Document



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 September 30, 2018
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 1-37745
 
 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, smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth 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
¨
 
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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 October 31, 2018 was 37,655,047.




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)
 
September 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
37,964

 
$
51,196

Short-term investments
1,172

 
8,779

Trade accounts receivable, net of allowances of $577 and $937
13,090

 
12,689

Deferred costs, current portion
365

 
426

Prepaid expenses and other current assets
4,719

 
3,715

Current assets of discontinued operations

 
17,456

Total current assets
57,310

 
94,261

Equipment, software, and leasehold improvements, at cost:
 
 
 
Equipment and software
40,016

 
46,417

Leasehold improvements
3,431

 
3,536

Total equipment, software, and leasehold improvements, at cost
43,447

 
49,953

Less accumulated depreciation and amortization
40,531

 
46,093

Net equipment, software, and leasehold improvements
2,916

 
3,860

Restricted cash equivalents
1,630

 
2,400

Other assets
5,723

 
5,588

Deferred costs, non-current portion
593

 
955

Deferred tax assets, net
1,019

 
1,047

Other intangible assets, net
120

 
325

Goodwill
17,060

 
13,060

Total assets
$
86,371

 
$
121,496

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,914

 
$
3,785

Accrued and other current liabilities
11,916

 
12,365

Commitment to Napster
2,750

 
2,750

Deferred revenue, current portion
1,969

 
3,097

Current liabilities of discontinued operations

 
17,107

Total current liabilities
20,549

 
39,104

Deferred revenue, non-current portion
312

 
443

Deferred rent
953

 
982

Deferred tax liabilities, net
170

 
19

Other long-term liabilities
1,082

 
1,775

Total liabilities
23,066

 
42,323

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 37,652 shares in 2018 and 37,341 shares in 2017
37

 
37

Additional paid-in capital
641,449

 
638,727

Accumulated other comprehensive loss
(61,077
)
 
(59,547
)
Retained deficit
(517,104
)
 
(500,044
)
Total shareholders’ equity
63,305

 
79,173

Total liabilities and shareholders’ equity
$
86,371

 
$
121,496

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)
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Net revenue (A)
$
17,579

 
$
18,557

 
$
52,953

 
$
59,853

Cost of revenue (B)
4,239

 
5,343

 
14,000

 
18,199

Gross profit
13,340

 
13,214

 
38,953

 
41,654

Operating expenses:
 
 
 
 
 
 
 
Research and development
8,052

 
7,152

 
23,398

 
22,085

Sales and marketing
4,998

 
4,883

 
15,878

 
17,534

General and administrative
4,586

 
5,081

 
15,526

 
15,638

Restructuring and other charges
632

 
557

 
1,320

 
2,271

Lease exit and related benefit

 

 
(454
)
 

Total operating expenses
18,268

 
17,673

 
55,668

 
57,528

Operating loss
(4,928
)
 
(4,459
)
 
(16,715
)
 
(15,874
)
Other income (expenses):
 
 
 
 
 
 
 
Interest income, net
72

 
116

 
270

 
353

Equity in net loss of Napster investment
(737
)
 

 
(737
)
 
(1,097
)
Other income (expenses), net
(112
)
 
(50
)
 
(195
)
 
(289
)
Total other income (expenses), net
(777
)
 
66

 
(662
)
 
(1,033
)
Loss from continuing operations before income taxes
(5,705
)
 
(4,393
)
 
(17,377
)
 
(16,907
)
Income tax expense
272

 
139

 
708

 
954

Net loss from continuing operations
(5,977
)
 
(4,532
)
 
$
(18,085
)
 
$
(17,861
)
Net income from discontinued operations, net of tax

 
198

 

 
717

Net loss
$
(5,977
)
 
$
(4,334
)
 
$
(18,085
)
 
$
(17,144
)
 
 
 
 
 
 
 
 
Net income (loss) per share - Basic:
 
 
 
 
 
 
 
Continuing operations
$
(0.16
)
 
$
(0.12
)
 
$
(0.48
)
 
$
(0.48
)
Discontinued operations

 

 

 
0.02

Net loss per share - Basic
$
(0.16
)
 
$
(0.12
)
 
$
(0.48
)
 
$
(0.46
)
Net income (loss) per share - Diluted
 
 
 
 
 
 
 
Continuing operations
$
(0.16
)
 
$
(0.12
)
 
$
(0.48
)
 
$
(0.48
)
Discontinued operations

 

 

 
0.02

Net loss per share - Diluted
$
(0.16
)
 
$
(0.12
)
 
$
(0.48
)
 
$
(0.46
)
Shares used to compute basic net income (loss) per share
37,618

 
37,200

 
37,549

 
37,112

Shares used to compute diluted net income (loss) per share
37,618

 
37,200

 
37,549

 
37,112

 
 
 
 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized investment holding gains (losses), net of reclassification adjustments
$
(3
)
 
$

 
$

 
$
10

Foreign currency translation adjustments, net of reclassification adjustments
(322
)
 
562

 
(1,530
)
 
1,802

Total other comprehensive income (loss)
(325
)
 
562

 
(1,530
)
 
1,812

Net loss
(5,977
)
 
(4,334
)
 
(18,085
)
 
(17,144
)
Comprehensive loss
$
(6,302
)
 
$
(3,772
)
 
$
(19,615
)
 
$
(15,332
)
 
 
 
 
 
 
 
 
(A) Components of net revenue:
 
 
 
 
 
 
 
License and product revenue
$
5,827

 
$
6,873

 
$
17,770

 
$
23,677

Service revenue
11,752

 
11,684

 
35,183

 
36,176


4



 
$
17,579

 
$
18,557

 
$
52,953

 
$
59,853

(B) Components of cost of revenue:
 
 
 
 
 
 
 
License and product revenue
$
1,523

 
$
2,163

 
$
4,743

 
$
6,683

Service revenue
2,716

 
3,180

 
9,257

 
11,516

 
$
4,239

 
$
5,343

 
$
14,000

 
$
18,199

See accompanying notes to unaudited condensed consolidated financial statements.

