10-Q 1 q210q2019.htm 10-Q Document



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2019
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 1-37745
 
 RealNetworks, Inc.
 
 
(Exact name of registrant as specified in its charter)
 
Washington
 
91-1628146
(State of incorporation)
 
(I.R.S. Employer
Identification Number)
1501 First Avenue South, Suite 600
Seattle, Washington
 
98134
(Address of principal executive offices)
 
(Zip Code)
 
(206) 674-2700
 
 
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
ý
Non-accelerated filer
 
¨  
  
Smaller reporting company
ý
 
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   ý
Title of each class
 
Trading Symbol(s)
 
Name of each exchange on which registered
Common Stock, Par Value $0.001 per share
 
RNWK
 
The NASDAQ Stock Market
Preferred Share Purchase Rights
 
RNWK
 
The NASDAQ Stock Market
The number of shares of the registrant’s Common Stock outstanding as of July 31, 2019 was 38,049,868.




TABLE OF CONTENTS
 

2



PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
June 30,
2019
 
December 31,
2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
26,339

 
$
35,561

Short-term investments

 
24

Trade accounts receivable, net of allowances of $644 and $560
31,957

 
11,751

Deferred costs, current portion
465

 
331

Prepaid expenses and other current assets
20,382

 
5,911

Total current assets
79,143

 
53,578

Equipment, software, and leasehold improvements, at cost:
 
 
 
Equipment and software
32,079

 
37,458

Leasehold improvements
3,319

 
3,292

Total equipment, software, and leasehold improvements, at cost
35,398

 
40,750

Less accumulated depreciation and amortization
32,268

 
37,996

Net equipment, software, and leasehold improvements
3,130

 
2,754

Operating lease assets
13,672

 

Restricted cash equivalents
2,124

 
1,630

Other assets
2,739

 
3,997

Deferred costs, non-current portion
797

 
528

Deferred tax assets, net
854

 
851

Other intangible assets, net
21,616

 
26

Goodwill
65,395

 
16,955

Total assets
$
189,470

 
$
80,319

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
5,224

 
$
3,910

Accrued royalties, fulfillment and other current liabilities
97,951

 
11,312

Commitment to Napster

 
2,750

Deferred revenue, current portion
6,054

 
2,125

Notes payable
7,878

 

Total current liabilities
117,107

 
20,097

Deferred revenue, non-current portion
179

 
268

Deferred rent

 
986

Deferred tax liabilities, net
1,262

 
1,168

Long-term lease liabilities
10,384

 

Other long-term liabilities
11,070

 
960

Total liabilities
140,002

 
23,479

Commitments and contingencies

 


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

 

Undesignated series: authorized 59,800 shares

 

Common stock, $0.001 par value authorized 250,000 shares; issued and outstanding 38,049 shares in 2019 and 37,728 shares in 2018
37

 
37

Additional paid-in capital
642,720

 
641,930

Accumulated other comprehensive loss
(61,697
)
 
(61,118
)
Retained deficit
(531,678
)
 
(524,009
)
Total shareholders’ equity
49,382

 
56,840

Noncontrolling interests
86

 

Total equity
49,468

 
56,840

Total liabilities and equity
$
189,470

 
$
80,319

See accompanying notes to unaudited condensed consolidated financial statements.

3



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
 
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Net revenue
$
44,248

 
$
15,724

 
$
83,720

 
$
35,374

Cost of revenue
27,282

 
4,625

 
52,152

 
9,761

Gross profit
16,966

 
11,099

 
31,568

 
25,613

Operating expenses:
 
 
 
 
 
 
 
Research and development
8,876

 
7,652

 
17,709

 
15,346

Sales and marketing
8,360

 
4,883

 
16,502

 
10,880

General and administrative
8,392

 
5,339

 
16,756

 
10,940

Restructuring and other charges
729

 
187

 
896

 
688

Lease exit and related benefit

 
(129
)
 

 
(454
)
Total operating expenses
26,357

 
17,932

 
51,863

 
37,400

Operating loss
(9,391
)
 
(6,833
)
 
(20,295
)
 
(11,787
)
Other income (expenses):
 
 
 
 
 
 
 
Interest expense
(43
)
 

 
(209
)
 

Interest income
40

 
111

 
117

 
198

Gain (loss) on equity investment, net

 

 
12,338

 

Other income (expenses), net
183

 
(42
)
 
310

 
(83
)
Total other income (expenses), net
180

 
69

 
12,556

 
115

Income (loss) before income taxes
(9,211
)
 
(6,764
)
 
(7,739
)
 
(11,672
)
Income tax expense
244

 
166

 
502

 
436

Net income (loss) including noncontrolling interests
(9,455
)
 
(6,930
)
 
(8,241
)
 
(12,108
)
Net income (loss) attributable to noncontrolling interests
(253
)
 

 
(572
)
 

Net income (loss) attributable to RealNetworks
$
(9,202
)
 
$
(6,930
)
 
$
(7,669
)
 
$
(12,108
)
 
 
 
 
 
 
 
 
Net income (loss) per share attributable to RealNetworks- Basic
$
(0.24
)
 
$
(0.18
)
 
$
(0.20
)
 
$
(0.32
)
Net income (loss) per share attributable to RealNetworks- Diluted
$
(0.24
)
 
$
(0.18
)
 
$
(0.20
)
 
$
(0.32
)
Shares used to compute basic net income (loss) per share
37,948

 
37,577

 
37,885

 
37,514

Shares used to compute diluted net income (loss) per share
37,948

 
37,577

 
37,885

 
37,514

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

 
$
2

 
$

 
$
3

Foreign currency translation adjustments, net of reclassification adjustments
(492
)
 
(1,604
)
 
(579
)
 
(1,208
)
Total other comprehensive income (loss)
(492
)
 
(1,602
)
 
(579
)
 
(1,205
)
Net income (loss) including noncontrolling interests
(9,455
)
 
(6,930
)
 
(8,241
)
 
(12,108
)
Comprehensive income (loss) including noncontrolling interests
(9,947
)
 
(8,532
)
 
(8,820
)
 
(13,313
)
Comprehensive income (loss) attributable to noncontrolling interests
(253
)
 

 
(572
)
 

Comprehensive income (loss) attributable to RealNetworks
$
(9,694
)
 
$
(8,532
)
 
$
(8,248
)
 
$
(13,313
)
See accompanying notes to unaudited condensed consolidated financial statements.

