|
|
Item 1.
|
Financial Statements
|
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
September 30,
2018
|
|
December 31,
2017
|
ASSETS
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
$
|
37,964
|
|
|
$
|
51,196
|
|
Short-term investments
|
1,172
|
|
|
8,779
|
|
Trade accounts receivable, net of allowances of $577 and $937
|
13,090
|
|
|
12,689
|
|
Deferred costs, current portion
|
365
|
|
|
426
|
|
Prepaid expenses and other current assets
|
4,719
|
|
|
3,715
|
|
Current assets of discontinued operations
|
—
|
|
|
17,456
|
|
Total current assets
|
57,310
|
|
|
94,261
|
|
Equipment, software, and leasehold improvements, at cost:
|
|
|
|
Equipment and software
|
40,016
|
|
|
46,417
|
|
Leasehold improvements
|
3,431
|
|
|
3,536
|
|
Total equipment, software, and leasehold improvements, at cost
|
43,447
|
|
|
49,953
|
|
Less accumulated depreciation and amortization
|
40,531
|
|
|
46,093
|
|
Net equipment, software, and leasehold improvements
|
2,916
|
|
|
3,860
|
|
Restricted cash equivalents
|
1,630
|
|
|
2,400
|
|
Other assets
|
5,723
|
|
|
5,588
|
|
Deferred costs, non-current portion
|
593
|
|
|
955
|
|
Deferred tax assets, net
|
1,019
|
|
|
1,047
|
|
Other intangible assets, net
|
120
|
|
|
325
|
|
Goodwill
|
17,060
|
|
|
13,060
|
|
Total assets
|
$
|
86,371
|
|
|
$
|
121,496
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
Current liabilities:
|
|
|
|
Accounts payable
|
$
|
3,914
|
|
|
$
|
3,785
|
|
Accrued and other current liabilities
|
11,916
|
|
|
12,365
|
|
Commitment to Napster
|
2,750
|
|
|
2,750
|
|
Deferred revenue, current portion
|
1,969
|
|
|
3,097
|
|
Current liabilities of discontinued operations
|
—
|
|
|
17,107
|
|
Total current liabilities
|
20,549
|
|
|
39,104
|
|
Deferred revenue, non-current portion
|
312
|
|
|
443
|
|
Deferred rent
|
953
|
|
|
982
|
|
Deferred tax liabilities, net
|
170
|
|
|
19
|
|
Other long-term liabilities
|
1,082
|
|
|
1,775
|
|
Total liabilities
|
23,066
|
|
|
42,323
|
|
Commitments and contingencies
|
|
|
|
Shareholders’ equity:
|
|
|
|
Preferred stock, $0.001 par value, no shares issued and outstanding:
|
|
|
|
Series A: authorized 200 shares
|
—
|
|
|
—
|
|
Undesignated series: authorized 59,800 shares
|
—
|
|
|
—
|
|
Common stock, $0.001 par value authorized 250,000 shares; issued and outstanding 37,652 shares in 2018 and 37,341 shares in 2017
|
37
|
|
|
37
|
|
Additional paid-in capital
|
641,449
|
|
|
638,727
|
|
Accumulated other comprehensive loss
|
(61,077
|
)
|
|
(59,547
|
)
|
Retained deficit
|
(517,104
|
)
|
|
(500,044
|
)
|
Total shareholders’ equity
|
63,305
|
|
|
79,173
|
|
Total liabilities and shareholders’ equity
|
$
|
86,371
|
|
|
$
|
121,496
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net revenue (A)
|
$
|
17,579
|
|
|
$
|
18,557
|
|
|
$
|
52,953
|
|
|
$
|
59,853
|
|
Cost of revenue (B)
|
4,239
|
|
|
5,343
|
|
|
14,000
|
|
|
18,199
|
|
Gross profit
|
13,340
|
|
|
13,214
|
|
|
38,953
|
|
|
41,654
|
|
Operating expenses:
|
|
|
|
|
|
|
|
Research and development
|
8,052
|
|
|
7,152
|
|
|
23,398
|
|
|
22,085
|
|
Sales and marketing
|
4,998
|
|
|
4,883
|
|
|
15,878
|
|
|
17,534
|
|
General and administrative
|
4,586
|
|
|
5,081
|
|
|
15,526
|
|
|
15,638
|
|
Restructuring and other charges
|
632
|
|
|
557
|
|
|
1,320
|
|
|
2,271
|
|
Lease exit and related benefit
|
—
|
|
|
—
|
|
|
(454
|
)
|
|
—
|
|
Total operating expenses
|
18,268
|
|
|
17,673
|
|
|
55,668
|
|
|
57,528
|
|
Operating loss
|
(4,928
|
)
|
|
(4,459
|
)
|
|
(16,715
|
)
|
|
(15,874
|
)
|
Other income (expenses):
|
|
|
|
|
|
|
|
Interest income, net
|
72
|
|
|
116
|
|
|
270
|
|
|
353
|
|
Equity in net loss of Napster investment
|
(737
|
)
|
|
—
|
|
|
(737
|
)
|
|
(1,097
|
)
|
Other income (expenses), net
|
(112
|
)
|
|
(50
|
)
|
|
(195
|
)
|
|
(289
|
)
|
Total other income (expenses), net
|
(777
|
)
|
|
66
|
|
|
(662
|
)
|
|
(1,033
|
)
|
Loss from continuing operations before income taxes
|
(5,705
|
)
|
|
(4,393
|
)
|
|
(17,377
|
)
|
|
(16,907
|
)
|
Income tax expense
|
272
|
|
|
139
|
|
|
708
|
|
|
954
|
|
Net loss from continuing operations
|
(5,977
|
)
|
|
(4,532
|
)
|
|
$
|
(18,085
|
)
|
|
$
|
(17,861
|
)
|
Net income from discontinued operations, net of tax
|
—
|
|
|
198
|
|
|
—
|
|
|
717
|
|
Net loss
|
$
|
(5,977
|
)
|
|
$
|
(4,334
|
)
|
|
$
|
(18,085
|
)
|
|
$
|
(17,144
|
)
|
|
|
|
|
|
|
|
|
Net income (loss) per share - Basic:
|
|
|
|
|
|
|
|
Continuing operations
|
$
|
(0.16
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.48
|
)
|
|
$
|
(0.48
|
)
|
Discontinued operations
|
—
|
|
|
—
|
|
|
—
|
|
|
0.02
|
|
Net loss per share - Basic
|
$
|
(0.16
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.48
|
)
|
|
$
|
(0.46
|
)
|
Net income (loss) per share - Diluted
|
|
|
|
|
|
|
|
Continuing operations
|
$
|
(0.16
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.48
|
)
|
|
$
|
(0.48
|
)
|
Discontinued operations
|
—
|
|
|
—
|
|
|
—
|
|
|
0.02
|
|
Net loss per share - Diluted
|
$
|
(0.16
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.48
|
)
|
|
$
|
(0.46
|
)
|
Shares used to compute basic net income (loss) per share
|
37,618
|
|
|
37,200
|
|
|
37,549
|
|
|
37,112
|
|
Shares used to compute diluted net income (loss) per share
|
37,618
|
|
|
37,200
|
|
|
37,549
|
|
|
37,112
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss):
|
|
|
|
|
|
|
|
Unrealized investment holding gains (losses), net of reclassification adjustments
|
$
|
(3
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
10
|
|
Foreign currency translation adjustments, net of reclassification adjustments
|
(322
|
)
|
|
562
|
|
|
(1,530
|
)
|
|
1,802
|
|
Total other comprehensive income (loss)
|
(325
|
)
|
|
562
|
|
|
(1,530
|
)
|
|
1,812
|
|
Net loss
|
(5,977
|
)
|
|
(4,334
|
)
|
|
(18,085
|
)
|
|
(17,144
|
)
|
Comprehensive loss
|
$
|
(6,302
|
)
|
|
$
|
(3,772
|
)
|
|
$
|
(19,615
|
)
|
|
$
|
(15,332
|
)
|
|
|
|
|
|
|
|
|
(A) Components of net revenue:
|
|
|
|
|
|
|
|
License and product revenue
|
$
|
5,827
|
|
|
$
|
6,873
|
|
|
$
|
17,770
|
|
|
$
|
23,677
|
|
Service revenue
|
11,752
|
|
|
11,684
|
|
|
35,183
|
|
|
36,176
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
17,579
|
|
|
$
|
18,557
|
|
|
$
|
52,953
|
|
|
$
|
59,853
|
|
(B) Components of cost of revenue:
|
|
|
|
|
|
|
|
License and product revenue
|
$
|
1,523
|
|
|
$
|
2,163
|
|
|
$
|
4,743
|
|
|
$
|
6,683
|
|
Service revenue
|
2,716
|
|
|
3,180
|
|
|
9,257
|
|
|
11,516
|
|
|
$
|
4,239
|
|
|
$
|
5,343
|
|
|
$
|
14,000
|
|
|
$
|
18,199
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
Cash flows from operating activities:
|
|
|
|
Net loss
|
$
|
(18,085
|
)
|
|
$
|
(17,144
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
Depreciation and amortization
|
1,738
|
|
|
2,402
|
|
Stock-based compensation
|
2,113
|
|
|
3,045
|
|
Equity in net loss of Napster
|
737
|
|
|
1,097
|
|
Deferred income taxes, net
|
5
|
|
|
(55
|
)
|
Fair value of warrants granted in 2015 and 2017, net of subsequent mark to market adjustments in 2018 and 2017
|
78
|
|
|
(367
|
)
|
Net change in certain operating assets and liabilities:
|
|
|
|
Trade accounts receivable
|
16,754
|
|
|
(3,516
|
)
|
Prepaid expenses and other assets
|
(979
|
)
|
|
1,072
|
|
Accounts payable
|
(15,235
|
)
|
|
(447
|
)
|
Accrued and other liabilities
|
(2,754
|
)
|
|
(3,630
|
)
|
Net cash used in operating activities
|
(15,628
|
)
|
|
(17,543
|
)
|
Cash flows from investing activities:
|
|
|
|
Purchases of equipment, software, and leasehold improvements
|
(698
|
)
|
|
(541
|
)
|
Purchases of short-term investments
|
—
|
|
|
(13,905
|
)
|
Proceeds from sales and maturities of short-term investments
|
7,607
|
|
|
43,754
|
|
Acquisition, net of cash acquired
|
(4,192
|
)
|
|
—
|
|
Advance to Napster
|
—
|
|
|
(1,500
|
)
|
Net cash provided by investing activities
|
2,717
|
|
|
27,808
|
|
Cash flows from financing activities:
|
|
|
|
Proceeds from issuance of common stock (stock options and stock purchase plan)
|
114
|
|
|
130
|
|
Tax payments from shares withheld upon vesting of restricted stock
|
(243
|
)
|
|
(338
|
)
|
Net cash used in financing activities
|
(129
|
)
|
|
(208
|
)
|
Effect of exchange rate changes on cash, cash equivalents and restricted cash
|
(962
|
)
|
|
1,519
|
|
Net increase (decrease) in cash, cash equivalents and restricted cash
|
(14,002
|
)
|
|
11,576
|
|
Cash, cash equivalents and restricted cash, beginning of period
|
53,596
|
|
|
36,421
|
|
Cash, cash equivalents, and restricted cash end of period
|
$
|
39,594
|
|
|
$
|
47,997
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
Cash received from income tax refunds
|
$
|
169
|
|
|
$
|
419
|
|
Cash paid for income taxes
|
$
|
862
|
|
|
$
|
1,124
|
|
Non-cash investing activities:
|
|
|
|
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements
|
$
|
(92
|
)
|
|
$
|
42
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended
September 30, 2018
and
2017
|
|
|
Note 1
|
Description of Business and Summary of Significant Accounting Policies
|
Description of Business.
