|
|
Item 1.
|
Financial Statements
|
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
June 30,
2019
|
|
December 31,
2018
|
ASSETS
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
$
|
26,339
|
|
|
$
|
35,561
|
|
Short-term investments
|
—
|
|
|
24
|
|
Trade accounts receivable, net of allowances of $644 and $560
|
31,957
|
|
|
11,751
|
|
Deferred costs, current portion
|
465
|
|
|
331
|
|
Prepaid expenses and other current assets
|
20,382
|
|
|
5,911
|
|
Total current assets
|
79,143
|
|
|
53,578
|
|
Equipment, software, and leasehold improvements, at cost:
|
|
|
|
Equipment and software
|
32,079
|
|
|
37,458
|
|
Leasehold improvements
|
3,319
|
|
|
3,292
|
|
Total equipment, software, and leasehold improvements, at cost
|
35,398
|
|
|
40,750
|
|
Less accumulated depreciation and amortization
|
32,268
|
|
|
37,996
|
|
Net equipment, software, and leasehold improvements
|
3,130
|
|
|
2,754
|
|
Operating lease assets
|
13,672
|
|
|
—
|
|
Restricted cash equivalents
|
2,124
|
|
|
1,630
|
|
Other assets
|
2,739
|
|
|
3,997
|
|
Deferred costs, non-current portion
|
797
|
|
|
528
|
|
Deferred tax assets, net
|
854
|
|
|
851
|
|
Other intangible assets, net
|
21,616
|
|
|
26
|
|
Goodwill
|
65,395
|
|
|
16,955
|
|
Total assets
|
$
|
189,470
|
|
|
$
|
80,319
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
Current liabilities:
|
|
|
|
Accounts payable
|
$
|
5,224
|
|
|
$
|
3,910
|
|
Accrued royalties, fulfillment and other current liabilities
|
97,951
|
|
|
11,312
|
|
Commitment to Napster
|
—
|
|
|
2,750
|
|
Deferred revenue, current portion
|
6,054
|
|
|
2,125
|
|
Notes payable
|
7,878
|
|
|
—
|
|
Total current liabilities
|
117,107
|
|
|
20,097
|
|
Deferred revenue, non-current portion
|
179
|
|
|
268
|
|
Deferred rent
|
—
|
|
|
986
|
|
Deferred tax liabilities, net
|
1,262
|
|
|
1,168
|
|
Long-term lease liabilities
|
10,384
|
|
|
—
|
|
Other long-term liabilities
|
11,070
|
|
|
960
|
|
Total liabilities
|
140,002
|
|
|
23,479
|
|
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 38,049 shares in 2019 and 37,728 shares in 2018
|
37
|
|
|
37
|
|
Additional paid-in capital
|
642,720
|
|
|
641,930
|
|
Accumulated other comprehensive loss
|
(61,697
|
)
|
|
(61,118
|
)
|
Retained deficit
|
(531,678
|
)
|
|
(524,009
|
)
|
Total shareholders’ equity
|
49,382
|
|
|
56,840
|
|
Noncontrolling interests
|
86
|
|
|
—
|
|
Total equity
|
49,468
|
|
|
56,840
|
|
Total liabilities and equity
|
$
|
189,470
|
|
|
$
|
80,319
|
|
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
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net revenue
|
$
|
44,248
|
|
|
$
|
15,724
|
|
|
$
|
83,720
|
|
|
$
|
35,374
|
|
Cost of revenue
|
27,282
|
|
|
4,625
|
|
|
52,152
|
|
|
9,761
|
|
Gross profit
|
16,966
|
|
|
11,099
|
|
|
31,568
|
|
|
25,613
|
|
Operating expenses:
|
|
|
|
|
|
|
|
Research and development
|
8,876
|
|
|
7,652
|
|
|
17,709
|
|
|
15,346
|
|
Sales and marketing
|
8,360
|
|
|
4,883
|
|
|
16,502
|
|
|
10,880
|
|
General and administrative
|
8,392
|
|
|
5,339
|
|
|
16,756
|
|
|
10,940
|
|
Restructuring and other charges
|
729
|
|
|
187
|
|
|
896
|
|
|
688
|
|
Lease exit and related benefit
|
—
|
|
|
(129
|
)
|
|
—
|
|
|
(454
|
)
|
Total operating expenses
|
26,357
|
|
|
17,932
|
|
|
51,863
|
|
|
37,400
|
|
Operating loss
|
(9,391
|
)
|
|
(6,833
|
)
|
|
(20,295
|
)
|
|
(11,787
|
)
|
Other income (expenses):
|
|
|
|
|
|
|
|
Interest expense
|
(43
|
)
|
|
—
|
|
|
(209
|
)
|
|
—
|
|
Interest income
|
40
|
|
|
111
|
|
|
117
|
|
|
198
|
|
Gain (loss) on equity investment, net
|
—
|
|
|
—
|
|
|
12,338
|
|
|
—
|
|
Other income (expenses), net
|
183
|
|
|
(42
|
)
|
|
310
|
|
|
(83
|
)
|
Total other income (expenses), net
|
180
|
|
|
69
|
|
|
12,556
|
|
|
115
|
|
Income (loss) before income taxes
|
(9,211
|
)
|
|
(6,764
|
)
|
|
(7,739
|
)
|
|
(11,672
|
)
|
Income tax expense
|
244
|
|
|
166
|
|
|
502
|
|
|
436
|
|
Net income (loss) including noncontrolling interests
|
(9,455
|
)
|
|
(6,930
|
)
|
|
(8,241
|
)
|
|
(12,108
|
)
|
Net income (loss) attributable to noncontrolling interests
|
(253
|
)
|
|
—
|
|
|
(572
|
)
|
|
—
|
|
Net income (loss) attributable to RealNetworks
|
$
|
(9,202
|
)
|
|
$
|
(6,930
|
)
|
|
$
|
(7,669
|
)
|
|
$
|
(12,108
|
)
|
|
|
|
|
|
|
|
|
Net income (loss) per share attributable to RealNetworks- Basic
|
$
|
(0.24
|
)
|
|
$
|
(0.18
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.32
|
)
|
Net income (loss) per share attributable to RealNetworks- Diluted
|
$
|
(0.24
|
)
|
|
$
|
(0.18
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.32
|
)
|
Shares used to compute basic net income (loss) per share
|
37,948
|
|
|
37,577
|
|
|
37,885
|
|
|
37,514
|
|
Shares used to compute diluted net income (loss) per share
|
37,948
|
|
|
37,577
|
|
|
37,885
|
|
|
37,514
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss):
|
|
|
|
|
|
|
|
Unrealized investment holding gains (losses), net of reclassification adjustments
|
$
|
—
|
|
|
$
|
2
|
|
|
$
|
—
|
|
|
$
|
3
|
|
Foreign currency translation adjustments, net of reclassification adjustments
|
(492
|
)
|
|
(1,604
|
)
|
|
(579
|
)
|
|
(1,208
|
)
|
Total other comprehensive income (loss)
|
(492
|
)
|
|
(1,602
|
)
|
|
(579
|
)
|
|
(1,205
|
)
|
Net income (loss) including noncontrolling interests
|
(9,455
|
)
|
|
(6,930
|
)
|
|
(8,241
|
)
|
|
(12,108
|
)
|
Comprehensive income (loss) including noncontrolling interests
|
(9,947
|
)
|
|
(8,532
|
)
|
|
(8,820
|
)
|
|
(13,313
|
)
|
Comprehensive income (loss) attributable to noncontrolling interests
|
(253
|
)
|
|
—
|
|
|
(572
|
)
|
|
—
|
|
Comprehensive income (loss) attributable to RealNetworks
|
$
|
(9,694
|
)
|
|
$
|
(8,532
|
)
|
|
$
|
(8,248
|
)
|
|
$
|
(13,313
|
)
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
|
|
|
|
|
|
|
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
Cash flows from operating activities:
|
|
|
|
Net income (loss) including noncontrolling interests
|
$
|
(8,241
|
)
|
|
$
|
(12,108
|
)
|
Adjustments to reconcile net income (loss) including noncontrolling interests to net cash used in operating activities:
|
|
|
|
Depreciation and amortization
|
2,959
|
|
|
1,231
|
|
Stock-based compensation
|
1,917
|
|
|
1,614
|
|
Deferred income taxes, net
|
—
|
|
|
(12
|
)
|
(Gain) loss on equity investment, net
|
(12,338
|
)
|
|
—
|
|
Foreign currency (gain) loss
|
(315
|
)
|
|
—
|
|
Fair value adjustments to contingent consideration liability
|
300
|
|
|
—
|
|
Mark to market adjustment of warrants
|
—
|
|
|
50
|
|
Net change in certain operating assets and liabilities:
|
|
|
|
Trade accounts receivable
|
671
|
|
|
16,960
|
|
Prepaid expenses, operating lease and other assets
|
(328
|
)
|
|
(1,633
|
)
|
Accounts payable
|
398
|
|
|
(16,601
|
)
|
Accrued, lease and other liabilities
|
(1,122
|
)
|
|
(2,231
|
)
|
Net cash used in operating activities
|
(16,099
|
)
|
|
(12,730
|
)
|
Cash flows from investing activities:
|
|
|
|
Purchases of equipment, software, and leasehold improvements
|
(873
|
)
|
|
(580
|
)
|
Proceeds from sales and maturities of short-term investments
|
24
|
|
|
5,726
|
|
Acquisition, net of cash acquired
|
12,260
|
|
|
(4,192
|
)
|
Net cash provided by investing activities
|
11,411
|
|
|
954
|
|
Cash flows from financing activities:
|
|
|
|
Proceeds from issuance of common stock (stock options and stock purchase plan)
|
144
|
|
|
114
|
|
Tax payments from shares withheld upon vesting of restricted stock
|
(287
|
)
|
|
(243
|
)
|
Proceeds from notes payable
|
19,760
|
|
|
—
|
|
Repayments of notes payable
|
(24,018
|
)
|
|
—
|
|
Other financing activities
|
450
|
|
|
—
|
|
Net cash provided by (used in) financing activities
|
(3,951
|
)
|
|
(129
|
)
|
Effect of exchange rate changes on cash, cash equivalents and restricted cash
|
(89
|
)
|
|
(731
|
)
|
Net increase (decrease) in cash, cash equivalents and restricted cash
|
(8,728
|
)
|
|
(12,636
|
)
|
Cash, cash equivalents and restricted cash, beginning of period
|
37,191
|
|
|
53,596
|
|
Cash, cash equivalents, and restricted cash end of period
|
$
|
28,463
|
|
|
$
|
40,960
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Additional
Paid-In
Capital
|
|
Accumulated
Other
Comprehensive
Income (Loss)
|
|
Retained
Earnings
(Deficit)
|
|
Total
Shareholders’
Equity
|
|
Non-controlling Interests
|
|
Total Equity
|
Shares
|
|
Amount
|
|
|
|
|
|
|
|
|
Balances, January 1, 2018
|
|
37,341
|
|
|
$
|
37
|
|
|
$
|
638,727
|
|
|
$
|
(59,547
|
)
|
|
$
|
(500,044
|
)
|
|
$
|
79,173
|
|
|
$
|
—
|
|
|
$
|
79,173
|
|
Cumulative effect of revenue recognition accounting change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,024
|
|
|
1,024
|
|
|
—
|
|
|
1,024
|
|
Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock
|
|
223
|
|
|
—
|
|
|
(232
|
)
|
|
—
|
|
|
—
|
|
|
(232
|
)
|
|
—
|
|
|
(232
|
)
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
1,157
|
|
|
—
|
|
|
—
|
|
|
1,157
|
|
|
—
|
|
|
1,157
|
|
Investments unrealized gains (losses), net of tax effects of $0
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
1
|
|
|
—
|
|
|
1
|
|
Foreign currency translation adjustments
|
|
—
|
|
|
—
|
|
|
—
|
|
|
396
|
|
|
—
|
|
|
396
|
|
|
—
|
|
|
396
|
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(5,178
|
)
|
|
(5,178
|
)
|
|
—
|
|
|
(5,178
|
)
|
Balances, March 31, 2018
|
|
37,564
|
|
|
$
|
37
|
|
|
$
|
639,652
|
|
|
$
|
(59,150
|
)
|
|
$
|
(504,197
|
)
|
|
$
|
76,342
|
|
|
$
|
—
|
|
|
$
|
76,342
|
|
Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock
|
|
48
|
|
|
—
|
|
|
103
|
|
|
—
|
|
|
—
|
|
|
103
|
|
|
—
|
|
|
103
|
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
457
|
|
|
—
|
|
|
—
|
|
|
457
|
|
|
—
|
|
|
457
|
|
Investments unrealized gains (losses), net of tax effects of $1
|
|
—
|
|
|
—
|
|
|
—
|
|
|
2
|
|
|
—
|
|
|
2
|
|
|
—
|
|
|
2
|
|
Foreign currency translation adjustments
|
|
|
|
|
|
|
|
(1,604
|
)
|
|
|
|
(1,604
|
)
|
|
|
|
(1,604
|
)
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(6,930
|
)
|
|
(6,930
|
)
|
|
—
|
|
|
(6,930
|
)
|
Balances, June 30, 2018
|
|
37,612
|
|
|
$
|
37
|
|
|
$
|
640,212
|
|
|
$
|
(60,752
|
)
|
|
$
|
(511,127
|
)
|
|
$
|
68,370
|
|
|
$
|
—
|
|
|
$
|
68,370
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Additional
Paid-In
Capital
|
|
Accumulated
Other
Comprehensive
Income (Loss)
|
|
Retained
Earnings
(Deficit)
|
|
Total
Shareholders’
Equity
|
|
Non-controlling Interests
|
|
Total Equity
|
Shares
|
|
Amount
|
|
|
|
|
|
|
|
|
Balances, January 1, 2019
|
|
37,728
|
|
|
$
|
37
|
|
|
$
|
641,930
|
|
|
$
|
(61,118
|
)
|
|
$
|
(524,009
|
)
|
|
$
|
56,840
|
|
|
$
|
—
|
|
|
$
|
56,840
|
|
Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock
|
|
190
|
|
|
—
|
|
|
(271
|
)
|
|
—
|
|
|
—
|
|
|
(271
|
)
|
|
—
|
|
|
(271
|
)
|
Napster acquisition
|
|
—
|
|
|
—
|
|
|
(1,346
|
)
|
|
—
|
|
|
—
|
|
|
(1,346
|
)
|
|
570
|
|
|
(776
|
)
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
1,384
|
|
|
—
|
|
|
—
|
|
|
1,384
|
|
|
—
|
|
|
1,384
|
|
Foreign currency translation adjustments
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(87
|
)
|
|
—
|
|
|
(87
|
)
|
|
—
|
|
|
(87
|
)
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,533
|
|
|
1,533
|
|
|
(319
|
)
|
|
1,214
|
|
Other equity transactions
|
|
—
|
|
|
—
|
|
|
362
|
|
|
—
|
|
|
—
|
|
|
362
|
|
|
88
|
|
|
450
|
|
Balances, March 31, 2019
|
|
37,918
|
|
|
$
|
37
|
|
|
$
|
642,059
|
|
|
$
|
(61,205
|
)
|
|
$
|
(522,476
|
)
|
|
$
|
58,415
|
|
|
$
|
339
|
|
|
$
|
58,754
|
|
Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares
|
|
131
|
|
|
—
|
|
|
128
|
|
|
—
|
|
|
—
|
|
|
128
|
|
|
—
|
|
|
128
|
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
533
|
|
|
—
|
|
|
—
|
|
|
533
|
|
|
—
|
|
|
533
|
|
Foreign currency translation adjustments
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(492
|
)
|
|
—
|
|
|
(492
|
)
|
|
—
|
|
|
(492
|
)
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(9,202
|
)
|
|
(9,202
|
)
|
|
(253
|
)
|
|
(9,455
|
)
|
Balances, June 30, 2019
|
|
38,049
|
|
|
$
|
37
|
|
|
$
|
642,720
|
|
|
$
|
(61,697
|
)
|
|
$
|
(531,678
|
)
|
|
$
|
49,382
|
|
|
$
|
86
|
|
|
$
|
49,468
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Six Months Ended
June 30, 2019
and
2018
|
|
|
Note 1
|
Description of Business and Summary of Significant Accounting Policies
|
Description of Business.
