Playtika Holding Corp. (PLTK) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
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 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.
•Offering 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 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 an effective 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.
65
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 Direct-to-Consumer 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 on various third-party platforms for which the platform providers collect proceeds from our customers and pay us an amount after deducting platform fees. For purchases made through both the third-party and Direct-to-Consumer platforms, 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.
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, including servers and internal use software. 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 Direct-to-Consumer 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. We also expect that research and development expenses specifically associated with new game development will fluctuate over time.
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,
66
and legal settlement expenses, as components of general and administrative expense. We expect general and administrative expenses will increase in absolute dollars to support our expected growth initiatives.
Interest expense and other, net
Our interest expense includes interest incurred under our December 2019 Credit Agreement and amortization of deferred financing costs, both of which are partially 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. In March 2021, we entered into two interest rate swap agreements, each with a notional value of $250 million, reducing our overall exposure to variable interest rates.
Interest income consists of interest earned on cash, cash equivalents and short-term bank deposits.
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, Israel, Germany, and Austria, 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 and the geographic mix to which they relate, the applicability of special tax regimes, changes in our business or operations, examination-related developments and uncertain tax positions, and changes in tax law.
Net Income
We calculate net income as revenue minus cost of revenues, research and development, sales and marketing and general and administrative expenses, interest and taxes.
67
Results of Operations
The tables below show 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.
We measure the performance of our 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 our management to understand and measure the engagement levels of the Company’s players, the size of its audience and its reach. See “Basis of Presentation” and “Summary Consolidated Financial and Other Data” for additional information of these measures.
| Year ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions, except percentages, Average DPUs, and ARPDAU) | 2022 | 2021 | 2020 | |||||||||||
| Revenues | $ | 2,615.5 | $ | 2,583.0 | $ | 2,371.5 | ||||||||
| Total cost and expenses | $ | 2,144.1 | $ | 2,020.8 | $ | 1,984.3 | ||||||||
| Operating income | $ | 471.4 | $ | 562.2 | $ | 387.2 | ||||||||
| Net income | $ | 275.3 | $ | 308.5 | $ | 92.1 | ||||||||
| Credit Adjusted EBITDA | $ | 805.1 | $ | 848.7 | $ | 858.9 | ||||||||
| Non-financial performance metrics | ||||||||||||||
| Average DAUs | 9.4 | 10.4 | 11.2 | |||||||||||
| Average DPUs (in thousands) | 314 | 300 | 285 | |||||||||||
| Average Daily Payer Conversion | 3.3 | % | 2.9 | % | 2.6 | % | ||||||||
| ARPDAU | $ | 0.76 | $ | 0.68 | $ | 0.58 | ||||||||
| Average MAUs | 31.4 | 34.0 | 34.2 |
Comparison of the year ended December 31, 2022 versus the year ended December 31, 2021
| Year ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | ||||||||
| Revenues earned through third-party platforms | $ | 2,008.6 | $ | 2,054.0 | ||||||
| Revenues earned through Direct-to-Consumer platforms | 606.9 | 529.0 | ||||||||
| Revenues | $ | 2,615.5 | $ | 2,583.0 | ||||||
| Cost of revenue | $ | 735.7 | $ | 729.0 | ||||||
| Research and development expenses | 472.3 | 386.7 | ||||||||
| Sales and marketing expenses | 603.7 | 581.7 | ||||||||
| General and administrative expenses | 332.4 | 323.4 | ||||||||
| Total costs and expenses | $ | 2,144.1 | $ | 2,020.8 |
Revenues
Revenues for the year ended December 31, 2022 increased by $32.5 million when compared to 2021. This year-over-year comparison includes incremental revenues of $34.3 million generated from the Company’s August 2021 acquisition Reworks. Absent this acquisition, revenues in 2022 declined when compared with 2021 as improved monetization and increased revenues from new content and product features across our broader portfolio of games were unable to offset the incremental revenues recognized in 2021 due to the Covid pandemic. The combination of unusually high DAUs in early
68
2021, combined with the continued focus of the Company’s marketing efforts on player conversion rather than increasing player traffic lead to a decrease in DAUs for 2022 when compared with 2021. The same focus on player conversion, combined with improvements to monetization, new content and new product features drove an increase in DPUs in 2022 compared to 2021. The increase in revenues generated from Direct-to-Consumer platforms as a percentage of total revenues resulted from marketing activities for the games offered through these platforms.
