10-Q 1 rnwk-2012930x10q.htm 10-Q RNWK-2012.9.30-10Q



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2012
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 0-23137
 
 RealNetworks, Inc.
 
 
(Exact name of registrant as specified in its charter)
 
Washington
 
91-1628146
(State of incorporation)
 
(I.R.S. Employer
Identification Number)
 
 
 
 
 
2601 Elliott Avenue, Suite 1000
Seattle, Washington
 
98121
(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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
  
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   ý
The number of shares of the registrant’s Common Stock outstanding as of October 25, 2012 was 35,240,161.




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)
 
September 30,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
170,702

 
$
106,333

Short-term investments
103,046

 
78,739

Trade accounts receivable, net of allowances for doubtful accounts and sales returns
35,716

 
41,165

Deferred costs, current portion
1,910

 
1,424

Prepaid expenses and other current assets
19,901

 
21,902

Total current assets
331,275

 
249,563

Equipment, software, and leasehold improvements, at cost:
 
 
 
Equipment and software
100,053

 
104,352

Leasehold improvements
26,184

 
25,947

Total equipment, software, and leasehold improvements, at cost
126,237

 
130,299

Less accumulated depreciation and amortization
93,287

 
92,825

Net equipment, software, and leasehold improvements
32,950

 
37,474

Restricted cash equivalents and investments
10,064

 
10,168

Equity method investments
3,703

 
7,798

Available for sale securities
36,819

 
37,204

Other assets
3,197

 
2,954

Deferred costs, non-current portion
170

 
843

Deferred tax assets, net, non-current portion
4,566

 
18,419

Other intangible assets, net
4,085

 
7,169

Goodwill
6,375

 
6,198

Total assets
$
433,204

 
$
377,790

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
21,350

 
$
17,151

Accrued and other liabilities
62,215

 
59,194

Deferred revenue, current portion
11,558

 
11,835

Accrued loss on excess office facilities, current portion
747

 
596

Total current liabilities
95,870

 
88,776

Deferred revenue, non-current portion
159

 
195

Accrued loss on excess office facilities, non-current portion
1,229

 
2,151

Deferred rent
2,712

 
2,944

Deferred tax liabilities, net, non-current portion
1,085

 
1,443

Other long-term liabilities
10,290

 
10,994

Total liabilities
111,345

 
106,503

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 35,198 shares in 2012 and 34,422 shares in 2011
35

 
34

Additional paid-in capital
584,210

 
575,515

Accumulated other comprehensive loss
(24,774
)
 
(24,884
)
Retained deficit
(237,612
)
 
(279,378
)
Total shareholders’ equity
321,859

 
271,287

Total liabilities and shareholders’ equity
$
433,204

 
$
377,790

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)
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net revenue (A)
$
59,088

 
$
84,414

 
$
191,578

 
$
255,467

Cost of revenue (B)
25,244

 
31,816

 
78,633

 
94,548

Gross profit
33,844

 
52,598

 
112,945

 
160,919

Sale of patents and other technology assets, net of costs (See Note 1)

 

 
116,353

 

Operating expenses:
 
 
 
 
 
 
 
Research and development
15,321

 
16,496

 
49,167

 
54,200

Sales and marketing
21,972

 
28,625

 
68,462

 
85,958

General and administrative
8,759

 
10,522

 
35,103

 
27,018

Restructuring and other charges
10,724

 
438

 
13,872

 
7,850

Loss (gain) on excess office facilities
243

 

 
243

 
(174
)
Total operating expenses
57,019

 
56,081

 
166,847

 
174,852

Operating income (loss)
(23,175
)
 
(3,483
)
 
62,451

 
(13,933
)
Other income (expenses):
 
 
 
 
 
 
 
Interest income, net
164

 
672

 
1,033

 
1,362

Gain (loss) on sale of equity and other investments, net
2,210

 

 
5,288

 

Equity in net loss of Rhapsody investment
(1,613
)
 
(1,440
)
 
(4,095
)
 
(5,739
)
Other income (expense), net
248

 
(228
)
 
1,674

 
(661
)
Total other income (expenses), net
1,009

 
(996
)
 
3,900

 
(5,038
)
Income (loss) before income taxes
(22,166
)
 
(4,479
)
 
66,351

 
(18,971
)
Income tax benefit (expense)
(48
)
 
(703
)
 
(24,583
)
 
(5,365
)
Net income (loss)
$
(22,214
)
 
$
(5,182
)
 
$
41,768

 
$
(24,336
)
Basic net income (loss) per share
$
(0.63
)
 
$
(0.15
)
 
$
1.20

 
$
(0.71
)
Diluted net income (loss) per share
$
(0.63
)
 
$
(0.15
)
 
$
1.19

 
$
(0.71
)
Shares used to compute basic net income (loss) per share
34,998

 
34,199

 
34,747

 
34,081

Shares used to compute diluted net income (loss) per share
34,998

 
34,199

 
35,000

 
34,081

Comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized investment holding gains (losses)
$
5,407

 
$
12,401

 
$
1,840

 
$
11,014

Foreign currency translation gains (losses)
506

 
(4,335
)
 
(1,730
)
 
(425
)
Total other comprehensive income (loss)
5,913

 
8,066

 
110

 
10,589

Net income (loss)
(22,214
)
 
(5,182
)
 
41,768

 
(24,336
)
Comprehensive income (loss)
$
(16,301
)
 
$
2,884

 
$
41,878

 
$
(13,747
)
(A) Components of net revenue:
 
 
 
 
 
 
 
License fees
$
11,957

 
$
15,344

 
$
41,137

 
$
50,576

Service revenue
47,131

 
69,070

 
150,441

 
204,891

 
$
59,088

 
$
84,414

 
$
191,578

 
$
255,467

(B) Components of cost of revenue:
 
 
 
 
 
 
 
License fees
$
3,226

 
$
3,458

 
$
9,143

 
$
13,504

Service revenue
22,018

 
28,358

 
69,490

 
81,044

 
$
25,244

 
$
31,816

 
$
78,633

 
$
94,548

See accompanying notes to unaudited condensed consolidated financial statements.

4



REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Nine Months Ended
September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income (loss)
$
41,768

 
$
(24,336
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
12,478

 
12,519

Stock-based compensation
6,419

 
9,086

Loss (gain) on disposal of equipment, software, and leasehold improvements
1,965

 
81

Equity in net loss of Rhapsody
4,095

 
5,739

Excess tax benefit from stock option exercises

 
(57
)
Deferred income taxes, net
22,399

 
(429
)
Gain on sale of patent and other technology assets, net of costs
(116,353
)
 

Gain on sale of equity and other investments, net
(5,288
)
 

Realized translation gain
(1,968
)
 

Other

 
(19
)
Net change in certain operating assets and liabilities:
 
 
 
Trade accounts receivable
5,848

 
9,328

Prepaid expenses and other assets
(2,956
)
 
11,575

Accounts payable
3,683

 
(13,376
)
Accrued and other liabilities
(2,840
)
 
(17,487
)
Net cash provided by (used in) operating activities
(30,750
)
 
(7,376
)
Cash flows from investing activities:
 
 
 
Purchases of equipment, software, and leasehold improvements
(6,478
)
 
(6,013
)
Proceeds from sale of patents and other technology assets, net of costs
116,353

 

Proceeds from sale of equity and other investments
7,244

 

Purchases of short-term investments
(76,191
)
 
(77,078
)
Proceeds from sales and maturities of short-term investments
51,885

 
95,104

Decrease (increase) in restricted cash equivalents and investments, net
103

 
(141
)
Payment of acquisition costs, net of cash acquired

 
(2,888
)
Net cash provided by (used in) investing activities
92,916

 
8,984

Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock (stock options and stock purchase plan)
3,240

 
1,940

Common Stock cash dividend paid

 
(136,793
)
Tax payments from shares withheld upon vesting of restricted stock
(964
)
 

Excess tax benefit from stock option exercises

 
57

Net cash provided by (used in) financing activities
2,276

 
(134,796
)
Effect of exchange rate changes on cash and cash equivalents
(73
)
 
(19
)
Net increase (decrease) in cash and cash equivalents
64,369

 
(133,207
)
Cash and cash equivalents, beginning of period
106,333

 
236,018

Cash and cash equivalents, end of period
$
170,702

 
$
102,811

Supplemental disclosure of cash flow information:
 
 
 
Cash received from income tax refunds
$
247

 
$
3,691

Cash paid for income taxes
$
2,015

 
$
4,435

Non-cash investing activities:
 
 
 
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements
$
116

 
$

See accompanying notes to unaudited condensed consolidated financial statements.