RealNetworks, Inc. and subsidiaries is a leading 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. Our Napster music business, which we acquired on January 18, 2019, offers a comprehensive set of digital music products and services designed to provide consumers with broad access to digital music. For more information on Napster, see
Note 5
Acquisitions
.
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 and cash flow.
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 subsidiaries in which it has a more than 50% voting interest. Noncontrolling interests primarily represent third-party ownership in the equity of Napster and are reflected separately in the Company’s financial statements. 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 six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending
December 31, 2019
. 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, 2018
(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 February 2016, the Financial Accounting Standards Board (FASB) issued new guidance related to the accounting for leases. A major change in the new guidance is that lessees are now required to present right-of-use assets and lease liabilities on the balance sheet. Enhanced disclosures are also required to give financial statement users the ability to assess the amount, timing and uncertainty of cash flows arising from leases. We adopted the new guidance effective January 1, 2019 and elected to apply the new guidance at the beginning of the year of adoption, rather than applying the new guidance retrospectively to each prior reporting period presented. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward historical lease classification. We have finalized our assessment of the impacts resulting from the new standard, including the impact on our internal controls. As a result of our evaluation, we have modified certain accounting policies and practices and existing controls. Adoption of the standard resulted in the recognition of
$12.5 million
of operating lease assets and
$14.6 million
of current and long-term operating lease liabilities as of January 1, 2019. The difference between the operating lease assets and lease liabilities recorded upon adoption relates to previously accrued deferred rent and lease exit and related charges included on our balance sheet as of December 31, 2018. Lease exit and related charges previously recorded pertain to the reduction in use of RealNetworks' office space and included estimates of sublease income expected to be received. The new guidance did not materially impact our consolidated statement of operations in the quarter of adoption or in the second quarter of 2019 and did not cause revision to
previously recorded estimates for lease exit charges. See
Note 14
Leases
for additional information about the new accounting standard.
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. We adopted the new guidance effective January 1, 2019, with no material impact on our consolidated financial statements and related disclosures.
Recently issued accounting pronouncements not yet adopted
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 in fiscal years beginning after December 15, 2019, with early adoption permitted. We are evaluating the impact of this 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
|
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.
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. This 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.
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.
Napster revenue arrangements include subscription services to the Napster music streaming service sold either directly to end users (direct to consumer) or through partners (business to business), who are generally telecommunications companies, that bundle the subscription with their own services or collect payment for the stand-alone subscriptions from their end customers. Napster also sells subscriptions to third parties to provide access to the Napster platform that is typically embedded in the third party's branded or co-branded service. Such subscriptions are included in the business to business sales channel.
For services sold through third parties to end customers, we evaluate the presentation of revenue on a gross or net basis based on whether we control the service provided to the end-user and are the principal (i.e. “gross”), or we arrange for other parties to provide the service to the end-user and are an agent (i.e. “net”). In our Napster business to business revenue stream, we generally operate as a principal in arrangements with end customers as we maintain control over the service prior to being transferred to the end customer.
Certain business to business customer arrangements include variable consideration based on usage. We estimate variable consideration as part of the total transaction price that is allocated to performance obligations, or distinct service periods within a performance obligation, on a relative standalone selling price basis.
Revenues related to Napster subscription services are recognized ratably over the contract period, typically 30 days. Direct to consumer subscriptions are paid in advance, typically on a monthly basis. Subscription services offered to businesses are invoiced on a monthly basis and the timing of payment generally does not vary significantly from the timing of invoice.
Disaggregation of Revenue
The following table presents our disaggregated revenue by source and segment (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30, 2019
|
|
Six Months Ended June 30, 2019
|
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
Business Line
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software License
|
|
$
|
944
|
|
|
$
|
957
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,679
|
|
|
$
|
1,556
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Subscription Services
|
|
1,040
|
|
|
6,040
|
|
|
3,073
|
|
|
28,583
|
|
|
2,128
|
|
|
12,380
|
|
|
6,058
|
|
|
52,920
|
|
Product Sales
|
|
206
|
|
|
—
|
|
|
2,177
|
|
|
—
|
|
|
425
|
|
|
—
|
|
|
4,165
|
|
|
—
|
|
Advertising and Other
|
|
430
|
|
|
—
|
|
|
798
|
|
|
—
|
|
|
874
|
|
|
|
|
1,535
|
|
|
—
|
|
Total
|
|
$
|
2,620
|
|
|
$
|
6,997
|
|
|
$
|
6,048
|
|
|
$
|
28,583
|
|
|
$
|
5,106
|
|
|
$
|
13,936
|
|
|
$
|
11,758
|
|
|
$
|
52,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30, 2018
|
|
Six Months Ended June 30, 2018
|
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
Business Line
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Software License
|
|
$
|
1,808
|
|
|
$
|
469
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,145
|
|
|
$
|
1,804
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Subscription Services
|
|
1,225
|
|
|
6,250
|
|
|
2,689
|
|
|
—
|
|
|
2,510
|
|
|
13,619
|
|
|
5,382
|
|
|
—
|
|
Product Sales
|
|
299
|
|
|
—
|
|
|
1,953
|
|
|
—
|
|
|
639
|
|
|
—
|
|
|
4,355
|
|
|
—
|
|
Advertising and Other
|
|
552
|
|
|
—
|
|
|
479
|
|
|
—
|
|
|
1,073
|
|
|
—
|
|
|
847
|
|
|
—
|
|
Total
|
|
$
|
3,884
|
|
|
$
|
6,719
|
|
|
$
|
5,121
|
|
|
$
|
—
|
|
|
$
|
9,367
|
|
|
$
|
15,423
|
|
|
$
|
10,584
|
|
|
$
|
—
|
|
The following table presents our disaggregated revenue by sales channel (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30, 2019
|
|
Six Months Ended June 30, 2019
|
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
Sales Channel
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business to Business
|
|
$
|
1,375
|
|
|
$
|
6,881
|
|
|
$
|
1,115
|
|
|
$
|
13,804
|
|
|
$
|
2,553
|
|
|
$
|
13,698
|
|
|
$
|
2,151
|
|
|
$
|
25,899
|
|
Direct to Consumer
|
|
1,245
|
|
|
116
|
|
|
4,933
|
|
|
14,779
|
|
|
2,553
|
|
|
238
|
|
|
9,607
|
|
|
27,021
|
|
Total
|
|
$
|
2,620
|
|
|
$
|
6,997
|
|
|
$
|
6,048
|
|
|
$
|
28,583
|
|
|
$
|
5,106
|
|
|
$
|
13,936
|
|
|
$
|
11,758
|
|
|
$
|
52,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30, 2018
|
|
Six Months Ended June 30, 2018
|
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
|
Consumer Media
|
|
Mobile Services
|
|
Games
|
|
Napster
|
Sales Channel
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business to Business
|
|
$
|
2,360
|
|
|
$
|
6,573
|
|
|
$
|
836
|
|
|
$
|
—
|
|
|
$
|
6,218
|
|
|
$
|
15,103
|
|
|
$
|
1,587
|
|
|
$
|
—
|
|
Direct to Consumer
|
|
1,524
|
|
|
146
|
|
|
4,285
|
|
|
—
|
|
|
3,149
|
|
|
320
|
|
|
8,997
|
|
|
—
|
|
Total
|
|
$
|
3,884
|
|
|
$
|
6,719
|
|
|
$
|
5,121
|
|
|
$
|
—
|
|
|
$
|
9,367
|
|
|
$
|
15,423
|
|
|
$
|
10,584
|
|
|
$
|
—
|
|
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
June 30, 2019
and
December 31, 2018
, our balance of long-term accounts receivable was
$0.1 million
and
$0.7 million
, respectively, and is included in other long-term assets on our condensed consolidated balance sheets. The decrease in this balance from
December 31, 2018
to
June 30, 2019
is primarily due to the timing of expected cash receipts. During the quarter and six months ended June 30, 2019, 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
June 30, 2019
, we had a deferred revenue balance of
$6.2 million
, an increase of
$3.8 million
from
December 31, 2018
, primarily due to deferred revenue associated with Napster.
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
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Total stock-based compensation expense
|
$
|
533
|
|
|
$
|
457
|
|
|
$
|
1,917
|
|
|
$
|
1,614
|
|
The fair value of RealNetworks options granted determined using the Black-Scholes model used the following weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Expected dividend yield
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Risk-free interest rate
|
2.26
|
%
|
|
2.72
|
%
|
|
2.32
|
%
|
|
2.59
|
%
|
Expected life (years)
|
3.8
|
|
|
3.8
|
|
|
4.1
|
|
|
4.0
|
|
Volatility
|
41
|
%
|
|
35
|
%
|
|
41
|
%
|
|
35
|
%
|
The total stock-based compensation amounts for
2019
and
2018
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
six months ended June 30, 2019
and 2018 was stock compensation expense recorded in the first quarter of 2019 and 2018 related to our 2018 and 2017 incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2019 and 2018, respectively.
As of
June 30, 2019
,
$3.1 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
3.1
years.