RealNetworks, Inc. and subsidiaries is a global provider of network-delivered digital media applications and services that make it easy to manage, play and share digital media. The Company also develops and markets software products and services that enable the creation, distribution and consumption of digital media, including audio and video.
Inherent in our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services and the ability to generate related revenue.
In this Quarterly Report on Form 10-Q (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”.
Basis of Presentation.
The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the
quarter and nine months ended
September 30, 2018
are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending
December 31, 2018
. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended
December 31, 2017
(the 10-K).
Use of Estimates.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
|
|
|
Note 2
|
Recent Accounting Pronouncements
|
Recently adopted accounting pronouncements
In May 2014, and subsequently updated and amended in 2015 and 2016, the Financial Accounting Standards Board (FASB) issued new revenue recognition guidance (Topic 606), which replaced most existing revenue recognition guidance in U.S. GAAP. The guidance requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method. Refer to Note 3 Revenue Recognition for further details.
In November 2016, the FASB issued guidance on the classification and presentation of changes in restricted cash on the statement of cash flows. We adopted this guidance on January 1, 2018, and retroactively applied the changes to the Statement of Cash Flows for all periods presented. As a result, we no longer classify changes in restricted cash within the investing section of our Statement of Cash flows, and instead include restricted cash with unrestricted cash as a combined total. The impact of the adoption did not have a material impact on the Condensed Consolidated Financial Statements.
Recently issued accounting pronouncements not yet adopted
In February 2016, the FASB issued new guidance related to the accounting for leases. A major change in the new guidance is that lessees will be required to present right-of-use assets and lease liabilities on the balance sheet. Enhanced disclosures will also be required to give financial statement users the ability to assess the amount, timing and uncertainty of cash flows arising from leases. In July 2018 the FASB issued an alternative method that permits application of the new guidance at the beginning of the year of adoption. This is in addition to the method of applying the new guidance
retrospectively to each prior reporting period presented. The new guidance will be effective for us on January 1, 2019, including interim periods within 2019. We continue to evaluate the effect that the guidance will have on our consolidated financial statements and related disclosures. We expect that the guidance will result in a material change to our Consolidated Balance Sheet as a result of capitalizing our operating leases.
In January 2017, the FASB issued new guidance simplifying the test for goodwill impairment. The new guidance eliminates Step 2 from the goodwill impairment test, instead requiring an entity to recognize a goodwill impairment charge for the amount by which the reporting unit's carrying amount exceeds the reporting unit's fair value. This guidance is effective for interim and annual goodwill impairment tests beginning on December 15, 2019, with early adoption permitted. We will be evaluating the impact of the guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
In June 2018, the FASB issued new guidance related to the measurement and classification for share-based awards to non-employees. The new guidance essentially aligns the measurement and classification for these awards with that for share-based awards to employees. The new guidance will be effective for us on January 1, 2019, including interim periods within 2019, with early adoption permitted. We will be evaluating the impact of the guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
|
|
|
Note 3
|
Revenue Recognition
|
Adoption of New Revenue Standard
On January 1, 2018 we adopted the new revenue recognition standard by applying the modified retrospective approach to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue recognition standard, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior periods.
We recorded a net decrease to opening retained deficit of
$1.0 million
as of January 1, 2018 due to the cumulative impact of adopting the new revenue recognition standard, with the impact primarily related to licensing of our RealPlayer product and full recognition of non-recurring engineering fees which were previously deferred and amortized over the life of the contract. The net impact to revenues as a result of adopting the new standard was a decrease of
$0.4 million
for the three months ended September 30, 2018 and an increase of
$2.0 million
for the nine months ended September 30, 2018.
Performance Obligations
We generate all of our revenue through contracts with customers. Revenue is either recognized over time as the service is provided, or at a point in time when the product is transferred to the customer, depending on the contract type. Our performance obligations typically have an original duration of one year or less.
Our software licensing revenue stream generates revenue through the on-premises licensing of our codec technologies and integrated RealTimes platform. We recognize revenue upfront at the point in time when the software is made available to the customer. In cases where a sale or usage-based royalty is promised in exchange for a license of our codec technologies, revenue is recognized as the subsequent usage occurs for the contractual amount owed by the customer for that usage, as is allowed under the licensing of intellectual property section of Topic 606. Software licensing in our Mobile Services segment is invoiced on a monthly basis either based on usage of the respective product, or on a fixed fee basis. Our Consumer Media licensing is invoiced either quarterly or annually based on the usage of the respective product, or on a fixed fee basis. For each of these, the timing of payment generally does not vary significantly from the timing of invoice, however, certain of our long-term Consumer Media licensing contracts have extended payment schedules which may exceed one year.
Our subscription services revenue stream allows customers to use hosted software over the respective contract period without taking possession of the technology. The stream is primarily comprised of our intercarrier messaging service, ringback tones, PC-based and mobile games subscriptions and our RealPlayer and SuperPass services. Revenues related to subscription service products are recognized ratably over the contract period, or as we have the right to invoice as a practical expedient when that amount corresponds directly with the value to the customer of our performance completed to date. Consumer subscription products are paid in advance, typically on a monthly or quarterly basis. Subscription services offered to businesses are invoiced on a monthly basis, generally based upon the amount of usage for the previous month, and the timing of payment generally does not vary significantly from the timing of invoice.
Our product sales revenue stream includes purchases of mobile and wholesale games, as well as our RealPlayer product. Retail purchases are recognized and paid for at the point in time the product is made available to the end user. For games which are sold through third-party application storefronts, we evaluate the transaction for gross or net revenue recognition. As we typically are the primary obligor in our third-party transactions, we recognize revenues gross of any app store fees. We then receive monthly payments from the respective app store for all purchases within the respective month.
Other revenues consist primarily of advertising and the distribution of third-party products, which are recognized and paid on a cost per impression or cost per download basis.
Disaggregation of Revenue
The following table presents our disaggregated revenue by source and segment (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30, 2018
|
|
Nine months ended September 30, 2018
|
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
Business Line
|
|
|
|
|
|
|
|
|
|
|
|
|
Software License
|
|
$
|
2,746
|
|
|
$
|
520
|
|
|
$
|
—
|
|
|
$
|
7,891
|
|
|
$
|
2,324
|
|
|
$
|
—
|
|
Subscription Services
|
|
1,232
|
|
|
6,828
|
|
|
2,744
|
|
|
3,742
|
|
|
20,447
|
|
|
8,126
|
|
Product Sales
|
|
281
|
|
|
—
|
|
|
2,280
|
|
|
920
|
|
|
—
|
|
|
6,635
|
|
Advertising and Other
|
|
474
|
|
|
—
|
|
|
474
|
|
|
1,547
|
|
|
—
|
|
|
1,321
|
|
Total
|
|
$
|
4,733
|
|
|
$
|
7,348
|
|
|
$
|
5,498
|
|
|
$
|
14,100
|
|
|
$
|
22,771
|
|
|
$
|
16,082
|
|
The following table presents our disaggregated revenue by sales channel (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30, 2018
|
|
Nine months ended September 30, 2018
|
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
Sales Channel
|
|
|
|
|
|
|
|
|
|
|
|
|
Business to Business
|
|
$
|
3,220
|
|
|
$
|
7,209
|
|
|
$
|
806
|
|
|
$
|
9,438
|
|
|
$
|
22,312
|
|
|
$
|
2,393
|
|
Direct to Consumer
|
|
1,513
|
|
|
139
|
|
|
4,692
|
|
|
4,662
|
|
|
459
|
|
|
13,689
|
|
Total
|
|
$
|
4,733
|
|
|
$
|
7,348
|
|
|
$
|
5,498
|
|
|
$
|
14,100
|
|
|
$
|
22,771
|
|
|
$
|
16,082
|
|
Contract Balances
The timing of revenue recognition may differ from the timing of invoicing to our customers. We record accounts receivable when the right to consideration becomes unconditional, except for the passage of time. For certain contracts, payment schedules may exceed one year; for those contracts we recognize a long-term receivable. As of
September 30, 2018
, our balance of long-term accounts receivable was
$0.3 million
, and is included in other long-term assets on our condensed consolidated balance sheets. During the quarter and nine months ended September 30, 2018, we recorded no impairments to our contract assets.
We record deferred revenue when cash payments are received or due in advance of our completion of the underlying performance obligation. As of September 30, 2018 we had a deferred revenue balance of
$2.3 million
, a decrease of
$1.3 million
from December 31, 2017. The decrease is due primarily to our transition to Topic 606, with
$0.8 million
recorded to retained earnings on January 1, 2018. The decrease is further due to
$0.2 million
of revenues recognized which were included in the deferred balance at December 31, 2017.
Significant Estimates
For certain of our contracts, we recognize revenues using the sales- and usage-based exception as defined in the licensing guidance of Topic 606. For these contracts, we typically receive reporting of actual usage a quarter in arrears, and as such, we are required to estimate the current quarter's usage. To make these estimates, we utilize historical reporting information, as well as industry trends and interim reporting to quantify total quarterly usage. As actual usage information is received, we record a true-up in the following quarter to reflect any variance from our estimate. Our true-up on our second quarter estimates recorded in the third quarter of 2018 was not material to our condensed consolidated financial statements.
Practical Expedients
For those contracts for which we recognize revenue at the amount to which we have the right to invoice for service performed, we do not disclose the value of any unsatisfied performance obligations. We also do not disclose the remaining unsatisfied performance obligations which have an original duration of one year or less. Additionally, we immediately expense sales commissions when incurred as the amortization period would have been less than one year. These costs are recorded within sales and marketing expense.
|
|
|
Note 4
|
Stock-Based Compensation
|
Total stock-based compensation expense recognized in our unaudited condensed consolidated statements of operations and comprehensive income (loss) includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Total stock-based compensation expense
|
$
|
499
|
|
|
$
|
748
|
|
|
$
|
2,113
|
|
|
$
|
3,045
|
|
The fair value of options granted determined using the Black-Scholes model used the following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Expected dividend yield
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Risk-free interest rate
|
2.78
|
%
|
|
1.61
|
%
|
|
2.69
|
%
|
|
1.71
|
%
|
Expected life (years)
|
3.8
|
|
|
3.7
|
|
|
3.9
|
|
|
4.2
|
|
Volatility
|
35
|
%
|
|
34
|
%
|
|
35
|
%
|
|
35
|
%
|
The total stock-based compensation amounts for
2018
and
2017
disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). Included in the expense for the
nine months ended September 30, 2018
and 2017 was stock compensation expense recorded in the first quarter of 2018 and 2017 related to our 2017 and 2016 incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2018 and 2017, respectively.