5



REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Nine Months Ended September 30, 2012 and 2011

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.
Inherent in the Company’s business are various risks and uncertainties, including limited history of certain of its product and service offerings. The Company’s success will depend on the acceptance of the Company’s technology, products and services and the ability to generate related revenue.
In this Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 (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 wholly-owned subsidiaries. All 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 the Company’s management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2012. 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, 2011 (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. In addition, current economic conditions may require the use of additional estimates, and certain estimates we make are subject to a greater degree of uncertainty as a result of the current economic conditions.
Reclassifications. Certain reclassifications have been made to the 2011 consolidated financial statements to conform to the 2012 presentation.
Accumulated Other Comprehensive Income (Loss). The components of accumulated other comprehensive income (loss) consisted of unrealized gains (losses) on investment securities and foreign currency translation gains (losses), net of applicable tax, as follows (in thousands):
 
 
September 30,
2012
 
December 31,
2011
Unrealized gains on investments, net of taxes
$
29,158

 
$
27,318

Foreign currency translation adjustments
(53,932
)
 
(52,202
)
Accumulated other comprehensive income (loss)
$
(24,774
)
 
$
(24,884
)
For the nine months ended September 30, 2012 we liquidated the investment in certain of our foreign entities and recorded a net pre-tax gain of $2.0 million in Other income (expense), net, in the consolidated statement of operations upon the release of the same amount of cumulative foreign exchange translation gain (loss) from accumulated other comprehensive income (loss) on the balance sheet.
In the quarter and nine months ended September 30, 2012 we realized pre-tax gains of $2.2 million and $4.3 million in the consolidated statement of operations related to the sale of a portion of the equity shares we hold in LoEn Entertainment, Inc., with the same amounts reclassified from accumulated other comprehensive income (loss) on the balance sheet. For more

6



information see Note 5, Fair Value Measurements.
Sale of Patents and Other Technology Assets to Intel Corporation. In the second quarter of 2012, we completed the sale of certain patents, patent applications and related rights held by us, and certain of our assets relating to our next generation video codec technologies to Intel Corporation (Intel) pursuant to an Asset Purchase Agreement (the Asset Purchase Agreement), dated as of January 26, 2012, between the Company and Intel. In accordance with the Asset Purchase Agreement, Intel acquired the assets for a cash purchase price of $120.0 million. In addition, pursuant to the license agreement, dated as of January 26, 2012 (the “License Agreement”), between Intel and the Company, Intel granted us a non-exclusive, royalty-free, fully paid up, irrevocable (except as set forth in the License Agreement) and worldwide license (without the right to grant sublicenses) to use the patent assets we sold to Intel in connection with our businesses. The transferability of the License Agreement is limited in the event of a change of control or character of the Company, as set forth in the License Agreement.
The entire $120.0 million of cash proceeds we received, net of certain direct costs incurred, was recorded as a gain on our statement of operations in the quarter ending June 30, 2012, since the patent assets and other technology had a net book value of zero. The gain recognized of $116.4 million in the nine months ended September 30, 2012 was net of related direct costs for the sale transaction totaling $3.6 million incurred in the first and second quarters of 2012.
Note 2. Recent Accounting Pronouncements
With the exception of the item discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2012, to be implemented as compared to the recent accounting pronouncements described in the 10-K that are of significance or potential significance to RealNetworks.
In September 2011, the FASB issued new guidance related to testing goodwill for impairment, which permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The new guidance became effective for our first quarter of 2012 and did not have a material effect on our consolidated financial statements.
Note 3. Stock-Based Compensation
Total stock-based compensation expense recognized was as follows (in thousands):
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Total stock-based compensation expense
$
2,354

 
$
2,957

 
$
6,419

 
$
9,086

The fair value of options granted determined using the Black-Scholes model used the following weighted-average assumptions:
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Expected dividend yield
0
%
 
0
%
 
0
%
 
0
%
Risk-free interest rate
0.48
%
 
0.82
%
 
0.51
%
 
1.71
%
Expected life (years)
4.1

 
4.0

 
4.1

 
4.0

Volatility
58
%
 
54
%
 
58
%
 
54
%

The total stock-based compensation amounts for 2012 and 2011 disclosed above are recorded in their respective line items within operating expenses in the consolidated statement of operations, including amounts that are reported in Restructuring and other charges. No stock-based compensation was capitalized as part of the cost of an asset as of September 30, 2012 or December 31, 2011. As of September 30, 2012, we had $12.5 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 years.
Note 4. Rhapsody Joint Venture
RealNetworks initially formed in 2007 a joint venture with MTV Networks, a division of Viacom International Inc.

7



(MTVN), to own and operate a business-to-consumer digital audio music service known as Rhapsody. Prior to March 31, 2010, we held a 51% interest in Rhapsody and MTVN owned the remaining 49%. On March 31, 2010, restructuring transactions involving Rhapsody were completed, and as a result, effective March 31, 2010 RealNetworks owned approximately 47% of Rhapsody. Subsequent to the restructuring transaction, the operating results of Rhapsody have been accounted for under the equity method of accounting for investments, and our proportionate share of the income or loss is recognized as a component of Other income (expenses), net in the statements of operations. As of September 30, 2012 we owned approximately 45% of Rhapsody. RealNetworks continues to provide certain operational transition services to Rhapsody. These transition services are expected to be completed in early 2013, and are discussed further in Footnote 18, Related Party Transactions.
We recorded our share of losses in the operations of Rhapsody of $1.6 million and $4.1 million for the quarter and nine months ended September 30, 2012, respectively. Our share of losses in the operations of Rhapsody for the quarter and nine months ended September 30, 2011 were $1.4 million and $5.7 million, respectively. The carrying value of our Rhapsody investment was $3.5 million as of September 30, 2012.
Summarized financial operating information for Rhapsody, which represents 100% of their financial information (in thousands):
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net revenue
$
36,389

 
$
30,453

 
$
109,368

 
$
93,508

Gross profit
9,266

 
10,512

 
28,757

 
29,358

Net loss
(3,424
)
 
(3,064
)
 
(9,031
)
 
(12,211
)
Note 5. Fair Value Measurements
We measure certain financial assets at fair value on a recurring basis, including cash equivalents, short-term investments, and equity investments of publicly traded companies. The fair value of these financial assets was determined based on three levels of inputs:
Level 1: Quoted prices in active markets for identical assets or liabilities
Level 2: Directly or indirectly observed inputs for the asset or liability, including quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active
Level 3: Significant unobservable inputs that reflect our own estimates of assumptions that market participants would use
Items Measured at Fair Value on a Recurring Basis
The following table presents information about our financial assets that have been measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011, and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands).
 
 
Fair Value Measurements as of
 
September 30, 2012
 
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
10,331

 
$

 
$
10,331

 
$

Corporate notes and bonds
83,473

 

 
83,473

 

Short-term investments:
 
 
 
 
 
 
 
Corporate notes and bonds
68,178

 

 
68,178

 

U.S. government agency securities
34,868

 
32,016

 
2,852

 

Restricted cash equivalents and investments
10,064

 
10,064

 

 

Equity investments in publicly traded securities
36,819

 
36,819

 

 

Total
$
243,733

 
$
78,899

 
$
164,834

 
$


8



 
Fair Value Measurements as of
 
December 31, 2011
 
Total
 
Level 1
 
Level 2
 
Level 3
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
6,544

 
$

 
$
6,544

 
$

Corporate notes and bonds
20,697

 

 
20,697

 

Short-term investments:
 
 
 
 
 
 
 
Corporate notes and bonds
39,254

 

 
39,254

 

U.S. government agency securities
39,485

 
34,881

 
4,604

 

Restricted cash equivalents and investments
10,168

 
10,168

 

 

Equity investments in publicly traded securities
37,204

 
37,204

 

 