Napster
On
January 18, 2019
, RealNetworks acquired an additional
42%
interest in Rhapsody International, Inc. (doing business as Napster) bringing our aggregate ownership to
84%
of Napster's outstanding equity, thus giving RealNetworks a majority voting interest. Napster's music streaming service provides users with broad access to digital music, offering on-demand streaming and conditional downloads through unlimited access to a catalog of millions of music tracks. Napster offers music services worldwide and generates revenue primarily through subscriptions to its music services either directly to consumers or through distribution partners.
Initially formed in 2007 and branded then as Rhapsody, Napster began as a joint venture between RealNetworks and MTV Networks, a division of Viacom International, Inc. Prior to the acquisition of the additional
42%
interest in Napster, we accounted for our investment using the equity method of accounting.
Following the January 2019 acquisition, RealNetworks has the right to nominate directors constituting a majority of the Napster board of directors, however, Napster will continue to operate as an independent business with its own board of directors, strategy and leadership team. We are consolidating Napster's financial results into our financial statements for fiscal periods following the closing of the acquisition, and Napster is reported as a separate segment in RealNetworks' consolidated financial statements. Napster, however, remains a distinct legal entity and RealNetworks assumes no ownership or control over the assets or liabilities of Napster.
We have preliminarily recorded 100% of the estimated fair value of the assets acquired and liabilities assumed as of
January 18, 2019
based on the results of an independent valuation. The
16%
of Napster that we do not own is accounted for as a noncontrolling interest in our consolidated financial statements, and as part of this consolidation, the carrying value of our previous
42%
equity method investment was remeasured to fair value on the acquisition date. The remeasurement to fair value of the historical
42%
ownership interest resulted in the recognition of a
$2.7 million
gain in the first quarter of 2019, which is a component of the overall gain recognized as a part of this transaction. Our consolidated balance sheet reflects Napster's working capital deficit, which results in a consolidated working capital deficit. RealNetworks does not have any contractual or implied obligation to provide funding or other financial support to Napster, or to guarantee or provide other such support related to Napster's third party borrowing or Napster's other obligations on our consolidated balance sheet, except as discussed in
Note 15
Commitments and Contingencies
.
The terms of the transaction included initial cash consideration of
$1.0 million
and additional contingent consideration. Initial cash consideration of
$0.2 million
was paid at closing and the remainder of the initial cash consideration is included in accrued royalties, fulfillment and other current liabilities and will be paid when due with existing cash balances. With regards to contingent consideration, over the five years following the acquisition, RealNetworks will pay the lesser of the following:
(a) an additional
$14.0 million
to seller, or
(b) if RealNetworks sells the interest to a third party for less than
$15.0 million
, the actual amount received by RealNetworks, minus the
$1.0 million
initial payment.
In the event that RealNetworks sells such equity interest for consideration in excess of
$15.0 million
, RealNetworks will pay seller additional consideration, dependent on the sale price, which shall in no event exceed an additional
$25.0 million
. In order for seller to receive the full
$40.0 million
, the proceeds from the sale of Napster received by RealNetworks for the
42%
equity interest acquired would have to exceed
$60.0 million
. These contingent consideration amounts were part of the total consideration at estimated fair value, as described in more detail below.
The following table summarizes the preliminary allocation of the total consideration to the estimated fair values of the assets acquired and liabilities assumed as of
January 18, 2019
(in thousands):
|
|
|
|
|
|
Consideration, at estimated fair value:
|
|
|
Cash
|
|
$
|
1,000
|
|
Contingent consideration
|
|
11,600
|
|
RealNetworks' preexisting 42% equity interest in Napster
|
|
2,700
|
|
Effective settlement of Napster debt and warrants, held by RealNetworks
|
|
6,408
|
|
Total consideration
|
|
$
|
21,708
|
|
|
|
|
Assets acquired and liabilities assumed, at estimated fair value:
|
|
|
Cash and cash equivalents
|
|
$
|
10,138
|
|
Accounts receivable
|
|
20,838
|
|
Prepaid expenses and other current assets
|
|
12,879
|
|
Restricted cash
|
|
2,322
|
|
Equipment, software and leasehold improvements
|
|
474
|
|
Operating lease assets
|
|
2,314
|
|
Other long-term assets
|
|
77
|
|
Deferred tax assets, net
|
|
5,942
|
|
Intangible assets
|
|
23,700
|
|
Goodwill
|
|
48,474
|
|
Total assets acquired
|
|
127,158
|
|
|
|
|
Accounts payable
|
|
937
|
|
Accrued royalties and fulfillment
|
|
71,980
|
|
Accrued and other current liabilities
|
|
7,475
|
|
Deferred revenue, current portion
|
|
3,600
|
|
Notes payable
|
|
12,115
|
|
Deferred tax liabilities, net
|
|
6,061
|
|
Long-term lease liabilities
|
|
1,197
|
|
Other long-term liabilities
|
|
1,515
|
|
Total liabilities assumed
|
|
104,880
|
|
Total net assets acquired
|
|
22,278
|
|
Noncontrolling interests
|
|
570
|
|
Net assets acquired
|
|
$
|
21,708
|
|
Under the acquisition method of accounting, the purchase price is allocated to the assets acquired and the liabilities assumed based on their estimated fair values. Due to the complexity and limited time since closing the transaction, the purchase price allocation is subject to change, which may result from additional information becoming available and additional analyses being performed on these acquired assets and assumed liabilities. Such changes could impact estimated fair values of intangible assets, accrued royalties and fulfillment, deferred revenue, and assets and liabilities assumed, as well as the contingent consideration, noncontrolling interests, and gain recognized from consolidation. Purchase price allocation adjustments may be recorded during the measurement period (a period not to exceed 12 months from the acquisition date). The final purchase price allocation could result in material differences, which could have a material impact on our financial statements.
Acquired intangible assets have a total weighted average useful life of approximately 8 years, are being amortized using the straight line method, and are comprised of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
Intangible category
|
|
Estimated fair value
|
|
Method used to calculate fair value
|
|
Estimated remaining useful life
|
Trade name and trademarks
|
|
$
|
6,800
|
|
|
Relief-from-royalty
|
|
15 years
|
Developed technology
|
|
5,900
|
|
|
Excess earnings
|
|
4 years
|
Customer relationships
|
|
5,900
|
|
|
Cost-to-replace
|
|
3 years
|
Partner relationships
|
|
5,100
|
|
|
Distributor method
|
|
8 years
|
Total
|
|
$
|
23,700
|
|
|
|
|
|
The estimated fair value amounts for each of these intangibles were determined using a fair value measurement categorized within Level 3 of the fair value hierarchy.
The fair value of the trade name and trademarks intangible asset was estimated using the income approach, utilizing the relief from royalty method, which values the assets by estimating the savings achieved by ownership of trade name and trademarks when compared with the cost of licensing them from an independent owner.
The fair value of developed technology was estimated using the income approach, utilizing the excess earnings method. Under this method, cash flows attributable to the asset are estimated by deducting economic costs, including operating expenses and contributory asset charges, from revenue expected to be generated by the asset.
The fair value of customer relationships was estimated using a cost-to-replace approach, whereby the number of subscribers and the cost to acquire subscribers are key estimates utilized in the valuation.
The fair value of partner relationships was estimated using the income approach, which uses market-based distributor data to value underlying distributor relationships. Revenue, earnings, and cash flow estimates associated with these underlying distributor relationships are key estimates in determining the fair value of the partner relationships intangibles.
The fair value of deferred revenue was estimated using the income approach, utilizing a cost to fulfill analysis by estimating the direct and indirect costs related to supporting remaining obligations plus an assumed operating margin.
The fair value of our preexisting
42%
equity method investment has been remeasured to an estimated fair value of
$2.7 million
, which resulted in a pretax gain of
$2.7 million
, as our existing carrying value was zero. This gain, as well as the settlement of preexisting relationships and other purchase accounting adjustments discussed below, comprise the total gain of
$12.3 million
recognized in Other income (expenses) in the Consolidated statement of operations for the first quarter of 2019.
The fair value of our preexisting equity method investment was calculated using an average of the income and market approach to arrive at estimated total enterprise value. The income approach fair value measurement was based on significant inputs that are not observable in the market and thus represents a fair value measurement categorized within Level 3 of the fair value hierarchy. Key assumptions used in estimating future cash flows included projected revenue growth and operating expenses, as well as the selection of an appropriate discount rate. Estimates of revenue growth and operating expenses were based on internal projections and considered the historical performance of Napster's business. The discount rate applied was based on Napster's weighted-average cost of capital and included a small-company risk premium. The market approach fair value measurement was based on a market comparable methodology. We used a group of comparable companies and selected an appropriate EBITDA and revenue multiple to apply to Napster's trailing twelve months and projected 2019, 2020 and 2021 EBITDA (weighted 90%) and revenues (weighted 10%). Assumptions in both the income and market approaches are significant to the overall valuation of Napster and changes to these assumptions could materially impact the preliminary fair values of assets acquired and liabilities assumed, noncontrolling interests, total consideration, and gain on consolidation.
The fair value of the contingent consideration was estimated using multiple scenarios for each tranche of contingent consideration and then probability weighting each scenario and discounting them to estimated fair value of
$11.6 million
. This fair value calculation is directly impacted by the estimated total enterprise value described above. After the completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, the contingent consideration will be adjusted quarterly to fair value through earnings. Of the total amount of
$11.6 million
, we accrued
$2.6 million
and
$9.0 million
in Accrued royalties, fulfillment and other current liabilities, and Other long-term liabilities, respectively, as of March 31, 2019. See Note 6 Fair Value Measurements for details on the adjustment to this liability for the second quarter of 2019.
The effective settlement of Napster's debt and warrants totaling
$6.4 million
represents the estimated fair value of debt and warrants held between RealNetworks and Napster as of the acquisition date. The estimated fair value is derived from the estimated total enterprise value described above. The resulting net gain of
$5.5 million
is included in Other income (expenses) in the Consolidated statement of operations.
As discussed in
Note 15
Commitments and Contingencies
, the preexisting
$2.8 million
guarantee related to Napster's outstanding indebtedness on their revolving credit facility was eliminated upon the consolidation of Napster. This resulted in RealNetworks recording a gain of
$2.8 million
, which is included in Other income (expenses) in the Consolidated statement of operations.
Prior to our acquisition of Napster, we accounted for our investment under the equity method of accounting and recorded Napster 's foreign currency translation adjustments in our equity. As part of the acquisition method of accounting, we released these amounts and recorded a gain of
$1.3 million
, which is included in Other income (expenses) in the Consolidated statement of operations.
We recorded the fair value of noncontrolling interests on the acquisition date, estimated at
$0.6 million
, using the estimated total enterprise value described above.
We also recorded goodwill of
$48.5 million
, representing the intangible assets that do not qualify for separate recognition for accounting purposes, including the expected growth in Napster's business to business model and the assembled workforce. The goodwill is reported in our Napster segment and is not deductible for income tax purposes. As discussed above, during the measurement period, purchase price allocation adjustments or changes in assumptions used in determining the total estimated enterprise value of Napster could materially impact goodwill recognized. Moreover, future performance of the Napster business will factor into our goodwill impairment analysis.
We began consolidating Napster's results of operations and cash flows into our consolidated financial statements after
January 18, 2019
. For the
quarter ended June 30, 2019
, Napster's revenue and net loss including noncontrolling interests in our consolidated statements of operations was
$28.6 million
and
$1.5 million
, respectively. For the
six months ended June 30, 2019
, Napster's revenue and net loss including noncontrolling interests in our consolidated statements of operations was
$52.9 million
and
$3.3 million
, respectively.
The following table provides the supplemental pro forma revenue and net results of the combined entity had the acquisition date of Napster been the first day of our first
quarter
of
2018
rather than during our first
quarter
of
2019
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended - Pro Forma (Unaudited)
June 30,
|
|
Six Months Ended - Pro Forma (Unaudited)
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net revenue
|
$
|
44,355
|
|
|
$
|
52,296
|
|
|
$
|
90,193
|
|
|
$
|
112,145
|
|
Net income (loss) attributable to RealNetworks
(1)
|
(8,455
|
)
|
|
(4,694
|
)
|
|
(17,973
|
)
|
|
2,295
|
|
(1)
The pro forma net earnings attributable to RealNetworks for the
quarter ended June 30, 2018
include
$0.4 million
of transaction costs, and for the six months ended June 30, 2018, pro forma net earnings attributable to RealNetworks include the acquisition related gain of
$12.3 million
and
$1.2 million
of transaction costs. The amounts in the supplemental pro forma earnings for the periods presented above fully eliminate intercompany transactions and conform Napster's accounting policies to RealNetworks'. These pro forma results also reflect amortization of acquisition-related intangibles and fair value adjustments to deferred revenue and contingent consideration.
