|
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|
|
Item 7.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
Overview
RealNetworks invented the streaming media category in 1995 and continues to build on its foundation of digital media expertise and innovation, creating a new generation of products and services to enhance and secure our daily lives. 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.
Within our Consumer Media segment, revenue is primarily derived from the software licensing of our video compression, or codec, technology, principally our prior-generation codec RealMedia Variable Bitrate, or RMVB, but also including some early revenue from sales of 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 include our intercarrier messaging service and ringback tones, as well as through software licenses for the integration of our RealTimes platform and certain system implementations. We generate a significant portion of our revenue from sales within our Mobile Services business to a few mobile carriers. Our Mobile Services segment also includes our computer vision platform, SAFR, which includes facial recognition technology that leverages artificial intelligence-based machine learning. To date, our SAFR business has not generated a significant level of revenue.
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. We derive revenue from player purchases of in-game virtual goods within our free-to-play games and from advertising on games sites. In addition, we derive revenue from the sale of individual games and subscription offerings.
As described in Note 4. Acquisitions, RealNetworks acquired an additional 42% interest in Napster on January 18, 2019 (the "Napster Acquisition") 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. The acquisition resulted in our recording of goodwill and definite-lived intangible assets, which we assess for impairment each quarter and which would be negatively impacted if Napster's business were to continue to decline or if it were to suffer significant financial distress.
The 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 sold directly to consumers, through distribution partners, or through various music platform services under co-branded arrangements. Napster generates a significant portion of revenue from sales to a few partners.
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 4. Acquisitions, Napster is operating as an independent company and their corporate expenses, including restructuring charges, are all included in Napster's segment results, and RealNetworks does not allocate any expenses to the Napster segment.
In 2019, our consolidated revenue increased by $102.6 million compared with 2018, due mostly to the Napster Acquisition on January 18, 2019 and the resulting consolidation of their results from the acquisition date forward. Napster's 2019 revenues from the acquisition date forward were $106.3 million. In 2019, our Games segment revenue increased $3.8 million, which was offset by decreases of $5.0 million in Consumer Media revenue and $2.5 million in Mobile Services revenue. See below for further information regarding fluctuations by segment.
Operating expenses increased by $27.4 million in 2019 compared with 2018 again due primarily to the consolidation of Napster's results from the acquisition date forward. Napster's operating expenses for the fiscal year of 2019 totaled $25.8
million which included $0.2 million of acquisition costs. Operating expenses in 2019 also included an additional $1.3 million of professional fees associated with the acquisition of Napster.
As of December 31, 2019, we had $16.8 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 from December 31, 2018 was primarily due to our ongoing cash flows used in operating activities, Napster's net repayment of debt of $4.7 million, and the $3.5 million cash required to be restricted under our Loan and Security Agreement, which we refer to as the Loan Agreement. These decreases were partially offset by the January 2019 Napster Acquisition, which added $9.9 million of cash, and the drawdown of $3.9 million from the revolving line of credit we entered into in August 2019.
See Note 22 Subsequent Event for information on the additional funding of approximately $10.0 million received by RealNetworks on February 10, 2020.
Consolidated results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Total revenue
|
|
$
|
172,113
|
|
|
$
|
69,510
|
|
|
|
|
$
|
102,603
|
|
|
148
|
%
|
|
|
|
|
Cost of revenue
|
|
103,127
|
|
|
17,727
|
|
|
|
|
85,400
|
|
|
482
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
68,986
|
|
|
51,783
|
|
|
|
|
17,203
|
|
|
33
|
%
|
|
|
|
|
Gross margin
|
|
40
|
%
|
|
74
|
%
|
|
|
|
(34)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
101,429
|
|
|
74,054
|
|
|
|
|
27,375
|
|
|
37
|
%
|
|
|
|
|
Operating income (loss)
|
|
$
|
(32,443)
|
|
|
$
|
(22,271)
|
|
|
|
|
$
|
(10,172)
|
|
|
(46)
|
%
|
|
|
|
|
2019 compared with 2018
In 2019, our consolidated revenue increased by $102.6 million, or 148%. The increase in revenue was predominantly due to the Napster Acquisition on January 18, 2019, and the consolidation of its results from the acquisition date forward. Napster's 2019 revenues from the acquisition date forward were $106.3 million. In 2019, our Games segment revenue increased $3.8 million, offset by decreases of $5.0 million in Consumer Media revenue and $2.5 million in Mobile Services revenue. See below for further information regarding fluctuations by segment. Gross margin decreased to 40% from 74%, driven by the lower margin of the Napster segment.
Operating expenses increased by $27.4 million in 2019 compared with 2018 primarily due to the consolidation of Napster's results from the acquisition date forward. Napster's operating expenses for the fiscal year of 2019 totaled $25.8 million, including $0.2 million of acquisition-related costs. Operating expenses within Corporate in 2019 included an additional $1.3 million of acquisition-related costs and $1.0 million of change in fair value of the Napster contingent consideration liability.
Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Total revenue
|
|
$
|
13,170
|
|
|
$
|
18,168
|
|
|
|
|
$
|
(4,998)
|
|
|
(28)
|
%
|
|
|
|
|
Cost of revenue
|
|
3,031
|
|
|
3,858
|
|
|
|
|
(827)
|
|
|
(21)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
10,139
|
|
|
14,310
|
|
|
|
|
(4,171)
|
|
|
(29)
|
%
|
|
|
|
|
Gross margin
|
|
77
|
%
|
|
79
|
%
|
|
|
|
(2)
|
%
|
|
|
|
|
|
|
Total operating expenses
|
|
11,186
|
|
|
14,419
|
|
|
|
|
(3,233)
|
|
|
(22)
|
%
|
|
|
|
|
Operating income (loss)
|
|
$
|
(1,047)
|
|
|
$
|
(109)
|
|
|
|
|
$
|
(938)
|
|
|
NM
|
|
|
|
|
|
2019 compared with 2018
Total Consumer Media revenue decreased by $5.0 million, or 28% as compared to the prior year, due primarily to decreased software license revenues of $3.4 million, as well as decreases in our subscription service revenues of $0.8 million and lower product sales, advertising and other revenues of $0.8 million.
Software License
For our software license revenues, the $3.4 million decrease was primarily related to declining shipments by our distribution partners of products embedded with our codec technology and the timing of contract renewals with our distribution partners. The bulk of these licenses for our codec technology are with companies based in China and, in the near term, it is possible we may see continued pressure in pricing and renewals, and potential further declines in sales. In addition, it is unclear whether or how the recent outbreak of coronavirus COVID-19 and its effect on Chinese companies will impact our codec business.
Subscription Services
For our subscription services revenues, the decrease of $0.8 million was primarily due to further declines in our legacy subscription products, which we expect to continue.
Cost of revenue decreased by $0.8 million, or 21%. This was primarily due to reductions in salaries and benefits of $0.5 million, and reductions in bandwidth and license royalty costs of $0.3 million.
Operating expenses decreased by $3.2 million, or 22%, compared to the prior year, primarily due to lower salaries and benefits, from headcount reductions, and professional services fees of $2.8 million as well as lower marketing expenses of $0.3 million.
Mobile Services
Mobile Services segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Total revenue
|
|
$
|
27,143
|
|
|
$
|
29,670
|
|
|
|
|
$
|
(2,527)
|
|
|
(9)
|
%
|
|
|
|
|
Cost of revenue
|
|
7,500
|
|
|
8,623
|
|
|
|
|
(1,123)
|
|
|
(13)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
19,643
|
|
|
21,047
|
|
|
|
|
(1,404)
|
|
|
(7)
|
%
|
|
|
|
|
Gross margin
|
|
72
|
%
|
|
71
|
%
|
|
|
|
1
|
%
|
|
|
|
|
|
|
Total operating expenses
|
|
29,340
|
|
|
28,066
|
|
|
|
|
1,274
|
|
|
5
|
%
|
|
|
|
|
Operating income (loss)
|
|
$
|
(9,697)
|
|
|
$
|
(7,019)
|
|
|
|
|
$
|
(2,678)
|
|
|
(38)
|
%
|
|
|
|
|
2019 compared with 2018
Mobile Services revenue decreased by $2.5 million, or 9%, and was primarily driven by a decrease of $2.8 million in subscription services revenue, offset by an increase of $0.3 million in software license revenue.
Software license
For our software license revenues, the $0.3 million increase was primarily the result of revenue from sales of our recently introduced SAFR product, which recognized negligible revenue in the prior year. At this time, we believe that there is risk that the effects of the recent outbreak of coronavirus COVID-19 on global mobility and corporate investment could negatively impact growth expectations and sales prospects for our SAFR business.
Subscription service
For our subscription services, the $2.8 million decrease was driven by fewer subscribers to our ringback tones causing a decrease in revenue of $3.5 million and a revenue decrease of $0.4 million related to professional services fees. These decreases were offset by an increase in revenue from our intercarrier messaging platform business of $1.1 million.
Cost of revenue decreased by $1.1 million or 13% as compared to the prior year, due primarily to reductions in salaries and benefits of $0.6 million related to headcount reductions and infrastructure costs of $0.4 million.
Operating expenses increased by $1.3 million or 5% primarily due to increased salaries and benefits related to increased investment in SAFR, partially offset by savings in our ringback tones business.
Games
Games segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Total revenue
|
|
$
|
25,489
|
|
|
$
|
21,672
|
|
|
|
|
$
|
3,817
|
|
|
18
|
%
|
|
|
|
|
Cost of revenue
|
|
6,975
|
|
|
6,123
|
|
|
|
|
852
|
|
|
14
|
%
|
|
|
|
|
Gross profit
|
|
18,514
|
|
|
15,549
|
|
|
|
|
2,965
|
|
|
19
|
%
|
|
|
|
|
Gross margin
|
|
73
|
%
|
|
72
|
%
|
|
|
|
1
|
%
|
|
|
|
|
|
|
Total operating expenses
|
|
20,220
|
|
|
20,324
|
|
|
|
|
(104)
|
|
|
(1)
|
%
|
|
|
|
|
Operating income (loss)
|
|
$
|
(1,706)
|
|
|
$
|
(4,775)
|
|
|
|
|
$
|
3,069
|
|
|
64
|
%
|
|
|
|
|
2019 compared with 2018
Games revenue increased by $3.8 million, or 18% as compared to the prior year primarily due to increases of $1.2 million in product sales revenues, $1.6 million in advertising and other revenues and $1.0 million in our subscription services 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.
Subscription Services
Our subscription sales increased $1.0 million as a result of new subscription offerings for our Original Stories games.
Product sales
Our product sales increased $1.2 million as a result of higher in-game purchases of $4.6 million compared to the prior-year period, offset by lower sales of games of $3.4 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 $1.6 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 by $0.9 million, or 14%, due to higher app store fees of $1.2 million, partially offset by lower publisher license and service royalties.
Operating expenses decreased by $0.1 million, primarily due to lower salaries, benefits, professional services fees and infrastructure expenses, offset by higher marketing fees of $1.4 million.
Napster
Napster segment results of operations were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
|
|
|
|
|
Total revenue
|
|
$
|
106,311
|
|
|
$
|
—
|
|
|
|
|
$
|
106,311
|
|
|
|
|
|
|
|
Cost of revenue
|
|
85,901
|
|
|
—
|
|
|
|
|
85,901
|
|
|
|
|
|
|
|
Gross profit
|
|
20,410
|
|
|
—
|
|
|
|
|
20,410
|
|
|
|
|
|
|
|
Gross margin
|
|
19
|
%
|
|
—
|
%
|
|
|
|
19
|
%
|
|
|
|
|
|
|
Total operating expenses
|
|
25,789
|
|
|
—
|
|
|
|
|
25,789
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
$
|
(5,379)
|
|
|
$
|
—
|
|
|
|
|
$
|
(5,379)
|
|
|
|
|
|
|
|
2019 compared with 2018
As described in Note 4. 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 $55.4 million of direct-to-consumer revenues and $50.9 million of revenues resulting from services sold through distribution partners in the year ended December 31, 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 year ended December 31, 2019 included $1.5 million of amortization expense related to intangible assets acquired.
Operating expenses primarily include salaries, benefits, and professional services fees. In the year ended December 31, 2019, Napster's operating expenses included $2.8 million of amortization expense related to intangible assets acquired and $0.5 million of restructuring charges.
Corporate
Corporate segment results of operations were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Cost of revenue
|
|
$
|
(280)
|
|
|
$
|
(877)
|
|
|
|
|
$
|
597
|
|
|
(68)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
14,894
|
|
|
11,245
|
|
|
|
|
3,649
|
|
|
32
|
%
|
|
|
|
|
Operating income (loss)
|
|
$
|
(14,614)
|
|
|
$
|
(10,368)
|
|
|
|
|
$
|
(4,246)
|
|
|
(41)
|
%
|
|
|
|
|
2019 compared with 2018
Cost of revenue increased by $0.6 million compared to the prior year due to the reversal in 2018 of certain aged royalty liabilities relating to our legacy music business.