Total
$
153,352

 
$
82,253

 
$
71,099

 
$

Our equity investments in publicly traded companies consisted of J-Stream Inc., a Japanese media services company, and LoEn Entertainment, Inc., a Korean digital music distribution company. These equity investments are accounted for as available for sale. The aggregate cost basis of these securities totaled $8.6 million as of September 30, 2012 and $10.8 million at December 31, 2011. In the quarter ended September 30, 2012 we sold for a gain a portion of the LoEn shares we hold, resulting in cash proceeds of $3.1 million and a pre-tax gain of $2.2 million. For the nine months ended September 30, 2012 cash proceeds from these sales totaled $6.4 million and the pre-tax gain was $4.3 million.
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. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the nine months ended September 30, 2012 and 2011, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.
Note 6. Cash, Cash Equivalents, Short-Term Investments, Restricted Cash Equivalents and Investments
Cash and cash equivalents, short-term investments, and restricted cash equivalents and investments as of September 30, 2012, consisted of the following (in thousands):
 
 
Amortized
Cost
 
Estimated
Fair Value
Cash and cash equivalents:
 
 
 
Cash
$
76,898

 
$
76,898

Money market mutual funds
10,331

 
10,331

Corporate notes and bonds
83,473

 
83,473

Total cash and cash equivalents
170,702

 
170,702

Short-term investments:
 
 
 
Corporate notes and bonds
68,094

 
68,178

U.S. government agency securities
34,845

 
34,868

Total short-term investments
102,939

 
103,046

Total cash, cash equivalents and short-term investments
$
273,641

 
$
273,748

Restricted cash equivalents and investments
$
10,064

 
$
10,064

Cash and cash equivalents, short-term investments, and restricted cash equivalents and investments as of December 31, 2011 consisted of the following (in thousands):
 

9



 
Amortized
Cost
 
Estimated
Fair Value
Cash and cash equivalents:
 
 
 
Cash
$
79,092

 
$
79,092

Money market mutual funds
6,544

 
6,544

Corporate notes and bonds
20,697

 
20,697

Total cash and cash equivalents
106,333

 
106,333

Short-term investments:
 
 
 
Corporate notes and bonds
39,309

 
39,254

U.S. Government agency securities
39,413

 
39,485

Total short-term investments
78,722

 
78,739

Total cash, cash equivalents, and short-term investments
$
185,055

 
$
185,072

Restricted cash equivalents and investments
$
10,168

 
$
10,168

Substantially all of the restricted cash equivalents and investments amounts as of September 30, 2012, and December 31, 2011 relate to cash pledged as collateral against a letter of credit in connection with lease agreements.
Realized gains or losses on sales of short-term investment securities for the quarters and nine months ended September 30, 2012 and 2011 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of September 30, 2012 and December 31, 2011 were not significant.
Investments with remaining contractual maturities of five years or less are classified as short-term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations. The contractual maturities of short-term investments as of September 30, 2012, were as follows (in thousands):
 
 
Estimated
Fair Value
Within one year
$
72,862

Between one year and five years
30,184

Total short-term investments
$
103,046

Note 7. Allowance for Doubtful Accounts Receivable and Sales Returns
Activity in the allowance for doubtful accounts receivable and sales returns (in thousands):
 
 
Allowance For
 
Doubtful
Accounts
Receivable
 
Sales
Returns
Balances, December 31, 2011
$
1,445

 
$
668

Addition (reduction) to allowance
(127
)
 
138

Amounts written off
(219
)
 
(118
)
Foreign currency translation
8

 

Balances, September 30, 2012
$
1,107

 
$
688

One customer accounted for 12% of trade accounts receivable as of September 30, 2012. As of December 31, 2011, one customer accounted for 17% of trade accounts receivable. One customer accounted for 11%, or $6.4 million, of revenue during the quarter ended September 30, 2012, in our Emerging segment. No one customer accounted for more than 10% of total revenue during the quarter ended September 30, 2011, or during the nine months ended September 30, 2012 and 2011.
Note 8. Other Intangible Assets
Other intangible assets consisted of the following (in thousands):
 

10



 
Gross
Amount
 
Accumulated
Amortization
 
Net
Customer relationships
$
29,863

 
$
26,735

 
$
3,128

Developed technology
24,075

 
23,123

 
952

Patents, trademarks and tradenames
3,442

 
3,442

 

Service contracts and other
5,366

 
5,361

 
5

Total other intangible assets, September 30, 2012
$
62,746

 
$
58,661

 
$
4,085

Total other intangible assets, December 31, 2011
$
69,631

 
$
62,462

 
$
7,169

Note 9. Goodwill
Changes in goodwill (in thousands):
 
Balances, December 31, 2011
$
6,198

Effects of foreign currency translation
177

Balances, September 30, 2012
$
6,375


Goodwill by the Company’s segments (in thousands):
 
 
September 30,
2012
Core products
$
779

Emerging products
580

Games
5,016

Total goodwill
$
6,375

Note 10. Accrued and Other Liabilities
Accrued and other liabilities consisted of (in thousands):
 
 
September 30, 2012
 
December 31, 2011
Royalties and other fulfillment costs
$
22,562

 
$
26,651

Employee compensation, commissions and benefits
14,503

 
12,698

Sales, VAT and other taxes payable
11,053

 
11,389

Deferred tax liabilities—current
4,080

 
232

Other
10,017

 
8,224

Total accrued and other liabilities
$
62,215

 
$
59,194

Note 11. Restructuring Charges
Restructuring and other charges in 2012 and 2011 consist of costs associated with the ongoing reorganization of our business operations and focus on aligning our operating expenses with our revenue profile.
In the third quarter of 2012 we announced we would be eliminating approximately 160 positions worldwide, with the reductions expected to be completed by the end of the first quarter of 2013. In the third quarter of 2012 we also assigned two of our existing domestic carrier service contracts for ringback tone, ring tone, and music on demand services to a third party. These actions resulted in the recording of restructuring charges totaling $10.7 million in the third quarter of 2012, comprised of employee separation costs of $5.0 million, contract assignment costs of $3.6 million and asset disposal and other costs of $2.1 million. The asset disposal cost recognized was for fixed assets and deferred labor costs related to the assigned carrier service contracts.
Details of restructuring charges for the nine months ended September 30, 2012 and 2011 are in the table below. Non-cash employee separation expenses incurred were for the incremental expense related to certain stock options for a separated employee. The amount accrued at September 30, 2012 for employee separation includes costs for those employees who will be separated in the early part of the fourth quarter of 2012 and is expected to be paid out by the end of 2012. The amount accrued

11



for contract assignment is expected to be paid out by the end of 2013.
Restructuring charges by type of cost (in thousands):
 
By Type of Cost
 

Employee Separation Costs
Contract Assignment Costs
Asset Disposal Expense and Other
Total
Costs incurred and charged to expense for the nine months ended September 30, 2012
$8,099
$3,629
$2,144
$13,872
Costs incurred and charged to expense for the nine months ended September 30, 2011
$6,957
$0
$893
$7,850

Changes to the accrued restructuring cost liability (in thousands):

 
By Type of Cost
 
 
Employee Separation Costs
Contract Assignment Costs
Total
Accrued liability as of December 31, 2011
$131
$0
$131
Costs incurred and charged to expense for the nine months ended September 30, 2012, excluding non-cash charges
7,347

3,629

10,976

Cash payments
(5,702
)
(1,929
)
(7,631
)
Accrued liability as of September 30, 2012
$1,776
$1,700
$3,476

Note 12. Loss on Excess Office Facilities
As a result of the reduction in use of RealNetworks' office space, primarily in the corporate headquarters in Seattle, Washington, and certain other locations, losses have been recognized representing rent and contractual operating expenses over the remaining life of the leases, and related write-downs of leasehold improvements to their estimated fair value. We regularly evaluate the market for office space. If the market for such space changes further in future periods, we may have to revise our estimates which may result in future adjustments to expense for excess office facilities.
Changes to the accrued loss on excess office facilities (in thousands):
 
Accrued loss December 31, 2011
$
2,747

Less amounts paid, net of sublease amounts
(865
)
Adjustments to lease loss accrual for the nine months ended September 30, 2012, including sublease income estimate revision
94

Accrued loss September 30, 2012
1,976

Less current portion
(747
)
Accrued loss, non-current portion
$
1,229

Note 13. Income Taxes
As of September 30, 2012, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the 10-K. We currently anticipate the closure of foreign and domestic income tax examinations in the next twelve months that may decrease our total unrecognized tax benefits by up to $13.8 million as a result of the successful defense of our positions, the settlement and payment of a liability, or a combination thereof. Of this amount, we anticipate a decrease in our total unrecognized tax benefits by up to $12.7 million in the fourth quarter of 2012 as a result of settling a

12



foreign tax examination shortly after the end of the third quarter of 2012. We are in the process of analyzing the impact of this settlement and currently expect to recognize a tax benefit in our consolidated statement of operations of approximately $11 million to $13 million relating to the recognition of unrecognized tax benefits in the fourth quarter of 2012.
 