The unaudited pro forma amounts are based upon the historical financial statements of RealNetworks and Napster and were prepared using the acquisition method of accounting and are not necessarily indicative of results for any current or future period. The purchase price allocation is preliminary and is subject to change prior to finalization. The final purchase price allocation could result in material differences, which could have a material impact on the accompanying pro forma amounts.
For the quarter and six months ended June 30, 2019, we incurred approximately
$0.4 million
and
$1.2 million
, respectively, in acquisition-related costs, including regulatory, legal, and other advisory fees, which we have recorded within general and administrative expenses.
Games
As described in more detail in our
2018
10-K, 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
in April 2018.
|
|
|
Note 6
|
Fair Value Measurements
|
Items Measured at Fair Value on a Recurring Basis
The following tables present information about our financial assets that have been measured at fair value on a recurring basis as of
June 30, 2019
and
December 31, 2018
, and indicates the fair value hierarchy of the valuation inputs utilized to determine fair value (in thousands)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
Amortized Cost as of
|
|
June 30, 2019
|
|
June 30, 2019
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
25,660
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
25,660
|
|
|
$
|
25,660
|
|
Money market funds
|
679
|
|
|
—
|
|
|
—
|
|
|
679
|
|
|
679
|
|
Total cash and cash equivalents
|
26,339
|
|
|
—
|
|
|
—
|
|
|
26,339
|
|
|
26,339
|
|
Restricted cash equivalents
|
—
|
|
|
2,124
|
|
|
—
|
|
|
2,124
|
|
|
2,124
|
|
Total assets
|
$
|
26,339
|
|
|
$
|
2,124
|
|
|
$
|
—
|
|
|
$
|
28,463
|
|
|
$
|
28,463
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Accrued royalties, fulfillment and other current liabilities
|
|
|
|
|
|
|
|
|
|
Napster acquisition contingent consideration
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,685
|
|
|
$
|
2,685
|
|
|
N/A
|
|
Other long-term liabilities
|
|
|
|
|
|
|
|
|
|
Napster acquisition contingent consideration
|
—
|
|
|
—
|
|
|
9,215
|
|
|
9,215
|
|
|
N/A
|
|
Total liabilities
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
11,900
|
|
|
$
|
11,900
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
Amortized Cost as of
|
|
December 31, 2018
|
|
December 31, 2018
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
22,853
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
22,853
|
|
|
$
|
22,853
|
|
Money market funds
|
12,708
|
|
|
—
|
|
|
—
|
|
|
12,708
|
|
|
12,708
|
|
Total cash and cash equivalents
|
35,561
|
|
|
—
|
|
|
—
|
|
|
35,561
|
|
|
35,561
|
|
Short-term investments:
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds
|
—
|
|
|
24
|
|
|
—
|
|
|
24
|
|
|
24
|
|
Total short-term investments
|
—
|
|
|
24
|
|
|
—
|
|
|
24
|
|
|
24
|
|
Restricted cash equivalents
|
—
|
|
|
1,630
|
|
|
—
|
|
|
1,630
|
|
|
1,630
|
|
Warrants issued by Napster (included in Other assets)
|
—
|
|
|
—
|
|
|
865
|
|
|
865
|
|
|
—
|
|
Total assets
|
$
|
35,561
|
|
|
$
|
1,654
|
|
|
$
|
865
|
|
|
$
|
38,080
|
|
|
$
|
37,215
|
|
Restricted cash equivalents as of
June 30, 2019
and
December 31, 2018
relate to cash pledged as collateral against letters of credit in connection with lease agreements.
Accrued royalties, fulfillment and other current liabilities and Other long-term liabilities as of
June 30, 2019
include the estimated fair value of the contingent consideration for the Napster acquisition, which was determined using a fair value measurement categorized within Level 3 of the fair value hierarchy. As discussed in
Note 5
Acquisitions
, after completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, this liability is adjusted quarterly to fair value through earnings. In the second quarter of 2019, we recorded the change in fair value of the contingent consideration of
$0.3 million
as an increase to the total liability on the consolidated balance sheet and as general and administrative expense on the consolidated statement of operations.
Realized gains or losses on sales of short-term investment securities for the quarters and six months ended
June 30, 2019
and
2018
were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of
June 30, 2019
and
December 31, 2018
were also not significant.
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
six months ended June 30, 2019
and
2018
, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
|
|
|
Note 7
|
Other Intangible Assets
|
Other intangible assets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2019
|
|
December 31, 2018
|
|
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
Amortizing intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
41,155
|
|
|
$
|
31,358
|
|
|
$
|
9,797
|
|
|
$
|
30,993
|
|
|
$
|
30,993
|
|
|
$
|
—
|
|
|
Developed technology
|
|
29,934
|
|
|
24,710
|
|
|
5,224
|
|
|
24,446
|
|
|
24,446
|
|
|
—
|
|
|
Patents, trademarks and tradenames
|
|
10,471
|
|
|
3,879
|
|
|
6,592
|
|
|
3,765
|
|
|
3,765
|
|
|
—
|
|
|
Service contracts
|
|
5,454
|
|
|
5,451
|
|
|
3
|
|
|
5,538
|
|
|
5,512
|
|
|
26
|
|
|
Total
|
|
$
|
87,014
|
|
|
$
|
65,398
|
|
|
$
|
21,616
|
|
|
$
|
64,742
|
|
|
$
|
64,716
|
|
|
$
|
26
|
|
Amortization expense related to other intangible assets during the quarters ended June 30,
2019
, and June 30,
2018
, was
$1.1 million
and
$0.1 million
, respectively. Amortization expense related to other intangible assets during the six months ended June 30,
2019
, and June 30,
2018
, was
$2.1 million
and
$0.2 million
, respectively.
Estimated future amortization of other intangible assets (in thousands):
|
|
|
|
|
|
|
|
Future Amortization
|
2019 (Excluding the six months ended June 30, 2019)
|
|
$
|
2,266
|
|
2020
|
|
4,526
|
|
2021
|
|
4,526
|
|
2022
|
|
2,641
|
|
2023
|
|
1,145
|
|
Thereafter
|
|
6,512
|
|
|
|
$
|
21,616
|
|
See
Note 5
Acquisitions
for details on our acquisitions. No impairments of other intangible assets were recognized in either of the
six months ended June 30, 2019
or
2018
.
The following table presents changes in goodwill (in thousands):
|
|
|
|
|
Balance, December 31, 2018
|
$
|
16,955
|
|
Increases due to current year acquisitions
|
48,474
|
|
Effects of foreign currency translation
|
(34
|
)
|
Balance, June 30, 2019
|
$
|
65,395
|
|
See
Note 5
Acquisitions
for details on our acquisitions and the impact to goodwill.
The following table presents goodwill by segments (in thousands):
|
|
|
|
|
|
June 30,
2019
|
Consumer Media
|
$
|
580
|
|
Mobile Services
|
2,032
|
|
Games
|
14,309
|
|
Napster
|
48,474
|
|
Total goodwill
|
$
|
65,395
|
|
No impairment of goodwill was recognized in either of the
six months ended June 30, 2019
or in
2018
.
|
|
|
Note 9
|
Accrued royalties, fulfillment and other current liabilities
|
Accrued royalties, fulfillment and other current liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
June 30, 2019
|
|
December 31, 2018
|
Royalties and other fulfillment costs
|
$
|
75,849
|
|
|
$
|
1,989
|
|
Employee compensation, commissions and benefits
|
6,395
|
|
|
4,444
|
|
Sales, VAT and other taxes payable
|
3,293
|
|
|
785
|
|
Operating Lease Liabilities - Current
|
5,028
|
|
|
—
|
|
Other
|
7,386
|
|
|
4,094
|
|
Total accrued royalties, fulfillment and other current liabilities
|
$
|
97,951
|
|
|
$
|
11,312
|
|
Included in royalties and other fulfillment costs are Napster's accrued music royalties totaling
$74.1 million
at June 30, 2019. Napster’s agreements and arrangements with rights holders for the content used in its business are complex and the determination of royalty accruals involves significant judgments, assumptions, and estimates of the amounts to be paid.
The variables involved in determining royalty accruals include unmatched royalty accruals, revenue to be recognized, the type of content used and the country it is used in, outstanding royalty audits, and identification of appropriate license holders, among other variables. In addition, some rights holders have allowed the use of their content while negotiations of the terms and conditions are ongoing. In certain jurisdictions, rights holders have several years to claim royalties for musical composition.
While Napster bases its estimates on historical experience and on various assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates in the event of modified assumptions or conditions.
Related to Napster's accrued music royalties are amounts that are advanced to certain music publishers for royalty amounts that have been agreed as being owed, but for which the underlying rights holder have not yet been specifically matched. These prepaid royalty amounts totaling
$12.9 million
at June 30, 2019 are included in Prepaid expenses and other current assets on the unaudited condensed consolidated balance sheets. When these amounts are ultimately matched and invoiced to Napster, the prepaid royalty amount and the related accrued royalty liability are offset on the unaudited condensed consolidated balance sheets.
|
|
|
Note 10
|
Notes Payable - Napster
|
In 2017, Napster entered into a Non-Recourse Purchase of Eligible Receivables Agreement (NRP Agreement) with an international bank (Purchaser) in which Napster will sell and assign on a continuing basis its eligible receivables to the Purchaser in return for
90%
of the receivables upfront, up to a maximum amount of
$15.0 million
in advances. The interest rate is
2.25%
above the 1-month-EURIBOR with a minimum
0.0%
rate applying to the 1-month-EURIBOR rate. As of
June 30, 2019
, Napster had
$7.9 million
borrowings outstanding with an interest rate of
2.25%
.
In 2015, Napster entered into a Loan and Security Agreement (Revolver LSA) with a bank. The available borrowing on the Revolver LSA was based upon Napster's accounts receivable and direct to consumer subscription deposits. The Revolver LSA had a maximum available balance of
$7.0 million
. The Revolver LSA matured and the loan balance was paid in full on April 30, 2019.
The Revolver LSA required Napster to maintain a balance of unrestricted cash at the bank of not less than
$1.5 million
plus
5%
of the total amount outstanding under the NRP Agreement. As the loan was paid off on April 30, 2019, this amount is no longer restricted.
|
|
|
Note 11
|
Restructuring Charges
|
Restructuring and other charges in
2019
and
2018
consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts, which primarily relate to severance costs due to workforce reductions.
Our Games segment continues its shift to focus on free-to-play games that offer in-game purchases of virtual goods and away from premium mobile games that require a one-time purchase. While certain new premium mobile games will be offered, this shift in focus resulted in restructuring costs of
$0.6 million
for the quarter, recorded in the Corporate segment.
Restructuring charges are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Separation Costs
|
|
Asset Related and Other Costs
|
|
Total
|
Costs incurred and charged to expense for the six months ended June 30, 2019
|
|
$
|
344
|
|
|
$
|
552
|
|
|
$
|
896
|
|
Costs incurred and charged to expense for the six months ended June 30, 2018
|
|
$
|
688
|
|
|
$
|
—
|
|
|
$
|
688
|
|
Changes to the accrued restructuring liability (which is included in Accrued royalties, fulfillment and other current liabilities) for
2019
(in thousands) are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Separation Costs
|
|
Asset Related and Other Costs
|
|
Total
|
Accrued liability at December 31, 2018
|
|
$
|
755
|
|
|
$
|
—
|
|
|
$
|
755
|
|
Costs incurred and charged to expense for the six months ended June 30, 2019, excluding noncash charges
|
|
344
|
|
|
227
|
|
|
571
|
|
Cash payments
|
|
(693
|
)
|
|
—
|
|
|
(693
|
)
|
Accrued liability at June 30, 2019
|
|
$
|
406
|
|
|
$
|
227
|
|
|
$
|
633
|
|
As of
June 30, 2019
, RealNetworks has
$4.5 million
in uncertain tax positions, of which
$4.1 million
of unrecognized tax positions was recorded through purchase accounting on January 18, 2019 as a result of the acquisition of Napster. 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.
|
|
|
Note 13
|
Income (Loss) Per Share
|
Basic net income (loss) per share (EPS) is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) attributable to RealNetworks 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
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net income (loss) attributable to RealNetworks
|
$
|
(9,202
|
)
|
|
$
|
(6,930
|
)
|
|
$
|
(7,669
|
)
|
|
$
|
(12,108
|
)
|
Weighted average common shares outstanding used to compute basic EPS
|
37,948
|
|
|
37,577
|
|
|
37,885
|
|
|
37,514
|
|
Dilutive effect of stock based awards
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average common shares outstanding used to compute diluted EPS
|
37,948
|
|
|
37,577
|
|
|
37,885
|
|
|
37,514
|
|
|
|
|
|
|
|
|
|
Basic EPS attributable to RealNetworks
|
$
|
(0.24
|
)
|
|
$
|
(0.18
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.32
|
)
|
Diluted EPS attributable to RealNetworks
|
$
|
(0.24
|
)
|
|
$
|
(0.18
|
)
|
|
$
|
(0.20
|
)
|
|
$
|
(0.32
|
)
|
During the quarter and six months ended
June 30, 2019
,
7.7 million
and
7.3 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 six months ended June 30, 2018,
5.9 million
and
6.0 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.
