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RNWK > SEC Filings for RNWK > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for REALNETWORKS INC

Form 10-Q for REALNETWORKS INC


8-May-2014

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:
the expected benefits and other consequences of our growth plans, strategic initiatives, and restructurings;

our expected introduction, and related monetization, of new and enhanced products, services and technologies across our businesses;

future revenues, operating expenses, income and other taxes, tax benefits, net income (loss) per diluted share available to common shareholders, acquisition costs and related amortization, and other measures of results of operations;

the effects of our past acquisitions and expectations for future acquisitions and divestitures;

plans, strategies and expected opportunities for future growth, increased profitability and innovation;

the expected financial position, performance, growth and profitability of, and investment in, our businesses and the availability of resources;

the effects of legislation, regulations, administrative proceedings, court rulings, settlement negotiations and other factors that may impact our businesses;

the continuation and expected nature of certain customer relationships;

impacts of competition and certain customer relationships on the future financial performance and growth of our businesses;

our involvement in potential claims, legal proceedings and government investigations, and the potential outcomes and effects of such potential claims, legal proceedings and governmental investigations on our business, prospects, financial condition or results of operations;

the effects 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
RealNetworks creates innovative products and services that make it easy to connect with and enjoy digital media. We invented the streaming media category in 1995 and continue to connect consumers with their digital media both directly and through partners, aiming to support every network, device, media type and social network.
We manage our business and report revenue and profit (loss) 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, intercarrier messaging, and our recently launched LISTEN product, and sales of technology licenses of our software products such as Helix. Our Games business, through its Slingo, GameHouse and Zylom brands, derives revenue 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 reporting those expenses as corporate items. 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.
For the three months ended March 31, 2014, our consolidated revenue declined by $11.1 million compared to the same period in 2013, with revenue declines for the quarter of $7.2 million in our RealPlayer Group, $3.3 million in Games, and $0.6 million in Mobile Entertainment.
Revenue from our legacy products continues to decline as a result of certain changes in our businesses and market-driven factors. In our RealPlayer Group segment, our first quarter revenue suffered from pricing pressure in our intellectual property licensing business and installation declines in our distribution of third party software business. Moreover, as we focus more of our distribution and marketing efforts on our new RealPlayer Cloud service, sales of RealPlayer Plus licenses are declining, resulting in reduced revenue. The business also continues to be negatively impacted by a decline in subscribers, primarily attributable to our SuperPass product. In our Games segment, our business continues to be challenged in line with overall trends in the online games market, including the shift from downloadable PC games to social networks and mobile devices. Revenue from our legacy SaaS business within Mobile Entertainment continues to be challenged, with pricing pressure from carriers, the termination of certain SaaS contracts, and the proliferation of smartphone applications and services, some of which do not depend on our carrier customers for distribution to consumers.
Over the past several quarters 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, an application and service for smartphone users featuring ringback tones and other services. 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. During the third quarter of 2013, 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. We expect to continue to invest heavily in our growth initiatives, including further development and marketing efforts around our new products, while also building on our efforts to streamline our operations and make our businesses more efficient.
During the quarter ended March 31, 2014 certain accrued royalty liabilities of $10.6 million associated with our historical music business, which had been originally recorded based on statutory rates, were extinguished. Condensed consolidated results of operations were as follows (dollars in thousands):

                                         Quarters Ended March 31,
                               2014         2013        $ Change     % Change
Total revenue               $ 45,724     $  56,793     $ (11,069 )      (19 )%
Cost of revenue               18,786        20,506        (1,720 )       (8 )%
Extinguishment of liability  (10,580 )           -       (10,580 )     (100 )%
Gross profit                  37,518        36,287         1,231          3  %
Gross margin                      82 %          64 %
Operating expenses            46,394        47,713        (1,319 )       (3 )%
Operating income (loss)     $ (8,876 )   $ (11,426 )   $   2,550         22  %

