Q2 10Q 2014



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 0-23137
 
 RealNetworks, Inc.
 
 
(Exact name of registrant as specified in its charter)
 
Washington
 
91-1628146
(State of incorporation)
 
(I.R.S. Employer
Identification Number)
 
 
 
 
 
1501 First Avenue South, Suite 600
Seattle, Washington
 
98134
(Address of principal executive offices)
 
(Zip Code)
 
(206) 674-2700
 
 
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
  
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   ý
The number of shares of the registrant’s Common Stock outstanding as of July 31, 2014 was 35,995,569.




TABLE OF CONTENTS
 
 
Page
 
 

2



PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
June 30,
2014
 
December 31,
2013
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
124,450

 
$
151,235

Short-term investments
70,583

 
74,920

Trade accounts receivable, net of allowances
21,580

 
24,613

Deferred costs, current portion
992

 
1,601

Deferred tax assets, current
311

 
306

Prepaid expenses and other current assets
9,910

 
9,124

Total current assets
227,826

 
261,799

Equipment, software, and leasehold improvements, at cost:
 
 
 
Equipment and software
86,755

 
86,721

Leasehold improvements
3,915

 
3,482

Total equipment, software, and leasehold improvements, at cost
90,670

 
90,203

Less accumulated depreciation and amortization
70,212

 
67,031

Net equipment, software, and leasehold improvements
20,458

 
23,172

Restricted cash equivalents and investments
3,000

 
3,000

Equity method investment
10,000

 
12,473

Available for sale securities
3,182

 
7,181

Other assets
3,073

 
2,332

Deferred costs, non-current portion
1,062

 
946

Deferred tax assets, net, non-current portion
1,405

 
1,409

Other intangible assets, net
11,928

 
12,993

Goodwill
18,005

 
17,476

Total assets
$
299,939

 
$
342,781

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
20,363

 
$
19,987

Accrued and other current liabilities
26,874

 
41,893

Deferred tax liabilities, net, current portion
911

 
899

Deferred revenue, current portion
7,835

 
7,498

Total current liabilities
55,983

 
70,277

Deferred revenue, non-current portion
145

 
166

Deferred rent
1,269

 
1,318

Deferred tax liabilities, net, non-current portion
1,725

 
1,556

Other long-term liabilities
607

 
483

Total liabilities
59,729

 
73,800

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 35,992 shares in 2014 and 35,833 shares in 2013
36

 
36

Additional paid-in capital
613,617

 
610,167

Accumulated other comprehensive loss
(51,117
)
 
(47,695
)
Retained deficit
(322,326
)
 
(293,527
)
Total shareholders’ equity
240,210

 
268,981

Total liabilities and shareholders’ equity
$
299,939

 
$
342,781

See accompanying notes to unaudited condensed consolidated financial statements.

3



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Net revenue (A)
$
40,825

 
$
49,850

 
$
86,549

 
$
106,643

Cost of revenue (B)
20,786

 
19,519

 
39,572

 
40,025

Extinguishment of liability (See Note 10)

 

 
(10,580
)
 

Gross profit
20,039

 
30,331

 
57,557

 
66,618

Operating expenses:
 
 
 
 
 
 
 
Research and development
13,267

 
14,993

 
27,326

 
30,244

Sales and marketing
16,016

 
19,269

 
37,739

 
40,403

General and administrative
8,577

 
8,691

 
17,894

 
18,637

Restructuring and other charges
541

 
816

 
1,757

 
2,198

Lease exit and related charges
470

 
3,066

 
549

 
3,066

Total operating expenses
38,871

 
46,835

 
85,265

 
94,548

Operating income (loss)
(18,832
)
 
(16,504
)
 
(27,708
)
 
(27,930
)
Other income (expenses):
 
 
 
 
 
 
 
Interest income, net
180

 
179

 
316

 
826

Gain (loss) on sale of available for sale securities, net

 

 
2,371

 

Equity in net loss of Rhapsody investment
(1,802
)
 
(1,347
)
 
(2,640
)
 
(3,580
)
Other income (expense), net
(95
)
 
(137
)
 
(172
)
 
(28
)
Total other income (expenses), net
(1,717
)
 
(1,305
)
 
(125
)
 
(2,782
)
Income (loss) before income taxes
(20,549
)
 
(17,809
)
 
(27,833
)
 
(30,712
)
Income tax expense (benefit)
480

 
662

 
966

 
(567
)
Net income (loss)
$
(21,029
)
 
$
(18,471
)
 
$
(28,799
)
 
$
(30,145
)
Basic net income (loss) per share
$
(0.59
)
 
$
(0.52
)
 
$
(0.80
)
 
$
(0.85
)
Diluted net income (loss) per share
$
(0.59
)
 
$
(0.52
)
 
$
(0.80
)
 
$
(0.85
)
Shares used to compute basic net income (loss) per share
35,890

 
35,455

 
35,865

 
35,399

Shares used to compute diluted net income (loss) per share
35,890

 
35,455

 
35,865

 
35,399

Comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized investment holding gains (losses), net of reclassification adjustments
$
(38
)
 
$
(1,622
)
 
$
(3,613
)
 
$
1,015

Foreign currency translation adjustments, net of reclassification adjustments
216

 
(388
)
 
191

 
(1,626
)
Total other comprehensive income (loss)
178

 
(2,010
)
 
(3,422
)
 
(611
)
Net income (loss)
(21,029
)
 
(18,471
)
 
(28,799
)
 
(30,145
)
Comprehensive income (loss)
$
(20,851
)
 
$
(20,481
)
 
$
(32,221
)
 
$
(30,756
)
(A) Components of net revenue:
 
 
 
 
 
 
 
License fees
$
6,664

 
$
10,162

 
$
15,243

 
$
22,991

Service revenue
34,161

 
39,688

 
71,306

 
83,652

 
$
40,825

 
$
49,850

 
$
86,549

 
$
106,643

(B) Components of cost of revenue:
 
 
 
 
 
 
 
License fees
$
2,170

 
$
2,161

 
$
4,382

 
$
4,315

Service revenue
18,616

 
17,358

 
35,190

 
35,710

 
$
20,786

 
$
19,519

 
$
39,572

 
$
40,025

See accompanying notes to unaudited condensed consolidated financial statements.

