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 2019 acquisition of a controlling interest in Napster and the anticipated sale of Napster in the fourth quarter of 2020, 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. 23 --------------------------------------------------------------------------------
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 three segments: (1) Consumer Media (2) Mobile Services, and (3) Games. 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.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 described in Note 5 Acquisitions and Dispositions,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 consolidated Napster's financial results into our financial statements, where Napster was reported as a separate segment. OnAugust 25, 2020 ,RealNetworks entered into a Support Agreement datedAugust 25, 2020 by and among its 84%-owned subsidiary, Napster, and MelodyVR Group PLC ("MelodyVR"), an English public limited company. The Support Agreement was executed in connection with an Agreement and Plan of Merger by and among Napster,MelodyVR , and their wholly owned subsidiary ("Merger Sub"). Pursuant to the Merger Agreement, Merger Sub will merge with and into Napster, with Napster surviving and becoming a wholly owned subsidiary ofMelodyVR (the "Transaction"). Other than as Securityholder Representative,RealNetworks is not a party to the Merger Agreement. Pursuant to the merger transaction, the transaction is valued at approximately$70 million asMelodyVR will assume approximately$44 million of Napster's payment obligations, primarily relating to music licensing, andMelodyVR will pay consideration of approximately$26.3 million to certain holders of debt and equity of Napster, comprised of$12.0 million in cash and approximately$11.3 million in the form of ordinary shares ofMelodyVR and subject to a$3.0 million 18-month indemnity escrow. The shares ofMelodyVR thatRealNetworks receives may not be sold or transferred, except in limited circumstances, for a period of one year. At the time of closing, the consideration will be applied to the full repayment of the advance to Napster on the revolving line of credit, as discussed in Note 8 Debt, payment of Napster's transaction expenses, and payment of amounts payable to certain of Napster's common stockholders. The final value toRealNetworks from the transaction is subject to the allocation to recipients of cash andMelodyVR equity, the market value ofMelodyVR equity, payment to the party from which a 42% equity interest was acquired inJanuary 2019 , transaction expenses, and the eventual payout of the indemnity escrow. The transaction is currently expected to close in the fourth quarter of 2020. Effective on the execution of the Agreement and Plan of Merger onAugust 25, 2020 , Napster is being treated as a discontinued operation and held-for-sale for accounting and disclosure purposes. As such, Napster's operating results and financial condition have been recast to conform to this presentation. 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 24 -------------------------------------------------------------------------------- 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 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 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 or into fiscal 2021, due to numerous uncertainties, including the duration and severity of the pandemic and containment measures. We will continue to monitor and evaluate the effects to our businesses and adjust our plans as needed. Financial Results As ofSeptember 30, 2020 , we had$13.2 million in unrestricted cash and cash equivalents, compared to$8.5 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 a promissory note issued in the second quarter of 2020 pursuant to the PPP of the CARES Act, withRealNetworks receiving$2.9 million . A subsidiary ofRealNetworks , Scener, also received$2.1 million in the third quarter of 2020, in return for issuing SAFE Notes, as described in Note 6 Fair Value Measurements. These increases were partially offset by our ongoing cash flows used in operating activities, which totaled$10.0 million for the first nine months of 2020. The following discussion reflectsRealNetworks' results from continuing operations. Condensed consolidated results were as follows (in thousands): Quarter Ended September 30, Nine months ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Total revenue$ 16,554 $ 17,691 $ (1,137) (6) %$ 50,461 $ 48,491 $ 1,970 4 % Cost of revenue 4,062 4,292 (230) (5) % 12,429 13,022 (593) (5) % Gross profit 12,492 13,399 (907) (7) % 38,032 35,469 2,563 7 % Gross margin 75 % 76 % 75 % 73 % Operating expenses 15,342 18,508 (3,166) (17) % 48,504 58,201 (9,697) (17) % Operating loss$ (2,850) $ (5,109) $ 2,259 44 %$ (10,472) $ (22,732) $ 12,260 54 % In the third quarter of 2020, our total consolidated revenue decreased$1.1 million as compared with the year-earlier period. For the third quarter of 2020 compared to the prior year period, our Consumer Media and Mobile Services segment revenues decreased by$1.5 million . These decreases were partially offset by an increase in revenues in our Games segment of$0.4 million . See below for further discussion of our