REALNETWORKS, INC. 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 aboutRealNetworks' 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 ourJanuary 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; •our expected financial position, including liquidity, cash usage and conservation, the availability of funding or other resources, and the potential for forgiveness of certain loans; •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 ofU.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, including global pandemics and financial crises, 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 entitled "Risk Factors."RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed byRealNetworks from time to time with theSecurities and Exchange Commission , particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. 21 --------------------------------------------------------------------------------
Overview
Our SegmentsRealNetworks 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 generated a modest 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 5 Acquisitions,RealNetworks acquired an additional 42% interest in Napster onJanuary 18, 2019 bringing our ownership of Napster's outstanding stock to 84%, thus giving us a majority voting interest. For fiscal periods following the closing of the acquisition, we consolidate Napster's financial results into our financial statements, where Napster is reported as a separate segment. In connection with the acquisition, we recorded 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 access digital music content from a variety of devices. The Napster 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 and generates revenue primarily through subscriptions sold directly to consumers, through distribution partners, or through various music platform services primarily 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 may also include restructuring charges and stock compensation expense. As stated in Note 5 Acquisitions, Napster operates as an independent company and, therefore,RealNetworks allocates no corporate expenses to the Napster segment. COVID-19 InMarch 2020 , theWorld Health Organization declared the outbreak of the novel coronavirus that causes COVID-19 to be a global pandemic. As the virus spread throughout theU.S. and the world, authorities implemented numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, business limitations, and shutdowns. In addition to the pandemic's widespread impact on public health and global society, reactions to the pandemic as well as measures taken to contain the virus have caused significant turmoil to the global economy and financial markets. Moreover, similar to other companies, we have taken steps to support the health and well-being of our employees, customers, partners and communities, which include working remotely and learning to operate our businesses in a fundamentally different way. As the pandemic and containment measures generally evolved throughout the first half of 2020, we have had to reevaluate our operating plans, resulting in some significant pivots for our growth initiatives. Moreover, as we continue to operate our businesses as efficiently as possible, we have taken steps to more aggressively reduce costs and reallocate resources. We are unable to predict the near-term and long-term impacts that the COVID-19 pandemic will have on our results from operations, financial condition, liquidity and cash flows for the remainder of fiscal 2020 due to numerous uncertainties, 22 -------------------------------------------------------------------------------- including the duration and severity of the pandemic and containment measures, but we will continue to monitor and evaluate the effects to our businesses and adjust our plans as needed. Recent Developments In the second quarter of 2020, we regained compliance with the Nasdaq minimum bid price requirement of$1.00 per share, after receiving notice of non-compliance inApril 2020 . Financial Results As ofJune 30, 2020 , we had$19.7 million in unrestricted cash and cash equivalents, compared to$16.8 million as ofDecember 31, 2019 . The 2020 increase in cash and cash equivalents compared to the prior year end amount was due to the$10.0 million in cash proceeds from our first quarter of 2020 issuance of Series B Preferred Stock and the proceeds from promissory notes issued in the second quarter of 2020 pursuant to the PPP of the CARES Act, withRealNetworks and Napster receiving$2.9 million and$1.7 million , respectively. These increases were partially offset by our ongoing cash flows used in operating activities, which totaled$8.6 million in the first six months of 2020, and Napster's net repayment of debt of$2.8 million under their Non-Recourse Purchase of Eligible Receivables Agreement (NRP Agreement). Condensed consolidated results of operations were as follows (in thousands): Quarter Ended June 30, Six months ended June 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Total revenue$ 40,424 $ 44,248 $ (3,824) (9) %$ 83,569 $ 83,720 $ (151) - % Cost of revenue 23,033 27,282 (4,249) (16) % 47,209 52,152 (4,943) (9) % Gross profit 17,391 16,966 425 3 % 36,360 31,568 4,792 15 % Gross margin 43 % 38 % 44 % 38 % Operating expenses 22,290 26,357 (4,067) (15) % 46,347 51,863 (5,516) (11) % Operating loss$ (4,899) $ (9,391) $ 4,492 48 %$ (9,987) $ (20,295) $ 10,308 51 % In the second quarter of 2020, our total consolidated revenue decreased$3.8 million as compared with the year-earlier period. For the second quarter of 2020 compared to the prior year period, Napster segment revenues decreased by$5.2 million , and our Mobile Services segment revenues decreased by$0.5 million . These decreases were partially offset by increases in revenues in our Consumer Media segment of$0.5 million and in our Games segment of$1.4 million . See below for further discussion of our segment results. Cost of revenue decreased by$4.2 million for the quarter endedJune 30, 2020 as compared with the year-earlier period, primarily due to decreases of$0.1 million in our Mobile Services segment,$4.3 million in the Napster segment, and$0.3 million in our Consumer Media segment, partially offset by a$0.3 million increase in our Games segment. Operating expenses decreased by$4.1 million in the quarter endedJune 30, 2020 as compared with the year-earlier period, primarily due to reductions of$3.3 million in salaries and benefits, marketing, and infrastructure expenses. Also, in the second quarter of 2019, we incurred expenses of$0.4 million for costs associated with our acquisition of Napster. For the six months endedJune 30, 2020 , our total consolidated revenue decreased$0.2 million as compared with the year-earlier period. Napster segment revenues decreased by$3.3 million . Napster's results are included in our consolidated results for the six months endedJune 30, 2020 , whereas the six months endedJune 30, 2019 includes Napster from the acquisition date ofJanuary 18, 2019 through the end of the period. Our Consumer Media segment revenues increased by$1.5 million and our Games segment revenues increased by$2.3 million , partially offset by the revenue decline in our Mobile Services segment of$0.8 million . See below for further discussion of our segment results. Cost of revenue decreased by$4.9 million for the six months endedJune 30, 2020 as compared with the year-earlier period, primarily due to decreases of$0.4 million in our Mobile Services segment,$4.6 million in Napster segment and$0.5 million in our Consumer Media segment, partially offset by a$0.4 million increase in our Games segment. Operating expenses decreased by$5.5 million for the six months endedJune 30, 2020 as compared with the year-earlier period, primarily due to the reductions of$4.4 million in salaries, benefits and infrastructure expenses. In the first six months of 2020, we incurred expenses of$0.2 million for costs associated with our acquisition of Napster, compared with$1.0 million in the first six months of 2019. 23 -------------------------------------------------------------------------------- Segment Operating Results Consumer Media Consumer Media segment results of operations were as follows (in thousands): Quarter EndedJune 30 , Six Months Ended June 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Revenue$ 3,159 $ 2,620 $ 539 21 %$ 6,654 $ 5,106 $ 1,548 30 % Cost of revenue 519 803 (284) (35) % 1,130 1,636 (506) (31) % Gross profit 2,640 1,817 823 45 % 5,524 3,470 2,054 59 % Gross margin 84 % 69 % 83 % 68 % Operating expenses 2,204 2,877 (673) (23) % 4,662 5,996 (1,334) (22) % Operating income (loss)$ 436 $ (1,060) $ 1,496 NM$ 862 $ (2,526) $ 3,388 NM Total Consumer Media revenue for the quarter endedJune 30, 2020 increased$0.5 million as compared to the same quarter in 2019, due primarily to higher software license revenues of$0.7 million , partially offset by lower subscription services revenues of$0.1 million , described more fully below. The overall increase in revenues was also offset by lower product sales, advertising and other revenues of$0.1 million . Software License For our software license revenues, the$0.7 million increase was primarily due to the timing of contract renewals and shipments to existing customers. The bulk of these licenses for our codec technology are with companies based inChina and, in the near term, it is possible we may see continued pressure in pricing and renewals, and declines in sales. Subscription Services For our subscription services revenues, the$0.1 million decrease was primarily due to declines in our legacy subscription products, which will continue to organically decline. Cost of revenue for the quarter endedJune 30, 2020 decreased$0.3 million compared with the year-earlier period. This was primarily due to reductions in salaries and benefits. Operating expenses decreased$0.7 million as compared with the year-earlier period, primarily due to reductions in salaries and benefits from headcount reductions. Total Consumer Media revenue for the six months endedJune 30, 2020 increased$1.5 million as compared to the prior year, due