We file numerous consolidated and separate income tax returns in the United States including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to United States federal income tax examinations for tax years before 2008 or state, local, or foreign income tax examinations for years before 1993. RealNetworks, Inc. and/or subsidiaries are under audit by the United States federal government, various states, and foreign jurisdictions for certain tax years subsequent to 1993.

Note 14. Earnings Per Share
Basic net income (loss) per share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) by the weighted average number of common and potentially dilutive common shares outstanding during the period. Basic and diluted EPS were calculated as follows (in thousands, except per share amounts):
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Net income (loss) available to common shareholders
$
(22,214
)
 
$
(5,182
)
 
$
41,768

 
$
(24,336
)
Weighted average common shares outstanding used to compute basic EPS
34,998

 
34,199

 
34,747

 
34,081

Dilutive effect of stock based awards

 

 
253

 

Weighted average common shares outstanding used to compute diluted EPS
34,998

 
34,199


35,000


34,081

Basic EPS
$
(0.63
)
 
$
(0.15
)
 
$
1.20

 
$
(0.71
)
Diluted EPS
$
(0.63
)
 
$
(0.15
)
 
$
1.19

 
$
(0.71
)
During the quarter and nine months ended September 30, 2012, 4.3 million and 5.3 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 nine months ended September 30, 2011, 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 15. Commitments and Contingencies
Litigation. On July 3, 2012, a lawsuit was filed against us by VoiceAge Corporation in the Supreme Court of the State of New York. VoiceAge asserts that we have breached our payment obligations under the terms of a patent license agreement between us and VoiceAge in respect of distribution of specified codec technology and is seeking a material amount of damages. We have removed the proceedings to New York federal court. We dispute VoiceAge’s allegations and the magnitude of the claimed damages, but we are unable to provide a meaningful quantification of the potential impact of the final resolution of this litigation on our future consolidated financial statements.
On May 24, 2012, a putative class action lawsuit was filed against us in Illinois federal court by an individual consumer subscriber to one of our subscription products. The lawsuit asserted that certain online marketing practices of our marketing affiliates violate federal and state laws. In October 2012, we settled this matter for an immaterial amount.
On October 28, 2011 and November 1, 2011, respectively, two lawsuits were filed by Callertone Innovations, LLC in the U.S. District Court for the District of Delaware. The first lawsuit was against T-Mobile USA, Inc. and the second lawsuit was against MetroPCS Wireless, Inc. and MetroPCS Communications, Inc., which we collectively refer to as MetroPCS. The lawsuits allege that T-Mobile and MetroPCS, respectively, infringe Callertone’s patents by providing ringback tone services. We agreed to indemnify each of T-Mobile and MetroPCS against the claims based on an indemnity that is claimed to be owed by us. The respective complaint was served on T-Mobile on January 16, 2012 and on MetroPCS on January 14, 2012. We filed our answers to each complaint on April 9, 2012. In each matter, we dispute the plaintiff’s allegations regarding both the validity of its patents and its claims of infringement against T-Mobile and MetroPCS, respectively. We are unable to provide a

13



meaningful quantification of the potential impact of the final resolution of these litigation matters on our future consolidated financial statements.
In July 2010, the Washington State Office of the Attorney General, or Washington AG, sent a letter referencing complaints from consumers relating to RealNetworks’ various consumer products since 2005. In light of the ensuing investigation commenced by the Washington AG, we accrued an estimated loss totaling $2.4 million during the first quarter of 2012. On May 24, 2012, we resolved the investigation through the entry of a consent decree filed in King County, Washington Superior Court. The consent decree provided for injunctive relief related to certain consumer marketing practices, for consumer restitution of up to $2.0 million, and for payment of the Washington AG’s costs and attorneys fees in the amount of $0.4 million. The consent decree resolved with prejudice all issues raised by the Washington AG in the complaint filed in the matter. Subsequent to the 90-day customer claims period that followed the filing of the consent decree, during the third quarter of 2012 it was determined that we would make payments of $0.4 million to eligible claimants, $0.5 million to the Washington AG as indirect restitution, and the $0.4 million to the Washington AG to cover its legal costs; all payments are expected to be made by the end of the fourth quarter of 2012. The total liability of $2.4 million originally accrued as of March 31, 2012, was reduced by the remaining amount of $1.1 million in the third quarter of 2012.
On April 25, 2007, a lawsuit was filed by Greenville Communications, LLC in Greenville, Mississippi against a number of cell phone carriers, including our partners T-Mobile USA, Inc. and Alltel Corporation, alleging that they infringe its patents by providing ringback tone services. We agreed to indemnify T-Mobile and Alltel against the claims based on an indemnity that is claimed to be owed by us. On August 27, 2007, our motion to transfer this matter to the U.S. District Court for the District of New Jersey was granted. The parties briefed claims construction, but the case was subsequently stayed pending reexamination of the patents at issue. On December 10, 2009, the U.S. Patent and Trademark Office issued notice of its intent to issue reexamination certificates for the patents in suit. The District Court lifted the stay on the litigation on January 29, 2010 and discovery resumed. On September 28, 2011, the District Court held a claims construction hearing, and on May 10, 2012, the District Court issued a ruling that was favorable to us and the other defendants. On or about August 8, 2012, the parties filed a stipulation with the District Court that, based on the District Court’s claims construction order, there is no infringement. We expect the stipulation filing to result in the District Court entering a judgment of non-infringement in favor of the defendants. Greenville has appealed the claims construction order and the judgment. At this time, we are unable to provide a meaningful quantification of the potential impact of the final resolution of this litigation on our future consolidated financial statements.
From time to time we are, and expect to continue to be, 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. These claims, including those described above, even if not meritorious, could force us to spend significant financial and managerial resources. We are not aware of any other legal proceedings or claims that we believe will have, individually or taken together, a material adverse effect on our business, prospects, financial condition or results of operations. However, we may incur substantial expenses in defending against third-party claims. 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.
Note 16. Guarantees
In the ordinary course of business, RealNetworks is subject to potential obligations for standard indemnification and warranty provisions that are contained within many of our customer license and service agreements, as described below.
Warranty provisions contained within our customer license and service agreements are generally consistent with those prevalent in our industry. The duration of our product warranties generally does not exceed 90 days following delivery of our products. Nearly all of our carrier contracts obligate us to indemnify our carrier customer for certain liabilities that may be incurred by them. Historically, we have not incurred significant obligations under our warranty provisions or associated with the carrier indemnification obligations. Accordingly, we do not maintain accruals for warranty-related obligations or for potential customer indemnification.
As discussed in Note 1, Description of Business and Summary of Significant Accounting Policies, we sold certain patents and other technology assets to Intel pursuant to the Asset Purchase Agreement. Pursuant to the Asset Purchase Agreement, we have specific obligations to indemnify Intel for breaches of the representations and warranties we made, and covenants we agreed to, in the Asset Purchase Agreement and for certain potential future intellectual property infringement claims brought by a third party against Intel. The amount of any potential liabilities related to our indemnification obligations will not be determined until a claim has been made, but the Asset Purchase Agreement provides that we will indemnify Intel up to the amount of the purchase price we received in the sale.
Note 17. Segment Information

