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RNWK > SEC Filings for RNWK > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for REALNETWORKS INC

Form 10-Q for REALNETWORKS INC


8-Aug-2013

Quarterly Report


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;

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 of our growth plans, strategic initiatives, and restructurings;

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
In the first quarter of 2013 we reorganized the management of our businesses and as a result, we now report the following three segments: (1) RealPlayer Group,
(2) Mobile Entertainment and (3) Games. Within our RealPlayer Group, revenue is derived from the sale of our RealPlayer media player software and related products, such as the distribution of third party software products, advertising on RealPlayer websites, and sales of RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass. The Mobile Entertainment business primarily includes revenue from SaaS services, systems integration, and professional services to mobile carriers, and sales of technology licenses of our software products such as Helix. The Games business primarily includes revenue from sales of games licenses, online games subscription services, advertising on games sites and social network sites, microtransactions from online and social games, and sales of mobile games. In addition, we now also allocate certain corporate expenses which are directly attributable to supporting the business, including but not limited to a portion of finance, legal, human resources and headquarters facilities, to our reportable segments rather than retaining those expenses in our corporate segment. The allocation of these costs to the business units will increase accountability for financial and operational performance within each of our reportable segments. RealNetworks' most significant expenses relate to cost of revenue, compensating employees, and selling and marketing our products and services. The historical financial information presented has been recast to reflect the new segments and the new corporate expense presentation.


In the quarter and six months ended June 30, 2013, our consolidated revenue declined by $15.7 million and $25.8 million, respectively, compared to the same periods in 2012. The decline for the quarter was due to a decline of $7.4 million in Mobile Entertainment revenue, a decline of $4.5 million in Games revenue, and a $3.8 million decline in RealPlayer Group revenue. For the year to date period the decline was primarily due to a decline of $12.7 million in Mobile Entertainment revenue and a decline of $9.7 million in Games revenue.

Our SaaS business within Mobile Entertainment continues to be impacted by 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. In our Games segment and in the general games market, consumer game play continues to shift from downloadable PC games to social networks and mobile devices. Since 2011, we have been focusing on developing social and mobile games and monetizing those game play experiences. However, the revenue we currently generate from social games is not a significant portion of our Games revenue.
We are continuing to invest in each of our businesses. For example, in the quarter ended June 30, 2013, we acquired Slingo, a social casino games company based in the U.S., for total cash consideration of $15.6 million. This acquisition is intended to enhance our footprint in the social casino games arena. Associated with this will be incremental costs for investment in new products over the next year, which will directly impact our operating income
(loss) before taxes.

We continue to focus on aligning our operating expenses with our revenue profile. The actions we initiated in the third quarter of 2012 to eliminate approximately 160 positions worldwide contributed significantly to the $6.5 million and $15.3 million decline in our total operating expenses for the quarter and six months ended June 30, 2013, respectively, compared to the same periods in 2012. In addition, on May 2, 2013, we entered into a new lease in a new location for our Seattle headquarters and concurrently negotiated an early termination to our current headquarters office lease. This action will meaningfully reduce our future annual facilities cost.
Condensed consolidated results of operations were as follows (dollars in thousands):

                                Quarters Ended June 30,                               Six months ended June 30,
                     2013          2012         $ Change     % Change       2013          2012         $ Change     % Change
Total revenue     $  49,850     $  65,526     $  (15,676 )      (24 )%   $ 106,643     $ 132,490     $  (25,847 )      (20 )%
Cost of revenue      19,519        25,962         (6,443 )      (25 )%      40,025        53,389        (13,364 )      (25 )%
Gross profit         30,331        39,564         (9,233 )      (23 )%      66,618        79,101        (12,483 )      (16 )%
Gross margin             61 %          60 %                                     62 %          60 %
Sale of patent
assets and other
technology
assets, net of
costs                     -       117,933       (117,933 )     (100 )%           -       116,353       (116,353 )     (100 )%
Operating
expenses             46,835        53,329         (6,494 )      (12 )%      94,548       109,828        (15,280 )      (14 )%
Operating income
(loss)            $ (16,504 )   $ 104,168     $ (120,672 )     (116 )%   $ (27,930 )   $  85,626     $ (113,556 )     (133 )%

