Item 1B.
Unresolved Staff Comments
None.
Our corporate and administrative headquarters and certain research and development and sales and marketing personnel are located at our facility in Seattle, Washington.
We lease properties primarily in the following locations that are utilized by all of our business segments, unless otherwise noted below, to house our research and development, sales and marketing, and general and administrative personnel:
(1)
As of December 31, 2017, we have reduced our use of the facility by 69%. The space which we no longer occupy is currently under sublease for all or a portion of the remaining lease term. For further information, please see Note 11. Lease Exit and Related Charges in this 10-K.
(2)
This facility is utilized only by our Games segment.
In addition, we lease smaller facilities in the U.S. and foreign countries, some of which support the operations of all of our business segments while others are dedicated to a specific business segment. We believe that our properties are in good
condition, adequate and suitable for the conduct of our business. For additional information regarding our obligations under leases, see Note 17. Commitments and Contingencies, in this 10-K.
Item 3.
Item 3.
Legal Proceedings
See Note 17. Commitments and Contingencies, in this 10-K.
Item 4.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II.
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on The NASDAQ Stock Market under the symbol RNWK.
The high and low intraday sales prices for our common stock were as follows:
As of January 31, 2018, there were approximately 179 holders of record of our common stock. Most shares of our common stock are held by brokers and other institutions on behalf of shareholders.
The declaration and payment of any future dividends, as well as the amount thereof, are subject to the discretion of our board of directors and will depend upon our results of operations, financial condition, capital levels, cash requirements, future prospects and other factors deemed relevant by our board of directors. Accordingly, there can be no assurance that we will declare and pay any dividends in the future. No cash dividends were paid in 2017 or 2016.
Comparison of 5 year cumulative total return to shareholders on RealNetworks, Inc., common stock with the cumulative total return on the NASDAQ Composite Index and the Dow Jones U.S. Technology Index for the period beginning on December 31, 2012 and ended on December 31, 2017.
The total return on our common stock and each index assumes the value of each investment was $100 on December 31, 2012, and that all dividends were reinvested. Return information is historical and not necessarily indicative of future performance.
Item 6.
Item 6.
Selected Financial Data
The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere in this report.
(A) Includes a $21.4 million pretax gain from the sale of equity securities in 2013. Additional details regarding this gain are available in our 2015 10-K.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
RealNetworks creates innovative technology products and services that make it easy to connect with and enjoy digital media. We manage our business and report revenue and operating income (loss) in three segments: (1) Consumer Media (2) Mobile Services, and (3) Games.
Within our Consumer Media segment revenue is primarily derived from the licensing of our video compression, or codec, technology, including our latest technology, RealMedia High Definition, or RMHD. We also generate revenue from the sales of our PC-based RealPlayer products, including RealPlayer Plus and related products. These products and services are delivered directly to consumers and through partners, such as OEMs and mobile device manufacturers.
Our Mobile Services business generates revenue primarily from the sale of SaaS services, which include our intercarrier messaging service, ringback tones, and the integration of our RealTimes platform. We generate a significant portion of our revenue from sales within our Mobile Services business from a few mobile carriers. The loss of these contracts or the termination or non-renewal or renegotiation of contract terms that are less favorable to us could result in the loss of future revenues and could result in the loss of anticipated profits.
Our Games business, through its GameHouse and Zylom brands, derives revenue from sales of mobile games, games licenses, online games subscription services, and advertising on games sites and within our games.
We sold the Slingo and social casino portion of our games business to Gaming Realms plc, a London-based online gaming company, for $18.0 million in August 2015. The purpose of the sale was to derive value from this business and to allow greater focus on our traditional casual games business. This transaction is further described in Note 3. Acquisitions and Disposals, to the consolidated financial statements included in Item 8 of Part II of this Form 10-K.
We allocate to our reportable segments certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, IT, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. Corporate expenses also include restructuring charges, lease exit and related charges, as well as stock compensation expense.
On December 31, 2017, our contract with LOEN Entertainment, Co, Ltd. (LOEN) for our music on demand services expired. As the profits generated from this business had significantly declined over time, we did not renew the sole contract for this service. Accordingly, we have reported the operating results of this business as discontinued operations for all periods presented. The assets and liabilities of the music on demand business at December 31, 2017 and 2016 have been reported as assets and liabilities of discontinued operations in the Consolidated Balance Sheet. Refer to Note 16 to our consolidated financial statements for additional information on these discontinued operations. Unless otherwise noted, amounts and percentages for all periods discussed below reflect the results of operations and financial condition of our continuing operations.
In 2017 our consolidated revenue declined by $2.8 million compared with 2016, due to a decrease of $2.5 million in Consumer Media revenue and $0.5 million in Mobile Services revenue. These decreases were offset by an increase of $0.3 million in Games revenue. See below for further information regarding fluctuations by segment.
As of December 31, 2017, we had $60.0 million in unrestricted cash, cash equivalents and short-term investments, compared to $77.1 million as of December 31, 2016. The 2017 decrease in cash, cash equivalents, and short-term investments from December 31, 2016 was due primarily to our ongoing cash flows used in operating activities.
In addition to our revenue growth plans, we have continued to reduce costs and better align our operating expenses with our revenue profile through various restructuring actions, as described below in Consolidated Operating Expenses. These actions drove the $16.5 million decline in our operating expenses during 2017 compared to 2016.
Summary of Results
Consolidated results of operations were as follows (dollars in thousands):
2017 compared with 2016
Revenue decreased by $2.8 million, or 3%. The reduction in revenue resulted from a decline of $2.5 million in our Consumer Media segment, and a decline of $0.5 million in our Mobile Services segment. These declines were offset by an increase of $0.3 million in our Games segment. For further detail regarding the changes, please see the discussions of segment revenues below. Gross margin increased to 71% from 66%, driven by margin increases in Consumer Media and Mobile Services, offset by decreased margin in our games business due to increased app store fees as our mix shifts towards mobile games.
Operating expenses decreased by $16.5 million as compared to the prior year as a result of our continuing cost reduction efforts. These efforts were the primary reason for reductions to salaries, benefits and professional services costs of $7.7 million, facilities costs of $4.6 million, marketing expense of $1.8 million and lower lease exit costs of $2.2 million. Further contributing to the decrease year over year is a benefit of $0.5 million relating to warrants received from Napster in the first quarter of 2017, which is discussed further in Note 5 Fair Value Measurements. These decreases were offset by an increase of $1.0 million in restructuring due to increased severance charges.
2016 compared with 2015
Revenue decreased by $11.0 million, or 12%. The reduction in revenue resulted from a decline of $5.6 million in our Games segment, a decline of $3.6 million in our Consumer Media segment and a decline of $1.8 million in our Mobile Services segment. For further detail regarding the changes, please see the discussions of segment revenues below. Gross margin increased to 66% from 57%, driven by margin increases in Consumer Media and Mobile Services, offset by decreased margin in our games business due to increased app store fees.
Operating expenses decreased by $31.5 million as compared to the prior year due to savings of $11.1 million realized from the sale of the Slingo and social casino games business and from the impact of our continuing cost reduction efforts. These efforts were the primary reason for reductions to personnel and related costs of $9.3 million, marketing costs of $7.9 million, restructuring of $4.1 million and facilities and related depreciation expense, due to the reduction of our corporate office space, of $2.8 million. These reductions were offset in part by the benefit recognized in the first quarter of 2015 relating to warrants received from Napster, an expense benefit received in 2015 for the release of certain previously accrued sales taxes, and higher stock compensation expense in 2016 resulting from the first quarter 2016 authorization and grant of fully vested equity awards as payment for 2015 incentive bonuses.
Segment Operating Results
Consumer Media
Consumer Media segment results of operations were as follows (dollars in thousands):
2017 compared with 2016
Total Consumer Media revenue in 2017 decreased by $2.5 million, or 10% as compared to the prior year. Of the decrease, $1.6 million is due to continuing declines in our subscription products, as well as a decrease of $0.6 million from licensing of our codec technologies due to timing of contract renewals.
Cost of revenue decreased by $2.6 million, resulting in an increase in gross margin of 8 percentage points. The decrease to cost of revenue was driven by lower bandwidth and other support costs of $1.8 million directly resulting from our ongoing efforts to optimize functionality and increase efficiencies. The decrease was also due to reduced royalties compared to the prior year of $0.3 million and reduced third party customer service costs of $0.3 million.
Operating expenses decreased by $3.9 million compared to the prior year, due to lower expenses for facilities and support services of $2.8 million as a result of our ongoing cost reduction efforts, the acceleration of depreciation expense of $0.7 million taken in the first quarter of 2016 related to the obsolescence of e-commerce assets, and lower marketing expense of $0.3 million.
2016 compared with 2015
Total Consumer Media revenue decreased by $3.6 million, or 12% as compared to the prior year. Of the decrease, $2.2 million is due primarily to the timing of contracts and contract renewals for codec technology licenses. Continuing declines in our subscription products of $1.5 million also contributed to the decrease in Consumer Media revenue.
Cost of revenue decreased by $6.2 million, resulting in an increase in gross margin of 18 percentage points. The decrease to cost of revenue was driven by lower bandwidth costs of $3.8 million, as well as a reduction in salaries and personnel expenses of $1.0 million and customer support costs of $0.4 million.
Operating expenses decreased by $8.1 million compared to the prior year. The decrease was primarily due to reductions in salaries and personnel costs of $4.5 million, marketing costs of $2.4 million and professional services of $1.5 million.
