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 March 31, 2019
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 every Interactive Data File required to be submitted 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, a smaller reporting company, or an 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.
Large accelerated filer
 
¨
  
Accelerated filer
ý
Non-accelerated filer
 
¨  
  
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




Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock, Par Value $0.001 per share
 
RNWK
 
The NASDAQ Stock Market
Preferred Share Purchase Rights
 
RNWK
 
The NASDAQ Stock Market
The number of shares of the registrant’s Common Stock outstanding as of May 6, 2019 was 37,943,871.




TABLE OF CONTENTS
 
 
Page
 
 

3



PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
March 31,
2019
 
December 31,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
36,897

 
$
35,561

Short-term investments

 
24

Trade accounts receivable, net of allowances of $646 and $560
32,427

 
11,751

Deferred costs, current portion
299

 
331

Prepaid expenses and other current assets
21,210

 
5,911

Total current assets
90,833

 
53,578

Equipment, software, and leasehold improvements, at cost:
 
 
 
Equipment and software
35,779

 
37,458

Leasehold improvements
3,207

 
3,292

Total equipment, software, and leasehold improvements, at cost
38,986

 
40,750

Less accumulated depreciation and amortization
35,923

 
37,996

Net equipment, software, and leasehold improvements
3,063

 
2,754

Operating lease assets
13,943

 

Restricted cash equivalents
4,045

 
1,630

Other assets
2,687

 
3,997

Deferred costs, non-current portion
372

 
528

Deferred tax assets, net
846

 
851

Other intangible assets, net
22,692

 
26

Goodwill
65,368

 
16,955

Total assets
$
203,849

 
$
80,319

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
4,564

 
$
3,910

Accrued royalties, fulfillment and other current liabilities
97,890

 
11,312

Commitment to Napster

 
2,750

Deferred revenue, current portion
6,031

 
2,125

Notes payable
13,313

 

Total current liabilities
121,798

 
20,097

Deferred revenue, non-current portion
225

 
268

Deferred rent

 
986

Deferred tax liabilities, net
1,268

 
1,168

Long-term lease liabilities
10,929

 

Other long-term liabilities
10,875

 
960

Total liabilities
145,095

 
23,479

Commitments and contingencies

 


Shareholders’ equity:
 
 
 
Preferred stock, $0.001 par value, no shares issued and outstanding:
 
 
 
Series A: authorized 200 shares

 

Undesignated series: authorized 59,800 shares

 

Common stock, $0.001 par value authorized 250,000 shares; issued and outstanding 37,918 shares in 2019 and 37,728 shares in 2018
37

 
37

Additional paid-in capital
642,059

 
641,930

Accumulated other comprehensive loss
(61,205
)
 
(61,118
)
Retained deficit
(522,476
)
 
(524,009
)
Total shareholders’ equity
58,415

 
56,840

Noncontrolling interests
339

 

Total equity
58,754

 
56,840

Total liabilities and equity
$
203,849

 
$
80,319

See accompanying notes to unaudited condensed consolidated financial statements.

4



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
 
Quarter Ended
March 31,
 
2019
 
2018
Net revenue (A)
$
39,472

 
$
19,650

Cost of revenue (B)
24,870

 
5,136

Gross profit
14,602

 
14,514

Operating expenses:
 
 
 
Research and development
8,833

 
7,694

Sales and marketing
8,142

 
5,997

General and administrative
8,364

 
5,601

Restructuring and other charges
167

 
501

Lease exit and related benefit

 
(325
)
Total operating expenses
25,506

 
19,468

Operating loss
(10,904
)
 
(4,954
)
Other income (expenses):
 
 
 
Interest expense
(166
)
 

Interest income
77

 
87

Gain (loss) on equity investment, net
12,338

 

Other income (expenses), net
127

 
(41
)
Total other income (expenses), net
12,376

 
46

Income (loss) before income taxes
1,472

 
(4,908
)
Income tax expense
258

 
270

Net income (loss) including noncontrolling interests
1,214

 
(5,178
)
Net income (loss) attributable to noncontrolling interests

(319
)
 

Net income (loss) attributable to RealNetworks
$
1,533

 
$
(5,178
)
 
 
 
 
Net income (loss) per share attributable to RealNetworks- Basic
$
0.04

 
$
(0.14
)
Net income (loss) per share attributable to RealNetworks- Diluted
$
0.04

 
$
(0.14
)
Shares used to compute basic net income (loss) per share
37,820

 
37,449

Shares used to compute diluted net income (loss) per share
37,912

 
37,449

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

 
$
1

Foreign currency translation adjustments, net of reclassification adjustments
(87
)
 
396

Total other comprehensive income (loss)
(87
)
 
397

Net income (loss) including noncontrolling interests
1,214

 
(5,178
)
Comprehensive income (loss) including noncontrolling interests
1,127

 
(4,781
)
Comprehensive income (loss) attributable to noncontrolling interests
(319
)
 

Comprehensive income (loss) attributable to RealNetworks
$
1,446

 
$
(4,781
)
 
 
 
 
(A) Components of net revenue:
 
 
 
License and product revenue
$
3,541

 
$
7,414

Service revenue
35,931

 
12,236

 
$
39,472

 
$
19,650

(B) Components of cost of revenue:
 
 
 
License and product revenue
$
1,369

 
$
1,755

Service revenue
23,501

 
3,381

 
$
24,870

 
$
5,136

See accompanying notes to unaudited condensed consolidated financial statements.

5



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Three Months Ended
March 31,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income (loss) including noncontrolling interests
$
1,214

 
$
(5,178
)
Adjustments to reconcile net income (loss) including noncontrolling interests to net cash used in operating activities:
 
 
 
Depreciation and amortization
1,482

 
620

Stock-based compensation
1,384

 
1,157

Deferred income taxes, net

 
(40
)
(Gain) loss on equity investment, net
(12,338
)
 

Foreign currency (gain) loss
(151
)
 

Mark to market adjustment of warrants

 
21

Net change in certain operating assets and liabilities:
 
 
 
Trade accounts receivable
(143
)
 
11,188

Prepaid expenses, operating lease and other assets
(1,063
)
 
(917
)
Accounts payable
(259
)
 
(10,622
)
Accrued, lease and other liabilities
555

 
(1,654
)
Net cash used in operating activities
(9,319
)
 
(5,425
)
Cash flows from investing activities:
 
 
 
Purchases of equipment, software, and leasehold improvements
(482
)
 
(316
)
Proceeds from sales and maturities of short-term investments
24

 
4,231

Acquisition, net of cash acquired
12,260

 

Net cash provided by investing activities
11,802

 
3,915

Cash flows from financing activities:
 
 
 
Tax payments from shares withheld upon vesting of restricted stock
(271
)
 
(232
)
Proceeds from notes payable
9,733

 

Repayments of notes payable
(8,437
)
 

Other financing activities
450

 

Net cash provided by (used in) financing activities
1,475

 
(232
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(207
)
 
331

Net increase (decrease) in cash, cash equivalents and restricted cash
3,751

 
(1,411
)
Cash, cash equivalents and restricted cash, beginning of period
37,191

 
53,596

Cash, cash equivalents, and restricted cash end of period
$
40,942

 
$
52,185

See accompanying notes to unaudited condensed consolidated financial statements.