Cost of revenue
Cost of revenue for the year ended December 31, 2022 increased by $6.7 million when compared with the year ended December 31, 2021. The increase in cost of revenue includes approximately $10.0 million in incremental platform fees associated with the August 2021 acquisition of Reworks. Absent this acquisition, cost of revenues for 2022 would have declined when compared to 2021, primarily as a result of the increase in revenues generated through our Direct-to-Consumer platforms, partially offset by increased depreciation and amortization expenses.
Research and development expenses
Research and development expenses for the year ended December 31, 2022 increased by $85.6 million when compared with the year ended December 31, 2021. Research and development expenses were adversely impacted by increased headcount and associated payroll costs in our existing research and development operations, including costs incurred in connection with severance payments incurred during the fourth quarter 2022 in connection with our workforce reduction. In addition, stock-based compensation costs, net of amounts capitalized, included in research and development expenses increased by $15.7 million for the year ended December 31, 2022 when compared with the year ended December 31, 2021.
Sales and marketing expenses
Sales and marketing expenses for the year ended December 31, 2022 increased by $22.0 million when compared with the year ended December 31, 2021. The increase in sales and marketing expenses was primarily related to increased amortization expense, increased media buy expenses, increased stock-based compensation costs, and increased headcount and higher associated payroll costs.
General and administrative expenses
General and administrative expenses for the year ended December 31, 2022 increased by $9.0 million when compared with the year ended December 31, 2021. General and administrative expenses includes stock-based compensation expenses of $69.5 million for the year ended December 31, 2022, compared with $64.4 million for the year ended December 31, 2021. Included in general and administrative expenses for the year ended December 31, 2021, with no comparable amount for the year ended December 31, 2022, are bonus expenses of approximately $35.4 million paid as a result of the successful initial public offering of the Company’s stock in January 2021. Adjusting for these items, general and administrative expenses increased by approximately $39.3 million, primarily due to increased compensation costs associated with the long-term incentive plan and costs associated with exploring strategic alternatives, which were partially offset by reduced expense attributable to adjusting contingent consideration to fair value.
69
Comparison of the year ended December 31, 2021 versus the year ended December 31, 2020
| Year ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | 2021 | 2020 | ||||||||
| Revenues earned through third-party platforms | $ | 2,054.0 | $ | 2,048.5 | ||||||
| Revenues earned through Direct-to-Consumer platforms | 529.0 | 323.0 | ||||||||
| Revenues | $ | 2,583.0 | $ | 2,371.5 | ||||||
| Cost of revenue | $ | 729.0 | $ | 712.2 | ||||||
| Research and development expenses | 386.7 | 268.9 | ||||||||
| Sales and marketing expenses | 581.7 | 502.0 | ||||||||
| General and administrative expenses | 323.4 | 501.2 | ||||||||
| Total costs and expenses | $ | 2,020.8 | $ | 1,984.3 |
Revenues
Revenues for the year ended December 31, 2021 increased by $211.5 million when compared to 2020. The increase in revenues was due to incremental revenues of $32.4 million generated from the Company’s August 2021 acquisition of 80% of the issued and registered shares and options of Reworks, combined with improved monetization and increased revenues from new content and product features across our broader portfolio of games when compared to 2020. The combination of unusually high DAUs in early 2020 related to the initial onset of COVID 19, combined with the continued focus of the Company’s marketing efforts on player conversion rather than increasing player traffic lead to a decrease in DAUs for 2021 when compared with 2020. The same focus on player conversion, combined with improvements to monetization, new content and new product features drove an increase in DPUs in 2021 compared with 2020. The increase in revenues generated from Direct-to-Consumer platforms as a percentage of total revenues resulted from marketing activities for the games offered through these platforms.