Operating expenses increased by $3.6 million, or 32%. The increase was primarily due to professional fees driven by $1.3 million of costs associated with our acquisition of Napster and higher salaries and benefits of $1.2 million. The overall increase was also impacted by $1.0 million related to the change in fair value of the Napster contingent consideration liability.
Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs including stock-based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, restructuring charges, and lease exit costs. Operating expenses were as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Research and development
|
|
$
|
34,848
|
|
|
$
|
30,789
|
|
|
|
|
$
|
4,059
|
|
|
13
|
%
|
|
|
|
|
Sales and marketing
|
|
32,778
|
|
|
21,140
|
|
|
|
|
11,638
|
|
|
55
|
%
|
|
|
|
|
General and administrative
|
|
31,305
|
|
|
20,706
|
|
|
|
|
10,599
|
|
|
51
|
%
|
|
|
|
|
Restructuring and other charges
|
|
2,498
|
|
|
1,873
|
|
|
|
|
625
|
|
|
33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease exit and related charges
|
|
—
|
|
|
(454)
|
|
|
|
|
454
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated operating expenses
|
|
$
|
101,429
|
|
|
$
|
74,054
|
|
|
|
|
$
|
27,375
|
|
|
37
|
%
|
|
|
|
|
Research and development expenses increased by $4.1 million, or 13%, in the year ended 2019 as compared to 2018 primarily due to the Napster Acquisition on January 18, 2019, and the consolidation of their results from the acquisition date forward. Napster's research and development expenses for the year ended December 31, 2019 totaled $7.0 million. This increase was offset by a decrease in salaries, benefits and professional services fees of $2.9 million related to our other segments.
Sales and marketing expenses increased by $11.6 million, or 55%, in the year ended 2019, compared with 2018. The increase was primarily due to the Napster Acquisition, as discussed above. Napster's sales and marketing expenses for the year ended December 31, 2019 totaled $9.8 million. The overall increase in sales and marketing expenses was also impacted by $1.0 million increase in salaries and benefits and $1.1 million in marketing expenses primarily due to increased efforts towards free-to-play games. These increases were offset by a $0.3 million decrease in infrastructure expense.
General and administrative expenses increased by $10.6 million, or 51%, in the year ended 2019, compared with 2018. The increase was primarily due to the Napster Acquisition as discussed above. Napster's general and administrative expenses for the year ended December 31, 2019 totaled $8.5 million, which includes $0.2 million of acquisition-related costs. We also incurred additional expenses of $1.3 million in 2019 for costs associated with the Napster Acquisition and recorded the change in fair value of the Napster contingent consideration liability of $1.0 million as an expense.
Restructuring and other charges and Lease exit and related charges consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. For additional details on these charges see Note 11. Restructuring Charges and Note 12. Lease Exit and Related Charges.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
2019-2018
Change
|
|
%
Change
|
|
|
|
|
Interest expense
|
|
$
|
(636)
|
|
|
$
|
—
|
|
|
|
|
$
|
(636)
|
|
|
NM
|
|
|
|
|
|
Interest income
|
|
131
|
|
|
344
|
|
|
|
|
(213)
|
|
|
(62)
|
%
|
|
|
|
|
Gain (loss) on equity investments, net
|
|
12,338
|
|
|
—
|
|
|
|
|
12,338
|
|
|
NM
|
|
|
|
|
|
Equity in net loss of Napster
|
|
—
|
|
|
(757)
|
|
|
|
|
757
|
|
|
NM
|
|
|
|
|
|
Other income (expense), net
|
|
420
|
|
|
(103)
|
|
|
|
|
523
|
|
|
NM
|
|
|
|
|
|
Total other income (expense), net
|
|
$
|
12,253
|
|
|
$
|
(516)
|
|
|
|
|
$
|
12,769
|
|
|
NM
|
|
|
|
|
|
Interest expense relates to RealNetworks and Napster's notes payable and long-term debt, as described in detail in Note 10. Notes Payable and Long-term Debt.
Total other income (expense), net, for the year ended December 31, 2019 includes $12.3 million related to RealNetworks' gain on consolidation of Napster, as described in more detail in Note 4. Acquisitions.
Income Taxes
During the years ended December 31, 2019 and 2018, we recognized income tax expense of $1.1 million and $2.2 million, respectively, related to U.S. and foreign income taxes.
The income tax expense for the year ended December 31, 2019 was largely the result of foreign withholding taxes and income taxes in foreign jurisdictions. The income tax expense for the year ended December 31, 2018 was largely the result of foreign withholding taxes, income taxes in foreign jurisdictions, and income tax expense for the accrued tax associated with future repatriations of foreign earnings that are no longer considered to be indefinitely reinvested.
We assess the likelihood that our deferred tax assets will be recovered based upon our consideration of many factors, including the current economic climate, our expectations of future taxable income, our ability to project such income, and the appreciation of our investments and other assets. We maintain a partial valuation allowance of $160.8 million for our deferred tax assets due to uncertainty regarding their realization as of December 31, 2019. The net increase in the valuation allowance since December 31, 2018 of $23.5 million was the result of an increase in current year deferred tax assets, mainly related to the acquisition of Napster, for which the Company maintains a valuation allowance.
We generate income in a number of foreign jurisdictions, some of which have higher tax rates and some of which have lower tax rates relative to the U.S. federal statutory rate. Changes to the blend of income between jurisdictions with higher or lower effective tax rates than the U.S. federal statutory rate could affect our effective tax rate. For the year ended December 31, 2019, decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to the U.S. federal statutory rate were 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.
As of December 31, 2019 and 2018, RealNetworks had $5.0 million and $0.4 million in uncertain tax positions, respectively. The increase in uncertain tax positions is primarily the result of the Napster Acquisition, for which unrecognized tax positions were recorded relating to federal research and development tax credit carryforward risks, as well as transfer pricing risks in certain foreign jurisdictions. The total amount of unrecognized tax benefits that would affect our effective tax rate if recognized, is $1.3 million as of December 31, 2019. Notwithstanding current year accruals for existing positions, 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.
Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term investments, and restricted cash and investments (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2019
|
|
2018
|
Working capital
|
|
$
|
(41,601)
|
|
|
$
|
33,481
|
|
Cash, cash equivalents, and short-term investments
|
|
16,805
|
|
|
35,585
|
|
Restricted cash equivalents
|
|
5,374
|
|
|
1,630
|
|
The 2019 decrease in working capital from December 31, 2018 was predominantly due to the consolidation of Napster, which has a negative working capital due in part to its accrued music royalties, which totaled $54.2 million at December 31, 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 $25.3 million in the year of 2019, Napster's net repayment of debt of $4.7 million, and amounts required to be restricted, as discussed below. These decreases were partially offset by proceeds from borrowing on our revolving credit facility of $3.9 million and our January 2019 Napster Acquisition, 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 the restricted amounts required by the Loan Agreement we entered into in August 2019. See Note 5. Fair Value Measurements for additional details.
The following summarizes cash flow activity (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Cash provided by (used in) operating activities
|
|
$
|
(25,370)
|
|
|
$
|
(19,221)
|
|
|
|
Cash provided by (used in) investing activities
|
|
11,081
|
|
|
3,798
|
|
|
|
Cash provided by (used in) financing activities
|
|
(623)
|
|
|
(62)
|
|
|
|
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 $6.1 million higher in the year ended December 31, 2019 as compared to 2018. Cash used in operations was higher primarily due to our higher operating loss recorded for year 2019 compared to the prior year.
For the year ended December 31, 2019, cash provided by investing activities of $11.1 million was primarily due to our Napster Acquisition 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 $1.2 million.
For the year ended December 31, 2018, cash provided by investing activities of $3.8 million was due to sales and maturities of short-term investments totaling $8.8 million. The sales and 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 purchases of equipment, software and leasehold improvements of $0.8 million.
Financing activities for the year ended December 31, 2019 used cash totaling $0.6 million. This cash outflow was primarily due to Napster's net repayment of debt of $4.7 million, partially offset by proceeds from borrowing on our revolving credit facility of $3.9 million. See Note 10. Notes Payable and Long-term Debt for additional details.
Financing activities for the year ended December 31, 2018 used cash totaling $0.1 million which was from $0.3 million for tax payments from shares withheld upon vesting of restricted stock offset in part by proceeds received from the issuance of common stock of $0.2 million.
While we currently have no planned significant capital expenditures for 2020 other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases. See Note 17. Leases for additional details.
As discussed in Note 4. 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 an additional $0.8 million as a current liability as of December 31, 2019. We also have recognized a liability for the estimated fair value of contingent consideration related to the acquisition. As discussed in Note 4. Acquisitions, this fair value amount was estimated using multiple scenarios for each tranche of contingent consideration, probability weighting each scenario, and discounting to arrive at an estimated fair value. This fair value calculation is directly impacted by the total estimated enterprise value of Napster. The contingent consideration will be adjusted quarterly to fair value through earnings, and as of December 31, 2019 the estimated fair value of the contingent consideration was $12.6 million, with $2.8 million recognized as a current liability and $9.8 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 December 31, 2019. See Note 4. Acquisitions for additional details.
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 10. Notes Payable and Long-term Debt, the bank extended a two-year revolving line of credit not to exceed $10.0 million in the aggregate. As of December 31, 2019, $3.9
million had been drawn on the revolving line of credit, and any further advances will be used for working capital and general corporate purposes.
In 2019, Mr. Glaser directly invested $0.8 million in one of our subsidiaries in exchange for shares of preferred stock of that entity. The subsidiary is developing a platform that transforms the experience of viewing video entertainment into a social, connected playground. As of December 31, 2019, RealNetworks owned approximately 82% of the subsidiary's outstanding equity, and we consolidate its financial results into our financial statements. The financial results of the subsidiary are reported in our Consumer Media segment.
On February 10, 2020, we entered into a Series B Preferred Stock Purchase Agreement with Mr. Glaser, pursuant to which Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of 8,064,516 shares of Series B Preferred Stock. The Series B Preferred Stock is non-voting and is convertible into common stock on a one-to-one basis, provided, however, that no conversion is permitted in the event that such conversion would cause Mr. Glaser’s beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our Second Amended and Restated Shareholder Rights Plan dated November 30, 2018. The Series B Preferred Stock has no liquidation preference and no preferred dividend.
We have evaluated our current liquidity position in light of our history of declining revenue and operating losses as well as our near-term expectations of net negative cash flows from operating activities. While we currently believe existing unrestricted cash balances, including the $10.0 million in cash proceeds from our recent sale of Series B Preferred Stock, along with current availability on our revolving line of credit will be sufficient to allow us to meet our obligations for the next 12 months, our assessment is subject to inherent risks and uncertainties. Moreover, our operating forecast is partly dependent on factors that are outside of our control. Compounding these risks, uncertainties, and other factors are the potential effects of the recent coronavirus pandemic and related impacts on global commerce and financial markets. Further, we must successfully complete the process currently underway with our lender of negotiating customary covenants for 2020. These conditions, when evaluated within the guidance of ASC 205-40, raise substantial doubt about our ability to meet our obligations over the ensuing 12 months and, therefore, to continue as a going concern.
We have active plans to mitigate these conditions. Specifically, we plan to reduce negative cash flow through operating expense reductions, as well as through the deferral of certain obligations where we believe that we have the legal basis to do so. In addition, we are evaluating various strategic opportunities, which may include selling certain businesses or product lines, soliciting external investment into certain of our businesses, or seeking other strategic partnerships. Our plans are subject to inherent risks and uncertainties, which are accentuated by the effects of the current pandemic and related financial crisis. Accordingly, there can be no assurance that our plans can be effectively implemented and, therefore, that the conditions can be effectively mitigated.
Napster will also require outside funding in order to meet its anticipated cash needs over the next 12 months. RealNetworks has no contractual or implied legal obligation to provide funding or other financial support to Napster, and any funding to Napster under the Loan Agreement must be effectuated by RealNetworks. Significant financial distress at Napster could have negative implications in our assessment of goodwill and long-lived assets on RealNetworks' balance sheet.
In the future, we may seek to raise additional funds through public or private equity financing or through other sources. Such sources of funding may or may not be available to us on 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 funds.
We conduct our operations primarily in four functional currencies: the U.S. dollar, Brazilian real, 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 December 31, 2019, approximately $11.4 million of the $16.8 million of cash and cash equivalents are held by our foreign subsidiaries outside the U.S. We have reevaluated our historical assertion that undistributed foreign earnings were indefinitely reinvested and for which deferred taxes were not provided. As a result of the enactment of the Tax Act and as of December 31, 2019, we are no longer indefinitely reinvesting substantially all of the Company's foreign earnings outside of the U.S. As a result of this change, we have recorded deferred taxes of $0.9 million as of December 31, 2019 to reflect local country and foreign withholding taxes associated with a future repatriation of such foreign earnings.