6



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
(Deficit)
 
Total
Shareholders’
Equity
 
Non-controlling Interests
 
Total Equity
Shares
 
Amount
 
 
 
 
 
 
 
 
Balances, January 1, 2018
 
37,341

 
$
37

 
$
638,727

 
$
(59,547
)
 
$
(500,044
)
 
$
79,173

 
$

 
$
79,173

Cumulative effect of revenue recognition accounting change
 


 


 


 


 
1,024

 
1,024

 

 
1,024

Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock
 
223

 

 
(232
)
 

 

 
(232
)
 

 
(232
)
Stock-based compensation
 

 

 
1,157

 

 

 
1,157

 

 
1,157

Investments unrealized gains (losses), net of tax effects of $0
 

 

 

 
1

 

 
1

 

 
1

Foreign currency translation adjustments
 

 

 

 
396

 

 
396

 

 
396

Net income (loss)
 

 

 

 

 
(5,178
)
 
(5,178
)
 

 
(5,178
)
Balances, March 31, 2018
 
37,564

 
$
37

 
$
639,652

 
$
(59,150
)
 
$
(504,197
)
 
$
76,342

 
$

 
$
76,342

 
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
(Deficit)
 
Total
Shareholders’
Equity
 
Non-controlling Interests
 
Total Equity
Shares
 
Amount
 
 
 
 
 
 
 
 
Balances, January 1, 2019
 
37,728

 
$
37

 
$
641,930

 
$
(61,118
)
 
$
(524,009
)
 
$
56,840

 
$

 
$
56,840

Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock
 
190

 

 
(271
)
 

 

 
(271
)
 

 
(271
)
Napster acquisition
 

 

 
(1,346
)
 

 

 
(1,346
)
 
570

 
(776
)
Stock-based compensation
 

 

 
1,384

 

 

 
1,384

 

 
1,384

Foreign currency translation adjustments
 

 

 

 
(87
)
 

 
(87
)
 

 
(87
)
Net income (loss)
 

 

 

 

 
1,533

 
1,533

 
(319
)
 
1,214

Other equity transactions
 

 

 
362

 

 

 
362

 
88

 
450

Balances, March 31, 2019
 
37,918

 
$
37

 
$
642,059

 
$
(61,205
)
 
$
(522,476
)
 
$
58,415

 
$
339

 
$
58,754


See accompanying notes to unaudited condensed consolidated financial statements.


7




REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters Ended March 31, 2019 and 2018
Note 1
Description of Business and Summary of Significant Accounting Policies
Description of Business. RealNetworks, Inc. and subsidiaries is a leading global provider of network-delivered digital media applications and services that make it easy to manage, play, and share digital media. The Company also develops and markets software products and services that enable the creation, distribution, and consumption of digital media, including audio and video. Our recently acquired Napster music business offers a comprehensive set of digital music products and services designed to provide consumers with broad access to digital music. For more information on Napster, see Note 5 Acquisitions.
Inherent in our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services, and the ability to generate related revenue and cash flow.
In this Quarterly Report on Form 10-Q (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”.
Basis of Presentation. The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries in which it has a more than 50% voting interest. Noncontrolling interests primarily represent third-party ownership in the equity of Napster and are reflected separately in the Company’s financial statements. Intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter ended March 31, 2019 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2019. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2018 (the 10-K).
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Note 2
Recent Accounting Pronouncements
Recently adopted accounting pronouncements
In February 2016, the Financial Accounting Standards Board (FASB) issued new guidance related to the accounting for leases. A major change in the new guidance is that lessees are now required to present right-of-use assets and lease liabilities on the balance sheet. Enhanced disclosures are also required to give financial statement users the ability to assess the amount, timing and uncertainty of cash flows arising from leases. We adopted the new guidance effective January 1, 2019 and elected to apply the new guidance at the beginning of the year of adoption, rather than applying the new guidance retrospectively to each prior reporting period presented. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward historical lease classification. We have finalized our assessment of the impacts resulting from the new standard, including the impact on our internal controls. As a result of our evaluation, we have modified certain accounting policies and practices and existing controls. Adoption of the standard resulted in the recognition of $12.5 million of operating lease assets and $14.6 million of current and long-term operating lease liabilities as of January 1, 2019. The difference between the operating lease assets and lease liabilities recorded upon adoption relates to previously accrued deferred rent and lease exit and related charges included on our balance sheet as of December 31, 2018. Lease exit and related charges previously recorded pertain to the reduction in use of RealNetworks' office space and included estimates of sublease income expected to be received. The new guidance did not materially impact our consolidated statement of operations in the quarter of adoption and did not cause revision to previously recorded estimates for lease exit charges. See Note 14 Leases for additional information about the new accounting standard.

8



In June 2018, the FASB issued new guidance related to the measurement and classification for share-based awards to non-employees. The new guidance essentially aligns the measurement and classification for these awards with that for share-based awards to employees. We adopted the new guidance effective January 1, 2019, with no material impact on our consolidated financial statements and related disclosures.
Recently issued accounting pronouncements not yet adopted
In January 2017, the FASB issued new guidance simplifying the test for goodwill impairment. The new guidance eliminates Step 2 from the goodwill impairment test, instead requiring an entity to recognize a goodwill impairment charge for the amount by which the reporting unit's carrying amount exceeds the reporting unit's fair value. This guidance is effective for interim and annual goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. We are evaluating the impact of this guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
Note 3
Revenue Recognition
On January 1, 2018, we adopted the new revenue recognition standard by applying the modified retrospective approach to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue recognition standard.
We recorded a net decrease to opening retained deficit of $1.0 million as of January 1, 2018 due to the cumulative impact of adopting the new revenue recognition standard. This impact primarily related to licensing of our RealPlayer product and full recognition of non-recurring engineering fees, which were previously deferred and amortized over the life of the contract.
We generate all of our revenue through contracts with customers. Revenue is either recognized over time as the service is provided, or at a point in time when the product is transferred to the customer, depending on the contract type. Our performance obligations typically have an original duration of one year or less.
Napster revenue arrangements include subscription services to the Napster music streaming service sold either directly to end users (direct to consumer) or through partners (business to business), who are generally telecommunications companies, that bundle the subscription with their own services or collect payment for the stand-alone subscriptions from their end customers. Napster also sells subscriptions to third parties to provide access to the Napster platform that is typically embedded in the third party's branded or co-branded service. Such subscriptions are included in the business to business sales channel.
For services sold through third parties to end customers, we evaluate the presentation of revenue on a gross or net basis based on whether we control the service provided to the end-user and are the principal (i.e. “gross”), or we arrange for other parties to provide the service to the end-user and are an agent (i.e. “net”). In our Napster business to business revenue stream, we generally operate as a principal in arrangements with end customers as we maintain control over the service prior to being transferred to the end customer.
Certain business to business customer arrangements include variable consideration based on usage. We estimate variable consideration as part of the total transaction price that is allocated to performance obligations, or distinct service periods within a performance obligation, on a relative standalone selling price basis.
Revenues related to Napster subscription services are recognized ratably over the contract period, typically 30 days. Direct to consumer subscriptions are paid in advance, typically on a monthly basis. Subscription services offered to businesses are invoiced on a monthly basis and the timing of payment generally does not vary significantly from the timing of invoice.

9



Disaggregation of Revenue
The following table presents our disaggregated revenue by source and segment (in thousands):
 
 
Quarter Ended March 31, 2019
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Business Line
 
 
 
 
 
 
 
 
Software License
 
$
735

 
$
599

 
$

 
$

Subscription Services
 
1,088

 
6,340

 
2,985

 
24,337

Product Sales
 
219

 

 
1,988

 

Advertising and Other
 
444

 

 
737

 

Total
 
$
2,486

 
$
6,939

 
$
5,710

 
$
24,337

 
 
 
 
 
 
 
 
 
 
 
Quarter Ended March 31, 2018
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Business Line
 
 
 
 
 
 
 
 
Software License
 
$
3,337

 
$
1,335

 
$

 
$

Subscription Services
 
1,285

 
7,369

 
2,693

 

Product Sales
 
340

 

 
2,402

 

Advertising and Other
 
521

 

 
368

 

Total
 
$
5,483

 
$
8,704

 
$
5,463

 
$

 
 
 
 
 
 
 
 
 
The following table presents our disaggregated revenue by sales channel (in thousands):
 
 
Quarter Ended March 31, 2019
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Sales Channel
 
 
 
 
 
 
 
 
Business to Business
 
$
1,178

 
$
6,817

 
$
1,036

 
$
12,095

Direct to Consumer
 
1,308

 
122

 
4,674

 
12,242

Total
 
$
2,486

 
$
6,939

 
$
5,710

 
$
24,337

 
 
 
 
 
 
 
 
 
 
 
Quarter Ended March 31, 2018
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Sales Channel
 
 
 
 
 
 
 
 
Business to Business
 
$
3,858

 
$
8,530

 
$
751

 
$

Direct to Consumer
 
1,625

 
174

 
4,712

 

Total
 
$
5,483

 
$
8,704

 
$
5,463

 
$

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 March 31, 2019 and December 31, 2018, our balance of long-term accounts receivable was insignificant and $0.7 million, respectively, and is included in other long-term assets on our condensed consolidated balance sheets. The decrease in this balance from December 31, 2018 to March 31, 2019 is primarily due to the timing of expected cash receipts. During the quarter ended March 31, 2019, we recorded no impairments to our contract assets.
We record deferred revenue when cash payments are received or due in advance of our completion of the underlying performance obligation. As of March 31, 2019, we had a deferred revenue balance of $6.3 million, an increase of $3.9 million from December 31, 2018, primarily due to deferred revenue associated with Napster.