4



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Six Months Ended
June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income (loss) including noncontrolling interests
$
(8,241
)
 
$
(12,108
)
Adjustments to reconcile net income (loss) including noncontrolling interests to net cash used in operating activities:
 
 
 
Depreciation and amortization
2,959

 
1,231

Stock-based compensation
1,917

 
1,614

Deferred income taxes, net

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

Foreign currency (gain) loss
(315
)
 

Fair value adjustments to contingent consideration liability
300

 

Mark to market adjustment of warrants

 
50

Net change in certain operating assets and liabilities:
 
 
 
Trade accounts receivable
671

 
16,960

Prepaid expenses, operating lease and other assets
(328
)
 
(1,633
)
Accounts payable
398

 
(16,601
)
Accrued, lease and other liabilities
(1,122
)
 
(2,231
)
Net cash used in operating activities
(16,099
)
 
(12,730
)
Cash flows from investing activities:
 
 
 
Purchases of equipment, software, and leasehold improvements
(873
)
 
(580
)
Proceeds from sales and maturities of short-term investments
24

 
5,726

Acquisition, net of cash acquired
12,260

 
(4,192
)
Net cash provided by investing activities
11,411

 
954

Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock (stock options and stock purchase plan)
144

 
114

Tax payments from shares withheld upon vesting of restricted stock
(287
)
 
(243
)
Proceeds from notes payable
19,760

 

Repayments of notes payable
(24,018
)
 

Other financing activities
450

 

Net cash provided by (used in) financing activities
(3,951
)
 
(129
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(89
)
 
(731
)
Net increase (decrease) in cash, cash equivalents and restricted cash
(8,728
)
 
(12,636
)
Cash, cash equivalents and restricted cash, beginning of period
37,191

 
53,596

Cash, cash equivalents, and restricted cash end of period
$
28,463

 
$
40,960

See accompanying notes to unaudited condensed consolidated financial statements.

5



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

 
$
37

 
$
638,727

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

 
$

 
$
79,173

Cumulative effect of revenue recognition accounting change
 


 


 


 


 
1,024

 
1,024

 

 
1,024

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

 

 
(232
)
 

 

 
(232
)
 

 
(232
)
Stock-based compensation
 

 

 
1,157

 

 

 
1,157

 

 
1,157

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

 

 

 
1

 

 
1

 

 
1

Foreign currency translation adjustments
 

 

 

 
396

 

 
396

 

 
396

Net income (loss)
 

 

 

 

 
(5,178
)
 
(5,178
)
 

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

 
$
37

 
$
639,652

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

 
$

 
$
76,342

Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock
 
48

 

 
103

 

 

 
103

 

 
103

Stock-based compensation
 

 

 
457

 

 

 
457

 

 
457

Investments unrealized gains (losses), net of tax effects of $1
 

 

 

 
2

 

 
2

 

 
2

Foreign currency translation adjustments
 
 
 
 
 
 
 
(1,604
)
 
 
 
(1,604
)
 
 
 
(1,604
)
Net income (loss)
 

 

 

 

 
(6,930
)
 
(6,930
)
 

 
(6,930
)
Balances, June 30, 2018
 
37,612

 
$
37

 
$
640,212

 
$
(60,752
)
 
$
(511,127
)
 
$
68,370

 
$

 
$
68,370

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

 
$
37

 
$
641,930

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

 
$

 
$
56,840

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

 

 
(271
)
 

 

 
(271
)
 

 
(271
)
Napster acquisition
 

 

 
(1,346
)
 

 

 
(1,346
)
 
570

 
(776
)
Stock-based compensation
 

 

 
1,384

 

 

 
1,384

 

 
1,384

Foreign currency translation adjustments
 

 

 

 
(87
)
 

 
(87
)
 

 
(87
)
Net income (loss)
 

 

 

 

 
1,533

 
1,533

 
(319
)
 
1,214

Other equity transactions
 

 

 
362

 

 

 
362

 
88

 
450

Balances, March 31, 2019
 
37,918

 
$
37

 
$
642,059

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

 
$
339

 
$
58,754

Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares
 
131

 

 
128

 

 

 
128

 

 
128

Stock-based compensation
 

 

 
533

 

 

 
533

 

 
533

Foreign currency translation adjustments
 

 

 

 
(492
)
 

 
(492
)
 

 
(492
)
Net income (loss)
 

 

 

 

 
(9,202
)
 
(9,202
)
 
(253
)
 
(9,455
)
Balances, June 30, 2019
 
38,049

 
$
37

 
$
642,720

 
$
(61,697
)
 
$
(531,678
)
 
$
49,382

 
$
86

 
$
49,468


See accompanying notes to unaudited condensed consolidated financial statements.

