collected for virtual items which are not consumed at the balance sheets date, or for players that are still active in the games. Sales and other taxes collected from customers on behalf of governmental authorities are accounted for on a net basis and are not included in revenues or operating expenses. We also have relationships with certain advertising service providers for advertisements within our games and revenues from these advertising providers is generated through impressions, clickthroughs, banner ads and offers. We have determined that displaying the advertisements within the mobile games is identified as a single performance obligation. The transaction price in advertising arrangements is established by our advertising service providers and is generally the product of the number of advertising units delivered (e.g. impressions, offers completed, etc.) and the contractually agreed upon price per unit. Revenues from advertisements and offers are recognized at a point-in-time when the advertisements are displayed in the game or the offer has been completed by the user as the customer simultaneously receives and consumes the benefits provided from these services. We have determined that we are generally acting as an agent in our advertising arrangements as the advertising service providers maintain the relationship with the customers, control the pricing of the advertising such that we do not know the total price paid by the customer to the service providers, and control the advertising product through the time the advertisements are displayed in our games. Therefore, we recognize revenues related to these arrangements on a net basis. Stock-based compensation Common stock valuation The valuation of our equity considers a number of objective and subjective factors that we believe market participants would consider, including (a) our business, financial condition, and results of operations, including related industry trends affecting our operations; (b) our forecasted operating performance and projected future cash flows; (c) the liquid or illiquid nature of our common stock; (d) the rights and privileges of our common stock; (e) market multiples of our most comparable public peers; and (f) market conditions affecting our industry. We used the income approach (discounted cash flow method) and the market approach (guideline public company method and guideline transaction method) to estimate our equity value. The income approach involves applying an appropriate risk-adjusted discount rate to projected cash flows based on forecasted revenues and costs. The guideline public company method estimates the value of a company by applying market multiples of publicly traded companies in the same or similar lines of business to the results and projected results of the company being valued. The guideline transaction method estimates the value of a company by applying valuation multiples paid in actual transaction for comparable public and private companies. In applying the market and income approaches to determine a value of the common stock, a discount was applied to reach the final valuation of the common stock based on the fact that, given we are a private company, there are impediments to liquidity, including lack of publicly available information and the lack of a trading market. We prepared, as of the valuation date, financial forecasts used in the computation of the estimated fair value of our equity for both the market and income approaches. The financial forecasts were based on assumed revenue growth rates and operating 68 margin levels that considered our past experience and future expectations. The risks associated with achieving these forecasts were assessed in selecting the appropriate cost of capital rates. The values derived under the market and income approaches were then used to determine an initial estimated fair market value of our equity. There is inherent uncertainty in our forecasts and projections, and if we had made different assumptions and estimates than those described previously, the amount of our equity valuation and stock-based compensation expense could have been materially different. Options granted on June 26, 2020 had an exercise price equal to the estimated fair value of our common stock as determined by our valuation as of June 26, 2020. The valuation used a non-marketability discount of 10%. Stock-based compensation expense We have a stock-based compensation program, which provides for equity awards including stock options and time-based RSUs. Share-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite service period for the award. We record forfeitures as a reduction of stock-based compensation expense as those forfeitures occur. We used the Black-Scholes option pricing model to estimate the fair value and compensation cost associated with employee incentive stock options. As we do not have a history of market prices for our common stock because the stock was not historically publicly traded, we used observable data for a group of peer companies that grant options with substantially similar terms to assist in developing our volatility assumption. The expected volatility of the stock was determined using weighted average measures of the implied volatility and the historical volatility for our peer group of companies for a period equal to the expected life of the option. The expected term assumption was derived based on an average between each vesting date and the expiration date of an option. The weighted-average risk-free interest rate was based on the interest rate for U.S. Treasury bonds. We do not anticipate paying cash dividends on our shares of common stock on a go-forward basis. If factors change and we employ different assumptions, stock-based compensation cost on future awards may differ significantly from what we have recorded in the past. Lower volatility and shorter expected terms or higher volatility and longer expected terms result in a decrease or increase, respectively, to stock-based compensation determined at the date of grant. Future stock-based compensation cost and unrecognized stock-based compensation will increase to the extent that we grant additional equity awards to employees or assume unvested equity awards in connection with acquisitions. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate any remaining unearned stock-based compensation cost or incur incremental cost. Our stock-based compensation expense is recorded in general and administrative expenses in the consolidated statements of comprehensive income. See Note 10, Stockholders’ Deficit, Equity Transactions and Stock Incentive Plan to the accompanying consolidated financial statements, for additional discussion. Income taxes We record income taxes under the asset and liability method of accounting for income taxes pursuant to ASC 740, Income Taxes . Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Deferred income taxes are determined using enacted tax rates that are expected to be effect in the year in which the deferred tax asset or liability is to be realized or settled. We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed periodically based on the more likely than not realization threshold. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, the 69 duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused and tax planning alternatives. We implement a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. The Tax Cuts and Jobs Act (“TCJA”) subjects a U.S. shareholder to tax on global intangible low-taxed income (“GILTI”) earned by certain foreign subsidiaries. We can make an accounting policy election to either treat taxes due on the GILTI inclusion as a current period expense or factor such amounts into the measurement of deferred taxes. We elected to account for the income tax effects of GILTI as a “period cost,” or an income tax expense in the year the tax is incurred. Recently Issued Accounting Pronouncements See Note 1 to our audited consolidated financial statements included elsewhere in this filing for a description of recently adopted accounting pronouncements and recently issued accounting pronouncements not yet adopted as of the date of this filing.