Overview

RealNetworks invented the streaming media category in 1995 and continues to
build on its foundation of digital media expertise and innovation, creating a
new generation of products and services to enhance and secure our daily lives.
We manage our business and report revenue and operating income (loss) in four
segments: (1) Consumer Media (2) Mobile Services, (3) Games, and (4) Napster.
Within our Consumer Media segment, revenue is primarily derived from the
software licensing of our video compression, or codec, technology, principally
our prior-generation codec RealMedia Variable Bitrate, or RMVB, but also
including some early revenue from sales of our latest technology, RealMedia High
Definition, or RMHD. We also generate revenue from the sale of our PC-based
RealPlayer products, including RealPlayer Plus and related products. These
products and services are delivered directly to consumers and through partners,
such as OEMs and mobile device manufacturers.
Our Mobile Services business generates revenue primarily from the sale of
subscription services, which include our intercarrier messaging service and
ringback tones, as well as through software licenses for the integration of our
RealTimes platform and certain system implementations. We generate a significant
portion of our revenue from sales within our Mobile Services business to a few
mobile carriers. Our Mobile Services segment also includes our computer vision
platform, SAFR, which includes facial recognition technology that leverages
artificial intelligence-based machine learning. To date, our SAFR business has
not generated a significant level of revenue.
Our Games business generates revenue primarily through the development,
publishing, and distribution of casual games under the GameHouse and Zylom
brands. Games are offered via mobile devices, digital downloads, and
subscription play. We derive revenue from player purchases of in-game virtual
goods within our free-to-play games and from advertising on games sites. In
addition, we derive revenue from the sale of individual games and subscription
offerings.
As described in Note 4. Acquisitions, RealNetworks acquired an additional 42%
interest in Napster on January 18, 2019 (the "Napster Acquisition") resulting in
our having a majority voting interest, owning 84% of Napster's outstanding
equity. We consolidate Napster's financial results into our financial statements
for fiscal periods following the closing of the acquisition, and Napster is
reported as a separate segment in RealNetworks financial statements and related
disclosures following the acquisition. The acquisition resulted in our recording
of goodwill and definite-lived intangible assets, which we assess for impairment
each quarter and which would be negatively impacted if Napster's business were
to continue to decline or if it were to suffer significant financial distress.
The Napster segment provides music products and services that enable consumers
to have access to digital music content from a variety of devices. The Napster
unlimited subscription service offers unlimited access to a catalog of tens of
millions of music tracks by way of on-demand streaming and conditional
downloads. Napster currently offers music services worldwide and generates
revenue primarily through subscriptions sold directly to consumers, through
distribution partners, or through various music platform services under
co-branded arrangements. Napster generates a significant portion of revenue from
sales to a few partners.
RealNetworks allocates to its Consumer Media, Mobile Services, and Games
reportable segments certain corporate expenses which are directly attributable
to supporting these businesses, including but not limited to a portion of
finance, IT, legal, human resources and headquarters facilities. Remaining
expenses, which are not directly attributable to supporting these businesses,
are reported as corporate items. These corporate items also can include
restructuring charges and stock compensation expense. As stated in Note 4.
Acquisitions, Napster is operating as an independent company and their corporate
expenses, including restructuring charges, are all included in Napster's segment
results, and RealNetworks does not allocate any expenses to the Napster segment.
In 2019, our consolidated revenue increased by $102.6 million compared with
2018, due mostly to the Napster Acquisition on January 18, 2019 and the
resulting consolidation of their results from the acquisition date forward.
Napster's 2019 revenues from the acquisition date forward were $106.3 million.
In 2019, our Games segment revenue increased $3.8 million, which was offset by
decreases of $5.0 million in Consumer Media revenue and $2.5 million in Mobile
Services revenue. See below for further information regarding fluctuations by
segment.
Operating expenses increased by $27.4 million in 2019 compared with 2018 again
due primarily to the consolidation of Napster's results from the acquisition
date forward. Napster's operating expenses for the fiscal year of 2019 totaled
$25.8
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million which included $0.2 million of acquisition costs. Operating expenses in
2019 also included an additional $1.3 million of professional fees associated
with the acquisition of Napster.
As of December 31, 2019, we had $16.8 million in unrestricted cash and cash
equivalents compared to $35.6 million as of December 31, 2018. The 2019 decrease
in cash and cash equivalents from December 31, 2018 was primarily due to our
ongoing cash flows used in operating activities, Napster's net repayment of debt
of $4.7 million, and the $3.5 million cash required to be restricted under our
Loan and Security Agreement, which we refer to as the Loan Agreement. These
decreases were partially offset by the January 2019 Napster Acquisition, which
added $9.9 million of cash, and the drawdown of $3.9 million from the revolving
line of credit we entered into in August 2019.
See Note 22 Subsequent Event for information on the additional funding of
approximately $10.0 million received by RealNetworks on February 10, 2020.
Consolidated results of operations were as follows (dollars in thousands):
                                                                     2019-2018         %
                                  2019            2018                 Change        Change
Total revenue                 $ 172,113       $  69,510             $ 102,603         148  %
Cost of revenue                 103,127          17,727                85,400         482  %

