Item 1A. Risk Factors
You should carefully consider the risks described below together with all of the other information included in this Form 10-Q. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or operating results, and the trading price of our common stock, could be materially harmed.
Risks Related to the COVID-19 Pandemic
Our operating plans and financial condition have been adversely affected by the various impacts of the COVID-19 pandemic, and we expect to experience continued adverse effects in future periods in connection with the ongoing public health and safety, governmental, and economic implications.
In March 2020, the World Health Organization declared the outbreak of the novel coronavirus that causes COVID-19 to be a global pandemic. As the virus spread throughout 2020, across the U.S. and the world, authorities implemented numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, business limitations, and shutdowns. In addition to the pandemic's widespread impact on public health and global society, reactions to the pandemic as well as measures taken to contain the virus initially caused significant turmoil to the global economy and financial markets. To address the public health and safety concerns, we took steps to support the health and well-being of our employees, customers, partners and communities, including working remotely and learning to operate our businesses in a fundamentally different way.
To date, we have had to change certain strategy and product plans in order to address implications of the pandemic to our businesses and, in particular, to our growth initiatives. Although forced to furlough some employees in the early days of the pandemic, we were able to bring those employees back to work during the second quarter of 2020. We also reduced expenditures throughout 2020 in an effort to efficiently manage our businesses in the restricted and uncertain climate. We continue to face risk, however, related to fixed facilities costs given the uncertain post-pandemic future of the use of physical office space. In addition, the initial turmoil in financial markets contributed to significant downward pressure on our stock price early in the pandemic. We cannot provide assurance that the actions we have taken will be sufficient, or that conditions will improve as the pandemic, and reactions thereto, continue to evolve.
The COVID-19 pandemic and the resultant economic instability and financial market turmoil added complexity, uncertainty and risk to nearly all aspects of our business. We are unable to fully predict the near-term and long-term impacts that the pandemic will have on our results from operations, financial condition, liquidity and cash flows for fiscal 2021 or beyond.
Risks Related to our Strategy
Our growth initiatives could take longer than planned, be unsuccessful, or deplete our cash resources, any of which would have a material adverse effect on the performance of our businesses and financial results, and could cause us to pursue additional debt or other funding sources.
In recent years, we have developed new products and technologies, and funded initiatives, intended to create growth in our businesses, while simultaneously taking steps to reduce costs and increase profitability. These growth initiatives, several of which have been unsuccessful over recent years, have impacted all segments of our organization, requiring us to allocate limited resources among our diverse business units. Our financial sustainability is largely dependent on the success of our growth initiatives, and there are many risks to that success, some of which are internal to our company, including our ability to develop and monetize our products and services, and some of which are externally driven and outside of our control, such as the potential impact of macroeconomic pressures and global pandemics. In particular, progress with our growth initiatives was negatively impacted by various reactions to the global outbreak of the coronavirus that causes COVID-19, such as travel restrictions, community lockdowns, tightening of corporate budgets, reduction in consumer confidence, and instability in financial markets. We cannot predict the duration or severity of these reactions or impacts to our business and, if prolonged, our cash reserves may prove insufficient, requiring us to pursue additional debt or other funding sources.
Given the ambitious and significant nature of our growth initiatives, there is substantial risk that we may be unsuccessful in implementing our plans in a timely manner, our cash reserves may be depleted or insufficient to fully implement our plans, our growth initiatives may not gain adequate momentum, or the combination of our growth initiatives and cost reductions may not prove to be profitable. Moreover, our acceptance of outside funding for any of our growth businesses, such as our April 2021 public offering and Scener's 2020 fundraising, exposes us to new risks and potential liabilities, including possible payment obligations and securities liability. Our business would suffer, and our operational results and financial outlook would be negatively impacted to a significant degree in the event that any of our growth initiatives fail.