As of
September 30, 2018
,
$3.3 million
of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately
3.8
years.
|
|
|
Note 5
|
Napster Joint Venture
|
As of
September 30, 2018
we owned approximately
42%
of the issued and outstanding stock of Rhapsody International Inc., doing business as Napster, and account for our investment using the equity method of accounting.
Rhapsody America LLC was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International Inc. (MTVN), to own and operate a business-to-consumer digital audio music service originally branded as Rhapsody. The service was re-branded in 2016 as Napster. In this Note, we refer to the business as Napster, although the legal entity in which we hold our investment is Rhapsody International, Inc.
Following certain restructuring transactions effective March 31, 2010, we began accounting for our investment using the equity method of accounting. As part of the 2010 restructuring transactions, RealNetworks contributed
$18.0 million
in cash, the Rhapsody brand and certain other assets, including content licenses, in exchange for shares of convertible preferred stock of Rhapsody, carrying a
$10.0 million
preference upon certain liquidation events.
We recorded our share of losses of Napster of
$0.7 million
for the quarter and nine months ended
September 30, 2018
; and
$0.0 million
and
$1.1 million
for the quarter and nine months ended September 30, 2017. Because of the
$10.0 million
liquidation preference on the preferred stock we hold in Napster, under the equity method of accounting we did not record any share of Napster losses that would reduce our carrying value of Napster, which is impacted by Napster equity transactions, below
$10.0 million
, until Napster's book value was reduced below
$10.0 million
. This occurred in the first quarter of 2015. As of
September 30, 2018
, the carrying value of our Napster equity investment was
zero
, as we did not have any further commitment to provide future support to Napster, with the exception of the guaranty discussed below. Unless we commit to provide future financial support to Napster, we do not record any further share of Napster losses that would reduce our carrying value of Napster below zero; in accordance with GAAP, we currently track those suspended losses outside of our financial statements.
In December 2016, RealNetworks entered into an agreement to loan up to
$5.0 million
to Napster for general operating purposes, as did Napster's other 42% owner. Each entity fully funded its loan, providing
$3.5 million
each in December 2016 and the remaining
$1.5 million
each in January 2017. These loans are subordinate to senior creditors, and bear an interest rate of
10%
per annum, which is added to the outstanding principal balance. At the time of signing the agreement we recognized previously suspended Napster losses, and, consequently, we did not record a receivable related to this loan.
As discussed in Note 4 to our 2017 Form 10-K, during November 2017, Napster entered into an amendment to its revolving credit facility. In conjunction with the amendment, both RealNetworks and Napster's other
42%
owner entered into an arrangement to guarantee up to
$2.75 million
each of Napster's outstanding indebtedness on the credit facility. As a result of this guaranty, in December 2017 we recognized previously suspended Napster losses up to the full
$2.75 million
guaranty in our consolidated statement of operations. As of the date of this filing, RealNetworks has not been required to pay any amounts under the guaranty, and the amount is reflected on our condensed consolidated balance sheets as Commitment to Napster.
Summarized financial information for Napster, which represents
100%
of its financial information, is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net revenue
|
$
|
34,814
|
|
|
$
|
42,816
|
|
|
$
|
111,343
|
|
|
$
|
134,414
|
|
Gross profit
|
10,029
|
|
|
7,245
|
|
|
28,690
|
|
|
19,927
|
|
Operating income (loss)
|
4,142
|
|
|
179
|
|
|
14,452
|
|
|
(9,692
|
)
|
Net income (loss)
|
2,768
|
|
|
(627
|
)
|
|
9,350
|
|
|
(13,960
|
)
|
|
|
|
Note 6
|
Fair Value Measurements
|
Items Measured at Fair Value on a Recurring Basis
The following table presents information about our financial assets that have been measured at fair value on a recurring basis as of
September 30, 2018
and
December 31, 2017
, and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
Amortized Cost as of
|
|
September 30, 2018
|
|
September 30, 2018
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
26,472
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
26,472
|
|
|
$
|
26,472
|
|
Money market funds
|
11,492
|
|
|
—
|
|
|
—
|
|
|
11,492
|
|
|
11,492
|
|
Total cash and cash equivalents
|
37,964
|
|
|
—
|
|
|
—
|
|
|
37,964
|
|
|
37,964
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds
|
—
|
|
|
1,172
|
|
|
—
|
|
|
1,172
|
|
|
1,172
|
|
Total short-term investments
|
—
|
|
|
1,172
|
|
|
—
|
|
|
1,172
|
|
|
1,172
|
|
Restricted cash equivalents
|
—
|
|
|
1,630
|
|
|
—
|
|
|
1,630
|
|
|
1,630
|
|
Warrants issued by Napster (included in Other assets)
|
—
|
|
|
—
|
|
|
911
|
|
|
911
|
|
|
—
|
|
Total
|
$
|
37,964
|
|
|
$
|
2,802
|
|
|
$
|
911
|
|
|
$
|
41,677
|
|
|
$
|
40,766
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
Amortized Cost as of
|
|
December 31, 2017
|
|
December 31, 2017
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
31,065
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
31,065
|
|
|
$
|
31,065
|
|
Money market funds
|
20,131
|
|
|
—
|
|
|
—
|
|
|
20,131
|
|
|
20,131
|
|
Total cash and cash equivalents
|
51,196
|
|
|
—
|
|
|
—
|
|
|
51,196
|
|
|
51,196
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds
|
—
|
|
|
8,779
|
|
|
—
|
|
|
8,779
|
|
|
8,779
|
|
Total short-term investments
|
—
|
|
|
8,779
|
|
|
—
|
|
|
8,779
|
|
|
8,779
|
|
Restricted cash equivalents
|
—
|
|
|
2,400
|
|
|
—
|
|
|
2,400
|
|
|
2,400
|
|
Warrants issued by Napster (included in Other assets)
|
—
|
|
|
—
|
|
|
989
|
|
|
989
|
|
|
—
|
|
Total
|
$
|
51,196
|
|
|
$
|
11,179
|
|
|
$
|
989
|
|
|
$
|
63,364
|
|
|
$
|
62,375
|
|
Restricted cash equivalents as of
September 30, 2018
and
December 31, 2017
relates to cash pledged as collateral against letters of credit in connection with lease agreements.
Realized gains or losses on sales of short-term investment securities for the
quarters and nine months ended
September 30, 2018
and
2017
were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of
September 30, 2018
and
December 31, 2017
were also not significant.
Investments with remaining contractual maturities of five years or less are classified as short-term because the investments are marketable and highly liquid, and we have the ability to utilize them for current operations. Contractual maturities of short-term investments as of
September 30, 2018
(in thousands):
|
|
|
|
|
|
Estimated
Fair Value
|
Within one year
|
$
|
1,172
|
|
Between one year and five years
|
—
|
|
Total short-term investments
|
$
|
1,172
|
|
In February 2015, Napster issued warrants to purchase Napster common shares to both RealNetworks and Napster's other 42% owner. The warrants were issued as compensation for past services provided by RealNetworks and the other 42% owner, and both warrants covered the same number of underlying shares, with a 10 year contractual term. The exercise price of the warrants was equal to the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of
5 years
and expected volatility of
55%
. On the date of issuance, we recognized and recorded the
$1.2 million
fair value of the warrant issued to RealNetworks within Other assets in the unaudited condensed consolidated balance sheets, and as an expense reduction within General and administrative expense in the unaudited condensed consolidated statements of operations. The warrants are free-standing derivatives and as such their fair value is determined each quarter using updated inputs in the Black-Scholes option-pricing model. At December 31, 2017 due to the management change and strategic shift undertaken by Napster, we determined that a change to the expected term was necessary. As a result, we extended the expected term by
3.25 years
, resulting in a total expected term for the warrant of
8.25 years
. During the
nine months ended September 30, 2018
, the decrease in the fair value of the warrants was insignificant.
In February 2017, Napster issued additional warrants to purchase Napster common shares to both RealNetworks and Napster's other 42% owner. Consistent with the warrants issued in 2015, the 2017 warrants were issued as compensation for past services provided by RealNetworks and the other 42% owner, and both warrants covered the same number of underlying shares, with a 10 year contractual term. The exercise price of the warrants exceeded the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of
5 years
and expected volatility of
55%
, resulting in a recognized fair value of
$0.5 million
in Other assets in the unaudited condensed consolidated balance sheets, and as an expense reduction within general and administrative expense in the unaudited condensed consolidated statements of operations. At December 31, 2017, due to the management change and strategic shift undertaken by Napster, we determined that a change to the expected term was necessary. As a result, we extended the expected term by
1
year, resulting in a total expected term for the warrant of
6 years
. During the
nine months ended September 30, 2018
, the decrease in the fair value of the warrants was insignificant.
Items Measured at Fair Value on a Non-recurring Basis
Certain of our assets and liabilities are measured at estimated fair value on a non-recurring basis, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the
nine months ended September 30, 2018
and
2017
, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
See
Note 11
,
Lease Exit and Related Charges
, for a discussion of the losses related to reductions in the use of RealNetworks' office space, which were recorded at the estimated fair value of remaining lease obligations, less expected sub-lease income.
|
|
|
Note 7
|
Other Intangible Assets
|
Other intangible assets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
|
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
Amortizing intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
31,149
|
|
|
$
|
31,079
|
|
|
$
|
70
|
|
|
$
|
32,286
|
|
|
$
|
31,997
|
|
|
$
|
289
|
|
|
Developed technology
|
|
24,571
|
|
|
24,571
|
|
|
—
|
|
|
25,177
|
|
|
25,177
|
|
|
—
|
|
|
Patents, trademarks and tradenames
|
|
3,788
|
|
|
3,788
|
|
|
—
|
|
|
3,932
|
|
|
3,896
|
|
|
36
|
|
|
Service contracts
|
|
5,559
|
|
|
5,509
|
|
|
50
|
|
|
5,576
|
|
|
5,576
|
|
|
—
|
|
|
Total
|
|
$
|
65,067
|
|
|
$
|
64,947
|
|
|
$
|
120
|
|
|
$
|
66,971
|
|
|
$
|
66,646
|
|
|
$
|
325
|
|
In conjunction with our acquisition of a Netherlands-based game development studio in the second quarter of 2018, we recorded
$0.1 million
in intangibles. Refer to Note 8 Goodwill for further details about the acquisition.
No impairments of other intangible assets were recognized in either of the
nine months ended September 30, 2018
or
2017
.
Changes in goodwill (in thousands):
|
|
|
|
|
Balance, December 31, 2017
|
$
|
13,060
|
|
Increases due to current year acquisitions
|
4,367
|
|
Effects of foreign currency translation
|
(367
|
)
|
Balance, September 30, 2018
|
$
|
17,060
|
|
On April 16, 2018, in order to acquire a full workforce, we purchased
100%
of the shares of a small, privately-held Netherlands-based game development studio for net cash consideration of
$4.2 million
. All tangible and intangible assets and liabilities recognized are reported within the Games segment. As a result of our preliminary purchase price allocation, we recorded
$0.1 million
of identifiable intangible assets relating to an existing customer contract. We also recorded goodwill of
$4.4 million
, representing the intangible assets that do not qualify for separate recognition for accounting purposes, primarily related to the assembled workforce and expected synergies in development of our Original Stories titles. The goodwill is not deductible for income tax purposes. We did not recognize significant revenue or loss before income taxes from this acquired business from the date of acquisition through September 30, 2018.