Gross profit                     68,986          51,783                17,203          33  %
Gross margin                         40  %           74  %                (34) %

Total operating expenses        101,429          74,054                27,375          37  %
Operating income (loss)       $ (32,443)      $ (22,271)            $ (10,172)        (46) %


2019 compared with 2018
In 2019, our consolidated revenue increased by $102.6 million, or 148%. The
increase in revenue was predominantly due to the Napster Acquisition on January
18, 2019, and the consolidation of its results from the acquisition date
forward. Napster's 2019 revenues from the acquisition date forward were $106.3
million. In 2019, our Games segment revenue increased $3.8 million, offset by
decreases of $5.0 million in Consumer Media revenue and $2.5 million in Mobile
Services revenue. See below for further information regarding fluctuations by
segment. Gross margin decreased to 40% from 74%, driven by the lower margin of
the Napster segment.
Operating expenses increased by $27.4 million in 2019 compared with 2018
primarily due to the consolidation of Napster's results from the acquisition
date forward. Napster's operating expenses for the fiscal year of 2019 totaled
$25.8 million, including $0.2 million of acquisition-related costs. Operating
expenses within Corporate in 2019 included an additional $1.3 million of
acquisition-related costs and $1.0 million of change in fair value of the
Napster contingent consideration liability.

Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (dollars in
thousands):
                                                                   2019-2018        %
                                 2019           2018                Change        Change
Total revenue                 $ 13,170       $ 18,168             $ (4,998)        (28) %
Cost of revenue                  3,031          3,858                 (827)        (21) %

Gross profit                    10,139         14,310               (4,171)        (29) %
Gross margin                        77  %          79  %                (2) %
Total operating expenses        11,186         14,419               (3,233)        (22) %
Operating income (loss)       $ (1,047)      $   (109)            $   (938)         NM


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2019 compared with 2018
Total Consumer Media revenue decreased by $5.0 million, or 28% as compared to
the prior year, due primarily to decreased software license revenues of $3.4
million, as well as decreases in our subscription service revenues of $0.8
million and lower product sales, advertising and other revenues of $0.8 million.
Software License
For our software license revenues, the $3.4 million decrease was primarily
related to declining shipments by our distribution partners of products embedded
with our codec technology and the timing of contract renewals with our
distribution partners. The bulk of these licenses for our codec technology are
with companies based in China and, in the near term, it is possible we may see
continued pressure in pricing and renewals, and potential further declines in
sales. In addition, it is unclear whether or how the recent outbreak of
coronavirus COVID-19 and its effect on Chinese companies will impact our codec
business.
Subscription Services
For our subscription services revenues, the decrease of $0.8 million was
primarily due to further declines in our legacy subscription products, which we
expect to continue.
Cost of revenue decreased by $0.8 million, or 21%. This was primarily due to
reductions in salaries and benefits of $0.5 million, and reductions in bandwidth
and license royalty costs of $0.3 million.
Operating expenses decreased by $3.2 million, or 22%, compared to the prior
year, primarily due to lower salaries and benefits, from headcount reductions,
and professional services fees of $2.8 million as well as lower marketing
expenses of $0.3 million.
Mobile Services
Mobile Services segment results of operations were as follows (dollars in
thousands):
                                                                   2019-2018        %
                                 2019           2018                Change        Change
Total revenue                 $ 27,143       $ 29,670             $ (2,527)         (9) %
Cost of revenue                  7,500          8,623               (1,123)        (13) %

Gross profit                    19,643         21,047               (1,404)         (7) %
Gross margin                        72  %          71  %                 1  %
Total operating expenses        29,340         28,066                1,274           5  %
Operating income (loss)       $ (9,697)      $ (7,019)            $ (2,678)        (38) %



2019 compared with 2018
Mobile Services revenue decreased by $2.5 million, or 9%, and was primarily
driven by a decrease of $2.8 million in subscription services revenue, offset by
an increase of $0.3 million in software license revenue.
Software license
For our software license revenues, the $0.3 million increase was primarily the
result of revenue from sales of our recently introduced SAFR product, which
recognized negligible revenue in the prior year. At this time, we believe that
there is risk that the effects of the recent outbreak of coronavirus COVID-19 on
global mobility and corporate investment could negatively impact growth
expectations and sales prospects for our SAFR business.
Subscription service
For our subscription services, the $2.8 million decrease was driven by fewer
subscribers to our ringback tones causing a decrease in revenue of $3.5 million
and a revenue decrease of $0.4 million related to professional services fees.
These decreases were offset by an increase in revenue from our intercarrier
messaging platform business of $1.1 million.
Cost of revenue decreased by $1.1 million or 13% as compared to the prior year,
due primarily to reductions in salaries and benefits of $0.6 million related to
headcount reductions and infrastructure costs of $0.4 million.
Operating expenses increased by $1.3 million or 5% primarily due to increased
salaries and benefits related to increased investment in SAFR, partially offset
by savings in our ringback tones business.