In August 2019, RealNetworks and Napster entered into a loan agreement with a third-party financial institution. Following the December 2020 sale of Napster to MelodyVR, the loan agreement was amended to remove Napster as a co-borrower and, among other modifications, to reduce the amount available under the revolving line of credit to a maximum of $6.5 million. The loan agreement, as amended, matures August 1, 2022 and contains customary covenants, including financial
covenants, minimum EBITDA levels, and maintaining a minimum unrestricted cash balance. We have not had a debt facility in our recent past, therefore the entry into this facility has introduced new risks to the company, including the risk that constraints around covenants may lead to less flexibility in operational decision making, the risk of default and various implications thereof, and the potential increase in liabilities on our balance sheet in the event that we draw down the line of credit.
In April 2020, following an assessment of eligibility and upon approval by our Board of Directors, RealNetworks issued a promissory note in the principal amount of $2.9 million pursuant to the Paycheck Protection Program, or PPP, of the CARES Act. In May 2020, Napster, then-majority owned by RealNetworks though it maintained distinct legal status and control, issued its own promissory note in the principal amount of $1.7 million pursuant to the PPP. On April 23, 2020, the Small Business Administration issued new guidance that introduced some uncertainty as to whether a public company with substantial market value and access to capital markets would qualify for participation in the PPP. Subsequently, on April 28, 2020 the Secretary of the Treasury and Small Business Administration announced that the government would review all PPP loans of more than $2 million for which the borrower applied for forgiveness. While we believe that RealNetworks and Napster fully qualified for the loans, should we be audited or reviewed by the U.S. Department of the Treasury as a result of filing an application for forgiveness or otherwise, such audit or review could result in the diversion of management’s time and attention and legal and reputational costs. RealNetworks applied for forgiveness of its PPP loan in January 2021; Napster applied for forgiveness of its PPP loan in December 2020. If an audit were to be conducted and an adverse finding received, all or a portion of the PPP loan could be required to be returned, which would reduce our liquidity and potentially result in fines and penalties.
The inability to obtain additional debt, whether through draws on our current line of credit or through a new debt facility, or the need to raise funds through other means, could negatively impact our liquidity and ability to invest in our growth initiatives. Moreover, we could be compelled to consider funding that would impact our governance structure. Our pursuit of debt or other sources of liquidity could impair our financial results and stock price.
We need to successfully monetize our new products and services in order to sustain and grow our businesses, and manage our cash resources.
In order to sustain our current level of business and to implement our growth initiatives, we must successfully monetize our new products and services, including through existing and new relationships with distribution partners, establishing new sales channels, and managing new supply chains. Our digital media products and services must be attractive and useful to distribution partners and end users. The successful acceptance and monetization of these products and services, therefore, is subject to unpredictable and volatile factors beyond our control, including end-user preferences, competing products and services, the rapid pace of change in the market, the effectiveness of our distribution channels, and significant global crises. Any failure by us to timely and accurately anticipate consumers’ changing needs and preferences, emerging technological trends and data privacy norms, or changes in the competitive or regulatory landscape for our products and services could result in a failure to monetize our new products or the loss of market opportunities, both of which we have experienced at various times in our past.
Our growth initiatives are highly dependent on the performance of mobile telecommunications carriers, distributors, and resellers. We distribute our messaging platform services, such as Kontxt, through a limited number of mobile telecommunications carriers. Our SAFR sales channel includes distributors and resellers, as well as sales directly to end users. The financial condition, performance, and demand of our products and services through these mobile telecommunications carriers, distributors, and resellers could deteriorate, weakening our ability to sell our products and services, causing a material negative impact on our financial results.
Moreover, in order to grow our new businesses, we must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether the products and services that we are developing or have introduced will meet the demands of the relevant market. As we have experienced, we may not realize a sufficient return, or may experience losses, on these investments, thereby further straining our limited cash resources and negatively affecting our ability to pursue other needed growth or strategic opportunities.
Sustaining and growing our businesses, and managing our cash resources, are subject to these risks inherent in developing, distributing and monetizing our new products and services. Our failure to manage these risks could further impair our operations and financial results to a material degree, and could cause an unsustainable depletion of our cash resources.
Furthermore, our products and services have been in the past and may be in the future subject to legal challenge. Responding to any such claims may require us to enter into royalty and licensing agreements on unfavorable terms, require us to stop distributing or selling, or to redesign our products or services, or to pay damages, any of which could constrain our growth plans and cash resources.