6




REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Six Months Ended June 30, 2019 and 2018
Note 1
Description of Business and Summary of Significant Accounting Policies
Description of Business. RealNetworks, Inc. and subsidiaries is a leading global provider of network-delivered digital media applications and services that make it easy to manage, play, and share digital media. The Company also develops and markets software products and services that enable the creation, distribution, and consumption of digital media, including audio and video. Our Napster music business, which we acquired on January 18, 2019, offers a comprehensive set of digital music products and services designed to provide consumers with broad access to digital music. For more information on Napster, see Note 5 Acquisitions.
Inherent in our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services, and the ability to generate related revenue and cash flow.
In this Quarterly Report on Form 10-Q (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”.
Basis of Presentation. The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries in which it has a more than 50% voting interest. Noncontrolling interests primarily represent third-party ownership in the equity of Napster and are reflected separately in the Company’s financial statements. Intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2019. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).
These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2018 (the 10-K).
Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Note 2
Recent Accounting Pronouncements
Recently adopted accounting pronouncements
In February 2016, the Financial Accounting Standards Board (FASB) issued new guidance related to the accounting for leases. A major change in the new guidance is that lessees are now required to present right-of-use assets and lease liabilities on the balance sheet. Enhanced disclosures are also required to give financial statement users the ability to assess the amount, timing and uncertainty of cash flows arising from leases. We adopted the new guidance effective January 1, 2019 and elected to apply the new guidance at the beginning of the year of adoption, rather than applying the new guidance retrospectively to each prior reporting period presented. In addition, we elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward historical lease classification. We have finalized our assessment of the impacts resulting from the new standard, including the impact on our internal controls. As a result of our evaluation, we have modified certain accounting policies and practices and existing controls. Adoption of the standard resulted in the recognition of $12.5 million of operating lease assets and $14.6 million of current and long-term operating lease liabilities as of January 1, 2019. The difference between the operating lease assets and lease liabilities recorded upon adoption relates to previously accrued deferred rent and lease exit and related charges included on our balance sheet as of December 31, 2018. Lease exit and related charges previously recorded pertain to the reduction in use of RealNetworks' office space and included estimates of sublease income expected to be received. The new guidance did not materially impact our consolidated statement of operations in the quarter of adoption or in the second quarter of 2019 and did not cause revision to

7



previously recorded estimates for lease exit charges. See Note 14 Leases for additional information about the new accounting standard.
In June 2018, the FASB issued new guidance related to the measurement and classification for share-based awards to non-employees. The new guidance essentially aligns the measurement and classification for these awards with that for share-based awards to employees. We adopted the new guidance effective January 1, 2019, with no material impact on our consolidated financial statements and related disclosures.
Recently issued accounting pronouncements not yet adopted
In January 2017, the FASB issued new guidance simplifying the test for goodwill impairment. The new guidance eliminates Step 2 from the goodwill impairment test, instead requiring an entity to recognize a goodwill impairment charge for the amount by which the reporting unit's carrying amount exceeds the reporting unit's fair value. This guidance is effective for interim and annual goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted. We are evaluating the impact of this guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
Note 3
Revenue Recognition
On January 1, 2018, we adopted the new revenue recognition standard by applying the modified retrospective approach to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under the new revenue recognition standard.
We recorded a net decrease to opening retained deficit of $1.0 million as of January 1, 2018 due to the cumulative impact of adopting the new revenue recognition standard. This impact primarily related to licensing of our RealPlayer product and full recognition of non-recurring engineering fees, which were previously deferred and amortized over the life of the contract.
We generate all of our revenue through contracts with customers. Revenue is either recognized over time as the service is provided, or at a point in time when the product is transferred to the customer, depending on the contract type. Our performance obligations typically have an original duration of one year or less.
Napster revenue arrangements include subscription services to the Napster music streaming service sold either directly to end users (direct to consumer) or through partners (business to business), who are generally telecommunications companies, that bundle the subscription with their own services or collect payment for the stand-alone subscriptions from their end customers. Napster also sells subscriptions to third parties to provide access to the Napster platform that is typically embedded in the third party's branded or co-branded service. Such subscriptions are included in the business to business sales channel.
For services sold through third parties to end customers, we evaluate the presentation of revenue on a gross or net basis based on whether we control the service provided to the end-user and are the principal (i.e. “gross”), or we arrange for other parties to provide the service to the end-user and are an agent (i.e. “net”). In our Napster business to business revenue stream, we generally operate as a principal in arrangements with end customers as we maintain control over the service prior to being transferred to the end customer.
Certain business to business customer arrangements include variable consideration based on usage. We estimate variable consideration as part of the total transaction price that is allocated to performance obligations, or distinct service periods within a performance obligation, on a relative standalone selling price basis.
Revenues related to Napster subscription services are recognized ratably over the contract period, typically 30 days. Direct to consumer subscriptions are paid in advance, typically on a monthly basis. Subscription services offered to businesses are invoiced on a monthly basis and the timing of payment generally does not vary significantly from the timing of invoice.

8



Disaggregation of Revenue
The following table presents our disaggregated revenue by source and segment (in thousands):
 
 
Quarter Ended June 30, 2019
 
Six Months Ended June 30, 2019
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Business Line
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Software License
 
$
944

 
$
957

 
$

 
$

 
$
1,679

 
$
1,556

 
$

 
$

Subscription Services
 
1,040

 
6,040

 
3,073

 
28,583

 
2,128

 
12,380

 
6,058

 
52,920

Product Sales
 
206

 

 
2,177

 

 
425

 

 
4,165

 

Advertising and Other
 
430

 

 
798

 

 
874

 

 
1,535

 

Total
 
$
2,620

 
$
6,997

 
$
6,048

 
$
28,583

 
$
5,106

 
$
13,936

 
$
11,758

 
$
52,920

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Business Line
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Software License
 
$
1,808

 
$
469

 
$

 
$

 
$
5,145

 
$
1,804

 
$

 
$

Subscription Services
 
1,225

 
6,250

 
2,689

 

 
2,510

 
13,619

 
5,382

 

Product Sales
 
299

 

 
1,953

 

 
639

 

 
4,355

 

Advertising and Other
 
552

 

 
479

 

 
1,073

 

 
847

 

Total
 
$
3,884

 
$
6,719

 
$
5,121

 
$

 
$
9,367

 
$
15,423

 
$
10,584

 
$

The following table presents our disaggregated revenue by sales channel (in thousands):
 
 
Quarter Ended June 30, 2019
 
Six Months Ended June 30, 2019
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Sales Channel
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Business to Business
 
$
1,375

 
$
6,881

 
$
1,115

 
$
13,804

 
$
2,553

 
$
13,698

 
$
2,151

 
$
25,899

Direct to Consumer
 
1,245

 
116

 
4,933

 
14,779

 
2,553

 
238

 
9,607

 
27,021

Total
 
$
2,620

 
$
6,997

 
$
6,048

 
$
28,583

 
$
5,106

 
$
13,936

 
$
11,758

 
$
52,920

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter Ended June 30, 2018
 
Six Months Ended June 30, 2018
 
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
 
Consumer Media
 
Mobile Services
 
Games
 
Napster
Sales Channel
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Business to Business
 