10



Practical Expedients
For those contracts for which we recognize revenue at the amount to which we have the right to invoice for service performed, we do not disclose the value of any unsatisfied performance obligations. We also do not disclose the remaining unsatisfied performance obligations which have an original duration of one year or less. Additionally, we immediately expense sales commissions when incurred as the amortization period would have been less than one year. These costs are recorded within sales and marketing expense.
Note 4
Stock-Based Compensation
Total stock-based compensation expense recognized in our unaudited condensed consolidated statements of operations and comprehensive income (loss) includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
 
Quarter Ended
March 31,
 
2019
 
2018
Total stock-based compensation expense
$
1,384

 
$
1,157

The fair value of RealNetworks options granted determined using the Black-Scholes model used the following weighted-average assumptions:
 
Quarter Ended
March 31,
 
2019
 
2018
Expected dividend yield
0
%
 
0
%
Risk-free interest rate
2.51
%
 
2.48
%
Expected life (years)
3.8

 
4.1

Volatility
41
%
 
35
%
The total stock-based compensation amounts for 2019 and 2018 disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). Included in the expense for the three months ended March 31, 2019 and 2018 was stock compensation expense recorded in the first quarter of 2019 and 2018 related to our 2018 and 2017 incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2019 and 2018, respectively.
As of March 31, 2019, $3.2 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 3.1 years.
Note 5
Acquisitions
Napster
On January 18, 2019, RealNetworks acquired an additional 42% interest in Rhapsody International, Inc. (doing business as Napster) bringing our aggregate ownership to 84% of Napster's outstanding equity, thus giving RealNetworks a majority voting interest. Napster's music streaming service provides users with broad access to digital music, offering on-demand streaming and conditional downloads through unlimited access to a catalog of millions of music tracks. Napster offers music services worldwide and generates revenue primarily through subscriptions to its music services either directly to consumers or through distribution partners.
Initially formed in 2007 and branded then as Rhapsody, Napster began as a joint venture between RealNetworks and MTV Networks, a division of Viacom International, Inc. Prior to the acquisition of the additional 42% interest in Napster, we accounted for our investment using the equity method of accounting.
Following the January 2019 acquisition, RealNetworks has the right to nominate directors constituting a majority of the Napster board of directors, however, Napster will continue to operate as an independent business with its own board of directors, strategy and leadership team. We are consolidating Napster's financial results into our financial statements for fiscal periods following the closing of the acquisition. For our first fiscal quarter of 2019, Napster is reported as a new segment in RealNetworks' consolidated financial statements.

11



We have preliminarily recorded 100% of the estimated fair value of the assets acquired and liabilities assumed as of January 18, 2019 based on the results of an independent valuation. The 16% of Napster that we do not own is accounted for as a noncontrolling interest in our consolidated financial statements, and as part of this consolidation, the carrying value of our previous 42% equity method investment has been remeasured to fair value. The remeasurement to fair value of the historical 42% ownership interest resulted in the recognition of a $2.7 million gain in the quarter ended March 31, 2019, which is a component of the overall gain recognized as a part of this transaction. Our consolidated balance sheet reflects Napster's working capital deficit, which results in a consolidated working capital deficit. RealNetworks does not have any contractual or implied obligation to provide funding or other financial support to Napster, or to guarantee or provide other such support related to Napster's third party borrowing or Napster's other obligations, except as discussed in Note 15 Commitments and Contingencies.
The terms of the transaction included initial cash consideration of $1.0 million and additional contingent consideration. Initial cash consideration of $0.2 million was paid at closing and the remainder of the initial cash consideration is included in accrued royalties, fulfillment and other current liabilities and will be paid when due with existing cash balances. With regards to contingent consideration, over the five years following the acquisition, RealNetworks will pay the lesser of the following:
(a) an additional $14.0 million to seller, or
(b) if RealNetworks sells the interest to a third party for less than $15.0 million, the actual amount received by RealNetworks, minus the $1.0 million initial payment.
In the event that RealNetworks sells such equity interest for consideration in excess of $15.0 million, RealNetworks will pay seller additional consideration, dependent on the sale price, which shall in no event exceed an additional $25.0 million. In order for seller to receive the full $40.0 million, the proceeds from the sale of Napster received by RealNetworks for the 42% equity interest acquired would have to exceed $60.0 million. These contingent consideration amounts were part of the total consideration at estimated fair value, as described in more detail below.

12



The following table summarizes the preliminary allocation of the total consideration to the estimated fair values of the assets acquired and liabilities assumed as of January 18, 2019 (in thousands):
Consideration, at estimated fair value:
 
 
Cash
 
$
1,000

Contingent consideration
 
11,600

RealNetworks' preexisting 42% equity interest in Napster
 
2,700

Effective settlement of Napster debt and warrants, held by RealNetworks
 
6,408

Total consideration
 
$
21,708

 
 
 
 
 
 
Assets acquired and liabilities assumed, at estimated fair value:
 
 
Cash and cash equivalents
 
$
10,138

Accounts receivable
 
20,838

Prepaid expenses and other current assets
 
12,879

Restricted cash
 
2,322

Equipment, software and leasehold improvements
 
474

Operating lease assets
 
2,314

Other long-term assets
 
77

Deferred tax assets, net
 
5,942

Intangible assets
 
23,700

Goodwill
 
48,474

  Total assets acquired
 
127,158

 
 
 
Accounts payable
 
937

Accrued royalties and fulfillment
 
71,980

Accrued and other current liabilities
 
7,475

Deferred revenue, current portion
 
3,600

Notes payable
 
12,115

Deferred tax liabilities, net
 
6,061

Long-term lease liabilities
 
1,197

Other long-term liabilities
 
1,515

   Total liabilities assumed
 
104,880

       Total net assets acquired
 
22,278

Noncontrolling interests
 
570

       Net assets acquired
 
$
21,708

Under the acquisition method of accounting, the purchase price is allocated to the assets acquired and the liabilities assumed based on their estimated fair values. Due to the complexity and limited time since closing the transaction, the purchase price allocation is subject to change, which may result from additional information becoming available and additional analyses being performed on these acquired assets and assumed liabilities. Such changes could impact estimated fair values of intangible assets, accrued royalties and fulfillment, deferred revenue, and assets and liabilities assumed, as well as the contingent consideration, noncontrolling interests, and gain recognized from consolidation. Purchase price allocation adjustments may be recorded during the measurement period (a period not to exceed 12 months from the acquisition date). The final purchase price allocation could result in material differences, which could have a material impact on our financial statements.

13



Acquired intangible assets have a total weighted average useful life of approximately 8 years, are being amortized using the straight line method, and are comprised of the following (in thousands):
Intangible category
 
Estimated fair value
 
Method used to calculate fair value
 
Estimated remaining useful life
Trade name and trademarks
 
$
6,800

 
Relief-from-royalty
 
15 years
Developed technology
 
5,900

 
Excess earnings
 
4 years
Customer relationships
 
5,900

 
Cost-to-replace
 
3 years
Partner relationships
 
5,100

 
Distributor method
 
8 years
Total
 
$
23,700

 
 
 
 