Mobile Services
Mobile Services segment results of operations were as follows (dollars in thousands):
2017 compared with 2016
Mobile Services revenue decreased by $0.5 million, or 2%, and was primarily driven by a decrease of $0.6 million for system integrations for our carrier partners and $0.6 million in our intercarrier messaging service. These decreases were offset by an increase of $0.4 million in our ringback tones business and of $0.4 million from our RealTimes platform.
Gross margin improved by $2.1 million, or 7 percentage points, as compared to the prior year. The increase was due primarily to our cost reduction efforts, including reductions to salaries and infrastructure costs, as well as reduced bandwidth and customer service costs.
Operating expenses decreased by $6.5 million due to a decrease in salaries and benefits of $3.8 million, reduced expenses for facilities and support services of $1.7 million and a reduction in marketing expense of $0.6 million.
2016 compared with 2015
Mobile Services revenue decreased by $1.8 million, or 5%, which was driven by a decrease of $2.2 million in our ringback tones business, as well as $0.8 million decrease from our Helix product, which we no longer sell. These decreases were offset in part by an increase of $1.9 million from system implementations of our RealTimes platform for certain carrier partners.
Gross margin improved by $2.7 million, or 12 percentage points, as compared to the prior year. The increase was due primarily to savings related to our SaaS service offerings, such as professional services, third-party customer service, ringback tones and from our RealTimes mobile services.
Operating expenses decreased by $9.9 million, due to a decrease in personnel and related expenses of $4.7 million and in marketing expense of $4.1 million.
Games
Games segment results of operations were as follows (dollars in thousands):
2017 compared with 2016
Games revenue increased by $0.3 million, or 1% as compared to the prior year due to growth in our mobile games business, as the increase of $1.9 million in our mobile games revenues was offset by a decrease of $1.6 million in our other games revenues.
Cost of revenue increased by $0.8 million, or 10%, as compared to the prior year, due to an increase of $0.6 million from increased royalty fees paid to developers, as well as an increase of $0.6 million in app store fees related to our mobile revenue growth in the casual games business. These increases were offset by lower facilities and support service costs as compared to the prior year.
Operating expenses increased by $0.8 million, or 4% as compared to the prior-year period, due to increased salaries, benefits and professional services costs of $1.2 million due to our continued investment in growing our mobile games offering, as well as increased facilities charges of $0.4 million. These increases were offset in part by lower marketing costs of $0.9 million.
2016 compared with 2015
Games revenue decreased by $5.6 million, or 18% as compared to the prior year. Of the total decline, $4.9 million was related to the sale of our Slingo and social casino business in August of 2015, as well as a decrease of $1.4 million in our subscription game business and $1.0 million in retail games. These declines were offset in part by an increase of $2.1 million due to growth in our mobile games business.
Cost of revenue decreased by $1.4 million, or 15%, as compared to the prior year, due to savings of $2.0 million realized following the sale of the Slingo and social casino games business. This decrease was offset in part by an increase of $0.7 million in app store fees related to our mobile revenue growth in the casual games business.
Operating expenses decreased by $9.4 million, or 32%. This reduction in operating expenses was due to savings of $11.1 million from the 2015 sale of our Slingo and social casino games business. These decreases were partially offset by increases of $2.3 million for salaries and related personnel costs from our continuing casual games busines
Corporate
Corporate segment results of operations were as follows (dollars in thousands):
2017 compared with 2016
Operating expenses decreased by $6.9 million, or 34%. The decrease was primarily due to a $4.6 million reduction in salary, benefit and professional service expenses, a reduction of $2.2 million in lease exit and related charges, as well as a benefit of $0.5 million relating to the warrant received from Napster in the first quarter of 2017, which is discussed further in Note 5 Fair Value Measurements and lower expenses for facilities and support services as a result of our reduction of office space at our corporate headquarters and ongoing cost reduction efforts. These decreases were offset by an increase of $1.0 million relating to increased restructuring charges due to increased severance cost as compared to the prior-year period.
2016 compared with 2015
Operating expenses decreased by $4.1 million, or 17%. The decrease was primarily due to $4.1 million lower restructuring charges in 2016 compared to 2015, as well as a reduction of $1.5 million in salary, benefit and professional service expenses, and lower expenses for facilities and support services as a result of our reduction of office space at our corporate headquarters and ongoing cost reduction efforts. These decreases were offset in part by the prior year release of $2.4 million for previously accrued sales taxes, a benefit of $1.2 million relating to the warrants received from Napster in the first quarter of 2015 and an increase in stock compensation expense of $0.8 million in 2016 due in part to the authorization and granting of fully vested equity awards for our 2015 incentive bonuses in the first quarter of 2016.
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):
Research and development expenses decreased by $0.2 million, or 1%, in the year ended 2017 as compared to 2016. The decrease was primarily due to lower expenses for facilities and support services of $1.0 million as a result of our ongoing cost reduction efforts. The decrease was also due to the acceleration of depreciation expense of $0.7 million taken in the first quarter of 2016. These decreases were offset in part by an increase of $1.3 million in salaries, benefits and professional services expense due to increased efforts towards our growth initiatives.
Research and development expenses decreased by $13.7 million, or 31%, in the year ended 2016 as compared to 2015. The decrease was primarily due to a $5.1 million reduction from the sale of our Slingo and social casino games business, a $5.1 million reduction in personnel and related expenses, and a $2.9 million decrease in infrastructure costs, including reduced expenses for facilities and support services as a result of reduction of office space at our corporate headquarters.
Sales and marketing expenses decreased by $8.7 million, or 27%, in the year ended 2017, compared with 2016. The decrease was due to reductions of $5.7 million in salaries, benefits and professional services fees, a $1.9 million decrease in marketing expenses, as well as decreased facilities and support services costs of $1.1 million.
Sales and marketing expenses decreased by $16.6 million, or 34%, in the year ended 2016, compared with 2015. The decrease was primarily due to a $4.9 million reduction from the sale of our Slingo and social casino games business, a decrease of $7.6 million in marketing expenses, a $2.6 million decrease in personnel and related expenses, as well as decreased facilities and support services costs.
General and administrative expenses decreased by $6.4 million, or 23%, in the year ended 2017 compared with 2016. The decrease was primarily due to a reduction of $3.4 million in salaries, benefits and professional services fees, a decrease of $1.8 million related to reduced facilities and support services costs, as well as the first quarter 2017 benefit of $0.5 million relating to warrants we received from Napster, which are discussed further in Note 5 Fair Value Measurements. Also contributing to the decrease was a benefit of $0.4 million in the first quarter of 2017 related to the release of previously accrued taxes.
General and administrative expenses increased by $2.9 million, or 12%, in the year ended 2016, compared with 2015. The increased costs year over year were partially due to the prior year release of $2.4 million for previously accrued sales taxes, the impact of the benefit received in 2015 relating to warrants received from Napster of $1.2 million, and accelerated depreciation
expense in 2016 due in part to a reduction in space at our corporate headquarters. These increases were offset in part by further reductions in personnel and related expenses of $1.6 million and savings recognized from the sale of our Slingo and social casino games business of $1.2 million.
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 re-alignment efforts. The restructuring expense amounts in all years primarily related to severance costs due to workforce reductions. For additional details on these charges see Note 10. Restructuring Charges and Note 11. Lease Exit and Related Charges.
Other Income (Expenses)
Other income (expenses), net was as follows (dollars in thousands):
The 2017 Gain (loss) on investment, net, was due to the collection and recognition of the second and final anniversary payment of $4.5 million from our 2015 sale of the Slingo and social casino business, which included an agreed-to additional $0.5 million as a result of the extension of the second anniversary payment from August to December.
The 2016 Gain (loss) on investments, net, was due to the collection and recognition of the first anniversary payment of $4.0 million from our 2015 sale of the Slingo and social casino business, a net gain of $2.5 million from the sale of our remaining J-Stream investment, and a gain of $2.0 million, net of transaction costs, from the sale of a domain name.
As described further in Note 4. Napster Joint Venture, we account for our investment in Napster under the equity method of accounting. The net carrying value of our investment in Napster is not necessarily indicative of the underlying fair value of our investment.
Income Taxes
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to, (1) reducing the U.S. federal corporate tax rate from 35 percent to 21 percent; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries; (4) requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations; (5) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized; (6) creating the base erosion anti-abuse tax (BEAT), a new minimum tax; (7) creating a new limitation on deductible interest expense; and (8) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017.
Based on currently available information we have estimated and accrued a discrete tax benefit of $3.6 million as a result of the Tax Act in the period ending December 31, 2017. This tax benefit primarily relates to the repeal of corporate AMT which allows AMT credit carryforwards to be refundable beginning in 2018.
For various reasons that are discussed below, we have not completed our final accounting for the income tax effects of certain elements of the Tax Act. If we were able to make reasonable estimates of the effects of elements for which our analysis is not yet complete, we recorded provisional adjustments. If we were not yet able to make reasonable estimates of the impact of certain elements, we have not recorded any adjustments related to those elements and have continued accounting for them in accordance with GAAP on the basis of the tax laws in effect before the Tax Act.
•
The Tax Act reduces the corporate tax rate to 21 percent, effective January 1, 2018. Consequently, we have recorded a decrease related to deferred tax assets and liabilities, with a corresponding adjustment to the valuation allowance. Our estimate of the impact of the corporate tax rate change was not material and is not expected to change materially from our provisional adjustments.