5



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Nine Months Ended
September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net loss
$
(18,085
)
 
$
(17,144
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
1,738

 
2,402

Stock-based compensation
2,113

 
3,045

Equity in net loss of Napster
737

 
1,097

Deferred income taxes, net
5

 
(55
)
Fair value of warrants granted in 2015 and 2017, net of subsequent mark to market adjustments in 2018 and 2017
78

 
(367
)
Net change in certain operating assets and liabilities:
 
 
 
Trade accounts receivable
16,754

 
(3,516
)
Prepaid expenses and other assets
(979
)
 
1,072

Accounts payable
(15,235
)
 
(447
)
Accrued and other liabilities
(2,754
)
 
(3,630
)
Net cash used in operating activities
(15,628
)
 
(17,543
)
Cash flows from investing activities:
 
 
 
Purchases of equipment, software, and leasehold improvements
(698
)
 
(541
)
Purchases of short-term investments

 
(13,905
)
Proceeds from sales and maturities of short-term investments
7,607

 
43,754

Acquisition, net of cash acquired
(4,192
)
 

Advance to Napster

 
(1,500
)
Net cash provided by investing activities
2,717

 
27,808

Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock (stock options and stock purchase plan)
114

 
130

Tax payments from shares withheld upon vesting of restricted stock
(243
)
 
(338
)
Net cash used in financing activities
(129
)
 
(208
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(962
)
 
1,519

Net increase (decrease) in cash, cash equivalents and restricted cash
(14,002
)
 
11,576

Cash, cash equivalents and restricted cash, beginning of period
53,596

 
36,421

Cash, cash equivalents, and restricted cash end of period
$
39,594

 
$
47,997

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash received from income tax refunds
$
169

 
$
419

Cash paid for income taxes
$
862

 
$
1,124

Non-cash investing activities:
 
 
 
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements
$
(92
)
 
$
42

See accompanying notes to unaudited condensed consolidated financial statements.

6




REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2018 and 2017
Note 1
Description of Business and Summary of Significant Accounting Policies
Description of Business. RealNetworks, Inc. and subsidiaries is a 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”.
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 management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2018. 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, 2017 (the 10-K).
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Note 2
Recent Accounting Pronouncements
Recently adopted accounting pronouncements
In May 2014, and subsequently updated and amended in 2015 and 2016, the Financial Accounting Standards Board (FASB) issued new revenue recognition guidance (Topic 606), which replaced most existing revenue recognition guidance in U.S. GAAP. The guidance requires 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. We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method. Refer to Note 3 Revenue Recognition for further details.
In November 2016, the FASB issued guidance on the classification and presentation of changes in restricted cash on the statement of cash flows. We adopted this guidance on January 1, 2018, and retroactively applied the changes to the Statement of Cash Flows for all periods presented. As a result, we no longer classify changes in restricted cash within the investing section of our Statement of Cash flows, and instead include restricted cash with unrestricted cash as a combined total. The impact of the adoption did not have a material impact on the Condensed Consolidated Financial Statements.
Recently issued accounting pronouncements not yet adopted
In February 2016, the FASB issued new guidance related to the accounting for leases. A major change in the new guidance is that lessees will be required to present right-of-use assets and lease liabilities on the balance sheet. Enhanced disclosures will also be required to give financial statement users the ability to assess the amount, timing and uncertainty of cash flows arising from leases. In July 2018 the FASB issued an alternative method that permits application of the new guidance at the beginning of the year of adoption. This is in addition to the method of applying the new guidance

7



retrospectively to each prior reporting period presented. The new guidance will be effective for us on January 1, 2019, including interim periods within 2019. We continue to evaluate the effect that the guidance will have on our consolidated financial statements and related disclosures. We expect that the guidance will result in a material change to our Consolidated Balance Sheet as a result of capitalizing our operating leases.
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 beginning on December 15, 2019, with early adoption permitted. We will be evaluating the impact of the guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
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. The new guidance will be effective for us on January 1, 2019, including interim periods within 2019, with early adoption permitted. We will be evaluating the impact of the guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
Note 3
Revenue Recognition
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. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue recognition standard, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior periods.
We recorded a net decrease to opening retained deficit of $1.0 million as of January 1, 2018 due to the cumulative impact of adopting the new revenue recognition standard, with the impact primarily related to licensing of our RealPlayer product and full recognition of non-recurring engineering fees which were previously deferred and amortized over the life of the contract. The net impact to revenues as a result of adopting the new standard was a decrease of $0.4 million for the three months ended September 30, 2018 and an increase of $2.0 million for the nine months ended September 30, 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 and our RealPlayer and SuperPass services. 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 mobile and wholesale games, as well as our RealPlayer product. 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.

8



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):
 
 
Quarter Ended September 30, 2018
 
Nine months ended September 30, 2018
 
 
Consumer Media
 
Mobile Services
 
Games
 
Consumer Media
 
Mobile Services
 
Games
Business Line
 
 
 
 
 
 
 
 
 
 
 
 
Software License
 
$
2,746

 
$
520

 
$

 
$
7,891

 
$
2,324

 
$

Subscription Services
 
1,232

 
6,828

 
2,744

 
3,742

 
20,447

 
8,126

Product Sales
 
281

 

 
2,280

 
920

 

 
6,635

Advertising and Other
 
474

 

 
474

 
1,547

 

 
1,321

Total
 
$
4,733

 
$
7,348

 
$
5,498

 
$
14,100

 
$
22,771

 
$
16,082

The following table presents our disaggregated revenue by sales channel (in thousands):
 
 
Quarter Ended September 30, 2018
 
Nine months ended September 30, 2018
 
 
Consumer Media
 
Mobile Services
 
Games
 
Consumer Media
 
Mobile Services
 
Games
Sales Channel
 
 
 
 
 
 
 
 
 
 
 