Cost of revenue
Cost of revenue for the year ended December 31, 2021 increased by $16.8 million when compared with the year ended December 31, 2020. The increase in cost of revenue includes approximately $9.7 million in incremental platform fees associated with the August 2021 acquisition of Reworks. The remaining increase was primarily due to increased amortization expense for capitalized software and for intangible assets associated with recent acquisitions.
Research and development expenses
Research and development expenses for the year ended December 31, 2021 increased by $117.8 million when compared with the year ended December 31, 2020. Research and development expenses were adversely impacted by increased headcount and associated payroll costs in our existing research and development operations and, to a lesser extent, by the expansion of our research and development operations into new offices in Poland. In addition, stock-based compensation costs, net of amounts capitalized, included in research and development expenses increased by $27.2 million for the year ended December 31, 2021 when compared with the year ended December 31, 2020.
Sales and marketing expenses
Sales and marketing expenses for the year ended December 31, 2021 increased by $79.7 million when compared with the year ended December 31, 2020. The increase in sales and marketing expenses was primarily due to approximately $21.7 million in incremental expenses incurred by us related to the acquisition of Reworks, and to increased marketing expenses related to media buy expenses, increased stock-based compensation costs, and increased headcount and higher associated payroll costs.
70
General and administrative expenses
General and administrative expenses for the year ended December 31, 2021 decreased by $177.8 million when compared with the year ended December 31, 2020. General and administrative expenses includes stock-based compensation expenses of $64.4 million for the year ended December 31, 2021, compared with $275.1 million for the year ended December 31, 2020. Included in general and administrative expenses for the year ended December 31, 2021, with no comparable amount for the year ended December 31, 2020, are bonus expenses of approximately $35.4 million paid as a result of the successful initial public offering of the Company’s stock in January 2021. Included in general and administrative expenses for the year ended December 31, 2020, with no comparable amount for the year ended December 31, 2021, are expenses of approximately $37.6 million related to a litigation settlement. Adjusting for these items, general and administrative expenses increased by approximately $35.2 million, primarily due to increased compensation costs associated with the long-term incentive plan, which was partially offset by reduced expense attributable to adjusting contingent consideration to fair value.
Other Factors Affecting Net Income
| Year ended December 31, | ||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | 2022 | 2021 | 2020 | |||||||||||
| Interest expense | $ | 117.5 | $ | 149.2 | $ | 198.3 | ||||||||
| Interest income | (14.1) | (0.8) | (0.1) | |||||||||||
| Foreign currency exchange, net | 7.0 | 5.7 | (5.7) | |||||||||||
| Other | 0.2 | (0.3) | 0.3 | |||||||||||
| Taxes on income | 85.5 | 99.9 | 102.3 |
Interest expense
Interest expense in 2022, 2021 and 2020 is primarily related to amounts borrowed under the December 2019 Credit Facilities.
The decrease in interest expense in 2022 when compared with 2021 is driven primarily by lower average interest rates. The increase in interest income in 2022 when compared with 2021 is driven primarily by more active investment of excess cash in income-bearing investments.
On March 11, 2021, the Company amended the Credit Agreement which, among other things, effected a refinancing of the Old Term Loan with a new $1.9 billion senior secured first lien term loan borrowed under the Credit Agreement. Also on March 11, 2021, the Company issued $600.0 million aggregate principal amount of its 4.250% senior notes due 2029 under an indenture, dated March 11, 2021. The combination of these two March 2021 transactions significantly reduced our average interest rates on our outstanding indebtedness, driving the decrease in interest expense in 2021 when compared with 2020.
Interest income
Interest income in 2022, 2021 and 2020 is primarily related to interest earned on cash, cash equivalents and short term bank deposits, of which there were greater amounts in 2022.