primarily to higher software license revenues of$2.0 million , partially offset by lower subscription services revenues of$0.3 million , described more fully below. The overall increase in revenues was also offset by lower product sales, advertising and other revenues of$0.2 million . Software License For our software license revenues, the$2.0 million increase was primarily due to the timing of contract renewals and shipments to existing customers. The bulk of these licenses for our codec technology are with companies based inChina and, in the near term, it is possible we may see continued pressure in pricing and renewals, and declines in sales. Subscription Services For our subscription services revenues, the$0.3 million decrease was primarily due to declines in our legacy subscription products, which will continue to organically decline. Cost of revenue for the six months endedJune 30, 2020 decreased$0.5 million compared with the year-earlier period. This was primarily due to reductions in salaries and benefits. Operating expenses decreased$1.3 million as compared with the year-earlier period, primarily due to reductions in salaries and benefits from headcount reductions, and marketing expenses. 24 -------------------------------------------------------------------------------- Mobile Services Mobile Services segment results of operations were as follows (in thousands): Quarter EndedJune 30 , Six Months Ended June 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Revenue$ 6,461 $ 6,997 $ (536) (8) %$ 13,151 $ 13,936 $ (785) (6) % Cost of revenue 1,782 1,865 (83) (4) % 3,478 3,913 (435) (11) % Gross profit 4,679 5,132 (453) (9) % 9,673 10,023 (350) (3) % Gross margin 72 % 73 % 74 % 72 % Operating expenses 5,682 7,438 (1,756) (24) % 13,270 14,999 (1,729) (12) % Operating loss$ (1,003) $ (2,306) $ 1,303 57 %$ (3,597) $ (4,976) $ 1,379 28 % Total Mobile Services revenue decreased by$0.5 million in the quarter endedJune 30, 2020 compared with the prior-year period. The revenue decrease was primarily due to lower subscription services revenues of$0.6 million , described more fully below. Software License Our software license revenues, which include our SAFR product, were flat year over year. Subscription Services The decline in our subscription services revenue was due to lower revenue of$0.7 million in our ringback tones business, partially offset by an increase in our messaging platform business of$0.1 million . Cost of revenue decreased by$0.1 million in the quarter endedJune 30, 2020 compared with the prior-year period, due primarily to reductions in salaries and benefits related to headcount reductions. Operating expenses decreased by$1.8 million for the quarter endedJune 30, 2020 compared with the year-earlier period due to lower salaries and benefits of$1.0 million , and lower marketing expenses of$0.8 million . Total Mobile Services revenue decreased by$0.8 million in the six months endedJune 30, 2020 compared with the prior-year period. The revenue decrease was due to lower subscription services revenues of$1.0 million , partially offset by a$0.2 million increase in software license revenues, described more fully below. Software License For our software license revenues, the increase was primarily due to revenue from sales of our SAFR product. Subscription Services The decline in our subscription services revenue was due to lower revenue of$1.4 million in our ringback tones business, partially offset by an increase in our messaging platform business of$0.4 million . Cost of revenue decreased by$0.4 million in the six months endedJune 30, 2020 compared with the prior-year period, due primarily to reductions in salaries and benefits related to headcount reductions. Operating expenses decreased by$1.7 million for the six months endedJune 30, 2020 compared with the year-earlier period, due primarily to a decrease in salaries and benefits of$0.5 million and lower marketing expenses of$1.0 million . 25 --------------------------------------------------------------------------------
Games
Games segment results of operations were as follows (in thousands):
Quarter Ended June 30, Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Revenue $ 7,465 $ 6,048 $ 1,417 23 % $ 14,102 $ 11,758 $ 2,344 20 %
Cost of revenue 1,958 1,655 303 18 % 3,752 3,325 427 13 %
Gross profit 5,507 4,393 1,114 25 % 10,350 8,433 1,917 23 %
Gross margin 74 % 73 % 73 % 72 %
Operating expenses 4,976 5,288 (312) (6) % 9,899 10,325 (426) (4) %
Operating income (loss) $ 531 $ (895) $ 1,426 NM $ 451 $ (1,892) $ 2,343 NM
Total Games revenue increased $1.4 million for the quarter ended June 30, 2020
as compared with the year-earlier period due primarily to increases of $1.5
million in product sales revenues and $0.2 million in advertising and other
revenues, partially offset by a $0.3 million decrease in our subscription
services revenues, described more fully below. Our Games segment has shifted 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 decreased $0.3 million as a result of lower subscribers
in the second quarter of 2020.