The estimated fair value amounts for each of these intangibles were determined using a fair value measurement categorized within Level 3 of the fair value hierarchy.
The fair value of the trade name and trademarks intangible asset was estimated using the income approach, utilizing the relief from royalty method, which values the assets by estimating the savings achieved by ownership of trade name and trademarks when compared with the cost of licensing them from an independent owner.
The fair value of developed technology was estimated using the income approach, utilizing the excess earnings method. Under this method, cash flows attributable to the asset are estimated by deducting economic costs, including operating expenses and contributory asset charges, from revenue expected to be generated by the asset.
The fair value of customer relationships was estimated using a cost-to-replace approach, whereby the number of subscribers and the cost to acquire subscribers are key estimates utilized in the valuation.
The fair value of partner relationships was estimated using the income approach, which uses market-based distributor data to value underlying distributor relationships. Revenue, earnings, and cash flow estimates associated with these underlying distributor relationships are key estimates in determining the fair value of the partner relationships intangibles.
The fair value of deferred revenue was estimated using the income approach, utilizing a cost to fulfill analysis by estimating the direct and indirect costs related to supporting remaining obligations plus an assumed operating margin.
The fair value of our preexisting 42% equity method investment has been remeasured to an estimated fair value of $2.7 million, which resulted in a pretax gain of $2.7 million, as our existing carrying value was zero. This gain, as well as the settlement of preexisting relationships and other purchase accounting adjustments discussed below, comprise the total gain of $12.3 million recognized in Other income (expenses) in the Consolidated statement of operations for the quarter ended March 31, 2019.
The fair value of our preexisting equity method investment was calculated using an average of the income and market approach to arrive at estimated total enterprise value. The income approach fair value measurement was based on significant inputs that are not observable in the market and thus represents a fair value measurement categorized within Level 3 of the fair value hierarchy. Key assumptions used in estimating future cash flows included projected revenue growth and operating expenses, as well as the selection of an appropriate discount rate. Estimates of revenue growth and operating expenses were based on internal projections and considered the historical performance of Napster's business. The discount rate applied was based on Napster's weighted-average cost of capital and included a small-company risk premium. The market approach fair value measurement was based on a market comparable methodology. We used a group of comparable companies and selected an appropriate EBITDA and revenue multiple to apply to Napster's trailing twelve months and projected 2019, 2020 and 2021 EBITDA (weighted 90%) and revenues (weighted 10%). Assumptions in both the income and market approaches are significant to the overall valuation of Napster and changes to these assumptions could materially impact the preliminary fair values of assets acquired and liabilities assumed, noncontrolling interests, total consideration, and gain on consolidation.
The fair value of the contingent consideration was estimated using multiple scenarios for each tranche of contingent consideration and then probability weighting each scenario and discounting them to estimated fair value of $11.6 million. This fair value calculation is directly impacted by the estimated total enterprise value described above. After the completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, the contingent consideration will be adjusted quarterly to fair value through earnings. Of the total amount of $11.6 million, we have accrued $2.6 million and $9.0 million in Accrued royalties, fulfillment and other current liabilities, and Other long-term liabilities, respectively.
The effective settlement of Napster's debt and warrants totaling $6.4 million represents the estimated fair value of debt and warrants held between RealNetworks and Napster as of the acquisition date. The estimated fair value is derived from the estimated total enterprise value described above. The resulting net gain of $5.5 million is included in Other income (expenses) in the Consolidated statement of operations.

14



As discussed in Note 15 Commitments and Contingencies, the preexisting $2.8 million guarantee related to Napster's outstanding indebtedness on their revolving credit facility was eliminated upon the consolidation of Napster. This resulted in RealNetworks recording a gain of $2.8 million, which is included in Other income (expenses) in the Consolidated statement of operations.
Prior to our acquisition of Napster, we accounted for our investment under the equity method of accounting and recorded Napster 's foreign currency translation adjustments in our equity. As part of the acquisition method of accounting, we released these amounts and recorded a gain of $1.3 million, which is included in Other income (expenses) in the Consolidated statement of operations.
We recorded the fair value of noncontrolling interests, estimated at $0.6 million, using the estimated total enterprise value described above.
We also recorded goodwill of $48.5 million, representing the intangible assets that do not qualify for separate recognition for accounting purposes, including the expected growth in Napster's business to business model and the assembled workforce. The goodwill is reported in our Napster segment and is not deductible for income tax purposes. As discussed above, during the measurement period, purchase price allocation adjustments or changes in assumptions used in determining the total estimated enterprise value of Napster could materially impact goodwill recognized. Moreover, future performance of the Napster business will factor into our goodwill impairment analysis.
We began consolidating Napster's results of operations and cash flows into our consolidated financial statements after January 18, 2019. For the quarter ended March 31, 2019, Napster's revenue and net loss including noncontrolling interests in our consolidated statements of operations was $24.3 million and $1.8 million, respectively.
The following table provides the supplemental pro forma revenue and net results of the combined entity had the acquisition date of Napster been the first day of our first quarter of 2018 rather than during our first quarter of 2019 (in thousands):
 
Quarter Ended - Pro Forma (Unaudited)
March 31,
 
2019
 
2018
Net revenue
$
45,838

 
$
59,849

Net income (loss) attributable to RealNetworks (1)
(9,517
)
 
6,989

(1)The pro forma net earnings attributable to RealNetworks for the quarter ended March 31, 2018 include the acquisition-related gain of $12.3 million and $0.8 million of transaction costs.
The amounts in the supplemental pro forma earnings for the periods presented above fully eliminate intercompany transactions and conform Napster's accounting policies to RealNetworks'. These pro forma results also reflect amortization of acquisition-related intangibles and fair value adjustments to deferred revenue.
The unaudited pro forma amounts are based upon the historical financial statements of RealNetworks and Napster and were prepared using the acquisition method of accounting and are not necessarily indicative of results for any current or future period. The purchase price allocation is preliminary and is subject to change prior to finalization. The final purchase price allocation could result in material differences, which could have a material impact on the accompanying pro forma amounts.
For the quarter ended March 31, 2019, we incurred approximately $0.8 million in acquisition-related costs, including regulatory, legal, and other advisory fees, which we have recorded within general and administrative expenses.
Games
As described in more detail in our 2018 10-K, in order to acquire a full workforce, we purchased 100% of the shares of a small, privately-held Netherlands-based game development studio for net cash consideration of $4.2 million in April 2018.

15



Note 6
Fair Value Measurements
Items Measured at Fair Value on a Recurring Basis
The following tables present information about our financial assets that have been measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018, and indicates the fair value hierarchy of the valuation inputs utilized to determine fair value (in thousands):
 
Fair Value Measurements as of
 
Amortized Cost as of
 
March 31, 2019
 
March 31, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
29,530

 
$

 
$

 
$
29,530

 
$
29,530

Money market funds
7,367

 

 

 
7,367

 
7,367

Total cash and cash equivalents
36,897

 

 

 
36,897

 
36,897

Restricted cash equivalents
1,921

 
2,124

 

 
4,045

 
4,045

Total assets
$
38,818

 
$
2,124

 
$

 
$
40,942

 
$
40,942

Liabilities:
 
 
 
 
 
 
 
 
 
Accrued royalties, fulfillment and other current liabilities
 
 
 
 
 
 
 
 
 
Napster acquisition contingent consideration
$

 
$

 
$
2,586

 
$
2,586

 
N/A

Other long-term liabilities
 
 
 
 
 
 
 
 
 
Napster acquisition contingent consideration

 

 
9,014

 
9,014

 
N/A

Total liabilities
$

 
$

 
$
11,600

 
$
11,600

 
N/A

 
Fair Value Measurements as of
 
Amortized Cost as of
 
December 31, 2018
 
December 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
22,853

 
$

 
$

 
$
22,853

 
$
22,853

Money market funds
12,708

 

 

 
12,708

 
12,708

Total cash and cash equivalents
35,561

 

 

 
35,561

 
35,561

Short-term investments:
 
 
 
 
 
 
 
 
 
Corporate notes and bonds

 
24

 

 
24

 
24

Total short-term investments

 
24

 

 
24

 
24

Restricted cash equivalents

 
1,630

 

 
1,630

 
1,630

Warrants issued by Napster (included in Other assets)

 

 
865

 
865

 

Total assets
$
35,561

 
$
1,654

 
$
865

 
$
38,080

 
$
37,215

Restricted cash equivalents as of March 31, 2019 and December 31, 2018 relate to cash pledged as collateral against letters of credit in connection with lease agreements and to a financial covenant in Napster's Amended Revolver Loan and Security Agreement (Revolver LSA). At March 31, 2019, $1.9 million of restricted cash equivalents related to the Revolver LSA covenant that requires Napster to maintain a cash balance at the bank of not less than $1.5 million at all times and 5% of all amounts outstanding under Napster's Non-Recourse Purchase of Eligible Receivables Agreement. See Note 10 Notes Payable - Napster for additional details.
Accrued royalties, fulfillment and other current liabilities and Other long-term liabilities as of March 31, 2019 include the preliminary estimated fair value of the contingent consideration for the Napster acquisition, which was determined using a fair value measurement categorized within Level 3 of the fair value hierarchy. As discussed in Note 5 Acquisitions, after completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, this liability will be adjusted quarterly to fair value through earnings.
Realized gains or losses on sales of short-term investment securities for the quarters ended March 31, 2019 and 2018 were not significant. Gross unrealized gains and losses on short-term investment securities as of March 31, 2019 and December 31, 2018 were also not significant.