We have commitments for future payments related to office facilities leases. We determine if an arrangement is a lease at inception. Operating leases are included in Operating lease assets, Other current liabilities, and Long-term lease liabilities on our consolidated balance sheets. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
Operating lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. Operating lease assets also exclude lease incentives and initial direct costs incurred. Some of our leases include options to extend or terminate the lease. Our leases generally include one or more options to renew; however, the exercise of lease renewal options is at our sole discretion. For nearly all of our operating leases, upon adoption of the new guidance, we have not assumed any options to extend will be exercised as part of our calculation of the lease liability. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
We have operating leases for office space and data centers with remaining lease terms of
1
year to
5
years.
Details related to lease expense and supplemental cash flow were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
|
2019
|
|
2019
|
Operating lease expense
|
|
$
|
1,463
|
|
|
$
|
2,803
|
|
Variable lease expense
|
|
358
|
|
|
511
|
|
Sublease income
|
|
(511
|
)
|
|
(986
|
)
|
Net lease expense
|
|
$
|
1,310
|
|
|
$
|
2,328
|
|
|
|
|
|
|
Operating cash outflows for lease liabilities
|
|
$
|
1,412
|
|
|
$
|
2,873
|
|
Details related to lease term and discount rate were as follows:
|
|
|
|
|
|
|
June 30, 2019
|
Weighted-average remaining lease term (in years)
|
|
4 years
|
|
Weighted-average discount rate
|
|
5.13
|
%
|
Future minimum lease payments as of June 30,
2019
were as follows (in thousands):
|
|
|
|
|
|
|
|
Operating
Leases
|
2019 (Excluding the six months ended June 30, 2019)
|
|
$
|
2,737
|
|
2020
|
|
4,909
|
|
2021
|
|
3,296
|
|
2022
|
|
2,429
|
|
2023
|
|
2,347
|
|
Thereafter
|
|
1,634
|
|
Total minimum payments
(a)
|
|
17,352
|
|
Less: Imputed interest
|
|
1,940
|
|
Present value of total minimum payments
(b)
|
|
$
|
15,412
|
|
(a)
Total minimum payments exclude executory costs, inclusive of insurance, maintenance, and taxes, of
$6.9 million
; minimum payments also have not been reduced by sublease rentals of
$6.1 million
due in the future under noncancelable subleases.
(b)
$10.4 million
is included in Long-term lease liabilities and
$5.0 million
is included in Accrued royalties, fulfillment, and other current liabilities on the condensed consolidated balance sheets.
As of December 31, 2018, future minimum lease payments were
$15.9 million
in the aggregate, which consisted of the following:
$3.7 million
in 2019;
$3.0 million
in 2020;
$2.7 million
in 2021;
$2.4 million
in 2022;
$2.3 million
in 2023; and
$1.6 million
thereafter.
|
|
|
Note 15
|
Commitments and Contingencies
|
We have been in the past and could become in the future 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. 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 2017, we entered into an arrangement whereby we may be required to guarantee up to
$2.8 million
of Napster's outstanding indebtedness on their revolving credit facility. At that time and as a result of the guaranty, RealNetworks recognized previously suspended Napster losses up to the full
$2.8 million
guaranty in our consolidated statement of operations and as a Commitment to Napster in our consolidated balance sheets. Given the controlling interest RealNetworks acquired in Napster in the first quarter of 2019, we have eliminated the previously recorded guaranty from RealNetworks' balance sheet in consolidation. RealNetworks has not been required to pay any portion of this commitment, and, as discussed in
Note 10
Notes Payable - Napster
, Napster fully repaid this loan balance on April 30, 2019, thus releasing RealNetworks' previously made guaranty.
In March 2016, Napster was notified of a putative consumer class action lawsuit relating to an alleged failure to pay so-called “mechanical royalties” on behalf of the plaintiffs and “other similarly-situated holders of mechanical rights in copyrighted musical works.” On April 7, 2017, the plaintiffs and Napster agreed to settlement terms during a mediation session. The long form Settlement Agreement was executed effective on January 16, 2019. The damages payable under the Settlement Agreement will be calculated on a claims made basis, subject to an overall maximum of
$10.0 million
. We have not recorded an accrual related to this settlement as of
June 30, 2019
as the amount payable is not reasonably estimable. In May 2019, public notice was posted about the settlement informing purported class members that they can make claims or object to the settlement. The claims period ends on December 31, 2019, on which date (or shortly thereafter), Napster expects to know the total amount of damages payable in respect to validly made claims. Damages for valid claims are expected to be paid in the second quarter of 2020.
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 the ordinary course of business, Napster enters into agreements with various content providers that guarantee a minimum amount of royalty payments in a given period. These minimum payments are generally based on targets and, based on our historical experience and expectations under relevant contracts, we anticipate that actual royalty accruals and payments will exceed minimum guarantees and, accordingly, we do not maintain accruals for these minimum guarantees.
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 17
|
Segment Information
|
We manage our business and report revenue and operating income (loss) in
four
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 SaaS services and our integrated RealTimes
®
platform which is sold to mobile carriers; (3) Games, which includes all our games-related businesses, including sales of mobile games, games licenses, in-game virtual goods, subscription services, and advertising on games and social network sites; and (4) Napster, which includes our on-demand music streaming and music services.
RealNetworks allocates to its Consumer Media, Mobile Services and Games reportable segments certain corporate expenses which are directly attributable to supporting these 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 these businesses, are reported as corporate items. These corporate items also include restructuring charges and stock compensation charges. As stated in
Note 5
Acquisitions
, Napster is operating as an independent company and includes all their corporate expenses in their segment results, and RealNetworks does not allocate any expenses to the Napster segment.
RealNetworks reports four reportable segments based on factors such as how we manage our operations and how the 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 six months ended
June 30, 2019
and
2018
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Media
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Revenue
|
$
|
2,620
|
|
|
$
|
3,884
|
|
|
$
|
5,106
|
|
|
$
|
9,367
|
|
Cost of revenue
|
803
|
|
|
1,028
|
|
|
1,636
|
|
|
2,021
|
|
Gross profit
|
1,817
|
|
|
2,856
|
|
|
3,470
|
|
|
7,346
|
|
Operating expenses
|
2,877
|
|
|
3,439
|
|
|
5,996
|
|
|
7,357
|
|
Operating income (loss)
|
$
|
(1,060
|
)
|
|
$
|
(583
|
)
|
|
$
|
(2,526
|
)
|
|
$
|
(11
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mobile Services
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Revenue
|
$
|
6,997
|
|
|
$
|
6,719
|
|
|
$
|
13,936
|
|
|
$
|
15,423
|
|
Cost of revenue
|
1,865
|
|
|
2,134
|
|
|
3,913
|
|
|
4,450
|
|
Gross profit
|
5,132
|
|
|
4,585
|
|
|
10,023
|
|
|
10,973
|
|
Operating expenses
|
7,438
|
|
|
6,969
|
|
|
14,999
|
|
|
14,335
|
|
Operating income (loss)
|
$
|
(2,306
|
)
|
|
$
|
(2,384
|
)
|
|
$
|
(4,976
|
)
|
|
$
|
(3,362
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Games
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Revenue
|
$
|
6,048
|
|
|
$
|
5,121
|
|
|
$
|
11,758
|
|
|
$
|
10,584
|
|
Cost of revenue
|
1,655
|
|
|
1,456
|
|
|
3,325
|
|
|
3,273
|
|
Gross profit
|
4,393
|
|
|
3,665
|
|
|
8,433
|
|
|
7,311
|
|
Operating expenses
|
5,288
|
|
|
5,095
|
|
|
10,325
|
|
|
10,012
|
|
Operating income (loss)
|
$
|
(895
|
)
|
|
$
|
(1,430
|
)
|
|
$
|
(1,892
|
)
|
|
$
|
(2,701
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Napster
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Revenue
|
$
|
28,583
|
|
|
$
|
—
|
|
|
$
|
52,920
|
|
|
$
|
—
|
|
Cost of revenue
|
23,026
|
|
|
—
|
|
|
43,422
|
|
|
—
|
|
Gross profit
|
5,557
|
|
|
—
|
|
|
9,498
|
|
|
—
|
|
Operating expenses
|
6,638
|
|
|
—
|
|
|
12,170
|
|
|
—
|
|
Operating income (loss)
|
$
|
(1,081
|
)
|
|
$
|
—
|
|
|
$
|
(2,672
|
)
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
|
Quarter Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Cost of revenue
|
$
|
(67
|
)
|
|
$
|
7
|
|
|
$
|
(144
|
)
|
|
$
|
17
|
|
Operating expenses
|
4,116
|
|
|
2,429
|
|
|
8,373
|
|
|
5,696
|
|
Operating income (loss)
|
$
|
(4,049
|
)
|
|
$
|
(2,436
|
)
|
|
$
|
(8,229
|
)
|
|
$
|
(5,713
|
)
|
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
June 30,
|
|
Six Months Ended
June 30,
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
United States
|
$
|
21,322
|
|
|
$
|
7,646
|
|
|
$
|
40,292
|
|
|
$
|
19,080
|
|
Europe
|
17,097
|
|
|
3,010
|
|
|
32,481
|
|
|
6,035
|
|
Rest of the World
|
5,829
|
|
|
5,068
|
|
|
10,947
|
|
|
10,259
|
|
Total net revenue
|
$
|
44,248
|
|
|
$
|
15,724
|
|
|
$
|
83,720
|
|
|
$
|
35,374
|
|
Long-lived assets (consisting of goodwill, equipment, software, leasehold improvements, operating lease assets, and other intangible assets) by geographic region (in thousands) are as follows:
|
|
|
|
|
|
|
|
|
|
June 30,
2019
|
|
December 31,
2018
|
United States
|
$
|
89,883
|
|
|
$
|
11,823
|
|
Europe
|
11,028
|
|
|
6,761
|
|
Rest of the World
|
2,902
|
|
|
1,151
|
|
Total long-lived assets
|
$
|
103,813
|
|
|
$
|
19,735
|
|
|
|
|
Note 18
|
Related Party Transactions
|
As described in
Note 5
Acquisitions
, on January 18, 2019, RealNetworks acquired an additional
42%
interest in Rhapsody International, Inc., (doing business as Napster), bringing our aggregate ownership interest to
84%
of Napster's outstanding equity, thus giving RealNetworks a majority voting interest in Napster. Following this acquisition of a controlling interest, we consolidate Napster's financial results into our financial statements for fiscal periods beginning with our first quarter of 2019. Rhapsody America LLC was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International, Inc., to own and operate a business-to-consumer digital audio music service originally branded as Rhapsody. The service has been significantly expanded and was re-branded in 2016 as Napster.
Following certain restructuring transactions effective March 31, 2010, we began accounting for the 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. Although we now consolidate Napster for reporting purposes, our convertible preferred stock and the related rights remain contractually binding instruments between RealNetworks and Napster.
In December 2016, RealNetworks and the other then-owner of
42%
of Napster each entered into an agreement to loan up to
$5.0 million
to Napster for general operating purposes, which loans were fully funded as of the end of January 2017 for an aggregate of
$10 million
. Included in RealNetworks' January 2019 acquisition of the additional
42%
interest in Napster, RealNetworks assumed the seller's
$5.0 million
note, resulting in RealNetworks holding
$10 million
of notes receivable from Napster. The terms of the notes were modified subsequent to the original December 2016 execution, including a provision, effective July 2018, that requires repayment at the greater of (a) principal plus accrued interest at an annual rate of
15%
or (b) a preference of three times the principal amount. In May 2019, RealNetworks extended a short-term loan to Napster in the principal amount of
$1.1 million
at an annual interest rate of
4.5%
. These loans are subordinate to Napster's third party debt, as discussed in
Note 10
Notes Payable - Napster
.
In each of February 2015 and February 2017, Napster issued warrants to purchase shares of its common stock to each of RealNetworks and the other then-owner of
42%
of Napster. The warrants have a
10
-year contractual term and were issued as compensation for past services provided by these two significant stockholders of Napster. As part of RealNetworks' January 2019 acquisition of the additional
42%
interest in Napster, RealNetworks assumed the warrants held by the seller.
Upon our acquisition of Napster, the notes and warrants were effectively settled and eliminated in our consolidated financial statements as they represented preexisting relationships between RealNetworks and Napster. However, the notes and warrants remain contractually binding instruments between RealNetworks and Napster.