Product Sales
Our product sales increased $1.5 million as a result of higher in-game purchases
of $2.4 million compared to the prior-year period, partially offset by lower
sales of games of $0.8 million , as we have shifted focus 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 $0.2 million as compared to the
prior-year period primarily as a result of offering more in-game advertising
within our free-to-play games.
Cost of revenue increased $0.3 million in the quarter ended June 30, 2020 when
compared with the prior-year period due to higher app store fees of $0.4
million , partially offset by lower publisher license and service royalties of
$0.1 million .
Operating expenses decreased $0.3 million in the quarter ended June 30, 2020
when compared with the prior-year period, due to lower professional services
fees of $0.2 million and salaries and benefits of $0.5 million , partially offset
by higher marketing expenses of $0.5 million .
Total Games revenue increased $2.3 million for the six months ended June 30,
2020 as compared with the year-earlier period due primarily to increases of $2.5
million in product sales revenues and $0.4 million in advertising and other
revenues, partially offset by a $0.6 million decrease in our subscription
services revenues.
Subscription Services
Our subscription sales decreased $0.6 million as a result of lower subscribers
in 2020.
Product Sales
Our product sales increased $2.5 million as a result of higher in-game purchases
of $4.0 million compared to the prior-year period, partially offset by lower
sales of games of $1.5 million , as we have shifted focus 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 $0.4 million as compared to the
prior-year period primarily as a result of offering more in-game advertising
within our free-to-play games.
Cost of revenue increased $0.4 million in the six months ended June 30, 2020
when compared with the prior-year period due to higher app store fees of $0.8
million , partially offset by lower publisher license and service royalties of
$0.3 million .
Operating expenses decreased $0.4 million in the six months ended June 30, 2020
when compared with the prior-year period, due to lower professional services
fees of $0.5 million and salaries and benefits of $0.8 million , partially offset
by higher marketing expenses of $1.1 million .
26
--------------------------------------------------------------------------------Napster
Napster segment results of operations were as follows (in thousands):
Quarter Ended June 30, Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Revenue $ 23,339 $ 28,583 $ (5,244) (18) % $ 49,662 $ 52,920 $ (3,258) (6) %
Cost of revenue 18,770 23,026 (4,256) (18) % 38,842 43,422 (4,580) (11) %
Gross profit 4,569 5,557 (988) (18) % 10,820 9,498 1,322 14 %
Gross margin 20 % 19 % 22 % 18 %
Operating expenses 6,609 6,638 (29) - % 13,070 12,170 900 7 %
Operating loss $ (2,040) $ (1,081) $ (959) (89) % $ (2,250) $ (2,672) $ 422 16 %
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.
Subscription Services
Napster's subscription revenues for the quarter ended June 30, 2020 decreased
$5.2 million compared to the same quarter of 2019 due to a $1.9 million decrease
in direct to consumer revenues and a $3.4 million decrease in sales through
distribution partners. The decreases were primarily due to lower subscribers.
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 quarter ended June 30, 2020 decreased $4.3
million primarily due to lower royalties related to the decline in revenue in
the second quarter of 2020 compared to the prior year period.
Operating expenses were flat for the quarter ended June 30, 2020 compared to the
prior year period, with lower salaries and benefits of $0.5 million offset by
higher professional service fees and restructuring charges.
Subscription Services
Napster's subscription revenues for the six months ended June 30, 2020 decreased
$3.3 million compared to the same quarter of 2019 due to a $0.6 million decrease
in direct to consumer revenues and a $2.6 million decrease in sales through
distribution partners. The decreases were primarily due to lower subscribers,
offset in part by an early termination fee from a platform partner in the first
quarter of 2020. Direct to consumer revenue was reduced in the first quarter of
2019 by $0.6 million due to a fair value reduction in deferred revenue at the
time of acquisition.