 
Business to Business
 
$
3,220

 
$
7,209

 
$
806

 
$
9,438

 
$
22,312

 
$
2,393

Direct to Consumer
 
1,513

 
139

 
4,692

 
4,662

 
459

 
13,689

Total
 
$
4,733

 
$
7,348

 
$
5,498

 
$
14,100

 
$
22,771

 
$
16,082

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 September 30, 2018, our balance of long-term accounts receivable was $0.3 million, and is included in other long-term assets on our condensed consolidated balance sheets. During the quarter and nine months ended September 30, 2018, we recorded no impairments to our contract assets.
We record deferred revenue when cash payments are received or due in advance of our completion of the underlying performance obligation. As of September 30, 2018 we had a deferred revenue balance of $2.3 million, a decrease of $1.3 million from December 31, 2017. The decrease is due primarily to our transition to Topic 606, with $0.8 million recorded to retained earnings on January 1, 2018. The decrease is further due to $0.2 million of revenues recognized which were included in the deferred balance at December 31, 2017.
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. Our true-up on our second quarter estimates recorded in the third quarter of 2018 was not material to our condensed 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.


9



Note 4
Stock-Based Compensation
Total stock-based compensation expense recognized in our unaudited condensed consolidated statements of operations and comprehensive income (loss) includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Total stock-based compensation expense
$
499

 
$
748

 
$
2,113

 
$
3,045

The fair value of options granted determined using the Black-Scholes model used the following weighted-average assumptions:
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Expected dividend yield
0
%
 
0
%
 
0
%
 
0
%
Risk-free interest rate
2.78
%
 
1.61
%
 
2.69
%
 
1.71
%
Expected life (years)
3.8

 
3.7

 
3.9

 
4.2

Volatility
35
%
 
34
%
 
35
%
 
35
%

The total stock-based compensation amounts for 2018 and 2017 disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). Included in the expense for the nine months ended September 30, 2018 and 2017 was stock compensation expense recorded in the first quarter of 2018 and 2017 related to our 2017 and 2016 incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2018 and 2017, respectively.

As of September 30, 2018, $3.3 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 3.8 years.

Note 5
Napster Joint Venture
As of September 30, 2018 we owned approximately 42% of the issued and outstanding stock of Rhapsody International Inc., doing business as Napster, and account for our investment using the equity method of accounting.
Rhapsody America LLC 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 originally branded as Rhapsody. The service was re-branded in 2016 as Napster. In this Note, we refer to the business as Napster, although the legal entity in which we hold our investment is Rhapsody International, Inc.
Following certain restructuring transactions effective March 31, 2010, we began accounting for our 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.
We recorded our share of losses of Napster of $0.7 million for the quarter and nine months ended September 30, 2018; and $0.0 million and $1.1 million for the quarter and nine months ended September 30, 2017. Because of the $10.0 million liquidation preference on the preferred stock we hold in Napster, under the equity method of accounting we did not record any share of Napster losses that would reduce our carrying value of Napster, which is impacted by Napster equity transactions, below $10.0 million, until Napster's book value was reduced below $10.0 million. This occurred in the first quarter of 2015. As of September 30, 2018, the carrying value of our Napster equity investment was zero, as we did not have any further commitment to provide future support to Napster, with the exception of the guaranty discussed below. Unless we commit to provide future financial support to Napster, we do not record any further share of Napster losses that would reduce our carrying value of Napster below zero; in accordance with GAAP, we currently track those suspended losses outside of our financial statements.

10



In December 2016, RealNetworks entered into an agreement to loan up to $5.0 million to Napster for general operating purposes, as did Napster's other 42% owner. Each entity fully funded its loan, providing $3.5 million each in December 2016 and the remaining $1.5 million each in January 2017. These loans are subordinate to senior creditors, and bear an interest rate of 10% per annum, which is added to the outstanding principal balance. At the time of signing the agreement we recognized previously suspended Napster losses, and, consequently, we did not record a receivable related to this loan.
As discussed in Note 4 to our 2017 Form 10-K, during November 2017, Napster entered into an amendment to its revolving credit facility. In conjunction with the amendment, both RealNetworks and Napster's other 42% owner entered into an arrangement to guarantee up to $2.75 million each of Napster's outstanding indebtedness on the credit facility. As a result of this guaranty, in December 2017 we recognized previously suspended Napster losses up to the full $2.75 million guaranty in our consolidated statement of operations. As of the date of this filing, RealNetworks has not been required to pay any amounts under the guaranty, and the amount is reflected on our condensed consolidated balance sheets as Commitment to Napster.
Summarized financial information for Napster, which represents 100% of its financial information, is as follows (in thousands): 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Net revenue
$
34,814

 
$
42,816

 
$
111,343

 
$
134,414

Gross profit
10,029

 
7,245

 
28,690

 
19,927

Operating income (loss)
4,142

 
179

 
14,452

 
(9,692
)
Net income (loss)
2,768

 
(627
)
 
9,350

 
(13,960
)
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 September 30, 2018 and December 31, 2017, 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
 
September 30, 2018
 
September 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
26,472

 
$

 
$

 
$
26,472

 
$
26,472

Money market funds
11,492

 

 

 
11,492

 
11,492

Total cash and cash equivalents
37,964

 

 

 
37,964

 
37,964

Short-term investments:
 
 
 
 
 
 
 
 
 
Corporate notes and bonds

 
1,172

 

 
1,172

 
1,172

Total short-term investments

 
1,172

 

 
1,172

 
1,172

Restricted cash equivalents

 
1,630

 

 
1,630

 
1,630

Warrants issued by Napster (included in Other assets)

 

 
911

 
911

 

Total
$
37,964

 
$
2,802

 
$
911

 
$
41,677

 
$
40,766




11



 
Fair Value Measurements as of
 
Amortized Cost as of
 
December 31, 2017
 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
31,065

 
$

 
$

 
$
31,065

 
$
31,065

Money market funds
20,131

 

 

 
20,131

 
20,131

Total cash and cash equivalents
51,196

 

 

 
51,196

 
51,196

Short-term investments:
 
 
 
 
 
 
 
 
 
Corporate notes and bonds

 
8,779

 

 
8,779

 
8,779

Total short-term investments

 
8,779

 