In August 2019, RealNetworks and Napster entered into a Loan and Security Agreement (the “Loan Agreement”) with a third-party financial institution. Under the terms of the Loan Agreement, the bank will extend a revolving line of credit not to exceed
$10 million
in the aggregate. Advances on the revolving line of credit, which will be used for working capital and general corporate purposes, are based on a borrowing base that comprises accounts receivable and direct-to-consumer deposits. As of the date of this filing, no amounts are outstanding on the revolving line of credit.
Borrowings under the Loan Agreement are secured by a first priority security interest in the assets of RealNetworks and Napster. Advances bear interest at a rate equal to one-half of one percent point (
0.5%
) above the greater of the prime rate or
5.5%
, with monthly payments of interest only and principal due at the end of the two-year term. The Loan Agreement contains customary covenants, including financial covenants, minimum EBITDA levels, and maintaining an unrestricted cash balance of
$3.5 million
.
|
|
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, and related 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, including our January 18, 2019 acquisition of a controlling interest in Napster, 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 funding or other 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 technology products 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
four
segments: (1) Consumer Media, (2) Mobile Services, (3) Games, and (4) Napster. See
Note 17
Segment Information
, and
Note 5
Acquisitions
to the unaudited
condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q for more information regarding our reportable segments and the first quarter of 2019 acquisition of Napster.
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 messaging platform services 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 Mobile Services segment also includes our facial recognition platform, SAFR (Secure, Accurate Facial Recognition), which detects and matches millions of faces by leveraging artificial intelligence-based machine learning.
Our Games business generates revenue primarily through the development, publishing, and distribution of casual games under the GameHouse and Zylom brands. Games are offered via mobile devices, digital downloads, and subscription play. In addition to the sale of individual games and subscription offerings, we also derive revenue from player purchases of in-game virtual goods within our free-to-play games and from advertising on games sites and social network sites.
As described in
Note 5
Acquisitions
, RealNetworks acquired an additional 42% interest in Napster on January 18, 2019 resulting in our having a majority voting interest, owning 84% of Napster's outstanding equity. We consolidate Napster's financial results into our financial statements for fiscal periods following the closing of the acquisition, and Napster is reported as a separate segment in RealNetworks financial statements and related disclosures following the acquisition.
Our Napster segment provides music products and services that enable consumers to have access to digital music content from a variety of devices. The Napster unlimited subscription service offers unlimited access to a catalog of tens of millions of music tracks by way of on-demand streaming and conditional downloads. Napster currently offers music services worldwide and generates revenue primarily through subscriptions to its music services either directly to consumers or distribution partners. We generate a significant portion of our revenue from sales within our Napster business to a few partners. 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.
RealNetworks allocates to its Consumer Media, Mobile Services, and Games reportable segments certain corporate expenses which are directly attributable to supporting these 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 these businesses, are reported as corporate items. These corporate items also can include restructuring charges and stock compensation expense. As stated in
Note 5
Acquisitions
, Napster is operating as an independent company and their corporate expenses are all included in Napster's segment results, and RealNetworks does not allocate any expenses to the Napster segment.
As of
June 30, 2019
, we had
$26.3 million
in unrestricted cash and cash equivalents, compared to
$35.6 million
as of
December 31, 2018
. The
2019
decrease in cash and cash equivalents compared to the prior year end amount was due to our ongoing cash flows used in operating activities, which totaled
$16.1 million
in the first
six
months of
2019
, and Napster's net repayment of debt of $4.3 million, offset in part by the January 2019 acquisition of Napster, which added $9.9 million of cash.
Condensed consolidated results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six months ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
Total revenue
|
$
|
44,248
|
|
|
$
|
15,724
|
|
|
$
|
28,524
|
|
|
181
|
%
|
|
$
|
83,720
|
|
|
$
|
35,374
|
|
|
$
|
48,346
|
|
|
137
|
%
|
Cost of revenue
|
27,282
|
|
|
4,625
|
|
|
22,657
|
|
|
490
|
%
|
|
52,152
|
|
|
9,761
|
|
|
42,391
|
|
|
434
|
%
|
Gross profit
|
16,966
|
|
|
11,099
|
|
|
5,867
|
|
|
53
|
%
|
|
31,568
|
|
|
25,613
|
|
|
5,955
|
|
|
23
|
%
|
Gross margin
|
38
|
%
|
|
71
|
%
|
|
|
|
|
|
38
|
%
|
|
72
|
%
|
|
|
|
|
Operating expenses
|
26,357
|
|
|
17,932
|
|
|
8,425
|
|
|
47
|
%
|
|
51,863
|
|
|
37,400
|
|
|
14,463
|
|
|
39
|
%
|
Operating loss
|
$
|
(9,391
|
)
|
|
$
|
(6,833
|
)
|
|
$
|
(2,558
|
)
|
|
(37
|
)%
|
|
$
|
(20,295
|
)
|
|
$
|
(11,787
|
)
|
|
$
|
(8,508
|
)
|
|
(72
|
)%
|
In the
second
quarter of
2019
, our total consolidated revenue increased
$28.5 million
as compared with the year-earlier period, due to the acquisition of Napster on January 18, 2019, and the resulting consolidation of their results from the acquisition date forward. Napster's revenues for the second quarter of 2019 totaled
$28.6 million
. For the second quarter of 2019 compared to the prior year period, our Games and Mobile Services segment segments revenues increased by
$0.9 million
and
$0.3 million
,
respectively, offset by declines in our Consumer Media segment of
$1.3 million
. See below for further discussion of our segment results.
Cost of revenue increased by
$22.7 million
for the
quarter ended June 30, 2019
, primarily due to the consolidation of Napster's results from the acquisition date forward. Napster's cost of revenue for the second quarter of 2019 totaled
$23.0 million
and its gross margin was
19 percent
.
Operating expenses increased by
$8.4 million
in the quarter ended
June 30, 2019
as compared with the year-earlier period, primarily due to the consolidation of Napster's results from the acquisition date forward. Napster operating expenses for the second quarter of 2019 totaled
$6.6 million
. Operating expenses within Corporate in the second quarter of 2019 included $0.6 million of restructuring costs due to the changes within our Games segment, $0.4 million of acquisition-related costs and $0.3 million of change in fair value of the Napster contingent consideration liability.
For the six months ended June 30, 2019, our total consolidated revenue increased
$48.3 million
as compared to the prior year, primarily due to the consolidation of Napster's results from the acquisition date forward. Napster's revenue for the six months ended June 30, 2019 totaled
$52.9 million
. For the six months ended June 30, 2019 compared to the prior year period, our Games segment revenue increased by
$1.2 million
, offset by declines in our Consumer Media segment and Mobile Services segment of
$4.3 million
and
$1.5 million
, respectively. See below for further discussion of our segment results.
Cost of revenue increased by
$42.4 million
in the six months ended June 30, 2019 as compared to the prior year period primarily due to the consolidation of Napster's results from the acquisition date forward. Napster's cost of revenue for the six months ended June 30, 2019 totaled
$43.4 million
and its gross margin was
18 percent
. This increase was offset by a
$0.4 million
decrease in our Consumer Media segment and a
$0.5 million
decrease in our Mobile Services segment.
Operating expenses increased by
$14.5 million
in the six months ended June 30, 2019 as compared with the prior year primarily due to the consolidation of Napster's results from the acquisition date forward. Napster's operating expenses for the six months ended June 30, 2019 totaled
$12.2 million
, including $0.2 million of acquisition-related costs. Operating expenses within Corporate in the six months ended June 30, 2019 included an additional $1.0 million of acquisition-related costs and $0.3 million of change in fair value of the Napster contingent consideration liability. Also contributing to the overall increase was $0.5 million increase in facilities expense. Included in the results for the six months ended June 30, 2018, there was a benefit of $0.5 million in lease exit and related charges following the renegotiation of certain leases.
Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
2,620
|
|
|
$
|
3,884
|
|
|
$
|
(1,264
|
)
|
|
(33
|
)%
|
|
$
|
5,106
|
|
|
$
|
9,367
|
|
|
$
|
(4,261
|
)
|
|
(45
|
)%
|
Cost of revenue
|
803
|
|
|
1,028
|
|
|
(225
|
)
|
|
(22
|
)%
|
|
1,636
|
|
|
2,021
|
|
|
(385
|
)
|
|
(19
|
)%
|
Gross profit
|
1,817
|
|
|
2,856
|
|
|
(1,039
|
)
|
|
(36
|
)%
|
|
3,470
|
|
|
7,346
|
|
|
(3,876
|
)
|
|
(53
|
)%
|
Gross margin
|
69
|
%
|
|
74
|
%
|
|
|
|
|
|
68
|
%
|
|
78
|
%
|
|
|
|
|
Operating expenses
|
2,877
|
|
|
3,439
|
|
|
(562
|
)
|
|
(16
|
)%
|
|
5,996
|
|
|
7,357
|
|
|
(1,361
|
)
|
|
(18
|
)%
|
Operating income (loss)
|
$
|
(1,060
|
)
|
|
$
|
(583
|
)
|
|
$
|
(477
|
)
|
|
(82
|
)%
|
|
$
|
(2,526
|
)
|
|
$
|
(11
|
)
|
|
$
|
(2,515
|
)
|
|
NM
|
|
Total Consumer Media revenue for the
quarter ended June 30, 2019
decreased
$1.3 million
as compared to the same quarter in 2018, due primarily to continued lower software license revenues of $0.9 million and subscription services revenues of $0.2 million, described more fully below. The overall decrease in revenues was also impacted by lower product sales, advertising and other revenues of $0.2 million.
Software License
For our software license revenues, the $0.9 million decrease was primarily due to the continuing decline of shipments by our customers and the timing of contract renewals. The bulk of these licenses are in China and, in the near term, we expect to see further declines.
Subscription Services
For our subscription services revenues, the $0.2 million decrease was primarily due to continuing declines in our legacy subscription products, which will continue to organically decline.
Cost of revenue for the
quarter ended June 30, 2019
decreased
$0.2 million
compared with the year-earlier period. This was primarily due to reductions in salaries and benefits, bandwidth and license royalty costs.
Operating expenses decreased
$0.6 million
as compared with the year-earlier period, primarily due to reductions in salaries, benefits, and professional services fees.
Total Consumer Media revenue for the
six months ended June 30, 2019
decreased
$4.3 million
as compared to the prior year, due primarily to lower software license revenues of $3.5 million and subscription services revenues of $0.4 million, described more fully below. The overall decrease in revenues was also impacted by lower product sales, advertising and other revenues of $0.4 million.
Software License
For our software license revenues, the $3.5 million decrease was primarily due to the continuing decline of shipments by our customers and the timing of contract renewals. The bulk of these licenses are in China and, in the near term, we expect to see further declines.
Subscription Services
For our subscription services revenues, the $0.4 million decrease was primarily due to continuing declines in our legacy subscription products, which will continue to organically decline.
Cost of revenue for the
six months ended June 30, 2019
decreased
$0.4 million
compared with the prior-year period. This was primarily due to reductions in salaries and benefits, bandwidth and license royalty costs.
Operating expenses decreased
$1.4 million
as compared with the prior-year period, primarily due to reductions in salaries, benefits, and professional services fees.
Mobile Services
Mobile Services segment results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
6,997
|
|
|
$
|
6,719
|
|
|
$
|
278
|
|
|
4
|
%
|
|
$
|
13,936
|
|
|
$
|
15,423
|
|
|
$
|
(1,487
|
)
|
|
(10
|
)%
|
Cost of revenue
|
1,865
|
|
|
2,134
|
|
|
(269
|
)
|
|
(13
|
)%
|
|
3,913
|
|
|
4,450
|
|
|
(537
|
)
|
|
(12
|
)%
|
Gross profit
|
5,132
|
|
|
4,585
|
|
|
547
|
|
|
12
|
%
|
|
10,023
|
|
|
10,973
|
|
|
(950
|
)
|
|
(9
|
)%
|
Gross margin
|
73
|
%
|
|
68
|
%
|
|
|
|
|
|
72
|
%
|
|
71
|
%
|
|
|
|
|
Operating expenses
|
7,438
|
|
|
6,969
|
|
|
469
|
|
|
7
|
%
|
|
14,999
|
|
|
14,335
|
|
|
664
|
|
|
5
|
%
|
Operating loss
|
$
|
(2,306
|
)
|
|
$
|
(2,384
|
)
|
|
$
|
78
|
|
|
3
|
%
|
|
$
|
(4,976
|
)
|
|
$
|
(3,362
|
)
|
|
$
|
(1,614
|
)
|
|
(48
|
)%
|
Total Mobile Services revenue increased by
$0.3 million
in the
quarter ended June 30, 2019
compared with the prior-year period. The revenue increase was due to higher software license revenues of $0.5 million, offset in part by a $0.2 million decrease in subscription services revenues, described more fully below.