4



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Six Months Ended
June 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(28,799
)
 
$
(30,145
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
6,145

 
9,874

Stock-based compensation
3,010

 
4,058

Equity in net loss of Rhapsody
2,640

 
3,580

Deferred income taxes, net
10

 
(1,668
)
Gain on sale of available for sale securities
(2,371
)
 

Realized translation gain
(48
)
 
(35
)
Extinguishment of liability
(10,580
)
 

Other

 
51

Net change in certain operating assets and liabilities:
 
 
 
Trade accounts receivable
3,346

 
5,355

Prepaid expenses and other assets
94

 
6,749

Accounts payable
(114
)
 
(92
)
Accrued and other liabilities
(4,111
)
 
(10,612
)
Net cash provided by (used in) operating activities
(30,778
)
 
(12,885
)
Cash flows from investing activities:
 
 
 
Purchases of equipment, software, and leasehold improvements
(1,689
)
 
(3,181
)
Proceeds from sale of available for sale securities
2,754

 

Purchases of short-term investments
(48,326
)
 
(70,647
)
Proceeds from sales and maturities of short-term investments
52,663

 
71,327

Acquisitions of businesses, net of cash acquired
(733
)
 
(16,107
)
Other
(467
)
 

Net cash provided by (used in) investing activities
4,202

 
(18,608
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock (stock options and stock purchase plan)
580

 
392

Tax payments from shares withheld upon vesting of restricted stock
(307
)
 
(800
)
Payment of contingent consideration
(696
)
 
(828
)
Net cash provided by (used in) financing activities
(423
)
 
(1,236
)
Effect of exchange rate changes on cash and cash equivalents
214

 
(1,259
)
Net increase (decrease) in cash and cash equivalents
(26,785
)
 
(33,988
)
Cash and cash equivalents, beginning of period
151,235

 
163,198

Cash and cash equivalents, end of period
$
124,450

 
$
129,210

Supplemental disclosure of cash flow information:
 
 
 
Cash received from income tax refunds
$
97

 
$
8,100

Cash paid for income taxes
$
1,074

 
$
2,147

Non-cash investing activities:
 
 
 
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements
$
(321
)
 
$
483

See accompanying notes to unaudited condensed consolidated financial statements.


5



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Six Months Ended June 30, 2014 and 2013
Note 1. Description of Business and Summary of Significant Accounting Policies
Description of Business. RealNetworks, Inc. and subsidiaries is a leading global provider of network-delivered digital media applications and services that make it easy to manage, play and share digital media. The Company also develops and markets software products and services that enable the creation, distribution and consumption of digital media, including audio and video.
Inherent in our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services and the ability to generate related revenue.
In this Quarterly Report on Form 10-Q (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”. “RealPlayer”, “LISTEN” and other trademarks of ours appearing in this report are our property.       
Basis of Presentation. The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of the Company’s management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2014. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2013 (the 10-K).
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, current economic conditions may require the use of additional estimates, and certain estimates we make are subject to a greater degree of uncertainty as a result of the current economic conditions.
Note 2. Recent Accounting Pronouncements
    
In May 2014, the Financial Accounting Standards Board (FASB) issued new revenue recognition guidance. The guidance will require an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new guidance is effective for us on January 1, 2017. Early application is not permitted. The guidance permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that the guidance will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor determined the effect of the standard on our ongoing financial reporting.     
In April 2014, the FASB issued new guidance related to discontinued operations. The guidance changes the criteria for reporting discontinued operations and modifies the related disclosure requirements. Under the new guidance, a discontinued operation is defined as a disposal of a component or group of components that represents a strategic shift that has, or will have, a major effect on an entity's operations and financial results.  The new guidance is effective for us on January 1, 2016. We are evaluating the impact that this guidance may have on our consolidated financial statements and related disclosures.
There have been no other recent accounting pronouncements or changes in accounting pronouncements to be implemented that are of significance or potential significance to RealNetworks.
Note 3. Acquisitions

6



In the quarter ended June 30, 2013, we acquired 100% of the voting interests in Slingo, Inc., a social casino games company based in the U.S., for total cash consideration of $15.6 million. The tangible and intangible assets and liabilities recognized are reported within the Games segment. The identifiable intangible assets associated with the acquisition totaled $8.0 million. Of this total, $4.5 million was related to tradenames and trademarks determined to have indefinite useful lives and will be evaluated annually in our fourth quarter for impairment, or more frequently, if circumstances indicate an impairment may exist. The remaining $3.5 million includes developed game technology and existing customer relationships with finite lives, and is being amortized over their useful lives. We recorded a net deferred tax liability of $2.7 million related to the intangible assets acquired. Goodwill totaling $9.9 million was recorded, representing the excess of purchase consideration over the fair value of net acquired assets, and was primarily related to the assembled workforce and expected synergies in the rapidly growing social casino games market. The goodwill is not deductible for income tax purposes. We expect this acquisition to enhance our footprint in the social casino games arena.
In the quarter ended September 30, 2013, we acquired 100% of the voting interests in Muzicall Limited, a ringback tone company based in London, for total cash consideration of $6.7 million. The tangible and intangible assets and liabilities recognized are reported in the Mobile Entertainment segment. The identifiable intangible assets associated with the acquisition totaled $5.4 million, and include tradenames and trademarks, developed technology, user base and carrier relationships. All identifiable intangible assets from this acquisition have finite lives, and are being amortized over their useful lives. We recorded a net deferred tax asset of $3.4 million related to the assets acquired, and a full valuation allowance. Goodwill totaling $1.3 million was recorded, representing the excess of purchase consideration over the fair value of net acquired assets acquired, and was primarily related to the assembled workforce and expected synergies in the ringback tone industry. The goodwill is not deductible for income tax purposes. This acquisition is intended to accelerate our growth initiatives within the Mobile Entertainment segment.
Note 4. Stock-Based Compensation
Total stock-based compensation expense recognized in our consolidated statements of operations includes amounts related to stock options, restricted stock units, and employee stock purchase plans and was as follows (in thousands):
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Total stock-based compensation expense
$
1,673

 
$
2,020

 
$
3,010

 
$
4,058

The fair value of options granted determined using the Black-Scholes model used the following weighted-average assumptions:
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Expected dividend yield
0
%
 