In the second quarter of 2013, our total consolidated revenue declined by $15.7 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $7.4 million in our Mobile Entertainment segment, a decline of $4.5 million in our Games segment, and a $3.8 million decline in RealPlayer Group revenue, due to the factors described above. Gross margin increased to 61% from 60% for the year earlier quarter as a result of a higher proportion of lower margin revenue in the prior year, in addition to lower personnel and related costs in the second quarter of 2013 that resulted from our ongoing expense alignment efforts. Operating expenses decreased by $6.5 million in the quarter ended June 30, 2013, compared with the prior year primarily due to reductions in personnel and related costs that resulted from our ongoing expense alignment efforts. Excluding restructuring and lease exit and related charges, operating expenses decreased by $8.8 million in the quarter ended June 30, 2013, compared to the same period of the prior year.
For the six months ended June 30, 2013, our total consolidated revenue declined by $25.8 million, compared with the year-earlier period. The reduction in revenue primarily resulted from a decline of $12.7 million in our Mobile Entertainment segment and a decline of $9.7 million in our Games segment, due to the factors described above. Gross margin increased to 62% from 60% for the year earlier quarter as a result of a higher proportion of lower margin revenue in the prior year, in addition to lower personnel and related costs in the first half of 2013 that resulted from our ongoing expense alignment efforts. Operating expenses decreased by $15.3 million in the six months ended June 30, 2013, compared with the prior year primarily due to reductions in personnel and related costs that resulted from our ongoing expense alignment efforts. Excluding


restructuring and lease exit and related charges, operating expenses decreased by $17.4 million in the six months ended June 30, 2013, compared to the same period of the prior year.
The 2012 gain from the sale of patents and other technology assets to Intel is net of certain direct expenses incurred for the sale transaction. 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
RealPlayer Group
The RealPlayer Group 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 RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass.
RealPlayer Group segment results of operations were as follows (dollars in thousands):

                              Quarters Ended June 30,                            Six months ended June 30,
                     2013         2012       $ Change    % Change       2013         2012       $ Change     % Change
Revenue           $ 18,383     $ 22,158     $ (3,775 )      (17 )%   $ 40,766     $ 44,239     $ (3,473 )       (8 )%
Cost of revenue      4,409        4,727         (318 )       (7 )%      9,720        9,291          429          5  %
Gross profit        13,974       17,431       (3,457 )      (20 )%     31,046       34,948       (3,902 )      (11 )%
Gross margin            76 %         79 %                                  76 %         79 %
Operating
expenses            14,001       12,792        1,209          9  %     30,207       28,767        1,440          5  %
Operating income
(loss)            $    (27 )   $  4,639     $ (4,666 )     (101 )%   $    839     $  6,181     $ (5,342 )      (86 )%

Total RealPlayer Group revenue decreased by $3.8 million in the quarter ended June 30, 2013, compared with the year-earlier period. This decrease was primarily a result of lower subscriptions revenue of $2.6 million due to fewer subscribers, primarily attributable to our SuperPass product. Further contributing to the decrease was lower revenues of $1.3 million in sales of intellectual property licenses.
Total RealPlayer Group revenue decreased by $3.5 million for the six months ended June 30, 2013, compared with the year-earlier period. This decrease was primarily a result of lower subscriptions revenue of $5.3 million due to subscriber attrition, primarily attributable to our SuperPass product. Partially offsetting this decrease was an increase in revenue of $3.1 million from distribution of third party software.
Gross margin during the quarter and six months ended June 30, 2013 declined by 3%, due primarily to a change in our estimates of accrued royalties, which resulted in an increase in partner royalties expense as a percentage of revenue during the quarter and six months ended June 30, 2013.
Operating expenses increased by $1.2 million and $1.4 million for the quarter and six months ended June 30, 2013, respectively, compared with the year-earlier periods. Personnel and related costs increased $1.8 million and $2.8 million during the quarter and six months ended June 30, 2013, respectively, due to investment in new product development. Further contributing to the increase during the six months ended was an increase in marketing spend of $0.8 million. Partially offsetting the increases for the six months ended June 30, 2013 was a decrease of $2.4 million, resulting from estimated amounts recorded during the quarter ended March 31, 2012 associated with the then-pending investigation by the Washington State Attorney General's office. As disclosed in the 2012 10-K, this matter was resolved in the third quarter of 2012 in an amount totaling $1.3 million.
Mobile Entertainment
The Mobile Entertainment segment primarily generates revenue and incurs costs from the sales of SaaS services, such as ringback tones, intercarrier messages, music on demand and video on demand; professional services and systems integration services to mobile carriers and mobile handset companies; and Helix software.
Mobile Entertainment segment results of operations were as follows (dollars in thousands):