Games

Games segment results of operations were as follows (dollars in thousands):


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                                                                   2019-2018        %
                                 2019           2018                Change        Change
Total revenue                 $ 25,489       $ 21,672             $  3,817          18  %
Cost of revenue                  6,975          6,123                  852          14  %
Gross profit                    18,514         15,549                2,965          19  %
Gross margin                        73  %          72  %                 1  %
Total operating expenses        20,220         20,324                 (104)         (1) %
Operating income (loss)       $ (1,706)      $ (4,775)            $  3,069          64  %


2019 compared with 2018
Games revenue increased by $3.8 million, or 18% as compared to the prior year
primarily due to increases of $1.2 million in product sales revenues, $1.6
million in advertising and other revenues and $1.0 million in our subscription
services revenues, described more fully below. Our Games segment continues to
shift its focus toward free-to-play games that offer in-game purchases of
virtual goods, the revenue from which is included within product sales, and away
from premium mobile games that require a one-time purchase.
Subscription Services
Our subscription sales increased $1.0 million as a result of new subscription
offerings for our Original Stories games.
Product sales
Our product sales increased $1.2 million as a result of higher in-game purchases
of $4.6 million compared to the prior-year period, offset by lower sales of
games of $3.4 million as we continue to shift toward free-to-play games that
offer in-game purchases of virtual goods and away from premium mobile games that
require a one-time purchase.
Advertising and other
Our advertising and other revenues increased $1.6 million as compared to the
prior-year period primarily as a result of offering more in-game advertising
within our free-to-play and other mobile games.
Cost of revenue increased by $0.9 million, or 14%, due to higher app store fees
of $1.2 million, partially offset by lower publisher license and service
royalties.
Operating expenses decreased by $0.1 million, primarily due to lower salaries,
benefits, professional services fees and infrastructure expenses, offset by
higher marketing fees of $1.4 million.
Napster
Napster segment results of operations were as follows (in thousands):
                                                               2019-2018
                                  2019         2018              Change
Total revenue                 $ 106,311       $ -             $ 106,311
Cost of revenue                  85,901         -                85,901
Gross profit                     20,410         -                20,410
Gross margin                         19  %      -  %                 19  %
Total operating expenses         25,789         -                25,789
Operating income (loss)       $  (5,379)      $ -             $  (5,379)



2019 compared with 2018
As described in Note 4. Acquisitions, we acquired control and began
consolidating Napster effective January 18, 2019. Our consolidated results
include Napster from the acquisition date forward.
Napster's revenues relate to subscription services and include $55.4 million of
direct-to-consumer revenues and $50.9 million of revenues resulting from
services sold through distribution partners in the year ended December 31, 2019.
Cost of revenues primarily consist of content royalties related to music label
and publishing rights for the domestic and international music streaming
services. These costs can vary materially from period to period due to the
significant judgments, assumptions, and estimates of the amounts to be paid.
Napster's cost of revenues for the year ended December 31, 2019 included $1.5
million of amortization expense related to intangible assets acquired.
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Operating expenses primarily include salaries, benefits, and professional
services fees. In the year ended December 31, 2019, Napster's operating expenses
included $2.8 million of amortization expense related to intangible assets
acquired and $0.5 million of restructuring charges.
Corporate
Corporate segment results of operations were as follows (dollars in thousands):
                                                                     2019-2018        %
                                  2019            2018                Change        Change
Cost of revenue               $    (280)      $    (877)            $    597         (68) %

Total operating expenses         14,894          11,245                3,649          32  %
Operating income (loss)       $ (14,614)      $ (10,368)            $ (4,246)        (41) %


2019 compared with 2018
Cost of revenue increased by $0.6 million compared to the prior year due to the
reversal in 2018 of certain aged royalty liabilities relating to our legacy
music business.
Operating expenses increased by $3.6 million, or 32%. The increase was primarily
due to professional fees driven by $1.3 million of costs associated with our
acquisition of Napster and higher salaries and benefits of $1.2 million. The
overall increase was also impacted by $1.0 million related to the change in fair
value of the Napster contingent consideration liability.
Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs
including stock-based compensation, consulting fees associated with product
development, sales commissions, amortization of certain intangible assets
capitalized in our acquisitions, professional service fees, advertising costs,
restructuring charges, and lease exit costs. Operating expenses were as follows
(dollars in thousands):
                                                                                  2019-2018        %
                                                2019           2018                Change        Change
Research and development                    $  34,848       $ 30,789             $  4,059          13  %
Sales and marketing                            32,778         21,140               11,638          55  %
General and administrative                     31,305         20,706               10,599          51  %
Restructuring and other charges                 2,498          1,873