•
The Tax Act repeals corporate AMT for tax years beginning January 1, 2018, and provides that existing AMT credit carryovers are refundable beginning in 2018. The Company has approximately $3.6 million of AMT
credit carryovers that are expected to be fully refunded by 2022. As there was a valuation allowance against the Company’s AMT credit deferred tax asset, the repeal of corporate AMT resulted in an income tax benefit for the year ended December 31, 2017. The impact of the repeal of corporate AMT is not expected to change materially from our provisional adjustments.
•
The Tax Act provides for a one-time deemed repatriation transition tax on previously untaxed accumulated and current earnings and profits (E&P) of certain foreign subsidiaries. To determine the amount of tax, the Company must determine the amount of post-1986 E&P of relevant subsidiaries. We are able to make a reasonable estimate of the transition tax, which is expected to be zero. However, we are continuing to gather additional information to precisely compute the amount of transition tax, if any.
•
The Tax Act creates a new requirement that certain income (i.e. GILTI) earned by controlled foreign corporations (CFCs) must be included currently in the gross income of the CFCs’ U.S. shareholder. GILTI is the excess of the shareholder’s “net CFC tested income” over the net deemed tangible income return, which is currently defined as the excess of (1) 10 percent of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income. Under GAAP, we are allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (“the period cost method”) or (2) factoring such amounts into the Company’s measurement of its deferred taxes (“the deferred method”). We have selected the period cost method. We are able to make a reasonable estimate of the GILTI inclusion, which is expected to be zero. However, because of the complexity of the new GILTI tax rules, we are continuing to evaluate this provision of the Tax Act and its application under GAAP.
The ultimate impact of the Tax Act may differ from these estimates, possibly materially, due to, among other things, changes in interpretations and assumptions made by the Company, as well as additional regulatory and accounting guidance that may be issued.
During the years ended December 31, 2017, 2016, and 2015, we recognized income tax benefit of $2.8 million, income tax expense of $0.8 million, and income tax benefit of $1.3 million, respectively, related to U.S. and foreign income taxes.
The income tax benefit for the year ended December 31, 2017 was largely the result of a $3.6 million income tax benefit related to the repeal of corporate AMT under the Tax Act, offset by withholding taxes and income taxes in foreign jurisdictions. The tax expense for the year ended December 31, 2016 was largely the result of foreign withholding taxes and income taxes in foreign jurisdictions. The tax benefit for the year ended December 31, 2015 was largely the result of an income tax benefit related to the sale of the Slingo and social casino games business in the quarter ended September 30, 2015, offset by foreign withholding taxes and income taxes in foreign jurisdictions.
We assess the likelihood that our deferred tax assets will be recovered based upon our consideration of many factors, including the current economic climate, our expectations of future taxable income, our ability to project such income, and the appreciation of our investments and other assets. We maintain a partial valuation allowance of $137.1 million for our deferred tax assets due to uncertainty regarding their realization as of December 31, 2017. The net decrease in the valuation allowance since December 31, 2016 of $39.2 million was the result of a decrease in current year deferred tax assets, which was primarily related to the corporate tax rate reduction under the Tax Act, for which the Company maintains a valuation allowance.
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. Changes to the blend of income between jurisdictions with higher or lower effective tax rates than the U.S. federal statutory rate could affect our effective tax rate. For the year ended December 31, 2017, decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to the U.S. federal statutory rate were 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 of December 31, 2017 and 2016, we had $0.4 million and $0.5 million of unrecognized tax benefits, respectively. The decrease in unrecognized tax benefits is due to federal research and development tax credit carryforward risks. As of December 31, 2017, there are no unrecognized tax benefits remaining that would affect our effective tax rate if recognized, as the offset would increase the valuation allowance. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We file numerous consolidated and separate income tax returns in the U.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term investments, and restricted cash and investments (in thousands):
The decrease in 2017 working capital as compared to December 31, 2016, which includes cash, cash equivalents, and short term investments, was primarily due to our ongoing negative cash flow used in our operations of $21.4 million.
The following summarizes cash flow activity (in thousands):
Cash used in operating activities consisted of net income (loss) adjusted for certain non-cash items such as depreciation and amortization, as well as the effect of changes in certain operating assets and liabilities.
Cash used in operating activities was $3.0 million less in 2017 as compared to 2016. The decrease in cash used in operating activities was primarily due to a lower operating loss in 2017 as compared to 2016, driven mainly by our ongoing cost reduction efforts, as previously discussed. The effect of the reduced operating loss was offset in part by the net increase in operating assets and liabilities during 2017 as compared to 2016. In the current year, we used cash of $7.1 million to fund the net change in operating assets and liabilities, while in 2016 the net change in operating assets and liabilities used $1.2 million.
Cash used in operating activities was $44.7 million less in 2016 as compared to 2015. The decrease in cash used in operating activities was primarily due to the improvement in our operating loss in 2016 as compared to 2015. Further contributing to the decrease was the net reduction in operating assets and liabilities during 2016 compared to 2015. In 2016, we used cash of $1.2 million to fund the net change in operating assets and liabilities while in 2015 the net change in operating assets and liabilities reduced our operation cash flow by $16.5 million.
For the year ended December 31, 2017, cash provided by investing activities of $37.1 million was due to sales and maturities, net of purchases, of short-term investments totaling $34.6 million, and cash proceeds from the 2015 sale of our Slingo and social casino games business of $4.5 million. These proceeds were offset in part by the advance paid to Napster of $1.5 million and purchases of equipment, software and leasehold improvements of $0.7 million.
For the year ended December 31, 2016, cash provided by investing activities of $11.6 million was due to sales and maturities, net of purchases, of short-term investments totaling $8.5 million, cash proceeds from the 2015 sale of our Slingo and social casino games business of $4.0 million, cash proceeds of $3.3 million from the sale of J-Stream, and cash proceeds from the sale of a domain name of $2.1 million. These proceeds were offset in part by the advance paid to Napster of $3.5 million and purchases of equipment, software and leasehold improvements of $2.4 million.
For the year ended December 31, 2015, cash provided by investing activities of $15.7 million was due to sales and maturities, net of purchases, of short-term investments totaling $6.6 million and the cash proceeds from the sale of our Slingo and social casino games business of $10.0 million.
Financing activities for the year ended December 31, 2017 used cash totaling $0.1 million which was from $0.4 million for tax payments from shares withheld upon vesting of restricted stock offset in part by proceeds received from the issuance of common stock of $0.2 million.
Financing activities for the year ended December 31, 2016 used cash totaling $0.3 million which was from $0.9 million for tax payments from shares withheld upon vesting of restricted stock offset in part by proceeds received from the issuance of common stock of $0.5 million.
Financing activities for the year ended December 31, 2015 provided cash totaling $0.3 million which was mainly from proceeds received from the issuance of common stock of $0.4 million, offset by $0.1 million for tax payments from shares withheld upon vesting of restricted stock.
While we currently have no planned significant capital expenditures for 2018 other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases.
We believe that our unrestricted current cash, cash equivalents, and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.
In the future, we may seek to raise additional funds through public or private equity financing, or through other sources such as future credit facilities. Such sources of funding may or may not be available to us at commercially reasonable terms. The sale of additional equity securities could result in dilution to our shareholders. In addition, in the future, we may enter into cash or stock acquisition transactions or other strategic transactions that could reduce cash available to fund our operations or result in dilution to shareholders.
If Napster continues to incur losses, if it otherwise experiences a significant decline in its business or financial condition, or if we provide financial support to or increase our investment in Napster, we could incur further losses on our investment, which could have an adverse effect on our financial condition, liquidity, and results of operations. For further information on Napster, please refer to Note 4. Napster Joint Venture.
Our cash equivalents and short-term investments consist of investment-grade securities, as specified in our investment policy guidelines. The policy limits the amount of credit exposure to any one non-U.S. government or non-U.S. agency issue or issuer to a maximum of 5% of the total portfolio. These securities are subject to interest rate risk and will decrease in value if interest rates increase. Because we have historically had the ability to hold our fixed income investments until maturity, we do not expect our operating results or cash flows to be significantly affected by a sudden change in market interest rates in our securities portfolio.
We conduct our operations primarily in three functional currencies: the U.S. dollar, the euro, and the Chinese yuan. We currently do not actively hedge our foreign currency exposures and are therefore subject to the risk of exchange rate fluctuations. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. Our exposure to foreign exchange rate fluctuations also arises from intercompany payables and receivables to and from our foreign subsidiaries.
As of December 31, 2017, approximately $19.1 million of the $60.0 million of cash, cash equivalents, and short-term investments was held by our foreign subsidiaries. While the Tax Act generally allows future repatriation of foreign funds without incurring additional U.S. taxes, certain funds may still be subject to foreign taxes. If these funds are needed for our operations in the U.S., we may be required to accrue and pay additional taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. We utilize a variety of tax planning and financing strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed. We do not expect restrictions or potential taxes on repatriation of amounts held outside of the U.S to have a material effect on our overall liquidity, financial condition or results of operations.
As of December 31, 2017, we have not provided foreign taxes on approximately $4.9 million of undistributed earnings of our foreign subsidiaries, since such earnings are considered permanently reinvested outside the U.S.