Our businesses, including in connection with our growth initiatives, face substantial competitive challenges that may impair our success, thus negatively impacting our future growth.
Our digital media products and services, including both longstanding and new products/solutions some of which are central to our growth initiatives, face a wide variety of competitors, many of which have longer operating histories, greater name or brand recognition, deeper and more expansive market penetration, more employees, and significantly greater resources than we do. In addition, current and potential competitors may include relatively new businesses that develop or use innovative technologies, products or features that could disrupt the market for technologies, products or features that we currently develop and market or seek to develop and market. In attempting to compete with any or all of these competitors, we may experience, as we have in the past, some or all of the following consequences, any of which would adversely affect our operating results and the trading price of our stock:
•reduced prices or margins;
•loss of current and potential customers, or partners and potential partners who distribute our products and services or who provide content that we distribute to our customers;
•changes to our products, services, technologies, licenses or business practices or strategies;
•lengthened sales cycles;
•inability to meet demands for more rapid sales or development cycles;
•industry-wide changes in content distribution to customers or in trends in consumer consumption of digital media products and services;
•pressure to prematurely release products or product enhancements; or
•degradation in our stature or reputation in the market.
Our Consumer Media technologies for media playback and production (RealPlayer, RealMedia VB and RealMedia HD) compete with alternative media playback technologies and audio and video content formats that have obtained broad market penetration. RealMedia VB and RealMedia HD are codecs, technology that enables compression and decompression of the media content in a (usually proprietary) format. We license our codec technology primarily to computer, smartphone and other mobile device manufacturers, and also to other partners that can support our efforts to build a strong ecosystem, like content providers and integrated circuit developers. To compete effectively, codec technologies must appeal to, and be adopted for use by, a wide range of parties: producers and providers of media content, consumers of media content, and device manufacturers who pre-load codec technologies onto their devices. Our ability to sustain or grow this business, which has recently experienced downward pressure, is dependent on the successful promotion and adoption of our codec technologies to a wide and diverse target market, which is a complex and highly uncertain undertaking. If we are unable to compete successfully, our Consumer Media business could decline as it has in the recent past or on a more accelerated basis.
The market for our Mobile Services business is highly competitive and continues to rapidly evolve. Our SaaS services face competition from a proliferation of applications and services, many of which carriers can deploy or offer to their subscribers, or which consumers can acquire independently of their carrier. We expect pricing pressure in this business to continue to materially impact our operating results in this business. Our Mobile Services growth initiatives compete with a wide variety of companies, as small startups and well established, heavily resourced global companies race to develop AI-based technologies and launch products in the computer vision market. The success of these initiatives is highly dependent on our ability to differentiate our product offering within this highly competitive environment.
The branded services in our Games business compete with other developers, aggregators and distributors of mobile, online, and downloadable games. Our competitors vary in size and capabilities, some of which have high volume distribution channels and greater financial resources than we do; while others may be smaller and more able to quickly or efficiently adjust to market conditions. We also face significant price competition in the casual games market, as our competitors increasingly focus on free-to-play games or reduce prices more aggressively. We expect competition to continue to intensify in this market. Our games development studios compete primarily with other developers of mobile, online, and downloadable games, and must continue to develop popular and high-quality game titles. Our Games business must also continue to execute on opportunities to expand the play of our games on a variety of non-PC platforms, including mobile, in order to maintain our competitive position and to grow the business. Moreover, continued growth in our Games business is in part dependent on the availability of funds to invest in marketing, which availability cannot be assured.
Issues with the use of artificial intelligence, or AI, in our offerings could result in reputational harm or liability.
Certain of our growth initiatives are centered around AI-based products and solutions, and we expect these initiatives to comprise an increasing percentage of our go-forward business. We envision a future in which our AI-based products and solutions help our customers live safer, smarter, more efficiently, and more successfully. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Inappropriate or controversial data practices by us, our distribution network, our end users, or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Some AI scenarios present ethical issues. If we enable or offer AI solutions that are controversial because of their impact on privacy, employment, or other social issues, we may experience brand or reputational harm.
Risks Related to our Operations
Our operating results are difficult to predict and may fluctuate, which may contribute to weakness or volatility in our stock price.