In the first quarter of 2014, our total consolidated revenue declined by $11.1 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $7.2 million in our RealPlayer Group segment, a decline of $3.3 million in our Games segment, and a $0.6 million decline in our Mobile Entertainment segment, due to the factors described above. Gross margin increased to 82% from 64% for the year earlier quarter, primarily due to the extinguishment of the liability described above. Partially offsetting this increase was a decrease in gross margin due to a higher proportion of lower margin revenue in the current year. Operating expenses decreased by $1.3 million in the quarter ended March 31, 2014, compared with the prior year, primarily due to a reduction in facilities costs of $1.2 million resulting from our Seattle headquarters move in the prior year.


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

                                    Quarters Ended March 31,
                           2014         2013       $ Change     % Change
Revenue                 $ 15,215     $ 22,383     $ (7,168 )     (32 )%
Cost of revenue            3,518        5,311       (1,793 )     (34 )%
Gross profit              11,697       17,072       (5,375 )     (31 )%
Gross margin                  77 %         76 %
Operating expenses        17,787       16,206        1,581        10  %
Operating income (loss) $ (6,090 )   $    866     $ (6,956 )      NM

Total RealPlayer Group revenue decreased by $7.2 million in the quarter ended March 31, 2014, compared with the year-earlier period. This decrease was primarily a result of lower subscriptions revenue of $2.1 million due to fewer subscribers, primarily attributable to our SuperPass product. Further contributing to the decline was lower revenue of RealPlayer Plus licenses of $2.0 million, lower revenue from the distribution of third party software products of $1.4 million, and lower sales of intellectual property licenses of $1.3 million.
Operating expenses increased by $1.6 million for the quarter ended March 31, 2014, compared with the year-earlier period. The increase was primarily due to increased marketing spend of $1.1 million, resulting from the drive to increase distribution of our new RealPlayer Cloud service. Mobile Entertainment
Mobile Entertainment segment results of operations were as follows (dollars in thousands):

                                    Quarters Ended March 31,
                           2014         2013       $ Change     % Change
Revenue                 $ 19,913     $ 20,495     $   (582 )      (3 )%
Cost of revenue           11,950       10,832        1,118        10  %
Gross profit               7,963        9,663       (1,700 )     (18 )%
Gross margin                  40 %         47 %
Operating expenses         9,616        9,111          505         6  %
Operating income (loss) $ (1,653 )   $    552     $ (2,205 )      NM

Total Mobile Entertainment revenue decreased by $0.6 million in the quarter ended March 31, 2014, compared with the year-earlier period. The decline during the quarter was primarily due to reduced revenue from our SaaS offerings of $0.2 million. The decrease in revenue resulted primarily from the termination of certain SaaS contracts totaling $3.5 million. Partially offsetting this decrease was an increase in music on demand revenue of $2.5 million from existing customers, in addition to an increase in our direct to consumer ringback tones revenue of $1.1 million resulting from our acquisition of Muzicall in September 2013.
Gross margin during the quarter ended March 31, 2014 declined by 7 percentage points, due primarily to a higher proportion of lower margin revenue in the current year.
Operating expenses increased by $0.5 million for the three months ended March 31, 2014, compared with the year-earlier period, primarily due to $0.7 million of marketing expenses related to Muzicall, which we acquired during the third quarter of 2013.
Games
Games segment results of operations were as follows (dollars in thousands):


                                    Quarters Ended March 31,
                           2014         2013       $ Change     % Change
Revenue                 $ 10,596     $ 13,915     $ (3,319 )     (24 )%
Cost of revenue            3,129        3,800         (671 )     (18 )%
Gross profit               7,467       10,115       (2,648 )     (26 )%
Gross margin                  70 %         73 %
Operating expenses         9,766       11,852       (2,086 )     (18 )%
Operating income (loss) $ (2,299 )   $ (1,737 )   $   (562 )     (32 )%