0
%
 
0
%
 
0
%
Risk-free interest rate
1.20
%
 
0.52
%
 
1.19
%
 
0.55
%
Expected life (years)
3.8

 
5.4

 
3.8

 
4.3

Volatility
40
%
 
48
%
 
40
%
 
48
%

The total stock-based compensation amounts for 2014 and 2013 disclosed above are recorded in their respective line items within operating expenses in the consolidated statement of operations. As of June 30, 2014, we had $11.5 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 3 years.
Note 5. Rhapsody Joint Venture
As of June 30, 2014 we owned approximately 45% of the issued and outstanding stock of Rhapsody and account for our investment using the equity method of accounting.
Rhapsody was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International Inc. (MTVN), to own and operate a business-to-consumer digital audio music service known as Rhapsody. Prior to March 31, 2010, we held a 51% interest in Rhapsody and MTVN owned the remaining 49%. On March 31, 2010, restructuring transactions involving Rhapsody were completed, and as a result, effective March 31, 2010 RealNetworks

7



owned approximately 47% of Rhapsody. Subsequent to the restructuring transaction, we have accounted for our investment in Rhapsody 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.
Subsequent to the 2010 restructuring transactions, RealNetworks provided certain operational transition services to Rhapsody. These transition services were completed in 2013, and RealNetworks has no further obligations or liabilities pursuant to the support services agreement.
We recorded our share of losses of Rhapsody of $1.8 million and $2.6 million for the quarter and six months ended June 30, 2014, respectively. Because of the $10.0 million liquidation preference on the preferred stock we hold in Rhapsody, under the equity method of accounting we do not record any share of Rhapsody losses that would reduce our carrying value of Rhapsody below $10.0 million, unless Rhapsody's book value is reduced below $10.0 million. The carrying value of our Rhapsody investment was $12.5 million as of December 31, 2013 and as of June 30, 2014 was $10.0 million.
Our share of the losses of Rhapsody for the quarter and six months ended June 30, 2013 were $1.3 million and $3.6 million, respectively.
Summarized financial information for Rhapsody, which represents 100% of their financial information (in thousands):
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Net revenue
$
42,427

 
$
34,679

 
$
84,430

 
$
68,641

Gross profit
7,870

 
8,767

 
16,991

 
16,612

Net loss
(4,717
)
 
(4,375
)
 
(6,347
)
 
(9,191
)
Note 6. Fair Value Measurements
Items Measured at Fair Value on a Recurring Basis
The following table presents information about our financial assets that have been measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands).

 
Fair Value Measurements as of
 
Amortized Cost as of
 
June 30, 2014
 
June 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
33,836

 
$

 
$

 
$
33,836

 
$
33,836

Money market funds

 
15,437

 

 
15,437

 
15,437

Corporate notes and bonds

 
75,177

 

 
75,177

 
75,178

Total cash and cash equivalents
33,836

 
90,614

 

 
124,450

 
124,451

Short-term investments:
 
 
 
 
 
 
 
 
 
Corporate notes and bonds

 
57,874

 

 
57,874

 
57,803

U.S. government agency securities
12,459

 
250

 

 
12,709

 
12,709

Total short-term investments
12,459

 
58,124

 

 
70,583

 
70,512

Restricted cash equivalents and investments

 
3,000

 

 
3,000

 
3,000

Equity investment in publicly traded securities
3,182

 

 

 
3,182

 
428

Total
$
49,477

 
$
151,738

 
$

 
$
201,215

 
$
198,391



8



 
Fair Value Measurements as of
 
Amortized Cost as of
 
December 31, 2013
 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
46,978

 
$

 
$

 
$
46,978

 
$
46,978

Money market funds
1

 
26,913

 

 
26,914

 
26,914

Corporate notes and bonds

 
77,043

 

 
77,043

 
77,044

U.S. government agency securities

 
300

 

 
300

 
300

Total cash and cash equivalents
46,979

 
104,256

 

 
151,235

 
151,236

Short-term investments:
 
 
 
 
 
 
 
 
 
Corporate notes and bonds

 
59,766

 

 
59,766

 
59,713

U.S. government agency securities
14,077

 
1,077

 

 
15,154

 
15,159

Total short-term investments
14,077

 
60,843

 

 
74,920

 
74,872

Restricted cash equivalents and investments

 
3,000

 

 
3,000

 
3,000

Equity investment in publicly traded securities
7,181

 

 

 
7,181

 
842

Total
$
68,237

 
$
168,099

 
$

 
$
236,336

 
$
229,950


Restricted cash equivalents and investments amounts as of June 30, 2014, and December 31, 2013 relate to cash pledged as collateral against a letter of credit in connection with a lease agreement.
Realized gains or losses on sales of short-term investment securities for the quarters and six months ended June 30, 2014 and 2013 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of June 30, 2014 and December 31, 2013 were not significant.
Investments with remaining contractual maturities of five years or less are classified as short-term because the investments are marketable and highly liquid, and we have the ability to utilize them for current operations. Contractual maturities of short-term investments as of June 30, 2014 (in thousands):
 
 
Estimated
Fair Value
Within one year
$
48,399

Between one year and five years
22,184

Total short-term investments
$
70,583

Our equity investment in a publicly traded company as of June 30, 2014 and December 31, 2013 consisted of J-Stream Inc., a Japanese media services company. This equity investment is accounted for as available for sale. In March 2014 we sold a portion of the J-Stream shares we held, resulting in cash proceeds of $2.8 million and a pre-tax gain of $2.4 million.
Items Measured at Fair Value on a Non-recurring Basis
Certain of our assets and liabilities are measured at estimated fair value on a non-recurring basis, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the six months ended June 30, 2014 and 2013, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
Note 7. Allowance for Doubtful Accounts Receivable and Sales Returns
Activity in the allowance for doubtful accounts receivable and sales returns (in thousands):
 

9



 
Allowance For
 
Doubtful
Accounts
Receivable
 
Sales
Returns
Balances, December 31, 2013
$
966

 
$
569

Addition (reduction) to allowance
341

 
(101
)
Amounts written off
(25
)
 