Contractual Obligations
Please refer to Note 17. Commitments and Contingencies, for details on our contractual obligations, which consist of operating leases for office facilities. For income tax liabilities for uncertain tax positions we cannot make a reasonably reliable estimate of the amount and period of any related future payments. As of December 31, 2017 we had $0.4 million of gross unrecognized tax benefits for uncertain tax positions.
Off-Balance Sheet Arrangements
We have operating lease obligations for office facility leases with future cash commitments that are not required to be recorded on our consolidated balance sheet. Accordingly, these operating lease obligations constitute off-balance sheet arrangements. In addition, since we do not maintain accruals associated with certain guarantees, as discussed in Note 18. Guarantees, those guarantee obligations also constitute off-balance sheet arrangements.
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Our critical accounting policies and estimates are as follows:
•
Revenue recognition;
•
Estimating music publishing rights and music royalty accruals;
•
Estimating recoverability of deferred costs;
•
Estimating allowances for doubtful accounts and sales returns;
•
Estimating losses on excess office facilities;
•
Valuation of equity method investments;
•
Valuation of definite-lived assets;
•
Valuation of goodwill;
•
Stock-based compensation; and
•
Accounting for income taxes.
Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Physical products are considered delivered to the customer once they have been shipped and title and risk of loss have been transferred. For online sales, the products or services are considered delivered at the time the product or services are made available, digitally, to the end user.
We recognize revenue on a gross or net basis. In most arrangements, we contract directly with end user customers, and are the primary obligor. In such arrangements, we recognize revenue on a gross basis. In some cases, we utilize third-party distributors who are the primary obligor to sell products or services directly to end user customers. In such instances, we recognize revenue on a net basis.
In our direct to consumer operations, we derive revenue primarily through (1) subscriptions sold by our Games segment and subscriptions of SuperPass within our Consumer Media segment (2) sales of content downloads, software and licenses offered by our Consumer Media, Mobile Services, and Games segments and (3) the sale of advertising and the distribution of third-party products on our websites and in our games.
Consumer subscription products are paid in advance, typically for monthly, quarterly or annual duration. Subscription revenue is recognized ratably over the related subscription time period. Revenue from sales of content downloads, software and licenses is recognized at the time the product is made available, digitally, to the end user. Revenue generated from advertising on our websites and from advertising and the distribution of third-party products included in our products is recognized as revenue at the time of delivery.
We also generate revenue through business-to-business channels by providing services within our Mobile Services segment enabling mobile carriers to deliver audio and video content to their customers and by selling software licenses and products and related support and other services. Revenue generated from services provided to mobile carriers that enable the delivery of audio and video content to their customers is recognized as the services are provided. Setup fees to build these services are recognized ratably upon launch of the service over the remaining expected term of the service.
Non-software revenue arrangements containing multiple elements are divided into separate units of accounting, after being evaluated for specific criteria. If the criteria for separation are met, revenue is allocated to the individual units using the relative price method. If the criteria are not met, the elements are treated as one unit of accounting and revenue recognition is delayed until all elements have been delivered. In the case of revenue arrangements containing software, elements are divided into separate units of accounting only when vendor-specific objective evidence has been established. In cases where vendor-specific objective evidence has not been established, undelivered elements are combined into one unit of accounting and are not recognized in revenue until all elements have been delivered.
Estimating Music Publishing Rights and Music Royalty Accruals. We have made estimates of amounts that may be owed related to music royalties for our historical domestic and international music services. Material differences may impact the amount and timing of our expense for any period if management made different judgments or utilized different estimates. Under copyright law, we may be required to pay licensing fees for digital sound recordings and compositions we have delivered. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory licenses where voluntary negotiations are unsuccessful, by arbitration. Our estimates are based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies. While we have based our estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates under different assumptions or conditions.
Estimating Recoverability of Deferred Costs. We defer costs on projects for service revenue and system sales. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire hardware and software from third parties and payroll costs for our employees and other third parties. We recognize such costs as a component of cost of revenue, the timing of which is dependent upon the revenue recognition policy by contract. For revenue recognized under the completed contract method, costs are deferred until the products are delivered, or upon completion of services or, where applicable, customer acceptance. For revenue recognized under the percentage of completion method, costs are recognized as products are delivered or services are provided in accordance with the percentage of completion calculation. For revenue recognized ratably over the term of the contract, costs
are recognized ratably over the term of the contract, commencing on the date of revenue recognition. At each balance sheet date, we review deferred costs to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue.
Assessing the recoverability of deferred project costs is based on significant assumptions and estimates, including future revenue and cost of sales. Significant or sustained decreases in revenue or increases in cost of sales in future periods could result in impairments of deferred project costs. We cannot accurately predict the amount and timing of any such impairments. Should the value of deferred project costs become impaired, we would record the appropriate charge, which could have a material adverse effect on our financial condition or results of operations.
Estimating Allowances for Doubtful Accounts and Sales Returns. We make estimates of the uncollectible portion of our accounts receivable. We specifically analyze the age of accounts receivable and historical bad debts, customer credit-worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Similarly, we make estimates of potential future product returns related to current period revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowance. Significant judgments and estimates are made and used in connection with establishing allowances for doubtful accounts and sales returns. Material differences may result in the amount and timing of our revenue for any period if we were to make different judgments or utilize different estimates or actual future experience was different from the judgments and estimates.
Estimating losses on excess office facilities. We make significant estimates in determining the appropriate amount of accrued loss on excess office facilities, including estimates of sublease income expected to be received. If we make different estimates, our loss on excess office facilities could be significantly different from that recorded, which could have a material impact on our operating results.
Valuation of Equity Method Investments. We use the equity method of accounting for investments in circumstances where we have the ability to exert significant influence, but not control, over an investee or joint venture. We record our percentage interest in the investee's recorded income or loss and changes in the investee's capital under this method, which will increase or decrease the reported value of our investment. See Note 4. Napster Joint Venture, for additional information. We initially record our investment based on a fair value analysis of the investment.
We evaluate impairment of an investment valued under the equity method if events and circumstances warrant. An impairment charge would be recorded if a decline in value of an equity investment below its carrying amount were determined to be other than temporary. In determining if a decline is other than temporary, we consider factors such as the length of time and extent to which the fair value of the investment has been less than the carrying amount of the investee or joint venture, the near-term and longer-term operating and financial prospects of the investee or joint venture and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery.
Valuation of Definite-Lived Assets. Definite-lived assets consist primarily of property, plant and equipment, as well as amortizable intangible assets acquired in business combinations. Definite-lived assets are amortized on a straight line basis over their estimated useful lives. We review definite-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If definite-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value.
The impairment analysis of definite-lived assets is based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of our definite-lived assets could result in the need to perform an impairment analysis in future periods which could result in a significant impairment. While we believe our estimates and assumptions are reasonable, due to their complexity and subjectivity, these estimates and assumptions could vary from period to period. Changes in these estimates and assumptions could materially affect the estimate of future undiscounted cash flows and related fair market values of these assets and result in significant impairments, which could have a material adverse effect on our financial condition or results of operations. For further discussion, please see the risk factor entitled, "Any impairment to our goodwill and definite-lived assets could result in a significant charge to our earnings" under Item 1A Risk Factors.
Valuation of Goodwill. We test goodwill for impairment on an annual basis, in our fourth quarter, or more frequently if circumstances indicate reporting unit carrying values may exceed their fair values. Circumstances that may indicate a reporting unit's carrying value exceeds its fair value include, but are not limited to: poor economic performance relative to historical or projected future operating results; significant negative industry, economic or company specific trends; changes in the manner of our use of the assets or the plans for our business; and loss of key personnel.
When evaluating goodwill for impairment, based upon our annual test or due to changes in circumstances described above, we first perform a qualitative assessment to determine if the fair value of a reporting unit is more likely than not less than the reporting unit's carrying amount including goodwill. If this assessment indicates it is more likely than not, we then compare the carrying value of the reporting unit to the estimated fair value of the reporting unit. If the carrying value of the reporting unit exceeds the estimated fair value, we then calculate the implied estimated fair value of goodwill for the reporting unit and compare it to the carrying amount of goodwill for the reporting unit. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to implied estimated value.
Significant judgments and estimates are required in determining the reporting units and assessing the fair value of the reporting units. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.
Stock-Based Compensation. Stock-based compensation cost is estimated at the grant date based on the award’s fair value and is recognized as expense over the requisite service period, which is the vesting period. For stock options, the fair value is calculated using the Black-Scholes option-pricing model or other appropriate valuation models such as Monte Carlo simulation. The valuation models require various highly judgmental assumptions including volatility in our common stock price and expected option life. If any of the assumptions used in the valuation models change significantly, stock-based compensation expense for new awards may differ materially in the future from the amounts recorded in our consolidated statement of operations. For all awards, we are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting forfeitures.
Accounting for Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred income tax expense and deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled. We must make assumptions, judgments and estimates to determine the current and deferred provision for income taxes, deferred tax assets and liabilities and any valuation allowance to be recorded against deferred tax assets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and future tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.
Each reporting period we must periodically assess the likelihood that our deferred tax assets will be recovered from future sources of taxable income, and to the extent that recovery is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefit in the statement of operations and comprehensive income. In certain instances, changes in the valuation allowance may be allocated directly to the related components of shareholders' equity on the consolidated balance sheet. Factors we consider in making such an assessment include, but are not limited to, past performance and our expectation of future taxable income, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our investments and other assets.
As of December 31, 2017, $19.1 million of the $60.0 million of cash, cash equivalents, and short-term investments was held by our foreign subsidiaries.