Software License
For our software license revenues, the increase was primarily due to revenue from sales of our new SAFR product in the second quarter of 2019.
Subscription Services
The decline in our subscription services revenue was due to lower revenue of $0.5 million in our ringback tones business, partially offset by an increase in our messaging platform business of $0.4 million.
Cost of revenue decreased by
$0.3 million
in the
quarter ended June 30, 2019
compared with the prior-year period, due primarily to reductions in salaries, benefits and infrastructure expenses.
Operating expenses increased by
$0.5 million
for the
quarter ended June 30, 2019
compared with the year-earlier period primarily due to increased salaries, benefits and marketing expenses related to increased efforts towards our growth initiatives.
Total Mobile Services revenue decreased by
$1.5 million
in the
six months ended June 30, 2019
compared with the prior-year period. The revenue decrease was due to declines of $1.2 million in subscription services revenues and $0.2 million in software license revenues, described more fully below.
Software License
For our software license revenues, the decrease was primarily the result of revenue recognition timing which caused more revenue to be recognized in the first quarter of 2018 for our integrated RealTimes products offered to mobile carriers; this was partially offset by the second quarter 2019 recognition of revenue from sales of our new SAFR product.
Subscription Services
For our subscription services, the decrease was primarily the result of lower revenue from our ringback tones business.
Cost of revenue decreased by
$0.5 million
in the
six months ended June 30, 2019
compared with the prior-year period, due primarily to reductions in salaries, benefits, and infrastructure expenses.
Operating expenses increased by
$0.7 million
for the
six months ended June 30, 2019
compared with the year-earlier period primarily due to increased salaries, benefits, and marketing expenses.
Games
Games segment results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
Revenue
|
$
|
6,048
|
|
|
$
|
5,121
|
|
|
$
|
927
|
|
|
18
|
%
|
|
$
|
11,758
|
|
|
$
|
10,584
|
|
|
$
|
1,174
|
|
|
11
|
%
|
Cost of revenue
|
1,655
|
|
|
1,456
|
|
|
199
|
|
|
14
|
%
|
|
3,325
|
|
|
3,273
|
|
|
52
|
|
|
2
|
%
|
Gross profit
|
4,393
|
|
|
3,665
|
|
|
728
|
|
|
20
|
%
|
|
8,433
|
|
|
7,311
|
|
|
1,122
|
|
|
15
|
%
|
Gross margin
|
73
|
%
|
|
72
|
%
|
|
|
|
|
|
72
|
%
|
|
69
|
%
|
|
|
|
|
Operating expenses
|
5,288
|
|
|
5,095
|
|
|
193
|
|
|
4
|
%
|
|
10,325
|
|
|
10,012
|
|
|
313
|
|
|
3
|
%
|
Operating loss
|
$
|
(895
|
)
|
|
$
|
(1,430
|
)
|
|
$
|
535
|
|
|
37
|
%
|
|
$
|
(1,892
|
)
|
|
$
|
(2,701
|
)
|
|
$
|
809
|
|
|
30
|
%
|
Total Games revenue increased
$0.9 million
for the
quarter ended June 30, 2019
as compared with the year-earlier period due primarily to increases of $0.7 million in our subscription services and advertising and other revenues and $0.2 million in product sales revenues, described more fully below. Our Games segment continues to shift its focus toward free-to-play games that offer in-game purchases of virtual goods, the revenue from which is included within product sales, and away from premium mobile games that require a one-time purchase. While certain new premium mobile games will be offered, this shift in focus resulted in restructuring costs of
$0.6 million
for the quarter, recorded in the Corporate segment.
Subscription Services
Our subscription sales increased $0.4 million as a result of new subscription offerings for our Original Stories.
Product Sales
Our product sales increased $0.2 million as a result of higher in-game purchases of $0.7 million compared to the prior-year period, partially offset by lower sales of games of $0.5 million as we continue to shift toward free-to-play games that offer in-game purchases of virtual goods and away from premium mobile games that require a one-time purchase.
Advertising and Other
Our advertising and other revenues increased $0.3 million as compared to the prior-year period primarily as a result of offering more in-game advertising within our free-to-play and other mobile games.
Cost of revenue increased
$0.2 million
in the
quarter ended June 30, 2019
when compared with the prior-year period due to higher app store fees of $0.3 million, partially offset by lower publisher license and service royalties of $0.1 million.
Operating expenses increased
$0.2 million
in the
quarter ended June 30, 2019
when compared with the prior-year period, due to higher marketing expenses.
Total Games revenue increased
$1.2 million
for the
six months ended June 30, 2019
as compared with the year-earlier period due primarily to increases of $1.4 million in our subscription services and advertising and other revenues, partially offset by a decrease of $0.2 million in product sales revenues, described more fully below.
Subscription Services
Our subscription sales increased $0.7 million as a result of new subscription offerings for our Original Stories games.
Product Sales
Our product sales decreased $0.2 million as a result of lower sales of games revenue of $1.6 million compared to the prior-year period, partially offset by higher in-game purchases of $1.4 million as we continue to shift toward free-to-play games that offer in-game purchases of virtual goods and away from premium mobile games that require a one-time purchase.
Advertising and Other
Our advertising and other revenues increased $0.7 million as compared to the prior-year period primarily as a result of offering more in-game advertising within our free-to-play and other mobile games.
Cost of revenue increased
$0.1 million
in the
six months ended June 30, 2019
when compared with the prior-year period due to higher app store fees of $0.4 million, partially offset by lower publisher license and service royalties of $0.2 million and facilities costs of $0.1 million.
Operating expenses increased
$0.3 million
in the
six months ended June 30, 2019
when compared with the prior-year period, largely due to professional services fees of $0.2 million from increased developer costs and marketing fees $0.5 million, partially offset by lower salaries and benefits of $0.2 million.
Napster
Napster segment results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
2019
|
|
2018
|
|
$ Change
|
Revenue
|
$
|
28,583
|
|
|
$
|
—
|
|
|
$
|
28,583
|
|
|
$
|
52,920
|
|
|
$
|
—
|
|
|
$
|
52,920
|
|
Cost of revenue
|
23,026
|
|
|
—
|
|
|
23,026
|
|
|
43,422
|
|
|
—
|
|
|
43,422
|
|
Gross profit
|
5,557
|
|
|
—
|
|
|
5,557
|
|
|
9,498
|
|
|
—
|
|
|
9,498
|
|
Gross margin
|
19
|
%
|
|
—
|
%
|
|
|
|
18
|
%
|
|
—
|
%
|
|
|
Operating expenses
|
6,638
|
|
|
—
|
|
|
6,638
|
|
|
12,170
|
|
|
—
|
|
|
12,170
|
|
Operating loss
|
$
|
(1,081
|
)
|
|
$
|
—
|
|
|
$
|
(1,081
|
)
|
|
$
|
(2,672
|
)
|
|
$
|
—
|
|
|
$
|
(2,672
|
)
|
As described in
Note 5
Acquisitions
, we acquired control and began consolidating Napster effective January 18, 2019. Our consolidated results include Napster from the acquisition date forward.
Napster's revenues relate to subscription services and include $14.8 million of direct to consumer revenues and $13.8 million of revenues resulting from services sold through distribution partners in the quarter ended June 30, 2019.
Cost of revenues primarily consist of content royalties related to music label and publishing rights for the domestic and international music streaming services. These costs can vary materially from period to period due to the significant judgments, assumptions, and estimates of the amounts to be paid. Napster's cost of revenues for the quarter ended June 30, 2019 included $0.4 million of amortization expense related to intangible assets acquired.
Operating expenses primarily include salaries, benefits, and professional services fees. In the quarter ended June 30, 2019, Napster's operating expenses included $0.8 million of amortization expense related to intangible assets acquired.
For the six months ended June 30, 2019 Napster's revenues included $27.0 million in direct to consumer revenues and $25.9 million of revenues resulting from services sold through distribution partners. Napster's direct to consumer revenues in the six months ended June 30, 2019 were reduced by $0.7 million of unfavorable impact from the fair value measurement of Napster deferred revenue upon acquisition.
Napster's cost of revenues for the six months ended June 30, 2019 included $0.7 million of amortization expense related to intangible assets acquired.
In the six months ended June 30, 2019, Napster's operating expenses included $1.4 million of amortization expense related to intangible assets acquired and $0.2 million of acquisition-related costs.
Corporate
Corporate results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
Cost of revenue
|
$
|
(67
|
)
|
|
$
|
7
|
|
|
$
|
(74
|
)
|
|
NM
|
|
|
$
|
(144
|
)
|
|
$
|
17
|
|
|
$
|
(161
|
)
|
|
NM
|
|
Operating expenses
|
4,116
|
|
|
2,429
|
|
|
1,687
|
|
|
69
|
%
|
|
8,373
|
|
|
5,696
|
|
|
2,677
|
|
|
47
|
%
|
Operating loss
|
$
|
(4,049
|
)
|
|
$
|
(2,436
|
)
|
|
$
|
(1,613
|
)
|
|
(66
|
)%
|
|
$
|
(8,229
|
)
|
|
$
|
(5,713
|
)
|
|
$
|
(2,516
|
)
|
|
(44
|
)%
|
Operating expenses increased by
$1.7 million
in the
quarter ended June 30, 2019
compared with the year-earlier period. The increase was primarily from $0.6 million of higher restructuring costs in the second quarter of 2019 due to the changes within our Games segment described in Note 11 Restructuring Charges and $0.4 million of costs associated with our acquisition of Napster. Note there are no other costs within Corporate related to our Napster segment. In addition, as described in more detail in Note 6 Fair Value Measurements, in the second quarter of 2019 we recorded the change in fair value of the Napster contingent consideration liability of $0.3 million as an expense.
Operating expenses increased by
$2.7 million
in the
six months ended June 30, 2019
compared with the year-earlier period, primarily due to higher salaries, benefits, and professional fees driven by $1.0 million of costs associated with our acquisition of Napster. The overall increase was also impacted by $0.2 million of higher restructuring costs in the first six months of 2019 due to the action described above and the second quarter 2019 expense of $0.3 million related to the Napster contingent consideration, also described above.
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 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
|
2019
|
|
2018
|
|
$ Change
|
|
% Change
|
Research and development
|
$
|
8,876
|
|
|
$
|
7,652
|
|
|
$
|
1,224
|
|
|
16
|
%
|
|
$
|
17,709
|
|
|
$
|
15,346
|
|
|
$
|
2,363
|
|
|
15
|
%
|
Sales and marketing
|
8,360
|
|
|
4,883
|
|
|
3,477
|
|
|
71
|
%
|
|
16,502
|
|
|
10,880
|
|
|
5,622
|
|
|
52
|
%
|
General and administrative
|
8,392
|
|
|
5,339
|
|
|
3,053
|
|
|
57
|
%
|
|
16,756
|
|
|
10,940
|
|
|
5,816
|
|
|
53
|
%
|
Restructuring and other charges
|
729
|
|
|
187
|
|
|
542
|
|
|
290
|
%
|
|
896
|
|
|
688
|
|
|
208
|
|
|
30
|
%
|
Lease exit and related charges
|
—
|
|
|
(129
|
)
|
|
129
|
|
|
(100
|
)%
|
|
—
|
|
|
(454
|
)
|
|
454
|
|
|
(100
|
)%
|
Total consolidated operating expenses
|
$
|
26,357
|
|
|
$
|
17,932
|
|
|
$
|
8,425
|
|
|
47
|
%
|
|
$
|
51,863
|
|
|
$
|
37,400
|
|
|
$
|
14,463
|
|
|
39
|
%
|
Research and development expenses increased by
$1.2 million
in the
quarter ended June 30, 2019
as compared with the year-earlier period, primarily due to the acquisition of Napster on January 18, 2019, and the resulting consolidation of their results from the acquisition date forward. Napster's research and development expenses for the second quarter of 2019 totaled
$1.8 million
. This increase was offset by a decrease in salaries, benefits, and professional services of $0.7 million related to our other segments.
Research and development expenses increased by
$2.4 million
in the
six months ended June 30, 2019
as compared with the year-earlier period, primarily due to the acquisition of Napster as discussed above. Napster's research and development expenses for the first half of 2019 totaled
$3.2 million
. These increases were offset by a decrease in salaries, benefits, and professional services of $1.1 million.
Sales and marketing expenses increased
$3.5 million
in the
quarter ended June 30, 2019
as compared with the year-earlier period, primarily due to the acquisition of Napster as discussed above. Napster's sales and marketing expenses for the second quarter of 2019 totaled
$2.5 million
. The overall increase in sales and marketing expenses was also impacted by $0.5 million increase in salaries, benefits, and professional services and $0.5 million in marketing expenses due to increased efforts towards our growth initiatives.