Taxes on income
The provision for income tax was $85.5 million for the year ended December 31, 2022 and the effective income tax rate was 23.7%. The difference between the effective income tax rate and the U.S. statutory tax rate is due to recurring items such as tax rates in foreign jurisdictions and the relative amounts of income earned in those jurisdictions, unrecognized tax benefits, and GILTI inclusion. It is also affected by items that are not consistent from year to year. Of these items, the primary differences related to the reversal of a valuation allowance relating to foreign net operating losses and return-to-provision adjustments.
The provision for income tax was $99.9 million for the year ended December 31, 2021 and the effective income tax rate was 24.5%. The difference between the effective income tax rate and the U.S. statutory tax rate was due to recurring items such as
71
tax rates in foreign jurisdictions and the relative amounts of income earned in those jurisdictions, unrecognized tax benefits, and GILTI inclusion. It is also affected by items that are not consistent from year to year. Of these items, the primary difference related to the reversal of deferred tax liabilities due to 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 $102.3 million for the year ended December 31, 2020, and the effective income tax rate was 52.6%. The difference between the effective income tax rate and the U.S. statutory tax rate was 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, 2020 was affected by significant non-deductible stock-based compensation expense for certain restricted stock units granted during the year ended December 31, 2020.
Net income
Upon aggregating all of the components of our results of operations above, net income for the year ended December 31, 2022 decreased by $33.2 million when compared with 2021. Net income for the year ended December 31, 2021 increased $216.4 million when compared to 2020.
Reconciliation of Credit Adjusted EBITDA to net income
Credit 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 Credit Adjusted EBITDA to net income, the closest GAAP financial measure. Our Credit Agreement defines Adjusted EBITDA (which we call “Credit 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, and (ix) certain other items. We calculate Credit Adjusted EBITDA Margin as Credit Adjusted EBITDA divided by revenues.
Credit Adjusted EBITDA and Credit 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 Credit Adjusted EBITDA and Credit 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) | 2022 | 2021 | 2020 | |||||||||||
| Net income | $ | 275.3 | $ | 308.5 | $ | 92.1 | ||||||||
| Provision for income taxes | 85.5 | 99.9 | 102.3 | |||||||||||
| Interest expense and other, net | 110.6 | 153.8 | 192.8 | |||||||||||
| Depreciation and amortization | 162.0 | 145.5 | 119.2 | |||||||||||
| EBITDA | 633.4 | 707.7 | 506.4 | |||||||||||
| Stock-based compensation(1) | 123.5 | 100.4 | 276.0 | |||||||||||
| Contingent consideration | (14.3) | (6.6) | 17.4 | |||||||||||
| Acquisition and related expenses(2) | 24.7 | 43.3 | 14.0 | |||||||||||
| Legal settlement(3) | — | — | 37.6 | |||||||||||
| Other items(4) | 37.8 | 3.9 | 7.5 | |||||||||||
| Credit Adjusted EBITDA | $ | 805.1 | $ | 848.7 | $ | 858.9 | ||||||||
| Net income margin | 10.5 | % | 11.9 | % | 3.9 | % | ||||||||
| Credit Adjusted EBITDA margin | 30.8 | % | 32.9 | % | 36.2 | % |
__________
72
(1) Reflects, for all years, stock-based compensation expense related to the issuance of equity awards to certain of our employees.
(2) Amounts for the year ended December 31, 2022 primarily relate to expenses incurred by the Company in connection with the evaluation of strategic alternatives for the Company. Amounts for the year ended December 31, 2021 primarily relate to bonus expenses paid as a result of the successful initial public offering of the Company’s stock in January 2021. Amounts for the year ended December 31, 2020 include third-party fees for actual or planned acquisitions, including related legal, consulting and other expenditures.
(3) Reflects a legal settlement expense of $37.6 million for the year ended December 31, 2020.
(4) Amount for the year ended December 31, 2022 consists of $13.2 million incurred by the Company for severance, $4.1 million incurred by the Company for relocation and support provided to employees due to the war in Ukraine and $16.4 million incurred related to the announced restructuring activities. Amounts for the years ended December 31, 2021 and 2020 include business optimization expenses.