Napster's cost of revenues for the six months ended June 30, 2020 decreased $4.6
million primarily due to lower royalties related to the decline in revenue.
Operating expenses increased by $0.9 million for the six months ended June 30,
2020 primarily due the inclusion of a full quarter of expenses in the first
quarter of 2020 compared to the prior year period and restructuring charges
incurred in the six months ended June 30, 2020 .
Corporate
Corporate results of operations were as follows (in thousands):
Quarter Ended June 30, Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Cost of revenue $ 4 $ (67) $ 71 NM $ 7 $ (144) $ 151 NM
Operating expenses 2,819 4,116 (1,297) (32) % 5,446 8,373 (2,927) (35) %
Operating loss $ (2,823) $ (4,049) $ 1,226 30 % $ (5,453) $ (8,229) $ 2,776 34 %
Operating expenses decreased by $1.3 million in the quarter ended June 30, 2020
compared with the year-earlier period, primarily due to a reduction in salaries
and benefits. The overall change was also impacted by lower Napster acquisition
costs of $0.4 million and $0.2 million of lower expense for the change in the
fair value of the Napster contingent consideration liability, as further
discussed in Note 6 Fair Value Measurements.
Operating expenses decreased by $2.9 million for the six months ended June 30,
2020 compared with the year-earlier period, primarily due to a reduction in
salaries and benefits in the first half of 2020. The overall change was also
impacted by lower Napster acquisition costs of $0.8 million for the six months
ended June 30, 2020 and a $0.5 million favorable change in the fair value of the
Napster contingent consideration liability, as further discussed in Note 6 Fair
Value Measurements.
27
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Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs
including stock-based compensation, consulting fees associated with product
development, sales commissions, amortization of certain intangible assets
capitalized in our acquisitions, professional service fees, advertising costs
and restructuring charges. Operating expenses were as follows (in thousands):
Quarter Ended June 30, Six Months Ended June 30,
2020 2019 $ Change % Change 2020 2019 $ Change % Change
Research and development $ 7,802 $ 8,876 $ (1,074) (12) % $ 16,420 $ 17,709 $ (1,289) (7) %
Sales and marketing 6,927 8,360 (1,433) (17) % 15,044 16,502 (1,458) (9) %
General and administrative 6,680 8,392 (1,712) (20) % 13,793 16,756 (2,963) (18) %
Restructuring and other charges 881 729 152 21 % 1,090 896 194 22 %
Total consolidated operating
expenses $ 22,290 $ 26,357 $ (4,067) (15) % $ 46,347 $ 51,863 $ (5,516) (11) %
Research and development expenses decreased by $1.1 million in the quarter ended
June 30, 2020 as compared with the year-earlier period, primarily due to lower
salaries and benefits and professional service fees totaling $1.0 million .
Research and development expenses decreased by $1.3 million for the six months
ended June 30, 2020 as compared with the year-earlier period, primarily due to
lower salaries and benefits and professional fees totaling $0.8 million , and a
decrease in infrastructure expenses of $0.4 million .
Sales and marketing expenses decreased $1.4 million in the quarter ended June
30, 2020 as compared with the year-earlier period, primarily due to a $1.3
million reduction in salaries and benefits.
Sales and marketing expenses decreased $1.5 million in the six months ended June
30, 2020 as compared with the year-earlier period due primarily to lower
salaries and benefits of $2.0 million , partially offset by an increase of $0.2
million of professional services fees.
General and administrative expenses decreased by $1.7 million in the quarter
ended June 30, 2020 as compared with the year-earlier period, primarily due to a
reduction in salaries and benefits, and infrastructure costs. The overall change
was also impacted by lower Napster acquisition costs of $0.4 million and $0.2
million of lower expense for the change in the fair value of the Napster
contingent consideration liability, further discussed in Note 6 Fair Value
Measurements.
General and administrative expenses decreased by $3.0 million in the six months
ended June 30, 2020 as compared with the year-earlier period, primarily due to a
reduction in salaries and benefits, and infrastructure costs. The overall change
was also impacted by lower Napster acquisition costs of $0.8 million and a $0.5
million favorable change in the fair value of the Napster contingent
consideration liability, as further discussed in Note 6 Fair Value Measurements.
