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RNWK > SEC Filings for RNWK > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for REALNETWORKS INC

Form 10-K for REALNETWORKS INC


6-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview
We manage our business and report our financial results in 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 and our recently launched RealPlayer Cloud service. Our Mobile Entertainment business generates revenue from the sale of its SaaS services, which include ringback tones, music on demand, and intercarrier messaging, and sales of technology licenses of our software products such as Helix. Our Games business revenue is derived from sales of games licenses, online games subscription services, advertising on games sites and social networks, microtransactions within online and social games, and sales of mobile games. We allocate certain corporate expenses which are directly attributable to supporting our businesses, 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 our business units ensures accountability for financial and operational performance within each of our reportable segments. Our most significant expenses relate to cost of revenue, compensating employees, and selling and marketing our products and services. In 2013 our consolidated revenue declined by $52.6 million compared with 2012, due to a decrease of $19.1 million in Mobile Entertainment revenue, a $17.2 million decrease in Games revenue, and a $16.3 million decrease in RealPlayer Group revenue. Revenue from our legacy products continues to decline as a result of certain changes in our businesses and market-driven factors. Our SaaS business within Mobile Entertainment continues to be negatively 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, our business continues to be challenged as 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. In our RealPlayer Group segment, revenue is being negatively impacted due to a decline in subscribers, primarily attributable to our SuperPass product. Over the past twelve months we have developed a growth plan, implemented strategic initiatives, and executed certain restructuring efforts, all in an effort to grow our businesses, move towards profitability, and streamline our operations. In line with our growth plan, we continue to invest in each of our three business units. From an organic growth perspective, we have invested in the internal development of major new products, including the August 2013 launch from our Games business of GameHouse Casino Plus with the Golden Dreams Sweepstakes feature, the September 2013 launch from our RealPlayer Group of RealPlayer Cloud, an integrated video player and cloud service, and the November 2013 launch from our Mobile Entertainment business of LISTEN, a ringback tone application and service for smartphone users. Complementing these internal development efforts, we have made certain targeted acquisitions including the second quarter 2013 acquisition of U.S.-based Slingo, Inc., creator of a highly popular social casino game that combines bingo and slots, for total cash consideration of $15.6 million. We expect this acquisition to enhance our footprint in the social casino games arena. During the third quarter, we acquired U.K.-based Muzicall Limited, a provider of ringback tone services to mobile carriers and media companies in Europe, for total cash consideration of $6.7 million. This acquisition is intended to accelerate our growth initiatives in the direct-to-consumer business within the Mobile Entertainment segment. We expect to continue to invest in our growth initiatives.

In addition to our revenue growth plans, we have continued to better align our operating expenses with our revenue profile. In line with this, during the third quarter of 2012, we initiated a restructuring that eliminated approximately 160


positions worldwide. During the third quarter of 2013, we moved our Seattle headquarters, which required certain one-time lease termination and move costs, but which has meaningfully reduced our future annual facilities cost. These and other restructuring efforts have contributed to an overall decline in our operating expenses. During the year ended December 31, 2013, our total operating expenses declined $18.0 million, compared to 2012. Summary of Results
Consolidated results of operations were as follows (dollars in thousands):

                                                                2013-2012         %         2012-2011        %
                        2013          2012          2011          Change        Change       Change        Change
Total revenue        $ 206,196     $ 258,842     $ 335,686     $  (52,646 )       (20 )%   $ (76,844 )       (23 )%
Cost of revenue         79,091       103,731       126,637        (24,640 )       (24 )%     (22,906 )       (18 )%
Impairment of
deferred costs               -             -        19,962              -           -  %     (19,962 )      (100 )%
Gross profit           127,105       155,111       189,087        (28,006 )       (18 )%     (33,976 )       (18 )%
Gross margin                62 %          60 %          56 %            2 %                        4 %
Sale of patents
and other
technology assets,
net of costs                 -       116,353             -       (116,353 )      (100 )%     116,353         100  %
Total operating
expenses               197,913       215,901       226,697        (17,988 )        (8 )%     (10,796 )        (5 )%
Operating income
(loss)               $ (70,808 )   $  55,563     $ (37,610 )   $ (126,371 )      (227 )%   $  93,173         248  %