Total Games revenue decreased by $3.3 million in the quarter ended March 31, 2014, compared with the year-earlier period. Lower revenue from license sales, our subscription products, and advertising contributed $1.6 million, $1.1 million, and $1.1 million, respectively, to the decline during the period. Partially offsetting these decreases was an increase of $0.6 million in games revenue as a result of the acquisition of Slingo in June 2013. Cost of revenue decreased by $0.7 million during the three months ended March 31, 2014, compared with the year-earlier period. The decrease was due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue. Gross margin declined during the three months ended March 31, 2014 by 3 percentage points, due primarily to a higher proportion of lower margin revenue in the current year.
Operating expenses declined by $2.1 million during the three months ended March 31, 2014, compared with the year-earlier period. The decrease was mainly due to reduced marketing spend of $1.2 million, in addition to reductions in personnel and related costs of $1.1 million. Partially offsetting this decline was an increase in total operating expense of $1.1 million related to Slingo, which we acquired during the second quarter of 2013. Corporate
We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments, rather than reporting those expenses as corporate items. 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 reported as corporate items. 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 March 31,
                               2014          2013        $ Change     % Change
Cost of revenue             $     189     $     563     $    (374 )      (66 )%
Extinguishment of liability $ (10,580 )   $       -     $ (10,580 )     (100 )%
Operating expenses              9,225        10,544        (1,319 )      (13 )%
Operating income (loss)     $   1,166     $ (11,107 )   $  12,273        110  %

During the quarter ended March 31, 2014 certain accrued royalty liabilities of $10.6 million associated with our historical music business, which had been originally recorded based on statutory rates, were extinguished.
Operating expenses decreased by $1.3 million during the quarter ended March 31, 2014, compared with the year-earlier period. The decrease during the quarter was primarily due to $0.7 million in reduced stock compensation expense during the quarter ended March 31, 2014 relating to performance-based awards. Further contributing to the decrease was a reduction in facilities costs of $0.6 million resulting from our Seattle headquarters move in the prior year. 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 March 31,
                                        2014        2013       $ Change     % Change
Research and development              $ 14,059    $ 15,251    $ (1,192 )      (8 )%
Sales and marketing                     21,723      21,134         589         3  %
General and administrative               9,317       9,946        (629 )      (6 )%
Restructuring and other charges          1,216       1,382        (166 )     (12 )%
Lease exit and related charges              79           -          79       100  %
Total consolidated operating expenses $ 46,394    $ 47,713    $ (1,319 )      (3 )%

Research and development expenses decreased by $1.2 million in the quarter ended March 31, 2014, compared with the year-earlier period, primarily due to reduced costs associated with the relocation of our Seattle headquarters of $0.8 million, in addition to reduced personnel and related costs of $0.7 million. Sales and marketing expenses increased by $0.6 million in the quarter ended March 31, 2014, compared with the year-earlier period. The increase was primarily due to higher marketing spend of $0.7 million aimed at driving higher revenue.
General and administrative expenses decreased by $0.6 million in the quarter ended March 31, 2014, compared with the year-earlier period. The decrease was primarily due to $0.7 million in reduced stock compensation expense during the quarter ended March 31, 2014 relating to performance-based awards. Restructuring and other charges and Lease exit and related charges consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense alignment efforts. The restructuring expense amounts in both years primarily relate to severance costs due to workforce reductions. For additional details on these charges see Note 11, Restructuring Charges and Note 12, Lease Exit and Related Charges.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):

                                                       Quarters Ended March 31,
                                           2014           2013         $ Change       % Change
Interest income, net                   $      136     $      647     $      (511 )       (79 )%
Gain (loss) on sale of available for
sale securities, net                        2,371              -           2,371         100  %
Equity in net loss of Rhapsody               (838 )       (2,233 )         1,395          62  %
Other income (expense), net                   (77 )          109            (186 )      (171 )%
Total other income (expense), net      $    1,592     $   (1,477 )   $     3,069         208  %