 
8,779

 
8,779

Restricted cash equivalents

 
2,400

 

 
2,400

 
2,400

Warrants issued by Napster (included in Other assets)

 

 
989

 
989

 

Total
$
51,196

 
$
11,179

 
$
989

 
$
63,364

 
$
62,375

Restricted cash equivalents as of September 30, 2018 and December 31, 2017 relates to cash pledged as collateral against letters of credit in connection with lease agreements.
Realized gains or losses on sales of short-term investment securities for the quarters and nine months ended September 30, 2018 and 2017 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of September 30, 2018 and December 31, 2017 were also 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 September 30, 2018 (in thousands):
 
 
Estimated
Fair Value
Within one year
$
1,172

Between one year and five years

Total short-term investments
$
1,172

In February 2015, Napster issued warrants to purchase Napster common shares to both RealNetworks and Napster's other 42% owner. The warrants were issued as compensation for past services provided by RealNetworks and the other 42% owner, and both warrants covered the same number of underlying shares, with a 10 year contractual term. The exercise price of the warrants was equal to the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of 5 years and expected volatility of 55%. On the date of issuance, we recognized and recorded the $1.2 million fair value of the warrant issued to RealNetworks within Other assets in the unaudited condensed consolidated balance sheets, and as an expense reduction within General and administrative expense in the unaudited condensed consolidated statements of operations. The warrants are free-standing derivatives and as such their fair value is determined each quarter using updated inputs in the Black-Scholes option-pricing model. At December 31, 2017 due to the management change and strategic shift undertaken by Napster, we determined that a change to the expected term was necessary. As a result, we extended the expected term by 3.25 years, resulting in a total expected term for the warrant of 8.25 years. During the nine months ended September 30, 2018, the decrease in the fair value of the warrants was insignificant.
In February 2017, Napster issued additional warrants to purchase Napster common shares to both RealNetworks and Napster's other 42% owner. Consistent with the warrants issued in 2015, the 2017 warrants were issued as compensation for past services provided by RealNetworks and the other 42% owner, and both warrants covered the same number of underlying shares, with a 10 year contractual term. The exercise price of the warrants exceeded the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of 5 years and expected volatility of 55%, resulting in a recognized fair value of $0.5 million in Other assets in the unaudited condensed consolidated balance sheets, and as an expense reduction within general and administrative expense in the unaudited condensed consolidated statements of operations. At December 31, 2017, due to the management change and strategic shift undertaken by Napster, we determined that a change to the expected term was necessary. As a result, we extended the expected term by 1 year, resulting in a total expected term for the warrant of 6 years. During the nine months ended September 30, 2018, the decrease in the fair value of the warrants was insignificant.

12



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 nine months ended September 30, 2018 and 2017, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.

See Note 11, 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 7
Other Intangible Assets
Other intangible assets (in thousands):
 
 
 
 
September 30, 2018
 
December 31, 2017
 
 
 
Gross
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
 
$
31,149

 
$
31,079

 
$
70

 
$
32,286

 
$
31,997

 
$
289

 
Developed technology
 
24,571

 
24,571

 

 
25,177

 
25,177

 

 
Patents, trademarks and tradenames
 
3,788

 
3,788

 

 
3,932

 
3,896

 
36

 
Service contracts
 
5,559

 
5,509

 
50

 
5,576

 
5,576

 

 
Total
 
$
65,067

 
$
64,947

 
$
120

 
$
66,971

 
$
66,646

 
$
325


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 8 Goodwill for further details about the acquisition.

No impairments of other intangible assets were recognized in either of the nine months ended September 30, 2018 or 2017.
Note 8
Goodwill
Changes in goodwill (in thousands):
 
Balance, December 31, 2017
$
13,060

Increases due to current year acquisitions
4,367

Effects of foreign currency translation
(367
)
Balance, September 30, 2018
$
17,060


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. All tangible and intangible assets and liabilities recognized are reported within the Games segment. As a result of our preliminary purchase price allocation, we recorded $0.1 million of identifiable intangible assets relating to an existing customer contract. We also recorded goodwill of $4.4 million, representing the intangible assets that do not qualify for separate recognition for accounting purposes, primarily related to the assembled workforce and expected synergies in development of our Original Stories titles. The goodwill is not deductible for income tax purposes. We did not recognize significant revenue or loss before income taxes from this acquired business from the date of acquisition through September 30, 2018.








13



Goodwill by segment (in thousands):
 
 
September 30,
2018
Consumer Media
$
580

Mobile Services
2,086

Games
14,394

Total goodwill
$
17,060


No impairment of goodwill was recognized in either of the nine months ended September 30, 2018 or in 2017.
Note 9
Accrued and Other Current Liabilities
Accrued and other current liabilities (in thousands):
 
 
September 30, 2018
 
December 31, 2017
Royalties and other fulfillment costs
$
3,315

 
$
2,965

Employee compensation, commissions and benefits
3,985

 
4,384

Sales, VAT and other taxes payable
1,463

 
1,782

Other
3,153

 
3,234

Total accrued and other current liabilities
$
11,916

 
$
12,365

Note 10
Restructuring Charges
Restructuring and other charges in 2018 and 2017 consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. The expense amounts in both years relate primarily to severance costs due to workforce reductions.
Restructuring charges are as follows (in thousands):
 
Employee Separation Costs
Costs incurred and charged to expense for the nine months ended September 30, 2018
$
1,320

Costs incurred and charged to expense for the nine months ended September 30, 2017
$
2,271

Changes to the accrued restructuring liability (which is included in Accrued and other current liabilities) for 2018 (in thousands) are as follows:
 
Employee Separation Costs
Accrued liability at December 31, 2017
$
244

Costs incurred and charged to expense for the nine months ended September 30, 2018
1,320