625 33 %



Lease exit and related charges                      -           (454)

454 NM

Total consolidated operating expenses $ 101,429 $ 74,054

$ 27,375 37 %




Research and development expenses increased by $4.1 million, or 13%, in the year
ended 2019 as compared to 2018 primarily due to the Napster Acquisition on
January 18, 2019, and the consolidation of their results from the acquisition
date forward. Napster's research and development expenses for the year ended
December 31, 2019 totaled $7.0 million. This increase was offset by a decrease
in salaries, benefits and professional services fees of $2.9 million related to
our other segments.
Sales and marketing expenses increased by $11.6 million, or 55%, in the year
ended 2019, compared with 2018. The increase was primarily due to the Napster
Acquisition, as discussed above. Napster's sales and marketing expenses for the
year ended December 31, 2019 totaled $9.8 million. The overall increase in sales
and marketing expenses was also impacted by $1.0 million increase in salaries
and benefits and $1.1 million in marketing expenses primarily due to increased
efforts towards free-to-play games. These increases were offset by a $0.3
million decrease in infrastructure expense.
General and administrative expenses increased by $10.6 million, or 51%, in the
year ended 2019, compared with 2018. The increase was primarily due to the
Napster Acquisition as discussed above. Napster's general and administrative
expenses for the year ended December 31, 2019 totaled $8.5 million, which
includes $0.2 million of acquisition-related costs. We also incurred additional
expenses of $1.3 million in 2019 for costs associated with the Napster
Acquisition and recorded the change in fair value of the Napster contingent
consideration liability of $1.0 million as an expense.
Restructuring and other charges and Lease exit and related charges consist of
costs associated with the ongoing reorganization of our business operations and
our ongoing expense re-alignment efforts. For additional details on these
charges see Note 11. Restructuring Charges and Note 12. Lease Exit and Related
Charges.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):
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                                                                                2019-2018        %
                                                2019          2018               Change        Change
Interest expense                             $   (636)      $    -             $   (636)         NM
Interest income                                   131          344                 (213)        (62) %
Gain (loss) on equity investments, net         12,338            -               12,338          NM
Equity in net loss of Napster                       -         (757)                 757          NM
Other income (expense), net                       420         (103)                 523          NM
Total other income (expense), net            $ 12,253       $ (516)

$ 12,769 NM




Interest expense relates to RealNetworks and Napster's notes payable and
long-term debt, as described in detail in Note 10. Notes Payable and Long-term
Debt.
Total other income (expense), net, for the year ended December 31, 2019 includes
$12.3 million related to RealNetworks' gain on consolidation of Napster, as
described in more detail in Note 4. Acquisitions.
Income Taxes
During the years ended December 31, 2019 and 2018, we recognized income tax
expense of $1.1 million and $2.2 million, respectively, related to U.S. and
foreign income taxes.
The income tax expense for the year ended December 31, 2019 was largely the
result of foreign withholding taxes and income taxes in foreign jurisdictions.
The income tax expense for the year ended December 31, 2018 was largely the
result of foreign withholding taxes, income taxes in foreign jurisdictions, and
income tax expense for the accrued tax associated with future repatriations of
foreign earnings that are no longer considered to be indefinitely reinvested.
We assess the likelihood that our deferred tax assets will be recovered based
upon our consideration of many factors, including the current economic climate,
our expectations of future taxable income, our ability to project such income,
and the appreciation of our investments and other assets. We maintain a partial
valuation allowance of $160.8 million for our deferred tax assets due to
uncertainty regarding their realization as of December 31, 2019. The net
increase in the valuation allowance since December 31, 2018 of $23.5 million was
the result of an increase in current year deferred tax assets, mainly related to
the acquisition of Napster, for which the Company maintains a valuation
allowance.
We generate income in a number of foreign jurisdictions, some of which have
higher tax rates and some of which have lower tax rates relative to the U.S.
federal statutory rate. Changes to the blend of income between jurisdictions
with higher or lower effective tax rates than the U.S. federal statutory rate
could affect our effective tax rate. For the year ended December 31, 2019,
decreases in tax expense from income generated in foreign jurisdictions with
lower tax rates in comparison to the U.S. federal statutory rate were offset by
increases in tax expense from income generated in foreign jurisdictions having
comparable, or higher tax rates in comparison to the U.S. federal statutory
rate.
As of December 31, 2019 and 2018, RealNetworks had $5.0 million and $0.4 million
in uncertain tax positions, respectively. The increase in uncertain tax
positions is primarily the result of the Napster Acquisition, for which
unrecognized tax positions were recorded relating to federal research and
development tax credit carryforward risks, as well as transfer pricing risks in
certain foreign jurisdictions. The total amount of unrecognized tax benefits
that would affect our effective tax rate if recognized, is $1.3 million as of
December 31, 2019. Notwithstanding current year accruals for existing positions,
we do not anticipate that the total amount of unrecognized tax benefits will
significantly change within the next twelve months.
We file numerous consolidated and separate income tax returns in the U.S.
including federal, state and local, as well as foreign jurisdictions. With few
exceptions, we are no longer subject to U.S. federal income tax examinations for
tax years before 2013 or state, local, or foreign income tax examinations for
years before 1993. We are currently under audit by various states and foreign
jurisdictions for certain tax years subsequent to 1993.
Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term
investments, and restricted cash and investments (in thousands):
                                                               December 31,
                                                            2019           2018
Working capital                                         $ (41,601)      $ 33,481
Cash, cash equivalents, and short-term investments         16,805         35,585
Restricted cash equivalents                                 5,374          1,630