Contractual Obligations
We have contractual obligations for Long-term debt and for Long-term lease liabilities, both of which are recorded on our balance sheet. For details on the maturity of Long-term debt please refer to Note 10. Notes Payable and Long-term Debt and for future minimum lease payments please refer to Note 17. Leases. Please also refer to Note 18. Commitments and Contingencies. For income tax liabilities for uncertain tax positions, we cannot make a reasonably reliable estimate of the amount and period of any related future payments. As of December 31, 2019, we had $5.0 million of gross unrecognized tax benefits for uncertain tax positions.
Off-Balance Sheet Arrangements
We do not maintain accruals associated with certain guarantees, as discussed in Note 19. Guarantees; those guarantee obligations constitute off-balance sheet arrangements.
As disclosed in Note 17. 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:
•Revenue recognition;
•Music royalties;
•Valuation of definite-lived assets and goodwill; and
•Accounting for income taxes.
Revenue Recognition. We recognize revenue from contracts with customers as control of the promised good or service is transferred. Please refer to Note 3. Revenue Recognition for further details regarding our recognition policies.
Music Royalties. Napster estimates the amounts of royalties payable to music publishers or other rights-holders in relation to the use of music content on Napster's 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 Napster's 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 Napster's content license agreements give the rights-holders the right to audit Napster's 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, Napster 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 its platform. These actions might be costly and could adversely impact Napster's 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 Napster's estimates and could adversely affect its 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 material 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 materially impact the amounts provided for income taxes in our consolidated financial statements.
Each reporting period we must periodically assess the likelihood that our deferred tax assets will be recovered from future sources of taxable income, and to the extent that recovery is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefit in the statement of operations and comprehensive income. In certain instances, changes in the valuation allowance may be allocated directly to the related components of shareholders' equity on the consolidated balance sheet. Factors we consider in making such an assessment include, but are not limited to, past performance and our expectation of future taxable income, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our investments and other assets.
As of December 31, 2019, approximately $11.4 million of the $16.8 million of cash and cash equivalents are held by our foreign subsidiaries outside the U.S. We have reevaluated our historical assertion that undistributed foreign earnings were indefinitely reinvested and for which deferred taxes were not provided. As a result of the enactment of the Tax Act and as of
December 31, 2019, we are no longer indefinitely reinvesting substantially all of the Company's foreign earnings outside of the U.S. As a result of this change, we have recorded deferred taxes of $0.9 million as of December 31, 2019 to reflect local country and foreign withholding taxes associated with a future repatriation of such foreign earnings.
Recently Issued Accounting Standards
See Note 2. Recent Accounting Pronouncements.
|
|
|
|
|
|
Item 8.
|
Financial Statements and Supplementary Data
|
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2019
|
|
December 31,
2018
|
ASSETS
|
|
|
|
Current assets:
|
|
|
|
Cash and cash equivalents
|
$
|
16,805
|
|
|
$
|
35,561
|
|
Short-term investments
|
—
|
|
|
24
|
|
Trade accounts receivable, net of allowances
|
29,507
|
|
|
11,751
|
|
Deferred costs, current portion
|
823
|
|
|
331
|
|
Prepaid expenses and other current assets
|
7,445
|
|
|
5,911
|
|
Total current assets
|
54,580
|
|
|
53,578
|
|
|
|
|
|
Equipment, software, and leasehold improvements, at cost:
|
|
|
|
Equipment and software
|
32,167
|
|
|
37,458
|
|
Leasehold improvements
|
3,311
|
|
|
3,292
|
|
Total equipment, software, and leasehold improvements
|
35,478
|
|
|
40,750
|
|
Less accumulated depreciation and amortization
|
32,657
|
|
|
37,996
|
|
Net equipment, software, and leasehold improvements
|
2,821
|
|
|
2,754
|
|
Operating lease assets
|
11,592
|
|
|
—
|
|
Restricted cash equivalents
|
5,374
|
|
|
1,630
|
|
|
|
|
|
|
|
|
|
Other assets
|
1,891
|
|
|
3,997
|
|
Deferred costs, non-current portion
|
1,021
|
|
|
528
|
|
Deferred tax assets, net
|
761
|
|
|
851
|
|
Other intangible assets, net
|
19,286
|
|
|
26
|
|
Goodwill
|
62,428
|
|
|
16,955
|
|
Total assets
|
$
|
159,754
|
|
|
$
|
80,319
|
|
LIABILITIES AND SHAREHOLDERS’ EQUITY
|
|
|
|
Current liabilities:
|
|
|
|
Accounts payable
|
$
|
4,927
|
|
|
$
|
3,910
|
|
Accrued royalties, fulfillment and other current liabilities
|
77,303
|
|
|
11,312
|
|
|
|
|
|
Commitment to Napster
|
—
|
|
|
2,750
|
|
Deferred revenue, current portion
|
6,620
|
|
|
2,125
|
|
Notes payable
|
7,331
|
|
|
—
|
|
Total current liabilities
|
96,181
|
|
|
20,097
|
|
Deferred revenue, non-current portion
|
96
|
|
|
268
|
|
Deferred rent
|
—
|
|
|
986
|
|
Deferred tax liabilities, net
|
1,172
|
|
|
1,168
|
|
Long-term lease liabilities
|
8,466
|
|
|
—
|
|
Long-term debt
|
3,900
|
|
|
—
|
|
Other long-term liabilities
|
11,666
|
|
|
960
|
|
Total liabilities
|
121,481
|
|
|
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 38,227 shares in 2019 and 37,728 shares in 2018
|
38
|
|
|
37
|
|
Additional paid-in capital
|
644,070
|
|
|
641,930
|
|
Accumulated other comprehensive loss
|
(61,323)
|
|
|
(61,118)
|
|
Retained deficit
|
(544,010)
|
|
|
(524,009)
|
|
Total shareholders’ equity
|
38,775
|
|
|
56,840
|
|
Noncontrolling interests
|
(502)
|
|
|
—
|
|
Total equity
|
38,273
|
|
|
56,840
|
|
Total liabilities and equity
|
$
|
159,754
|
|
|
$
|
80,319
|
|
See accompanying notes to consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Net revenue
|
$
|
172,113
|
|
|
$
|
69,510
|
|
|
|
Cost of revenue
|
103,127
|
|
|
17,727
|
|
|
|
Gross profit
|
68,986
|
|
|
51,783
|
|
|
|
Operating expenses:
|
|
|
|
|
|
Research and development
|
34,848
|
|
|
30,789
|
|
|
|
Sales and marketing
|
32,778
|
|
|
21,140
|
|
|
|
General and administrative
|
31,305
|
|
|
20,706
|
|
|
|
Restructuring and other charges
|
2,498
|
|
|
1,873
|
|
|
|
Lease exit and related charges
|
—
|
|
|
(454)
|
|
|
|
Total operating expenses
|
101,429
|
|
|
74,054
|
|
|
|
Operating loss
|
(32,443)
|
|
|
(22,271)
|
|
|
|
Other income (expenses):
|
|
|
|
|
|
Interest expense
|
(636)
|
|
|
—
|
|
|
|
Interest income
|
131
|
|
|
344
|
|
|
|
Gain (loss) on equity investment, net
|
12,338
|
|
|
—
|
|
|
|
Equity in net loss of Napster investment
|
—
|
|
|
(757)
|
|
|
|
Other income (expense), net
|
420
|
|
|
(103)
|
|
|
|
Total other income (expenses), net
|
12,253
|
|
|
(516)
|
|
|
|
Income (loss) before income taxes
|
(20,190)
|
|
|
(22,787)
|
|
|
|
Income tax expense
|
1,068
|
|
|
2,202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) including noncontrolling interests
|
(21,258)
|
|
|
(24,989)
|
|
|
|
Net income (loss) attributable to noncontrolling interests
|
(1,257)
|
|
|
—
|
|
|
|
Net income (loss) attributable to RealNetworks
|
$
|
(20,001)
|
|
|
$
|
(24,989)
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share attributable to RealNetworks- Basic
|
$
|
(0.53)
|
|
|
$
|
(0.66)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share attributable to RealNetworks- Diluted
|
$
|
(0.53)
|
|
|
$
|
(0.66)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used to compute basic net income (loss) per share
|
37,994
|
|
|
37,582
|
|
|
|
Shares used to compute diluted net income (loss) per share
|
37,994
|
|
|
37,582
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss):
|
|
|
|
|
|
Unrealized investment holding gains (losses), net of reclassification adjustments
|
$
|
—
|
|
|
$
|
17
|
|
|
|
Foreign currency translation adjustments, net of reclassification adjustments
|
(205)
|
|
|
(1,588)
|
|
|
|
Total other comprehensive income (loss)
|
(205)
|
|
|
(1,571)
|
|
|
|
Net income (loss) including noncontrolling interests
|
(21,258)
|
|
|
(24,989)
|
|
|
|
Comprehensive income (loss) including noncontrolling interests
|
(21,463)
|
|
|
(26,560)
|
|
|
|
Comprehensive income (loss) attributable to noncontrolling interests
|
(1,257)
|
|
|
—
|
|
|
|
Comprehensive income (loss) attributable to RealNetworks
|
$
|
(20,206)
|
|
|
$
|
(26,560)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REALNETWORKS, INC. AND SUBSIDIARIES
|
|
|
|
|
|
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
Net income (loss) including noncontrolling interests
|
$
|
(21,258)
|
|
|
$
|
(24,989)
|
|
|
|
Adjustments to reconcile net income (loss) including noncontrolling interests to net cash used in operating activities:
|
|
|
|
|
|
Depreciation and amortization
|
5,834
|
|
|
2,135
|
|
|
|
Stock-based compensation
|
2,881
|
|
|
2,508
|
|
|
|
|
|
|
|
|
|
Equity in net loss of Napster
|
—
|
|
|
757
|
|
|
|
|
|
|
|
|
|
Lease exit and related charges
|
—
|
|
|
(454)
|
|
|
|
Deferred income taxes, net
|
(30)
|
|
|
1,170
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Gain) loss on equity investment, net
|
(12,338)
|
|
|
—
|
|
|
|
Foreign currency (gain) loss
|
(310)
|
|
|
—
|
|
|
|
Fair value adjustments to contingent consideration liability
|
1,000
|
|
|
—
|
|
|
|
Mark to market adjustment of warrants
|
—
|
|
|
124
|
|
|
|
|
|
|
|
|
|
Net change in certain operating assets and liabilities:
|
|
|
|
|
|
Trade accounts receivable
|
3,089
|
|
|
17,971
|
|
|
|
Prepaid expenses, operating lease and other assets
|
5,083
|
|
|
(377)
|
|
|
|
Accounts payable
|
243
|
|
|
(15,125)
|
|
|
|
Accrued, lease and other liabilities
|
(9,564)
|
|
|
(2,941)
|
|
|
|
Net cash provided by (used in) operating activities
|
(25,370)
|
|
|
(19,221)
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
Purchases of equipment, software, and leasehold improvements
|
(1,192)
|
|
|
(765)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from sales and maturities of short-term investments
|
24
|
|
|
8,755
|
|
|
|
Acquisitions, net of cash acquired
|
12,249
|
|
|
(4,192)
|
|
|
|
Net cash provided by (used in) investing activities
|
11,081
|
|
|
3,798
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
Proceeds from issuance of common stock (stock options and stock purchase plan)
|
199
|
|
|
199
|
|
|
|
|
|
|
|
|
|
Tax payments from shares withheld upon vesting of restricted stock
|
(309)
|
|
|
(261)
|
|
|
|
Proceeds from notes payable and revolving credit facility
|
41,201
|
|
|
—
|
|
|
|
Repayments of notes payable and revolving credit facility
|
(41,992)
|
|
|
—
|
|
|
|
Payment of financing fees
|
(622)
|
|
|
—
|
|
|
|
Other financing activities
|
900
|
|
|
—
|
|
|
|
Net cash provided by (used in) financing activities
|
(623)
|
|
|
(62)
|
|
|
|
Effect of exchange rate changes on cash, cash equivalents and restricted cash
|
(100)
|
|
|
(920)
|
|
|
|
Net increase (decrease) in cash, cash equivalents and restricted cash
|
(15,012)
|
|
|
(16,405)
|
|
|
|
Cash, cash equivalents, and restricted cash, beginning of year
|
37,191
|
|
|
53,596
|
|
|
|
Cash, cash equivalents, and restricted cash, end of year
|
$
|
22,179
|
|
|
$
|
37,191
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REALNETWORKS, INC. AND SUBSIDIARIES
|
|
|
|
|
|
CONSOLIDATED STATEMENTS OF CASH FLOWS - Continued
|
|
|
|
|
|
(In thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
Cash received from income tax refunds
|
$
|
2,256
|
|
|
$
|
308
|
|
|
|
Cash paid for income taxes
|
$
|
1,195
|
|
|
$
|
1,198
|
|
|
|
Cash paid for interest expense
|
$
|
412
|
|
|
$
|
—
|
|
|
|
Non-cash investing activities:
|
|
|
|
|
|
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements
|
$
|
(83)
|
|
|
$
|
10
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
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, December 31, 2017
|
|
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
|
|
387
|
|
|
—
|
|
|
(62)
|
|
|
—
|
|
|
—
|
|
|
(62)
|
|
|
—
|
|
|
|
(62)
|
|
Share of Napster equity transactions
|
|
—
|
|
|
—
|
|
|
757
|
|
|
—
|
|
|
—
|
|
|
757
|
|
|
—
|
|
|
|
757
|
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
2,508
|
|
|
—
|
|
|
—
|
|
|
2,508
|
|
|
—
|
|
|
|
2,508
|
|
Other comprehensive income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,571)
|
|
|
—
|
|
|
(1,571)
|
|
|
—
|
|
|
|
(1,571)
|
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(24,989)
|
|
|
(24,989)
|
|
|
—
|
|
|
|
(24,989)
|
|
Balances, December 31, 2018
|
|
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
|
|
499
|
|
|
1
|
|
|
(110)
|
|
|
—
|
|
|
—
|
|
|
(109)
|
|
|
—
|
|
|
|
(109)
|
|
Napster acquisition
|
|
—
|
|
|
—
|
|
|
(1,346)
|
|
|
—
|
|
|
—
|
|
|
(1,346)
|
|
|
570
|
|
|
|
(776)
|
|
Stock-based compensation
|
|
—
|
|
|
—
|
|
|
2,881
|
|
|
—
|
|
|
—
|
|
|
2,881
|
|
|
—
|
|
|
|
2,881
|
|
Other comprehensive income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(205)
|
|
|
—
|
|
|
(205)
|
|
|
—
|
|
|
|
(205)
|
|
Net income (loss)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(20,001)
|
|
|
(20,001)
|
|
|
(1,257)
|
|
|
|
(21,258)
|
|
Other equity transactions (1)
|
|
—
|
|
|
—
|
|
|
715
|
|
|
—
|
|
|
—
|
|
|
715
|
|
|
185
|
|
|
900
|
|
Balances, December 31, 2019
|
|
38,227
|
|
|
$
|
38
|
|
|
$
|
644,070
|
|
|
$
|
(61,323)
|
|
|
$
|
(544,010)
|
|
|
$
|
38,775
|
|
|
$
|
(502)
|
|
|
|
$
|
38,273
|
|
(1) In 2019, Mr. Glaser directly invested $0.8 million in one of our subsidiaries in exchange for shares of preferred stock of that entity. See Note 21. Related Party Transactions for additional details.