As of December 31, 2017, we have not provided foreign taxes on approximately $4.9 million of undistributed earnings of our foreign subsidiaries, since such earnings are considered permanently reinvested outside the U.S. As part of the transition tax under the Tax Cuts and Jobs Act the Company can now distribute, tax-free, earnings from our foreign subsidiaries to the U.S. However, for certain earnings, foreign taxes may be imposed upon distribution. As such, the Company asserts that the undistributed earnings of its foreign subsidiaries will continue to be permanently reinvested in jurisdictions where foreign taxes would be assessed upon distribution to the U.S. It is not practicable to determine the foreign tax liability or benefit on such earnings due to the timing of such future distributions 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 repatriated, an additional provision for foreign taxes may be necessary.
Recently Issued Accounting Standards
See Note 2. Recent Accounting Pronouncements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
The following discussion about our market risk involves forward-looking statements. All statements that do not relate to matters of historical fact should be considered forward-looking statements. Actual results could differ materially from those projected in any forward-looking statements.
Interest Rate Risk. Our exposure to interest rate risk from changes in market interest rates relates primarily to our short-term investment portfolio. Our short-term investments consist of investment grade debt securities as specified in our investment policy. Investments in both fixed and floating rate instruments carry a degree of interest rate risk. The fair value of fixed rate securities may be adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Additionally, a declining rate environment creates reinvestment risk because as securities mature the proceeds are reinvested at a lower rate, generating less interest income. See Note 5. Fair Value Measurements for additional information. Due in part to these factors, our future interest income may be adversely impacted due to changes in interest rates. In addition, we may incur losses in principal if we are forced to sell securities that have declined in market value due to changes in interest rates. Because we have historically had the ability to hold our short-term investments until maturity, we would not expect our operating results or cash flows to be significantly impacted by a sudden change in market interest rates. There have been no material changes in our investment methodology regarding our cash equivalents and short-term investments during the quarter ended December 31, 2017. Based on our cash, cash equivalents, short-term investments, and restricted cash equivalents as of December 31, 2017, a hypothetical 10% increase/decrease in interest rates would not increase/decrease our annual interest income or cash flows by more than a nominal amount.
Investment Risk. As of December 31, 2017, we had an investment in voting capital stock of a privately held technology company for business and strategic purposes. See Note 1. Description of Business and Summary of Significant Accounting Policies - Equity Method Investments, and Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates (Valuation of equity method investments) in this 10-K for details on our accounting treatment for this investment, including the analysis of other-than-temporary impairments.
Foreign Currency Risk. We conduct business internationally in several currencies and thus are exposed to adverse movements in foreign currency exchange rates.
Our exposure to foreign exchange rate fluctuations arise in part from: (1) translation of the financial results of foreign subsidiaries into U.S. dollars in consolidation; (2) the remeasurement of non-functional currency assets, liabilities and intercompany balances into U.S. dollars for financial reporting purposes; and (3) non-U.S. dollar denominated sales to foreign customers and expenses incurred in currencies other than the U.S.
Our foreign currency risk management program reduces, but does not entirely eliminate, the impact of currency exchange rate movements.
We have cash balances denominated in foreign currencies which are subject to foreign currency fluctuation risk. A substantial portion of our foreign currency denominated cash is held in euros. A hypothetical 10% increase or decrease in the euro relative to the U.S. dollar as of December 31, 2017 would not result in a material impact on our financial position, results of operations or cash flows.
Item 8.
Item 8.
Financial Statements and Supplementary Data
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
See accompanying notes to consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
See accompanying notes to consolidated financial statements.
See accompanying notes to consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
See accompanying notes to consolidated financial statements.
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2017, 2016 and 2015
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 our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services and the ability to generate related revenue.
In this Annual Report on Form 10-K for the year ended December 31, 2017 (10-K), RealNetworks, Inc. and subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”.
Basis of Presentation. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.
The consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the year ended December 31, 2017 are not necessarily indicative of the results that may be expected for any subsequent periods.
On December 31, 2017, our contract with LOEN Entertainment, Co, Ltd. (LOEN) for our music on demand services expired without renewal. Accordingly, we have reported the operating results of this business as discontinued operations for all periods presented. The assets and liabilities of the music on demand business at December 31, 2017 and 2016 have been reported as assets and liabilities of discontinued operations in the Consolidated Balance Sheet. Refer to Note 16 Discontinued Operations. Unless otherwise noted, discussion within these notes to the consolidated financial statements relates to continuing operations.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (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.
Cash and Cash Equivalents and Short-Term Investments We consider all short-term investments with a remaining contractual maturity at date of purchase of three months or less to be cash equivalents.
Other short-term investments with remaining contractual maturities of five years or less are classified as short-term because the investments are marketable and highly liquid, and we have the ability to utilize them for current operations. Realized gains and losses and any declines in value judged to be other-than-temporary on short-term investments are included in other income (expense), net. Realized and unrealized gains and losses on short-term investments are determined using the specific identification method.
Trade Accounts Receivable. Trade accounts receivable consist of amounts due from customers and do not bear interest. The allowance for doubtful accounts and sales returns is our estimate of the amount of probable credit losses and returns in our existing accounts receivable. We determine the allowances based on analysis of historical bad debts, customer concentrations, customer credit-worthiness, return history and current economic trends. We review the allowances for doubtful accounts and sales returns quarterly. Past due balances over 90 days and specified other balances are reviewed individually for collectability. All other balances are reviewed on an aggregate basis. Account balances are written off against the allowance after all reasonable means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance sheet credit exposure related to our customers.
Concentration of Credit Risk. Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, and accounts receivable. Short-term investments consist of U.S. government and government agency securities, corporate notes and bonds, and municipal securities. We derive a portion of our revenue from a large number of individual consumers spread globally. We also derive revenue from several large customers. If the financial condition or results of operations of any one of the large customers deteriorates substantially, our operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. We do not generally require collateral and we maintain an allowance for estimated credit losses on customer accounts when considered necessary.
Depreciation and Amortization. Depreciation of equipment and software, as well as amortization of leasehold improvements is computed using the straight-line method over the lesser of the estimated useful lives of the assets or the related lease term. The useful life of equipment and software is generally three to five years.
Depreciation and amortization expense of these assets during the years ended December 31, 2017, 2016, and 2015 was $2.3 million, $6.0 million and $8.1 million, respectively.
Equity Method Investment. We use the equity method in circumstances where we have the ability to exert significant influence, but not control, over an investee or joint venture. We initially record our investment based on a fair value analysis of the investment. We record our percentage interest in the investee's recorded income or loss and changes in the investee's capital under this method, which will increase or decrease the reported value of our investment. See Note 4, Napster Joint Venture for additional information.
We evaluate impairment of an investment accounted for under the equity method if events and circumstances warrant. An impairment charge would be recorded if a decline in the fair value of an equity investment below its carrying amount were determined to be other than temporary. In determining if a decline is other than temporary, we consider factors such as the length of time and extent to which the fair value of the investment has been less than the carrying amount of the investee or joint venture, the near-term and longer-term operating and financial prospects of the investee or joint venture and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery.
Deferred Costs. We defer certain costs on projects for service revenues and system sales. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire hardware and software from third parties and payroll and related costs for employees and other third parties. Deferred costs are capitalized during the implementation period.
We recognize such costs as a component of cost of revenue, the timing of which is dependent upon the revenue recognition policy by contract. At each balance sheet date, we review deferred costs to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue or if actual deferred costs exceed estimated contractual revenue. Assessing the recoverability of deferred costs is based on significant assumptions and estimates, including future revenue and cost of sales. Significant or sustained decreases in revenue or increases in cost of sales in future periods could result in impairments of deferred project costs and prepaid royalty advances. We cannot accurately predict the amount and timing of any such impairments. Should deferred project costs or prepaid royalty advances become impaired, we would record the appropriate charge, which could have a material adverse effect on our financial condition and results of operations.
Definite-Lived Tangible and Intangible Assets. Definite-lived tangible assets include equipment, software and leasehold improvements and are carried at cost less accumulated depreciation and amortization. Definite-lived intangible assets consist primarily of the fair value of customer agreements and contracts, and developed technology acquired in business combinations and are amortized over their estimated useful lives.
We review these assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. If the carrying amount of an asset group is not recoverable, an impairment loss is recognized if the carrying amount of the asset group exceeds its estimated fair value, which is generally determined as the present value of estimated future cash flows to a market participant. Our impairment analysis is based on significant assumptions of future results, including operating and cash flow projections. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, could result in the need to record an impairment charge in future periods.
Goodwill. We test goodwill for impairment on an annual basis, in our fourth quarter, or more frequently if circumstances indicate reporting unit carrying values may exceed their fair values. Circumstances that may indicate a reporting unit's carrying value exceeds its fair value include, but are not limited to: poor economic performance relative to historical or projected future operating results; significant negative industry, economic or company specific trends; changes in the manner of our use of the assets or the plans for our business; and loss of key personnel.
When evaluating goodwill for impairment, based upon our annual test or due to changes in circumstances described above, we first perform a qualitative assessment to determine if the fair value of a reporting unit is more likely than not less than the reporting unit's carrying amount including goodwill. If this assessment indicates it is more likely than not, we then compare the carrying value of the reporting unit to the estimated fair value of the reporting unit. If the carrying value of the reporting unit exceeds the estimated fair value, we then calculate the implied estimated fair value of goodwill for the reporting unit and compare it to the carrying amount of goodwill for the reporting unit. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to implied
estimated value. Significant judgment is required in determining the reporting units and assessing fair value of the reporting units.