Sales and marketing expenses increased
$5.6 million
in the
six months ended June 30, 2019
as compared with the year-earlier period, primarily due to the acquisition of Napster as discussed above. Napster's sales and marketing expenses for the first half of 2019 totaled
$4.6 million
. The overall increase in sales and marketing expenses was also impacted by $0.7 million
increase in salaries, benefits, and professional services and $0.4 million in marketing expenses due to increased efforts towards our growth initiatives.
General and administrative expenses increased by
$3.1 million
in the
quarter ended June 30, 2019
as compared with the year-earlier period. The increase was primarily due to the acquisition of Napster as discussed above. Napster's general and administrative expenses for the second quarter of 2019 totaled
$2.4 million
. We also incurred expenses of $0.4 million in the second quarter of 2019 for costs associated with our acquisition of Napster. In addition, as described in more detail in Note 6 Fair Value Measurements, in the second quarter of 2019 we recorded the change in fair value of the Napster contingent consideration liability of $0.3 million as an expense.
General and administrative expenses increased by
$5.8 million
in the
six months ended June 30, 2019
as compared with the year-earlier period. The increase was primarily due to the acquisition of Napster as discussed above. Napster's general and administrative expenses for the first half of 2019 totaled
$4.4 million
. We also incurred expenses of $1.0 million in the first half of 2019 for costs associated with our acquisition of Napster. In addition, in the second quarter of 2019 we recorded the change in fair value of the Napster contingent consideration liability of $0.3 million as an expense.
Restructuring and other charges consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts. For additional details on these charges, see
Note 11
Restructuring Charges
.
Other Income (Expense)
Other income (expense), net was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended June 30,
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
|
$ Change
|
|
2019
|
|
2018
|
|
$ Change
|
Interest expense
|
$
|
(43
|
)
|
|
$
|
—
|
|
|
$
|
(43
|
)
|
|
$
|
(209
|
)
|
|
$
|
—
|
|
|
$
|
(209
|
)
|
Interest income
|
40
|
|
|
111
|
|
|
(71
|
)
|
|
117
|
|
|
198
|
|
|
(81
|
)
|
Gain (loss) on equity investment, net
|
—
|
|
|
—
|
|
|
—
|
|
|
12,338
|
|
|
—
|
|
|
12,338
|
|
Other income (expense), net
|
183
|
|
|
(42
|
)
|
|
225
|
|
|
310
|
|
|
(83
|
)
|
|
393
|
|
Total other income (expense), net
|
$
|
180
|
|
|
$
|
69
|
|
|
$
|
111
|
|
|
$
|
12,556
|
|
|
$
|
115
|
|
|
$
|
12,441
|
|
Interest expense relates to Napster's notes payable, described in detail in
Note 10
Notes Payable - Napster
.
Total other income (expense), net, for the six months ended June 30, 2019 includes
$12.3 million
related to RealNetworks' gain on consolidation of Napster, as described in more detail in
Note 5
Acquisitions
.
Income Taxes
During the
quarters ended
June 30, 2019
and
2018
, we recognized income tax expense of
$0.2 million
related to U.S. and foreign income taxes, respectively. During the six months ended June 30, 2019 and 2018, we recognized income tax expense of
$0.5 million
and
$0.4 million
, respectively, related to U.S. and foreign income taxes.
As of
June 30, 2019
, RealNetworks has
$4.5 million
in uncertain tax positions, of which $4.1 million of unrecognized tax positions was recorded through purchase accounting on January 18, 2019 as a result of the acquisition of Napster. 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
second
quarter of
2019
. 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 June 30, 2019
, 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
second
quarter of
2019
was minimal.
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):
|
|
|
|
|
|
|
|
|
|
June 30, 2019
|
|
December 31, 2018
|
Working capital
|
$
|
(37,964
|
)
|
|
$
|
33,481
|
|
Cash, cash equivalents, and short-term investments
|
26,339
|
|
|
35,585
|
|
Restricted cash equivalents
|
2,124
|
|
|
1,630
|
|
The
2019
decrease in working capital from December 31,
2018
was due primarily to the consolidation of Napster, which has a negative working capital position, due in part to its accrued music royalties, which totaled
$74.1 million
at June 30, 2019.
Cash and cash equivalents, and short-term investments decreased from December 31,
2018
due to our ongoing negative cash flow from operating activities, which totaled
$16.1 million
in the first
six
months of
2019
, and Napster's net repayment of debt of $4.3 million, offset in part by our January 2019 acquisition of Napster, which added
$9.9 million
of net cash and cash equivalents. In the near term, we expect to see continued net negative cash flow from operating activities.
The increase in restricted cash equivalents is due to Napster's restricted amounts. See Note 6 Fair Value Measurements for additional details.
The following summarizes cash flow activity (in thousands):
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
2019
|
|
2018
|
Cash used in operating activities
|
$
|
(16,099
|
)
|
|
$
|
(12,730
|
)
|
Cash provided by investing activities
|
11,411
|
|
|
954
|
|
Cash used in financing activities
|
(3,951
|
)
|
|
(129
|
)
|
Cash used in operating activities consisted of net income (loss) including noncontrolling interests adjusted for certain non-cash items such as depreciation and amortization, stock-based compensation, gain on equity investment, fair value adjustments to contingent consideration liability and the effect of changes in certain operating assets and liabilities.
Cash used in operating activities was
$3.4 million
higher in the
six months ended June 30, 2019
as compared to the same period in
2018
. Cash used in operations was higher due to our higher operating loss recorded for the six months ended June 30, 2019 compared to the prior year period, partially offset by the net change in operating assets and liabilities.
For the
six months ended June 30, 2019
, cash provided by investing activities of
$11.4 million
was primarily due to our acquisition of Napster on January 18, 2019. Our initial cash consideration paid at closing of $0.2 million was offset by the cash, cash equivalents and restricted cash on Napster's balance sheet at that date. As fully described below, we are obligated to make further cash payments relating to the acquisition. The increase was offset in part by fixed asset purchases of $0.9 million.
For the
six
months ended
June 30, 2018
, cash provided by investing activities of
$1.0 million
was due to sales and maturities of short-term investments, which totaled
$5.7 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 $0.6 million.
Cash used by financing activities for the
six months ended June 30, 2019
was
$4.0 million
. This cash outflow was primarily due to Napster's April 30, 2019 payoff of its outstanding revolver, in the amount of $4.9 million. Napster's borrowings are described in
Note 10
Notes Payable - Napster
.
Cash used in financing activities for the
six
months ended
June 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.
Three
customers in our Napster segment accounted for more than 10% of trade accounts receivable as of
June 30, 2019
, with the customers accounting for
26%
,
13%
and
10%
each.
Three
customers individually comprised more than 10% of trade accounts receivable at
December 31, 2018
, with the customers accounting for
23%
,
11%
and
10%
each.
One
customer in our Napster segment accounted for
14%
of consolidated revenue, or
$12.0 million
, during the
six months ended June 30, 2019
. No individual customer accounted for 10% or more of our consolidated revenue during the
six months ended June 30, 2018
.
While we currently have no planned significant capital expenditures for the remainder of
2019
other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases.
As discussed in
Note 5
Acquisitions
, we acquired a controlling interest in Napster on January 18, 2019. We paid initial cash consideration of $0.2 million in the first quarter of 2019 and have accrued $0.8 million as a current liability as of June 30, 2019. We also have recognized a liability for the estimated fair value of the contingent consideration. As discussed in
Note 5
Acquisitions
, this fair value amount was estimated using multiple scenarios for each tranche of contingent consideration and then probability weighting each scenario and discounting them to arrive at an estimated fair value. This fair value calculation is directly impacted by the total estimated enterprise value of Napster. After the completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, the contingent consideration will be adjusted quarterly to fair value through earnings. As of June 30, 2019, the estimated fair value of the contingent consideration was $11.9 million, with $2.7 million recognized as a current liability and $9.2 million as a long-term liability. Any future amounts RealNetworks pays for contingent consideration could vary materially from the estimated amounts we have accrued as of June 30, 2019.
In August, 2019, RealNetworks and Napster entered into the Loan Agreement with a third-party financial institution. Under the terms of the Agreement, which are further described in
Note 19
Subsequent Event
, the bank will extend a revolving line of credit not to exceed $10 million in the aggregate. Advances on the revolving line of credit will be used for working capital and general corporate purposes. As of the date of this filing, we have not requested a draw on the revolving line of credit, though may do so in future.
We believe that RealNetworks' current unrestricted cash and cash equivalents, will be sufficient to meet anticipated cash needs for working capital and capital expenditures for at least the next 12 months. For Napster to meet its future liquidity needs, it will need additional financing to fund its operations and growth. RealNetworks has no contractual or implied legal obligation to provide funding or other financial support to Napster.
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.
Our cash equivalents consist of money market mutual funds.
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
June 30, 2019
,
$17.1 million
of the
$26.3 million
of cash and cash equivalents was held by our foreign subsidiaries.
Off-Balance Sheet Arrangements
We do not maintain accruals associated with certain guarantees, as discussed in
Note 16
Guarantees
, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q, thus these guarantee obligations constitute off-balance sheet arrangements.
As disclosed in
Note 14
Leases
, we adopted the new accounting requirement for leases on January 1, 2019 and thus our operating lease obligations are now recorded on our consolidated balance sheet, rather than disclosed as off-balance sheet items.
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:
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Valuation of definite-lived assets and goodwill; and
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Accounting for income taxes.
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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
in both this 10-Q and our 2018 10-K for further details regarding our recognition policies.
Music Royalties.
In certain circumstances, Napster estimates the amounts of royalties payable to record labels, music publishers, or other rights-holders in relation to Napster’s use of music content on its music services (both domestic and international). Material differences in these estimates and the actual amounts ultimately determined to be payable may impact the amount and timing of expense in future periods. Napster’s license agreements with rights-holders for the content used on its music service are often complex, and the determination of royalty accruals can involve significant judgments, assumptions, and estimates of the amounts to be paid. The variables involved in determining royalty payments or accruals may include the applicable revenue, the type of content used, the country it is used in, the number of plays, the number of subscribers, the rights granted to trial or promotional users, and identification of the appropriate license holder, among other variables. In addition, some rights-holders have allowed the use of their content prior to finalizing the applicable license agreement. In these circumstances, royalties are accrued based on our best estimate of the expected amount.
In certain jurisdictions, rights-holders may have several years to claim royalties for musical compositions, in respect of which ownership has not already been claimed. While Napster bases its estimates on contractual rates, historical experience and on various other assumptions that management believes to be reasonable, actual results may differ materially from these estimates under different assumptions or conditions.
Many of our content license agreements give the rights-holders the right to audit our royalty payments. Given the complexity of the licensing arrangements, any such audit could result in disputes over whether Napster has correctly reported and paid the proper royalties. If such a dispute were to occur, we could be required to pay additional royalties, and the amounts involved could be material.
Napster may occasionally be involved in legal actions or other third-party assertions related to use of content on our platform. These actions might be costly and could adversely impact our financial position, results of operations, or cash flows. Napster records a liability when it is probable that a loss has been incurred and the amount can be reasonably estimated. Determining whether a loss is probable and estimable requires management to use significant judgment. Given the uncertainties associated with any litigation, the actual outcome can be different than our estimates and could adversely affect our results of operations, financial position, and cash flows.
Valuation of Definite-Lived Assets and Goodwill.
Assets acquired and liabilities assumed in a business acquisition are measured at fair value under the purchase accounting method and any goodwill is recognized as the excess of the total purchase price over the fair value of assets acquired and liabilities assumed. The fair value estimates are based upon estimates and assumptions relating to future revenues, cash flows, operating expenses and costs of capital. 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 long-term operating plans and risk-commensurate discount rates and cost of capital. In addition, the size, scope, and complexity of an acquisition will affect the time it takes to obtain the necessary information to record the acquired assets and liabilities at fair value. It may take up to one year to finalize the initial fair value estimates used in the preliminary purchase accounting. Accordingly, it is reasonably likely that our initial estimates will be subsequently revised, which could affect carrying amounts of goodwill, intangibles, noncontrolling interests, contingent consideration, and potentially other assets and liabilities in our financial statements.
Our definite-lived assets consist primarily of amortizable intangible assets acquired in business combinations, property, plant and equipment, and right-of-use operating lease assets. 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 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.
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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 Napster's Notes payable. Napster's borrowing arrangements have floating rate interest payments and thus have a degree of interest rate risk, if interest rates increase. Based on Napster's outstanding Notes payable as of
June 30, 2019
, a hypothetical 10% increase/decrease in interest rates would not increase/decrease our annual interest expense or cash flows by more than a nominal amount.
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 euro, Chinese yuan and Japanese yen. A hypothetical 10% increase or decrease in those currencies relative to the U.S. dollar as of
June 30, 2019
would not result in a material impact on our financial position, results of operations or cash flows.