Cash payments
(976
)
Accrued liability at September 30, 2018
$
588


14



Note 11
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%. Consequently, we recorded a reduction to our lease loss accrual to reflect our reduced future obligations. This reduction has also been recorded as a benefit of $0.3 million in our condensed consolidated statement of operations for the nine months ended September 30, 2018. We continue to regularly evaluate the market for office space. If the market for such space changes further in future periods, we may have to revise our estimates which may result in future adjustments to expense for excess office facilities.
Changes to accrued lease exit and related charges (which is included in Accrued and other current liabilities) for 2018 (in thousands) are as follows:
 
Accrued loss at December 31, 2017
$
2,058

Additions and adjustments to the lease loss accrual, including estimated sublease income
(454
)
Less amounts paid, net of sublease amounts
(484
)
Accrued loss at September 30, 2018
1,120

Less current portion (included in Accrued and other current liabilities)
(119
)
Accrued loss, non-current portion (included in Other long term liabilities)
$
1,001


Note 12
Shareholders’ Equity
Accumulated Other Comprehensive Income (Loss)

Changes in components of accumulated other comprehensive income (loss) (in thousands):
 
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2018
 
2017
 
2018
 
2017
Investments
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive income (loss), beginning of period
 
$
5

 
$
4

 
$
2

 
$
(6
)
 
Unrealized gains (loss), net of tax effects of ($1), $0, $0 and $5
 
(3
)
 

 

 
10

 
Net current period other comprehensive income (loss)
 
(3
)
 

 

 
10

 
Accumulated other comprehensive income balance, end of period
 
$
2

 
$
4

 
$
2

 
$
4

Foreign currency translation
 
 
 
 
 
 
 
 
 
Accumulated other comprehensive loss, beginning of period
 
$
(60,757
)
 
$
(60,399
)
 
$
(59,549
)
 
$
(61,639
)
 
Translation adjustments
 
(322
)
 
562

 
(1,530
)
 
1,802

 
Net current period other comprehensive income (loss)
 
(322
)
 
562

 
(1,530
)
 
1,802

 
Accumulated other comprehensive loss balance, end of period
 
$
(61,079
)
 
$
(59,837
)
 
$
(61,079
)
 
$
(59,837
)
Total accumulated other comprehensive loss, end of period
 
$
(61,077
)
 
$
(59,833
)
 
$
(61,077
)
 
$
(59,833
)

Note 13
Income Taxes
As of September 30, 2018, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the 2017 10-K. 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.

15



Note 14
Loss Per Share
Basic net loss per share (EPS) is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net 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):
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Net loss from continuing operations
$
(5,977
)
 
$
(4,532
)
 
$
(18,085
)
 
$
(17,861
)
Weighted average common shares outstanding used to compute basic EPS
37,618

 
37,200

 
37,549

 
37,112

Dilutive effect of stock based awards

 

 

 

Weighted average common shares outstanding used to compute diluted EPS
37,618

 
37,200


37,549


37,112

 
 
 
 
 
 
 
 
Basic EPS from continuing operations
$
(0.16
)
 
$
(0.12
)
 
$
(0.48
)
 
$
(0.48
)
Diluted EPS from continuing operations
$
(0.16
)
 
$
(0.12
)
 
$
(0.48
)
 
$
(0.48
)
During the quarter and nine months ended September 30, 2018, 6.7 million and 6.3 million shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
During the quarter and nine months ended September 30, 2017, 5.3 million and 5.2 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.
Note 15
Discontinued Operations

On December 31, 2017, our contract with our low-margin music on demand customer LOEN expired. The activity for this contract represented our only revenue source relating to music on demand services, and we did not renew the sole contract for this service, resulting in the abandonment of the related business. As the exit of the music on demand business represented a strategic shift, and the amounts were financially significant to our consolidated results, at December 31, 2017 we determined this business should be reported as a discontinued operation, and treated it as such beginning in our fourth quarter of 2017.

The following table summarizes the results of operations, which were recorded in our Mobile Services segment, relating to the discontinued operation (in thousands):

 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2018
 
2017
 
2018
 
2017
Net revenue
 
$

 
$
11,445

 
$

 
$
33,837

Cost of revenue
 

 
11,191

 

 
32,918

Gross profit
 

 
254

 

 
919

Income taxes
 

 
56

 

 
202

Income from discontinued operations, net of tax
 
$

 
$
198

 
$

 
$
717


The following table summarizes the remaining carrying amounts of major classes of assets and liabilities of the discontinued operation (in thousands). These assets and liabilities relate to final settlements of prior year activity between various parties. These balances were fully settled prior to the end of the second quarter of 2018.

16



 
 
September 30,
2018
 
December 31,
2017
Trade accounts receivable, net
 
$

 
$
17,456

Total current assets of discontinued operations
 

 
17,456

 
 
 
 
 
Accounts payable
 
$

 
$
15,836

Accrued and other current liabilities
 

 
1,271

Total current liabilities of discontinued operations
 
$

 
$
17,107


The cash flows related to the discontinued operation have not been segregated, and are included in the Consolidated Statements of Cash Flows. For all periods presented, depreciation and amortization, capital expenditures and significant operating non-cash items from the discontinued operation were not material.
Note 16
Commitments and Contingencies
From time to time we are and may be 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. Although we believe that resolving such claims, individually or in aggregate, will not have a material adverse impact on our business or financial condition, these matters are subject to inherent uncertainties. 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 some of our carrier customers.
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 18
Segment Information
We manage our business and report revenue and operating income (loss) in three 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 subscription services and our integrated RealTimes platform which is sold to mobile carriers; and (3) Games, which includes all our games-related businesses, including sales of mobile games, sales of games licenses, games subscription services, advertising on games sites and within our games, and microtransactions from online games.
We allocate to our reportable segments 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. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. Also reported in our corporate segment are restructuring charges, lease exit and related charges, as well as stock-based compensation expense.
RealNetworks reports three 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

17



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 nine months ended September 30, 2018 and 2017 (in thousands):
Consumer Media
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Revenue
$
4,733

 
$
4,197

 
$
14,100

 
$
16,817

Cost of revenue
955

 
981

 
2,976

 
3,545

Gross profit
3,778

 
3,216

 
11,124

 
13,272

Operating expenses
3,448

 
3,217

 
10,805

 
10,957

Operating income (loss)
$
330

 
$
(1
)
 