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The 2019 decrease in working capital from December 31, 2018 was predominantly
due to the consolidation of Napster, which has a negative working capital due in
part to its accrued music royalties, which totaled $54.2 million at December 31,
2019.
Cash and cash equivalents, and short-term investments decreased from December
31, 2018 due to our ongoing negative cash flow from operating activities, which
totaled $25.3 million in the year of 2019, Napster's net repayment of debt of
$4.7 million, and amounts required to be restricted, as discussed below. These
decreases were partially offset by proceeds from borrowing on our revolving
credit facility of $3.9 million and our January 2019 Napster Acquisition, which
added $9.9 million of net cash and cash equivalents. In the near term, we expect
to see continued net negative cash flow from operating activities.
The increase in restricted cash equivalents is due to the restricted amounts
required by the Loan Agreement we entered into in August 2019. See Note 5. Fair
Value Measurements for additional details.
The following summarizes cash flow activity (in thousands):
                                                         Years Ended

December 31,


                                                           2019

2018

Cash provided by (used in) operating activities $ (25,370) $ (19,221) Cash provided by (used in) investing activities

            11,081

3,798


Cash provided by (used in) financing activities              (623)

(62)




Cash used in operating activities consisted of net income (loss) including
noncontrolling interests adjusted for certain non-cash items such as
depreciation and amortization, stock-based compensation, gain on equity
investment, fair value adjustments to contingent consideration liability and the
effect of changes in certain operating assets and liabilities.
Cash used in operating activities was $6.1 million higher in the year ended
December 31, 2019 as compared to 2018. Cash used in operations was higher
primarily due to our higher operating loss recorded for year 2019 compared to
the prior year.
For the year ended December 31, 2019, cash provided by investing activities of
$11.1 million was primarily due to our Napster Acquisition on January 18, 2019.
Our initial cash consideration paid at closing of $0.2 million was offset by the
cash, cash equivalents and restricted cash on Napster's balance sheet at that
date. As fully described below, we are obligated to make further cash payments
relating to the acquisition. The increase was offset in part by fixed asset
purchases of $1.2 million.
For the year ended December 31, 2018, cash provided by investing activities of
$3.8 million was due to sales and maturities of short-term investments totaling
$8.8 million. The sales and maturities were offset by our purchase of a
Netherlands-based game development studio in the second quarter of 2018 for net
cash consideration of $4.2 million and by purchases of equipment, software and
leasehold improvements of $0.8 million.
Financing activities for the year ended December 31, 2019 used cash totaling
$0.6 million. This cash outflow was primarily due to Napster's net repayment of
debt of $4.7 million, partially offset by proceeds from borrowing on our
revolving credit facility of $3.9 million. See Note 10. Notes Payable and
Long-term Debt for additional details.
Financing activities for the year ended December 31, 2018 used cash totaling
$0.1 million which was from $0.3 million for tax payments from shares withheld
upon vesting of restricted stock offset in part by proceeds received from the
issuance of common stock of $0.2 million.
While we currently have no planned significant capital expenditures for 2020
other than those in the ordinary course of business, we do have contractual
commitments for future payments related to office leases. See Note 17. Leases
for additional details.
As discussed in Note 4. Acquisitions, we acquired a controlling interest in
Napster on January 18, 2019. We paid initial cash consideration of $0.2 million
in the first quarter of 2019 and have accrued an additional $0.8 million as a
current liability as of December 31, 2019. We also have recognized a liability
for the estimated fair value of contingent consideration related to the
acquisition. As discussed in Note 4. Acquisitions, this fair value amount was
estimated using multiple scenarios for each tranche of contingent consideration,
probability weighting each scenario, and discounting to arrive at an estimated
fair value. This fair value calculation is directly impacted by the total
estimated enterprise value of Napster. The contingent consideration will be
adjusted quarterly to fair value through earnings, and as of December 31, 2019
the estimated fair value of the contingent consideration was $12.6 million, with
$2.8 million recognized as a current liability and $9.8 million as a long-term
liability. Any future amounts RealNetworks pays for contingent consideration
could vary materially from the estimated amounts we have accrued as of December
31, 2019. See Note 4. Acquisitions for additional details.
In August 2019, RealNetworks and Napster entered into the Loan Agreement with a
third-party financial institution. Under the terms of the Agreement, which are
further described in Note 10. Notes Payable and Long-term Debt, the bank
extended a two-year revolving line of credit not to exceed $10.0 million in the
aggregate. As of December 31, 2019, $3.9
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million had been drawn on the revolving line of credit, and any further advances
will be used for working capital and general corporate purposes.
In 2019, Mr. Glaser directly invested $0.8 million in one of our subsidiaries in
exchange for shares of preferred stock of that entity. The subsidiary is