(4
)
Foreign currency translation
4

 
(1
)
Balances, June 30, 2014
$
1,286

 
$
463

One customer accounted for 17% of trade accounts receivable and one other customer accounted for 12% of trade accounts receivable, as of June 30, 2014. One customer accounted for 17% of trade accounts receivable as of December 31, 2013.
One customer accounted for 21% and 19% of consolidated revenue, or $8.6 million and $16.4 million, during the quarter and six months ended June 30, 2014, and is reflected in our Mobile Entertainment segment. One additional customer accounted for 12% of consolidated revenue, or $10.5 million for the six months ended June 30, 2014, and is reflected in our RealPlayer Group and Games segments. One customer accounted for approximately 13% and 14% of consolidated revenue, or $6.5 million and $15.1 million, during the quarter and six months ended June 30, 2013, and is reflected in our RealPlayer Group and Games segments. One additional customer accounted for approximately 11% of consolidated revenue, or $5.6 million, during the quarter ended June 30, 2013, in our Mobile Entertainment segment.
Note 8. Other Intangible Assets
Other intangible assets (in thousands):
 
 
 
 
As of June 30,
 
As of December 31,
 
 
 
2014
 
2013
 
 
 
Gross
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
 
$
36,350

 
$
33,512

 
$
2,838

 
$
35,156

 
$
31,262

 
$
3,894

 
Developed technology
 
29,738

 
26,365

 
3,373

 
29,097

 
25,039

 
4,058

 
Patents, trademarks and tradenames
 
4,145

 
3,784

 
361

 
4,021

 
3,627

 
394

 
Service contracts
 
6,619

 
5,763

 
856

 
5,679

 
5,532

 
147

 
 
 
76,852

 
69,424

 
7,428

 
73,953

 
65,460

 
8,493

Non-amortizing intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Trademarks and tradenames
 
4,500

 

 
4,500

 
4,500

 

 
4,500

 
Total
 
$
81,352

 
$
69,424

 
$
11,928

 
$
78,453

 
$
65,460

 
$
12,993


In the second quarter of 2014 a small acquisition of a business related to our RealPlayer Group resulted in an intangible asset of $0.8 million being recorded.

No impairments of other intangible assets were recognized in either of the six months ended June 30, 2014 or 2013.
Note 9. Goodwill
Changes in goodwill (in thousands):
 
Balance, December 31, 2013
$
17,476

Increases due to current year acquisitions
460

Effects of foreign currency translation
69

Balance, June 30, 2014
$
18,005


Goodwill by segment (in thousands):
 

10



 
June 30,
2014
RealPlayer Group
$
1,043

Mobile Entertainment
2,202

Games
14,760

Total goodwill
$
18,005


In the second quarter of 2014 a small acquisition of a business related to our RealPlayer Group resulted in goodwill of $0.5 million being recorded.

No impairment of goodwill was recognized in either of the six months ended June 30, 2014 or 2013.

Note 10. Accrued and Other Current Liabilities
Accrued and other current liabilities (in thousands):
 
 
June 30, 2014
 
December 31, 2013
Royalties and other fulfillment costs
$
5,033

 
$
16,467

Employee compensation, commissions and benefits
7,037

 
10,060

Sales, VAT and other taxes payable
6,862

 
7,237

Other
7,942

 
8,129

Total accrued and other current liabilities
$
26,874

 
$
41,893

During the quarter ended March 31, 2014, certain accrued royalty liabilities of $10.6 million associated with our historical music business, which had originally been recorded based on statutory rates, were extinguished.
Note 11. Restructuring Charges
Restructuring and other charges in 2014 and 2013 consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense alignment efforts. The expense amounts in both years relate primarily to severance costs due to workforce reductions.
In the latter half of 2012, we announced the elimination of approximately 160 positions worldwide, which was concluded as of the second quarter of 2013. During 2013 and 2014, we have incurred restructuring charges consisting of costs associated with the reorganization of our business operations and our ongoing expense alignment efforts. These costs are reflected in the table below.
Restructuring charges by type of cost (in thousands):
 
Employee Separation Costs
Asset Related and Other Costs
Total
Costs incurred and charged to expense for the six months ended June 30, 2014
$
1,757


$
1,757

Costs incurred and charged to expense for the six months ended June 30, 2013
$
1,818

380

$
2,198


Changes to the accrued restructuring cost liability (in thousands):

11



 
Employee Separation Costs
Accrued liability as of December 31, 2013
$
756

Costs incurred and charged to expense for the six months ended June 30, 2014
1,757

Cash payments
(2,263
)
Accrued liability as of June 30, 2014 (included in Accrued and other current liabilities)
$
250


Note 12. Lease Exit and Related Charges
As a result of the reduction in use of RealNetworks' office space, losses have been recognized representing rent and contractual operating expenses over the remaining life of the leases.
Changes to accrued lease exit and related charges (in thousands):
 
Accrued loss as of December 31, 2013
$
254

Additions and adjustments to the lease exit charges accrual, including sublease income estimate revision
400

Less amounts paid, net of sublease amounts
(124
)
Accrued loss as of June 30, 2014 (included in Accrued and other current liabilities)
$
530

Note 13.
Shareholders’ Equity
Accumulated Other Comprehensive Income (Loss)

Changes in components of accumulated other comprehensive income (in thousands):

 
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
 
 
2014
 
2013
 
2014
 
2013
Investments
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income (loss), beginning of period
 
$
2,822

 
$
29,322

 
$
6,397

 
26,685

 
Unrealized gains (losses), net of tax effects of $0, $913, $0 and $(716)
 
(38
)
 
(1,622
)
 
(1,242
)
 
1,015

 
Reclassification adjustments for losses (gains) included in other income (expense), net of tax effects of $0, $0, $(4) and $0
 

 

 
(2,371
)
 

 
Net current period other comprehensive income
 
(38
)
 
(1,622
)
 
(3,613
)
 
1,015

 
Accumulated other comprehensive income (loss) balance, end of period
 
$
2,784

 
$
27,700

 
$
2,784

 
$
27,700

Foreign currency translation
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income (loss), beginning of period
 
$
(54,117
)
 
$
(54,463
)
 
$
(54,092
)
 
$
(53,225
)
 
Translation adjustments
 
216

 
(353
)
 
239

 
(1,591
)
 
Reclassification adjustments for losses (gains) included in other income (expense)
 

 
(35
)
 
(48
)
 
(35
)
 
Net current period other comprehensive income
 
216

 
(388
)
 
191

 
(1,626
)
 
Accumulated other comprehensive income (loss) balance, end of period
 
$
(53,901
)
 
$
(54,851
)
 
$
(53,901
)
 
$
(54,851
)
Total accumulated other comprehensive income (loss), end of period
 
$
(51,117
)
 
$
(27,151
)
 
$
(51,117
)
 