$
319

 
$
2,315



18



Mobile Services
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Revenue
$
7,348

 
$
7,678

 
$
22,771

 
$
23,597

Cost of revenue
2,052

 
2,134

 
6,502

 
7,750

Gross profit
5,296

 
5,544

 
16,269

 
15,847

Operating expenses
6,825

 
6,437

 
21,160

 
21,261

Operating loss
$
(1,529
)
 
$
(893
)
 
$
(4,891
)
 
$
(5,414
)

Games

 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Revenue
$
5,498

 
$
6,682

 
$
16,082

 
$
19,439

Cost of revenue
1,228

 
2,226

 
4,501

 
6,842

Gross profit
4,270

 
4,456

 
11,581

 
12,597

Operating expenses
5,447

 
5,071

 
15,459

 
15,108

Operating loss
$
(1,177
)
 
$
(615
)
 
$
(3,878
)
 
$
(2,511
)

Corporate
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Cost of revenue
$
4

 
$
2

 
$
21

 
$
62

Operating expenses
2,548

 
2,948

 
8,244

 
10,202

Operating loss
$
(2,552
)
 
$
(2,950
)
 
$
(8,265
)
 
$
(10,264
)
Our customers consist primarily of consumers and corporations located in the U.S., Europe, and various foreign countries (Rest of the World). Revenue by geographic region (in thousands):
 
 
Quarter Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
United States
$
9,026

 
$
10,098

 
$
28,106

 
$
30,727

Europe
3,005

 
3,337

 
9,040

 
9,737

Rest of the World
5,548

 
5,122

 
15,807

 
19,389

Total net revenue
$
17,579

 
$
18,557

 
$
52,953

 
$
59,853

Long-lived assets (which consist of primarily of goodwill, but also includes equipment, software, leasehold improvements, and other intangible assets) by geographic region (in thousands) are as follows:
 
 
September 30,
2018
 
December 31,
2017
United States
$
11,862

 
$
12,236

Europe
7,001

 
3,437

Rest of the World
1,233

 
1,572

Total long-lived assets
$
20,096

 
$
17,245



19



Note 19
Related Party Transactions
 See Note 5, Napster Joint Venture, and Note 6, Fair Value Measurements, for details on transactions involving Napster.

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, distribution and 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 “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 applications and services that make it easy to connect with and enjoy digital media. We manage our business and report revenue and operating income (loss) in three segments: (1) Consumer Media, (2) Mobile Services, and (3) Games. See Note 18 Segment Information, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q.
Within our Consumer Media segment revenue is primarily derived from the software licensing of our video compression, or codec, technology, including our latest technology, RealMedia High Definition, or RMHD. We also generate revenue from the sale of our PC-based RealPlayer products, including RealPlayer Plus and related products. These products and services are delivered directly to consumers and through partners, such as OEMs and mobile device manufacturers.
Our Mobile Services business generates revenue primarily from the sale of subscription services, which includes our 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

20



Services business to a few mobile carriers. The loss of these contracts, whether by termination or non-renewal or renegotiation of contract terms that are less favorable to us could result in the loss of future revenues and anticipated profits.
Our Games business, through the GameHouse and Zylom brands, derives revenue from product sales of mobile games, games licenses, games subscription services, and advertising on games sites and within our games.
We allocate to our reportable segments certain corporate expenses which are directly attributable to supporting our 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 the business, are reported as corporate items. These corporate items also include restructuring charges, lease exit and related charges, as well as stock compensation expense.
On December 31, 2017, our contract with LOEN Entertainment, Co, Ltd. (LOEN) for our music on demand services expired. As the profits generated from this business had significantly declined over time, we did not renew the sole contract for this service. Accordingly, we have reported the operating results and related assets and liabilities of this business as discontinued operations for all periods presented. Refer to Note 15 to our unaudited condensed consolidated financial statements for additional information on these discontinued operations. Unless otherwise noted, amounts and percentages for all periods discussed below reflect the results of operations and financial condition of our continuing operations.
As discussed in Note 3 Revenue Recognition, as a result of our transition to Topic 606, in the three months ended September 30, 2018, our net revenues were $0.4 million lower as compared to revenues which would have been recognized under previous accounting guidance. For the nine months ended September 30, 2018 our net revenues were $2.0 million higher as compared to the revenues which would have been recognized under previous accounting guidance.

As of September 30, 2018, we had $39.1 million in unrestricted cash, cash equivalents and short-term investments, compared to $60.0 million as of December 31, 2017. The 2018 decrease of cash, cash equivalents, and short-term investments was due to our ongoing cash flows used in operating activities and to the April 2018 acquisition of a Netherlands-based game development studio, as discussed in Note 8 Goodwill.

Condensed consolidated results of operations were as follows (dollars in thousands):
 
 
Quarter Ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
$ Change
 
% Change
 
2018
 
2017
 
$ Change
 
% Change
Total revenue
$
17,579

 
$
18,557

 
$
(978
)
 
(5
)%
 
$
52,953

 
$
59,853

 
$
(6,900
)
 
(12
)%
Cost of revenue
4,239

 
5,343

 
(1,104
)
 
(21
)%
 
14,000

 
18,199

 
(4,199
)
 
(23
)%
Gross profit
13,340

 
13,214

 
126

 
1
 %
 
38,953

 
41,654

 
(2,701
)
 
(6
)%
Gross margin
76
%
 
71
%
 
 
 
 
 
74
%
 
70
%
 
 
 
 
Operating expenses
18,268

 
17,673

 
595

 
3
 %
 
55,668

 
57,528

 
(1,860
)
 
(3
)%
Operating loss
$
(4,928
)
 
$
(4,459
)
 
$
(469
)
 
(11
)%
 
$
(16,715
)
 
$
(15,874
)
 
$
(841
)
 