developing a platform that transforms the experience of viewing video
entertainment into a social, connected playground. As of December 31, 2019,
RealNetworks owned approximately 82% of the subsidiary's outstanding equity, and
we consolidate its financial results into our financial statements. The
financial results of the subsidiary are reported in our Consumer Media segment.
On February 10, 2020, we entered into a Series B Preferred Stock Purchase
Agreement with Mr. Glaser, pursuant to which Mr. Glaser invested approximately
$10.0 million in RealNetworks in exchange for the issuance to him of 8,064,516
shares of Series B Preferred Stock. The Series B Preferred Stock is non-voting
and is convertible into common stock on a one-to-one basis, provided, however,
that no conversion is permitted in the event that such conversion would cause
Mr. Glaser's beneficial ownership of our common stock to exceed the 38.5%
threshold set forth in our Second Amended and Restated Shareholder Rights Plan
dated November 30, 2018. The Series B Preferred Stock has no liquidation
preference and no preferred dividend.
We have evaluated our current liquidity position in light of our history of
declining revenue and operating losses as well as our near-term expectations of
net negative cash flows from operating activities. While we currently believe
existing unrestricted cash balances, including the $10.0 million in cash
proceeds from our recent sale of Series B Preferred Stock, along with current
availability on our revolving line of credit will be sufficient to allow us to
meet our obligations for the next 12 months, our assessment is subject to
inherent risks and uncertainties. Moreover, our operating forecast is partly
dependent on factors that are outside of our control. Compounding these risks,
uncertainties, and other factors are the potential effects of the recent
coronavirus pandemic and related impacts on global commerce and financial
markets. Further, we must successfully complete the process currently underway
with our lender of negotiating customary covenants for 2020. These conditions,
when evaluated within the guidance of ASC 205-40, raise substantial doubt about
our ability to meet our obligations over the ensuing 12 months and, therefore,
to continue as a going concern.
We have active plans to mitigate these conditions. Specifically, we plan to
reduce negative cash flow through operating expense reductions, as well as
through the deferral of certain obligations where we believe that we have the
legal basis to do so. In addition, we are evaluating various strategic
opportunities, which may include selling certain businesses or product lines,
soliciting external investment into certain of our businesses, or seeking other
strategic partnerships. Our plans are subject to inherent risks and
uncertainties, which are accentuated by the effects of the current pandemic and
related financial crisis. Accordingly, there can be no assurance that our plans
can be effectively implemented and, therefore, that the conditions can be
effectively mitigated.
Napster will also require outside funding in order to meet its anticipated cash
needs over the next 12 months. RealNetworks has no contractual or implied legal
obligation to provide funding or other financial support to Napster, and any
funding to Napster under the Loan Agreement must be effectuated by RealNetworks.
Significant financial distress at Napster could have negative implications in
our assessment of goodwill and long-lived assets on RealNetworks' balance sheet.
In the future, we may seek to raise additional funds through public or private
equity financing or through other sources. Such sources of funding may or may
not be available to us on commercially reasonable terms. The sale of additional
equity securities could result in dilution to our shareholders. In addition, in
the future, we may enter into cash or stock acquisition transactions or other
strategic transactions that could reduce cash available to fund our operations
or result in dilution to shareholders.
Our cash equivalents consist of money market funds.
We conduct our operations primarily in four functional currencies: the U.S.
dollar, Brazilian real, the euro and the Chinese yuan. We currently do not
actively hedge our foreign currency exposures and are therefore subject to the
risk of exchange rate fluctuations. We are exposed to foreign exchange rate
fluctuations as the financial results of foreign subsidiaries are translated
into U.S. dollars in consolidation. Our exposure to foreign exchange rate
fluctuations also arises from intercompany payables and receivables to and from
our foreign subsidiaries.
As of December 31, 2019, approximately $11.4 million of the $16.8 million of
cash and cash equivalents are held by our foreign subsidiaries outside the U.S.
We have reevaluated our historical assertion that undistributed foreign earnings
were indefinitely reinvested and for which deferred taxes were not provided. As
a result of the enactment of the Tax Act and as of December 31, 2019, we are no
longer indefinitely reinvesting substantially all of the Company's foreign
earnings outside of the U.S. As a result of this change, we have recorded
deferred taxes of $0.9 million as of December 31, 2019 to reflect local country
and foreign withholding taxes associated with a future repatriation of such
foreign earnings.
Contractual Obligations
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We have contractual obligations for Long-term debt and for Long-term lease
liabilities, both of which are recorded on our balance sheet. For details on the
maturity of Long-term debt please refer to Note 10. Notes Payable and Long-term
Debt and for future minimum lease payments please refer to Note 17. Leases.
Please also refer to Note 18. Commitments and Contingencies. For income tax