$
(27,151
)

Note 14. Income Taxes

12



As of June 30, 2014, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the 2013 10-K. We currently anticipate the expiration of the statute of limitations within the next twelve months that may decrease the Company's total unrecognized tax benefit by an amount up to $0.9 million.
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 2008 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 are currently under United States federal audit for the consolidated group (RealNetworks, Inc. and Subsidiaries) for the year ended December 31, 2012.
Note 15. Earnings (Loss) 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. Basic and diluted EPS (in thousands, except per share amounts):
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss)
$
(21,029
)
 
$
(18,471
)
 
$
(28,799
)
 
$
(30,145
)
Weighted average common shares outstanding used to compute basic EPS
35,890

 
35,455

 
35,865

 
35,399

Dilutive effect of stock based awards

 

 

 

Weighted average common shares outstanding used to compute diluted EPS
35,890

 
35,455


35,865


35,399

Basic EPS
$
(0.59
)
 
$
(0.52
)
 
$
(0.80
)
 
$
(0.85
)
Diluted EPS
$
(0.59
)
 
$
(0.52
)
 
$
(0.80
)
 
$
(0.85
)
During the quarter and six months ended June 30, 2014, 6.3 million and 6.2 million shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
During the quarter and six months ended June 30, 2013, 4.3 million and 4.3 million shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
Note 16. Commitments and Contingencies
We may become 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.  
Note 17. Guarantees
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 carrier customers.
In relation to the 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

13



against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.  
Note 18. Segment Information
We have three reportable segments: (1) RealPlayer Group, which includes sales of our RealPlayer media player software and related products, such as the distribution of third party software products, advertising on RealPlayer websites, and sales of RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass and our recently launched RealPlayer Cloud service; (2) Mobile Entertainment, which includes our SaaS services, our recently launched LISTEN product, and sales of technology licenses of our software products such as Helix; and (3) Games, which includes all our games-related businesses, including sales of games licenses, online games subscription services, advertising on games sites and social network sites, microtransactions from online and social games, and sales of mobile games.
We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments. These corporate expenses include but are not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. All restructuring, lease exit and related charges, and loss on litigation settlements are included in the corporate segment.
RealNetworks reports three reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker reviews results. Our Chief Operating Decision Maker is considered to be the CEO Staff (CEOS), which includes the Chief Executive Officer, Chief Financial Officer, our Presidents, General Counsel and certain Senior Vice Presidents. The CEOS reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.
Segment results for the quarters and six months ended June 30, 2014 and 2013 (in thousands):
RealPlayer Group
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
8,556

 
$
18,383

 
$
23,771

 
$
40,766

Cost of revenue
3,620

 
4,409

 
7,138

 
9,720

Gross profit
4,936

 
13,974

 
16,633

 
31,046

Operating expenses
12,489

 
14,001

 
30,276

 
30,207

Operating income (loss)
$
(7,553
)
 
$
(27
)
 
$
(13,643
)
 
$
839



Mobile Entertainment
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
23,182

 
$
18,592

 
$
43,095

 
$
39,087

Cost of revenue
14,298

 
11,170

 
26,248

 
22,002

Gross profit
8,884

 
7,422

 
16,847

 
17,085

Operating expenses
9,424

 
8,412

 
19,040

 
17,523

Operating income (loss)
$
(540
)
 
$
(990
)
 
$
(2,193
)
 
$
(438
)


Games
 

14



 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
9,087

 
$
12,875

 
$
19,683

 
$
26,790

Cost of revenue
2,717

 
3,381

 
5,846

 
7,181

Gross profit
6,370

 
9,494

 
13,837

 
19,609

Operating expenses
8,769

 
11,755

 
18,535

 
23,607

Operating income (loss)
$
(2,399
)
 
$
(2,261
)
 
$
(4,698
)
 
$
(3,998
)


Corporate
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenue
$
151

 
$
559

 
$
340

 
$
1,122

Extinguishment of liability

 

 
(10,580
)
 

Operating expenses
8,189

 
12,667

 
17,414

 
23,211

Operating income (loss)
$
(8,340
)
 
$
(13,226
)
 
$
(7,174
)
 
$
(24,333
)
Our customers consist primarily of consumers and corporations located in the U.S., Europe, Republic of Korea and various foreign countries (Rest of the world). Revenue by geographic region (in thousands):
 
 
Quarters Ended
June 30,
 
Six Months Ended
June 30,
 
2014
 
2013
 
2014
 
2013
United States
$
15,092

 
$
21,463

 
$
35,520

 
$
49,486

Europe
6,968

 
9,272

 
15,380

 
20,528

Republic of Korea
11,092

 
11,259

 
21,386

 
20,223

Rest of the world
7,673

 
7,856

 
14,263

 
16,406

Total net revenue
$
40,825

 
$
49,850

 
$
86,549

 
$
106,643

Long-lived assets (consists of equipment, software, leasehold improvements, other intangible assets, and goodwill) by geographic region (in thousands):
 
 
June 30,
2014
 
December 31,
2013
United States
$
37,107

 
$
40,347

Europe
8,348

 
8,280

Republic of Korea
763

 
936

Rest of the world
4,173

 
4,078

Total long-lived assets
$
50,391

 
$
53,641


Note 19. Related Party Transactions
Transactions with Rhapsody. See Note 5, Rhapsody Joint Venture, for details on the 2010 restructuring transaction involving Rhapsody. Subsequent to the restructuring transaction, we were obligated to provide Rhapsody with certain support services. These support services, which included information technology and limited operational support provided directly to Rhapsody, were completed in 2013. RealNetworks has no further obligations or liabilities pursuant to the support services agreement.