Fair Value. Fair value is the price that would be received from selling an asset or paid in transfering a liability in an orderly transaction between market participants at the measurement date. Our fair value measurements consider the principal or most advantageous market in which we would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability, such as inherent risk, transfer restrictions and credit risk.
Fair values are 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
Research and Development. Costs incurred in research and development are expensed as incurred. Software development costs are capitalized when a product’s technological feasibility has been established through the date the product is available for general release to customers. Other than internal use software, we have not capitalized any software development costs, as technological feasibility is generally not established until a working model is completed, at which time substantially all development is complete.
Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Physical products are considered delivered to the customer once they have been shipped and title and risk of loss have been transferred. For online sales, the products or services are considered delivered at the time the products or services are made available, digitally, to the end user.
We recognize revenue on a gross or net basis. In most arrangements, we contract directly with end user customers, and are the primary obligor. In such arrangements, we recognize revenue on a gross basis. In some cases, we utilize third-party distributors who are the primary obligor to sell products or services directly to end user customers. In such instances, we recognize revenue on a net basis.
In our direct to consumer operations, we derive revenue through (1) subscriptions sold by our Games segment and subscriptions of SuperPass within our Consumer Media segment, (2) sales of content downloads, software and licenses offered by our Consumer Media, Mobile Services, and Games segments and (3) the sale of advertising and the distribution of third-party products on our websites and in our games.
Consumer subscription products are paid in advance, typically for monthly, quarterly or annual duration. Subscription revenue is recognized ratably over the related subscription time period. Revenue from sales of content downloads, software and licenses is recognized at the time the product is made available, digitally, to the end user. Revenue generated from advertising on our websites and from advertising and the distribution of third-party products included in our products is recognized as revenue at the time of delivery.
We also generate revenue through business-to-business channels by providing services within our Mobile Services segment enabling mobile carriers to deliver audio and video content to their customers and by selling software licenses and products and related support and other services. Revenue generated from services provided to mobile carriers that enable the delivery of audio and video content to their customers is recognized as the services are provided. Setup fees to build these services are recognized ratably upon launch of the service over the remaining expected term of the service.
Non-software revenue arrangements containing multiple elements are divided into separate units of accounting, after being evaluated for specific criteria. If the criteria for separation are met, revenue is allocated to the individual units using the relative fair value method. If the criteria are not met, the elements are treated as one unit of accounting and revenue recognition is delayed until all elements have been delivered. In the case of revenue arrangements containing software, elements are divided into separate units of accounting only when vendor-specific objective evidence has been established. In cases where vendor-specific objective evidence has not been established, undelivered elements are combined into one unit of accounting and are not recognized in revenue until all elements have been delivered.
Advertising Expenses. We expense the cost of advertising and promoting our products as incurred. These costs are included in sales and marketing expense and totaled $4.5 million in 2017, $6.1 million in 2016 and $16.5 million in 2015.
Foreign Currency. The functional currency of the Company’s foreign subsidiaries is generally the currency of the country in which the subsidiary operates. Assets and liabilities of foreign operations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. The net gain or loss resulting from translation is shown as translation
adjustment and included in Accumulated Other Comprehensive Income (AOCI) in shareholders’ equity. Income and expense accounts are translated into U.S. dollars using average rates of exchange. Gains and losses from foreign currency transactions are included in the consolidated statements of operations.
Accounting for Taxes Collected from Customers. Our revenues are reported net of sales and other transaction taxes that are collected from customers and remitted to taxing authorities.
Income Taxes. We compute income taxes using the asset and liability method, under which deferred income taxes are provided for temporary differences between financial reporting basis and tax basis of our assets and liabilities and operating loss and tax credit carryforwards. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character in the appropriate taxing jurisdictions. Adjustments to the valuation allowance could be required in the future if we estimate that the amount of deferred tax assets to be realized is more or less than the net amount we have recorded. Any increase or decrease in the valuation allowance could have the effect of increasing or decreasing the income tax provision in the statement of operations.
Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled.
We file numerous consolidated and separate income tax returns in the U.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.
We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. We recognize accrued interest and penalties related to uncertain tax positions as a component of income tax expense.
Stock-Based Compensation. Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. We use the Black-Scholes option-pricing model or other appropriate valuation models such as Monte Carlo simulation to determine the fair value of stock-based option awards. The fair value of restricted stock awards is based on the closing market price of our common stock on the grant date of the award. Generally, we recognize the compensation cost for awards on a straight-line basis for the entire award, over the applicable vesting period. For performance-based awards, expense is recognized when it is probable the performance goal will be achieved, however if the likelihood becomes improbable, that expense is reversed. For market-based stock options, fair value is measured at the grant date using the Monte Carlo simulation model and we recognize compensation cost for these awards on a straight-line basis over the requisite service period for each separately vesting portion of the awards. For our employee stock purchase plan, compensation expense is measured based on the discount the employee is entitled to upon purchase.
The valuation models for stock-based option awards require various judgmental assumptions including volatility in our common stock price and expected option life. If any of the assumptions used in the valuation models change significantly, stock-based compensation expense for new awards may differ materially in the future from the amounts recorded in the consolidated statements of operations. For all awards, we also estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.
Net Income 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 dilutive potential common shares outstanding during the period.
Note 2.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued new revenue recognition guidance, which was subsequently updated and amended in 2015 and 2016. The guidance requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective.
The guidance permits two methods of adoption: the full retrospective method where the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, where the cumulative effect of applying the standard would be recognized at the date of initial application. We will adopt the requirements of the new standard effective January 1, 2018, and will use the modified retrospective transition method with the cumulative effect to the opening balance of retained earnings recognized as of the date of initial adoption.
Under the new standard, the greatest impact will be in certain areas where we will be required to estimate usage which drives the underlying revenue. Under the current guidance, we do not recognize revenues until we achieve fixed and determinable status, which would typically be at a later date. We also expect an impact related to the licensing of our RealTimes and RealPlayer products. As we transition to the new revenue standard, we will recognize the revenue predominantly at the time of delivery rather than over the contract period, which results in an acceleration of revenue. Revenue recognition for all other product lines will not be be significantly impacted. The new standard will not have a cash impact and will not affect the economics of the underlying customer contracts.
Our disclosures in our notes to the Consolidated Financial Statements related to revenue recognition will be significantly expanded under the new standard, specifically around the quantitative and qualitative information about our underlying performance obligations. Our assessment of impacts resulting from the new standard is substantially complete, including the impact on our controls and differences in the timing or method of revenue recognition for our contracts. As a result of our evaluation, we have modified certain accounting policies and practices and updated certain existing controls. We also designed and implemented specific controls over our evaluation of the impact of the new standard, including our calculation of the cumulative adjustment to Retained Deficit. As a result of the new standard, based on currently executed contracts, we expect to record a cumulative adjustment increasing our Retained Deficit on January 1, 2018 of approximately $1.0 million to $1.5 million.
In February 2016, the FASB issued new guidance related to the accounting for leases by lessees. A major change in the new guidance is that lessees will be required to present right-of-use assets and lease liabilities on the balance sheet. The new guidance will be effective for us on January 1, 2019, including interim periods within 2019. We will continue to evaluate the effect that the guidance will have on our consolidated financial statements and related disclosures. We expect that the guidance will result in a material change to our Consolidated Balance Sheet as a result of capitalizing certain of our operating leases.
In November 2016, the FASB issued new guidance on the classification and presentation of changes in restricted cash on the statement of cash flows. This guidance is effective for interim and annual reporting for us on January 1, 2018. We do not expect the adoption of this guidance to have a material qualitative impact on our statement of cash flows.
In January 2017, the FASB issued new guidance simplifying the test for goodwill impairment. The new guidance eliminates Step 2 from the goodwill impairment test, instead requiring an entity to recognize a goodwill impairment charge for the amount by which the reporting unit's carrying amount exceeds the reporting unit's fair value. This guidance is effective for interim and annual goodwill impairment tests beginning on December 15, 2019, with early adoption permitted. We will be evaluating the impact of the guidance, but do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.
There have been no other recent accounting pronouncements or changes in accounting pronouncements to be implemented that are of significance or potential significance to RealNetworks.
Note 3.
Acquisitions and Disposals
As described in our 2016 10-K, on July 24, 2015, we entered into an agreement to sell the Slingo and social casino portion of our games business to Gaming Realms plc. Of the total transaction price of $18.0 million, $10.0 million was paid in cash at closing on August 10, 2015, $4.0 million was paid in cash in August 2016, and the remaining $4.0 million was paid in cash in December 2017, along with an additional $0.5 million payment related to an agreed-to extension of this final payment, which was originally due in August 2017. We recognized the gain related to both the 2016 and 2017 payments in Gain (loss) on investments, net, on the statement of operations in 2016 and 2017. We recorded in 2015 the related foreign currency gain of $0.5 million in Other income and expense and an income tax benefit of $1.6 million from the reversal of a Slingo deferred tax liability.
Note 4.
Napster Joint Venture
As of December 31, 2017 we owned approximately 42% of the issued and outstanding stock of Rhapsody International, Inc., doing business as Napster, and account for our investment using the equity method of accounting.