16



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 three months ended March 31, 2019 and 2018, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
Note 7
Other Intangible Assets
Other intangible assets (in thousands):
 
 
 
March 31, 2019
 
December 31, 2018
 
 
 
Gross
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
 
$
41,507

 
$
31,117

 
$
10,390

 
$
30,993

 
$
30,993

 
$

 
Developed technology
 
30,164

 
24,571

 
5,593

 
24,446

 
24,446

 

 
Patents, trademarks and tradenames
 
10,506

 
3,801

 
6,705

 
3,765

 
3,765

 

 
Service contracts
 
5,474

 
5,470

 
4

 
5,538

 
5,512

 
26

 
Total
 
$
87,651

 
$
64,959

 
$
22,692

 
$
64,742

 
$
64,716

 
$
26

Amortization expense related to other intangible assets during the quarters ended March 31, 2019, and March 31, 2018, was $1.0 million and $0.1 million, respectively.
Estimated future amortization of other intangible assets (in thousands):
 
 
Future Amortization
2019 (Excluding the three months ended March 31, 2019)
 
$
3,392

2020
 
4,518

2021
 
4,518

2022
 
2,634

2023
 
1,138

Thereafter
 
6,492

 
 
$
22,692

See Note 5 Acquisitions for details on our acquisitions. No impairments of other intangible assets were recognized in either of the three months ended March 31, 2019 or 2018.

17



Note 8
Goodwill
The following table presents changes in goodwill (in thousands):
Balance, December 31, 2018
$
16,955

Increases due to current year acquisitions
48,474

Effects of foreign currency translation
(61
)
Balance, March 31, 2019
$
65,368

See Note 5 Acquisitions for details on our acquisitions and the impact to goodwill.
The following table presents goodwill by segments (in thousands):
 
March 31,
2019
Consumer Media
$
580

Mobile Services
2,059

Games
14,255

Napster
48,474

Total goodwill
$
65,368

No impairment of goodwill was recognized in either of the three months ended March 31, 2019 or in 2018.

18



Note 9
Accrued royalties, fulfillment and other current liabilities
Accrued royalties, fulfillment and other current liabilities (in thousands):
 
March 31, 2019
 
December 31, 2018
Royalties and other fulfillment costs
$
75,731

 
$
1,989

Employee compensation, commissions and benefits
6,242

 
4,444

Sales, VAT and other taxes payable
3,706

 
785

Operating Lease Liabilities - Current

4,890

 

Other
7,321

 
4,094

Total accrued royalties, fulfillment and other current liabilities
$
97,890

 
$
11,312

Included in royalties and other fulfillment costs are Napster's accrued music royalties totaling $73.7 million. Napster’s agreements and arrangements with rights holders for the content used in its business are complex and the determination of royalty accruals involves significant judgments, assumptions, and estimates of the amounts to be paid.
The variables involved in determining royalty accruals include unmatched royalty accruals, revenue to be recognized, the type of content used and the country it is used in, outstanding royalty audits, and identification of appropriate license holders, among other variables. In addition, some rights holders have allowed the use of their content while negotiations of the terms and conditions are ongoing. In certain jurisdictions, rights holders have several years to claim royalties for musical composition.
While Napster bases its estimates on historical experience and on various assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates in the event of modified assumptions or conditions.
Related to Napster's accrued music royalties are amounts that are advanced to certain music publishers for royalty amounts that have been agreed as being owed, but for which the underlying rights holder have not yet been specifically matched. These prepaid royalty amounts totaling $12.8 million at March 31, 2019 are included in Prepaid expenses and other current assets on the unaudited condensed consolidated balance sheets. When these amounts are ultimately matched and invoiced to Napster, the prepaid royalty amount and the related accrued royalty liability are offset on the unaudited condensed consolidated balance sheets.
Note 10
Notes Payable - Napster
In 2015, Napster entered into a Loan and Security Agreement (Revolver LSA) with a bank. The Revolver LSA was amended and restated in 2017 and, in January 2019, Napster entered into the second amendment to the amended Revolver LSA. The available borrowing on the Revolver LSA is based upon Napster's accounts receivable and direct to consumer subscription deposits. The amended Revolver LSA has a maximum available balance of $7 million. The maturity date is no later than April 30, 2019 with earlier maturity possible based on conditions set forth in the Revolver LSA. The interest rate is 0.75% above the Prime Rate (defined as the greater of 4.25% or the Prime Rate published in the Wall Street Journal). Interest is due monthly. At March 31, 2019, Napster had $4.9 million borrowings outstanding with an interest rate of 6.25%. Subsequent to quarter end, the Revolver LSA matured and the loan balance was paid in full on April 30, 2019.
In 2017, Napster entered into a Non-Recourse Purchase of Eligible Receivables Agreement (NRP Agreement) with an international bank (Purchaser) in which Napster will sell and assign on a continuing basis its eligible receivables to the Purchaser in return for 90% of the receivables upfront, up to a maximum amount of $15.0 million in advances. The interest rate is 2.25% above the 1-month-EURIBOR with a minimum 0.0% rate applying to the 1-month-EURIBOR rate. At March 31, 2019, Napster had $8.4 million borrowings outstanding with an interest rate of 2.25%.
The Revolver LSA required Napster to maintain a balance of unrestricted cash at the bank of not less than $1.5 million plus 5% of the total amount outstanding under the NRP Agreement. At March 31, 2019, Napster had $1.9 million of restricted cash equivalents related to the Revolver LSA covenant. As the loan was paid off on April 30, 2019, this amount is no longer restricted.

19



Note 11
Restructuring Charges
Restructuring and other charges in 2019 and 2018 consist of costs associated with the ongoing reorganization of our business operations and 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 three months ended March 31, 2019
$
167

Costs incurred and charged to expense for the three months ended March 31, 2018
$
501

Changes to the accrued restructuring liability (which is included in Accrued royalties, fulfillment and other current liabilities) for 2019 (in thousands) are as follows:
 
Employee Separation Costs
Accrued liability at December 31, 2018
$
755

Costs incurred and charged to expense for the three months ended March 31, 2019
167

Cash payments
(590
)
Accrued liability at March 31, 2019
$
332

Note 12
Income Taxes
As of March 31, 2019, RealNetworks has $4.5 million in uncertain tax positions. The increase in uncertain tax position at March 31, 2019 is related to $4.1 million of unrecognized tax positions recorded through purchase accounting on January 18, 2019 as a result of the acquisition of Napster. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We file numerous consolidated and separate income tax returns in the U.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
Note 13
Income (Loss) Per Share
Basic net income (loss) per share (EPS) is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common and dilutive potential common shares outstanding during the period. Basic and diluted EPS (in thousands, except per share amounts):
 
Quarter Ended
March 31,
 
2019
 
2018
Net income (loss) attributable to RealNetworks
$
1,533

 
$
(5,178
)
Weighted average common shares outstanding used to compute basic EPS
37,820

 
37,449

Dilutive effect of stock based awards
92

 

Weighted average common shares outstanding used to compute diluted EPS
37,912

 
37,449

 
 
 
 
Basic EPS attributable to RealNetworks
$
0.04

 
$
(0.14
)
Diluted EPS attributable to RealNetworks
$
0.04

 
$
(0.14
)
During the quarters ended March 31, 2019 and 2018, 6.8 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.