segment results. Cost of revenue decreased by$0.2 million for the quarter endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to decreases in our Mobile Services segment. Operating expenses decreased by$3.2 million in the quarter endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to lower salaries and benefits and professional service fees of$2.2 million . For the nine months endedSeptember 30, 2020 , our total consolidated revenue increased$2.0 million as compared with the year-earlier period. Our Games and Consumer Media segment revenues increased by$2.8 million and$0.5 million , respectively, and were partially offset by the revenue decline in our Mobile Services segment of$1.3 million . See below for further discussion of our segment results. Cost of revenue decreased by$0.6 million for the nine months endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to a total decrease of$1.2 million in our Consumer Media and Mobile Services segments, partially offset by a$0.4 million increase in our Games segment. Operating expenses decreased by$9.7 million for the nine months endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to reductions in salaries and benefits of$5.7 million and lower professional service fees of$1.5 million , primarily driven by Napster acquisition costs incurred in the prior year period. 25 -------------------------------------------------------------------------------- Segment Operating Results Consumer Media Consumer Media segment results of operations were as follows (in thousands): Quarter Ended September 30, Nine Months Ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Revenue$ 2,543 $ 3,632 $ (1,089) (30) %$ 9,197 $ 8,738 $ 459 5 % Cost of revenue 593 705 (112) (16) % 1,723 2,341 (618) (26) % Gross profit 1,950 2,927 (977) (33) % 7,474 6,397 1,077 17 % Gross margin 77 % 81 % 81 % 73 % Operating expenses 2,092 2,692 (600) (22) % 6,754 8,688 (1,934) (22) % Operating income (loss)$ (142) $ 235 $ (377) NM$ 720 $ (2,291) $ 3,011 NM Total Consumer Media revenue for the quarter endedSeptember 30, 2020 decreased$1.1 million as compared to the same quarter in 2019, due primarily to lower software license revenues of$1.3 million and lower subscription services of$0.1 million , partially offset by higher advertising and other revenue of$0.3 million . The overall increase in advertising and other revenue was due to the non-recurring recognition of previously deferred third-party software product distribution revenue in the amount of$0.6 million . Software License For our software license revenues, the$1.3 million decrease was primarily due to the recognition of revenue on a contract that was effectuated and recognized in the third quarter of 2019. Also contributing to the decrease was 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 endedSeptember 30, 2020 decreased$0.1 million compared with the year-earlier period. This was primarily due to reductions in salaries and benefits. Operating expenses decreased$0.6 million as compared with the year-earlier period, primarily due to reductions in salaries and benefits from headcount reductions and lower professional fees. Total Consumer Media revenue for the nine months endedSeptember 30, 2020 increased$0.5 million as compared to the prior year, due primarily to higher software license revenues of$0.7 million and higher advertising and other revenue of$0.2 million , partially offset by lower subscription services revenues of$0.4 million , described more fully below. 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. This increase was partially offset by the recognition of revenue on a contract that was effectuated and recognized in the third quarter of 2019. While we experienced an increase in software license revenues for the nine months endedSeptember 30, 2020 , 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$0.4 million decrease was primarily due to declines in our legacy subscription products, which will continue to organically decline. Cost of revenue for the nine months endedSeptember 30, 2020 decreased$0.6 million compared with the year-earlier period. This was primarily due to reductions in salaries and benefits. Operating expenses decreased$1.9 million as compared with the year-earlier period, primarily due to reductions in salaries and benefits from headcount reductions, and lower marketing expenses. 26 -------------------------------------------------------------------------------- Mobile Services Mobile Services segment results of operations were as follows (in thousands): Quarter Ended September 30, Nine Months Ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Revenue$ 6,400 $ 6,895 $ (495) (7) %$ 19,551 $ 20,831 $ (1,280) (6) % Cost of revenue 1,511 1,721 (210) (12) % 4,989 5,634 (645) (11) % Gross profit 4,889 5,174 (285) (6) % 14,562 15,197 (635) (4) % Gross margin 76 % 75 % 74 % 73 % Operating expenses 5,577 7,143 (1,566) (22) % 18,847 22,142 (3,295) (15) % Operating loss$ (688) $ (1,969) $ 1,281 65 %$ (4,285) $ (6,945) $ 2,660 38 % Total Mobile Services revenue decreased by$0.5 million in the quarter endedSeptember 30, 2020 compared with the prior-year period. The revenue decrease was primarily due to lower subscription services revenues in our ringback