The trading price for our common stock has been in steady decline for many years, though, particularly more recently, has also been vulnerable to significant volatility caused by general market conditions or unusual stock-specific trading activity. There can be no assurance that our common stock will not experience additional, and potentially more significant, volatility in the future caused by unpredictable external factors. In addition, as a result of the rapidly changing markets in which we compete, and restructuring, impairment and other one-time events specific to us, our operating results may fluctuate or decline from period to period, which may contribute to weakness or volatility in our stock price. Moreover, the general difficulty in forecasting our operating results and identifying meaningful performance metrics, especially when factoring in our growth initiatives, could result in actual results that differ materially from expected results, again causing weakness and volatility in our stock price. Compounding these internal factors are external factors, such as the significant instability in global financial markets experienced over the past year, that will impact our operating results and stock price, potentially driving our stock price to record lows as occurred in 2020 or to significant activity levels as occurred in early 2021.
The difficulty in forecasting our operating results may also cause over- or under-investment in certain growth initiatives, as such investment is often planned based on expected financial results. This over-/under-investment could cause more severe fluctuations in operating results and, likely, further volatility in our stock price.
Further, because our common stock is listed on the Nasdaq Global Select Market, we must meet Nasdaq's continued listing requirements, in particular, financial requirements that include maintaining a minimum bid price of at least $1.00. In April 2020, we received a letter from the Listing Qualifications Department of the Nasdaq Global Select Market indicating that, based upon the closing bid price of our common stock for the 30 consecutive business day period from March 11, 2020 to April 23, 2020, we did not meet the minimum bid price of $1.00 per share required for continued listing on Nasdaq. In June 2020, we received a second letter from Nasdaq Staff indicating that we had regained compliance with Nasdaq Listing Rule 5450(a)(1) based on its determination that the closing bid price of our common stock had been at $1.00 per share or greater for the 10 business days from May 15 to May 29, 2020. Although we are currently in compliance with all applicable continued listing requirements and have received no contradictory notification from Nasdaq, our stock price could again fall below the $1.00 minimum as a result of valuation pressure, stock-specific trading activity or general declines in the stock market. We regularly monitor our compliance with Nasdaq's continued listing requirements, and, as necessary, our Board will consider the implementation of various measures intended to support continued compliance.
Any impairment to our goodwill, definite-lived, and right-of-use operating lease assets could result in a material charge to our earnings.
In accordance with GAAP, we test goodwill for possible impairment on an annual basis or more frequently in the event of certain indications of possible impairment. We review definite-lived and operating lease assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. These events or circumstances could include a significant change in the business climate, including a significant sustained decline in a reporting unit’s fair value, changes in our operating plans and forecasts, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of our business, a significant sustained decline in our market capitalization and other factors. If we were to determine that an impairment had occurred, we would be required to record an impairment charge, which could have a material negative, and unanticipated, impact on our financial results.
Continued loss of revenue from our subscription services is likely to cause further harm to our operating results.
Our operating results have been and will continue to be adversely impacted by the loss of subscription revenue related to our more traditional products and services. Subscribers cancel their subscriptions to our services for many reasons, including a perception that they do not use the services sufficiently or that the service does not provide enough value, a lack of attractive or exclusive content generally or as compared with competitive service offerings, or because customer service issues are not satisfactorily resolved. Revenue from our SuperPass subscription service, for example, has continued to decline over several periods, due to changes in consumer preferences and changes on our part to focus on other products and services we offer, and we expect this trend to continue.
Difficulty recruiting and retaining key personnel could significantly impair our operations or jeopardize our ability to meet our growth objectives.
Our success depends substantially on the contributions and abilities of certain key personnel, and we cannot provide assurance that we will be able to retain them in the near term or recruit them in the future. In 2020, we experienced a significant level of executive turnover, as we have experienced in the past and could experience in the future, which could impact our ability to retain key personnel. Also, qualified individuals are in high demand and competition for such qualified personnel in our industry, particularly engineering talent, is extremely intense, and we may incur significant costs to attract or retain them. Changes in immigration or other policies in the U.S. or other jurisdictions that make it more difficult to hire and retain key talent, or to assign individuals to any of our locations as needed to meet business needs, could adversely affect our ability to attract key talent or deploy individuals as needed, and thereby adversely affect our business and financial results. Further,
repeated restructuring of our businesses and related cost-reduction efforts, as well as declines and volatility in our stock price, have caused instability in our workforce that makes it more difficult to retain and recruit key personnel. Given these factors, there can be no assurance that we will be able to attract and retain the key personnel necessary to sustain our business or support future growth.