Rhapsody America LLC was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International Inc. (MTVN), to own and operate a business-to-consumer digital audio music service
originally branded as Rhapsody. The service was re-branded in 2016 as Napster. In this Note, we refer to the business as Napster, although the legal entity in which we hold our investment is Rhapsody International, Inc.
Following certain restructuring transactions effective March 31, 2010, we began accounting for our investment using the equity method of accounting. As part of the 2010 restructuring transactions, RealNetworks contributed $18.0 million in cash, the Rhapsody brand and certain other assets, including content licenses, in exchange for shares of convertible preferred stock of Rhapsody International, Inc., carrying a $10.0 million preference upon certain liquidation events.
We recorded our share of losses of the Napster business of $4.0 million, $6.5 million, and $14.5 million for the years ended December 31, 2017, 2016 and 2015, respectively. Because of the $10.0 million liquidation preference on the preferred stock we hold in Napster, under the equity method of accounting we did not record any share of Napster losses that would reduce the carrying value of our investment, which is impacted by Napster equity transactions, below $10.0 million, until Napster's book value was reduced below $10.0 million, which occurred in the first quarter of 2015. As of December 31, 2017, the carrying value of our Napster equity investment was zero, as we did not have any further commitment to provide future support to Napster, with the exception of the guaranty discussed below. Unless we commit to provide future financial support to Napster, we do not record any further share of Napster losses that would reduce our carrying value of Napster below zero; in accordance with generally accepted accounting principles in the U.S., we currently track those suspended losses outside of our financial statements.
In December 2016, RealNetworks entered into an agreement to loan up to $5 million to Napster for general operating purposes, as did Napster's other 42% owner, Columbus Nova. Each entity fully funded its loan, providing $3.5 million each in December 2016 and the remaining $1.5 million each in January 2017. These 12-month loans are subordinate to senior creditors, and bear an interest rate of 10% per annum, which accretes into the outstanding principal balance. At the time of signing the agreement we recognized previously suspended Napster losses, and, consequently, we did not record a receivable related to this loan. The parties have agreed to extend the term of these loans.
During the second quarter of 2017, Napster defaulted on its loans to senior lenders due to a breach of a financial covenant, thus causing a cross default on Napster's loan to us. In June 2017, Napster obtained forbearance agreements from the senior lenders, pursuant to which (in general terms) the lenders agreed not to exercise remedies against Napster relating to defaults existing at June 30, 2017, which was subsequently extended through November 2017. In October 2017, Napster entered into a financing agreement with a new third party lender, pursuant to which Napster would factor certain receivables in return for cash advances. Napster applied the initial cash proceeds from this arrangement to pay in full and terminate all outstanding term loans with its then-existing third party lenders and a portion of amounts outstanding under a revolving credit facility. In November 2017, Napster entered into an amendment to its revolving credit facility, which updated all effective covenants and relieved all existing defaults, thereby relieving the cross default on Napster's loan to us and its loan to Columbus Nova.
In conjunction with Napster's amendment to its revolving credit facility, both RealNetworks and Columbus Nova entered into an arrangement to guarantee up to $2.75 million each of Napster's outstanding indebtedness on the credit facility. As a result of this guaranty, we have recognized previously suspended Napster losses up to the full $2.75 million guaranty in the Equity in net loss of Napster investment line item in our consolidated statements of operations. As of the date of this filing, RealNetworks has not been required to pay any amounts under the guaranty, and the amount is reflected on our consolidated balance sheets as Commitment to Napster.
Summarized financial information for Napster, which represents 100% of their financial information, is as follows (in thousands):
Note 5.
Fair Value Measurements
Items Measured at Fair Value on a Recurring Basis
The following tables present information about our financial assets that have been measured at fair value on a recurring basis as of December 31, 2017 and 2016, and indicates the fair value hierarchy of the valuation inputs utilized to determine fair value (in thousands).
Restricted cash equivalents and investments as of December 31, 2017 and 2016 relate to cash pledged as collateral against letters of credit in connection with lease agreements.
Realized gains and losses on sales of short-term investment securities for 2017, 2016, and 2015 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of December 31, 2017 and 2016 were not significant.
Investments with remaining contractual maturities of five years or less are classified as short-term because the investments are marketable and highly liquid, and we have the ability to utilize them for current operations. Contractual maturities of short-term investments as of December 31, 2017 are as follows (in thousands):
In February 2015, Napster issued warrants to purchase Napster common shares to both RealNetworks and Columbus Nova. The warrants were issued as compensation for past services provided by RealNetworks and Columbus Nova, and both warrants covered the same number of underlying shares, with a 10 year contractual term. The exercise price of the warrants was equal to the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of 5 years and expected volatility of 55%. On the date of issuance, we recognized and recorded the $1.2 million fair value of the warrant issued to RealNetworks within Other assets in the consolidated balance sheets, and as an expense reduction within General and administrative expense in the consolidated statements of operations. The warrants are free-standing derivatives and as such their fair value is determined each quarter using updated inputs in the Black-Scholes option-pricing model. At December 31, 2017, due to the management change and strategic shift undertaken by Napster, we determined that a change to the expected term was necessary. As a result, we extended the expected term by 3.25 years, resulting in a total expected term for the warrant of 8.25 years. During the twelve months ended December 31, 2017 the decrease in the fair value of the warrants was approximately $0.1 million.
In February 2017, Napster issued additional warrants to purchase Napster common shares to both RealNetworks and Columbus Nova. Consistent with the warrants issued in 2015, the 2017 warrants were issued as compensation for past services provided by RealNetworks and Columbus Nova, and both warrants covered the same number of underlying shares, with a 10 year contractual term. The exercise price of the warrants exceeded the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of 5 years and expected volatility of 55%, resulting in a recognized fair value of $0.5 million in Other assets in the consolidated balance sheets, and as an expense reduction within General and administrative expense in the consolidated statements of operations. At December 31, 2017, due to the management change and strategic shift undertaken by Napster, we determined that a change to the expected term was necessary. As a result, we extended the expected term by 1 year, resulting in a total expected term for the warrant of 6 years. During the twelve months ended December 31, 2017 the decrease in fair value of the warrants was approximately $0.2 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, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). We did not record any impairments on those assets required to be measured at fair value on a non-recurring basis in 2017, 2016 or 2015.
See Note 11. Lease Exit and Related Charges, for a discussion of the losses related to reductions in the use of RealNetworks' office space, which were recorded at the estimated fair value of remaining lease obligations, less expected sub-lease income.
Note 6.
Allowance for Doubtful Accounts Receivable and Sales Returns
Activity in the allowance for doubtful accounts receivable (in thousands):
Activity in the allowance for sales returns (in thousands):
One customer accounted for 20% of trade accounts receivable at December 31, 2017. Three customers comprised more than 10% of our trade accounts receivable as of December 31, 2016, with the customers individually accounting for 25%, 16% and 12%.
One customer accounted for 10% or $8.0 million, of consolidated revenue during the year ended December 31, 2017, in our Mobile Services segment.
One customer accounted for 11%, or $9.1 million, of consolidated revenue during the year ended December 31, 2016, which is reflected in our Mobile Services segment.
No customer accounted for ten percent or more of our consolidated revenue during the year ended December 31, 2015.
Note 7.
Other Intangible Assets
Other intangible assets (in thousands):
An asset purchase relating to our Games business was completed in the second quarter of 2016, and resulted in an intangible asset of $0.2 million.
In the third quarter of 2016 we recognized a gain of $2.0 million, net of transaction costs, to Gain (loss) on investments, net, as the result of a sale of a domain name with no book value to a third party.
Amortization expense related to other intangible assets during the years ended December 31, 2017, 2016, and 2015 was $0.7 million, $1.0 million, and $2.3 million, respectively.
Estimated future amortization of other intangible assets (in thousands):
No impairments of other intangible assets were recognized in 2017, 2016 or 2015.
Changes in goodwill (in thousands):
Goodwill by segment (in thousands):
No impairments of goodwill were recorded in 2017, 2016, or 2015.
Note 9.
Accrued and Other Current Liabilities
Accrued and other current liabilities (in thousands):
Restructuring and other charges in 2017, 2016 and 2015 consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. The expense amounts in all three years primarily relate to severance costs due to workforce reductions.
Restructuring charges are as follows (in thousands):
Changes to the accrued restructuring liability (which is included in Accrued and other current liabilities) for 2017, 2016 and 2015, (in thousands):
As a result of the reduction in use of RealNetworks' office space, primarily in our 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, including contractual, or estimates of, sublease income expected to be received, and related write-downs of leasehold improvements to their estimated fair value.
In 2015, we recorded $2.5 million of losses primarily relating to an approximate 43% reduction of office space at our leased corporate headquarters in Seattle, Washington. In 2016, we recorded additional losses of $2.2 million primarily relating to reduction of our office space at our corporate headquarters, resulting in total reduction of 69% as of December 31, 2016.
We continue to 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):
Accumulated Other Comprehensive Loss
Changes in components of accumulated other comprehensive loss (in thousands):
Preferred Stock. Each share of Series A preferred stock entitles the holder to one thousand votes and dividends equal to one thousand times the aggregate per share amount of dividends declared on the common stock. There are no shares of Series A preferred stock outstanding.
Undesignated preferred stock will have rights and preferences that are determinable by the Board of Directors if and when determination of a new series of preferred stock has been established.