tones business of$0.6 million . Cost of revenue decreased by$0.2 million in the quarter endedSeptember 30, 2020 compared with the prior-year period, due primarily to reductions in salaries and benefits related to headcount reductions. Operating expenses decreased by$1.6 million for the quarter endedSeptember 30, 2020 compared with the year-earlier period due to reductions in salaries and benefits of$1.1 million and lower marketing expenses of$0.2 million . Lower professional service fees and facility costs also contributed to the decrease. Total Mobile Services revenue decreased by$1.3 million in the nine months endedSeptember 30, 2020 compared with the prior-year period. The revenue decrease was primarily due to lower subscription services revenues of$1.5 million , partially offset by a$0.3 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$1.9 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$0.6 million in the nine months endedSeptember 30, 2020 compared with the prior-year period, due primarily to reductions in salaries and benefits related to headcount reductions. Operating expenses decreased by$3.3 million for the nine months endedSeptember 30, 2020 compared with the year-earlier period, due primarily to a reduction in salaries and benefits of$1.6 million , lower marketing expenses of$1.3 million and lower facility costs of$0.4 million . Games Games segment results of operations were as follows (in thousands): Quarter Ended September 30, Nine Months Ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Revenue$ 7,611 $ 7,164 $ 447 6 %$ 21,713 $ 18,922 $ 2,791 15 % Cost of revenue 1,955 1,934 21 1 % 5,707 5,259 448 9 % Gross profit 5,656 5,230 426 8 % 16,006 13,663 2,343 17 % Gross margin 74 % 73 % 74 % 72 % Operating expenses 5,152 5,151 1 - % 15,051 15,476 (425) (3) % Operating income (loss)$ 504 $ 79 $ 425 538 %$ 955 $ (1,813) $ 2,768 NM Total Games revenue increased$0.4 million for the quarter endedSeptember 30, 2020 as compared with the year-earlier period due primarily to increases of$0.8 million in product sales revenues, partially offset by a$0.4 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 27 -------------------------------------------------------------------------------- Our subscription sales decreased$0.4 million as a result of lower subscribers in the third quarter of 2020. Product Sales Our product sales increased$0.8 million as a result of higher in-game purchases of$1.4 million compared to the prior-year period, partially offset by lower sales of games of$0.6 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 were flat when compared to the prior year period. Cost of revenue was flat when compared to the prior year period. Operating expenses were unchanged in the quarter endedSeptember 30, 2020 when compared with the prior-year period as higher marketing costs during the period were offset by lower salaries and benefits and professional service fees and development costs. Total Games revenue increased$2.8 million for the nine months endedSeptember 30, 2020 as compared with the year-earlier period due primarily to increases of$3.3 million in product sales revenues and$0.4 million in advertising and other revenues, partially offset by a$0.9 million decrease in our subscription services revenues. Subscription Services Our subscription sales decreased$0.9 million as a result of lower subscribers in 2020. Product Sales Our product sales increased$3.3 million as a result of higher in-game purchases of$5.5 million compared to the prior-year period, partially offset by lower sales of games of$2.1 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 nine months endedSeptember 30, 2020 when compared with the prior-year period due primarily to higher app store fees of$1.0 million , partially offset by lower publisher license and service royalties of$0.4 million . Operating expenses decreased$0.4 million in the nine months endedSeptember 30, 2020 when compared with the prior-year period, due to lower salaries and benefits of$1.1 million and professional service fees and development costs of$1.0 million , offset by higher marketing expenses of$1.7 million . Corporate Corporate results of operations were as follows (in thousands): Quarter Ended September 30, Nine Months Ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Cost of revenue $ 3$ (68) $ 71 NM$ 10 $ (212) $ 222 NM Operating expenses 2,521 3,522 (1,001) (28) % 7,852 11,895 (4,043) (34) % Operating loss$ (2,524) $ (3,454) $ 930 27 %$ (7,862) $ (11,683) $ 3,821 33 % Operating expenses decreased by$1.0 million in the quarter endedSeptember 30, 2020 compared with the year-earlier period, primarily due to lower restructuring and other charges of$0.4 million and professional service fees of$0.2 million . Operating expenses decreased by$4.0 million for the nine months endedSeptember 30, 2020 compared with the year-earlier period, primarily due to a reduction in salaries and benefits of$1.5 million , lower professional fees of$0.7 million , and lower restructuring and other charges of$0.5 million . 