liabilities for uncertain tax positions, we cannot make a reasonably reliable
estimate of the amount and period of any related future payments. As of
December 31, 2019, we had $5.0 million of gross unrecognized tax benefits for
uncertain tax positions.
Off-Balance Sheet Arrangements
We do not maintain accruals associated with certain guarantees, as discussed in
Note 19. Guarantees; those guarantee obligations constitute off-balance sheet
arrangements.
As disclosed in Note 17. Leases, we adopted the new accounting requirement for
leases on January 1, 2019 and thus our operating lease obligations are now
recorded on our consolidated balance sheet, rather than disclosed as off-balance
sheet items.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported
period. Our critical accounting policies and estimates are as follows:
•Revenue recognition;
•Music royalties;
•Valuation of definite-lived assets and goodwill; and
•Accounting for income taxes.
Revenue Recognition. We recognize revenue from contracts with customers as
control of the promised good or service is transferred. Please refer to Note 3.
Revenue Recognition for further details regarding our recognition policies.
Music Royalties. Napster estimates the amounts of royalties payable to music
publishers or other rights-holders in relation to the use of music content on
Napster's music services (both domestic and international). Material differences
in these estimates and the actual amounts ultimately determined to be payable
may impact the amount and timing of expense in future periods. Napster's license
agreements with rights-holders for the content used on its music service are
often complex, and the determination of royalty accruals can involve significant
judgments, assumptions, and estimates of the amounts to be paid. The variables
involved in determining royalty payments or accruals may include the applicable
revenue, the type of content used, the country it is used in, the number of
plays, the number of subscribers, the rights granted to trial or promotional
users, and identification of the appropriate license holder, among other
variables. In addition, some rights-holders have allowed the use of their
content prior to finalizing the applicable license agreement. In these
circumstances, royalties are accrued based on Napster's best estimate of the
expected amount.
In certain jurisdictions, rights-holders may have several years to claim
royalties for musical compositions, in respect of which ownership has not
already been claimed. While Napster bases its estimates on contractual rates,
historical experience and on various other assumptions that management believes
to be reasonable, actual results may differ materially from these estimates
under different assumptions or conditions.
Many of Napster's content license agreements give the rights-holders the right
to audit Napster's royalty payments. Given the complexity of the licensing
arrangements, any such audit could result in disputes over whether Napster has
correctly reported and paid the proper royalties. If such a dispute were to
occur, Napster could be required to pay additional royalties, and the amounts
involved could be material.
Napster may occasionally be involved in legal actions or other third-party
assertions related to use of content on its platform. These actions might be
costly and could adversely impact Napster's financial position, results of
operations, or cash flows. Napster records a liability when it is probable that
a loss has been incurred and the amount can be reasonably estimated. Determining
whether a loss is probable and estimable requires management to use significant
judgment. Given the uncertainties associated with any litigation, the actual
outcome can be different than Napster's estimates and could adversely affect its
results of operations, financial position, and cash flows.
Valuation of Definite-Lived Assets and Goodwill. Assets acquired and liabilities
assumed in a business acquisition are measured at fair value under the purchase
accounting method and any goodwill is recognized as the excess of the total
purchase price over the fair value of assets acquired and liabilities assumed.
The fair value estimates are based upon estimates and assumptions relating to
future revenues, cash flows, operating expenses and costs of capital. These
estimates and assumptions are complex and subject to a significant degree of
judgment with respect to certain factors including, but not limited to, the cash
flows of long-term operating plans and risk-commensurate discount rates and cost
of capital. In addition, the size, scope, and complexity of an acquisition will
affect the time it takes to obtain the necessary information to record the
acquired assets and
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liabilities at fair value. It may take up to one year to finalize the initial
fair value estimates used in the preliminary purchase accounting. Accordingly,
it is reasonably likely that our initial estimates will be subsequently revised,
which could affect carrying amounts of goodwill, intangibles, noncontrolling
interests, contingent consideration, and potentially other assets and
liabilities in our financial statements.
Our definite-lived assets consist primarily of amortizable intangible assets
acquired in business combinations, property, plant and equipment, and
right-of-use operating lease assets. Definite-lived assets are amortized on a
straight line basis over their estimated useful lives. We review definite-lived
assets for impairment whenever events or changes in circumstances indicate the
carrying amount of such assets may not be recoverable. Recoverability of these
assets is measured by comparison of their carrying amount to future undiscounted
cash flows the assets are expected to generate. If definite-lived assets are