14



We have three reportable segments: (1) Core Products, which includes financial results from existing and future software as a service offerings of ringback tones, ringtones, music on demand, video on demand, storefront services and inter-carrier messaging; systems integration and professional services; Helix software and licenses for handsets; SuperPass; and the Company’s international radio subscriptions; (2) Emerging Products, which includes financial results from RealPlayer, including distribution of third-party products, advertising and other revenue, and new products and services that will be introduced over time for consumers or enterprise customers; and (3) Games, which includes all games-related financial results, including game sales, subscriptions services, syndication services, advertising-supported games, and mobile and social games.
Corporate overhead expenses, including but not limited to finance, legal, stock compensation and headquarters facilities are reported in the aggregate as “Corporate” expenses and are not reflected in segment results for the business segments described in the preceding paragraph. Corporate amounts in 2012 also include the gain on sale of patent and other technology assets, net of costs. Only direct business segment expenses, such as research and development, marketing and certain other business shared services are reflected in the associated business segment results.
RealNetworks reports three reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker reviews results. Our Chief Operating Decision Maker is considered to be the CEO Staff (CEOS), which includes the interim Chief Executive Officer, Chief Financial Officer, Executive Vice President, General Counsel and certain Senior Vice Presidents. The CEOS reviews financial information presented on both a consolidated basis and on a business segment basis, accompanied by certain disaggregated information about products and services, geographical regions and corporate expenses for purposes of making decisions and assessing financial performance. 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.
Segment results for the quarters and nine months ended September 30, 2012 and 2011 were as follows (in thousands):
Core Products
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Revenue
$
34,078

 
$
50,705

 
$
110,025

 
$
144,547

Cost of revenue
17,323

 
22,492

 
52,832

 
62,829

Gross profit
16,755

 
28,213

 
57,193

 
81,718

Operating expenses
15,575

 
19,398

 
50,072

 
57,958

Operating income (loss)
$
1,180

 
$
8,815

 
$
7,121

 
$
23,760



15



Emerging Products
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Revenue
$
10,134

 
$
10,764

 
$
30,206

 
$
34,616

Cost of revenue
2,041

 
3,913

 
5,946

 
8,431

Gross profit
8,093

 
6,851

 
24,260

 
26,185

Operating expenses
8,245

 
8,884

 
22,883

 
28,144

Operating income (loss)
$
(152
)
 
$
(2,033
)
 
$
1,377

 
$
(1,959
)


16



Games
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Revenue
$
14,876

 
$
22,945

 
$
51,347

 
$
76,304

Cost of revenue
4,936

 
7,197

 
17,169

 
23,771

Gross profit
9,940

 
15,748

 
34,178

 
52,533

Operating expenses
11,648

 
14,159

 
38,171

 
46,184

Operating income (loss)
$
(1,708
)
 
$
1,589

 
$
(3,993
)
 
$
6,349



17



Corporate
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
Cost of revenue
$
944

 
$
(1,786
)
 
$
2,686

 
$
(483
)
Gain on sale of patents and other technology assets, net of costs

 

 
116,353

 

Operating expenses
21,551

 
13,640

 
55,721

 
42,566

Operating income (loss)
$
(22,495
)
 
$
(11,854
)
 
$
57,946

 
$
(42,083
)
Our customers consist primarily of consumers and corporations located in the U.S., Europe and various foreign countries. Revenue by geographic region was as follows (in thousands):
 
 
Quarters Ended
September 30,
 
Nine Months Ended
September 30,
 
2012
 
2011
 
2012
 
2011
United States
$
29,101

 
$
38,969

 
$
89,529

 
$
125,422

Europe
12,470

 
18,059

 
43,021

 
56,043

Rest of the world
17,517

 
27,386

 
59,028

 
74,002

Total net revenue
$
59,088

 
$
84,414

 
$
191,578

 
$
255,467

Long-lived assets, consisting of equipment, software, leasehold improvements, other intangible assets, and goodwill by geographic region were as follows (in thousands):
 
 
September 30,
2012
 
December 31,
2011
United States
$
31,393

 
$
38,543

Europe
2,474

 
2,949

Rest of the world
9,543

 
9,349

Total long-lived assets
$
43,410

 
$
50,841

Net assets by geographic location were as follows (in thousands):
 
 
September 30,
2012
 
December 31,
2011
United States
$
283,847

 
$
225,271

Europe
24,041

 
30,130

Rest of the world
13,971

 
15,886

Total net assets
$
321,859

 
$
271,287

Note 18. Related Party Transactions
Transactions with Rhapsody. See Note 4, Rhapsody Joint Venture, for details on the 2010 restructuring transaction involving Rhapsody. Subsequent to the restructuring transaction, we are obligated to provide Rhapsody with certain support services . These support services are expected to be completed in early 2013, unless earlier terminated by Rhapsody. The support services include information technology and limited operational support provided directly to Rhapsody. The amount of these and other support service costs were based on various measures depending on the service provided, including vendor fees, an allocation of fixed costs and time employees spend on providing services to Rhapsody. RealNetworks allocates the cost of providing these support services and records such allocation as a reduction to the related expense in the period for which it was incurred. During the quarter and nine months ended September 30, 2012, we charged Rhapsody $0.2 million and $0.7 million, respectively, for the support services. During the quarter and nine months ended September 30, 2011, we charged Rhapsody $0.2 million and $2.0 million, respectively, for the support services.

18



Transactions with LoEn Entertainment, Inc. In 2008, RealNetworks acquired approximately 11% of the outstanding shares of LoEn Entertainment, Inc. (LoEn). We paid market price for the common shares of LoEn, which are traded on the Korean Securities Dealers Automated Quotations. Our investment in LoEn is treated as an equity investment of a public company and is marked-to-market each period with resulting unrealized gains or losses recognized in accumulated other comprehensive loss. During the quarter and nine months ended September 30, 2012, we recorded revenue from LoEn of $4.0 million and $12.0 million, respectively. During the quarter and nine months ended September 30, 2011, we recorded revenue from LoEn of $7.0 million and $15.6 million, respectively. Revenue consisted primarily of sales of application service provider services, which include sales of ringback tones, music-on-demand, video-on-demand, and inter-carrier messaging services. Associated with these transactions, we also recorded accounts receivable of $3.3 million as of September 30, 2012. Accounts payable and cost of revenue associated with LoEn as of and for the periods ended September 30, 2012 and 2011 were nominal.

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about RealNetworks’ industry, products, management’s beliefs, and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:
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 and expectations for future acquisitions and divestitures;
the effect on our businesses of the sale of certain patent assets and next generation codec assets to Intel Corporation;
plans, strategies and expected opportunities for future growth, increased profitability and innovation;
the prospects for creation and growth of strategic partnerships and the resulting financial benefits from such partnerships;
the expected financial position, performance, growth and profitability of, and investment in, our businesses and the availability of resources;
our involvement in potential claims, legal proceedings and government investigations, the expected course and costs of existing claims, legal proceedings and government investigations, and the potential outcomes and effects of both existing and potential claims, legal proceedings and governmental investigations on our business, prospects, financial condition or results of operations;
the expected benefits and other consequences from the 2010 restructuring of Rhapsody and from our other strategic initiatives;
our expected introduction of new and enhanced products, services and technologies across our businesses;
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;
the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations; and
the effect of economic and market conditions on our business, prospects, financial condition or results of operations.
These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in Item 1A of Part II 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 by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.
Overview
We manage our business and report revenue and profit (loss) in three segments: (1) Core Products, (2) Emerging Products and (3) Games. Within Core Products, our revenue is derived primarily from the sale of our software as a service (SaaS) offerings, and within Emerging Products, our revenue is derived primarily from the sale of our RealPlayer media player software and from the associated distribution of third-party products. We report common corporate overhead expenses, including finance, legal, headquarters facilities and stock compensation costs, in the aggregate as Corporate results. Our most

19



significant expenses relate to cost of revenue, compensating employees, and selling and marketing our products and services.
In the quarter and nine months ended September 30, 2012, our consolidated revenue declined by $25.3 million and $63.9 million, respectively, compared with the comparable periods in 2011. The declines in both the quarter and nine-month periods were principally the result of declines in revenue in both our Core Products and Games segments.

Our SaaS business within Core Products continues to experience competitive pricing pressure from carriers and the proliferation of smartphone applications and services, some of which do not depend on our carrier customers for distribution to consumers. In addition, we are still experiencing pricing pressure from carriers for our intercarrier messaging services, which prevents this revenue from rising in spite of increased usage of our services. In our Games segment, consumer’s game play continues to shift from downloadable PCs games and online game subscriptions, where we currently generate 85% of overall Games revenues, to social networks and mobile devices. Since 2011, we have been focusing on developing social games and monetizing social game play experiences. However, the revenue we currently generate from social games is not a significant portion of our Games revenue. Our Emerging Products segment is experiencing declines in revenue as a result of market saturation related to third-party software products we distribute.