See accompanying notes to consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 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 develops and markets software products and services that enable the creation, distribution and consumption of digital media, including audio and video, features GameHouse Original Stories, a unique IP portfolio of free-to-play mobile casual games, and continues to invest in our platform for facial recognition and computer vision for live video, SAFR, which enables new applications for security, convenience, and analytics. We acquired the Napster music business on January 18, 2019, which 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 4. 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 Annual Report on Form 10-K for the year ended December 31, 2019 (10-K), RealNetworks, Inc. and subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”.
Basis of Presentation. The 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 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 year ended December 31, 2019 are not necessarily indicative of the results that may be expected for any subsequent periods.
Liquidity and Capital Resources. Our unrestricted cash and cash equivalents balance at December 31, 2019 was $16.8 million and our operating loss for the fiscal year ended December 31, 2019 was $32.4 million.We have evaluated our current liquidity position in light of our history of declining revenue and operating losses as well as our near-term expectations of net negative cash flows from operating activities. While we currently believe existing unrestricted cash balances, including the $10.0 million in cash proceeds from our recent sale of Series B Preferred Stock, along with current availability on our revolving line of credit will be sufficient to allow us to meet our obligations for the next 12 months, our assessment is subject to inherent risks and uncertainties. Moreover, our operating forecast is partly dependent on factors that are outside of our control. Compounding these risks, uncertainties, and other factors are the potential effects of the recent coronavirus pandemic and related impacts on global commerce and financial markets. Further, we must successfully complete the process currently underway with our lender of negotiating customary covenants for 2020. These conditions, when evaluated within the guidance of ASC 205-40, raise substantial doubt about our ability to meet our obligations over the 12 months from the date of this filing and, therefore, to continue as a going concern. Our financial statements do not include any adjustment relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.
We have active plans to mitigate these conditions. Specifically, we plan to reduce negative cash flow through operating expense reductions, as well as through the deferral of certain obligations where we believe that we have the legal basis to do so. In addition, we are evaluating various strategic opportunities, which may include selling certain businesses or product lines, soliciting external investment into certain of our businesses, or seeking other strategic partnerships. Our plans are subject to inherent risks and uncertainties, which become significantly magnified when the effects of the current pandemic and related financial crisis are included in the assessment. Accordingly, there can be no assurance that our plans can be effectively implemented and, therefore, that the conditions can be effectively mitigated.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (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.
Cash and Cash Equivalents and Short-Term Investments. We consider all short-term investments with a remaining contractual maturity at date of purchase of three months or less to be cash equivalents.
Trade Accounts Receivable. Trade accounts receivable consist of amounts due from customers and do not bear interest. The allowance for doubtful accounts and sales returns is our estimate of the amount of probable credit losses and returns in our
existing accounts receivable. We determine the allowances based on analysis of historical bad debts, customer concentrations, changes in customer credit-worthiness, return history and current economic trends. We review the allowances for doubtful accounts and sales returns quarterly. Past due balances over 90 days and specified other balances are reviewed individually for collectability. All other balances are reviewed on an aggregate basis. Account balances are written off against the allowance after all reasonable means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance sheet credit exposure related to our customers.
Concentration of Credit Risk. Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. We derive a portion of our revenue from a large number of individual consumers spread globally. We also derive revenue from several large customers. If the financial condition or results of operations of any one of the large customers deteriorates substantially, our operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. We do not generally require collateral and we maintain an allowance for estimated credit losses on customer accounts when considered necessary.
Depreciation and Amortization. Depreciation of equipment and software, as well as amortization of leasehold improvements is computed using the straight-line method over the lesser of the estimated useful lives of the assets or the related lease term. The useful life of equipment and software is generally three to five years.
Depreciation and amortization expense of these assets during the years ended December 31, 2019 and 2018 was $1.5 million and $1.7 million, respectively.
Equity Method Investment. We use the equity method in circumstances where we have the ability to exert significant influence, but not control, over an investee or joint venture. We initially record our investment based on a fair value analysis of the investment. We record our percentage interest in the investee's recorded income or loss and changes in the investee's capital under this method, which will increase or decrease the reported value of our investment.
We evaluate impairment of an investment accounted for under the equity method if events and circumstances warrant. An impairment charge would be recorded if a decline in the fair value of an equity investment below its carrying amount were determined to be other than temporary. In determining if a decline is other than temporary, we consider factors such as the length of time and extent to which the fair value of the investment has been less than the carrying amount of the investee or joint venture, the near-term and longer-term operating and financial prospects of the investee or joint venture and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery.
Deferred Costs. We defer certain costs on projects for service revenues and system sales. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire hardware and software from third parties and payroll and related costs for employees and other third parties. Deferred costs are capitalized during the implementation period.
We recognize such costs as a component of cost of revenue, the timing of which is dependent upon the revenue recognition policy by contract. At each balance sheet date, we review deferred costs to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue or if actual deferred costs exceed estimated contractual revenue. Assessing the recoverability of deferred costs is based on significant assumptions and estimates, including future revenue and cost of sales. Significant or sustained decreases in revenue or increases in cost of sales in future periods could result in impairments of deferred project costs and prepaid royalty advances. We cannot accurately predict the amount and timing of any such impairments. Should deferred project costs or prepaid royalty advances become impaired, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations.
Definite-Lived Tangible and Intangible Assets. Definite-lived tangible assets include equipment, software and leasehold improvements and are carried at cost less accumulated depreciation and amortization. Definite-lived intangible assets consist primarily of the fair value of trade name and trademarks, customer and partner agreements and contracts, and developed technology acquired in business combinations and are amortized over their estimated useful lives.
We review these assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. If the carrying amount of an asset group is not recoverable, an impairment loss is recognized if the carrying amount of the asset group exceeds its estimated fair value, which is generally determined as the present value of estimated future cash flows to a market participant. Our impairment analysis is based on significant assumptions of future results, including operating and cash flow projections. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, could result in the need to record an impairment charge in future periods.
Goodwill. 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. Circumstances that may indicate a reporting unit's carrying value exceeds its fair value include, but are not limited to: poor economic performance relative to historical or projected future operating results; significant negative industry, economic or company specific trends; changes in the manner of our use of the assets or the plans for our business; and loss of key personnel.
When evaluating goodwill for impairment, based upon our annual test or due to changes in circumstances described above, 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. Significant judgment is required in determining the reporting units and assessing fair value of the reporting units.
Fair Value. Fair value is the price that would be received from selling an asset or paid in transfering a liability in an orderly transaction between market participants at the measurement date. Our fair value measurements consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk.
Fair values are determined based on three levels of inputs:
•Level 1: Quoted prices in active markets for identical assets or liabilities
•Level 2: Directly or indirectly observed inputs for the asset or liability, including quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active
•Level 3: Significant unobservable inputs that reflect our own estimates of assumptions that market participants would use
Research and Development. Costs incurred in research and development are expensed as incurred. Software development costs are capitalized when a product’s technological feasibility has been established through the date the product is available for general release to customers. Other than internal use software, we have not capitalized any software development costs, as technological feasibility is generally not established until a working model is completed, at which time substantially all development is complete.
Revenue Recognition. We recognize revenue from contracts with customers as control of the promised good or service is transferred. Please refer to Note 3. Revenue Recognition for further details regarding our recognition policies.
Cost of Revenue in Napster Segment. Napster estimates the amounts of royalties payable to certain music publishers or other rights-holders in relation to the use of music content on Napster's 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 Napster's 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 Napster's content license agreements give the rights-holders the right to audit Napster's 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, Napster 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 its platform. These actions might be costly and could adversely impact Napster's 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 Napster's estimates and could adversely affect its results of operations, financial position, and cash flows.
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. When these amounts are ultimately matched and invoiced to Napster, the prepaid royalty amount and the related accrued royalty liability are offset on the consolidated balance sheets. Please refer to Note 9. Accrued and Other Current Liabilities for further details.
Advertising Expenses. We expense the cost of advertising and promoting our products as incurred. These costs are included in sales and marketing expense and totaled $8.8 million in 2019 and $4.3 million in 2018.
Foreign Currency. The functional currency of the Company’s foreign subsidiaries is generally the currency of the country in which the subsidiary operates. Assets and liabilities of foreign operations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. The net gain or loss resulting from translation is shown as translation adjustment and included in Accumulated Other Comprehensive Income (AOCI) in shareholders’ equity. Income and expense accounts are translated into U.S. dollars using average rates of exchange. Gains and losses from foreign currency transactions are included in the consolidated statements of operations.
Accounting for Taxes Collected from Customers. Our revenues are reported net of sales and other transaction taxes that are collected from customers and remitted to taxing authorities.
Income Taxes. We compute income taxes using the asset and liability method, under which deferred income taxes are provided for temporary differences between financial reporting basis and tax basis of our assets and liabilities and operating loss and tax credit carryforwards. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character in the appropriate taxing jurisdictions. Adjustments to the valuation allowance could be required in the future if we estimate that the amount of deferred tax assets to be realized is more or less than the net amount we have recorded. Any increase or decrease in the valuation allowance could have the effect of increasing or decreasing the income tax provision in the statement of operations.
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 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.
We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. We recognize accrued interest and penalties related to uncertain tax positions as a component of income tax expense.
Stock-Based Compensation. Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. We use the Black-Scholes option-pricing model or other appropriate valuation models such as Monte Carlo simulation to determine the fair value of stock-based option awards. The fair value of restricted stock awards is based on the closing market price of our common stock on the grant date of the award. Generally, we recognize the compensation cost for awards on a straight-line basis for the entire award, over the applicable vesting period. For performance-based awards, expense is recognized when it is probable the performance goal will be achieved, however if the likelihood becomes improbable, that expense is reversed. For market-based stock options, fair value is measured at the grant date using the Monte Carlo simulation model, and we recognize compensation cost for these awards on a straight-line basis over the requisite service period for each separately vesting portion of the awards. For our employee stock purchase plan, compensation expense is measured based on the discount the employee is entitled to upon purchase.
The valuation models for stock-based option awards require various judgmental assumptions including volatility in our common stock price and expected option life. If any of the assumptions used in the valuation models change significantly, stock-based compensation expense for new awards may differ materially in the future from the amounts recorded in the
consolidated statements of operations. For all awards, we also estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.
Net Income Per Share. Basic net income (loss) per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) by the weighted average number of common and dilutive potential common shares outstanding during the period.
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Note 2.