considered to be impaired, the impairment to be recognized equals the amount by
which the carrying value of the assets exceeds their fair market value.
We test goodwill for impairment on an annual basis, in our fourth quarter, or
more frequently if circumstances indicate reporting unit carrying values may
exceed their fair values. As part of this test, we first perform a qualitative
assessment to determine if the fair value of a reporting unit is more likely
than not less than the reporting unit's carrying amount including goodwill. If
this assessment indicates it is more likely than not, we then compare the
carrying value of the reporting unit to the estimated fair value of the
reporting unit. If the carrying value of the reporting unit exceeds the
estimated fair value, we then calculate the implied estimated fair value of
goodwill for the reporting unit and compare it to the carrying amount of
goodwill for the reporting unit. If the carrying amount of goodwill exceeds the
implied estimated fair value, an impairment charge to current operations is
recorded to reduce the carrying value to implied estimated value.
The impairment analysis of definite-lived assets and goodwill is based upon
estimates and assumptions relating to our future revenue, cash flows, operating
expenses, costs of capital and capital purchases. These estimates and
assumptions are complex and subject to a significant degree of judgment with
respect to certain factors including, but not limited to, the cash flows of our
long-term operating plans, market and interest rate risk, and risk-commensurate
discount rates and cost of capital. Significant or sustained declines in future
revenue or cash flows, or adverse changes in our business climate, among other
factors, and their resulting impact on the estimates and assumptions relating to
the value of our definite-lived and goodwill assets could result in the need to
perform an impairment analysis in future periods which could result in a
significant impairment. While we believe our estimates and assumptions are
reasonable, due to their complexity and subjectivity, these estimates and
assumptions could vary from period to period. Changes in these estimates and
assumptions could materially affect the estimate of future cash flows and
related fair values of these assets and result in significant impairments, which
could have a material adverse effect on our financial condition or results of
operations. For further discussion, please see the risk factor entitled, "Any
impairment to our goodwill and definite-lived assets could result in a material
charge to our earnings" under Item 1A Risk Factors.
Accounting for Income Taxes. We use the asset and liability method of accounting
for income taxes. Under this method, income tax expense is recognized for the
amount of taxes payable or refundable for the current year. In addition,
deferred income tax expense and deferred tax assets and liabilities are
recognized for the expected future tax consequences of temporary differences
between the financial reporting and tax basis of assets and liabilities and for
operating losses and tax credit carryforwards. Deferred tax assets and
liabilities and operating loss and tax credit carryforwards are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences and operating loss and tax credit carryforwards are
expected to be recovered or settled. We must make assumptions, judgments and
estimates to determine the current and deferred provision for income taxes,
deferred tax assets and liabilities and any valuation allowance to be recorded
against deferred tax assets. Our judgments, assumptions, and estimates relative
to the current provision for income tax take into account current tax laws, our
interpretation of current tax laws and possible outcomes of future audits
conducted by foreign and domestic tax authorities. Changes in tax law or our
interpretation of tax laws and future tax audits could materially impact the
amounts provided for income taxes in our consolidated financial statements.
Each reporting period we must periodically assess the likelihood that our
deferred tax assets will be recovered from future sources of taxable income, and
to the extent that recovery is not more likely than not, a valuation allowance
must be established. The establishment of a valuation allowance and increases to
such an allowance result in either increases to income tax expense or reduction
of income tax benefit in the statement of operations and comprehensive income.
In certain instances, changes in the valuation allowance may be allocated
directly to the related components of shareholders' equity on the consolidated
balance sheet. Factors we consider in making such an assessment include, but are
not limited to, past performance and our expectation of future taxable income,
macroeconomic conditions and issues facing our industry, existing contracts, our
ability to project future results and any appreciation of our investments and
other assets.
As of December 31, 2019, approximately $11.4 million of the $16.8 million of
cash and cash equivalents are held by our foreign subsidiaries outside the U.S.
We have reevaluated our historical assertion that undistributed foreign earnings
were indefinitely reinvested and for which deferred taxes were not provided. As
a result of the enactment of the Tax Act and as of
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December 31, 2019, we are no longer indefinitely reinvesting substantially all
of the Company's foreign earnings outside of the U.S. As a result of this
change, we have recorded deferred taxes of $0.9 million as of December 31, 2019
to reflect local country and foreign withholding taxes associated with a future
repatriation of such foreign earnings.
Recently Issued Accounting Standards
See Note 2. Recent Accounting Pronouncements.

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