(5
)%
In the third quarter of 2018, our total consolidated revenue decreased $1.0 million as compared with the year-earlier period, due to decreases in revenue of $1.2 million in our Games segment and $0.3 million in our Mobile Services segment, offset by an increase of $0.5 million in our Consumer Media segment. See below for further discussion around the fluctuations for each segment.
Cost of revenue decreased by $1.1 million for the quarter ended September 30, 2018, due primarily to a decline of $1.0 million in our Games segment.
Operating expenses increased by $0.6 million in the quarter ended September 30, 2018 as compared with the year-earlier period, primarily due to an increase in costs associated with our growth initiatives as well as ongoing operating expenses related to our acquisition of a Netherlands-based game development studio described in Note 8. The increase was offset in part with ongoing cost reduction efforts.
For the nine months ended September 30, 2018, our total consolidated revenue decreased $6.9 million as compared to the prior year. The year-over-year decrease was due to lower revenues of $3.4 million in our Games segment, $2.7 million in our Consumer Media segment and $0.8 million in our Mobile Services segment. See below for further discussion around the fluctuations for each segment.

21



Cost of revenue decreased by $4.2 million in the nine months ended September 30, 2018 as compared to the prior year period due to decreased costs in all three operating segments: $2.3 million in Games, $1.2 million in Mobile Services and $0.6 million in Consumer Media.
Operating expenses decreased by $1.9 million in the nine months ended September 30, 2018 as compared with the prior year primarily due to reduced restructuring costs of $1.0 million and a benefit of $0.5 million in lease exit and related charges following the renegotiation of certain leases in the first quarter of 2018. Also contributing to the overall decrease were reductions of $0.6 million in facilities and support services, and $0.4 million in marketing expense. These decreases were offset by certain benefits recorded in the first quarter of 2017: $0.5 million relating to the warrants we received from Napster and a $0.4 million release of previously accrued taxes.
Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (dollars in thousands):
 
 
Quarter Ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
$ Change
 
% Change
 
2018
 
2017
 
$ Change
 
% Change
Revenue
$
4,733

 
$
4,197

 
$
536

 
13
 %
 
$
14,100

 
$
16,817

 
$
(2,717
)
 
(16
)%
Cost of revenue
955

 
981

 
(26
)
 
(3
)%
 
2,976

 
3,545

 
(569
)
 
(16
)%
Gross profit
3,778

 
3,216

 
562

 
17
 %
 
11,124

 
13,272

 
(2,148
)
 
(16
)%
Gross margin
80
%
 
77
%
 
 
 
 
 
79
%
 
79
%
 
 
 
 
Operating expenses
3,448

 
3,217

 
231

 
7
 %
 
10,805

 
10,957

 
(152
)
 
(1
)%
Operating income (loss)
$
330

 
$
(1
)
 
$
331

 
NM

 
$
319

 
$
2,315

 
$
(1,996
)
 
(86
)%

Total Consumer Media revenue for the quarter ended September 30, 2018 increased $0.5 million as compared to the same quarter in 2017, due primarily to increased software license revenues of $0.7 million, offset by a decrease in our subscription services revenues of $0.2 million, described more fully below.
Software License
For our software license revenues, the $0.7 million increase is primarily due to the timing of shipments from existing customers and new business revenue.
Subscription Services
For our subscription services revenues, the decrease is primarily due to $0.2 million from continuing declines in our legacy subscription products.
Cost of revenue was flat for the quarter ended September 30, 2018, compared with the year-earlier period. This was primarily due to increased salaries and benefits costs, offset by lower bandwidth and license royalty costs.
Operating expenses increased $0.2 million as compared with the year-earlier period, due to increased salaries, benefits and professional services fees.
Total Consumer Media revenue for the nine months ended September 30, 2018 decreased $2.7 million as compared to the prior year, due primarily to decreased software license revenues of $2.2 million, as well as a decrease in our subscription services revenues of $0.8 million, described more fully below. These decreases were offset in part by an increase in advertising and other revenues of $0.2 million.
Software License
For our software license revenues, the year-over-year decrease was partially due to the timing of shipments by our customers. In the second quarter of 2017, we recognized revenue on certain large shipments, whereas in 2018 shipments were more evenly distributed. As a result of this shift in timing, we recorded $0.5 million less revenue during the nine months ended September 30, 2018. The variance was also driven by the execution and recognition of large contract renewals in the first quarter of 2017.



22



Subscription Services
For our subscription services revenues, the decrease was primarily due to $0.8 million from continuing declines in our legacy subscription products.
Cost of revenue decreased by $0.6 million in the nine months ended September 30, 2018 when compared to the prior-year period due to decreases of $0.5 million in bandwidth costs, $0.4 million in royalty costs, and $0.2 million in third party customer support costs. These decreases were offset by an increase of $0.5 million in salaries and benefits costs.
Operating expenses decreased $0.2 million in the nine months ended September 30, 2018 as compared with the year-earlier period, primarily due to reduced costs for facilities and support services.
Mobile Services
Mobile Services segment results of operations were as follows (dollars in thousands): 
 
Quarter Ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
$ Change
 
% Change
 
2018
 
2017
 
$ Change
 
% Change
Revenue
$
7,348

 
$
7,678

 
$
(330
)
 
(4
)%
 
$
22,771

 
$
23,597

 
$
(826
)
 
(4
)%
Cost of revenue
2,052

 
2,134

 
(82
)
 
(4
)%
 
6,502

 
7,750

 
(1,248
)
 
(16
)%
Gross profit
5,296

 
5,544

 
(248
)
 
(4
)%
 
16,269

 
15,847

 
422

 
3
 %
Gross margin
72
%
 
72
%
 
 
 
 
 
71
%
 
67
%
 
 
 
 
Operating expenses
6,825

 
6,437

 
388

 
6
 %
 
21,160

 
21,261

 
(101
)
 
 %
Operating loss
$
(1,529
)
 
$
(893
)
 
$
(636
)
 
(71
)%
 
$
(4,891
)
 
$
(5,414
)
 