$
2,360

 
$
6,573

 
$
836

 
$

 
$
6,218

 
$
15,103

 
$
1,587

 
$

Direct to Consumer
 
1,524

 
146

 
4,285

 

 
3,149

 
320

 
8,997

 

Total
 
$
3,884

 
$
6,719

 
$
5,121

 
$

 
$
9,367

 
$
15,423

 
$
10,584

 
$

Contract Balances
The timing of revenue recognition may differ from the timing of invoicing to our customers. We record accounts receivable when the right to consideration becomes unconditional, except for the passage of time. For certain contracts, payment schedules may exceed one year; for those contracts we recognize a long-term receivable. As of June 30, 2019 and December 31, 2018, our balance of long-term accounts receivable was $0.1 million and $0.7 million, respectively, and is included in other long-term assets on our condensed consolidated balance sheets. The decrease in this balance from December 31, 2018 to June 30, 2019 is primarily due to the timing of expected cash receipts. During the quarter and six months ended June 30, 2019, we recorded no impairments to our contract assets.
We record deferred revenue when cash payments are received or due in advance of our completion of the underlying performance obligation. As of June 30, 2019, we had a deferred revenue balance of $6.2 million, an increase of $3.8 million from December 31, 2018, primarily due to deferred revenue associated with Napster.


9



Practical Expedients
For those contracts for which we recognize revenue at the amount to which we have the right to invoice for service performed, we do not disclose the value of any unsatisfied performance obligations. We also do not disclose the remaining unsatisfied performance obligations which have an original duration of one year or less. Additionally, we immediately expense sales commissions when incurred as the amortization period would have been less than one year. These costs are recorded within sales and marketing expense.
Note 4
Stock-Based Compensation
Total stock-based compensation expense recognized in our unaudited condensed consolidated statements of operations and comprehensive income (loss) includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
 
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Total stock-based compensation expense
$
533

 
$
457

 
$
1,917

 
$
1,614

The fair value of RealNetworks options granted determined using the Black-Scholes model used the following weighted-average assumptions:
 
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Expected dividend yield
0
%
 
0
%
 
0
%
 
0
%
Risk-free interest rate
2.26
%
 
2.72
%
 
2.32
%
 
2.59
%
Expected life (years)
3.8

 
3.8

 
4.1

 
4.0

Volatility
41
%
 
35
%
 
41
%
 
35
%
The total stock-based compensation amounts for 2019 and 2018 disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). Included in the expense for the six months ended June 30, 2019 and 2018 was stock compensation expense recorded in the first quarter of 2019 and 2018 related to our 2018 and 2017 incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2019 and 2018, respectively.
As of June 30, 2019, $3.1 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 3.1 years.
Note 5
Acquisitions
Napster
On January 18, 2019, RealNetworks acquired an additional 42% interest in Rhapsody International, Inc. (doing business as Napster) bringing our aggregate ownership to 84% of Napster's outstanding equity, thus giving RealNetworks a majority voting interest. Napster's music streaming service provides users with broad access to digital music, offering on-demand streaming and conditional downloads through unlimited access to a catalog of millions of music tracks. Napster offers music services worldwide and generates revenue primarily through subscriptions to its music services either directly to consumers or through distribution partners.
Initially formed in 2007 and branded then as Rhapsody, Napster began as a joint venture between RealNetworks and MTV Networks, a division of Viacom International, Inc. Prior to the acquisition of the additional 42% interest in Napster, we accounted for our investment using the equity method of accounting.
Following the January 2019 acquisition, RealNetworks has the right to nominate directors constituting a majority of the Napster board of directors, however, Napster will continue to operate as an independent business with its own board of directors, strategy and leadership team. We are consolidating Napster's financial results into our financial statements for fiscal periods following the closing of the acquisition, and Napster is reported as a separate segment in RealNetworks' consolidated financial statements. Napster, however, remains a distinct legal entity and RealNetworks assumes no ownership or control over the assets or liabilities of Napster.

10



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

11



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

Contingent consideration
 
11,600

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

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

Total consideration
 
$
21,708

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

Accounts receivable
 
20,838

Prepaid expenses and other current assets
 
12,879

Restricted cash
 
2,322

Equipment, software and leasehold improvements
 
474

Operating lease assets
 
2,314

Other long-term assets
 
77

Deferred tax assets, net
 
5,942

Intangible assets
 
23,700

Goodwill
 
48,474

  Total assets acquired
 
127,158

 
 
 
Accounts payable
 
937

Accrued royalties and fulfillment
 
71,980

Accrued and other current liabilities
 
7,475

Deferred revenue, current portion
 
3,600

Notes payable
 
12,115

Deferred tax liabilities, net
 
6,061

Long-term lease liabilities
 
1,197

Other long-term liabilities
 
1,515

   Total liabilities assumed
 
104,880

       Total net assets acquired
 
22,278

Noncontrolling interests
 
570

       Net assets acquired
 
$
21,708

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

12



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

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

 
Excess earnings
 
4 years
Customer relationships
 
5,900

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

 
Distributor method
 
8 years
Total
 
$
23,700

 
 
 
 