Acquisitions and divestitures involve costs and risks that could harm our business and impair our ability to realize potential benefits from these transactions.
As part of our business strategy, we have acquired and sold technologies and businesses in the past and expect that we will continue to do so in the future. The failure to adequately manage transaction costs and address the financial, legal and operational risks raised by acquisitions and divestitures of technology and businesses could harm our business and prevent us from realizing the benefits of these transactions. In addition, we may identify and acquire target companies, but those companies may not be complementary to our current operations and may not leverage our existing infrastructure or operational experience, which may increase the risks associated with completing acquisitions.
For example, our January 18, 2019 acquisition of a controlling interest in Napster represented a significant acquisition for RealNetworks. To effectuate the acquisition and incorporate Napster's financial results into our financial statements, we incurred significant transaction-related costs throughout fiscal year 2019 and early in 2020. Moreover, the 2020 sale of our Napster stake in connection with the merger of Napster and MelodyVR resulted in further significant transaction-related expenses, certain ongoing indemnification obligations, and the payment of a portion of proceeds to a third party.
Transaction-related costs and financial risks related to completed and potential future purchase or sale transactions may harm our financial position, reported operating results, or stock price. Previous acquisitions have resulted in significant expenses, including amortization of purchased technology, amortization of acquired identifiable intangible assets and incurring charges for the impairment of goodwill and other intangible assets, which are reflected in our operating expenses. New acquisitions and any potential additional future impairment of the value of purchased assets, including goodwill, could have a material negative impact on our future operating results. In compliance with GAAP, we evaluate these assets for impairment at least annually. Factors that may be considered a change in circumstances, indicating that our goodwill or definite-lived assets may not be recoverable, include reduced future revenue and cash flow estimates due to changes in our forecasts, and unfavorable changes to valuation multiples and discount rates due to changes in the market. If we were to conclude that any of these assets were impaired, we would have to recognize an impairment charge that could materially impact our financial results.
Purchase and sale transactions also involve operational risks that could harm our existing operations or prevent realization of anticipated benefits from a transaction. These operational risks include:
• difficulties and expenses in assimilating the operations, products, technology, information systems, and/or personnel of the acquired company;
• retaining key management or employees of the acquired company;
• entrance into unfamiliar markets, industry segments, or types of businesses;
• operating, managing and integrating acquired businesses in remote locations or in countries in which we have little or no prior experience;
• diversion of management time and other resources from existing operations;
• impairment of relationships with employees, affiliates, advertisers or content providers of our business or acquired business;
• assumption of known and unknown liabilities of the acquired company, including intellectual property claims; and
• potential impacts to our system of internal controls and disclosure controls and procedures.
Risks Related to Regulations and Other External Factors
Government regulation of the Internet, facial recognition technology, artificial intelligence and other related technologies is evolving, and unfavorable developments could have an adverse effect on our operating results.
We are subject to regulations and laws specific to the marketing, sale and delivery of goods and services. These laws and regulations, which continue to evolve, cover taxation, user privacy, data collection and protection, copyrights, electronic contracts, sales procedures, automatic subscription renewals, credit card processing procedures, consumer protections, digital games distribution, broadband Internet access and content restrictions. We cannot guarantee that we have been or will be fully compliant in every jurisdiction, as it is not entirely clear how existing laws and regulations governing issues such as privacy, taxation and consumer protection apply or will be enforced with respect to the products and services we sell. Moreover, as Internet commerce continues to evolve, increasing regulation and/or enforcement efforts by federal, state and foreign agencies and the prospects for private litigation claims related to our data collection, privacy policies or other e-commerce practices become more likely. In addition, the adoption of any laws or regulations or the imposition of other legal requirements that adversely affect our ability to market, sell, and deliver our products and services could decrease our ability to offer or customer demand for our service offerings, resulting in lower revenue. Moreover, in the U.S., certain states have and more states may impose stricter privacy laws that may impact accepted business practices. We cannot provide assurance that the changes that we
have adopted to our business practices will be compliant or that new compliance frameworks such as this will not have a negative impact on our financial results.