We continue to focus on aligning our operating expenses with our revenue profile, and in the third quarter of 2012 we announced we would be eliminating approximately 160 positions worldwide, with the reductions expected to be completed by the end of the first quarter of 2013. In the third quarter of 2012 we also assigned two of our existing domestic carrier service contracts for ringback tone, ring tone, and music on demand services to a third party. These actions resulted in the recording of restructuring charges totaling $10.7 million in the third quarter of 2012. Of the total 160 positions being eliminated, approximately one-third of the impacted individual employees could be reassigned to another position within the Company. Because of this uncertainty, no severance expense was recorded for this group as of September 30, 2012, however, to the extent that we are unable to reassign any of these individuals, we expect to record additional severance charges.
In the second quarter of 2012 we completed the sale of certain patents, patent applications and related rights and assets relating to our Next Generation Video codec technologies pursuant to the Asset Purchase Agreement with Intel Corporation dated January 26, 2012. We received gross cash consideration of $120.0 million from the sale, and reported the sales proceeds, net of related direct costs, as a gain on the statement of operations. This gain accounts for the material improvement in our operating income (loss) and net income (loss) for nine months ended September 30, 2012, compared with the 2011 prior year period.
Condensed consolidated results of operations were as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Total revenue
$
59,088

 
$
84,414

 
$
(25,326
)
 
(30
)%
 
$
191,578

 
$
255,467

 
$
(63,889
)
 
(25
)%
Cost of revenue
25,244

 
31,816

 
(6,572
)
 
(21
)%
 
78,633

 
94,548

 
(15,915
)
 
(17
)%
Gross profit
33,844

 
52,598

 
(18,754
)
 
(36
)%
 
112,945

 
160,919

 
(47,974
)
 
(30
)%
Gross margin
57
%
 
62
%
 
 
 
 
 
59
%
 
63
%
 
 
 
 
Sale of patent assets and other technology assets, net of costs

 

 

 
 %
 
116,353

 

 
116,353

 
100
 %
Operating expenses
57,019

 
56,081

 
938

 
2
 %
 
166,847

 
174,852

 
(8,005
)
 
(5
)%
Operating income (loss)
$
(23,175
)
 
$
(3,483
)
 
$
(19,692
)
 
(565
)%
 
$
62,451

 
$
(13,933
)
 
$
76,384

 
548
 %
In the third quarter of 2012, our total consolidated revenue declined by $25.3 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $16.6 million in our Core Products segment and a decline of $8.1 million in our Games segment, due to the factors described above. Gross margin declined to 57% from 62% for the year earlier quarter as a result of a decrease of $4.2 million in royalty expense in the prior year, due to a change in estimates in our accrued royalties.
Operating expenses increased by $0.9 million in the quarter ended September 30, 2012, compared with the prior year primarily due to increased restructuring costs of $10.3 million. This increase was partially offset by reduced personnel and related costs of $7.3 million, and reduced marketing expenses of $1.7 million, due in turn to our ongoing work to align our operating expenses with our revenue profile.
For the nine months ended September 30, 2012, our total consolidated revenue declined by $63.9 million, compared with

20



the year-earlier period. The reduction in revenue resulted from a decline of $34.5 million in our Core Products segment, a decline of $25.0 million in our Games segment, and a decline of $4.4 million in our Emerging Products segment, due to the factors described above. Gross margin declined to 59% from 63% compared with the year-earlier period as a result of a decrease of $5.5 million in royalty expense in the prior year, due to a change in estimates in our accrued royalties.
Operating expenses improved by $8.0 million for the nine months ended September 30, 2012, compared with the prior year period due primarily to reduced personnel and related costs of $16.1 million, and reduced marketing expenses of $5.0 million, due in turn to our ongoing work to align our operating expenses with our revenue profile. These declines were partially offset by an increase in restructuring costs totaling $6.0 million, and expenses we recorded of $1.3 million in the nine months ended September 30 2012, associated with the investigation by the Washington State Attorney General’s Office, which was resolved through a consent decree entered into in the quarter ended June 30, 2012. In addition, operating expenses in the nine months ended September 30, 2011 were favorably impacted by a benefit of $6.4 million related to an insurance reimbursement for previously settled litigation that reduced expenses during the quarter ended March 31, 2011.
The gain from the sale of patents and other technology assets to Intel Corporation of $117.9 million in the second quarter of 2012 reflects the cash proceeds of $120.0 million less $2.1 million of direct expenses incurred in that quarter. We incurred $1.6 million of direct expenses in the first quarter of 2012, resulting in a net gain of $116.4 million for the nine months ended September 30, 2012.
See “Segment Operating Results” below for more information and discussion regarding changes in the operating results for each of our reporting segments.
Segment Operating Results
Core Products
The Core Products segment primarily generates revenue and incurs costs from the sales of SaaS services, such as ringback tones, inter-carrier messages, music on demand and video on demand; professional services and system integration services to carriers and mobile handset companies; sales of licenses of our software products such as Helix for handsets; and consumer subscriptions such as SuperPass and international radio subscriptions.
Core Products segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Revenue
$
34,078

 
$
50,705

 
$
(16,627
)
 
(33
)%
 
$
110,025

 
$
144,547

 
$
(34,522
)
 
(24
)%
Cost of revenue
17,323

 
22,492

 
(5,169
)
 
(23
)%
 
52,832

 
62,829

 
(9,997
)
 
(16
)%
Gross profit
16,755

 
28,213

 
(11,458
)
 
(41
)%
 
57,193

 
81,718

 
(24,525
)
 
(30
)%
Gross margin
49
%
 
56
%
 
 
 
 
 
52
%
 
57
%
 
 
 
 
Operating expenses
15,575

 
19,398

 
(3,823
)
 
(20
)%
 
50,072

 
57,958

 
(7,886
)
 
(14
)%
Operating income (loss)
$
1,180

 
$
8,815

 
$
(7,635
)
 
(87
)%
 
$
7,121

 
$
23,760

 
$
(16,639
)
 
(70
)%
Total Core Products revenue decreased by $16.6 million in the quarter ended September 30, 2012, compared with the year-earlier period, primarily due to reduced revenue from our SaaS offerings of $9.7 million. The decline in SaaS revenue was due primarily to a $7.4 million decline in our ringback tone, music on demand and intercarrier messaging revenues due to both fewer subscribers and lower contract prices. Revenue from systems integration declined $3.6 million, and revenues on our SuperPass product decreased $2.4 million due to a decline in subscribers.
Total Core Products revenue decreased by $34.5 million for the nine months ended September 30, 2012, compared with the year-earlier period, primarily due to reduced revenue from our SaaS offerings of $23.7 million. The decline in SaaS revenue was due primarily to a $19.6 million decline in our ringback tone, intercarrier messaging and video on demand revenues due to both fewer subscribers and lower contract prices. Revenue from our SuperPass product decreased $5.0 million due to a decline in subscribers, and revenue from systems integration declined $4.3 million.
Cost of revenue decreased during the quarter and the nine months ended September 30, 2012 by $5.2 million and $10.0 million, respectively, compared with the year-earlier periods. During the quarter and nine months ended, costs related to our SaaS offerings decreased by $2.9 million and $6.8 million, respectively. In addition, costs related to systems integration sales decreased during the quarter and nine months ended by $2.5 million and $3.2 million, respectively. Partially offsetting these decreases was an increase in costs compared to the prior year periods due to a reduction in royalty expense from a change in

21



estimates of our accrued royalties related to our SuperPass product during the quarter and nine months ended September 30, 2011, of $1.3 million and $1.9 million, respectively.
Operating expenses declined by $3.8 million and $7.9 million for the quarter and nine months ended September 30, 2012, respectively, compared with the year-earlier periods, primarily due to reductions in personnel and related costs that resulted from our ongoing work to align our operating expenses with our revenue profile.
Emerging Products
The Emerging Products segment primarily generates revenue and incurs costs from sales of RealPlayer and its related products, such as the distribution of third-party software products, advertising on RealPlayer websites, and sales of RealPlayerPlus software licenses to consumers. Also included within the Emerging Products segment is the cost to build and develop new product offerings for consumers and business customers.
Emerging Products segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Revenue
$
10,134