The estimated fair value amounts for each of these intangibles were determined using a fair value measurement categorized within Level 3 of the fair value hierarchy.
The fair value of the trade name and trademarks intangible asset was estimated using the income approach, utilizing the relief from royalty method, which values the assets by estimating the savings achieved by ownership of trade name and trademarks when compared with the cost of licensing them from an independent owner.
The fair value of developed technology was estimated using the income approach, utilizing the excess earnings method. Under this method, cash flows attributable to the asset are estimated by deducting economic costs, including operating expenses and contributory asset charges, from revenue expected to be generated by the asset.
The fair value of customer relationships was estimated using a cost-to-replace approach, whereby the number of subscribers and the cost to acquire subscribers are key estimates utilized in the valuation.
The fair value of partner relationships was estimated using the income approach, which uses market-based distributor data to value underlying distributor relationships. Revenue, earnings, and cash flow estimates associated with these underlying distributor relationships are key estimates in determining the fair value of the partner relationships intangibles.
The fair value of deferred revenue was estimated using the income approach, utilizing a cost to fulfill analysis by estimating the direct and indirect costs related to supporting remaining obligations plus an assumed operating margin.
The fair value of our preexisting 42% equity method investment has been remeasured to an estimated fair value of $2.7 million, which resulted in a pretax gain of $2.7 million, as our existing carrying value was zero. This gain, as well as the settlement of preexisting relationships and other purchase accounting adjustments discussed below, comprise the total gain of $12.3 million recognized in Other income (expenses) in the Consolidated statement of operations for the first quarter of 2019.
The fair value of our preexisting equity method investment was calculated using an average of the income and market approach to arrive at estimated total enterprise value. The income approach fair value measurement was based on significant inputs that are not observable in the market and thus represents a fair value measurement categorized within Level 3 of the fair value hierarchy. Key assumptions used in estimating future cash flows included projected revenue growth and operating expenses, as well as the selection of an appropriate discount rate. Estimates of revenue growth and operating expenses were based on internal projections and considered the historical performance of Napster's business. The discount rate applied was based on Napster's weighted-average cost of capital and included a small-company risk premium. The market approach fair value measurement was based on a market comparable methodology. We used a group of comparable companies and selected an appropriate EBITDA and revenue multiple to apply to Napster's trailing twelve months and projected 2019, 2020 and 2021 EBITDA (weighted 90%) and revenues (weighted 10%). Assumptions in both the income and market approaches are significant to the overall valuation of Napster and changes to these assumptions could materially impact the preliminary fair values of assets acquired and liabilities assumed, noncontrolling interests, total consideration, and gain on consolidation.
The fair value of the contingent consideration was estimated using multiple scenarios for each tranche of contingent consideration and then probability weighting each scenario and discounting them to estimated fair value of $11.6 million. This fair value calculation is directly impacted by the estimated total enterprise value described above. After the completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, the contingent consideration will be adjusted quarterly to fair value through earnings. Of the total amount of $11.6 million, we accrued $2.6 million and $9.0 million in Accrued royalties, fulfillment and other current liabilities, and Other long-term liabilities, respectively, as of March 31, 2019. See Note 6 Fair Value Measurements for details on the adjustment to this liability for the second quarter of 2019.
The effective settlement of Napster's debt and warrants totaling $6.4 million represents the estimated fair value of debt and warrants held between RealNetworks and Napster as of the acquisition date. The estimated fair value is derived from the estimated total enterprise value described above. The resulting net gain of $5.5 million is included in Other income (expenses) in the Consolidated statement of operations.

13



As discussed in Note 15 Commitments and Contingencies, the preexisting $2.8 million guarantee related to Napster's outstanding indebtedness on their revolving credit facility was eliminated upon the consolidation of Napster. This resulted in RealNetworks recording a gain of $2.8 million, which is included in Other income (expenses) in the Consolidated statement of operations.
Prior to our acquisition of Napster, we accounted for our investment under the equity method of accounting and recorded Napster 's foreign currency translation adjustments in our equity. As part of the acquisition method of accounting, we released these amounts and recorded a gain of $1.3 million, which is included in Other income (expenses) in the Consolidated statement of operations.
We recorded the fair value of noncontrolling interests on the acquisition date, estimated at $0.6 million, using the estimated total enterprise value described above.
We also recorded goodwill of $48.5 million, representing the intangible assets that do not qualify for separate recognition for accounting purposes, including the expected growth in Napster's business to business model and the assembled workforce. The goodwill is reported in our Napster segment and is not deductible for income tax purposes. As discussed above, during the measurement period, purchase price allocation adjustments or changes in assumptions used in determining the total estimated enterprise value of Napster could materially impact goodwill recognized. Moreover, future performance of the Napster business will factor into our goodwill impairment analysis.
We began consolidating Napster's results of operations and cash flows into our consolidated financial statements after January 18, 2019. For the quarter ended June 30, 2019, Napster's revenue and net loss including noncontrolling interests in our consolidated statements of operations was $28.6 million and $1.5 million, respectively. For the six months ended June 30, 2019, Napster's revenue and net loss including noncontrolling interests in our consolidated statements of operations was $52.9 million and $3.3 million, respectively.
The following table provides the supplemental pro forma revenue and net results of the combined entity had the acquisition date of Napster been the first day of our first quarter of 2018 rather than during our first quarter of 2019 (in thousands):
 
Quarter Ended - Pro Forma (Unaudited)
June 30,
 
Six Months Ended - Pro Forma (Unaudited)
June 30,
 
2019
 
2018
 
2019
 
2018
Net revenue
$
44,355

 
$
52,296

 
$
90,193

 
$
112,145

Net income (loss) attributable to RealNetworks (1)
(8,455
)
 
(4,694
)
 
(17,973
)
 
2,295

(1) The pro forma net earnings attributable to RealNetworks for the quarter ended June 30, 2018 include $0.4 million of transaction costs, and for the six months ended June 30, 2018, pro forma net earnings attributable to RealNetworks include the acquisition related gain of $12.3 million and $1.2 million of transaction costs. The amounts in the supplemental pro forma earnings for the periods presented above fully eliminate intercompany transactions and conform Napster's accounting policies to RealNetworks'. These pro forma results also reflect amortization of acquisition-related intangibles and fair value adjustments to deferred revenue and contingent consideration.
The unaudited pro forma amounts are based upon the historical financial statements of RealNetworks and Napster and were prepared using the acquisition method of accounting and are not necessarily indicative of results for any current or future period. The purchase price allocation is preliminary and is subject to change prior to finalization. The final purchase price allocation could result in material differences, which could have a material impact on the accompanying pro forma amounts.
For the quarter and six months ended June 30, 2019, we incurred approximately $0.4 million and $1.2 million, respectively, in acquisition-related costs, including regulatory, legal, and other advisory fees, which we have recorded within general and administrative expenses.
Games
As described in more detail in our 2018 10-K, in order to acquire a full workforce, we purchased 100% of the shares of a small, privately-held Netherlands-based game development studio for net cash consideration of $4.2 million in April 2018.