20



Note 14
Leases
We have commitments for future payments related to office facilities leases. We determine if an arrangement is a lease at inception. Operating leases are included in Operating lease assets, Other current liabilities, and Long-term lease liabilities on our consolidated balance sheets. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
Operating lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. Operating lease assets also exclude lease incentives and initial direct costs incurred. Some of our leases include options to extend or terminate the lease. Our leases generally include one or more options to renew; however, the exercise of lease renewal options is at our sole discretion. For nearly all of our operating leases, upon adoption of the new guidance, we have not assumed any options to extend will be exercised as part of our calculation of the lease liability. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
We have operating leases for office space and data centers with remaining lease terms of 1 year to 6 years.
Details related to our operating lease assets and operating lease liabilities (in thousands, except lease term and discount rate):
 
 
Quarter Ended
March 31,
 
 
2019
Operating lease expense
 
$
1,340

Variable lease expense
 
153

Sublease income
 
(475
)
Net lease expense
 
$
1,018

 
 
 
Operating cash outflows for lease liabilities
 
$
1,461

 
 
 
Weighted-average remaining lease term
 
4 Years

Weighted-average discount rate
 
5.11
%
Future minimum lease payments as of March 31, 2019 were as follows (in thousands):
 
 
Operating
Leases
2019 (Excluding the three months ended March 31, 2019)
 
$
3,919

2020
 
4,445

2021
 
3,065

2022
 
2,430

2023
 
2,348

Thereafter
 
1,634

Total minimum payments(a)
 
17,841

Less: Imputed interest
 
2,022

Present value of total minimum payments(b)
 
$
15,819

(a)Total minimum payments exclude executory costs, inclusive of insurance, maintenance, and taxes, of $7.4 million; minimum payments also have not been reduced by sublease rentals of $6.7 million due in the future under noncancelable subleases.
(b)$10.9 million is included in Long-term lease liabilities and $4.9 million is included in Accrued royalties, fulfillment, and other current liabilities on the condensed consolidated balance sheets.
As of December 31, 2018, future minimum lease payments were $15.9 million in the aggregate, which consisted of the following: $3.7 million in 2019; $3.0 million in 2020; $2.7 million in 2021; $2.4 million in 2022; $2.3 million in 2023; and $1.6 million thereafter.

21



Note 15
Commitments and Contingencies
We have been in the past and could become in the future subject to legal proceedings, governmental investigations, and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks, and other intellectual property rights. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.  
In 2017, we entered into an arrangement whereby we may be required to guarantee up to $2.8 million of Napster's outstanding indebtedness on their revolving credit facility. At that time and as a result of the guaranty, RealNetworks recognized previously suspended Napster losses up to the full $2.8 million guaranty in our consolidated statement of operations and as a Commitment to Napster in our consolidated balance sheets. Given the controlling interest RealNetworks acquired in Napster in the first quarter of 2019, we have eliminated the previously recorded guaranty from RealNetworks' balance sheet in consolidation. As of the date of this filing, RealNetworks has not been required to pay any portion of this commitment, and, as discussed in Note 10 Notes Payable - Napster, Napster fully repaid this loan balance on April 30, 2019, thus releasing RealNetworks' previously made guaranty.    
In March 2016, Napster was notified of a putative consumer class action lawsuit relating to an alleged failure to pay so-called “mechanical royalties” on behalf of the plaintiffs and “other similarly-situated holders of mechanical rights in copyrighted musical works.” On April 7, 2017, the plaintiffs and Napster agreed to settlement terms during a mediation session. The long form Settlement Agreement was executed effective on January 16, 2019. The damages payable under the Settlement Agreement will be calculated on a claims made basis, subject to an overall maximum of $10.0 million. We have not recorded an accrual related to this settlement as of March 31, 2019 as the amount payable is not reasonably estimable. In May 2019, public notice was posted about the settlement informing purported class members that they can make claims or object to the settlement. The claims period ends on December 31, 2019, on which date (or shortly thereafter) Napster expects to know the total amount of damages payable in respect to validly made claims. Damages for valid claims are expected to be paid in the second quarter of 2020.
Note 16
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 the ordinary course of business, Napster enters into agreements with various content providers that guarantee a minimum amount of royalty payments in a given period. These minimum payments are generally based on targets and, based on our historical experience and expectations under relevant contracts, we anticipate that actual royalty accruals and payments will exceed minimum guarantees and, accordingly, we do not maintain accruals for these minimum guarantees.
In relation to certain patents and other technology assets we sold to Intel in the second quarter of 2012, we have specific obligations to indemnify Intel for breaches of the representations and warranties that we made and covenants that we agreed to in the asset purchase agreement for certain potential future intellectual property infringement claims brought by third parties against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.  

22



Note 17
Segment Information
We manage our business and report revenue and operating income (loss) in four segments: (1) Consumer Media, which includes licensing of our codec technology and our PC-based RealPlayer products, including RealPlayer Plus and related products; (2) Mobile Services, which includes our SaaS services and our integrated RealTimes® platform which is sold to mobile carriers; (3) Games, which includes all our games-related businesses, including sales of mobile games, games licenses, in-game virtual goods, subscription services, and advertising on games and social network sites; and (4) Napster, which includes our on-demand music streaming and music services.
RealNetworks allocates to its Consumer Media, Mobile Services and Games reportable segments certain corporate expenses which are directly attributable to supporting these businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting these businesses, are reported as corporate items. These corporate items also include restructuring charges and stock compensation charges. As stated in Note 5 Acquisitions, Napster is operating as an independent company and includes all their corporate expenses in their segment results, and RealNetworks does not allocate any expenses to the Napster segment.
RealNetworks reports four reportable segments based on factors such as how we manage our operations and how the Chief Operating Decision Maker (CODM) reviews results. The CODM reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.

23



Segment results for the quarters ended March 31, 2019 and 2018 (in thousands):
 Consumer Media
Quarter Ended
March 31,
 
2019
 
2018
Revenue
$
2,486

 
$
5,483

Cost of revenue
833

 
993

Gross profit
1,653

 
4,490

Operating expenses
3,119

 
3,918

Operating income (loss)
$
(1,466
)
 
$
572

Mobile Services
Quarter Ended
March 31,
 
2019
 
2018
Revenue
$
6,939

 
$
8,704

Cost of revenue
2,048

 
2,316

Gross profit
4,891

 
6,388

Operating expenses
7,561

 
7,366

Operating income (loss)
$
(2,670
)
 
$
(978
)
 Games
Quarter Ended
March 31,
 
2019
 
2018
Revenue
$
5,710

 
$
5,463

Cost of revenue
1,670

 
1,817

Gross profit
4,040

 
3,646

Operating expenses
5,037

 
4,917

Operating income (loss)
$
(997
)
 
$
(1,271
)
 Napster
Quarter Ended
March 31,
 
2019
 
2018
Revenue
$
24,337

 
$

Cost of revenue
20,396

 

Gross profit
3,941

 

Operating expenses
5,532

 

Operating income (loss)
$
(1,591
)
 
$

Corporate
Quarter Ended
March 31,
 
2019
 
2018
Cost of revenue
$
(77
)
 
$
10

Operating expenses
4,257

 
3,267

Operating income (loss)
$
(4,180
)
 
$
(3,277
)

24



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
March 31,
 
2019
 
2018
United States
$
18,970

 
$
11,434

Europe
15,384

 
3,025

Rest of the World
5,118

 
5,191

Total net revenue
$
39,472

 
$
19,650

Long-lived assets (consisting of of goodwill, equipment, software, leasehold improvements, operating lease assets, and other intangible assets) by geographic region (in thousands) are as follows:
 