Restructuring and other charges consist of costs associated with the ongoing
reorganization of our business operations and expense re-alignment efforts. For
additional details on these charges, see Note 9 Restructuring Charges.
Other Income (Expense)
Other income (expense), net was as follows (in thousands):
Quarter Ended June 30, Six Months Ended June 30,
2020 2019 $ Change 2020 2019 $ Change
Interest expense $ (278) $ (43) $ (235) $ (540) $ (209) $ (331)
Interest income 23 40 (17) 28 117 (89)
Gain (loss) on equity investment, net (53) - (53) (53) 12,338 (12,391)
Other income (expense), net (134) 183 (317) 661 310 351
Total other income (expense), net $ (442) $ 180 Interest expense relates toRealNetworks and Napster's notes payable and long-term debt, as described in more detail in Note 8 Notes Payable and Long-term debt. Gain (loss) on equity investment, net, for the six months endedJune 30, 2019 included a$12.3 million gain in the first quarter of 2019 related toRealNetworks' consolidation of Napster, as described in more detail in Note 5 Acquisitions. The fluctuations in Other income (expense) primarily relate to foreign exchange gains and losses. 28 -------------------------------------------------------------------------------- Income Taxes We recognized income tax expense of$0.2 million and$0.2 million during the quarters endedJune 30, 2020 and 2019, respectively, related toU.S. and foreign income taxes. During the six months endedJune 30, 2020 and 2019, we recognized income tax expense of$0.4 million and$0.5 million , respectively, related toU.S. and foreign income taxes. As ofJune 30, 2020 ,RealNetworks has$5.0 million in uncertain tax positions. We currently anticipate the expiration of the statute of limitations within the next twelve months that may decrease the Company's total unrecognized tax benefit by an amount up to$1.3 million . The majority of our tax expense is due to income in our foreign jurisdictions. In addition, we have not benefited from losses in theU.S. and certain foreign jurisdictions in the second quarter of 2020. We generate income in a number of foreign jurisdictions, some of which have higher or lower tax rates relative to theU.S. federal statutory rate. Our tax expense could fluctuate significantly on a quarterly basis to the extent income is less than anticipated in countries with lower statutory tax rates and more than anticipated in countries with higher statutory tax rates. For the quarter endedJune 30, 2020 , decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to theU.S. federal statutory rate was offset by increases in tax expense from income generated in foreign jurisdictions having comparable, or higher tax rates in comparison to theU.S. federal statutory rate. The effect of differences in foreign tax rates on the Company's tax expense for the second quarter of 2020 was minimal. We file numerous consolidated and separate income tax returns in theU.S. , including federal, state and local returns, as well as in foreign jurisdictions. With few exceptions, we are no longer subject toUnited States federal income tax examinations for tax years prior to 2013 or state, local or foreign income tax examinations for years prior to 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993. New Accounting Pronouncements See Note 2 Recent Accounting Pronouncements, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q. Liquidity and Capital Resources The following summarizes working capital, cash and cash equivalents, and restricted cash (in thousands): June 30, 2020 December 31, 2019 Working capital$ (36,258) $ (41,601) Cash and cash equivalents 19,688 16,805 Restricted cash equivalents 5,374 5,374 Cash and cash equivalents increased fromDecember 31, 2019 due to the$10.0 million in cash proceeds from the first quarter 2020 issuance of Series B Preferred Stock and the total cash proceeds of$4.6 million from the PPP promissory notes issued in the second quarter of 2020, as described in Note 8 Notes Payable and Long-term debt, partially offset by our ongoing cash flows used in operating activities, which totaled$8.6 million in the first six months of 2020, and Napster's net repayment of debt of$2.8 million . The following summarizes cash flow activity (in thousands): Six Months Ended
2020 2019
Cash used in operating activities$ (8,577) $ (16,099) Cash (used in) provided by investing activities (326)
11,411
Cash provided by (used in) financing activities 11,882
(3,951)