15




Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about RealNetworks’ industry, products, management’s beliefs, and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:
the expected benefits and other consequences of our growth plans, strategic initiatives, and restructurings;
our expected introduction, and related monetization, of new and enhanced products, services and technologies across our businesses;
future revenues, operating expenses, income and other taxes, tax benefits, net income (loss) per diluted share available to common shareholders, acquisition costs and related amortization, and other measures of results of operations;
the effects of our past acquisitions and expectations for future acquisitions and divestitures;
plans, strategies and expected opportunities for future growth, increased profitability and innovation;
the expected financial position, performance, growth and profitability of, and investment in, our businesses and the availability of resources;
the effects of legislation, regulations, administrative proceedings, court rulings, settlement negotiations and other factors that may impact our businesses;
the continuation and expected nature of certain customer relationships;
impacts of competition and certain customer relationships on the future financial performance and growth of our businesses;
our involvement in potential claims, legal proceedings and government investigations, and the potential outcomes and effects of such potential claims, legal proceedings and governmental investigations on our business, prospects, financial condition or results of operations;
the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations; and
the effect of economic and market conditions on our business, prospects, financial condition or results of operations.
These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in Item 1A of Part II entitled “Risk Factors.” RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
Overview
RealNetworks creates innovative products and services that make it easy to connect with and enjoy digital media. We invented the streaming media category in 1995 and continue to connect consumers with their digital media both directly and through partners, aiming to support every network, device, media type and social network.
We manage our business and report revenue and operating income (loss) in three segments: (1) RealPlayer Group, (2) Mobile Entertainment, and (3) Games. Within our RealPlayer Group, revenue is derived from the sale of our RealPlayer media player software and related products, such as the distribution of third party software products, advertising on RealPlayer websites, and sales of RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass and our recently launched RealPlayer Cloud service. Our Mobile Entertainment business generates revenue from the sale of its SaaS services, which include ringback tones, music on demand, intercarrier messaging, and our recently launched LISTEN product, and sales of technology licenses of our software products such as Helix. Our Games business, through its Slingo, GameHouse and Zylom brands, derives revenue from sales of games licenses, online games subscription services, advertising on games sites and social networks, microtransactions within online and social games, and sales of mobile games.
We allocate certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities, to our reportable segments. The allocation of these costs to our business units ensures accountability for financial and operational performance within each of our reportable

16



segments. Our most significant expenses relate to cost of revenue, compensating employees, and selling and marketing our products and services.
For the quarter and six months ended June 30, 2014, our consolidated revenue declined by $9.0 million and $20.1 million, respectively, compared to the same periods in 2013. The decline in revenue for the quarter in our RealPlayer Group was $9.8 million and $3.8 million in Games. Revenue increased for the quarter in Mobile Entertainment by $4.6 million. For the year to date period, the decline was primarily due to a decline of $17.0 million in our RealPlayer Group and a decline of $7.1 million in Games. For the year to date period, revenue increased by $4.0 million in Mobile Entertainment.
Revenue from our legacy products continues to decline as a result of certain changes in our businesses and market-driven factors. In our RealPlayer Group segment, revenue suffered from pricing pressure and lower distribution in our intellectual property licensing business and from installation declines as well as lower rates in our third party software distribution business. Moreover, as we focus more of our distribution and marketing efforts on our new RealPlayer Cloud service, sales of RealPlayer Plus licenses are declining, resulting in reduced revenue. The business also continues to be negatively impacted by a decline in subscribers, primarily attributable to our SuperPass product. In our Games segment, our business continues to be challenged in line with overall trends in the online games market, including the shift from downloadable PC games to social networks and mobile devices. In our Mobile Entertainment segment, the revenue increase was related primarily to our music on demand services in Korea and our acquisition of Muzicall in September of 2013, which increased our direct-to-consumer ringback tones revenue. Partially offsetting these increases was a loss in revenue due to termination of carrier contracts.
Over the past several quarters we have developed a growth plan, implemented strategic initiatives, and executed certain restructuring efforts, all in an effort to grow our businesses, move towards profitability, and streamline our operations. In line with our growth plan, we continue to invest in each of our three business units. During the first half of 2014, we released RealPlayer Cloud worldwide. This global roll out allows us to reach our base of millions of active RealPlayer users around the world. In our Mobile Entertainment business we continue our efforts to roll out our new LISTEN product. LISTEN leverages our pioneering leadership in ringback tones, and our large, global installed base of over 18 million active ringback tone subscribers with more than 20 carriers worldwide, to create a hybrid distribution model that combines partnership with carriers with direct-to-consumer marketing. In our Games business we announced our plans to release Slingo Adventure on Facebook, iOS, and Android. We expect to continue to invest heavily in our growth initiatives, including further development and marketing efforts around our products, while also building on our efforts to streamline our operations and make our businesses more efficient.
During the quarter ended March 31, 2014 certain accrued royalty liabilities of $10.6 million associated with our historical music business, which had originally been recorded based on statutory rates, were extinguished.
Condensed consolidated results of operations were as follows (dollars in thousands):
 
 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Total revenue
$
40,825

 
$
49,850

 
$
(9,025
)
 
(18
)%
 
$
86,549

 
$
106,643

 
$
(20,094
)
 
(19
)%
Cost of revenue
20,786

 
19,519

 
1,267

 
6
 %
 
39,572

 
40,025

 
(453
)
 
(1
)%
Extinguishment of liability

 

 

 
 %
 
(10,580
)
 

 
(10,580
)
 
(100
)%
Gross profit
20,039

 
30,331

 
(10,292
)
 
(34
)%
 
57,557

 
66,618

 
(9,061
)
 
(14
)%
Gross margin
49
%
 
61
%
 
 
 
 
 
67
%
 
62
%
 
 
 
 
Operating expenses
38,871

 
46,835

 
(7,964
)
 
(17
)%
 
85,265

 
94,548

 
(9,283
)
 
(10
)%
Operating income (loss)
$
(18,832
)
 
$
(16,504
)
 
$
(2,328
)
 
(14
)%
 
$
(27,708
)
 
$
(27,930
)
 
$
222

 
(1
)%
In the second quarter of 2014, our total consolidated revenue declined by $9.0 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $9.8 million in our RealPlayer Group segment and a decline of $3.8 million in our Games segment, due to the factors described above. These declines were partially offset by an increase of $4.6 million in our Mobile Entertainment segment. Gross margin decreased to 49% from 61% during the quarter ended June 30, 2014, due primarily to a decline in higher margin revenues. Operating expenses decreased by $8.0 million in the quarter ended June 30, 2014, compared with the prior year, primarily due to $2.6 million of higher lease exit and related charges in 2013, related to our Seattle headquarters move, reduced marketing costs in 2014 of $2.6 million and reductions in personnel and related costs of $2.7 million.
For the six months ended June 30, 2014, our total consolidated revenue declined by $20.1 million, compared with the year-earlier period. The reduction in revenue primarily resulted from a decline of $17.0 million in our RealPlayer Group and a