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, short-term bank deposits, and borrowings under our Credit Facility and Revolver. Our cash and cash equivalents and short-term bank deposits totaled $768.7 million and $1,117.1 million at December 31, 2022 and December 31, 2021, respectively. As of December 31, 2022 and 2021, we had $600 million in additional borrowing capacity pursuant to our Revolving Credit Facility. 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, or, if necessary, borrowings under our Revolving Credit facility or, if necessary, additional term loans or issuances of equity.
Our restricted cash totaled $1.7 million and $2.0 million at December 31, 2022 and December 31, 2021, 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, short-term bank deposits, restricted cash, borrowing capacity under our Revolving Credit Facility 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.
73
Cash flows
The following tables present a summary of our cash flows for the periods indicated (in millions):
| Year ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | ||||||||
| Net cash flows provided by operating activities | $ | 493.7 | $ | 551.7 | $ | 517.7 | ||||
| Net cash flows used in investing activities | (74.6) | (609.4) | (98.1) | |||||||
| Net cash flows provided by (used in) financing activities | (652.0) | 559.7 | (181.3) | |||||||
| Effect of foreign exchange rate changes on cash and cash equivalents | (15.7) | (6.6) | 13.3 | |||||||
| Net change in cash, cash equivalents and restricted cash | $ | (248.6) | $ | 495.4 | $ | 251.6 |
Operating activities
Net cash flows provided by operating activities for the year ended December 31, 2022 decreased $58.0 million when compared with the year ended December 31, 2021. Net cash flows provided by operating activities for the year ended December 31, 2021 increased $34.0 million when compared with the year ended December 31, 2020.
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, 2022 decreased $534.8 million when compared to the year ended December 31, 2021 mainly due to $394.1 million of consideration paid (net of cash acquired) for the 2021 acquisition of Reworks.
Net cash flows used in investing activities for the year ended December 31, 2021 increased $511.3 million when compared to the year ended December 31, 2020, due to $394.1 million of consideration paid (net of cash acquired) for the 2021 acquisition of Reworks.
Financing activities
Net cash flows used in financing activities for the year ended December 31, 2022 was $652.0 million when compared to net cash flows provided by financing activities of $559.7 million for the year ended December 31, 2021. Financing activity cash flows for the year ended December 31, 2022 primarily related to the Company’s Tender Offer in October 2022. Financing activity cash flows for the year ended December 31, 2021 primarily related to the Company’s initial public offering of its equity in January 2021, and the refinancing of its Old Term Loan (as defined below) in March 2021.
Net cash flows provided by financing activities for the year ended December 31, 2021 increased $741.0 million when compared to the year ended December 31, 2020. Financing activity cash flows for the year ended December 31, 2021 primarily relate to the Company’s initial public offering of its equity in January 2021, and the refinancing of its Old Term Loan in March 2021. Financing activity cash flows for the year ended December 31, 2020 primarily relate to repayments on the Company’s bank borrowings.
Capital resources
On December 10, 2019, we entered into $2,750 million of senior secured credit facilities (the “Credit Facilities”), consisting of a $250 million revolving credit facility (the “Revolving Credit Facility”), and a $2,500 million first lien term loan (the “Old Term Loan”). The Credit Facilities were provided pursuant to the Credit Agreement, dated as of December 10, 2019, by and among Playtika, the lenders party thereto, and Credit Suisse, AG, Cayman Islands Branch, as administrative agent (in
74
such capacity, the "Administrative Agent") and collateral agent (in such capacity, the "Collateral Agent"). Proceeds borrowed under the Credit Facilities on the closing date were used to pay off the outstanding balance on our prior debt facility. On June 15, 2020, we increased the capacity of the Revolving Credit Facility to $350 million. On January 15, 2021, we increased the borrowing capacity of the Revolving Credit Facility from $350 million to $550 million.
On March 11, 2021, the Credit Agreement was amended pursuant to an Incremental Assumption Agreement No. 3 and Second Amendment to Credit Agreement (the “Second Amendment”).
