Item 1.01. Entry into a Material Definitive Agreement.
On January 18, 2019, RealNetworks Digital Music of California, Inc. (“RN Sub”), a California corporation and a wholly owned subsidiary of RealNetworks, Inc. (“RealNetworks” or the “Company”) entered into a Purchase Agreement (the “Purchase Agreement”) with Rhapsody Applebee, LLC, a Delaware limited liability company (“Seller”) whereby RN Sub acquired all of Seller's equity and debt interests in Rhapsody International, Inc., a Delaware corporation doing business as Napster (“Napster”). (The acquisition of the equity and debt interests is referred to below as the “Acquisition.”)
Immediately prior to the Acquisition, each of RealNetworks (indirectly through RN Sub) and Seller held approximately 42% of the outstanding stock of Napster, and RealNetworks accounted for the investment using the equity method of accounting. In addition, immediately prior to the Acquisition, each of RealNetworks and Seller held a $5 million secured note receivable from Napster, with each note being subordinate to Napster's senior debt, accruing interest at an annual rate of 10%, and having a preference under certain circumstances equal to three times the principal amount.
Effective January 18, 2019, as a result of the Acquisition, RealNetworks, through RN Sub, owns an aggregate of approximately 84% of the outstanding stock of Napster and has the right to nominate directors constituting a majority of the Napster board of directors. Accordingly, although Napster will continue to operate as an independent company, RealNetworks has acquired control over Napster’s business: a proprietary platform that provides global access to copyrighted and public-domain music, playlists, reviews, and radio stations via the internet and wireless device apps. Napster generates revenue primarily through subscriptions to its music services, either directly to consumers or through distribution partners such as mobile carriers.
Pursuant to the Purchase Agreement, in exchange for Seller's 42% equity stake in Napster plus Seller's $5 million note receivable from Napster, RN Sub committed to pay $1.0 million no later than 90 days following the reinstatement of normal operations at the Office of Foreign Assets Control, a portion of which is to be paid to third parties for professional services rendered to Seller. During the five years following the Acquisition, RealNetworks will pay the lesser of (a) an additional $14.0 million to Seller, (paid ratably over such five-year period), or (b) if RealNetworks sells the stake to a third party for less than $15.0 million, the actual amount received by RealNetworks, minus the $1.0 million initial payment. Moreover, in the event that RealNetworks sells such equity stake for consideration in excess of $15.0 million, then RealNetworks will pay Seller additional consideration, which shall in no event exceed an additional $25.0 million. In order for Seller to receive the full $40.0 million, the proceeds received by RealNetworks for the 42% equity interest acquired would have to exceed $60.0 million.
As a majority-owned subsidiary controlled by RealNetworks, it is expected that Napster's financial results will be consolidated into the Company's financial statements for fiscal periods following the closing of the Acquisition. As disclosed in Note 4 of the Company's financial statements for the year ended December 31, 2017 included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 27, 2018 (the "RealNetworks 2017 10-K"), as of December 31, 2017 Napster had current assets of $43.0 million and current liabilities of $119.8 million. Napster's current liabilities include accrued but unbilled music royalties related to past services, the ultimate payment of which is uncertain and which are similar in nature to historical accruals of RealNetworks described in the RealNetworks 2017 10-K in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates - Estimating Music Publishing Rights and Royalty Accruals." Napster's current liabilities as of December 31, 2017 also include approximately $11.1 million related to the notes payable to RealNetworks and Seller described above, which will be payable exclusively to RealNetworks following the Acquisition
and which will be eliminated in consolidation, and approximately $19.6 million outstanding on Napster's senior debt facilities. These December 31, 2017 liabilities are representative of the more current balances, which will be incorporated into RealNetworks' balance sheet for periods following the closing of the Acquisition. The Company will publicly report Napster's more recent financial information, including its material current liabilities, pursuant to Item 9.01 of this Current Report on Form 8-K on the timeline noted under such item below. In addition, beginning with the Company's Quarterly Report on Form 10-Q for the three months ended March 31, 2019, RealNetworks' financial results will be reported on a consolidated basis including Napster's financial results for the respective period.