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Recent Accounting Pronouncements
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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 2019 and did not cause revision to previously recorded estimates for lease exit charges. See Note 17. 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, 2022, with early adoption permitted. We do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
In June 2016, the FASB issued new guidance amending existing guidance for the accounting of credit losses on financial instruments. Under the new guidance, the valuation allowance for credit losses is expected to be incurred over the financial asset’s contractual term. We reviewed the new credit loss standard and determined that it applies to our accounts receivable, which are typically of short duration and for which we have not historically experienced significant credit losses. This guidance is effective for us in fiscal years beginning after December 15, 2022 with a cumulative effect of adoption recorded as an adjustment to retained earnings. We are in the process of evaluating the effect that this new guidance will have on our consolidated financial statements and related disclosures.
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Note 3.
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Revenue Recognition
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Adoption of New Revenue Standard
On January 1, 2018 we adopted the new revenue recognition standard by applying the modified retrospective approach to those contracts which were not completed as of January 1, 2018. Under the modified retrospective approach, we recorded a net decrease to opening retained deficit of $1.0 million as of January 1, 2018.
Performance Obligations
We generate all of our revenue through contracts with customers. Revenue is either recognized over time as the service is provided, or at a point in time when the product is transferred to the customer, depending on the contract type. Our performance obligations typically have an original duration of one year or less.
Our software licensing revenue stream generates revenue through the on-premises licensing of our codec technologies and integrated RealTimes platform. We recognize revenue upfront at the point in time when the software is made available to the customer. In cases where a sale or usage-based royalty is promised in exchange for a license of our codec technologies, revenue is recognized as the subsequent usage occurs for the contractual amount owed by the customer for that usage, as is allowed under the licensing of intellectual property section of Topic 606. Software licensing in our Mobile Services segment is invoiced on a monthly basis either based on usage of the respective product, or on a fixed fee basis. Our Consumer Media licensing is invoiced either quarterly or annually based on the usage of the respective product, or on a fixed fee basis. For each of these, the timing of payment generally does not vary significantly from the timing of invoice, however, certain of our long-term Consumer Media licensing contracts have extended payment schedules which may exceed one year.
Our subscription services revenue stream allows customers to use hosted software over the respective contract period without taking possession of the technology. The stream is primarily comprised of our intercarrier messaging service, ringback tones, PC-based and mobile games subscriptions, our RealPlayer and SuperPass services, and the Napster music streaming service. Revenues related to subscription service products are recognized ratably over the contract period, or as we have the right to invoice as a practical expedient when that amount corresponds directly with the value to the customer of our performance completed to date. Consumer subscription products are paid in advance, typically on a monthly or quarterly basis. Subscription services offered to businesses are invoiced on a monthly basis, generally based upon the amount of usage for the previous month, and the timing of payment generally does not vary significantly from the timing of invoice.
Our product sales revenue stream includes purchases of in-game virtual goods, mobile and wholesale games, as well as our RealPlayer product. Proceeds from sales of in-game virtual goods are initially recorded in deferred revenue and are recognized as revenues over 30 days, our estimate of the time period that end users benefit from these purchases and our related performance obligation is satisfied. Retail purchases are recognized and paid for at the point in time the product is made available to the end user. For games which are sold through third-party application storefronts, we evaluate the transaction for gross or net revenue recognition. As we typically are the primary obligor in our third-party transactions, we recognize revenues gross of any app store fees. We then receive monthly payments from the respective app store for all purchases within the respective month.
Other revenues consist primarily of advertising and the distribution of third-party products, which are recognized and paid on a cost per impression or cost per download basis.
Disaggregation of Revenue
The following table presents our disaggregated revenue by source and segment (in thousands):
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Year ended December 31, 2019
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Consumer Media
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Mobile Services
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Games
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Napster
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Business Line
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Software License
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$
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6,522
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|
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$
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3,101
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|
$
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—
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|
|
$
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—
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Subscription Services
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|
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|
|
4,148
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|
|
24,042
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|
|
12,121
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|
|
106,311
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Product Sales
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|
825
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|
|
—
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|
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9,823
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—
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Advertising and Other
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1,675
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|
|
—
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|
|
3,545
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—
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Total
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$
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13,170
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|
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$
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27,143
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|
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$
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25,489
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|
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$
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106,311
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Year ended December 31, 2018
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Consumer Media
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Mobile Services
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Games
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Napster
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Business Line
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|
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Software License
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|
|
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|
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|
$
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9,940
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|
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$
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2,838
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|
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$
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—
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|
|
$
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—
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Subscription Services
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|
|
|
|
|
|
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4,895
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|
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26,832
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|
|
11,141
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|
|
—
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Product Sales
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|
|
|
|
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|
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1,177
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|
|
—
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|
|
8,647
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|
|
—
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Advertising and Other
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|
|
|
|
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|
|
2,156
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|
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—
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|
|
1,884
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|
|
—
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Total
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|
|
|
$
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18,168
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|
|
$
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29,670
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|
|
$
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21,672
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|
|
$
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—
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The following table presents our disaggregated revenue by sales channel (in thousands):
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|
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|
Year ended December 31, 2019
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Media
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|
Mobile Services
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|
Games
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|
Napster
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Sales Channel
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business to Business
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|
|
|
|
|
|
|
$
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8,199
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|
|
$
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26,691
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|
|
$
|
4,710
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|
|
$
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50,895
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Direct to Consumer
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|
|
|
|
|
|
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4,971
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|
|
452
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|
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20,779
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|
|
55,416
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Total
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|
|
|
|
|
|
|
$
|
13,170
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|
|
$
|
27,143
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|
|
$
|
25,489
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|
|
$
|
106,311
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|
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|
Year ended December 31, 2018
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|
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|
|
|
|
|
|
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|
|
Consumer Media
|
|
Mobile Services
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|
Games
|
|
Napster
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Sales Channel
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business to Business
|
|
|
|
|
|
|
|
$
|
12,096
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|
|
$
|
29,081
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|
|
$
|
3,225
|
|
|
$
|
—
|
|
Direct to Consumer
|
|
|
|
|
|
|
|
6,072
|
|
|
589
|
|
|
18,447
|
|
|
—
|
|
Total
|
|
|
|
|
|
|
|
$
|
18,168
|
|
|
$
|
29,670
|
|
|
$
|
21,672
|
|
|
$
|
—
|
|
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 December 31, 2019 and 2018 our balance of long-term accounts receivable was $0.3 million and $0.7 million, respectively, and is included in other long-term assets on our consolidated balance sheets. The decrease in this balance from December 31, 2018 to December 31, 2019 is primarily due to the timing of expected cash receipts. During the year ended December 31, 2019, we recorded no impairments to our contract assets.
We record deferred revenue when cash payments are received in advance of our completion of the underlying performance obligation. As of December 31, 2019 we had a deferred revenue balance of $6.7 million, an increase of $4.3 million from December 31, 2018, primarily due to Napster deferred revenue.
Significant Estimates
For certain of our contracts, we recognize revenues using the sales- and usage-based exception as defined in the licensing guidance of Topic 606. For these contracts, we typically receive reporting of actual usage a quarter in arrears, and as such, we are required to estimate the current quarter's usage. To make these estimates, we utilize historical reporting information, as well as industry trends and interim reporting to quantify total quarterly usage. As actual usage information is received, we record a true-up in the following quarter to reflect any variance from our estimate. In the year ended December 31, 2019, we did not record any material true-ups to our consolidated financial statements.
Practical Expedients
For those contracts for which we recognize revenue at the amount to which we have the right to invoice for service performed, we do not disclose the value of any unsatisfied performance obligations. We also do not disclose the remaining unsatisfied performance obligations which have an original duration of one year or less. Additionally, we immediately expense sales commissions when incurred as the amortization period would have been less than one year. These costs are recorded within sales and marketing expense.
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 Napster 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 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 at the time of acquisition, 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 18. 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 final 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
|
|
$
|
10,127
|
|
|
|
|
|
Accounts receivable
|
|
20,915
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
2,421
|
|
|
|
|
|
Restricted cash
|
|
2,322
|
|
|
|
|
|
Equipment, software and leasehold improvements
|
|
474
|
|
|
|
|
|
Operating lease assets
|
|
2,400
|
|
|
|
|
|
Other long-term assets
|
|
77
|
|
|
|
|
|
Deferred tax assets, net
|
|
5,932
|
|
|
|
|
|
Intangible assets
|
|
23,700
|
|
|
|
|
|
Goodwill
|
|
45,520
|
|
|
|
|
|
Total assets acquired
|
|
113,888
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
786
|
|
|
|
|
|
Accrued royalties and fulfillment
|
|
59,036
|
|
|
|
|
|
Accrued and other current liabilities
|
|
7,032
|
|
|
|
|
|
Deferred revenue, current portion
|
|
3,526
|
|
|
|
|
|
Notes payable
|
|
12,211
|
|
|
|
|
|
Deferred tax liabilities, net
|
|
6,208
|
|
|
|
|
|
Long-term lease liabilities
|
|
1,190
|
|
|
|
|
|
Other long-term liabilities
|
|
1,621
|
|
|
|
|
|
Total liabilities assumed
|
|
91,610
|
|
|
|
|
|
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. In the fourth quarter of 2019, we recorded purchase price allocation adjustments that reflect new information obtained during the measurement period about facts and circumstances that existed at the date of the acquisition. These adjustments did not have a material effect on current or prior period consolidated financial statements and are primarily associated with the estimated fair values of acquired prepaid royalties, accrued royalties, and accrued taxes, with a corresponding net reduction of $3.0 million to goodwill. Adjustments to acquired prepaid royalties and accrued royalties also include the matching and invoicing of music royalties owed as of the opening balance sheet, as discussed in Note 9. Accrued and Other Current Liabilities.
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 was 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 in 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. At the time of acquisition, we used a group of comparable companies and selected an appropriate EBITDA multiple to apply to Napster's projected 2020 and 2021 EBITDA. Assumptions in both the income and market approaches were significant to the overall valuation of Napster and changes to these assumptions could have materially impacted the 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 at the time of acquisition. This fair value calculation was directly impacted by the estimated total enterprise value described above. 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 5. Fair Value Measurements for details on the adjustment to this liability.
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 was derived from the estimated total enterprise value described above. The resulting net gain of $5.5 million was included in Other income (expenses) in the Consolidated statement of operations in 2019.
As discussed in Note 18. 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 at the time of acquisition, which was included in Other income (expenses) in the Consolidated statement of operations in 2019. RealNetworks has not been required to pay any portion of this commitment, and, as discussed in Note 10. Notes Payable and Long-term Debt, Napster fully repaid this loan balance on April 30, 2019, thus releasing RealNetworks' previous guaranty.
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 at the time of acquisition, which is included in Other income (expenses) in the Consolidated statement of operations in 2019.
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 $45.5 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 the Napster segment and is not deductible for income tax purposes. 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 year ended December 31, 2019, Napster's revenue and net loss including noncontrolling interests in our consolidated statements of operations was $106.3 million and $6.4 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended - Pro Forma (Unaudited)
December 31,
|
|
|
|
2019
|
|
2018
|
Net revenue
|
$
|
178,732
|
|
|
$
|
214,687
|
|
Net income (loss) attributable to RealNetworks (1)
|
(29,152)
|
|
|
(9,422)
|
|
(1) The pro forma net earnings attributable to RealNetworks for the year ended December 31, 2018 include the acquisition related gain of $12.3 million and $1.5 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.
For the year ended December 31, 2019, we incurred approximately $1.5 million in acquisition-related costs, including regulatory, legal, and other advisory fees, which we have recorded within general and administrative expenses.
Games
On April 16, 2018, in order to acquire a full workforce, we purchased 100% of the shares of a small, privately-held Netherlands-based game development studio for net cash consideration of $4.2 million.
|
|
|
|
|
|
Note 5.
|
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 December 31, 2019 and 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
|
|
December 31, 2019
|
|
|
|
|
|
|
|
December 31, 2019
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
Cash and cash equivalents:
|
|
|
|
|
|
|
|
|
|
Cash
|
$
|
14,887
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
14,887
|
|
|
$
|
14,887
|
|
Money market funds
|
1,918
|
|
|
—
|
|
|
—
|
|
|
1,918
|
|
|
1,918
|
|
Total cash and cash equivalents
|
16,805
|
|
|
—
|
|
|
—
|
|
|
16,805
|
|
|
16,805
|
|
Restricted cash equivalents
|
3,500
|
|
|
1,874
|
|
|
—
|
|
|
5,374
|
|
|
5,374
|
|
Total assets
|
$
|
20,305
|
|
|
$
|
1,874
|
|
|
$
|
—
|
|
|
$
|
22,179
|
|
|
$
|
22,179
|
|
Accrued royalties, fulfillment and other current liabilities
|
|
|
|
|
|
|
|
|
|
Napster acquisition contingent consideration
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,800
|
|
|
$
|
2,800
|
|
|
N/A
|
|
Other long-term liabilities
|
|
|
|
|
|
|
|
|
|
Napster acquisition contingent consideration
|
—
|
|
|
—
|
|
|
9,800
|
|
|
9,800
|
|
|
N/A
|
|
Total liabilities
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
12,600
|
|
|
$
|
12,600
|
|
|
N/A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of
|
|
|
|
|
|
|
|
Amortized Cost as of
|
|
December 31, 2018
|
|
|
|
|
|
|
|
December 31, 2018
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
Warrant 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 December 31, 2019 and 2018 relate to cash pledged as collateral against letters of credit in connection with lease agreements and, as of December 31, 2019, our Loan Agreement requires us to maintain a minimum balance of $3.5 million unrestricted cash at the bank. See Note 10. Notes Payable and Long-term Debt for additional details.