In addition, through the operation of our SAFR product, we are subject to regulations and laws generally and specifically applicable to the provision of facial recognition technology. New laws and regulations are under discussion and those that exist are untested, thus we cannot guarantee that we have been or will be fully compliant in every jurisdiction. Moreover, the voluntary development of norms, standards, and best practices by companies providing facial recognition and similar technology could require modifications to our technology or practices that may be costly or incompatible with our financial model.
As we pursue further sales of our SAFR product to governmental agencies, such as the Small Business Innovation Research (SBIR) contracts with the U.S. Air Force in 2020, we may become subject to more extensive contracting rules, standards, and audits.
Future regulations, or changes in laws and regulations or their existing interpretations or applications, could require us to further change our business practices, raise compliance costs or other costs of doing business and result in additional historical or future liabilities for us, resulting in adverse impacts on our business and our operating results.
As a consumer-facing business, we receive complaints from our customers regarding our consumer marketing efforts and our customer service practices. Some of these customers may also complain to government agencies, and from time to time, those agencies have made inquiries to us about these practices. In addition, we may receive complaints or inquiries directly from governmental agencies that have not been prompted by consumers. We cannot provide assurance that governmental agencies will not bring future claims, as they have on occasion in the past, regarding our marketing, or consumer services or other practices.
We face financial and operational risks associated with doing business in non-U.S. jurisdictions and operating a global business, that have in the past and could in the future have a material adverse impact on our business, financial condition and results of operations.
A material portion of our revenue is derived from sales outside of the U.S. and most of our employees are located outside of the U.S. Consequently, our business and operations depend significantly on global and national economic conditions and on applicable trade regulations and tariffs. For example, our business in China could be negatively affected by an actual or perceived lack of stability or consistency in U.S.-China trade policy. The growth of our business is also dependent in part on successfully managing our international operations. Our non-U.S. sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:
•periodic local or geographic economic downturns and unstable political conditions;
•price and currency exchange controls;
•fluctuation in the relative values of currencies;
•difficulty in repatriating cash, whether as a result of tax laws or otherwise;
•compliance with current and changing tax laws, and the coordination of compliance with U.S. tax laws and the laws of any of the jurisdictions in which we do business;
•difficulties protecting intellectual property;
•compliance with labor laws and other laws governing employees;
•local labor disputes;
•changes in trading policies, regulatory requirements, tariffs and other barriers, or the termination or renegotiation of existing trade agreements;
•impact of changes in immigration or other policies impacting our ability to attract, hire, and retain key talent;
•potential implications resulting from the outbreak of disease on a global scale or localized in countries in which we do business or have employees; and
•difficulties in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors and representatives.
Because consumers may consider the purchase of our digital entertainment products and services to be a discretionary expenditure, their decision whether to purchase our products and services may be influenced by macroeconomic factors that affect consumer spending such as unemployment, access to credit, negative financial news, and declines in income. In addition, mobile telecommunication carriers and other business partners may reduce their business or advertising spending with us or for our products and services they distribute to users in the face of adverse macroeconomic conditions, such as financial market volatility, government austerity programs, tight credit, and declines in asset values. We have in the past recorded material asset impairment charges due in part to weakness in the global economy, and we may need to record additional impairments to our assets in future periods in the event of renewed weakness and uncertainty in the global or a relevant national economy. Accordingly, any significant weakness in the national and/or global economy could materially impact our business, financial condition and results of operations in a negative manner.