                               Quarters Ended June 30,                              Six months ended June 30,
                     2013         2012       $ Change     % Change        2013         2012       $ Change      % Change
Revenue           $ 18,592     $ 26,005     $ (7,413 )      (29 )%     $ 39,087     $ 51,780     $ (12,693 )      (25 )%
Cost of revenue     11,170       14,875       (3,705 )      (25 )%       22,002       30,353        (8,351 )      (28 )%
Gross profit         7,422       11,130       (3,708 )      (33 )%       17,085       21,427        (4,342 )      (20 )%
Gross margin            40 %         43 %                                    44 %         41 %
Operating
expenses             8,412       13,851       (5,439 )      (39 )%       17,523       28,655       (11,132 )      (39 )%
Operating income
(loss)            $   (990 )   $ (2,721 )   $  1,731         64  %     $   (438 )   $ (7,228 )   $   6,790         94  %

Total Mobile Entertainment revenue decreased by $7.4 million and $12.7 million in the quarter and six months ended June 30, 2013, respectively, compared with the year-earlier periods. The declines during the quarter and six months ended June 30, 2013 were primarily due to reduced revenue from our SaaS offerings of $6.3 million and $11.1 million, respectively. The decline in SaaS revenue was due to $4.5 million and $6.4 million of lost revenue upon the termination of certain SaaS contracts over the last four quarters, and to $2.7 million and $6.1 million lower revenue due to fewer subscribers on existing contracts, and pricing pressures from carriers across our tones business, intercarrier messaging, and other carrier services, during the quarter and six months ended June 30, 2013, respectively.
Cost of revenue decreased by $3.7 million and $8.4 million during the quarter and six months ended June 30, 2013, respectively, compared with the year-earlier periods. Costs related to our SaaS offerings decreased by $3.5 million and $8.0 million during the quarter and six months ended, respectively, due to the lower revenues and to lower personnel and related costs that resulted from our ongoing expense alignment efforts.
Operating expenses declined by $5.4 million and $11.1 million for the quarter and six months ended June 30, 2013, compared with the year-earlier periods, primarily due to reductions in personnel and related costs of $4.9 million and $9.9 million during the quarter and six months ended, respectively, that resulted from our ongoing expense alignment efforts. 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 June 30,                             Six months ended June 30,
                     2013         2012       $ Change     % Change        2013         2012       $ Change     % Change
Revenue           $ 12,875     $ 17,363     $ (4,488 )      (26 )%     $ 26,790     $ 36,471     $ (9,681 )      (27 )%
Cost of revenue      3,381        5,630       (2,249 )      (40 )%        7,181       12,343       (5,162 )      (42 )%
Gross profit         9,494       11,733       (2,239 )      (19 )%       19,609       24,128       (4,519 )      (19 )%
Gross margin            74 %         68 %                                    73 %         66 %
Operating
expenses            11,755       13,801       (2,046 )      (15 )%       23,607       27,939       (4,332 )      (16 )%
Operating income
(loss)            $ (2,261 )   $ (2,068 )   $   (193 )       (9 )%     $ (3,998 )   $ (3,811 )   $   (187 )       (5 )%

Total Games revenue decreased by $4.5 million in the quarter ended June 30, 2013, compared with the year-earlier period. Lower revenue from license sales, our subscription products, and advertising contributed $2.2 million, $1.6 million, and $1.2 million respectively, to the decline during the period. Slightly offsetting these decreases was an increase of $0.6 million in games revenue as a result of the acquisition of Slingo, a social casino games company, during the quarter.
Total Games revenue decreased by $9.7 million during the six months ended June 30, 2013, compared with the year-earlier period. Lower revenue from license sales, subscription products, and advertising contributed $4.5 million, $3.4 million, and $1.7 million, respectively, to the decline during the period. Slightly offsetting these decreases was an increase of $0.6 million in games revenue as a result of the acquisition of Slingo during the quarter. Cost of revenue decreased by $2.2 million and $5.2 million during the quarter and six months ended June 30, 2013, respectively, compared with the year-earlier periods. The decreases were due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue. Gross margins increased during the quarter and six months ended