17



decline of $7.1 million in our Games segment, due to the factors described above, partially offset by an increase in Mobile Entertainment revenue of $4.0 million primarily due to an increase in music on demand services in Korea. Gross margin increased to 67% from 62% for the year earlier period primarily due to the extinguishment of the liability in the first quarter of 2014 described above. Operating expenses decreased by $9.3 million in the six months ended June 30, 2014, compared with the prior year primarily due to reductions in personnel and related costs of $4.2 million and to reduced charges for restructuring and lease exit activities of $3.0 million, which resulted from our ongoing expense alignment efforts.
Segment Operating Results
RealPlayer Group
RealPlayer Group segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Revenue
$
8,556

 
$
18,383

 
$
(9,827
)
 
(53
)%
 
$
23,771

 
$
40,766

 
$
(16,995
)
 
(42
)%
Cost of revenue
3,620

 
4,409

 
(789
)
 
(18
)%
 
7,138

 
9,720

 
(2,582
)
 
(27
)%
Gross profit
4,936

 
13,974

 
(9,038
)
 
(65
)%
 
16,633

 
31,046

 
(14,413
)
 
(46
)%
Gross margin
58
%
 
76
%
 
 
 
 
 
70
%
 
76
%
 
 
 
 
Operating expenses
12,489

 
14,001

 
(1,512
)
 
(11
)%
 
30,276

 
30,207

 
69

 
 %
Operating income (loss)
$
(7,553
)
 
$
(27
)
 
$
(7,526
)
 
NA
 
$
(13,643
)
 
$
839

 
$
(14,482
)
 
NA

Total RealPlayer Group revenue decreased by $9.8 million in the quarter ended June 30, 2014, compared with the year-earlier period. This decrease was primarily a result of reduced rates that caused a decrease in our third party distribution revenue by $4.3 million and lower subscriptions revenue of $1.7 million due to fewer subscribers, primarily attributable to our SuperPass product. Further contributing to the decline was a decrease in RealPlayer Plus license revenue of $2.1 million due to our focus on RealPlayer Cloud, and due to lower distribution of intellectual property licenses of $1.4 million.

Total RealPlayer Group revenue decreased by $17.0 million in the six months ended June 30, 2014, compared with the year-earlier period. This decrease was primarily a result of reduced rates that caused a decrease in our third party distribution revenue by $5.8 million and lower subscriptions revenue of $3.9 million due to fewer subscribers, primarily attributable to our SuperPass product. Further contributing to the decline was a decrease in RealPlayer license revenue of $4.2 million due to our focus on RealPlayer Cloud and a decrease of $2.6 million in distribution of intellectual property licenses.
Cost of revenue decreased by $0.8 million during the quarter ended June 30, 2014, compared with the year-earlier period. Costs related to our RealPlayer Plus licensing business decreased by $0.7 million due to lower royalties. Costs related to our subscription business declined $0.1 million in connection with lower subscription revenue.
Cost of revenue decreased by $2.6 million during the six months ended June 30, 2014, compared with the year-earlier period. Costs related to our RealPlayer Plus licensing business decreased by $1.0 million due to lower royalties. Costs related to our subscription business declined $1.0 million in connection with lower subscription revenue.
Gross margin during the quarter and six months ended June 30, 2014 declined as a result of the reduced rates from our third party distribution business.
Operating expenses decreased by $1.5 million in the quarter ended June 30, 2014, compared with the year-earlier period primarily due to decreased marketing spend of $1.8 million in line with the decrease in our third party distribution revenue.
Mobile Entertainment
Mobile Entertainment segment results of operations were as follows (dollars in thousands): 

18



 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Revenue
$
23,182

 
$
18,592

 
$
4,590

 
25
%
 
$
43,095

 
$
39,087

 
$
4,008

 
10
 %
Cost of revenue
14,298

 
11,170

 
3,128

 
28
%
 
26,248

 
22,002

 
4,246

 
19
 %
Gross profit
8,884

 
7,422

 
1,462

 
20
%
 
16,847

 
17,085

 
(238
)
 
(1
)%
Gross margin
38
%
 
40
%
 
 
 
 
 
39
%
 
44
%
 
 
 
 
Operating expenses
9,424

 
8,412

 
1,012

 
12
%
 
19,040

 
17,523

 
1,517

 
9
 %
Operating income (loss)
$
(540
)
 
$
(990
)
 
$
450

 
45
%
 
$
(2,193
)
 
$
(438
)
 
$
(1,755
)
 
(401
)%
Total Mobile Entertainment revenue increased by $4.6 million in the quarter ended June 30, 2014, compared with the year-earlier period. The increase was primarily due to an increase in music on demand revenue in Korea of $3.1 million and increased revenue of $1.4 million for systems integration services in Japan, and our acquisition of Muzicall in the third quarter of 2013, which increased our direct-to-consumer ringback tones revenue by $0.9 million. Partially offsetting these increases was a loss in revenue due to termination of carrier contracts of $0.9 million.
Total Mobile Entertainment revenue increased by $4.0 million in the six months ended June 30, 2014, compared with the year-earlier period. The increase was primarily due to an increase in music on demand revenue in Korea of $6.0 million and increased revenue of $1.2 million for systems integration services in Japan, and our acquisition of Muzicall, which increased our direct-to-consumer ringback tones revenue by $2.0 million. Partially offsetting these increases was a loss in revenue due to termination of carrier contracts of $4.4 million.
Cost of revenue increased by $3.1 million and $4.2 million in the quarter and six months ended June 30, 2014, respectively, compared with the year-earlier period due to an increase in label royalties related to our in music on demand services.
Gross margin for the six months ended June 30, 2014 declined to 39% from 44% due to a decline in higher margin revenues.
Operating expenses increased by $1.0 million and $1.5 million for the quarter and six months ended June 30, 2014, respectively, compared with the year-earlier periods, primarily due to $0.6 million of marketing expenses related to Muzicall and LISTEN, and $0.5 million in people-related expenses related to Muzicall.
Games
Games segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Revenue
$
9,087

 
$
12,875

 
$
(3,788
)
 
(29
)%
 
$
19,683

 
$
26,790

 
$
(7,107
)
 
(27
)%
Cost of revenue
2,717

 
3,381

 
(664
)
 
(20
)%
 
5,846

 
7,181

 
(1,335
)
 
(19
)%
Gross profit
6,370

 
9,494

 
(3,124
)
 