Goodwill by segment (in thousands):
|
|
|
|
|
|
September 30,
2018
|
Consumer Media
|
$
|
580
|
|
Mobile Services
|
2,086
|
|
Games
|
14,394
|
|
Total goodwill
|
$
|
17,060
|
|
No impairment of goodwill was recognized in either of the
nine months ended September 30, 2018
or in
2017
.
|
|
|
Note 9
|
Accrued and Other Current Liabilities
|
Accrued and other current liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Royalties and other fulfillment costs
|
$
|
3,315
|
|
|
$
|
2,965
|
|
Employee compensation, commissions and benefits
|
3,985
|
|
|
4,384
|
|
Sales, VAT and other taxes payable
|
1,463
|
|
|
1,782
|
|
Other
|
3,153
|
|
|
3,234
|
|
Total accrued and other current liabilities
|
$
|
11,916
|
|
|
$
|
12,365
|
|
|
|
|
Note 10
|
Restructuring Charges
|
Restructuring and other charges in
2018
and
2017
consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. The expense amounts in both years relate primarily to severance costs due to workforce reductions.
Restructuring charges are as follows (in thousands):
|
|
|
|
|
|
Employee Separation Costs
|
Costs incurred and charged to expense for the nine months ended September 30, 2018
|
$
|
1,320
|
|
Costs incurred and charged to expense for the nine months ended September 30, 2017
|
$
|
2,271
|
|
Changes to the accrued restructuring liability (which is included in Accrued and other current liabilities) for
2018
(in thousands) are as follows:
|
|
|
|
|
|
Employee Separation Costs
|
Accrued liability at December 31, 2017
|
$
|
244
|
|
Costs incurred and charged to expense for the nine months ended September 30, 2018
|
1,320
|
|
Cash payments
|
(976
|
)
|
Accrued liability at September 30, 2018
|
$
|
588
|
|
|
|
|
Note 11
|
Lease Exit and Related Charges
|
As a result of the reduction in use of RealNetworks' office space, lease exit and related charges have been recognized representing rent and contractual operating expenses over the remaining life of the leases, including estimates of sublease income expected to be received. In the first quarter of 2018, we renegotiated the lease for our Seattle headquarters, reducing our total leased space by
15%
. Consequently, we recorded a reduction to our lease loss accrual to reflect our reduced future obligations. This reduction has also been recorded as a benefit of
$0.3 million
in our condensed consolidated statement of operations for the
nine months ended September 30, 2018
. We continue to regularly evaluate the market for office space. If the market for such space changes further in future periods, we may have to revise our estimates which may result in future adjustments to expense for excess office facilities.
Changes to accrued lease exit and related charges (which is included in Accrued and other current liabilities) for
2018
(in thousands) are as follows:
|
|
|
|
|
Accrued loss at December 31, 2017
|
$
|
2,058
|
|
Additions and adjustments to the lease loss accrual, including estimated sublease income
|
(454
|
)
|
Less amounts paid, net of sublease amounts
|
(484
|
)
|
Accrued loss at September 30, 2018
|
1,120
|
|
Less current portion (included in Accrued and other current liabilities)
|
(119
|
)
|
Accrued loss, non-current portion (included in Other long term liabilities)
|
$
|
1,001
|
|
|
|
|
Note 12
|
Shareholders’ Equity
|
Accumulated Other Comprehensive Income (Loss)
Changes in components of accumulated other comprehensive income (loss) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Investments
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss), beginning of period
|
|
$
|
5
|
|
|
$
|
4
|
|
|
$
|
2
|
|
|
$
|
(6
|
)
|
|
Unrealized gains (loss), net of tax effects of ($1), $0, $0 and $5
|
|
(3
|
)
|
|
—
|
|
|
—
|
|
|
10
|
|
|
Net current period other comprehensive income (loss)
|
|
(3
|
)
|
|
—
|
|
|
—
|
|
|
10
|
|
|
Accumulated other comprehensive income balance, end of period
|
|
$
|
2
|
|
|
$
|
4
|
|
|
$
|
2
|
|
|
$
|
4
|
|
Foreign currency translation
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive loss, beginning of period
|
|
$
|
(60,757
|
)
|
|
$
|
(60,399
|
)
|
|
$
|
(59,549
|
)
|
|
$
|
(61,639
|
)
|
|
Translation adjustments
|
|
(322
|
)
|
|
562
|
|
|
(1,530
|
)
|
|
1,802
|
|
|
Net current period other comprehensive income (loss)
|
|
(322
|
)
|
|
562
|
|
|
(1,530
|
)
|
|
1,802
|
|
|
Accumulated other comprehensive loss balance, end of period
|
|
$
|
(61,079
|
)
|
|
$
|
(59,837
|
)
|
|
$
|
(61,079
|
)
|
|
$
|
(59,837
|
)
|
Total accumulated other comprehensive loss, end of period
|
|
$
|
(61,077
|
)
|
|
$
|
(59,833
|
)
|
|
$
|
(61,077
|
)
|
|
$
|
(59,833
|
)
|
As of
September 30, 2018
, there have been
no
material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the
2017
10-K. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We file numerous consolidated and separate income tax returns in the U.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
Basic net loss per share (EPS) is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net loss by the weighted average number of common and dilutive potential common shares outstanding during the period. Basic and diluted EPS (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net loss from continuing operations
|
$
|
(5,977
|
)
|
|
$
|
(4,532
|
)
|
|
$
|
(18,085
|
)
|
|
$
|
(17,861
|
)
|
Weighted average common shares outstanding used to compute basic EPS
|
37,618
|
|
|
37,200
|
|
|
37,549
|
|
|
37,112
|
|
Dilutive effect of stock based awards
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average common shares outstanding used to compute diluted EPS
|
37,618
|
|
|
37,200
|
|
|
37,549
|
|
|
37,112
|
|
|
|
|
|
|
|
|
|
Basic EPS from continuing operations
|
$
|
(0.16
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.48
|
)
|
|
$
|
(0.48
|
)
|
Diluted EPS from continuing operations
|
$
|
(0.16
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
(0.48
|
)
|
|
$
|
(0.48
|
)
|
During the quarter and nine months ended
September 30, 2018
,
6.7 million
and
6.3 million
shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
During the quarter and nine months ended
September 30, 2017
,
5.3 million
and
5.2 million
shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
|
|
|
Note 15
|
Discontinued Operations
|
On December 31, 2017, our contract with our low-margin music on demand customer LOEN expired. The activity for this contract represented our only revenue source relating to music on demand services, and we did not renew the sole contract for this service, resulting in the abandonment of the related business. As the exit of the music on demand business represented a strategic shift, and the amounts were financially significant to our consolidated results, at December 31, 2017 we determined this business should be reported as a discontinued operation, and treated it as such beginning in our fourth quarter of 2017.
The following table summarizes the results of operations, which were recorded in our Mobile Services segment, relating to the discontinued operation (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Net revenue
|
|
$
|
—
|
|
|
$
|
11,445
|
|
|
$
|
—
|
|
|
$
|
33,837
|
|
Cost of revenue
|
|
—
|
|
|
11,191
|
|
|
—
|
|
|
32,918
|
|
Gross profit
|
|
—
|
|
|
254
|
|
|
—
|
|
|
919
|
|
Income taxes
|
|
—
|
|
|
56
|
|
|
—
|
|
|
202
|
|
Income from discontinued operations, net of tax
|
|
$
|
—
|
|
|
$
|
198
|
|
|
$
|
—
|
|
|
$
|
717
|
|
The following table summarizes the remaining carrying amounts of major classes of assets and liabilities of the discontinued operation (in thousands). These assets and liabilities relate to final settlements of prior year activity between various parties. These balances were fully settled prior to the end of the second quarter of 2018.
|
|
|
|
|
|
|
|
|
|
|
|
September 30,
2018
|
|
December 31,
2017
|
Trade accounts receivable, net
|
|
$
|
—
|
|
|
$
|
17,456
|
|
Total current assets of discontinued operations
|
|
—
|
|
|
17,456
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
—
|
|
|
$
|
15,836
|
|
Accrued and other current liabilities
|
|
—
|
|
|
1,271
|
|
Total current liabilities of discontinued operations
|
|
$
|
—
|
|
|
$
|
17,107
|
|
The cash flows related to the discontinued operation have not been segregated, and are included in the Consolidated Statements of Cash Flows. For all periods presented, depreciation and amortization, capital expenditures and significant operating non-cash items from the discontinued operation were not material.
|
|
|
Note 16
|
Commitments and Contingencies
|
From time to time we are and may be subject to legal proceedings, governmental investigations and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. Although we believe that resolving such claims, individually or in aggregate, will not have a material adverse impact on our business or financial condition, these matters are subject to inherent uncertainties. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.
In the ordinary course of business, RealNetworks is subject to potential obligations for standard warranty and indemnification provisions that are contained within many of our customer license and service agreements. Our warranty provisions are consistent with those prevalent in our industry, and we do not have a history of incurring losses on warranties; therefore, we do not maintain accruals for warranty-related obligations. With regard to indemnification provisions, nearly all of our carrier contracts obligate us to indemnify our carrier customers for certain liabilities that may be incurred by them. We have received in the past, and may receive in the future, claims for indemnification from some of our carrier customers.
In relation to certain patents and other technology assets we sold to Intel in the second quarter of 2012, we have specific obligations to indemnify Intel for breaches of the representations and warranties that we made and covenants that we agreed to in the asset purchase agreement for certain potential future intellectual property infringement claims brought by third parties against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.
|
|
|
Note 18
|
Segment Information
|
We manage our business and report revenue and operating income (loss) in
three
segments: (1) Consumer Media, which includes licensing of our codec technology and our PC-based RealPlayer products, including RealPlayer Plus and related products; (2) Mobile Services, which includes our subscription services and our integrated RealTimes platform which is sold to mobile carriers; and (3) Games, which includes all our games-related businesses, including sales of mobile games, sales of games licenses, games subscription services, advertising on games sites and within our games, and microtransactions from online games.
We allocate to our reportable segments certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. Also reported in our corporate segment are restructuring charges, lease exit and related charges, as well as stock-based compensation expense.
RealNetworks reports three reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker (CODM) reviews results. The CODM reviews financial information presented on both a
consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.