The Second Amendment, among other things, effected a refinancing of Old Term Loan with a new $1.9 billion senior secured first lien term loan borrowed under the Credit Agreement (the “New Term Loan”), increased the Revolving Credit Facility to $600 million and extended the maturity of the Revolving Credit Facility to March 11, 2026. The New Term Loan matures on March 11, 2028 and requires scheduled quarterly principal payments in amounts equal to 0.25% of the original aggregate principal amount of the New Term Loan, with the balance due at maturity.
Also on March 11, 2021, we issued $600.0 million aggregate principal amount of our 4.250% senior notes due 2029 (the “Notes”). The Notes mature on March 15, 2029. Interest on the Notes will accrue at a rate of 4.250% per annum. Interest on the Notes is payable semi-annually in cash in arrears on March 15 and September 15 of each year, commencing on September 15, 2021.
Significant terms of the Credit Facilities, the New Term Loan and the Notes, including balances outstanding, interest and fees, mandatory and voluntary prepayment requirements, collateral and guarantors and restrictive covenants are detailed in Note 12, 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.
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 allocate 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.
75
Significant estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from acquired technology and acquired trademarks and user base 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 related to new games or updates to existing games are expensed as incurred to research and development in the consolidated statements 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 1st 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 conduct 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.
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.
76
Impairment of long-lived assets
Our long-lived assets to be held or used, including right-of-use (“ROU”) assets, and identifiable intangible assets that are subject to amortization are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in accordance with ASC 360, Accounting for the Impairment or Disposal of Long-Lived Assets. Impairment indicators include any significant changes in the manner of the Company’s use of the assets and significant negative industry or economic trends. We recognize impairment based on the difference between the fair value of the asset and its carrying value. Fair value is generally measured based on either quoted market prices, if available, or a discounted cash flow analysis.
Upon determination that the carrying value of a long-lived asset may not be recoverable based upon a comparison of aggregate undiscounted projected future cash flows to the carrying amount of the asset, an impairment charge is recorded for the excess of the carrying amount over fair value. There is inherent uncertainty in our forecasts and projections used in any impairment analysis, and different assumptions and estimates could have lead to different impairment test results, and those results could have been materially different.
The preparation of cash flow projections for use in any impairment indicators test or fair value analysis requires management to make critical estimates, judgments and assumptions with regards to estimated future cash flows, as they are, by their nature, subjective and actual results may differ materially from such estimates. Cash flow estimates are unpredictable and inherently uncertain, since they are based on the current regulatory, political and economic climates, recent operating information and projections. Such estimates could be negatively impacted by changes in federal, state or local regulations, economic downturns, competition, events affecting various forms of travel and access to our properties, and other factors. If our estimates of future cash flows are not met or if there are changes in significant assumptions and judgments used in the estimation process, we may have to record impairment charges in the future.
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. 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
77
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 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 expense
We have a stock-based compensation program which provides for equity awards including time-based stock options, restricted stock units (“RSUs”) and performance stock units (“PSUs”). Stock-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense on a straight-line basis over the requisite service period for options and RSUs and on an accelerated basis for PSUs. The Company records 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 stock options. As we do not have a long history of market prices for our common stock because the stock was not publicly traded prior to January 2021, we used observable data for a group of peer companies that grant options with substantially similar terms to assist in developing our volatility assumptions. 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 options. The weighted-average risk-free interest rates were based on the interest rate for U.S. Treasury bonds. The expected term assumptions were derived using the simplified method, which is based on an average between each vesting date and the expiration date of an option. This method was chosen because there was no historical option exercise experience due to us being privately held. We do not anticipate paying cash dividends on our shares of common stock in the future. The stock options have a contractual term of 10 years. Except as otherwise provided in an agreement between us and the employee, if an employee is terminated (voluntarily or involuntarily), any unvested awards as of the date of termination will be forfeited.