28 -------------------------------------------------------------------------------- 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, changes in the fair value of the contingent consideration liability, and restructuring charges. Operating expenses were as follows (in thousands): Quarter Ended September 30, Nine Months Ended September 30, 2020 2019 $ Change % Change 2020 2019 $ Change % Change Research and development$ 5,781 $ 6,931 $ (1,150) (17) %$ 18,375 $ 21,439 $ (3,064) (14) % Sales and marketing 5,130 5,644 (514) (9) % 15,969 17,501 (1,532) (9) % General and administrative 4,124 5,242 (1,118) (21) % 13,063 17,674 (4,611) (26) % Restructuring and other charges 307 691 (384) (56) % 1,097 1,587 (490) (31) % Total consolidated operating expenses$ 15,342 $ 18,508 $ (3,166) (17) %$ 48,504 $ 58,201 $ (9,697) (17) % Research and development expenses decreased by$1.2 million in the quarter endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to a reduction in salaries and benefits of$0.7 million and lower professional service fees and development costs of$0.4 million . Research and development expenses decreased by$3.1 million for the nine months endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to a reduction in salaries and benefits of$1.5 million and lower professional service fees and development costs of$1.3 million . Sales and marketing expenses decreased$0.5 million in the quarter endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to a$0.8 million reduction in salaries and benefits, partially offset by a$0.3 million increase in marketing expense. Sales and marketing expenses decreased$1.5 million in the nine months endedSeptember 30, 2020 as compared with the year-earlier period due primarily to lower salaries and benefits of$2.2 million , partially offset by an increase of$0.5 million of professional services fees and marketing expense. General and administrative expenses decreased by$1.1 million in the quarter endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to a lower professional service fees of$0.3 million and salaries and benefits of$0.2 million . General and administrative expenses decreased by$4.6 million in the nine months endedSeptember 30, 2020 as compared with the year-earlier period, primarily due to a reduction in salaries and benefits of$2.0 million and infrastructure costs of$0.6 million . Lower professional service fees also contributed as we incurred$1.1 million of Napster acquisition costs in the year-earlier period. 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 September 30, Nine Months Ended September 30, 2020 2019 $ Change 2020 2019 $ Change Interest expense$ (7) $ -$ (7) $ (12) $ -$ (12) Interest income 6 - 6 31 89 (58) Gain (loss) on equity investment, net (37) - (37) (90) 12,338 (12,428) Other income (expense), net (104) 85 (189) 63 197 (134) Total other income (expense), net$ (142) $ 85
Gain (loss) on equity investment, net, for the nine months endedSeptember 30, 2019 included a$12.3 million gain in the first quarter of 2019 related toRealNetworks' acquisition of Napster, as described in more detail in Note 5 Acquisitions and Dispositions. The fluctuations in Other income (expense) primarily relate to foreign exchange gains and losses. 29 -------------------------------------------------------------------------------- Income Taxes We recognized income tax expense of$0.3 million and$0.2 million during the quarters endedSeptember 30, 2020 and 2019, respectively, related toU.S. and foreign income taxes. During the nine months endedSeptember 30, 2020 and 2019, we recognized income tax expense of$0.6 million and$0.5 million , respectively, related toU.S. and foreign income taxes. As ofSeptember 30, 2020 ,RealNetworks has$0.5 million in uncertain tax positions. 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 as of the third 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 endedSeptember 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 third 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): September 30, 2020 December 31, 2019 Working capital $ (4,696) $ 2,664 Cash and cash equivalents 13,245 8,472 Restricted cash equivalents 4,630 4,880 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. the cash proceeds of$2.9 million from the PPP promissory note issued in the second quarter of 2020, as described in Note 8 Debt and$2.1 million in cash received by Scener, a subsidiary ofRealNetworks , during the third quarter of 2020 in return for issuing rights to investors for certain shares of Scener's capital stock through the SAFE Notes, as described in Note 6 Fair Value Measurements. The increase was partially offset by our ongoing cash flows used in operating activities, which totaled$10.0 million in the first nine months of 2020. The following summarizes cash flow activity (in thousands): Nine
Months Ended
2020 2019
Cash used in operating activities $ (10,033) $ (18,309)
Cash (used in) provided by investing activities (261) 11,453
Cash provided by financing activities 14,970 4,086
Cash used in operating activities consisted of net income (loss) from continuing
operations 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 $8.3 million lower in the nine months
ended September 30, 2020 as compared to the same period in 2019. This
improvement was primarily due to our lower operating loss recorded for the nine
months ended September 30, 2020 compared to the prior year period.