Segment results for the
quarters and nine months ended
September 30, 2018
and
2017
(in thousands):
Consumer Media
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Revenue
|
$
|
4,733
|
|
|
$
|
4,197
|
|
|
$
|
14,100
|
|
|
$
|
16,817
|
|
Cost of revenue
|
955
|
|
|
981
|
|
|
2,976
|
|
|
3,545
|
|
Gross profit
|
3,778
|
|
|
3,216
|
|
|
11,124
|
|
|
13,272
|
|
Operating expenses
|
3,448
|
|
|
3,217
|
|
|
10,805
|
|
|
10,957
|
|
Operating income (loss)
|
$
|
330
|
|
|
$
|
(1
|
)
|
|
$
|
319
|
|
|
$
|
2,315
|
|
Mobile Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Revenue
|
$
|
7,348
|
|
|
$
|
7,678
|
|
|
$
|
22,771
|
|
|
$
|
23,597
|
|
Cost of revenue
|
2,052
|
|
|
2,134
|
|
|
6,502
|
|
|
7,750
|
|
Gross profit
|
5,296
|
|
|
5,544
|
|
|
16,269
|
|
|
15,847
|
|
Operating expenses
|
6,825
|
|
|
6,437
|
|
|
21,160
|
|
|
21,261
|
|
Operating loss
|
$
|
(1,529
|
)
|
|
$
|
(893
|
)
|
|
$
|
(4,891
|
)
|
|
$
|
(5,414
|
)
|
Games
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Revenue
|
$
|
5,498
|
|
|
$
|
6,682
|
|
|
$
|
16,082
|
|
|
$
|
19,439
|
|
Cost of revenue
|
1,228
|
|
|
2,226
|
|
|
4,501
|
|
|
6,842
|
|
Gross profit
|
4,270
|
|
|
4,456
|
|
|
11,581
|
|
|
12,597
|
|
Operating expenses
|
5,447
|
|
|
5,071
|
|
|
15,459
|
|
|
15,108
|
|
Operating loss
|
$
|
(1,177
|
)
|
|
$
|
(615
|
)
|
|
$
|
(3,878
|
)
|
|
$
|
(2,511
|
)
|
Corporate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Cost of revenue
|
$
|
4
|
|
|
$
|
2
|
|
|
$
|
21
|
|
|
$
|
62
|
|
Operating expenses
|
2,548
|
|
|
2,948
|
|
|
8,244
|
|
|
10,202
|
|
Operating loss
|
$
|
(2,552
|
)
|
|
$
|
(2,950
|
)
|
|
$
|
(8,265
|
)
|
|
$
|
(10,264
|
)
|
Our customers consist primarily of consumers and corporations located in the U.S., Europe, and various foreign countries (Rest of the World). Revenue by geographic region (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
United States
|
$
|
9,026
|
|
|
$
|
10,098
|
|
|
$
|
28,106
|
|
|
$
|
30,727
|
|
Europe
|
3,005
|
|
|
3,337
|
|
|
9,040
|
|
|
9,737
|
|
Rest of the World
|
5,548
|
|
|
5,122
|
|
|
15,807
|
|
|
19,389
|
|
Total net revenue
|
$
|
17,579
|
|
|
$
|
18,557
|
|
|
$
|
52,953
|
|
|
$
|
59,853
|
|
Long-lived assets (which consist of primarily of goodwill, but also includes equipment, software, leasehold improvements, and other intangible assets) by geographic region (in thousands) are as follows:
|
|
|
|
|
|
|
|
|
|
September 30,
2018
|
|
December 31,
2017
|
United States
|
$
|
11,862
|
|
|
$
|
12,236
|
|
Europe
|
7,001
|
|
|
3,437
|
|
Rest of the World
|
1,233
|
|
|
1,572
|
|
Total long-lived assets
|
$
|
20,096
|
|
|
$
|
17,245
|
|
|
|
|
Note 19
|
Related Party Transactions
|
See
Note 5
,
Napster Joint Venture
, and
Note 6
,
Fair Value Measurements
, for details on transactions involving Napster.
|
|
Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about RealNetworks’ industry, products, management’s beliefs, and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:
|
|
•
|
the expected benefits and other consequences of our growth plans, strategic initiatives, and restructurings;
|
|
|
•
|
our expected introduction, distribution and monetization, of new and enhanced products, services and technologies across our businesses;
|
|
|
•
|
future revenues, operating expenses, income and other taxes, tax benefits, net income (loss) per diluted share available to common shareholders, acquisition costs and related amortization, and other measures of results of operations;
|
|
|
•
|
the effects of our past acquisitions and expectations for future acquisitions and divestitures;
|
|
|
•
|
plans, strategies and expected opportunities for future growth, increased profitability and innovation;
|
|
|
•
|
the expected financial position, performance, growth and profitability of, and investment in, our businesses and the availability of resources;
|
|
|
•
|
the effects of legislation, regulations, administrative proceedings, court rulings, settlement negotiations and other factors that may impact our businesses;
|
|
|
•
|
the continuation and expected nature of certain customer relationships;
|
|
|
•
|
impacts of competition and certain customer relationships on the future financial performance and growth of our businesses;
|
|
|
•
|
our involvement in potential claims, legal proceedings and government investigations, and the potential outcomes and effects of such potential claims, legal proceedings and governmental investigations on our business, prospects, financial condition or results of operations;
|
|
|
•
|
the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations; and
|
|
|
•
|
the effect of economic and market conditions on our business, prospects, financial condition or results of operations.
|
These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in Item 1A of Part II “Risk Factors.” RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
Overview
RealNetworks creates innovative applications and services that make it easy to connect with and enjoy digital media. We manage our business and report revenue and operating income (loss) in three segments: (1) Consumer Media, (2) Mobile Services, and (3) Games. See
Note 18
Segment Information
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q.
Within our Consumer Media segment revenue is primarily derived from the software licensing of our video compression, or codec, technology, including our latest technology, RealMedia High Definition, or RMHD. We also generate revenue from the sale of our PC-based RealPlayer products, including RealPlayer Plus and related products. These products and services are delivered directly to consumers and through partners, such as OEMs and mobile device manufacturers.
Our Mobile Services business generates revenue primarily from the sale of subscription services, which includes our intercarrier messaging service and ringback tones, as well as through software licenses for the integration of our RealTimes platform and certain system implementations. We generate a significant portion of our revenue from sales within our Mobile
Services business to a few mobile carriers. The loss of these contracts, whether by termination or non-renewal or renegotiation of contract terms that are less favorable to us could result in the loss of future revenues and anticipated profits.
Our Games business, through the GameHouse and Zylom brands, derives revenue from product sales of mobile games, games licenses, games subscription services, and advertising on games sites and within our games.
We allocate to our reportable segments certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, IT, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. These corporate items also include restructuring charges, lease exit and related charges, as well as stock compensation expense.
On December 31, 2017, our contract with LOEN Entertainment, Co, Ltd. (LOEN) for our music on demand services expired. As the profits generated from this business had significantly declined over time, we did not renew the sole contract for this service. Accordingly, we have reported the operating results and related assets and liabilities of this business as discontinued operations for all periods presented. Refer to
Note 15
to our unaudited condensed consolidated financial statements for additional information on these discontinued operations. Unless otherwise noted, amounts and percentages for all periods discussed below reflect the results of operations and financial condition of our continuing operations.
As discussed in
Note 3
Revenue Recognition
, as a result of our transition to Topic 606, in the three months ended September 30, 2018, our net revenues were $0.4 million lower as compared to revenues which would have been recognized under previous accounting guidance. For the nine months ended September 30, 2018 our net revenues were $2.0 million higher as compared to the revenues which would have been recognized under previous accounting guidance.
As of
September 30, 2018
, we had
$39.1 million
in unrestricted cash, cash equivalents and short-term investments, compared to
$60.0 million
as of
December 31, 2017
. The
2018
decrease of cash, cash equivalents, and short-term investments was due to our ongoing cash flows used in operating activities and to the April 2018 acquisition of a Netherlands-based game development studio, as discussed in Note 8 Goodwill.
Condensed consolidated results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
Total revenue
|
$
|
17,579
|
|
|
$
|
18,557
|
|
|
$
|
(978
|
)
|
|
(5
|
)%
|
|
$
|
52,953
|
|
|
$
|
59,853
|
|
|
$
|
(6,900
|
)
|
|
(12
|
)%
|
Cost of revenue
|
4,239
|
|
|
5,343
|
|
|
(1,104
|
)
|
|
(21
|
)%
|
|
14,000
|
|
|
18,199
|
|
|
(4,199
|
)
|
|
(23
|
)%
|
Gross profit
|
13,340
|
|
|
13,214
|
|
|
126
|
|
|
1
|
%
|
|
38,953
|
|
|
41,654
|
|
|
(2,701
|
)
|
|
(6
|
)%
|
Gross margin
|
76
|
%
|
|
71
|
%
|
|
|
|
|
|
74
|
%
|
|
70
|
%
|
|
|
|
|
Operating expenses
|
18,268
|
|
|
17,673
|
|
|
595
|
|
|
3
|
%
|
|
55,668
|
|
|
57,528
|
|
|
(1,860
|
)
|
|
(3
|
)%
|
Operating loss
|
$
|
(4,928
|
)
|
|
$
|
(4,459
|
)
|
|
$
|
(469
|
)
|
|
(11
|
)%
|
|
$
|
(16,715
|
)
|
|
$
|
(15,874
|
)
|
|
$
|
(841
|
)
|
|
(5
|
)%
|
In the
third
quarter of
2018
, our total consolidated revenue decreased
$1.0 million
as compared with the year-earlier period, due to decreases in revenue of $1.2 million in our Games segment and $0.3 million in our Mobile Services segment, offset by an increase of $0.5 million in our Consumer Media segment. See below for further discussion around the fluctuations for each segment.
Cost of revenue decreased by
$1.1 million
for the
quarter ended September 30, 2018
, due primarily to a decline of $1.0 million in our Games segment.
Operating expenses increased by
$0.6 million
in the quarter ended
September 30, 2018
as compared with the year-earlier period, primarily due to an increase in costs associated with our growth initiatives as well as ongoing operating expenses related to our acquisition of a Netherlands-based game development studio described in Note 8. The increase was offset in part with ongoing cost reduction efforts.
For the
nine months ended September 30, 2018
, our total consolidated revenue decreased
$6.9 million
as compared to the prior year. The year-over-year decrease was due to lower revenues of $3.4 million in our Games segment, $2.7 million in our Consumer Media segment and $0.8 million in our Mobile Services segment. See below for further discussion around the fluctuations for each segment.
Cost of revenue decreased by
$4.2 million
in the
nine months ended September 30, 2018
as compared to the prior year period due to decreased costs in all three operating segments: $2.3 million in Games, $1.2 million in Mobile Services and $0.6 million in Consumer Media.
Operating expenses decreased by
$1.9 million
in the nine months ended September 30, 2018 as compared with the prior year primarily due to reduced restructuring costs of $1.0 million and a benefit of $0.5 million in lease exit and related charges following the renegotiation of certain leases in the first quarter of 2018. Also contributing to the overall decrease were reductions of $0.6 million in facilities and support services, and $0.4 million in marketing expense. These decreases were offset by certain benefits recorded in the first quarter of 2017: $0.5 million relating to the warrants we received from Napster and a $0.4 million release of previously accrued taxes.
Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
4,733
|
|
|
$
|
4,197
|
|
|
$
|
536
|
|
|
13
|
%
|
|
$
|
14,100
|
|
|
$
|
16,817
|
|
|
$
|
(2,717
|
)
|
|
(16
|
)%
|
Cost of revenue
|
955
|
|
|
981
|
|
|
(26
|
)
|
|
(3
|
)%
|
|
2,976
|
|
|
3,545
|
|
|
(569
|
)
|
|
(16
|
)%
|
Gross profit
|
3,778
|
|
|
3,216
|
|
|
562
|
|
|
17
|
%
|
|
11,124
|
|
|
13,272
|
|
|
(2,148
|
)
|
|
(16
|
)%
|
Gross margin
|
80
|
%
|
|
77
|
%
|
|
|
|
|
|
79
|
%
|
|
79
|
%
|
|
|
|
|
Operating expenses
|
3,448
|
|
|
3,217
|
|
|
231
|
|
|
7
|
%
|
|
10,805
|
|
|
10,957
|
|
|
(152
|
)
|
|
(1
|
)%
|
Operating income (loss)
|
$
|
330
|
|
|
$
|
(1
|
)
|
|
$
|
331
|
|
|
NM
|
|
|
$
|
319
|
|
|
$
|
2,315
|
|
|
$
|
(1,996
|
)
|
|
(86
|
)%
|
Total Consumer Media revenue for the
quarter ended September 30, 2018
increased
$0.5 million
as compared to the same quarter in 2017, due primarily to increased software license revenues of $0.7 million, offset by a decrease in our subscription services revenues of $0.2 million, described more fully below.
Software License
For our software license revenues, the $0.7 million increase is primarily due to the timing of shipments from existing customers and new business revenue.
Subscription Services
For our subscription services revenues, the decrease is primarily due to $0.2 million from continuing declines in our legacy subscription products.
Cost of revenue was flat for the
quarter ended September 30, 2018
, compared with the year-earlier period. This was primarily due to increased salaries and benefits costs, offset by lower bandwidth and license royalty costs.
Operating expenses increased
$0.2 million
as compared with the year-earlier period, due to increased salaries, benefits and professional services fees.
Total Consumer Media revenue for the
nine months ended September 30, 2018
decreased
$2.7 million
as compared to the prior year, due primarily to decreased software license revenues of $2.2 million, as well as a decrease in our subscription services revenues of $0.8 million, described more fully below. These decreases were offset in part by an increase in advertising and other revenues of $0.2 million.
Software License
For our software license revenues, the year-over-year decrease was partially due to the timing of shipments by our customers. In the second quarter of 2017, we recognized revenue on certain large shipments, whereas in 2018 shipments were more evenly distributed. As a result of this shift in timing, we recorded $0.5 million less revenue during the nine months ended September 30, 2018. The variance was also driven by the execution and recognition of large contract renewals in the first quarter of 2017.
Subscription Services
For our subscription services revenues, the decrease was primarily due to $0.8 million from continuing declines in our legacy subscription products.
Cost of revenue decreased by
$0.6 million
in the
nine months ended September 30, 2018
when compared to the prior-year period due to decreases of $0.5 million in bandwidth costs, $0.4 million in royalty costs, and $0.2 million in third party customer support costs. These decreases were offset by an increase of $0.5 million in salaries and benefits costs.
Operating expenses decreased
$0.2 million
in the
nine months ended September 30, 2018
as compared with the year-earlier period, primarily due to reduced costs for facilities and support services.
Mobile Services
Mobile Services segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
7,348
|
|
|
$
|
7,678
|
|
|
$
|
(330
|
)
|
|
(4
|
)%
|
|
$
|
22,771
|
|
|
$
|
23,597
|
|
|
$
|
(826
|
)
|
|
(4
|
)%
|
Cost of revenue
|
2,052
|
|
|
2,134
|
|
|
(82
|
)
|
|
(4
|
)%
|
|
6,502
|
|
|
7,750
|
|
|
(1,248
|
)
|
|
(16
|
)%
|
Gross profit
|
5,296
|
|
|
5,544
|
|
|
(248
|
)
|
|
(4
|
)%
|
|
16,269
|
|
|
15,847
|
|
|
422
|
|
|
3
|
%
|
Gross margin
|
72
|
%
|
|
72
|
%
|
|
|
|
|
|
71
|
%
|
|
67
|
%
|
|
|
|
|
Operating expenses
|
6,825
|
|
|
6,437
|
|
|
388
|
|
|
6
|
%
|
|
21,160
|
|
|
21,261
|
|
|
(101
|
)
|
|
—
|
%
|
Operating loss
|
$
|
(1,529
|
)
|
|
$
|
(893
|
)
|
|
$
|
(636
|
)
|
|
(71
|
)%
|
|
$
|
(4,891
|
)
|
|
$
|
(5,414
|
)
|
|
$
|
523
|
|
|
10
|
%
|
Total Mobile Services revenue decreased by
$0.3 million
in the
quarter ended September 30, 2018
compared with the prior-year period. The revenue decrease was due to declines of $0.1 million in our subscription services revenue stream and $0.3 million in our software license revenue stream, described more fully below.
Software license
For our software license revenues, the decrease was primarily due to declines in our legacy integrated RealTimes product offered to mobile carriers.
Subscription services
For our subscription services, the decrease was primarily the result of a decrease of $0.3 million in our ringback tones business offset by a $0.2 million increase in professional services fees.
Cost of revenue decreased by
$0.1 million
in the
quarter ended September 30, 2018
compared with the prior-year period, due primarily to reductions in bandwidth costs.
Operating expenses increased by
$0.4 million
for the
quarter ended September 30, 2018
compared with the year-earlier period primarily due to increased professional services fees and marketing spend relating to our growth initiatives.
Total Mobile Services revenue decreased by
$0.8 million
for the
nine months ended September 30, 2018
as compared to the prior-year period, as a decrease to our subscription services revenue stream of $1.2 million was offset in part by an increase in our software license revenue stream of $0.4 million, described more fully below.
Software license
For our software license revenues, the increase was primarily due to the recognition of $0.6 million in revenues generated by our integrated RealTimes products offered to mobile carriers due to our transition to Topic 606 in the first quarter of 2018.
Subscription service
For our subscription services, the $1.2 million decrease was primarily a result of a decrease in our ringback tones business, driven mostly by the recognition of $0.9 million in the first quarter of 2017 following the execution of a long-term contract with our partner in Brazil. Also contributing to the decrease was a $0.3 million reduction in our intercarrier messaging business. These decreases were offset by the recognition of $0.6 million in non-recurring engineering services relating to our ringback tones businesses, which was accelerated due to our transition to Topic 606 in the first quarter of 2018.
Cost of revenue decreased by
$1.2 million
for the
nine months ended September 30, 2018
when compared to the prior-year period, due primarily to lower bandwidth costs of $0.6 million, third-party customer service of $0.2 million, and salaries, professional services fees and benefits of $0.2 million.
Operating expenses decreased by
$0.1 million
in the
nine months ended September 30, 2018
as compared with the year-earlier period primarily due to a reduction in facilities and support services costs.
Games
Games segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
5,498
|
|
|
$
|
6,682
|
|
|
$
|
(1,184
|
)
|
|
(18
|
)%
|
|
$
|
16,082
|
|
|
$
|
19,439
|
|
|
$
|
(3,357
|
)
|
|
(17
|
)%
|
Cost of revenue
|
1,228
|
|
|
2,226
|
|
|
(998
|
)
|
|
(45
|
)%
|
|
4,501
|
|
|
6,842
|
|
|
(2,341
|
)
|
|
(34
|
)%
|
Gross profit
|
4,270
|
|
|
4,456
|
|
|
(186
|
)
|
|
(4
|
)%
|
|
11,581
|
|
|
12,597
|
|
|
(1,016
|
)
|
|
(8
|
)%
|
Gross margin
|
78
|
%
|
|
67
|
%
|
|
|
|
|
|
72
|
%
|
|
65
|
%
|
|
|
|
|
Operating expenses
|
5,447
|
|
|
5,071
|
|
|
376
|
|
|
7
|
%
|
|
15,459
|
|
|
15,108
|
|
|
351
|
|
|
2
|
%
|
Operating loss
|
$
|
(1,177
|
)
|
|
$
|
(615
|
)
|
|
$
|
(562
|
)
|
|
(91
|
)%
|
|
$
|
(3,878
|
)
|
|
$
|
(2,511
|
)
|
|
$
|
(1,367
|
)
|
|
(54
|
)%
|
Total Games revenue declined
$1.2 million
for the
quarter ended September 30, 2018
as compared with the year-earlier period due primarily to a decrease of $1.6 million in our product sales revenue stream, offset by an increase of $0.4 million in our advertising and other revenue stream, described more fully below.
Product sales
For our product sales, the decrease was primarily due to one new game launch in the third quarter of 2018 compared to two launches in the third quarter of 2017. In addition, the performance of certain Original Stories titles in the third quarter of 2018 had less comparative success than those titles in the third quarter of 2017.
Advertising and other
Our advertising and other revenues increased $0.4 million as compared to the prior-year period primarily as a result of new initiatives to offer in-game advertising within our mobile games.
Cost of revenue decreased
$1.0 million
in the
quarter ended September 30, 2018
when compared with the prior-year period. We recorded decreased royalties of $0.3 million and decreased app store fees of $0.4 million. In addition, as a result of our April 2018 acquisition of a Netherlands-based game development studio described in Note 8, we no longer pay royalties to this studio; however, operating expenses relating to the ongoing operation of this studio have been incurred as noted in the following paragraph.
Operating expenses increased
$0.4 million
in the
quarter ended September 30, 2018
, compared with the prior-year period due primarily to an increase of $0.4 million in salaries and benefits costs, including in connection with the April 2018 acquisition of a Netherlands-based game development studio described in Note 8.
Total Games revenue declined
$3.4 million
in the
nine months ended September 30, 2018
as compared with the prior-year period. The decrease was due primarily to a decrease of $3.8 million in our product sales revenue stream, offset by an increase of $0.9 million in our advertising and other revenue stream, described more fully below. The overall decrease was also impacted by a decrease of $0.2 million in our subscription services.
Product sales
For our product sales, the decrease of $3.8 million was due primarily to timing of launches and specific games launched within our Original Stories portfolio. As of the third quarter of 2018, we have published five Original Stories titles, compared to seven titles in 2017, of which, our 2017 launches experienced more comparative success than those titles released in 2018.
Advertising and other
Our advertising and other revenues increased $0.9 million as compared to the prior-year period primarily as a result of new initiatives to offer in-game advertising within our mobile games.
Cost of revenue decreased by
$2.3 million
in the
nine months ended September 30, 2018
as compared to the prior year period. We recorded decreased royalties of $1.0 million and decreased app store fees of $0.9 million. In addition, as a result of our April 2018 acquisition of a Netherlands-based game development studio described in Note 8, we no longer pay royalties for this studio; however, operating expenses relating to the ongoing operation of this studio have been incurred.
Operating expenses increased
$0.4 million
in the
nine months ended September 30, 2018
when compared to the prior-year period, as an increase of $0.8 million in salaries and benefits costs was offset by a decrease of $0.5 million in marketing fees.
Corporate
Corporate segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
Cost of revenue
|
$
|
4
|
|
|
$
|
2
|
|
|
$
|
2
|
|
|
(100
|
)%
|
|
$
|
21
|
|
|
$
|
62
|
|
|
$
|
(41
|
)
|
|
66
|
%
|
Operating expenses
|
2,548
|
|
|
2,948
|
|
|
(400
|
)
|
|
(14
|
)%
|
|
8,244
|
|
|
10,202
|
|
|
(1,958
|
)
|
|
(19
|
)%
|
Operating loss
|
$
|
(2,552
|
)
|
|
$
|
(2,950
|
)
|
|
$
|
398
|
|
|
13
|
%
|
|
$
|
(8,265
|
)
|
|
$
|
(10,264
|
)
|
|
$
|
1,999
|
|
|
19
|
%
|
Operating expenses decreased by
$0.4 million
in the
quarter ended September 30, 2018
compared with the year-earlier period. The decrease was primarily due to $0.5 million lower salaries, benefits, professional services and facilities costs due to our ongoing cost reduction efforts.