2013 compared with 2012
Revenue decreased by $52.6 million, or 20%. The reduction in revenue resulted from a decline of $19.1 million in our Mobile Entertainment segment, a decline of $17.2 million in our Games segment, and a decline of $16.3 million in our RealPlayer Group segment, due to the factors described above. Gross margin increased to 62% from 60%, primarily as a result of lower personnel and related costs that resulted from our ongoing expense alignment efforts. Operating expenses decreased by $18.0 million primarily due to reductions in personnel and related costs that resulted from our ongoing expense alignment efforts. 2012 compared with 2011
Revenue decreased by $76.8 million, or 23%. The reduction in revenue resulted from a decline of $35.1 million in our Mobile Entertainment segment, a decline of $30.8 million in our Games segment, and a decline of $10.9 million in our RealPlayer Group segment, due to the factors described above. Cost of revenue decreased by $22.9 million compared with the year earlier period due primarily to the decline in revenue, partially offset by a decrease of $5.5 million in royalty expense in 2011, due to a change in estimates of our accrued royalties. Operating expenses improved by $10.8 million due primarily to reduced personnel and related costs of $20.3 million and reduced marketing expenses of $6.7 million, due to our ongoing work to align our operating expenses with our revenue profile. These declines were partially offset by an increase of $10.5 million in restructuring costs and lease exit and related charges, in addition to a benefit in 2011 of $6.4 million related to an insurance reimbursement for previously settled litigation that reduced expenses during the quarter ended March 31, 2011.

Segment Results
RealPlayer Group
RealPlayer Group segment results of operations were as follows (dollars in
thousands):

                                                                2013-2012       %        2012-2011        %
                          2013         2012         2011         Change       Change       Change       Change
Total revenue          $ 75,206     $ 91,469     $ 102,378     $ (16,263 )     (18 )%   $ (10,909 )      (11 )%
Cost of revenue          16,220       21,544        21,534        (5,324 )     (25 )%          10          -  %
Impairment of
deferred costs                -            -           633             -         -  %        (633 )     (100 )%
Gross profit             58,986       69,925        80,211       (10,939 )     (16 )%     (10,286 )      (13 )%
Gross margin                 78 %         76 %          78 %           2 %                     (2 )%
Total operating
expenses                 60,484       55,223        59,829         5,261        10  %      (4,606 )       (8 )%
Operating income
(loss)                 $ (1,498 )   $ 14,702     $  20,382     $ (16,200 )    (110 )%   $  (5,680 )      (28 )%

2013 compared with 2012


Total RealPlayer Group revenue decreased by $16.3 million, or 18%. This decrease was primarily a result of lower subscriptions revenue of $11.8 million due to fewer subscribers, primarily attributable to our SuperPass product. Gross margin increased by 2 percentage points, due primarily to a higher proportion of lower margin revenue in the prior year. Operating expenses increased by $5.3 million. Personnel and related costs increased $5.2 million, primarily due to investment in our new RealPlayer Cloud service. 2012 compared with 2011
Revenue decreased by $10.9 million, or 11%. This decrease was due primarily to a decline in subscriptions revenue, mainly from our SuperPass product, of $8.9 million. Operating expenses decreased by $4.6 million, due primarily to reductions in personnel and related costs of $7.6 million, which resulted from our ongoing work to align our operating expenses with our revenue profile. Partially offsetting these decreases was increased expense of $1.3 million related to the expense in 2012 for the final settlement of the Washington State Attorney General's office matter, as disclosed in the 2012 10K, in addition to increased marketing spend of $0.8 million. Mobile Entertainment
Mobile Entertainment segment results of operations were as follows (dollars in thousands):