78
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. Higher volatility and longer expected terms result in an increase 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 equity awards, we may be required to accelerate any remaining unearned stock-based compensation cost or incur incremental cost.
We use the associated per-share value at the time of grant to determine the compensation cost to be recognized associated with RSUs and PSUs granted. We periodically review the estimates of performance against the defined criteria to assess the expected payout of each outstanding PSU grant and adjust the stock compensation expense accordingly.
For RSUs, shares are issued on the vesting dates net of the applicable statutory income tax withholding to be paid by us on behalf of our employees. As a result, fewer shares are generally issued than the number of RSUs outstanding, and the income tax withholding is recorded as a reduction to additional paid-in capital.
Our stock-based compensation expense is recorded in the financial statement line items relevant to each of the award recipients. See Note 13, Equity Transactions and Stock Incentive Plan, in the accompanying audited consolidated financial statements for the three years ended December 31, 2022 for additional discussion.
Derivative instruments
We use interest rate swap contracts to reduce our exposure to fluctuating interest rates associated with our variable rate debt, and to effectively increase the portion of debt upon which we pay a fixed interest rate. Our interest rate swap agreements are designated as cash flow hedges under ASC 815, Derivatives and Hedging (“ASC 815”), involving the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional amount. These hedges are highly effective in offsetting changes in our future expected cash flows due to the fluctuation of our variable rate debt.
We monitor the effectiveness of our hedges on a quarterly basis, both qualitatively and quantitatively. We performed a regression analysis at inception of the hedging relationship and at period end in which it compared the change in the fair value of the swap transaction and the change in fair value of a hypothetical interest rate swap having terms that identically match the terms of the debt's interest rate payments based on at least 30 observations that are based on historical swap rates. Based on the regression results, we believe that, at inception and at period end, the hedging instrument is expected to be highly effective at offsetting changes in the hedged transactions attributable to the risk being hedged. For each future reporting period, we will continue performing retrospective and prospective assessments of hedge effectiveness in a single regression analysis by updating the regression analysis that was prepared at inception of the hedging relationship.
We use foreign currency derivative contracts to reduce our exposure to fluctuating exchange rates between the United States dollar (as our functional currency) and certain expense lines denominated in Israeli Shekels (“ILS”), Polish Zloty (“PLN”) and Romanian Leu (“RON”). Our derivative contracts are designated as cash flow hedges under ASC 815. We monitor the effectiveness of our hedges on a quarterly basis, both qualitatively and quantitatively, and expects these hedges to remain highly effective at offsetting fluctuations in exchange rates through their respective maturity dates. See Note 14, Derivative Instruments, for additional discussion.
The fair value of derivative financial instruments is recognized as an asset or liability at each balance sheet date, with changes in fair value recorded in other comprehensive income on the consolidated statements of comprehensive income until the future underlying transactions occur. The fair value approximates the amount we would pay or receive if these contracts were settled at the respective valuation dates. The inputs used to measure the fair value of our interest rate swap agreements are categorized as Level 2 in the fair value hierarchy as established by ASC 820, Fair Value Measurement (“ASC 820”). The inputs used to measure the fair value of our foreign currency derivative contracts are categorized as Level 2 in the fair value hierarchy as established by ASC 820.
79
Income taxes
Valuation allowances
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 duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards expiring unused and tax planning alternatives.
Uncertain tax positions
The Company is subject to income taxes in the U.S. and numerous foreign jurisdictions. The evaluation of the Company’s uncertain tax positions involves significant judgment in the interpretation and application of GAAP and complex domestic and international tax laws, and matters related to the allocation of international taxation rights between countries. Although management believes the Company’s reserves are reasonable, no assurance can be given that the final outcome of these uncertainties will not be different from that which is reflected in the Company’s reserves. Reserves are adjusted considering changing facts and circumstances, such as the closing of a tax examination. Resolution of these uncertainties in a manner inconsistent with management’s expectations could have a material impact on the Company’s financial condition and operating results.
Recently issued accounting pronouncements
See Note 1, Organization and Summary of Significant Accounting Policies, 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.