Accrued royalties, fulfillment and other current liabilities and Other long-term liabilities as of December 31, 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 4. Acquisitions, this liability is adjusted quarterly to fair value through earnings. During the fiscal year ended December 31, 2019, we recorded the change in fair value of the contingent consideration of $1.0 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.
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). We did not record any impairments on those assets required to be measured at fair value on a non-recurring basis in 2019 or 2018.
See Note 12. Lease Exit and Related Charges, for a discussion of the losses related to reductions in the use of RealNetworks' office space, which were recorded at the estimated fair value of remaining lease obligations, less expected sub-lease income.
|
|
|
|
|
|
Note 6.
|
Allowance for Doubtful Accounts Receivable and Sales Returns
|
Activity in the allowance for doubtful accounts receivable (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Balance, beginning of year
|
|
$
|
475
|
|
|
$
|
725
|
|
|
|
Assumed through acquisition of Napster
|
|
81
|
|
|
—
|
|
|
|
Addition (reduction) to allowance
|
|
24
|
|
|
(224)
|
|
|
|
|
|
|
|
|
|
|
Effects of foreign currency translation
|
|
(15)
|
|
|
(26)
|
|
|
|
Balance, end of year
|
|
$
|
565
|
|
|
$
|
475
|
|
|
|
Activity in the allowance for sales returns (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Balance, beginning of year
|
|
$
|
85
|
|
|
$
|
212
|
|
|
|
Addition (reduction) to allowance
|
|
(32)
|
|
|
(126)
|
|
|
|
Amounts written off
|
|
(21)
|
|
|
—
|
|
|
|
Effects of foreign currency translation
|
|
—
|
|
|
(1)
|
|
|
|
Balance, end of year
|
|
$
|
32
|
|
|
$
|
85
|
|
|
|
Total, Allowance for Doubtful Accounts Receivable and Sales Returns
|
|
$
|
597
|
|
|
$
|
560
|
|
|
|
Three customers individually comprised more than 10% of trade accounts receivable at December 31, 2019, with the customers accounting for 31%, 11% 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 accounted for 14%, or $23.8 million, of consolidated revenue during the year ended December 31, 2019, in the Napster segment.
One customer accounted for 11%, or $7.7 million, of consolidated revenue during the year ended December 31, 2018, in our Mobile Services segment.
|
|
|
|
|
|
Note 7.
|
Other Intangible Assets
|
Other intangible assets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
|
|
|
2018
|
|
|
|
|
|
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
|
Gross
Amount
|
|
Accumulated
Amortization
|
|
Net
|
Amortizing intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships
|
|
$
|
41,198
|
|
|
$
|
32,764
|
|
|
$
|
8,434
|
|
|
$
|
30,993
|
|
|
$
|
30,993
|
|
|
$
|
—
|
|
|
Developed technology
|
|
30,031
|
|
|
25,545
|
|
|
4,486
|
|
|
24,446
|
|
|
24,446
|
|
|
—
|
|
|
Patents, trademarks and tradenames
|
|
10,477
|
|
|
4,111
|
|
|
6,366
|
|
|
3,765
|
|
|
3,765
|
|
|
—
|
|
|
Service contracts
|
|
5,443
|
|
|
5,443
|
|
|
—
|
|
|
5,538
|
|
|
5,512
|
|
|
26
|
|
|
Total
|
|
$
|
87,149
|
|
|
$
|
67,863
|
|
|
$
|
19,286
|
|
|
$
|
64,742
|
|
|
$
|
64,716
|
|
|
$
|
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In conjunction with our acquisition of Napster in the first quarter of 2019, we recorded $23.7 million in intangibles. In conjunction with our acquisition of a Netherlands-based game development studio in the second quarter of 2018, we recorded $0.1 million in intangibles. Refer to Note 4. Acquisitions for further details about the acquisitions.
Amortization expense related to other intangible assets during the years ended December 31, 2019 and 2018 was $4.4 million and $0.4 million, respectively.
Estimated future amortization of other intangible assets (in thousands):
|
|
|
|
|
|
|
|
2020
|
$
|
4,516
|
|
2021
|
4,516
|
|
2022
|
2,631
|
|
2023
|
1,136
|
|
2024
|
1,075
|
|
Thereafter
|
5,412
|
|
Total
|
$
|
19,286
|
|
No impairments of other intangible assets were recognized in 2019 or 2018.
Changes in goodwill (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2019
|
|
2018
|
Balance, beginning of year
|
|
|
|
|
Goodwill
|
|
$
|
327,608
|
|
|
$
|
323,713
|
|
Accumulated impairment losses
|
|
(310,653)
|
|
|
(310,653)
|
|
|
|
16,955
|
|
|
13,060
|
|
|
|
|
|
|
Increases (decreases) due to current year acquisitions (disposals)
|
|
45,520
|
|
|
4,367
|
|
Effects of foreign currency translation
|
|
(47)
|
|
|
(472)
|
|
|
|
45,473
|
|
|
3,895
|
|
Balance, end of year
|
|
|
|
|
Goodwill
|
|
373,081
|
|
|
327,608
|
|
Accumulated impairment losses
|
|
(310,653)
|
|
|
(310,653)
|
|
|
|
$
|
62,428
|
|
|
$
|
16,955
|
|
See Note 4. Acquisitions, for details on our acquisitions and the impact to goodwill.
Goodwill by segment (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2019
|
|
2018
|
Consumer Media
|
|
$
|
580
|
|
|
$
|
580
|
|
Mobile Services
|
|
2,074
|
|
|
2,040
|
|
Games
|
|
14,254
|
|
|
14,335
|
|
Napster
|
|
45,520
|
|
|
—
|
|
Total goodwill
|
|
$
|
62,428
|
|
|
$
|
16,955
|
|
No impairments of goodwill were recorded in 2019 or 2018.
|
|
|
|
|
|
Note 9.
|
Accrued and Other Current Liabilities
|
Accrued and other current liabilities (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2019
|
|
December 31, 2018
|
Royalties and other fulfillment costs
|
$
|
55,750
|
|
|
$
|
1,989
|
|
Employee compensation, commissions and benefits
|
6,858
|
|
|
4,444
|
|
Sales, VAT and other taxes payable
|
2,547
|
|
|
785
|
|
Operating lease liabilities - current
|
4,805
|
|
|
—
|
|
Other
|
7,343
|
|
|
4,094
|
|
Total accrued royalties, fulfillment and other current liabilities
|
$
|
77,303
|
|
|
$
|
11,312
|
|
Included in royalties and other fulfillment costs are Napster's accrued music royalties totaling $54.2 million at December 31, 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 $2.0 million at December 31, 2019 are included in Prepaid expenses and other current assets on the 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 consolidated balance sheets.
|
|
|
|
|
|
Note 10.
|
Notes Payable and Long-term Debt
|
In August 2019, RealNetworks and Napster entered into a Loan and Security Agreement (Loan Agreement) with a third-party financial institution. Under the terms of the Loan Agreement, the bank extended a revolving line of credit not to exceed $10 million in the aggregate. Available 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. 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 a minimum balance of $3.5 million unrestricted cash at the bank. We are in the process of negotiating the customary covenants for 2020, and we do not expect the resulting revisions to have a material effect on the Loan Agreement.
As of December 31, 2019, RealNetworks had $3.9 million outstanding debt from the revolving line of credit, which was loaned to Napster bearing interest and fees commensurate with our costs. See Note 21. Related Party Transactions for additional details.
We paid and capitalized $0.6 million of financing fees to enter into the revolving line of credit, and the financing fees will be amortized over the term of the debt. The current and non-current unamortized fees were $0.3 million and $0.2 million at December 31, 2019, respectively, and are included in Deferred costs, current and non-current on our consolidated balance sheets.
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 December 31, 2019, Napster had $7.3 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. Included in employee separation costs was restructuring expense of $0.5 million related to and reported in the Napster segment. Asset related and other costs primarily relate to the termination of certain contracts in the second quarter of 2019 as we continue to shift focus onto free-to-play games that offer in-game purchases of virtual goods and away from the premium mobile games that require a one-time purchase.
Restructuring charges are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Separation Costs
|
|
|
Asset Related and Other Costs
|
|
|
Total
|
|
|
|
|
Costs incurred and charged to expense for the year ended December 31, 2019
|
$
|
1,770
|
|
|
$
|
728
|
|
|
$
|
2,498
|
|
|
|
|
Costs incurred and charged to expense for the year ended December 31, 2018
|
$
|
1,873
|
|
|
$
|
—
|
|
|
$
|
1,873
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes to the accrued restructuring liability (which is included in Accrued and other current liabilities) for 2019 and 2018 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Separation Costs
|
|
Asset Related and Other Costs
|
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued liability as of December 31, 2017
|
$
|
244
|
|
|
$
|
—
|
|
|
$
|
244
|
|
|
|
Costs incurred and charged to expense for the year ended December 31, 2018
|
1,873
|
|
|
—
|
|
|
1,873
|
|
|
|
Cash payments
|
(1,362)
|
|
|
—
|
|
|
(1,362)
|
|
|
|
Accrued liability as of December 31, 2018
|
755
|
|
|
—
|
|
|
755
|
|
|
|
Costs incurred and charged to expense for the year ended December 31, 2019, excluding noncash charges
|
1,770
|
|
|
174
|
|
|
1,944
|
|
|
|
Cash payments
|
(2,203)
|
|
|
—
|
|
|
(2,203)
|
|
|
|
Accrued liability as of December 31, 2019
|
$
|
322
|
|
|
$
|
174
|
|
|
$
|
496
|
|
|
|
|
|
|
|
|
|
Note 12.
|
Lease Exit and Related Charges
|
As a result of the reduction in use of RealNetworks' office space, lease exit and related charges have been recognized representing rent and contractual operating expenses over the remaining life of the leases, including estimates of sublease income expected to be received. In the first quarter of 2018, we renegotiated the lease for our Seattle headquarters, reducing our total leased space by 15% and recorded a reduction to our lease loss accrual to reflect our reduced future obligations.
Changes to accrued lease exit and related charges are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
|
|
|
2018
|
|
|
Accrued loss, beginning of year
|
|
|
|
$
|
2,058
|
|
|
|
Additions and adjustments to the lease loss accrual, including estimated sublease income
|
|
|
|
(454)
|
|
|
|
|
|
|
|
|
|
|
Less amounts paid, net of sublease income
|
|
|
|
(382)
|
|
|
|
Accrued loss, end of year
|
|
|
|
1,222
|
|
|
|
Less current portion (included in Accrued and other current liabilities)
|
|
|
|
(346)
|
|
|
|
Accrued loss, non-current portion (included in Other long term liabilities)
|
|
|
|
$
|
876
|
|
|
|
On January 1, 2019, we adopted the new lease standard, and previously accrued lease exit and related charges reduced our recorded operating lease assets at the time of adoption. See Note 2. Recent Accounting Pronouncements for additional information about the new accounting standard and impacts of adoption.
|
|
|
|
|
|
Note 13.
|
Shareholders’ Equity
|
Accumulated Other Comprehensive Loss
Changes in components of accumulated other comprehensive loss (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Investments
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss), beginning of period
|
|
$
|
19
|
|
|
$
|
2
|
|
|
|
|
Unrealized gains (losses), net of tax effects of $0 and $18
|
|
—
|
|
|
17
|
|
|
|
|
Net current period other comprehensive income (loss)
|
|
—
|
|
|
17
|
|
|
|
|
Accumulated other comprehensive income (loss) balance, end of period
|
|
$
|
19
|
|
|
$
|
19
|
|
|
|
Foreign currency translation
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive loss, beginning of period
|
|
$
|
(61,137)
|
|
|
$
|
(59,549)
|
|
|
|
|
Translation adjustments
|
|
(205)
|
|
|
(1,588)
|
|
|
|
|
Net current period other comprehensive income (loss)
|
|
(205)
|
|
|
(1,588)
|
|
|
|
|
Accumulated other comprehensive loss balance, end of period
|
|
$
|
(61,342)
|
|
|
$
|
(61,137)
|
|
|
|
Total accumulated other comprehensive loss, end of period
|
|
|
$
|
(61,323)
|
|
|
$
|
(61,118)
|
|
|
|
Preferred Stock. Each share of Series A preferred stock entitles the holder to one votes and dividends equal to one thousand times the aggregate per share amount of dividends declared on the common stock. There are no shares of Series A preferred stock outstanding.