As described further in Note 5, 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 $3.1 million for the quarter ended March 31, 2014 was primarily due to the gain on sale of a portion of our shares held in J-Stream, as discussed further in Note 6, Fair Value Measurements.
Income Taxes
During the quarters ended March 31, 2014 and 2013, we recognized income tax expense of $0.5 million and an income tax benefit of $1.2 million, respectively, related to U.S. and foreign income taxes. The change in income tax expense during the three months ended March 31, 2014 was largely the result of an income tax benefit related to unrealized gains on investment securities recognized in other comprehensive income in the quarter ending March 31, 2013. As of March 31, 2014, there have been no material changes to RealNetworks' uncertain tax positions disclosures as provided in Note 14 of the 2013 10-K. We currently anticipate the expiration of the statute of limitations within the next twelve months that may decrease the Company's total unrecognized tax benefit by an amount up to $0.9 million.


The majority of our tax expense is due to income in our foreign jurisdictions and we have not benefitted from losses in the U.S. and certain foreign jurisdictions in the first quarter of 2014.We generate income in a number of foreign jurisdictions, some of which have higher or 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 less than anticipated in countries with lower statutory tax rates and more than anticipated in countries with higher statutory tax rates. For the quarter ended March 31, 2014, decreases in tax expense from 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 first quarter of 2014 is minimal.
As of March 31, 2014, 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. or may be remitted tax-free to the U.S. If these amounts were distributed to the U.S., in the future in the form of dividends or otherwise, we could be subject to additional U.S. income and foreign withholding taxes. It is not practicable to determine the foreign withholding and U.S. 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 U.S., 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. We are currently under audit by 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 March 31,
                    2014        2013       $ Change      % Change
United States     $ 20,428    $ 28,024    $  (7,596 )     (27 )%
Europe               8,412      11,255       (2,843 )     (25 )%
Republic of Korea   10,294       8,964        1,330        15  %
Rest of world        6,590       8,550       (1,960 )     (23 )%
Total net revenue $ 45,724    $ 56,793    $ (11,069 )     (19 )%

Revenue in the United States declined by $7.6 million in the quarter ended March 31, 2014, compared with the year-earlier period. The decline was due primarily to lower sales of our subscriptions products of $2.0 million, a decline in revenue generated from our SaaS offerings of $1.7 million, and lower revenue generated from the distribution of third party software products of $1.6 million.
Revenue in Europe declined by $2.8 million in the quarter ended March 31, 2014, compared with the year-earlier period. The decrease was primarily due to lower revenue from our Games business of $2.3 million, as well as lower revenue from RealPlayer Plus licenses of $0.7 million.
Revenue in Korea increased by $1.3 million in the quarter ended March 31, 2014, compared with the year-earlier period. The increase was primarily due to higher music on demand revenue of $2.9 million, partially offset by a decline in intellectual property license revenue of $0.7 million, and lower ringback tones revenue of $0.4 million.
Revenue in the rest of world decreased by $2.0 million in the quarter ended March 31, 2014, compared with the year-earlier period. The decrease was primarily due to lower revenue from our SaaS offerings of $1.0 million, and decreased revenue from RealPlayer Plus licenses of $0.7 million. New Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2014 to be implemented that are of significance or potential significance to RealNetworks.


Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term
investments, and restricted cash (in thousands):

                                                    March 31,     December 31,
                                                      2014            2013
Working capital                                    $  188,567    $      191,522
Cash, cash equivalents, and short-term investments    209,637           226,155
Restricted cash equivalents and investments             3,000             3,000

The decrease in 2014 of cash, cash equivalents, and short-term investments from December 31, 2013 was primarily due to cash used in operating activities of $18.5 million in the first quarter of 2014.
The following summarizes cash flow activity (in thousands):

. . .

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