 
$
10,764

 
$
(630
)
 
(6
)%
 
$
30,206

 
$
34,616

 
$
(4,410
)
 
(13
)%
Cost of revenue
2,041

 
3,913

 
(1,872
)
 
(48
)%
 
5,946

 
8,431

 
(2,485
)
 
(29
)%
Gross profit
8,093

 
6,851

 
1,242

 
18
 %
 
24,260

 
26,185

 
(1,925
)
 
(7
)%
Gross margin
80
%
 
64
%
 
 
 
 
 
80
%
 
76
%
 
 
 
 
Operating expenses
8,245

 
8,884

 
(639
)
 
(7
)%
 
22,883

 
28,144

 
(5,261
)
 
(19
)%
Operating income (loss)
$
(152
)
 
$
(2,033
)
 
$
1,881

 
93
 %
 
$
1,377

 
$
(1,959
)
 
$
3,336

 
170
 %

Total Emerging Products revenue decreased by $0.6 million and $4.4 million in the quarter and nine months ended September 30, 2012, respectively, compared with the year-earlier periods. These decreases were primarily due to lower revenue from advertising during the quarter and nine months ended, of $0.6 million and $2.0 million, respectively. In addition, revenue related to the distribution of third-party software declined during the nine months ended September 30, 2012 by $2.7 million, due to fewer units distributed.
Cost of revenue decreased by $1.9 million and $2.5 million for the quarter and nine months ended September 30, 2012, respectively, primarily due to the cost impacts of certain advertising agreements that occurred in 2011.
Operating expenses decreased by $0.6 million and $5.3 million for the quarter and nine months ended September 30, 2012, respectively, compared with the year-earlier periods. The decreases were due in part to reductions in personnel and related costs that resulted from our ongoing work to align our operating expenses with our revenue profile, during the quarter and nine months ended, of $1.8 million and $6.6 million, respectively. Partially offsetting these decreases was increased marketing spend to drive the distribution of RealPlayer, during the quarter and nine months ended, of $1.3 million and $1.6 million, respectively.
Games
The Games segment primarily generates revenue and incurs costs from the creation, distribution and sales of games licenses, online games subscription services, advertising on game sites and social network sites, games syndication services, and microtransactions from online and social games, and sales of mobile games.
Games segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Revenue
$
14,876

 
$
22,945

 
$
(8,069
)
 
(35
)%
 
$
51,347

 
$
76,304

 
$
(24,957
)
 
(33
)%
Cost of revenue
4,936

 
7,197

 
(2,261
)
 
(31
)%
 
17,169

 
23,771

 
(6,602
)
 
(28
)%
Gross profit
9,940

 
15,748

 
(5,808
)
 
(37
)%
 
34,178

 
52,533

 
(18,355
)
 
(35
)%
Gross margin
67
%
 
69
%
 
 
 
 
 
67
%
 
69
%
 
 
 
 
Operating expenses
11,648

 
14,159

 
(2,511
)
 
(18
)%
 
38,171

 
46,184

 
(8,013
)
 
(17
)%
Operating income (loss)
$
(1,708
)
 
$
1,589

 
$
(3,297
)
 
(207
)%
 
$
(3,993
)
 
$
6,349

 
$
(10,342
)
 
(163
)%

22



Total Games revenue decreased by $8.1 million in the quarter ended September 30, 2012, compared with the year-earlier period. Lower revenue from license sales and our subscription products contributed $3.2 million and $2.9 million, respectively, to the decline during the period. The decrease in license revenue reflected a decrease in the number of games sold through our games syndication services of $0.9 million, as well as lower sales of mobile games of $1.3 million. Lower subscription revenue was a result of fewer subscribers compared with the year-earlier period.
Total Games revenue decreased by $25.0 million for the nine months ended September 30, 2012, compared with the year-earlier period. Lower revenue from license sales and our subscription products contributed $10.9 million and $8.4 million, respectively, to the decline during the period. The decrease in license revenue included a decrease in the number of games sold through our games syndication services of $4.4 million, as well as lower sales of mobile games of $3.6 million. Lower subscription revenue was a result of fewer subscribers compared with the year-earlier period.
Cost of revenue decreased by $2.3 million and $6.6 million in the quarter and nine months ended September 30, 2012, respectively, compared with the year-earlier periods. These decreases were primarily due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue.
Operating expenses declined by $2.5 million and $8.0 million for the quarter and nine months ended September 30, 2012, respectively, compared with the year-earlier periods. The decreases were mainly due to reductions in marketing expenses of $2.1 million and $5.6 million, primarily related to our non-social games, in the quarter and nine months ended September 30, 2012, respectively.
Corporate
Certain corporate-level activity is not allocated to our segments, including costs of: human resources, legal, finance, information technology, procurement activities, litigation, corporate headquarters, legal settlements and contingencies, stock compensation, restructuring costs and losses on excess office facilities.

Corporate segment results of operations were as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Cost of revenue
$
944

 
$
(1,786
)
 
$
2,730

 
153
 %
 
$
2,686

 
$
(483
)
 
$
3,169

 
656
%
Gain on sale of patent assets and other technology assets, net of costs

 

 

 
 %
 
116,353

 

 
116,353

 
100
%
Operating expenses
21,551

 
13,640

 
7,911

 
58
 %
 
55,721

 
42,566

 
13,155

 
31
%
Operating income (loss)
$
(22,495
)
 
$
(11,854
)
 
$
(10,641
)
 
(90
)%
 
$
57,946

 
$
(42,083
)
 
$
100,029

 
238
%
Cost of revenue increased during the quarter and nine months ended September 30, 2012 by $2.7 million and $3.2 million, respectively, primarily due to a reduction in expense in the prior year periods from a change in estimates of our accrued royalties on our historical music business of approximately $2.8 million and $3.6 million during the quarter and nine months ended September 30, 2011, respectively.
The net gain from the sale of patents and other technology assets to Intel Corporation of $116.4 million in the nine months ended September 30, 2012 reflects the cash proceeds of $120.0 million in the second quarter, less $3.6 million of direct transaction expenses incurred during the first and second quarters.
Operating expenses increased by $7.9 million in the quarter ended September 30, 2012, compared with the year-earlier period. The increase compared with the prior period was primarily due to an increase in restructuring costs of $10.3 million. This increase was partially offset by reductions in personnel and related costs of $2.3 million, which resulted from our ongoing work to align our operating expenses with our revenue profile.
Operating expenses increased by $13.2 million for the nine months ended September 30, 2012, compared with the year-earlier period. The increase compared with the prior period was primarily due to increased restructuring costs and losses on excess office facilities totaling $6.4 million, and to the impact of a benefit in the first quarter of 2011 of $6.4 million related to an insurance reimbursement for previously settled litigation that reduced expense in the prior year. These increases were partially offset by reductions in personnel and related costs of $1.7 million in the nine months ended September 30, 2012, which resulted from our ongoing work to align our operating expenses with our revenue profile.
Consolidated Operating Expenses

23



Consolidated operating expenses consist primarily of salaries and related personnel costs including stock based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, restructuring and related charges, and losses on excess office facilities. Operating expenses were as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Research and development
$
15,321

 
$
16,496

 
$
(1,175
)
 
(7
)%
 
$
49,167

 
$
54,200

 
$
(5,033
)
 
(9
)%
Sales and marketing
21,972

 
28,625

 
(6,653
)
 
(23
)%
 
68,462

 
85,958

 
(17,496
)
 
(20
)%
General and administrative
8,759

 
10,522

 
(1,763
)
 
(17
)%
 
35,103

 
27,018

 
8,085

 
30
 %
Restructuring and other charges
10,724

 
438

 
10,286

 
2,348
 %
 
13,872

 
7,850

 
6,022

 
77
 %
Loss (gain) on excess office facilities
243

 

 
243

 
100
 %
 
243

 
(174
)
 
417

 
240
 %
Total consolidated operating expenses
$
57,019

 
$
56,081

 
$
938

 
2
 %
 
$
166,847

 
$
174,852

 
$
(8,005
)
 