See Note 22. Subsequent Event for information on the additional funding of approximately $10.0 million received by
RealNetworks in exchange for the issuance of Series B preferred stock on February 10, 2020.
Undesignated preferred stock will have rights and preferences that are determinable by the Board of Directors if and when determination of a new series of preferred stock has been established.
|
|
|
|
|
|
Note 14.
|
Employee Stock and Benefit Plans
|
Equity Compensation Plans. Under our equity incentive plans, we may grant various types of equity awards to employees and Directors. We have granted time-vest and performance-vest stock options and time-vest and performance-vest restricted stock. Generally, options vest based on continuous employment, over a four-year period. The options generally expire seven years from the date of grant and are exercisable at the market value of the common stock at the grant date. Time-vest restricted stock awards generally vest based on continuous employment over a two or four-year period. Performance-based awards vest if the specified performance targets are met and the grantee remains employed over the required period. The performance targets for these awards are generally based on the achievement of company-specific financial results. For these performance-based awards, expense is recognized when it is probable the performance goal will be achieved. We have also issued market-based performance stock options to certain employees. These awards vest if the market condition is met and the grantee remains employed over the requisite service period.
We issue new shares of common stock upon exercise of stock options and the vesting of restricted stock. As of December 31, 2019, there were 2.0 million shares of common stock authorized for future equity awards. Each restricted stock unit granted reduces and each restricted stock unit forfeited or canceled increases the shares available for future grant by a factor of 1.6 shares. Each stock option granted reduces and each stock option forfeited or canceled increases the shares available for future grant by a factor of one share. We also have an employee stock purchase plan, under which 0.1 million shares of common stock are authorized for future issuance as of December 31, 2019.
Stock-based compensation expense recognized in our consolidated statements of operations includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Total stock-based compensation expense
|
|
$
|
2,881
|
|
|
$
|
2,508
|
|
|
|
The total stock-based compensation amounts disclosed above are recorded in the respective line items within operating expenses in the consolidated statement of operations. Included in the expense for 2019 and 2018 was stock compensation recorded for 2018 and 2017, respectively, incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2019 and 2018, respectively. No stock-based compensation was capitalized as part of the cost of an asset as of December 31, 2019 or 2018. As of December 31, 2019, we had $2.3 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 2.9 years.
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, the valuation models for stock option awards require various highly judgmental assumptions. The assumption for the expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, including the contractual terms, vesting schedules, and expectations of future employee behavior. Expected stock price volatility is based on historical volatility of our common stock for the related expected term. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to the expected term of the stock options. The dividend yield is estimated at zero because we do not currently anticipate paying dividends in the foreseeable future.
The fair value of options granted used the following weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Expected dividend yield
|
|
—
|
%
|
|
—
|
%
|
|
|
Risk-free interest rate
|
|
2.12
|
%
|
|
2.71
|
%
|
|
|
Expected term (years)
|
|
4.0
|
|
4.3
|
|
|
Volatility
|
|
41
|
%
|
|
35
|
%
|
|
|
Restricted stock unit and award activity was as follows (shares are in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Shares
|
Weighted Average Grant Date Fair Value Per Share
|
Total Grant Date Fair Value of Vested Awards (000's)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested shares, December 31, 2017
|
192
|
|
$
|
4.53
|
|
|
Granted
|
943
|
|
2.56
|
|
|
Vested
|
(402)
|
|
3.18
|
|
$
|
1,278
|
|
Forfeited/Canceled
|
(35)
|
|
4.69
|
|
|
Nonvested shares, December 31, 2018
|
698
|
|
$
|
2.63
|
|
|
Granted
|
701
|
|
2.54
|
|
|
Vested
|
(499)
|
|
3.10
|
|
$
|
1,547
|
|
Forfeited/Canceled
|
(55)
|
|
3.33
|
|
|
Nonvested shares, December 31, 2019
|
845
|
|
$
|
2.24
|
|
|
At December 31, 2019 the aggregate intrinsic value of restricted stock awards was $1.0 million and the weighted average remaining contractual term was approximately 1 year.
Stock option activity (shares are in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
|
Weighted Average Grant Date Fair Value
|
|
|
|
Number
of Shares
|
|
Weighted
Average
Exercise Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2017
|
|
|
6,076
|
|
|
$
|
5.47
|
|
|
|
Options granted at common stock price
|
|
|
2,339
|
|
|
3.17
|
|
|
$
|
1.01
|
|
Options exercised
|
|
|
—
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options cancelled
|
|
|
(1,087)
|
|
|
6.68
|
|
|
|
Outstanding, December 31, 2018
|
|
|
7,328
|
|
|
$
|
4.56
|
|
|
|
Options granted at common stock price
|
|
|
988
|
|
|
2.33
|
|
|
$
|
0.81
|
|
Options exercised
|
|
|
—
|
|
|
—
|
|
|
|
Options cancelled
|
|
|
(845)
|
|
|
4.67
|
|
|
|
Outstanding, December 31, 2019
|
|
|
7,471
|
|
|
$
|
4.25
|
|
|
|
Exercisable, December 31, 2019
|
|
|
4,667
|
|
|
$
|
4.92
|
|
|
|
Vested and expected to vest, December 31, 2019
|
|
|
6,335
|
|
|
$
|
4.44
|
|
|
|
As of December 31, 2019, the weighted average remaining contractual life of the options was as follows: outstanding options 4.4 years; exercisable options 3.7 years; and vested and expected to vest options 4.2 years. As of December 31, 2019, there was no aggregate intrinsic value for our outstanding, exercisable or vested and expected to vest options.
The aggregate intrinsic value of stock options exercised in 2019 was zero, and for 2018 was insignificant.
Employee Stock Purchase Plan. Our Employee Stock Purchase Plan (ESPP) allows an eligible employee to purchase shares of our common stock at a price equal to 85 percent of the fair market value of the common stock at the end of the semi-annual offering periods, subject to certain limitations. Under the ESPP, 143,800 and 79,200 shares were purchased during the years ended December 31, 2019 and 2018, respectively.
Retirement Savings Plan. We have a salary deferral plan (401(k) Plan) that covers substantially all employees. Eligible employees may contribute a portion of their eligible compensation to the plan up to limits stated in the plan documents, not to exceed the dollar amounts set by applicable laws. We match a percentage of employee contributions up to certain limits. During the years ended December 31, 2019 and 2018, we contributed $0.4 million and $0.2 million, respectively, in matching contributions. We can terminate the matching contributions at our discretion. We have no other post-employment or post-retirement benefit plans.
Components of income (loss) before income taxes (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
United States operations
|
|
$
|
(12,567)
|
|
|
$
|
(16,144)
|
|
|
|
Foreign operations
|
|
(7,623)
|
|
|
(6,643)
|
|
|
|
Income (loss) before income taxes
|
|
$
|
(20,190)
|
|
|
$
|
(22,787)
|
|
|
|
Components of income tax expense (benefit) (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Current:
|
|
|
|
|
|
|
United States federal
|
|
$
|
454
|
|
|
$
|
612
|
|
|
|
State and local
|
|
98
|
|
|
53
|
|
|
|
Foreign
|
|
546
|
|
|
367
|
|
|
|
Total current
|
|
1,098
|
|
|
1,032
|
|
|
|
Deferred:
|
|
|
|
|
|
|
United States federal
|
|
(54)
|
|
|
338
|
|
|
|
State and local
|
|
—
|
|
|
—
|
|
|
|
Foreign
|
|
24
|
|
|
832
|
|
|
|
Total deferred
|
|
(30)
|
|
|
1,170
|
|
|
|
Total income tax expense (benefit)
|
|
$
|
1,068
|
|
|
$
|
2,202
|
|
|
|
Income tax expense differs from “expected” income tax expense (computed by applying the U.S. federal income tax rate of 21% in 2019 and 2018) due to the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
United States federal tax expense (benefit) at statutory rate
|
|
$
|
(4,240)
|
|
|
$
|
(4,785)
|
|
|
|
State taxes, net of United States federal tax expense (benefit)
|
|
607
|
|
|
(694)
|
|
|
|
Change in valuation allowance
|
|
4,389
|
|
|
5,804
|
|
|
|
Non-deductible stock compensation
|
|
253
|
|
|
448
|
|
|
|
Impact of non-U.S. jurisdictional tax rate difference
|
|
(311)
|
|
|
(117)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development tax credit
|
|
(125)
|
|
|
(12)
|
|
|
|
|
|
|
|
|
|
|
Increase (reversal) of unrecognized tax benefits
|
|
96
|
|
|
—
|
|
|
|
Basis difference in investment
|
|
—
|
|
|
159
|
|
|
|
Non-U.S. withholding tax
|
|
283
|
|
|
470
|
|
|
|
Change in indefinite reinvestment assertion
|
|
(72)
|
|
|
998
|
|
|
|
Other
|
|
188
|
|
|
(69)
|
|
|
|
Total income tax expense (benefit)
|
|
$
|
1,068
|
|
|
$
|
2,202
|
|
|
|
Net deferred tax assets, which are recorded at December 31, 2019 and December 31, 2018 using a 21% tax rate in the U.S. following the passage of the Tax Act, are comprised of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2019
|
|
2018
|
Deferred tax assets:
|
|
|
|
|
United States federal net operating loss carryforwards
|
|
$
|
85,270
|
|
|
$
|
62,983
|
|
Deferred expenses
|
|
3,226
|
|
|
660
|
|
Research and development tax credit carryforwards
|
|
19,694
|
|
|
24,523
|
|
Right of use tax asset
|
|
2,696
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
2,697
|
|
|
2,603
|
|
State net operating loss carryforwards
|
|
13,880
|
|
|
11,971
|
|
Foreign net operating loss carryforwards
|
|
34,079
|
|
|
31,254
|
|
Deferred revenue
|
|
900
|
|
|
67
|
|
Equipment, software, and leasehold improvements
|
|
2,922
|
|
|
2,642
|
|
Intangibles
|
|
6,216
|
|
|
13
|
|
Net unrealized gains and basis differences on investments
|
|
—
|
|
|
1,193
|
|
Other
|
|
455
|
|
|
839
|
|
Gross deferred tax assets
|
|
172,035
|
|
|
138,748
|
|
Less valuation allowance
|
|
160,783
|
|
|
137,246
|
|
Gross deferred tax assets, net of valuation allowance
|
|
$
|
11,252
|
|
|
$
|
1,502
|
|
Deferred tax liabilities:
|
|
|
|
|
Other intangible assets
|
|
$
|
(4,667)
|
|
|
$
|
(155)
|
|
Right of use tax liability
|
|
(2,333)
|
|
|
—
|
|
Undistributed foreign earnings
|
|
(909)
|
|
|
(1,001)
|
|
Other
|
|
(838)
|
|
|
(663)
|
|
Net unrealized gains and basis differences on investments
|
|
(2,916)
|
|
|
—
|
|
Gross deferred tax liabilities
|
|
(11,663)
|
|
|
(1,819)
|
|
Net deferred tax assets (liabilities)
|
|
$
|
(411)
|
|
|
$
|
(317)
|
|
As of December 31, 2019, we maintained a valuation allowance of $160.8 million for our deferred tax assets that we believe are not more likely than not to be realized. The net change in valuation allowance was a $23.5 million increase and a $0.1 million increase during the years ended December 31, 2019 and 2018, respectively. The net increase in the valuation
allowance since December 31, 2018 of $23.5 million was the result of the acquisition of Napster and an increase in current year deferred tax assets for which the Company maintains a valuation allowance.
RealNetworks' U.S. federal net operating loss carryforwards totaled $406.0 million and $299.9 million at December 31, 2019 and 2018, respectively. The increase is mainly due to net operating loss carryforwards from the acquisition of Napster, in addition to the current year U.S. taxable loss. The remaining net operating loss carryforwards as of December 31, 2019 are from prior U.S. taxable losses and from acquired subsidiaries that are limited under Internal Revenue Code Section 382. These net operating loss carryforwards expire between 2024 and 2037.
Income tax receivables were $1.8 million and $3.6 million at December 31, 2019 and 2018. $0.9 million of the $1.8 million is refundable in 2020 and has been recorded in our current tax receivable. The remaining $0.9 million remains in other long term assets.
RealNetworks' U.S. federal research and development tax credit carryforward totaled $19.7 million and $24.5 million at December 31, 2019 and 2018. The research and development credit carryforwards expire between 2020 and 2039.
As of December 31, 2018, the Company no longer intends to indefinitely reinvest substantially all of the Company's foreign earnings outside of the U.S. We have recorded deferred taxes of $0.9 million and $1.0 million as of December 31, 2019 and 2018, respectively, for local country and foreign withholding taxes associated with the repatriation of such foreign earnings.