June 30, 2013 due to lower margin projects that occurred in the year-earlier period, in addition to intangible assets that were fully amortized in 2012, resulting in lower expense in 2013.
Operating expenses declined by $2.0 million and $4.3 million during the quarter and six months ended June 30, 2013, respectively, compared with the year-earlier period. During the quarter-ended June 30, 2013, the decrease was mainly due to reductions in marketing expense of $0.9 million, in addition to reductions in personnel and related costs of $1.1 million, resulting from our ongoing expense alignment efforts. Partially offsetting these declines was an increase in total operating expense of $0.8 million as a result of the acquisition of Slingo during the quarter. During the six months ended June 30, 2013, the decrease was primarily due to reductions in personnel and related costs of $2.8 million, and reductions in marketing expense of $1.9 million. Partially offsetting these declines was an increase in total operating expense of $0.8 million as a result of the acquisition of Slingo during the quarter.
In the quarter ended June 30, 2013, we acquired Slingo, a social casino games company based in the U.S., for total cash consideration of $15.6 million. This acquisition is intended to enhance our footprint in the social casino games arena. Associated with this will be incremental costs for investment in new products over the next year, which will directly impact our operating income
(loss) before taxes. Corporate
We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments, rather than retaining those expenses in our corporate segment. These allocated corporate expenses include but are not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are retained in aggregate in our corporate segment. All restructuring and lease exit and related charges are included in the corporate segment.

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

                                   Quarters Ended June 30,                               Six months ended June 30,
                        2013          2012         $ Change     % Change       2013          2012        $ Change     % Change
Cost of revenue      $     559     $     730     $     (171 )      (23 )%   $   1,122     $  1,402     $     (280 )      (20 )%
Sale of patent and
other technology
assets, net of costs         -       117,933       (117,933 )     (100 )%           -      116,353       (116,353 )     (100 )%
Operating expenses      12,667        12,885           (218 )       (2 )%      23,211       24,467         (1,256 )       (5 )%
Operating income
(loss)               $ (13,226 )   $ 104,318     $ (117,544 )     (113 )%   $ (24,333 )   $ 90,484     $ (114,817 )     (127 )%

The 2012 gain from the sale of patents and other technology assets to Intel Corporation of $117.9 million reflects the cash proceeds of $120.0 million less $2.1 million of direct transaction expenses incurred in the second quarter. We incurred $1.6 million of direct transaction expenses in the first quarter of 2012, resulting in a gain of $116.4 million for the six months ended June 30, 2012.
Operating expenses declined by $0.2 million and $1.3 million during the quarter and six months ended June 30, 2013, respectively, compared with the year-earlier periods. The decreases during the quarter and six months ended were primarily due to reductions in personnel and related costs of $2.9 million and $3.5 million, respectively, resulting from our ongoing expense alignment efforts, in addition to reduced restructuring charges of $0.7 million and $0.9 million, respectively, primarily related to severance. Partially offsetting these decreases were net lease exit and related charges of $3.1 million in the second quarter of 2013 due to termination fees on our current headquarters office lease. See further discussion on this in Note 12, Lease Exit and Related Charges.
Consolidated Operating Expenses
Our operating expenses consist primarily of salaries and related personnel costs including stock based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, and restructuring charges. Operating expenses were as follows (dollars in thousands):


                                    Quarters Ended June 30,                             Six months ended June 30,
                          2013         2012       $ Change     % Change       2013         2012        $ Change      % Change
Research and
development            $ 14,993     $ 16,028     $ (1,035 )      (6 )%     $ 30,244     $  33,846     $  (3,602 )     (11 )%
Sales and marketing      19,269       22,694       (3,425 )     (15 )%       40,403        46,490        (6,087 )     (13 )%
General and
administrative            8,691       13,068       (4,377 )     (33 )%       18,637        26,344        (7,707 )     (29 )%
Restructuring and
other charges               816        1,539         (723 )     (47 )%        2,198         3,148          (950 )     (30 )%
Lease exit and related
charges                   3,066            -        3,066       100  %        3,066             -         3,066       100  %
Total consolidated
operating expenses     $ 46,835     $ 53,329     $ (6,494 )     (12 )%     $ 94,548     $ 109,828     $ (15,280 )     (14 )%

Research and development expenses decreased by $1.0 million in the quarter ended June 30, 2013, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $0.9 million resulting from our ongoing expense alignment efforts.
Research and development expenses decreased by $3.6 million in the six months ended June 30, 2013, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $3.8 million resulting from our ongoing expense alignment efforts.
Sales and marketing expenses decreased by $3.4 million in the quarter ended June 30, 2013, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $2.1 million resulting from our ongoing expense alignment efforts, and to lower marketing expense of $1.6 million.
Sales and marketing expenses decreased by $6.1 million in the six months ended June 30, 2013, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $4.9 million resulting from our ongoing expense alignment efforts.
General and administrative expenses decreased by $4.4 million in the quarter ended June 30, 2013, compared with the year-earlier period. The decrease was primarily due to a decrease in personnel and related costs of $3.2 million. General and administrative expenses decreased by $7.7 million in the six months . . .

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