                                                                 2013-2012        %        2012-2011       %
                          2013         2012          2011          Change       Change      Change       Change
Total revenue          $ 81,181     $ 100,318     $ 135,452     $ (19,137 )      (19 )%   $ (35,134 )     (26 )%
Cost of revenue          47,608        57,670        74,524       (10,062 )      (17 )%     (16,854 )     (23 )%
Impairment of
deferred costs                -             -        19,329             -          -  %     (19,329 )    (100 )%
Gross profit             33,573        42,648        41,599        (9,075 )      (21 )%       1,049         3  %
Gross margin                 41 %          43 %          31 %          (2 )%                     12 %
Total operating
expenses                 35,839        52,614        61,921       (16,775 )      (32 )%      (9,307 )     (15 )%
Operating income
(loss)                 $ (2,266 )   $  (9,966 )   $ (20,322 )   $   7,700         77  %   $  10,356        51  %

2013 compared with 2012
In the quarter ended September 30, 2013, we acquired Muzicall, a ringback tone company based in London, for total cash consideration of $6.7 million. This acquisition is intended to accelerate our growth initiatives within the Mobile Entertainment segment.
Mobile Entertainment revenue decreased by $19.1 million, or 19%. This decrease was primarily due to reduced revenue from our SaaS offerings of $16.0 million, resulting from $17.0 million of lost revenue upon the termination of certain SaaS contracts over the last six quarters. Slightly offsetting this decrease was an increase in ringback tones revenue of $2.1 million, resulting from our purchase of Muzicall.
Gross margin declined by 2 percentage points, due primarily to a higher proportion of lower margin revenue, such as music on demand, in the current year. Operating expenses declined by $16.8 million primarily due to reductions in personnel and related costs of $17.2 million that resulted in part from the termination of certain SaaS contracts mentioned above, as well as from our ongoing expense alignment efforts. Partially offsetting these declines was an increase in total operating expense of $2.5 million as a result of the acquisition of Muzicall in 2013.

2012 compared with 2011
Total Mobile Entertainment revenue decreased by $35.1 million, or 26%. This decrease was primarily due to reduced revenue from our SaaS offerings of $29.1 million. The decline in SaaS revenue was due primarily to a $24.3 million decline in our ringback tone, intercarrier messaging and video on demand revenues due to both fewer subscribers and lower contract prices. In addition, revenue from systems integration declined $4.0 million.
Gross margin increased primarily due to the impairments of deferred costs of $19.3 million within the year ended December 31, 2011, related to certain contracts with carrier customers for which the total estimated costs exceeded the total estimated revenues expected to be recognized. Operating expenses decreased by $9.3 million primarily due to reductions in personnel and related costs that resulted from our restructuring efforts. Games
Games segment results of operations were as follows (dollars in thousands):


                                                                    2013-2012       %        2012-2011        %
                              2013          2012         2011        Change       Change       Change       Change
Total revenue              $  49,809     $ 67,055     $ 97,856     $ (17,246 )     (26 )%   $ (30,801 )      (31 )%
Cost of revenue               13,359       21,828       30,835        (8,469 )     (39 )%      (9,007 )      (29 )%
Gross profit                  36,450       45,227       67,021        (8,777 )     (19 )%     (21,794 )      (33 )%
Gross margin                      73 %         67 %         68 %           6 %                     (1 )%
Total operating expenses      47,177       51,890       62,595        (4,713 )      (9 )%     (10,705 )      (17 )%
Operating income (loss)    $ (10,727 )   $ (6,663 )   $  4,426     $  (4,064 )     (61 )%   $ (11,089 )     (251 )%