14



Note 6
Fair Value Measurements
Items Measured at Fair Value on a Recurring Basis
The following tables present information about our financial assets that have been measured at fair value on a recurring basis as of June 30, 2019 and December 31, 2018, and indicates the fair value hierarchy of the valuation inputs utilized to determine fair value (in thousands):
 
Fair Value Measurements as of
 
Amortized Cost as of
 
June 30, 2019
 
June 30, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 
Assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
 
 
Cash
$
25,660

 
$

 
$

 
$
25,660

 
$
25,660

Money market funds
679

 

 

 
679

 
679

Total cash and cash equivalents
26,339

 

 

 
26,339

 
26,339

Restricted cash equivalents

 
2,124

 

 
2,124

 
2,124

Total assets
$
26,339

 
$
2,124

 
$

 
$
28,463

 
$
28,463

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

 
$

 
$
2,685

 
$
2,685

 
N/A

Other long-term liabilities
 
 
 
 
 
 
 
 
 
Napster acquisition contingent consideration

 

 
9,215

 
9,215

 
N/A

Total liabilities
$

 
$

 
$
11,900

 
$
11,900

 
N/A

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

 
$

 
$

 
$
22,853

 
$
22,853

Money market funds
12,708

 

 

 
12,708

 
12,708

Total cash and cash equivalents
35,561

 

 

 
35,561

 
35,561

Short-term investments:
 
 
 
 
 
 
 
 
 
Corporate notes and bonds

 
24

 

 
24

 
24

Total short-term investments

 
24

 

 
24

 
24

Restricted cash equivalents

 
1,630

 

 
1,630

 
1,630

Warrants issued by Napster (included in Other assets)

 

 
865

 
865

 

Total assets
$
35,561

 
$
1,654

 
$
865

 
$
38,080

 
$
37,215

Restricted cash equivalents as of June 30, 2019 and December 31, 2018 relate to cash pledged as collateral against letters of credit in connection with lease agreements.
Accrued royalties, fulfillment and other current liabilities and Other long-term liabilities as of June 30, 2019 include the estimated fair value of the contingent consideration for the Napster acquisition, which was determined using a fair value measurement categorized within Level 3 of the fair value hierarchy. As discussed in Note 5 Acquisitions, after completion of the measurement period or in conjunction with changes in fair value unrelated to our preliminary estimate of fair value, this liability is adjusted quarterly to fair value through earnings. In the second quarter of 2019, we recorded the change in fair value of the contingent consideration of $0.3 million as an increase to the total liability on the consolidated balance sheet and as general and administrative expense on the consolidated statement of operations.
Realized gains or losses on sales of short-term investment securities for the quarters and six months ended June 30, 2019 and 2018 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of June 30, 2019 and December 31, 2018 were also not significant.

15



Items Measured at Fair Value on a Non-recurring Basis
Certain of our assets and liabilities are measured at estimated fair value on a non-recurring basis, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the six months ended June 30, 2019 and 2018, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
Note 7
Other Intangible Assets
Other intangible assets (in thousands):
 
 
 
June 30, 2019
 
December 31, 2018
 
 
 
Gross
Amount
 
Accumulated
Amortization
 
Net
 
Gross
Amount
 
Accumulated
Amortization
 
Net
Amortizing intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
 
$
41,155

 
$
31,358

 
$
9,797

 
$
30,993

 
$
30,993

 
$

 
Developed technology
 
29,934

 
24,710

 
5,224

 
24,446

 
24,446

 

 
Patents, trademarks and tradenames
 
10,471

 
3,879

 
6,592

 
3,765

 
3,765

 

 
Service contracts
 
5,454

 
5,451

 
3

 
5,538

 
5,512

 
26

 
Total
 
$
87,014

 
$
65,398

 
$
21,616

 
$
64,742

 
$
64,716

 
$
26

Amortization expense related to other intangible assets during the quarters ended June 30, 2019, and June 30, 2018, was $1.1 million and $0.1 million, respectively. Amortization expense related to other intangible assets during the six months ended June 30, 2019, and June 30, 2018, was $2.1 million and $0.2 million, respectively.
Estimated future amortization of other intangible assets (in thousands):
 
 
Future Amortization
2019 (Excluding the six months ended June 30, 2019)
 
$
2,266

2020
 
4,526

2021
 
4,526

2022
 
2,641

2023
 
1,145

Thereafter
 
6,512

 
 
$
21,616

See Note 5 Acquisitions for details on our acquisitions. No impairments of other intangible assets were recognized in either of the six months ended June 30, 2019 or 2018.

16



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

Increases due to current year acquisitions
48,474

Effects of foreign currency translation
(34
)
Balance, June 30, 2019
$
65,395

See Note 5 Acquisitions for details on our acquisitions and the impact to goodwill.
The following table presents goodwill by segments (in thousands):
 
June 30,
2019
Consumer Media
$
580

Mobile Services
2,032

Games
14,309

Napster
48,474

Total goodwill
$
65,395

No impairment of goodwill was recognized in either of the six months ended June 30, 2019 or in 2018.

17



Note 9
Accrued royalties, fulfillment and other current liabilities
Accrued royalties, fulfillment and other current liabilities (in thousands):
 
June 30, 2019
 
December 31, 2018
Royalties and other fulfillment costs
$
75,849

 
$
1,989

Employee compensation, commissions and benefits
6,395

 
4,444

Sales, VAT and other taxes payable
3,293

 
785

Operating Lease Liabilities - Current
5,028

 