Operating expenses decreased by
$2.0 million
in the
nine months ended September 30, 2018
when compared with the year-earlier period. The decrease was primarily due to lower restructuring costs and a benefit in lease exit and related charges due to the renegotiation of certain leases in the first quarter of 2018, totaling $1.4 million. A decrease of $0.8 million in salaries, benefits, professional services and facilities costs due to our ongoing cost reduction efforts also reduced operating expenses compared to the prior year. These decreases were offset by certain benefits recorded in the first quarter of 2017: $0.5 million relating to the warrants received from Napster and a $0.4 million release of previously accrued taxes.
Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs including stock-based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, restructuring charges and lease exit costs. Operating expenses were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
|
2018
|
|
2017
|
|
$ Change
|
|
% Change
|
Research and development
|
$
|
8,052
|
|
|
$
|
7,152
|
|
|
$
|
900
|
|
|
13
|
%
|
|
$
|
23,398
|
|
|
$
|
22,085
|
|
|
$
|
1,313
|
|
|
6
|
%
|
Sales and marketing
|
4,998
|
|
|
4,883
|
|
|
115
|
|
|
2
|
%
|
|
15,878
|
|
|
17,534
|
|
|
(1,656
|
)
|
|
(9
|
)%
|
General and administrative
|
4,586
|
|
|
5,081
|
|
|
(495
|
)
|
|
(10
|
)%
|
|
15,526
|
|
|
15,638
|
|
|
(112
|
)
|
|
(1
|
)%
|
Restructuring and other charges
|
632
|
|
|
557
|
|
|
75
|
|
|
13
|
%
|
|
1,320
|
|
|
2,271
|
|
|
(951
|
)
|
|
(42
|
)%
|
Lease exit and related charges
|
—
|
|
|
—
|
|
|
—
|
|
|
NM
|
|
|
(454
|
)
|
|
—
|
|
|
(454
|
)
|
|
NM
|
|
Total consolidated operating expenses
|
$
|
18,268
|
|
|
$
|
17,673
|
|
|
$
|
595
|
|
|
3
|
%
|
|
$
|
55,668
|
|
|
$
|
57,528
|
|
|
$
|
(1,860
|
)
|
|
(3
|
)%
|
Research and development expenses increased by
$0.9 million
in the
quarter ended September 30, 2018
as compared with the year-earlier period, primarily due to an increase in salaries, benefits and professional services expense, primarily reflecting our continued efforts towards our growth initiatives. Our April 2018 acquisition of a Netherlands-based game development studio described in Note 8, also resulted in a $0.3 million increase in research and development expenses.
Research and development expenses increased by
$1.3 million
in the
nine months ended September 30, 2018
as compared with the prior year period, due to an increase in salaries, benefits and professional services expense, reflecting our continued efforts towards our growth initiatives. Our April 2018 acquisition of a Netherlands-based game development studio described in Note 8, also resulted in a $0.3 million increase in research and development expenses.
Sales and marketing expenses increased by
$0.1 million
in the
quarter ended September 30, 2018
compared with the year-earlier period. The increase was due to a $0.2 million increase in salaries, benefits and professional service fees offset by a $0.1 million decrease in overhead costs.
Sales and marketing expenses decreased by
$1.7 million
in the
nine months ended September 30, 2018
as compared with the prior year period. The decrease is primarily comprised of a $0.8 million reduction in salaries, benefits and professional services fees, a $0.3 million reduction to marketing expense and a $0.3 million reduction in facilities and support services costs.
General and administrative expenses decreased by $0.5 million in the quarter ended September 30, 2018, compared with the year-earlier period. The decrease was due to a $0.5 million decrease in salaries, benefits and professional service costs.
General and administrative expenses decreased by
$0.1 million
in the
nine months ended September 30, 2018
as compared with the year-earlier period. In the first quarter of 2017 we recorded a benefit of $0.5 million relating to warrants we received from Napster and a benefit of $0.4 million from the release of previously accrued taxes. These benefits were offset by decreases in 2018 compared with 2017 of $0.3 million in salaries, benefits and professional services costs and $0.3 million in facilities and support services as a result of our ongoing cost reduction efforts.
Restructuring and other charges and Lease exit and related charges consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts. Restructuring expense primarily relates to severance costs due to workforce reductions. For additional details on these charges see
Note 10
,
Restructuring Charges
and
Note 11
,
Lease Exit and Related Charges
.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 30,
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
|
$ Change
|
|
2018
|
|
2017
|
|
$ Change
|
Interest income, net
|
$
|
72
|
|
|
$
|
116
|
|
|
$
|
(44
|
)
|
|
$
|
270
|
|
|
$
|
353
|
|
|
$
|
(83
|
)
|
Equity in net loss of Napster
|
(737
|
)
|
|
—
|
|
|
(737
|
)
|
|
(737
|
)
|
|
(1,097
|
)
|
|
360
|
|
Other income (expense), net
|
(112
|
)
|
|
(50
|
)
|
|
(62
|
)
|
|
(195
|
)
|
|
(289
|
)
|
|
94
|
|
Total other income (expense), net
|
$
|
(777
|
)
|
|
$
|
66
|
|
|
$
|
(843
|
)
|
|
$
|
(662
|
)
|
|
$
|
(1,033
|
)
|
|
$
|
371
|
|
We account for our investment in Napster under the equity method of accounting, as described in
Note 5
,
Napster Joint Venture
. The net carrying value of our investment in Napster is not necessarily indicative of the underlying fair value of our investment.
Income Taxes
During the
quarters ended
September 30, 2018
and
2017
, we recognized income tax expense of
$0.3 million
and
$0.1 million
, respectively, related to U.S. and foreign income taxes. The change in income tax expense during the quarter ended
September 30, 2018
was largely the result of changes in our jurisdictional income.
As of
September 30, 2018
, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the
2017
10-K. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
The majority of our tax expense is due to income in our foreign jurisdictions and we have not benefitted from losses in the U.S. and certain foreign jurisdictions in the
third
quarter of
2018
. We generate income in a number of foreign jurisdictions, some of which have higher or lower tax rates relative to the U.S. federal statutory rate. Our tax expense could fluctuate significantly on a quarterly basis to the extent income is less than anticipated in countries with lower statutory tax rates and more than anticipated in countries with higher statutory tax rates. For the
quarter ended September 30, 2018
, decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to the U.S. federal statutory rate was offset by increases in tax expense from income generated in foreign jurisdictions having comparable, or higher tax rates in comparison to the U.S. federal statutory rate. The effect of differences in foreign tax rates on the Company's tax expense for the
third
quarter of
2018
was minimal.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act. The Company continues to analyze the impact of the Tax Cuts and Jobs Act on its financial statements, including the impact of the one-time deemed repatriation transition tax on previously untaxed accumulated and current earnings and profits of certain foreign subsidiaries and global intangible low-taxed income (GILTI) earned by controlled foreign corporations. As of September 30, 2018, the provisional amounts recorded in the financial statements for the period ending December 31, 2017 have not changed. However, the Company continues to evaluate the implications of tax reform and any additional impacts from the enactment of the Tax Cuts and Jobs Act will be recorded as they are identified during the measurement period as provided for in accordance with the SEC's SAB No. 118.
As of
September 30, 2018
, we have not provided for U.S. federal and state income taxes on certain undistributed earnings of our foreign subsidiaries, since such earnings are considered indefinitely reinvested outside the U.S. As part of the transition tax under the Tax Cuts and Jobs Act, the Company can now distribute, tax-free, earnings from our foreign subsidiaries to the U.S. However, for certain earnings, foreign taxes may be imposed upon distribution. As such, the Company asserts that the undistributed earnings of its foreign subsidiaries will continue to be permanently reinvested in jurisdictions where foreign taxes would be assessed upon distribution to the U.S. It is not practicable to determine the foreign tax liability or benefit on such earnings due to the timing of such future distributions and the complexity of the computation if such earnings were not deemed to be permanently reinvested. If future events, including material changes in estimates of cash, working capital, and long-term investment requirements necessitate that these earnings be distributed, an additional provision for foreign taxes may be necessary.
We file numerous consolidated and separate income tax returns in the U.S., including federal, state and local returns, as well as in foreign jurisdictions. With few exceptions, we are no longer subject to United States federal income tax examinations for tax years prior to 2013 or state, local or foreign income tax examinations for years prior to 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
New Accounting Pronouncements
See
Note 2
,
Recent Accounting Pronouncements
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q.
Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term investments, and restricted cash (in thousands):
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
Working capital
|
$
|
36,761
|
|
|
$
|
55,157
|
|
Cash, cash equivalents, and short-term investments
|
39,136
|
|
|
59,975
|
|
Restricted cash equivalents and investments
|
1,630
|
|
|
2,400
|
|
The
2018
decrease of cash, cash equivalents, and short-term investments from December 31,
2017
was due primarily to our ongoing negative cash flows used in operating activities, which totaled
$15.6 million
in the first
nine
months of 2018, as well as our April purchase of a Netherlands-based game development studio.
The following summarizes cash flow activity (in thousands):
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
2018
|
|
2017
|
Cash used in operating activities
|
$
|
(15,628
|
)
|
|
$
|
(17,543
|
)
|
Cash provided by investing activities
|
2,717
|
|
|
27,808
|
|
Cash used in financing activities
|
(129
|
)
|
|
(208
|
)
|
Cash used in operating activities consisted of net loss adjusted for certain non-cash items such as depreciation and amortization, stock-based compensation, equity in net loss of Napster, and the effect of changes in certain operating assets and liabilities.
Cash used in operating activities was
$1.9 million
less in the
nine months ended September 30, 2018
as compared to the same period in
2017
. Cash used in operations was less due primarily to the net change in operating assets and liabilities during 2018 compared to 2017. In the current year, we used cash of $2.2 million from the net change in operating assets and liabilities while in 2017 the net change in operating assets and liabilities used $6.5 million. This improvement was offset in part by the higher operating loss in 2018 compared to 2017.
For the
nine months ended September 30, 2018
, cash provided by investing activities of
$2.7 million
was due to sales and maturities of short-term investments, which totaled
$7.6 million
. The maturities were offset by our purchase of a Netherlands-based game development studio in the second quarter of 2018 for net cash consideration of $4.2 million and by fixed asset purchases of $0.7 million.
For the
nine
months ended
September 30, 2017
, cash provided by investing activities of $27.8 million was due to sales and maturities, net of purchases, of short-term investments, which totaled $29.8 million. The increase was offset in part by our advance paid to Napster of $1.5 million, as discussed further in Note 5 Napster Joint Venture, and fixed asset purchases of $0.5 million.