Our international operations involve risks inherent in doing business globally, including difficulties in managing operations due to distance, language, cultural differences, local economic conditions, outbreak of diseases, different or conflicting laws and regulations, taxes, and exchange rate fluctuations. The functional currency of our foreign subsidiaries is typically the local currency of the country in which each subsidiary operates. We translate our subsidiaries’ revenues into U.S. dollars in our financial statements, and continued volatility in foreign exchange rates may result in lower reported revenue or net assets in future periods. If we do not effectively manage any of the risks inherent in running our international businesses, our operating results and financial condition could be harmed. As another example, the COVID-19 pandemic has resulted in travel and work restrictions globally, and may further disrupt our ability to produce and sell products. We continue to monitor the impacts of the pandemic to our business, as well as rapidly evolving expectations regarding its severity and duration. We are unable to predict the full effects of this pandemic on our operations and financial results.
Our business is conducted in accordance with existing international trade relationships, and trade laws and regulations. Changes in geopolitical relationships and laws or policies governing the terms of foreign trade, such as the recent rise in protectionist politics and economic nationalism, could create uncertainty regarding our ability to operate and conduct commercial relationships in affected jurisdictions, which could have a material adverse effect on our business and financial results. Additionally, our global operations may also be adversely affected by political events, domestic or international terrorist events and hostilities or complications due to natural or human-caused disasters. These uncertainties could have a material adverse effect on the continuity of our business and our results of operations and financial condition.
Our business and operating results will suffer and we may be subject to market risk and legal liability if our systems or networks fail, become unavailable, unsecured or perform poorly so that current or potential users do not have adequate access to our products, services and websites.
Our ability to provide our products and services to our customers and operate our business depends on the continued operation and security of our information systems and networks and those of our service providers. A significant or repeated reduction in the performance, security or availability of our information systems and network infrastructure or that of our service providers could harm our ability to conduct our business, and harm our reputation and ability to attract and retain users, customers, advertisers and content providers. Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate.
We sell many of our products and services through online sales transactions directly with consumers, and their credit card information is collected and stored by our payment processors. The systems of our third party service providers may not prevent future improper access or disclosure of credit card information or personally identifiable information. We have a privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client, third party payment providers, and server products. A security breach that leads to disclosure of consumer account information, or any failure by us to comply with our posted privacy policy or existing or new privacy legislation, could harm our reputation, impact the market for our products and services, or subject us to litigation. We have on occasion experienced system errors and failures that caused interruption in availability of products or content or an increase in response time. Problems with our systems and networks, or the third party systems and networks that we utilize, could result from a failure to adequately maintain and enhance these systems and networks, natural disasters and similar events, power failures, intentional actions to disrupt systems and networks and many other causes. Many of our services do not currently have fully redundant systems or a formal disaster recovery plan, and we may not have adequate business interruption insurance to compensate us for losses that may occur from a system outage.
Changes in regulations applicable to the Internet and e-commerce that increase the taxes on the services we provide could materially harm our business and operating results.
As Internet commerce continues to evolve, increasing taxation by state, local or foreign tax authorities becomes more likely. For example, taxation of electronically delivered products and services or other charges imposed by government agencies may also be imposed. We collect transactional taxes and we believe we are compliant and current in all jurisdictions where we have a collection obligation for transaction taxes. Any regulation imposing greater taxes or other fees for products and services could result in a decline in the sale of products and services and the viability of those products and services, harming our business and operating results. A successful assertion by one or more states or foreign tax authorities that we should collect and remit sales or other taxes on the sale of our products or services could result in substantial liability for past sales.
In those countries where we have a tax obligation, we collect and remit value added tax, or VAT, on sales of “electronically supplied services” provided to European Union residents. The collection and remittance of VAT subjects us to additional currency fluctuation risks.
Changes in accounting standards and subjective assumptions, estimates, and judgments by management related to complex accounting matters could significantly affect our financial results or financial condition.
We prepare our financial statements in conformity with GAAP. These accounting principles are subject to interpretation or changes by the Financial Accounting Standards Board, or FASB, and the SEC, and new accounting pronouncements and
varying interpretations of accounting standards and practices have occurred in the past and are expected to occur in the future. Moreover, our financial statements require the application of judgments and estimates regarding a wide range of matters that are relevant to our business, such as revenue recognition, asset impairment and fair value determinations, and the acquisition method of accounting and its related estimated fair value amounts. Changes in accounting standards or practices, or in our judgments and estimates underlying accounting standards and practices, could harm and/or materially impact our operating results and/or financial condition. Changes to existing accounting rules or to our judgments and estimates underlying those rules could materially impact our reported operating results and financial condition.