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) loss on equity investments, fair value adjustments to contingent consideration liability and the effect of changes in certain operating assets and liabilities. Cash used in operating activities was$7.5 million lower in the six months endedJune 30, 2020 as compared to the same period in 2019. This improvement was primarily due to our lower operating loss recorded for the six months endedJune 30, 2020 compared to the prior year period. For the six months endedJune 30, 2020 , cash used by investing activities consisted of fixed asset purchases of$0.3 million . For the six months endedJune 30, 2019 , cash provided by investing activities of$11.4 million was primarily due to our acquisition of Napster onJanuary 18, 2019 . Our initial cash consideration paid at closing of$0.2 million was offset by the cash, 29 -------------------------------------------------------------------------------- cash equivalents and restricted cash on Napster's balance sheet at that date. The increase was offset in part by fixed asset purchases of$0.9 million . Cash provided by financing activities for the six months endedJune 30, 2020 was$11.9 million . This cash inflow was primarily due to the$10.0 million in cash proceeds from the first quarter 2020 issuance of Series B Preferred Stock and the total cash proceeds of$4.6 million from the PPP promissory notes issued in the second quarter of 2020, offset by Napster's net repayment of debt of$2.8 million . See Note 8 Notes Payable and Long-term debt and Note 13Related Party Transactions for additional details. Cash used by financing activities for the six months endedJune 30, 2019 was$4.0 million . This cash outflow was primarily due to Napster'sApril 30, 2019 payoff of its Loan and Security Agreement (Revolver LSA), in the amount of$4.9 million . Three customers accounted for more than 10% of trade accounts receivable as ofJune 30, 2020 , with the customers accounting for 23%, 12% and 10% each. Three customers individually comprised more than 10% of trade accounts receivable atDecember 31, 2019 , with the customers accounting for 31%, 11% and 10% each. One customer in our Napster segment accounted for 13% of consolidated revenue, or$10.5 million , during the six months endedJune 30, 2020 . One customer in our Napster segment accounted for 14% of consolidated revenue, or$12.0 million , during the six months endedJune 30, 2019 . While we currently have no planned significant capital expenditures for the remainder of 2020 other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases. As discussed in Note 5 Acquisitions, we acquired a controlling interest in Napster onJanuary 18, 2019 . We paid initial cash consideration of$0.2 million in the first quarter of 2019 and the remaining$0.8 million of initial cash consideration is accrued as a current liability. We also have recognized a liability for the estimated fair value of the contingent consideration related to the acquisition. As discussed in Note 5 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 ofJune 30, 2020 , the estimated fair value of the contingent consideration was$12.4 million , with$5.4 million recognized as a current liability and$7.0 million as a long-term liability. Any future amountsRealNetworks pays for contingent consideration could vary materially from the estimated amounts we have accrued as ofJune 30, 2020 . InAugust 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 8 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 ofJune 30, 2020 ,$3.9 million had been drawn on the revolving line of credit, and any further advances will be used for working capital and general corporate purposes. 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. We currently believe existing unrestricted cash balances, 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. However, 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. 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 pandemic and related financial impacts. 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 byRealNetworks . Significant financial distress at Napster could have negative implications in our assessment of goodwill and long-lived assets onRealNetworks' 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 30 -------------------------------------------------------------------------------- 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. Our revenue and expenses are primarily denominated inU.S. dollars. For our foreign operations, the majority of our revenues and expenses are denominated in other currencies, such as the euro, Brazilian real, 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 intoU.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 ofJune 30, 2020 , approximately$8.8 million of the$19.7 million of cash and cash equivalents was held by our foreign subsidiaries outside theU.S. Off-Balance Sheet Arrangements We do not maintain accruals associated with certain guarantees, as discussed in Note 19 Guarantees, to the consolidated financial statements included in Item 8 of Part II of our 2019 10-K. Thus, these guarantee obligations constitute off-balance sheet arrangements. 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 estimates are discussed in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of our annual report on Form 10-K for the year endedDecember 31, 2019 . Due to the coronavirus pandemic, there has been uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require updates to our estimates or judgments or require us to revise the carrying value of our assets or liabilities. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions. 31
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