(5
)%
Research and development expenses decreased by $1.2 million in the quarter ended September 30, 2012, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $1.1 million resulting from our ongoing work to align our operating expenses with our revenue profile.
Research and development expenses decreased by $5.0 million for the nine months ended September 30, 2012, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $4.1 million resulting from our ongoing work to align our operating expenses with our revenue profile.
Sales and marketing expenses decreased by $6.7 million in the quarter ended September 30, 2012, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $4.5 million resulting from our ongoing work to align our operating expenses with our revenue profile and to lower expenses for marketing and related activities of $1.7 million.
Sales and marketing expenses decreased by $17.5 million for the nine months ended September 30, 2012, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $11.3 million resulting from our ongoing work to align our operating expenses with our revenue profile and to lower expenses for marketing and related activities of $5.3 million.
General and administrative expenses decreased by $1.8 million in the quarter ended September 30, 2012, compared with the year-earlier period. The decrease was primarily due to an expense benefit of $1.1 million in the third quarter of 2012 related to the previously disclosed investigation by the Washington State Attorney General's office, for which we originally accrued an estimated expense of $2.4 million for in the first quarter of 2012. The matter was resolved and the related ultimate loss amount to RealNetworks was determined in the third quarter, at an amount totaling $1.3 million. For additional details, see Note 15, Commitments and Contingencies.
General and administrative expenses increased by $8.1 million for the nine months ended September 30, 2012, compared with the year-earlier period. This increase was primarily due to the impact of a benefit in the first quarter of 2011 of $6.4 million related to an insurance reimbursement for previously settled litigation that reduced expense in the prior year, and to expenses totaling $1.3 million for the nine months ended September 30, 2012 for amounts associated with the Washington State Attorney General’s office matter described above.
Restructuring and other charges in 2012 and 2011 consist of costs associated with the ongoing reorganization of our business operations and focus on aligning our operating expenses with our revenue profile. In the third quarter of 2012 we announced we would be eliminating approximately 160 positions worldwide, with the reductions expected to be completed by the end of the first quarter of 2013. In the third quarter of 2012 we also assigned two of our existing domestic carrier service contracts for ringback tone, ring tone, and music on demand services to a third party. These actions resulted in the recording of restructuring charges totaling $10.7 million in the third quarter of 2012. Of the total 160 positions being eliminated, approximately one-third of the impacted individual employees could be reassigned to another position within the Company. Because of this uncertainty, no severance expense was recorded for this group as of September 30, 2012, however, to the extent that we are unable to reassign any of these individuals, we expect to record additional severance charges.

24




Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
Interest income, net
$
164

 
$
672

 
$
(508
)
 
(76
)%
 
$
1,033

 
$
1,362

 
$
(329
)
 
(24
)%
Gain (loss) on sale of equity investments, net
$
2,210

 
$

 
$
2,210

 
100
 %
 
$
5,288

 
$

 
$
5,288

 
100
 %
Equity in net loss of Rhapsody
(1,613
)
 
(1,440
)
 
(173
)
 
(12
)%
 
(4,095
)
 
(5,739
)
 
1,644

 
29
 %
Other income (expense), net
248

 
(228
)
 
476

 
209
 %
 
1,674

 
(661
)
 
2,335

 
353
 %
Total other income (expense), net
$
1,009

 
$
(996
)
 
$
2,005

 
201
 %
 
$
3,900

 
$
(5,038
)
 
$
8,938

 
177
 %
The increase in Other income (expense), net, of $2.0 million for the quarter ended September 30, 2012, was primarily due to the gain on the sale of a portion of our investment in LoEn Entertainment, Inc. totaling $2.2 million, which is discussed further in Note 1, Description of Business and Summary of Significant Accounting Policies.
The increase in Other income (expense), net, of $8.9 million for the nine months ended September 30, 2012, was due primarily to the gain on the sale of a portion of our investment in LoEn Entertainment, Inc. and a gain on the sale of our Film.com assets, totaling $5.3 million. Also contributing to the increase were non-cash gains for the nine months ended September 30, 2012, due to the release of a $2.0 million cumulative foreign exchange translation gain from accumulated other comprehensive loss on the balance sheet related to the liquidations of investments in certain of our foreign entities.
We account for our investment in Rhapsody under the equity method of accounting for investments. Under this method, our proportionate share of the reported income (loss) of Rhapsody is recognized in our statement of operations, and as an increase (decrease) to the net carrying value of our Rhapsody investment. The net carrying value of our investment in Rhapsody is not necessarily indicative of the underlying fair value of our investment.
Income Taxes
During the quarters ended September 30, 2012 and 2011, we recognized income tax expense of $48 thousand and $0.7 million, respectively, related to U.S. and foreign income taxes. During the nine months ended September 30, 2012 and 2011, we recognized income tax expense of $24.6 million and $5.4 million, respectively, related to U.S. and foreign income taxes. The change in income tax expense and the change in income tax expense as a percentage of pre-tax income during the quarter and nine months ended September 30, 2012, was largely the result of a change in the jurisdictional income mix and the impact of the second quarter 2012 gain on the sale of patents and other assets to Intel Corporation.
The sale of patents and other technology assets to Intel Corporation, which was completed on April 5, 2012 and is described in more detail in Note 1, Description of Business and Summary of Significant Accounting Policies, was recorded as a gain, before certain direct costs, of $120.0 million in the quarter ended June 30, 2012. For GAAP reporting purposes, this transaction was considered a discrete item for the quarter ended June 30, 2012. Because of our U.S. net operating loss carryforwards and capital loss carryforwards, we do not expect to incur any significant cash tax costs related to this transaction.
As of September 30, 2012, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the 2011 10-K. We currently anticipate the closure of foreign and domestic income tax examinations in the next twelve months that may decrease our total unrecognized tax benefits by up to $13.8 million as a result of the successful defense of our positions, the settlement and payment of a liability, or a combination thereof. Of this amount, we anticipate a decrease in our total unrecognized tax benefits by up to $12.7 million in the fourth quarter of 2012 as a result of settling a foreign tax examination shortly after the end of the third quarter of 2012. We are in the process of analyzing the impact of this settlement and currently expect to recognize a tax benefit in our consolidated statement of operations of approximately $11 million to $13 million relating to the recognition of unrecognized tax benefits in the fourth quarter of 2012.
We generate income in a number of foreign jurisdictions, some of which have higher tax rates and some of which have lower tax rates relative to the U.S. federal statutory rate. Our tax expense could fluctuate significantly on a quarterly basis to the extent income is lower than anticipated in countries where we have lower statutory tax rates and higher than anticipated in countries where we have higher statutory tax rates. For the quarter ended September 30, 2012, decreases in tax expense from

25



income generated in foreign jurisdictions with lower tax rates in comparison to the U.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 the U.S. federal statutory rate. As such, the effect of differences in foreign tax rates on the Company’s tax expense for the third quarter of 2012 was minimal.
As of September 30, 2012, we have not provided for U.S. federal and state income taxes on certain undistributed earnings of our foreign subsidiaries, since such earnings are considered indefinitely reinvested outside the U.S. If these amounts were distributed to the U.S., in the form of dividends or otherwise, the Company could be subject to additional U.S. income taxes. It is not practicable to determine the U.S. federal income tax liability or benefit on such earnings due to the timing of such future distributions, the availability of foreign tax credits, and the complexity of the computation if such earnings were not deemed to be permanently reinvested. If future events, including material changes in estimates of cash, working capital, and long-term investment requirements necessitate that these earnings be distributed, an additional provision for U.S. income and foreign withholding taxes, net of foreign tax credits, may be necessary.
We file numerous consolidated and separate income tax returns in the United States, including federal, state and local returns, as well as in foreign jurisdictions. With few exceptions, we are no longer subject to United States federal income tax examinations for tax years prior to 2008 or state, local or foreign income tax examinations for years prior to 1993. RealNetworks, Inc. and /or subsidiaries are under audit by the United States federal government, various states, and foreign jurisdictions for certain tax years subsequent to 1993.
Geographic Revenue
Revenue by geographic region was as follows (dollars in thousands):
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
$ Change
 
% Change
 
2012
 
2011
 
$ Change
 
% Change
United States
$
29,101

 
$
38,969

 
$
(9,868
)
 
(25
)%