2013 compared with 2012
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. Games revenue decreased by $17.2 million, or 26%. Lower revenue from license sales, subscription products, and advertising contributed $8.3 million, $5.8 million, and $4.3 million, respectively, to the decline during the period. Slightly offsetting these decreases was an increase of $2.1 million in games revenue as a result of the acquisition of Slingo. Cost of revenue decreased by $8.5 million, or 39%. The decrease was due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue. Gross margin increased due to both lower margin projects that occurred in the prior year periods, in addition to lower personnel and related costs in the current period resulting from our ongoing expense alignment efforts. Operating expenses decreased by $4.7 million, or 9%. The decrease was primarily due to reductions in personnel and related costs of $5.5 million, and reductions in marketing expense of $1.9 million. Partially offsetting these declines was an increase in total operating expense of $3.9 million as a result of the acquisition and investment in new products related to Slingo. 2012 compared with 2011 Games revenue decreased by $30.8 million, or 31%. Lower revenue from license sales and our subscription products contributed $13.9 million and $10.2 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 $4.9 million, as well as lower sales of mobile games of $4.8 million. Lower subscription revenue was a result of fewer subscribers compared with the year-earlier period. Further contributing to the decline was lower revenue from advertising of $4.9 million. Cost of revenue decreased by $9.0 million, or 29%. This decrease was primarily due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue. Operating expenses decreased by $10.7 million, or 17%. The decrease was primarily due to reductions in marketing expenses of $7.2 million, primarily related to our non-social games, in addition to reductions in personnel and related costs of $2.4 million. 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, lease exit and related charges, and, for 2013, the loss on litigation settlements, are included in the corporate segment.

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

                                                                  2013-2012        %         2012-2011        %
                           2013          2012         2011          Change       Change       Change       Change
Cost of revenue         $   1,904     $  2,689     $    (256 )   $     (785 )     (29 )%   $     2,945        NM
Gain on sale of
patents and other
technology assets,
net of costs                    -      116,353             -       (116,353 )    (100 )%       116,353       100 %
Total operating
expenses                   54,413       56,174        42,352         (1,761 )      (3 )%        13,822        33 %
Operating income
(loss)                  $ (56,317 )   $ 57,490     $ (42,096 )   $ (113,807 )    (198 )%   $    99,586       237 %


2013 compared with 2012
The 2012 gain from the sale of patents and other technology assets to Intel Corporation of $116.4 million 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 decreased by $1.8 million, or 3%. The decrease was primarily due to reductions in personnel and related costs of $3.0 million, in addition to reduced restructuring charges of $9.7 million. Partially offsetting these decreases were the 2013 litigation settlements of $11.5 million. 2012 compared with 2011
Cost of revenue increased by $2.9 million. The increase was due primarily to a reduction in expense in 2011 from a change in estimates of our accrued royalties on our historical music business of approximately $3.6 million. The 2012 gain from the sale of patents and other technology assets to Intel Corporation of $116.4 million 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 $13.8 million, or 33%. The increase compared with 2011 was primarily due to increased restructuring costs and lease exit and related charges totaling $10.5 million, and to the impact of a benefit in 2011 of $6.4 million related to an insurance reimbursement for previously settled litigation that reduced expense in 2011. These increases were partially offset by reductions in personnel and related costs of $2.1 million in 2012, which resulted from our ongoing work to align our operating expenses with our revenue profile.
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):

                                                                     2013-2012       %       2012-2011       %
                             2013          2012          2011         Change      Change      Change      Change
Research and
development               $  60,880     $  63,194     $  70,212     $  (2,314 )     (4 )%   $  (7,018 )    (10 )%
Sales and marketing          80,011        90,301       111,300       (10,290 )    (11 )%     (20,999 )    (19 )%
General and
administrative               36,643        43,891        37,181        (7,248 )    (17 )%       6,710       18  %
Restructuring and other
charges                       5,765        15,225         8,650        (9,460 )    (62 )%       6,575       76  %
Lease exit and related
charges (gains)               3,089         3,290          (646 )        (201 )     (6 )%       3,936      609  %
Loss on litigation
settlements                  11,525             -             -        11,525      100  %           -        -  %
Total consolidated
operating expenses        $ 197,913     $ 215,901     $ 226,697     $ (17,988 )     (8 )%   $ (10,796 )     (5 )%