Other
7,386

 
4,094

Total accrued royalties, fulfillment and other current liabilities
$
97,951

 
$
11,312

Included in royalties and other fulfillment costs are Napster's accrued music royalties totaling $74.1 million at June 30, 2019. Napster’s agreements and arrangements with rights holders for the content used in its business are complex and the determination of royalty accruals involves significant judgments, assumptions, and estimates of the amounts to be paid.
The variables involved in determining royalty accruals include unmatched royalty accruals, revenue to be recognized, the type of content used and the country it is used in, outstanding royalty audits, and identification of appropriate license holders, among other variables. In addition, some rights holders have allowed the use of their content while negotiations of the terms and conditions are ongoing. In certain jurisdictions, rights holders have several years to claim royalties for musical composition.
While Napster bases its estimates on historical experience and on various assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates in the event of modified assumptions or conditions.
Related to Napster's accrued music royalties are amounts that are advanced to certain music publishers for royalty amounts that have been agreed as being owed, but for which the underlying rights holder have not yet been specifically matched. These prepaid royalty amounts totaling $12.9 million at June 30, 2019 are included in Prepaid expenses and other current assets on the unaudited condensed consolidated balance sheets. When these amounts are ultimately matched and invoiced to Napster, the prepaid royalty amount and the related accrued royalty liability are offset on the unaudited condensed consolidated balance sheets.
Note 10
Notes Payable - Napster
In 2017, Napster entered into a Non-Recourse Purchase of Eligible Receivables Agreement (NRP Agreement) with an international bank (Purchaser) in which Napster will sell and assign on a continuing basis its eligible receivables to the Purchaser in return for 90% of the receivables upfront, up to a maximum amount of $15.0 million in advances. The interest rate is 2.25% above the 1-month-EURIBOR with a minimum 0.0% rate applying to the 1-month-EURIBOR rate. As of June 30, 2019, Napster had $7.9 million borrowings outstanding with an interest rate of 2.25%.
In 2015, Napster entered into a Loan and Security Agreement (Revolver LSA) with a bank. The available borrowing on the Revolver LSA was based upon Napster's accounts receivable and direct to consumer subscription deposits. The Revolver LSA had a maximum available balance of $7.0 million. The Revolver LSA matured and the loan balance was paid in full on April 30, 2019.
The Revolver LSA required Napster to maintain a balance of unrestricted cash at the bank of not less than $1.5 million plus 5% of the total amount outstanding under the NRP Agreement. As the loan was paid off on April 30, 2019, this amount is no longer restricted.

18



Note 11
Restructuring Charges
Restructuring and other charges in 2019 and 2018 consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts, which primarily relate to severance costs due to workforce reductions.
Our Games segment continues its shift to focus on free-to-play games that offer in-game purchases of virtual goods and away from premium mobile games that require a one-time purchase. While certain new premium mobile games will be offered, this shift in focus resulted in restructuring costs of $0.6 million for the quarter, recorded in the Corporate segment.
Restructuring charges are as follows (in thousands):
 
 
Employee Separation Costs
 
Asset Related and Other Costs
 
Total
Costs incurred and charged to expense for the six months ended June 30, 2019
 
$
344

 
$
552

 
$
896

Costs incurred and charged to expense for the six months ended June 30, 2018
 
$
688

 
$

 
$
688

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

 
$

 
$
755

Costs incurred and charged to expense for the six months ended June 30, 2019, excluding noncash charges
 
344

 
227

 
571

Cash payments
 
(693
)
 

 
(693
)
Accrued liability at June 30, 2019
 
$
406

 
$
227

 
$
633

Note 12
Income Taxes
As of June 30, 2019, RealNetworks has $4.5 million in uncertain tax positions, of which $4.1 million of unrecognized tax positions was recorded through purchase accounting on January 18, 2019 as a result of the acquisition of Napster. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We file numerous consolidated and separate income tax returns in the U.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.

19



Note 13
Income (Loss) Per Share
Basic net income (loss) per share (EPS) is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common and dilutive potential common shares outstanding during the period. Basic and diluted EPS (in thousands, except per share amounts):
 
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Net income (loss) attributable to RealNetworks
$
(9,202
)
 
$
(6,930
)
 
$
(7,669
)
 
$
(12,108
)
Weighted average common shares outstanding used to compute basic EPS
37,948

 
37,577

 
37,885

 
37,514

Dilutive effect of stock based awards

 

 

 

Weighted average common shares outstanding used to compute diluted EPS
37,948

 
37,577


37,885


37,514

 
 
 
 
 
 
 
 
Basic EPS attributable to RealNetworks
$
(0.24
)
 
$
(0.18
)
 
$
(0.20
)
 
$
(0.32
)
Diluted EPS attributable to RealNetworks
$
(0.24
)
 
$
(0.18
)
 
$
(0.20
)
 
$
(0.32
)
During the quarter and six months ended June 30, 2019, 7.7 million and 7.3 million shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
During the quarter and six months ended June 30, 2018, 5.9 million and 6.0 million shares of common stock, respectively, of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.
Note 14
Leases
We have commitments for future payments related to office facilities leases. We determine if an arrangement is a lease at inception. Operating leases are included in Operating lease assets, Other current liabilities, and Long-term lease liabilities on our consolidated balance sheets. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.
Operating lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As our leases do not provide an implicit rate, we use our estimated incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. Operating lease assets also exclude lease incentives and initial direct costs incurred. Some of our leases include options to extend or terminate the lease. Our leases generally include one or more options to renew; however, the exercise of lease renewal options is at our sole discretion. For nearly all of our operating leases, upon adoption of the new guidance, we have not assumed any options to extend will be exercised as part of our calculation of the lease liability. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
We have operating leases for office space and data centers with remaining lease terms of 1 year to 5 years.
Details related to lease expense and supplemental cash flow were as follows (in thousands):
 
 
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
 
2019
 
2019
Operating lease expense
 
$
1,463

 
$
2,803

Variable lease expense
 
358

 
511

Sublease income
 
(511
)
 
(986
)
Net lease expense
 
$
1,310

 
$
2,328

 
 
 
 
 
Operating cash outflows for lease liabilities
 
$
1,412

 
$
2,873


20



Details related to lease term and discount rate were as follows:
 
 
June 30, 2019
Weighted-average remaining lease term (in years)
 
4 years

Weighted-average discount rate
 
5.13
%
Future minimum lease payments as of June 30, 2019 were as follows (in thousands):
 
 
Operating
Leases
2019 (Excluding the six months ended June 30, 2019)
 