We may be subject to additional income tax assessments and changes in applicable tax regulations could adversely affect our financial results.
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes, income taxes payable, and net deferred tax assets. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in our historical financial statements. An audit or litigation can result in significant additional income taxes payable in the U.S. or foreign jurisdictions which could have a material adverse effect on our financial condition and results of operations.
Risks Related to our Governance and Capital Structure
Our Chairman of the Board and Chief Executive Officer beneficially owns 38.5% of our common stock, which gives him significant control over certain major decisions on which our shareholders may vote or which may discourage an acquisition of us.
Robert Glaser, our Chairman of the Board and Chief Executive Officer, beneficially owns 38.5% of our common stock. As a result, Mr. Glaser and his affiliates will have significant influence to:
•elect or defeat the election of our directors;
•amend or prevent amendment of our articles of incorporation or bylaws;
•effect or prevent a merger, sale of assets or other corporate transaction; and
•control the outcome of any other matter submitted to the shareholders for vote.
Furthermore, on February 10, 2020, we entered into a Series B Preferred Stock Purchase Agreement with Mr. Glaser pursuant to which Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of approximately 8 million shares of our Series B Preferred Stock, par value $0.001 per share. The rights, preferences, limitations, and powers of the Series B Preferred Stock are set forth in and governed by the designation of rights and preferences of Series B Preferred Stock filed with the Secretary of State of the State of Washington. Those rights, preferences, limitations, and powers include the right to proportional adjustment and the right to any dividends or distributions declared with regard to our common stock, but the Series B Preferred Stock has no voting or consent rights, has no liquidation preference, has no preferred dividend, and has limitations on transferability. Each share of Series B Preferred Stock is convertible into one share of our common stock, however no conversion is permitted in the event that it would cause Mr. Glaser’s beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our shareholder rights plan dated November 30, 2018.
The stock ownership of Mr. Glaser may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of RealNetworks, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price.
Provisions of our charter documents, shareholder rights plan, and Washington law could discourage our acquisition by a third party.
Our articles of incorporation provide for a strategic transactions committee of the board of directors. Without the prior approval of this committee, and subject to certain limited exceptions, the board of directors does not have the authority to:
•adopt a plan of merger;
•authorize the sale, lease, exchange or mortgage of assets representing more than 50% of the book value of our assets prior to the transaction or on which our long-term business strategy is substantially dependent;
•authorize our voluntary dissolution; or
•take any action that has the effect of any of the above.
Mr. Glaser has special rights under our articles of incorporation to appoint or remove members of the strategic transactions committee at his discretion that could make it more difficult for RealNetworks to be sold or to complete another change of control transaction without Mr. Glaser’s consent. RealNetworks has also entered into an agreement providing Mr. Glaser with certain contractual rights relating to the enforcement of our charter documents and Mr. Glaser’s roles and authority within RealNetworks. These rights and his role as Chairman of the Board of Directors, together with Mr. Glaser’s significant beneficial ownership, create unique potential for concentrated influence of Mr. Glaser over potentially material transactions involving RealNetworks and decisions regarding the future strategy and leadership of RealNetworks.
We adopted a shareholder rights plan in December 1998, which was amended and restated in December 2008, amended in April 2016 and February 2018, and again amended and restated in November 2018. The plan provides that shares of our common stock have associated preferred stock purchase rights, the exercise of which would make the acquisition of RealNetworks by a third party more expensive to that party, having the effect of discouraging third parties from acquiring RealNetworks without the approval of our board of directors, which has the power to redeem these rights and prevent their exercise.
Washington law imposes restrictions on some transactions between a corporation and certain significant shareholders. The foregoing provisions of our charter documents, shareholder rights plan, our agreement with Mr. Glaser, and Washington law, as well as our charter provisions that provide for a classified board of directors and the availability of “blank check” preferred stock, could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Not applicable
(b) Not applicable
(c) Not applicable
Item 3. Default Upon Senior Securities
None
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
None
Item 6. Exhibits
See Index to Exhibits below.