$
523

 
10
 %
Total Mobile Services revenue decreased by $0.3 million in the quarter ended September 30, 2018 compared with the prior-year period. The revenue decrease was due to declines of $0.1 million in our subscription services revenue stream and $0.3 million in our software license revenue stream, described more fully below.
Software license
For our software license revenues, the decrease was primarily due to declines in our legacy integrated RealTimes product offered to mobile carriers.
Subscription services
For our subscription services, the decrease was primarily the result of a decrease of $0.3 million in our ringback tones business offset by a $0.2 million increase in professional services fees.
Cost of revenue decreased by $0.1 million in the quarter ended September 30, 2018 compared with the prior-year period, due primarily to reductions in bandwidth costs.
Operating expenses increased by $0.4 million for the quarter ended September 30, 2018 compared with the year-earlier period primarily due to increased professional services fees and marketing spend relating to our growth initiatives.
Total Mobile Services revenue decreased by $0.8 million for the nine months ended September 30, 2018 as compared to the prior-year period, as a decrease to our subscription services revenue stream of $1.2 million was offset in part by an increase in our software license revenue stream of $0.4 million, described more fully below.
Software license
For our software license revenues, the increase was primarily due to the recognition of $0.6 million in revenues generated by our integrated RealTimes products offered to mobile carriers due to our transition to Topic 606 in the first quarter of 2018.
Subscription service
For our subscription services, the $1.2 million decrease was primarily a result of a decrease in our ringback tones business, driven mostly by the recognition of $0.9 million in the first quarter of 2017 following the execution of a long-term contract with our partner in Brazil. Also contributing to the decrease was a $0.3 million reduction in our intercarrier messaging business. These decreases were offset by the recognition of $0.6 million in non-recurring engineering services relating to our ringback tones businesses, which was accelerated due to our transition to Topic 606 in the first quarter of 2018.
Cost of revenue decreased by $1.2 million for the nine months ended September 30, 2018 when compared to the prior-year period, due primarily to lower bandwidth costs of $0.6 million, third-party customer service of $0.2 million, and salaries, professional services fees and benefits of $0.2 million.

23



Operating expenses decreased by $0.1 million in the nine months ended September 30, 2018 as compared with the year-earlier period primarily due to a reduction in facilities and support services costs.
Games
Games segment results of operations were as follows (dollars in thousands):
 
 
Quarter Ended September 30,
 
Nine months ended September 30,
 
2018
 
2017
 
$ Change
 
% Change
 
2018
 
2017
 
$ Change
 
% Change
Revenue
$
5,498

 
$
6,682

 
$
(1,184
)
 
(18
)%
 
$
16,082

 
$
19,439

 
$
(3,357
)
 
(17
)%
Cost of revenue
1,228

 
2,226

 
(998
)
 
(45
)%
 
4,501

 
6,842

 
(2,341
)
 
(34
)%
Gross profit
4,270

 
4,456

 
(186
)
 
(4
)%
 
11,581

 
12,597

 
(1,016
)
 
(8
)%
Gross margin
78
%
 
67
%
 
 
 
 
 
72
%
 
65
%
 
 
 
 
Operating expenses
5,447

 
5,071

 
376

 
7
 %
 
15,459

 
15,108

 
351

 
2
 %
Operating loss
$
(1,177
)
 
$
(615
)
 
$
(562
)
 
(91
)%
 
$
(3,878
)
 
$
(2,511
)
 
$
(1,367
)
 
(54
)%
Total Games revenue declined $1.2 million for the quarter ended September 30, 2018 as compared with the year-earlier period due primarily to a decrease of $1.6 million in our product sales revenue stream, offset by an increase of $0.4 million in our advertising and other revenue stream, described more fully below.
Product sales
For our product sales, the decrease was primarily due to one new game launch in the third quarter of 2018 compared to two launches in the third quarter of 2017. In addition, the performance of certain Original Stories titles in the third quarter of 2018 had less comparative success than those titles in the third quarter of 2017.
Advertising and other
Our advertising and other revenues increased $0.4 million as compared to the prior-year period primarily as a result of new initiatives to offer in-game advertising within our mobile games.
Cost of revenue decreased $1.0 million in the quarter ended September 30, 2018 when compared with the prior-year period. We recorded decreased royalties of $0.3 million and decreased app store fees of $0.4 million. In addition, as a result of our April 2018 acquisition of a Netherlands-based game development studio described in Note 8, we no longer pay royalties to this studio; however, operating expenses relating to the ongoing operation of this studio have been incurred as noted in the following paragraph.
Operating expenses increased $0.4 million in the quarter ended September 30, 2018, compared with the prior-year period due primarily to an increase of $0.4 million in salaries and benefits costs, including in connection with the April 2018 acquisition of a Netherlands-based game development studio described in Note 8.
Total Games revenue declined $3.4 million in the nine months ended September 30, 2018 as compared with the prior-year period. The decrease was due primarily to a decrease of $3.8 million in our product sales revenue stream, offset by an increase of $0.9 million in our advertising and other revenue stream, described more fully below. The overall decrease was also impacted by a decrease of $0.2 million in our subscription services.
Product sales
For our product sales, the decrease of $3.8 million was due primarily to timing of launches and specific games launched within our Original Stories portfolio. As of the third quarter of 2018, we have published five Original Stories titles, compared to seven titles in 2017, of which, our 2017 launches experienced more comparative success than those titles released in 2018.
Advertising and other
Our advertising and other revenues increased $0.9 million as compared to the prior-year period primarily as a result of new initiatives to offer in-game advertising within our mobile games.
Cost of revenue decreased by $2.3 million in the nine months ended September 30, 2018 as compared to the prior year period. We recorded decreased royalties of $1.0 million and decreased app store fees of $0.9 million. In addition, as a result of our April 2018 acquisition of a Netherlands-based game development studio described in Note 8, we no longer pay royalties for this studio; however, operating expenses relating to the ongoing operation of this studio have been incurred.

24



Operating expenses increased $0.4 million in the nine months ended September 30, 2018 when compared to the prior-year period, as an increase of $0.8 million in salaries and benefits costs was offset by a decrease of $0.5 million in marketing fees.
Corporate
Corporate segment results of operations were as follows (dollars in thousands):