For the nine months ended September 30, 2020 , cash used by investing activities
consisted of fixed asset purchases of $0.3 million .
For the nine months ended September 30, 2019 , cash provided by investing
activities of $11.5 million was primarily due to our acquisition of Napster on
January 18, 2019 . Our initial cash consideration paid at closing of $0.2 million
was offset by
30
--------------------------------------------------------------------------------
the cash, cash equivalents and restricted cash on Napster's balance sheet at
that date. The increase was offset in part by fixed asset purchases of $0.8
million .
Cash provided by financing activities for the nine months ended September 30,
2020 was $15.0 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 PPP promissory note proceeds of $2.9 million issued in the second
quarter of 2020. Additionally, Scener, a subsidiary of RealNetworks , received
$2.1 million in funds in the third quarter of 2020 from the issuance of SAFE
Notes. See Note 6 Fair Value Measurements, Note 8 Debt, and Note 13 Related
Party Transactions for additional details.
Cash provided by financing activities for the nine months ended September 30,
2019 was $4.1 million . This cash inflow was primarily due proceeds from
borrowing on our revolving credit facility of $3.9 million . See Note 8 Debt for
additional details.
Two customers accounted for more than 10% of trade accounts receivable as of
September 30, 2020 , with the customers accounting for 26% and 14% each. Two
customers individually comprised more than 10% of trade accounts receivable at
December 31, 2019 , with the customers accounting for 26% and 11% each. Two
customers accounted for 26% of consolidated revenue, or $13.3 million , during
the nine months ended September 30, 2020 . One customer accounted for 14% of
consolidated revenue, or $6.6 million , during the nine months ended September
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 and Dispositions, we acquired a controlling
interest in Napster on January 18, 2019 , and, as part of the purchase, we paid
initial cash consideration of $0.2 million in the first quarter of 2019.
Subsequent to RealNetworks' January 18, 2019 acquisition, Napster has continued
to operate as an independent business with its own board of directors, strategy
and leadership team.
On August 25, 2020 , we entered into a transaction with MelodyVR to sell our
controlling interest in Napster, and the transaction is expected to close in the
fourth quarter of 2020. The transaction is valued at approximately $70 million
as MelodyVR will assume approximately $44 million of Napster's payment
obligations, primarily relating to music licensing, and MelodyVR will pay
consideration of approximately $26.3 million to certain holders of debt and
equity of Napster, comprised of $12.0 million in cash and approximately $11.3
million in the form of ordinary shares of MelodyVR and subject to a $3.0 million
18-month indemnity escrow. The shares of MelodyVR that RealNetworks receives may
not be sold or transferred, except in limited circumstances, for a period of one
year. At the time of closing, the consideration will be applied to the full
repayment of the advance to Napster on the revolving line of credit, as
discussed in Note 8 Debt, payment of Napster's transaction expenses, and payment
of amounts payable to certain of Napster's common stockholders. The final value
to RealNetworks from the transaction is subject to the allocation to recipients
of cash and MelodyVR equity, the market value of MelodyVR equity, payment to the
party from which a 42% equity interest was acquired in January 2019 , transaction
expenses, and the eventual payout of the indemnity escrow.
As of September 30, 2020 , the estimated fair value of the contingent
consideration, associated with the January 2019 purchase of the controlling
interest in Napster, was $12.4 million . The fair value of the contingent
consideration is included in RealNetworks' current liabilities in the
consolidated balance sheet. Any future amounts RealNetworks pays for contingent
consideration could vary materially from the estimated amounts we have accrued
as of September 30, 2020 .
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 8 Debt, the bank extended a two-year revolving line of
credit not to exceed $10.0 million in the aggregate. As of September 30, 2020 ,
$3.9 million had been drawn on the revolving line of credit. As discussed above,
we expect to make a full repayment on this line of credit at the time of closing
on the sale of our controlling interest in Napster to MelodyVR . Any future
advances are expected to 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,
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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.
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 revenue and expenses are primarily denominated in U.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 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 September 30, 2020 , approximately $8.4 million of the $13.2 million of
cash and cash equivalents was held by our foreign subsidiaries outside the U.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 ended
December 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.
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