March 31,
2019
 
December 31,
2018
United States
$
91,750

 
$
11,823

Europe
11,146

 
6,761

Rest of the World
2,170

 
1,151

Total long-lived assets
$
105,066

 
$
19,735

Note 18
Related Party Transactions
 As described in Note 5 Acquisitions, on January 18, 2019, RealNetworks acquired an additional 42% interest in Rhapsody International, Inc., (doing business as Napster), bringing our aggregate ownership interest to 84% of Napster's outstanding equity, thus giving RealNetworks a majority voting interest in Napster. Following this acquisition of a controlling interest, we consolidate Napster's financial results into our financial statements for fiscal periods beginning with our first quarter of 2019. Rhapsody America LLC was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International, Inc., to own and operate a business-to-consumer digital audio music service originally branded as Rhapsody. The service has been significantly expanded and was re-branded in 2016 as Napster.
Following certain restructuring transactions effective March 31, 2010, we began accounting for the investment using the equity method of accounting. As part of the 2010 restructuring transactions, RealNetworks contributed $18.0 million in cash, the Rhapsody brand and certain other assets, including content licenses, in exchange for shares of convertible preferred stock of Rhapsody, carrying a $10.0 million preference upon certain liquidation events. Although we now consolidate Napster for reporting purposes, our convertible preferred stock and the related rights remain contractually binding instruments between RealNetworks and Napster.
In December 2016, RealNetworks and the other then-owner of 42% of Napster each entered into an agreement to loan up to $5.0 million to Napster for general operating purposes, which loans were fully funded as of the end of January 2017 for an aggregate of $10 million. Included in RealNetworks' January 2019 acquisition of the additional 42% interest in Napster, RealNetworks assumed the seller's $5.0 million note, resulting in RealNetworks holding $10 million of notes receivable from Napster. The terms of the notes were modified subsequent to the original December 2016 execution, including a provision, effective July 2018, that requires repayment at the greater of (a) principal plus accrued interest at an annual rate of 15% or (b) a preference of three times the principal amount. These loans are subordinate to Napster's third party debt, as discussed in Note 10 Notes Payable - Napster.
In each of February 2015 and February 2017, Napster issued warrants to purchase shares of its common stock to each of RealNetworks and the other then-owner of 42% of Napster. The warrants have a 10-year contractual term and were issued as compensation for past services provided by these two significant stockholders of Napster. As part of RealNetworks' January 2019 acquisition of the additional 42% interest in Napster, RealNetworks assumed the warrants held by the seller.
Upon our acquisition of Napster, the notes and warrants were effectively settled and eliminated in our consolidated financial statements as they represented preexisting relationships between RealNetworks and Napster. However, the notes and warrants remain contractually binding instruments between RealNetworks and Napster.


25



Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about RealNetworks’ industry, products, management’s beliefs, and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:
the expected benefits and other consequences of our growth plans, strategic initiatives, and restructurings;
our expected introduction, and related monetization, of new and enhanced products, services and technologies across our businesses;
future revenues, operating expenses, income and other taxes, tax benefits, net income (loss) per diluted share available to common shareholders, acquisition costs and related amortization, and other measures of results of operations;
the effects of our past acquisitions, including our January 18, 2019 acquisition of a controlling interest in Napster, and expectations for future acquisitions and divestitures;
plans, strategies and expected opportunities for future growth, increased profitability and innovation;
the expected financial position, performance, growth and profitability of, and investment in, our businesses and the availability of funding or other resources;
the effects of legislation, regulations, administrative proceedings, court rulings, settlement negotiations and other factors that may impact our businesses;
the continuation and expected nature of certain customer relationships;
impacts of competition and certain customer relationships on the future financial performance and growth of our businesses;
our involvement in potential claims, legal proceedings and government investigations, and the potential outcomes and effects of such potential claims, legal proceedings and governmental investigations on our business, prospects, financial condition or results of operations;
the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations; and
the effect of economic and market conditions on our business, prospects, financial condition or results of operations.
These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in Item 1A of Part II “Risk Factors.” RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
Overview
RealNetworks creates innovative technology products and services that make it easy to connect with and enjoy digital media. We manage our business and report revenue and operating income (loss) in four segments: (1) Consumer Media, (2) Mobile Services, (3) Games, and (4) Napster. See Note 17 Segment Information, and Note 5 Acquisitions to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q for more information regarding our reportable segments and the first quarter of 2019 acquisition of Napster.
Within our Consumer Media segment, revenue is primarily derived from the software licensing of our video compression, or codec, technology, including our latest technology, RealMedia High Definition, or RMHD. We also generate revenue from the sale of our PC-based RealPlayer products, including RealPlayer Plus and related products. These products and services are delivered directly to consumers and through partners, such as OEMs and mobile device manufacturers.
Our Mobile Services business generates revenue primarily from the sale of subscription services, which includes our messaging platform services and ringback tones, as well as through software licenses for the integration of our RealTimes platform and certain system implementations. We generate a significant portion of our revenue from sales within our Mobile Services business to a few mobile carriers. The loss of these contracts, whether by termination or non-renewal or renegotiation of contract terms that are less favorable to us could result in the loss of future revenues and anticipated profits. Our Mobile Services segment also includes our facial recognition platform, SAFR (Secure, Accurate Facial Recognition), which detects and matches millions of faces by leveraging artificial intelligence-based machine learning.
Our Games business generates revenue primarily through the development, publishing, and distribution of casual games under the GameHouse and Zylom brands. Games are offered via mobile devices, digital downloads, and subscription play. In

26



addition to the sale of individual games and subscription offerings, we also derive revenue from player purchases of in-game virtual goods and from advertising on games sites and social network sites.
As described in Note 5 Acquisitions, RealNetworks acquired an additional 42% interest in Napster on January 18, 2019 resulting in our now having a majority voting interest, owning 84% of Napster's outstanding equity. We are now consolidating Napster's financial results into our financial statements for fiscal periods following the closing of the acquisition, and Napster is reported as a new segment in RealNetworks financial statements and related disclosures for the first quarter of 2019.
Our Napster segment provides music products and services that enable consumers to have access to digital music content from a variety of devices. The Napster unlimited subscription service offers unlimited access to a catalog of tens of millions of music tracks by way of on-demand streaming and conditional downloads. Napster currently offers music services worldwide and generates revenue primarily through subscriptions to its music services either directly to consumers or distribution partners. We generate a significant portion of our revenue from sales within our Napster business to a few partners. The loss of these contracts, whether by termination or non-renewal or renegotiation of contract terms that are less favorable to us could result in the loss of future revenues and anticipated profits.
RealNetworks allocates to its Consumer Media, Mobile Services, and Games reportable segments certain corporate expenses which are directly attributable to supporting these businesses, including but not limited to a portion of finance, IT, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting these businesses, are reported as corporate items. These corporate items also can include restructuring charges and stock compensation expense. As stated in Note 5 Acquisitions, Napster is operating as an independent company and their corporate expenses are all included in Napster's segment results, and RealNetworks does not allocate any expenses to the Napster segment.
As of March 31, 2019, we had $36.9 million in unrestricted cash and cash equivalents, compared to $35.6 million as of December 31, 2018. The 2019 increase in cash and cash equivalents compared to the prior year end amount was due to our January 2019 acquisition of Napster, which added $9.9 million of cash, offset by our ongoing cash flows used in operating activities.
Condensed consolidated results of operations were as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
 
% Change
Total revenue
$
39,472

 
$
19,650

 
$
19,822

 
101
 %
Cost of revenue
24,870

 
5,136

 
19,734

 
384
 %
Gross profit
14,602

 
14,514

 
88

 
1
 %
Gross margin
37
%
 
74
%
 
 
 
 
Operating expenses
25,506

 
19,468

 
6,038

 
31
 %
Operating loss
$
(10,904
)
 
$
(4,954
)
 
$
(5,950
)
 
(120
)%
In the first quarter of 2019, our total consolidated revenue increased $19.8 million as compared with the year-earlier period, due to the acquisition of Napster on January 18, 2019, and the resulting consolidation of their results from the acquisition date forward. Napster revenues for the first quarter of 2019 totaled $24.3 million. For the first quarter of 2019 compared to the prior year period, our Games segment revenue increased by $0.2 million, offset by declines in our Consumer Media segment and Mobile Services segment of $3.0 million and $1.8 million, respectively. See below for further discussion of our segment results.
Cost of revenue increased by $19.7 million for the quarter ended March 31, 2019, primarily due to the consolidation of Napster's results from the acquisition date forward. Napster's cost of revenue for the first quarter of 2019 totaled $20.4 million and its gross margin was 16 percent.
Operating expenses increased by $6.0 million in the quarter ended March 31, 2019 as compared with the year-earlier period, primarily due to the consolidation of Napster's results from the acquisition date forward. Napster operating expenses for the first quarter of 2019 totaled $5.5 million, including $0.2 million of acquisition-related costs. Operating expenses within Corporate in the first quarter of 2019 included an additional $0.6 million of acquisition-related costs.