Cash used in financing activities for the
nine months ended September 30, 2018
was
$0.1 million
. This cash outflow was due to tax payments on shares withheld upon vesting of restricted stock, net of proceeds received from the employee stock purchase plan.
Cash used in financing activities for the
nine
months ended
September 30, 2017
was $0.2 million. This cash outflow was due mainly to tax payments on shares withheld upon vesting of restricted stock, net of proceeds received from the employee stock purchase plan.
One customer in our Mobile Services segment accounted for 25% of trade accounts receivable as of
September 30, 2018
. At
December 31, 2017
, one customer in our Mobile Services segment accounted for
20%
of trade accounts receivable.
One customer in our Mobile Services segment accounted for
12%
of consolidated revenue or
$2.0 million
during the
quarter ended September 30, 2018
. No individual customer accounted for 10% or more of our consolidated revenue during the nine months ended September 30, 2018. One customer in our Mobile Services segment accounted for 11% of consolidated revenue, or $2.0 million during the quarter ended September 30, 2017. The same customer accounted for 10% of consolidated revenue, or $6.1 million during the nine months ended September 30, 2017.
While we currently have no planned significant capital expenditures for the remainder of
2018
other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases.
We believe that our current unrestricted cash, cash equivalents, and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.
In the future, we may seek to raise additional funds through public or private equity financing, or through other sources such as credit facilities. Such sources of funding may or may not be available to us at commercially reasonable terms. The sale of additional equity securities could result in dilution to our shareholders. In addition, in the future, we may enter into cash or stock acquisition transactions or other strategic transactions that could reduce cash available to fund our operations or result in dilution to shareholders.
If Napster incurs losses, if it otherwise experiences a significant decline in its business or financial condition, or if we provide financial support to, or increase our investment in Napster, we could incur further losses on our investment, which could have an adverse effect on our financial condition, liquidity, and results of operations. For further information on Napster, please refer to
Note 5
Napster Joint Venture
.
Our cash equivalents and short-term investments consist of investment grade securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one non-U.S. Government or non-U.S. Agency issue or issuer to a maximum of 5% of the total portfolio. These securities are subject to interest rate risk and will decrease in value if interest rates increase. Because we have historically had the ability to hold our fixed income investments until maturity, we do not expect our operating results or cash flows to be significantly affected by a sudden change in market interest rates in our securities portfolio.
We conduct our operations primarily in three functional currencies: the U.S. dollar, the euro and the Chinese yuan. We currently do not actively hedge our foreign currency exposures and are therefore subject to the risk of exchange rate fluctuations. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Our exposure to foreign exchange rate fluctuations also arises from intercompany payables and receivables to and from our foreign subsidiaries.
As of
September 30, 2018
, approximately
$16.4 million
of unrestricted cash, cash equivalents, and short-term investments was held by our foreign subsidiaries. While the Tax Act generally allows future repatriation of foreign funds without incurring additional U.S. taxes, certain funds may still be subject to foreign taxes. If these funds are needed for our operations in the U.S., we may be required to accrue and pay additional taxes, and incur additional costs, to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed. We do not expect restrictions or potential taxes on repatriation of amounts held outside of the U.S. to have a material effect on our overall liquidity, financial condition or results of operations.
Off-Balance Sheet Arrangements
We have operating lease obligations for office facility leases with future cash commitments that are not currently required under GAAP to be recorded on our consolidated balance sheet. Accordingly, these operating lease obligations constitute off-balance sheet arrangements. In addition, since we do not maintain accruals associated with certain guarantees, as discussed in
Note 17
,
Guarantees
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q, those guarantee obligations also constitute off-balance sheet arrangements.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Our critical accounting policies and estimates are as follows:
|
|
•
|
Estimating losses on excess office facilities;
|
|
|
•
|
Valuation of equity method investments;
|
|
|
•
|
Valuation of definite-lived assets and goodwill; and
|
|
|
•
|
Accounting for income taxes.
|
Revenue Recognition.
We recognize revenue from contracts with customers as control of the promised good or service is transferred. Please refer to
Note 3
Revenue Recognition
for further details regarding our recognition policies.
Estimating losses on excess office facilities.
We make significant estimates in determining the appropriate amount of accrued loss on excess office facilities, including estimates of sublease income expected to be received. If we make different estimates, our loss on excess office facilities could be significantly different from that recorded, which could have a material impact on our operating results.
Valuation of Equity Method Investments.
We use the equity method of accounting for investments in circumstances where we have the ability to exert significant influence, but not control, over an investee or joint venture. We record our percentage interest in the investee's recorded income or loss and changes in the investee's capital under this method, which will increase or decrease the reported value of our investment. See
Note 5
,
Napster Joint Venture
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q, for additional information. We initially record our investment based on a fair value analysis of the investment.
We evaluate impairment of an investment valued under the equity method if events and circumstances warrant. An impairment charge would be recorded if a decline in value of an equity investment below its carrying amount were determined to be other than temporary. In determining if a decline is other than temporary, we consider factors such as the length of time and extent to which the fair value of the investment has been less than the carrying amount of the investee or joint venture, the near-term and longer-term operating and financial prospects of the investee or joint venture and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery.
Valuation of Definite-Lived Assets and Goodwill.
Definite-lived assets consist primarily of property, plant and equipment, as well as amortizable intangible assets acquired in business combinations. Definite-lived assets are amortized on a straight line basis over their estimated useful lives. We review definite-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If definite-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value.
We test goodwill for impairment on an annual basis, in our fourth quarter, or more frequently if circumstances indicate reporting unit carrying values may exceed their fair values. As part of this test, we first perform a qualitative assessment to determine if the fair value of a reporting unit is more likely than not less than the reporting unit's carrying amount including goodwill. If this assessment indicates it is more likely than not, we then compare the carrying value of the reporting unit to the estimated fair value of the reporting unit. If the carrying value of the reporting unit exceeds the estimated fair value, we then calculate the implied estimated fair value of goodwill for the reporting unit and compare it to the carrying amount of goodwill for the reporting unit. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to implied estimated value.
The impairment analysis of definite-lived assets and goodwill is based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of our definite-lived and goodwill assets could result in the need to perform an impairment analysis in future periods which could result in a significant impairment. While we believe our estimates and assumptions are reasonable, due to their complexity and subjectivity, these estimates and assumptions could vary from period to period. Changes in these estimates and assumptions could materially affect the estimate of future cash flows and related fair market values of these assets and result in significant impairments, which could have a material adverse effect on our financial condition or results of operations. For further discussion, please see the risk factor entitled, "Any impairment to our goodwill, and definite-lived assets could result in a significant charge to our earnings" under Item 1A Risk Factors.
Accounting for Income Taxes.
We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred income tax expense and deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled. We must make assumptions, judgments and estimates to determine the current and deferred provision for income taxes, deferred tax assets and liabilities and any valuation allowance to be recorded against deferred tax assets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
Each reporting period we must periodically assess the likelihood that our deferred tax assets will be recovered from future sources of taxable income, and to the extent that recovery is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefit in the statement of operations and comprehensive income. In certain instances, changes in the valuation allowance may be allocated directly to the related components of shareholders' equity on the consolidated balance sheet. Factors we consider in making such an assessment include, but are not limited to, past performance and our expectation of future taxable income, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our investments and other assets.
As of
September 30, 2018
,
$16.4 million
of the
$39.1 million
of cash, cash equivalents, and short-term investments was held by our foreign subsidiaries.
As of
September 30, 2018
, we have not provided for foreign taxes on certain undistributed earnings of our foreign subsidiaries, since such earnings are considered indefinitely reinvested outside the U.S. As part of the transition tax under the Tax Cuts and Jobs Act, the Company can now distribute, tax-free, earnings from our foreign subsidiaries to the U.S. However, for certain earnings, foreign taxes may be imposed upon distribution. As such, the Company asserts that the undistributed earnings of its foreign subsidiaries will continue to be permanently reinvested in jurisdictions where foreign taxes would be assessed upon distribution to the U.S. It is not practicable to determine the foreign tax liability or benefit on such earnings due to the timing of such future distributions and the complexity of the computation if such earnings were not deemed to be permanently reinvested. If future events, including material changes in estimates of cash, working capital, and long-term investment requirements necessitate that these earnings be distributed, an additional provision for foreign taxes may be necessary.
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Item 3.
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Quantitative and Qualitative Disclosures About Market Risk
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The following discussion about our market risk involves forward-looking statements. All statements that do not relate to matters of historical fact should be considered forward-looking statements. Actual results could differ materially from those projected in any forward-looking statements.
Interest Rate Risk.
Our exposure to interest rate risk from changes in market interest rates relates primarily to our short-term investment portfolio. Our short-term investments consist of investment grade debt securities as specified in our investment policy. Investments in both fixed and floating rate instruments carry a degree of interest rate risk. The fair value of fixed rate securities may be adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Additionally, a declining rate environment creates reinvestment risk because as securities mature the proceeds are reinvested at a lower rate, generating less interest income. See
Note 6
,
Fair Value Measurements
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q, for additional information. Due in part to these factors, our future interest income may be adversely impacted due to changes in interest rates. In addition, we may incur losses in principal if we are forced to sell securities that have declined in market value due to changes in interest rates. Because we have historically had the ability to hold our short-term investments until maturity, we would not expect our operating results or cash flows to be significantly impacted by a sudden change in market interest rates. There have been no material changes in our investment methodology regarding our cash equivalents and short-term investments during the quarter ended
September 30, 2018
. Based on our cash, cash equivalents, short-term investments, and restricted cash equivalents as of
September 30, 2018
, a hypothetical 10% increase/decrease in interest rates would not increase/decrease our annual interest income or cash flows by more than a nominal amount.
Investment Risk.
As of
September 30, 2018
, we had an investment in the voting capital stock of a privately held technology company. See
Note 1
,
Description of Business and Summary of Significant Accounting Policies
-
Equity Method Investments,
and Management's Discussion and Analysis of Financial Condition and Results of Operations -
Critical Accounting Policies and Estimates
(
Valuation of equity method investments
) in our Form 10-K for details on our accounting treatment for this investment, including the analysis of other-than-temporary impairments.
Foreign Currency Risk.
We conduct business internationally in several currencies and thus are exposed to adverse movements in foreign currency exchange rates.
Our exposure to foreign exchange rate fluctuations arise in part from: (1) translation of the financial results of foreign subsidiaries into U.S. dollars in consolidation; (2) the remeasurement of non-functional currency assets, liabilities and intercompany balances into U.S. dollars for financial reporting purposes; and (3) non-U.S. dollar denominated sales to foreign customers.
Our foreign currency risk management program reduces, but does not entirely eliminate, the impact of currency exchange rate movements.
We have cash balances denominated in foreign currencies which are subject to foreign currency fluctuation risk. The majority of our foreign currency denominated cash is held in euros, Chinese yuan and Japanese yen. A hypothetical 10% increase or decrease in those currencies relative to the U.S. dollar as of
September 30, 2018
would not result in a material impact on our financial position, results of operations or cash flows.
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Item 4.
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Controls and Procedures
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(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of
September 30, 2018
. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based upon that evaluation, our chief executive officer and chief financial officer concluded that, as of
September 30, 2018
, our disclosure controls and procedures were effective.
(b) Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the
third
quarter of
2018
that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.