Research and development expenses decreased by $2.3 million, or 4%, in the year-ended 2013, compared with 2012. While we continue to invest in new products, we saw an overall decrease in personnel and related costs of $3.6 million, resulting from our ongoing expense alignment efforts.
Research and development expenses, including non-cash stock-based compensation, decreased by $7.0 million, or 10%, in the year-ended 2012, compared with 2011. This decrease was primarily due to a decrease in personnel and related costs of $6.1 million.
Sales and marketing expenses, including non-cash stock-based compensation, decreased by $10.3 million, or 11%, in the year-ended 2013, compared with 2012. The decrease was due primarily to a decrease in personnel and related costs of $7.8 million resulting from our ongoing expense alignment efforts. Sales and marketing expenses, including non-cash stock-based compensation, decreased by $21.0 million, or 19%, in the year-ended 2012, compared with 2011. The decrease was due primarily to a decrease in personnel and related costs of $13.4 million. Further contributing to the decline in sales and marketing costs was reductions in marketing expenses of $7.1 million, primarily related to our non-social games.
General and administrative expenses, including non-cash stock-based compensation, decreased by $7.2 million, or 17%, in the year-ended 2013, compared with 2012. Contributing to the decrease for the period was a decrease in personnel and


related costs of $6.0 million, and to $1.3 million related to the expense in 2012 for the final settlement of the Washington State Attorney General's office matter, as disclosed in the 2012 10-K.
General and administrative expenses, including non-cash stock-based compensation, increased by $6.7 million, or 18%, in the year-ended 2012, compared with 2011. 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.
Restructuring and other charges in 2013, 2012 and 2011 consist of costs associated with the ongoing reorganization of our business operations and primarily relate to severance costs due to workforce reductions. For additional details on these charges see Note 10, Restructuring Charges.
As a result of the reduction in use of RealNetworks' office space, primarily in our former 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. For additional details on these charges see Note 11, Lease Exit and Related Charges. Loss on litigation settlements recorded during 2013 relates to settlement agreements executed in October 2013, for which we paid in full an aggregate amount of $11.5 million during the fourth quarter of 2013, as discussed in Note 16, Commitments and Contingencies.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):

                                          2013        Change        2012        Change        2011
Interest income, net                   $  1,133          (5 )%   $  1,192         (23 )%   $  1,552
Gain (loss) on sale of equity
investments,net                          21,389         n/a         5,072         n/a             -
Equity in net loss of Rhapsody           (6,268 )        10  %     (5,709 )       (28 )%     (7,898 )
Other income (expense), net                 467         (62 )%      1,241        (362 )%       (473 )
Total other income (expense), net      $ 16,721         831  %   $  1,796        (126 )%   $ (6,819 )

As described further in Note 4, Rhapsody Joint Venture, we account for our investment in Rhapsody under the equity method of accounting. The net carrying value of our investment in Rhapsody is not necessarily indicative of the underlying fair value of our investment.
The increase in Other income (expense), net, of $14.9 million for 2013, was due primarily to the $21.4 million net Gain (loss) on sale of equity investments in 2013. This net gain was due to the sale of all our remaining shares of common stock in LoEn Entertainment, Inc. For additional details on this transaction see Note 5, Fair Value Measurements.
The increase in Other income (expense), net, of $8.6 million for 2012, was due primarily to the $5.1 million net Gain (loss) on sale of equity investments in 2012. This net gain was driven by 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. An additional increase was due to non-cash gains for 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. Income Taxes
During the years ended December 31, 2013, 2012, and 2011, we recognized income tax expense of $4.9 million, $12.5 million and an income tax benefit of $17.3 million, respectively, related to U.S. and foreign income taxes.
The tax expense in the year ended December 31, 2013 was largely the result of valuation allowances we recorded in certain foreign jurisdictions. The tax expense for the year ended December 31, 2012 was largely the result of the sale of certain patent assets and other technology assets to Intel Corporation for . . .

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