(33
)%
 
13,837

 
19,609

 
(5,772
)
 
(29
)%
Gross margin
70
%
 
74
%
 
 
 
 
 
70
%
 
73
%
 
 
 
 
Operating expenses
8,769

 
11,755

 
(2,986
)
 
(25
)%
 
18,535

 
23,607

 
(5,072
)
 
(21
)%
Operating income (loss)
$
(2,399
)
 
$
(2,261
)
 
$
(138
)
 
(6
)%
 
$
(4,698
)
 
$
(3,998
)
 
$
(700
)
 
(18
)%
Total Games revenue decreased by $3.8 million in the quarter ended June 30, 2014, compared with the year-earlier period. Lower revenue from our subscription products, licensing and advertising due to continued declines in our storefront and subscription businesses contributed $1.5 million, $0.7 million and $1.3 million, respectively, to the overall decrease.
Total Games revenue decreased by $7.1 million in the six months ended June 30, 2014, compared with the year-earlier period. Lower revenue from our subscription products, licensing and advertising due to continued declines in our storefront and subscription businesses contributed $2.6 million, $2.1 million and $1.9 million, respectively, to the overall decrease.
Cost of revenue decreased by $0.7 million and $1.3 million in the quarter and six months ended June 30, 2014, respectively, compared with the year-earlier period. The decreases were due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue. The decrease in cost of revenue was also due to a decline in our advertising business. Gross margin declined during the quarter and six months ended June 30, 2014 to 70% from 74% and to 70% from 73%, respectively, due primarily to a higher proportion of lower margin revenue in the current year.

19



Operating expenses declined by $3.0 million in the quarter ended June 30, 2014, compared with the year-earlier period. The decrease was due to reductions in personnel and related costs of $1.9 million and reduced marketing spend of $1.3 million.
Operating expenses declined by $5.1 million in the six months ended June 30, 2014, compared with the year-earlier period. The decrease was due to reductions in personnel and related costs of $2.4 million and reduced marketing spend of $2.3 million.
Corporate
We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments. These allocated corporate expenses include but are not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. All restructuring, and lease exit and related charges, are included in the corporate segment.

Corporate segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Cost of revenue
$
151

 
$
559

 
$
(408
)
 
(73
)%
 
$
340

 
$
1,122

 
$
(782
)
 
(70
)%
Extinguishment of liability

 

 

 
 %
 
(10,580
)
 

 
(10,580
)
 
(100
)%
Operating expenses
8,189

 
12,667

 
(4,478
)
 
(35
)%
 
17,414

 
23,211

 
(5,797
)
 
(25
)%
Operating income (loss)
$
(8,340
)
 
$
(13,226
)
 
$
4,886

 
37
 %
 
$
(7,174
)
 
$
(24,333
)
 
$
17,159

 
71
 %
During the quarter ended March 31, 2014 certain accrued royalty liabilities of $10.6 million associated with our historical music business, which had originally been recorded based on statutory rates, were extinguished.
Operating expenses decreased by $4.5 million in the quarter ended June 30, 2014 , compared with the year-earlier period. The decrease during the quarter was primarily due to a reduction of $2.9 million for restructuring and lease exit charges, $1.9 million in savings resulting from with the relocation of our Seattle headquarters and $1.1 million in reduced personnel and related costs due to our ongoing expense alignment efforts. These decreases were partially offset by the impact of a benefit in 2013 of $1.4 million from the reduction to our liability for estimated sales taxes that reduced operating expenses in 2013.
Operating expenses decreased by $5.8 million in the six months ended June 30, 2014, compared with the year-earlier period. The decrease was primarily due to a reduction of $3.0 million for restructuring and lease exit charges, $2.5 million in savings resulting from with the relocation of our Seattle headquarters and $1.9 million in reduced personnel and related costs due to our ongoing expense alignment efforts. These decreases were partially offset by the impact of a benefit in 2013 of $1.7 million from the reduction to our liability for estimated sales taxes that reduced operating expenses in 2013.
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, and restructuring charges. Operating expenses were as follows (dollars in thousands):
 
 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Research and development
$
13,267

 
$
14,993

 
$
(1,726
)
 
(12
)%
 
$
27,326

 
$
30,244

 
$
(2,918
)
 
(10
)%
Sales and marketing
16,016

 
19,269

 
(3,253
)
 
(17
)%
 
37,739

 
40,403

 
(2,664
)
 
(7
)%
General and administrative
8,577

 
8,691

 
(114
)
 
(1
)%
 
17,894

 
18,637

 
(743
)
 
(4
)%
Restructuring and other charges
541

 
816

 
(275
)
 
(34
)%
 
1,757

 
2,198

 
(441
)
 
(20
)%
Lease exit and related charges
470

 
3,066

 
(2,596
)
 
(85
)%
 
549

 
3,066

 
(2,517
)
 
(82
)%
Total consolidated operating expenses
$
38,871

 
$
46,835

 
$
(7,964
)
 
(17
)%
 
$
85,265

 
$
94,548

 
$
(9,283
)
 
(10
)%

20



Research and development expenses decreased by $1.7 million and $2.9 million, respectively, in the quarter and six months ended June 30, 2014, compared with the year-earlier period. The decrease was primarily due to savings resulting from the relocation of our Seattle headquarters of $1.4 million and $2.3 million, respectively.
Sales and marketing expenses decreased by $3.3 million and $2.7 million, respectively, in the quarter and six months ended June 30, 2014, compared with the year-earlier period. The decrease was primarily due to reduced marketing spend of $2.7 million and $2.0 million, respectively.
General and administrative expenses decreased by $0.7 million in the six months ended June 30, 2014, compared with the year-earlier period. The decrease was due to $2.5 million in reduced personnel and related costs due to our ongoing expense alignment efforts, partially offset by the impact of a benefit in 2013 of $1.7 million from the reduction to our liability for estimated sales taxes that reduced operating expenses in 2013.
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 alignment efforts. The restructuring expense amounts in both years primarily relate to severance costs due to workforce reductions. 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):
 
 
Quarters Ended June 30,
 
Six months ended June 30,
 
2014
 
2013
 
$ Change
 
% Change
 
2014
 
2013
 
$ Change
 
% Change
Interest income, net
$
180

 
$
179

 
$
1

 
1
 %
 
$
316

 
$
826

 
$
(510
)
 
(62
)%