27



Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
 
% Change
Revenue
$
2,486

 
$
5,483

 
$
(2,997
)
 
(55
)%
Cost of revenue
833

 
993

 
(160
)
 
(16
)%
Gross profit
1,653

 
4,490

 
(2,837
)
 
(63
)%
Gross margin
66
%
 
82
%
 
 
 
 
Operating expenses
3,119

 
3,918

 
(799
)
 
(20
)%
Operating income (loss)
$
(1,466
)
 
$
572

 
$
(2,038
)
 
NM

Total Consumer Media revenue for the quarter ended March 31, 2019 decreased $3.0 million as compared to the same quarter in 2018, due primarily to lower software license revenues of $2.6 million and subscription services revenues of $0.2 million, described more fully below. The overall decrease in revenues was also impacted by lower advertising and other revenues of $0.2 million.
Software License
For our software license revenues, the $2.6 million decrease was primarily due to declining shipments by our customers and the timing of contract renewals.
Subscription Services
For our subscription services revenues, the $0.2 million decrease was primarily due to continuing declines in our legacy subscription products.
Cost of revenue for the quarter ended March 31, 2019 decreased $0.2 million compared with the year-earlier period. This was primarily due to lower bandwidth and license royalty costs.
Operating expenses decreased $0.8 million as compared with the year-earlier period, primarily due to reductions in salaries, benefits, and professional services fees.
Mobile Services
Mobile Services segment results of operations were as follows (in thousands): 
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
 
% Change
Revenue
$
6,939

 
$
8,704

 
$
(1,765
)
 
(20
)%
Cost of revenue
2,048

 
2,316

 
(268
)
 
(12
)%
Gross profit
4,891

 
6,388

 
(1,497
)
 
(23
)%
Gross margin
70
%
 
73
%
 
 
 
 
Operating expenses
7,561

 
7,366

 
195

 
3
 %
Operating loss
$
(2,670
)
 
$
(978
)
 
$
(1,692
)
 
(173
)%
Total Mobile Services revenue decreased by $1.8 million in the quarter ended March 31, 2019 compared with the prior-year period. The revenue decrease was due to declines of $1.1 million in subscription services revenues and $0.7 million in software license revenues, described more fully below.
Software License
For our software license revenues, the decrease was primarily due to higher revenues recognized in the first quarter of 2018 for our integrated RealTimes products offered to mobile carriers due to the timing of revenue recognition for contract renewal.

28



Subscription Services
For our subscription services, the decrease was primarily the result of a decrease of $1.3 million in our ringback tones business, partially offset by an increase in our messaging platform business of $0.3 million.
Cost of revenue decreased by $0.3 million in the quarter ended March 31, 2019 compared with the prior-year period, due primarily to reductions in salaries, benefits, and professional services fees.
Operating expenses increased by $0.2 million for the quarter ended March 31, 2019 compared with the year-earlier period primarily due to increased facilities and support services costs.
Games
Games segment results of operations were as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
 
% Change
Revenue
$
5,710

 
$
5,463

 
$
247

 
5
 %
Cost of revenue
1,670

 
1,817

 
(147
)
 
(8
)%
Gross profit
4,040

 
3,646

 
394

 
11
 %
Gross margin
71
%
 
67
%
 
 
 
 
Operating expenses
5,037

 
4,917

 
120

 
2
 %
Operating loss
$
(997
)
 
$
(1,271
)
 
$
274

 
22
 %
Total Games revenue increased $0.2 million for the quarter ended March 31, 2019 as compared with the year-earlier period due primarily to increases of $0.6 million in our subscription services and advertising and other revenues, partially offset by a decrease of $0.4 million in product sales revenues, described more fully below.
Subscription Services
Our subscription sales increased $0.3 million as a result of new subscription offerings for our Original Stories.
Product Sales
Lower product sales of $0.4 million compared to the prior-year period was primarily due to a decrease in sales of games, partially offset by in-game purchases, due to a recently launched free to play game which offers advertising in lieu of purchasing the game. This model shifts the revenue from product sales to advertising, as discussed below.
Advertising and Other
Our advertising and other revenues increased $0.3 million as compared to the prior-year period primarily as a result of new initiatives to offer in-game advertising within our free to play and other mobile games.
Cost of revenue decreased $0.1 million in the quarter ended March 31, 2019 when compared with the prior-year period due to lower publisher license and service royalties. This is a result of our April 2018 acquisition of a Netherlands-based game development studio, as we no longer pay royalties to this studio. However, operating expenses relating to the ongoing operation of the studio have been and will continue to be incurred and are now reported within operating expenses, as noted in the following paragraph.
Operating expenses increased $0.1 million in the quarter ended March 31, 2019 when compared with the prior-year period, largely due to salaries, benefits, and professional services fees from increased developer costs, as a result of our acquisition of a Netherlands-based game development studio.

29



Napster
Napster segment results of operations were as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
Revenue
$
24,337

 
$

 
$
24,337

Cost of revenue
20,396

 

 
20,396

Gross profit
3,941

 

 
3,941

Gross margin
16
%
 
%
 
 
Operating expenses
5,532

 

 
5,532

Operating loss
$
(1,591
)
 
$

 
$
(1,591
)
As described in Note 5 Acquisitions, we acquired control and began consolidating Napster effective January 18, 2019. Our consolidated results include Napster from the acquisition date forward.
Napster's revenues relate to subscription services and include $12.2 million of direct to consumer revenues and $12.1 million of revenues sold through distribution partners. Napster's direct to consumer revenues in the first quarter of 2019 were reduced by $0.6 million of unfavorable impact from the fair value measurement of Napster deferred revenue at the time of acquisition.
Cost of revenues primarily consist of content royalties related to music label and publishing rights for its domestic and international music streaming services. These costs can vary materially from period to period due to the significant judgments, assumptions, and estimates of the amounts to be paid. Napster's cost of revenues for the first quarter of 2019 included $0.3 million of amortization expense related to intangible assets acquired.
Operating expenses primarily include salaries, benefits, and professional services fees. In the first quarter of 2019, Napster's operating expenses included $0.6 million of amortization expense related to intangible assets acquired and $0.2 million of acquisition-related costs.
Corporate
Corporate results of operations were as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
 
% Change
Cost of revenue
$
(77
)
 
$
10

 
$
(87
)
 
NM

Operating expenses
4,257

 
3,267

 
990

 
30
 %
Operating loss
$
(4,180
)
 
$
(3,277
)
 
$
(903
)
 
(28
)%
Operating expenses increased by $1.0 million in the quarter ended March 31, 2019 compared with the year-earlier period. The increase was due to higher salaries, benefits, and professional fees primarily related to $0.6 million of costs associated with our acquisition of Napster. Note there are no other costs within Corporate related to our Napster segment.
Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs including stock-based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, restructuring charges, and lease exit costs. Operating expenses were as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
 
% Change
Research and development
$
8,833

 
$
7,694

 
$
1,139

 
15
 %
Sales and marketing
8,142

 
5,997

 
2,145

 
36
 %
General and administrative
8,364

 
5,601

 
2,763

 
49
 %
Restructuring and other charges
167

 
501

 
(334
)
 
(67
)%
Lease exit and related charges

 
(325
)
 
325

 
(100
)%
Total consolidated operating expenses
$
25,506

 
$
19,468

 
$
6,038

 
31
 %

30



Research and development expenses increased by $1.1 million in the quarter ended March 31, 2019 as compared with the year-earlier period, primarily due to the acquisition of Napster on January 18, 2019, and the resulting consolidation of their results from the acquisition date forward. Napster's research and development expenses for the first quarter of 2019 totaled $1.4 million. This increase was partially offset by a decrease in salaries, benefits, and professional services of $0.4 million reflecting our continued cost reduction efforts.
Sales and marketing expenses increased $2.1 million compared with the year-earlier period, primarily due to the acquisition of Napster as discussed above. Napster's sales and marketing expenses for the first quarter of 2019 totaled $2.2 million.
General and administrative expenses increased by $2.8 million in the quarter ended March 31, 2019, compared with the year-earlier period. The increase was primarily due to the acquisition of Napster as discussed above. Napster's general and administrative expenses for the first quarter of 2019 totaled $2.0 million. We also incurred higher general and administrative expenses of $0.8 million primarily due to costs associated with our acquisition of Napster.
Restructuring and other charges consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts. Restructuring expense primarily related to severance costs due to workforce reductions. For additional details on these charges, see Note 11 Restructuring Charges.
Other Income (Expense)
Other income (expense), net was as follows (in thousands):
 
Quarter Ended March 31,
 
2019
 
2018
 
$ Change
Interest expense
$
(166
)
 
$

 
$
(166
)
Interest income
77