As of December 31, 2019 and 2018, RealNetworks had $5.0 million and $0.4 million in uncertain tax positions, respectively. The increase in uncertain tax positions was primarily the result of the acquisition of Napster, for which unrecognized tax positions were recorded relating to federal research and development tax credit carryforward risks, as well as transfer pricing risks in certain foreign jurisdictions. Notwithstanding current year accruals for existing positions, we do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We recognize interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of December 31, 2019, we have approximately $0.6 million of accrued interest or penalties related to uncertain tax positions. There was no accrued interest or penalties related to uncertain tax positions as of December 31, 2018.
Reconciliation of the beginning and ending balances of the total amounts of unrecognized tax benefits (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Balance, beginning of year
|
|
$
|
374
|
|
|
$
|
358
|
|
|
|
Increases related to prior year tax positions
|
|
4,125
|
|
|
8
|
|
|
|
Decreases related to prior year tax positions
|
|
(85)
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Increases related to current year tax positions
|
|
606
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
5,020
|
|
|
$
|
374
|
|
|
|
|
|
|
|
|
|
Note 16.
|
Earnings (Loss) Per Share
|
Basic and diluted net income (loss) per share (EPS) (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to RealNetworks
|
|
$
|
(20,001)
|
|
|
$
|
(24,989)
|
|
|
|
Weighted average common shares outstanding used to compute basic EPS
|
|
37,994
|
|
|
37,582
|
|
|
|
Dilutive effect of stock based awards
|
|
—
|
|
|
—
|
|
|
|
Weighted average common shares outstanding used to compute diluted EPS
|
|
37,994
|
|
|
37,582
|
|
|
|
Basic EPS from continuing operations attributable to RealNetworks
|
|
$
|
(0.53)
|
|
|
$
|
(0.66)
|
|
|
|
Diluted EPS from continuing operations attributable to RealNetworks
|
|
$
|
(0.53)
|
|
|
$
|
(0.66)
|
|
|
|
Approximately 7.7 million and 6.5 million shares of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS for the years ended December 31, 2019 and 2018, respectively, 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 effective as of January 1, 2019. 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 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2019
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease expense
|
|
$
|
5,600
|
|
|
|
|
|
Variable lease expense
|
|
877
|
|
|
|
|
|
Sublease income
|
|
(2,028)
|
|
|
|
|
|
Net lease expense
|
|
$
|
4,449
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating cash outflows for lease liabilities
|
|
$
|
5,643
|
|
|
|
|
|
Details related to lease term and discount rate were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2019
|
|
|
Weighted-average remaining lease term (in years)
|
|
4 years
|
|
|
Weighted-average discount rate
|
|
5.14
|
%
|
|
|
Future minimum lease payments as of December 31, 2019 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Office
Leases
|
|
|
|
|
2020
|
|
$
|
5,057
|
|
|
|
|
|
2021
|
|
3,276
|
|
|
|
|
|
2022
|
|
2,426
|
|
|
|
|
|
2023
|
|
2,348
|
|
|
|
|
|
2024
|
|
1,634
|
|
|
|
|
|
Thereafter
|
|
—
|
|
|
|
|
|
Total minimum payments (a)
|
|
14,741
|
|
|
|
|
|
Less: Imputed interest
|
|
1,470
|
|
|
|
|
|
Present value of total minimum payments (b)
|
|
$
|
13,271
|
|
|
|
|
|
(a) Total minimum payments exclude executory costs, inclusive of insurance, maintenance, and taxes, of $6.1 million; minimum payments also have not been reduced by sublease rentals of $5.3 million due in the future under noncancelable subleases.
(b) $8.5 million is included in Long-term lease liabilities and $4.8 million is included in Accrued royalties, fulfillment, and other current liabilities on the 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. Total minimum payments excluded executory costs, inclusive of insurance, maintenance, and taxes, of $6.2 million; minimum payments also have not been reduced by sublease rentals of $6.0 million due in the future under noncancelable subleases.
Rent expense during the year ended December 31, 2018 was $2.8 million.
|
|
|
|
|
|
Note 18.
|
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 its 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 and Long-term Debt, Napster fully repaid this loan balance on April 30, 2019, thus releasing RealNetworks' previous 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. In May 2019, public notice was posted about the settlement informing purported class members that they could make claims or object to the settlement, and the claims period ended on December 31, 2019. The preliminary results show that the claimed damages are not significant, and valid claims are expected to be paid by Napster 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 20.
|
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 in-game virtual goods, mobile games and games licenses, games subscription services, and in-game advertising and advertising on games 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 4. Acquisitions, Napster is operating as an independent company and includes all their corporate expenses, including restructuring charges, in their segment results, and RealNetworks does not allocate any expenses to the Napster segment.
RealNetworks reports the four reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker (CODM) reviews results. The CODM reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1. Description of Business and Summary of Significant Accounting Policies.
Segment results for the years ended December 31, 2019 and 2018 were as follows (in thousands):
Consumer Media
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Revenue
|
|
$
|
13,170
|
|
|
$
|
18,168
|
|
|
|
Cost of revenue
|
|
3,031
|
|
|
3,858
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
10,139
|
|
|
14,310
|
|
|
|
Operating expenses
|
|
11,186
|
|
|
14,419
|
|
|
|
Operating income (loss)
|
|
$
|
(1,047)
|
|
|
$
|
(109)
|
|
|
|
Mobile Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Revenue
|
|
$
|
27,143
|
|
|
$
|
29,670
|
|
|
|
Cost of revenue
|
|
7,500
|
|
|
8,623
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
19,643
|
|
|
21,047
|
|
|
|
Operating expenses
|
|
29,340
|
|
|
28,066
|
|
|
|
Operating income (loss)
|
|
$
|
(9,697)
|
|
|
$
|
(7,019)
|
|
|
|
Games
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Revenue
|
|
$
|
25,489
|
|
|
$
|
21,672
|
|
|
|
Cost of revenue
|
|
6,975
|
|
|
6,123
|
|
|
|
Gross profit
|
|
18,514
|
|
|
15,549
|
|
|
|
Operating expenses
|
|
20,220
|
|
|
20,324
|
|
|
|
Operating income (loss)
|
|
$
|
(1,706)
|
|
|
$
|
(4,775)
|
|
|
|
Napster
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Revenue
|
|
$
|
106,311
|
|
|
$
|
—
|
|
|
|
Cost of revenue
|
|
85,901
|
|
|
—
|
|
|
|
Gross profit
|
|
20,410
|
|
|
—
|
|
|
|
Operating expenses
|
|
25,789
|
|
|
—
|
|
|
|
Operating income (loss)
|
|
$
|
(5,379)
|
|
|
$
|
—
|
|
|
|
Corporate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
Cost of revenue
|
|
$
|
(280)
|
|
|
$
|
(877)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
14,894
|
|
|
11,245
|
|
|
|
Operating income (loss)
|
|
$
|
(14,614)
|
|
|
$
|
(10,368)
|
|
|
|
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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31,
|
|
|
|
|
|
|
|
2019
|
|
2018
|
|
|
United States
|
|
$
|
83,360
|
|
|
$
|
35,803
|
|
|
|
Europe
|
|
64,484
|
|
|
12,144
|
|
|
|
|
|
|
|
|
|
|
Rest of the World
|
|
24,269
|
|
|
21,563
|
|
|
|
Total
|
|
$
|
172,113
|
|
|
$
|
69,510
|
|
|
|
Long-lived assets (consists of equipment, software, leasehold improvements, operating lease assets, other intangible assets, and goodwill) by geographic region (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
|
2019
|
|
2018
|
United States
|
|
$
|
83,342
|
|
|
$
|
11,823
|
|
Europe
|
|
10,504
|
|
|
6,761
|
|
|
|
|
|
|
Rest of the World
|
|
2,281
|
|
|
1,151
|
|
Total long-lived assets
|
|
$
|
96,127
|
|
|
$
|
19,735
|
|
|
|
|
|
|
|
Note 21.
|
Related Party Transactions
|
As described in Note 4. 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 $10.0 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 $10.0 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. In August 2019, RealNetworks established a two-year term on this short-term loan and, as discussed in Note 10. Notes Payable and Long-term Debt, loaned Napster an additional $3.9 million and charged Napster for associated fees. As a result, the principal amount on this two-year note is $5.4 million. Both the two-year note and the $10.0 million loan are subordinate to RealNetworks' and Napster's third party debt.
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 RealNetworks' acquisition of a controlling interest in Napster, the notes and warrants were effectively settled and eliminated in our consolidated financial statements as they represent preexisting relationships between RealNetworks and Napster. However, the notes and warrants remain contractually binding instruments between RealNetworks and Napster.
In 2019, Mr. Glaser directly invested $0.8 million in one of our subsidiaries in exchange for shares of preferred stock of that entity. The subsidiary is developing a platform that transforms the experience of viewing video entertainment into a social, connected playground. As of December 31, 2019, RealNetworks owned approximately 82% of the subsidiary's outstanding equity, and we consolidate its financial results into our financial statements. The financial results of the subsidiary are reported in our Consumer Media segment.
|
|
|
|
|
|
Note 22.
|
Subsequent Event
|
On February 10, 2020, we entered into a Series B Preferred Stock Purchase Agreement with Mr. Glaser, pursuant to which Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of 8,064,516 shares of Series B Preferred Stock. The Series B Preferred Stock is non-voting and is convertible into common stock on a one-to-one basis, provided, however, that no conversion is permitted in the event that such conversion would cause Mr. Glaser’s beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our Second Amended and Restated Shareholder Rights Plan dated November 30, 2018. The Series B Preferred Stock has no liquidation preference and no preferred dividend.
|
|
|
|
|
|
Note 23.
|
Quarterly Information (Unaudited)
|
The following table summarizes the unaudited statement of operations for each quarter of 2019 and 2018 (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Dec. 31
|
|
Sept. 30
|
|
June 30
|
|
Mar. 31
|
2019
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
172,113
|
|
|
$
|
43,400
|
|
|
$
|
44,993
|
|
|
$
|
44,248
|
|
|
$
|
39,472
|
|
Gross profit
|
|
68,986
|
|
|
18,703
|
|
|
18,715
|
|
|
16,966
|
|
|
14,602
|
|
Operating (loss) income
|
|
(32,443)
|
|
|
(5,883)
|
|
|
(6,265)
|
|
|
(9,391)
|
|
|
(10,904)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to RealNetworks (2)
|
|
(20,001)
|
|
|
(6,364)
|
|
|
(5,968)
|
|
|
(9,202)
|
|
|
1,533
|
|
Basic net income (loss) per share (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share - basic
|
|
(0.53)
|
|
|
(0.17)
|
|
|
(0.16)
|
|
|
(0.24)
|
|
|
0.04
|
|
Diluted net income (loss) per share (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share - diluted
|
|
(0.53)
|
|
|
(0.17)
|
|
|
(0.16)
|
|
|
(0.24)
|
|
|
0.04
|
|
2018
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
69,510
|
|
|
$
|
16,557
|
|
|
$
|
17,579
|
|
|
$
|
15,724
|
|
|
$
|
19,650
|
|
Gross profit
|
|
51,783
|
|
|
12,830
|
|
|
13,340
|
|
|
11,099
|
|
|
14,514
|
|
Operating (loss) income
|
|
(22,271)
|
|
|
(5,556)
|
|
|
(4,928)
|
|
|
(6,833)
|
|
|
(4,954)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to RealNetworks (2)
|
|
(24,989)
|
|
|
(6,904)
|
|
|
(5,977)
|
|
|
(6,930)
|
|
|
(5,178)
|
|
Basic net income (loss) per share (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share - basic
|
|
(0.66)
|
|
|
(0.18)
|
|
|
(0.16)
|
|
|
(0.18)
|
|
|
(0.14)
|
|
Diluted net income (loss) per share (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share - diluted
|
|
(0.66)
|
|
|
(0.18)
|
|
|
(0.16)
|
|
|
(0.18)
|
|
|
(0.14)
|
|
(1)The sum of the quarterly net income per share amounts will not necessarily equal net income per share for the year due to the use of weighted average quarterly shares and the effects of rounding.
(2)Net income attributable to RealNetworks for the quarter ended March 31, 2019 includes $12.3 million related to RealNetworks' gain on consolidation of Napster, as described in more detail in Note 4. Acquisitions.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
RealNetworks, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of RealNetworks, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 30, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Codification Topic 842 - Leases.
Going Concern
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations and anticipates negative operating cash flows that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company's auditor since 1994.
Seattle, Washington
March 30, 2020
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
RealNetworks, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited RealNetworks, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2019 and 2018, and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively, the consolidated financial statements), and our report dated March 30, 2020 expressed an unqualified opinion on those consolidated financial statements.
The Company acquired an additional 42% interest in Napster during 2019, and management excluded from its assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, Napster’s internal control over financial reporting associated with 63% of total assets and 62% of total revenue included in the consolidated financial statements of the Company as of and for the year ended December 31, 2019. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Napster.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Seattle, Washington
March 30, 2020