$
2,737

2020
 
4,909

2021
 
3,296

2022
 
2,429

2023
 
2,347

Thereafter
 
1,634

Total minimum payments(a)
 
17,352

Less: Imputed interest
 
1,940

Present value of total minimum payments(b)
 
$
15,412

(a)Total minimum payments exclude executory costs, inclusive of insurance, maintenance, and taxes, of $6.9 million; minimum payments also have not been reduced by sublease rentals of $6.1 million due in the future under noncancelable subleases.
(b)$10.4 million is included in Long-term lease liabilities and $5.0 million is included in Accrued royalties, fulfillment, and other current liabilities on the condensed consolidated balance sheets.
As of December 31, 2018, future minimum lease payments were $15.9 million in the aggregate, which consisted of the following: $3.7 million in 2019; $3.0 million in 2020; $2.7 million in 2021; $2.4 million in 2022; $2.3 million in 2023; and $1.6 million thereafter.
Note 15
Commitments and Contingencies
We have been in the past and could become in the future subject to legal proceedings, governmental investigations, and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks, and other intellectual property rights. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.  
In 2017, we entered into an arrangement whereby we may be required to guarantee up to $2.8 million of Napster's outstanding indebtedness on their revolving credit facility. At that time and as a result of the guaranty, RealNetworks recognized previously suspended Napster losses up to the full $2.8 million guaranty in our consolidated statement of operations and as a Commitment to Napster in our consolidated balance sheets. Given the controlling interest RealNetworks acquired in Napster in the first quarter of 2019, we have eliminated the previously recorded guaranty from RealNetworks' balance sheet in consolidation. RealNetworks has not been required to pay any portion of this commitment, and, as discussed in Note 10 Notes Payable - Napster, Napster fully repaid this loan balance on April 30, 2019, thus releasing RealNetworks' previously made guaranty.    
In March 2016, Napster was notified of a putative consumer class action lawsuit relating to an alleged failure to pay so-called “mechanical royalties” on behalf of the plaintiffs and “other similarly-situated holders of mechanical rights in copyrighted musical works.” On April 7, 2017, the plaintiffs and Napster agreed to settlement terms during a mediation session. The long form Settlement Agreement was executed effective on January 16, 2019. The damages payable under the Settlement Agreement will be calculated on a claims made basis, subject to an overall maximum of $10.0 million. We have not recorded an accrual related to this settlement as of June 30, 2019 as the amount payable is not reasonably estimable. In May 2019, public notice was posted about the settlement informing purported class members that they can make claims or object to the settlement. The claims period ends on December 31, 2019, on which date (or shortly thereafter), Napster expects to know the total amount of damages payable in respect to validly made claims. Damages for valid claims are expected to be paid in the second quarter of 2020.

21



Note 16
Guarantees
In the ordinary course of business, RealNetworks is subject to potential obligations for standard warranty and indemnification provisions that are contained within many of our customer license and service agreements. Our warranty provisions are consistent with those prevalent in our industry, and we do not have a history of incurring losses on warranties; therefore, we do not maintain accruals for warranty-related obligations. With regard to indemnification provisions, nearly all of our carrier contracts obligate us to indemnify our carrier customers for certain liabilities that may be incurred by them. We have received in the past, and may receive in the future, claims for indemnification from some of our carrier customers.
In the ordinary course of business, Napster enters into agreements with various content providers that guarantee a minimum amount of royalty payments in a given period. These minimum payments are generally based on targets and, based on our historical experience and expectations under relevant contracts, we anticipate that actual royalty accruals and payments will exceed minimum guarantees and, accordingly, we do not maintain accruals for these minimum guarantees.
In relation to certain patents and other technology assets we sold to Intel in the second quarter of 2012, we have specific obligations to indemnify Intel for breaches of the representations and warranties that we made and covenants that we agreed to in the asset purchase agreement for certain potential future intellectual property infringement claims brought by third parties against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.  
Note 17
Segment Information
We manage our business and report revenue and operating income (loss) in four segments: (1) Consumer Media, which includes licensing of our codec technology and our PC-based RealPlayer products, including RealPlayer Plus and related products; (2) Mobile Services, which includes our SaaS services and our integrated RealTimes® platform which is sold to mobile carriers; (3) Games, which includes all our games-related businesses, including sales of mobile games, games licenses, in-game virtual goods, subscription services, and advertising on games and social network sites; and (4) Napster, which includes our on-demand music streaming and music services.
RealNetworks allocates to its Consumer Media, Mobile Services and Games reportable segments certain corporate expenses which are directly attributable to supporting these businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting these businesses, are reported as corporate items. These corporate items also include restructuring charges and stock compensation charges. As stated in Note 5 Acquisitions, Napster is operating as an independent company and includes all their corporate expenses in their segment results, and RealNetworks does not allocate any expenses to the Napster segment.
RealNetworks reports four reportable segments based on factors such as how we manage our operations and how the Chief Operating Decision Maker (CODM) reviews results. The CODM reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.

22



Segment results for the quarters and six months ended June 30, 2019 and 2018 (in thousands):
 Consumer Media
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Revenue
$
2,620

 
$
3,884

 
$
5,106

 
$
9,367

Cost of revenue
803

 
1,028

 
1,636

 
2,021

Gross profit
1,817

 
2,856

 
3,470

 
7,346

Operating expenses
2,877

 
3,439

 
5,996

 
7,357

Operating income (loss)
$
(1,060
)
 
$
(583
)
 
$
(2,526
)
 
$
(11
)
Mobile Services
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Revenue
$
6,997

 
$
6,719

 
$
13,936

 
$
15,423

Cost of revenue
1,865

 
2,134

 
3,913

 
4,450

Gross profit
5,132

 
4,585

 
10,023

 
10,973

Operating expenses
7,438

 
6,969

 
14,999

 
14,335

Operating income (loss)
$
(2,306
)
 
$
(2,384
)
 
$
(4,976
)
 
$
(3,362
)
 Games
Quarter Ended
June 30,
 
Six Months Ended
June 30,
 
2019
 
2018
 
2019
 
2018
Revenue
$
6,048

 
$
5,121