Equity Compensation Plans. Under our equity incentive plans we may grant various types of equity awards to employees and Directors. We have granted time-vest and performance-vest stock options and time-vest and performance-vest restricted stock. Generally, options vest based on continuous employment, over a four-year period. The options generally expire seven years from the date of grant and are exercisable at the market value of the common stock at the grant date. Time-vest restricted stock awards generally vest based on continuous employment over a two or four-year period. Performance-based awards vest if the specified performance targets are met and the grantee remains employed over the required period. The performance targets for these awards are generally based on the achievement of company-specific financial results. For these performance-based awards, expense is recognized when it is probable the performance goal will be achieved. We have also issued market-based performance stock options to certain employees. These awards vest if the market condition is met and the grantee remains employed over the requisite service period.
We issue new shares of common stock upon exercise of stock options and the vesting of restricted stock. As of December 31, 2017 there were 5.9 million shares of common stock authorized for future equity awards. Each restricted stock unit granted reduces and each restricted stock unit forfeited or canceled increases the shares available for future grant by a factor of 1.6 shares. Each stock option granted reduces and each stock option forfeited or canceled increases the shares available for future grant by a factor of one share. We also have an employee stock purchase plan, under which 0.3 million shares of common stock are authorized for future issuance as of December 31, 2017.
Stock-based compensation expense recognized in our consolidated statements of operations includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):
The total stock-based compensation amounts disclosed above are recorded in the respective line items within operating expenses in the consolidated statement of operations. Included in the expense for both 2017 and 2016 was stock compensation expense recorded for 2016 and 2015, respectively, incentive bonuses paid in fully vested restricted stock units which were authorized and granted in 2017 and 2016. No stock-based compensation was capitalized as part of the cost of an asset as of December 31, 2017, 2016, or 2015. As of December 31, 2017, we had $4.0 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 two years.
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, the valuation models for stock option awards require various highly judgmental assumptions. The assumption for the expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, including the contractual terms, vesting schedules, and expectations of future employee behavior. Expected stock price volatility is based on historical volatility of our common stock for the related expected term. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to the expected term of the stock options. The dividend yield is estimated at zero because we do not currently anticipate paying dividends in the foreseeable future.
The fair value of options granted, excluding the options related to the 2016 Exchange described below, used the following weighted average assumptions:
Restricted stock unit and award activity was as follows (shares are in thousands):
At December 31, 2017 the aggregate intrinsic value of restricted stock awards was $0.7 million and the weighted average remaining contractual term was approximately 1 year.
Stock option activity (shares are in thousands):
In 2016 and 2015 we granted 400,000 and 200,000 market-based stock options, which are included in the stock option tables above.
As of December 31, 2017, the weighted average remaining contractual life of the options was as follows: outstanding options 4.9 years; exercisable options 4.1 years; and vested and expected to vest options 4.9 years. As of December 31, 2017, there was no aggregate intrinsic value for our outstanding, exercisable or vested and expected to vest options.
The aggregate intrinsic value of stock options exercised in 2017, 2016 and 2015 was insignificant.
Employee Stock Purchase Plan. Our Employee Stock Purchase Plan (ESPP) allows an eligible employee to purchase shares of our common stock at a price equal to 85 percent of the fair market value of the common stock at the end of the semi-annual offering periods, subject to certain limitations. Under the ESPP, 49,700, 53,600 and 94,400 shares were purchased during the years ended December 31, 2017, 2016 and 2015, respectively.
Retirement Savings Plan. We have a salary deferral plan (401(k) Plan) that covers substantially all employees. Eligible employees may contribute a portion of their eligible compensation to the plan up to limits stated in the plan documents, not to exceed the dollar amounts set by applicable laws. During the years ended December 31, 2017, 2016, and 2015, we matched 50% of the first three percent of participating employees’ contributions, and contributed $0.3 million, $0.3 million, and $0.6 million, respectively, in matching contributions. We can terminate the matching contributions at our discretion. We have no other post-employment or post-retirement benefit plans.
Stock Option Exchange. In September 2016, our shareholders approved amendments to our stock plans to allow for an option exchange program. The program, which launched on November 3, 2016, offered eligible employees and certain other service providers an opportunity to exchange certain outstanding options, with a per share exercise price in excess of $4.33 (the "Eligible Options"), for new awards. The Company granted these new options on December 6, 2016, with an exercise price of $4.73, the fair market price of the Company's common stock as quoted on the Nasdaq Global Select Market at the close of business on that day. Members of the Company's Board of Directors, including our CEO, were not eligible for this program. In connection with the program, options to purchase 2.0 million shares of the Company's common stock were exchanged, representing 58% of total shares of common stock underlying the Eligible Options. As a result of the exchange, an additional $1.5 million, gross of estimated forfeitures, will be recognized over approximately 2 years, or the remaining average vesting period.
Components of income (loss) before income taxes (in thousands):
Components of income tax expense (benefit) (in thousands):
Income tax expense differs from “expected” income tax expense (computed by applying the U.S. federal income tax rate of 35%) due to the following (in thousands):
Net deferred tax assets, which are recorded at December 31, 2017 using a 21% tax rate in the U.S. following the passage of the Tax Act, are comprised of the following (in thousands):
Income tax receivables were $3.6 million and insignificant at December 31, 2017 and 2016, respectively.
In 2017, we continued to record a valuation allowance on the deferred tax assets that we believe are not more likely than not to be realized. The net change in valuation allowance was a $39.2 million decrease and a $2.4 million increase during the years ended December 31, 2017 and 2016, respectively.
We maintain a valuation allowance of $137.1 million for our deferred tax assets due to uncertainty regarding their realization as of December 31, 2017. The net decrease in the valuation allowance since December 31, 2016 of $39.2 million was the result of a decrease in current year deferred tax assets, which was primarily related to the reduction in corporate tax rate as a result of the Tax Act, for which the Company maintains a valuation allowance.
RealNetworks' U.S. federal net operating loss carryforwards totaled $283.1 million and $268.5 million at December 31, 2017 and 2016, respectively. The increase is mainly due to the current year U.S. taxable loss. The remaining net operating loss carryforwards as of December 31, 2017 are from prior U.S. taxable losses and from acquired subsidiaries that are limited under Internal Revenue Code Section 382. These net operating loss carryforwards expire between 2024 and 2037.
In 2017, we evaluated the current and future impacts of the Tax Act. The primary impact in 2017 was the elimination of the AMT credit carryforward. We have concluded on a preliminary basis, as allowed under the SEC's SAB 118, that we will not owe U.S. taxes on previously untaxed accumulated and current E&P of certain foreign subsidiaries or on global intangible low-taxed income earned by controlled foreign corporations. This preliminary conclusion is based on our history of negative E&P generated by our foreign subsidiaries.
RealNetworks' AMT credit carryforward remained at $3.6 million from December 31, 2016 to December 31, 2017. The Tax Act repealed the corporate AMT for tax years beginning January 1, 2018, and provides that existing AMT credit carryovers are refundable beginning in 2018. The Company's $3.6 million of AMT credit carryovers are expected to be fully refunded by 2022. A $3.6 million benefit has been recognized in the 2017 income tax provision as a result of this change in the U.S. tax law.
RealNetworks' U.S. federal research and development tax credit carryforward totaled $24.5 million and $24.7 million at December 31, 2017 and 2016, respectively. The research and development credit carryforwards expire between 2020 and 2036.
As of December 31, 2017 and 2016, we had $0.4 million and $0.5 million of unrecognized tax benefits, respectively. The decrease in unrecognized tax benefits is due to federal research and development tax credit carryforward risks. As of December 31, 2017, there are no unrecognized tax benefits remaining that would affect our effective tax rate if recognized, as the offset would increase the valuation allowance. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months.
We recognize interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of December 31, 2017, and 2016 we have no accrued interest or penalties related to uncertain tax positions.
Reconciliation of the beginning and ending balances of the total amounts of unrecognized tax benefits (in thousands):
Basic and diluted net income (loss) per share (EPS) (in thousands, except per share data):
Approximately 5.3 million, 4.8 million, and 5.7 million shares of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS for the years ended December 31, 2017, 2016, and 2015, respectively, because of their antidilutive effect.
On December 31, 2017, our contract with our low-margin music on demand customer LOEN expired. The activity for this contract represented our only revenue source relating to music on demand services, and we did not renew the sole contract for this service, resulting in the abandonment of the related business. As the exit of the music on demand business represents a strategic shift, and the amounts were financially significant to our consolidated results, at December 31, 2017 we determined this business should be reported as a discontinued operation.
The following table summarizes the results of operations, which were recorded in our Mobile Services segment, relating to the discontinued operation (in thousands):
The following table summarizes the carrying amounts of major classes of assets and liabilities of the discontinued operation (in thousands):
The cash flows related to the discontinued operation have not been segregated, and are included in the Consolidated Statements of Cash Flows. For all periods presented, depreciation and amortization, capital expenditures and significant operating non-cash items from the discontinued operation were not material.
Commitments. We have commitments for future payments related to office facilities leases. We lease office facilities under various operating leases expiring through 2024. Future minimum payments as of December 31, 2017 are as follows (in thousands):
(a) Minimum payments have not been reduced by minimum sublease rentals of $10.7 million due in the future under noncancelable subleases.
Of the total office lease future minimum payments, $2.1 million is recorded in accrued lease exit and related charges at December 31, 2017.
Rent expense during the years ended December 31, 2017, 2016, and 2015, was $3.0 million, $4.2 million, and $5.8 million, respectively.
In late 2017 we entered into an arrangement whereby we may be required to guarantee up to $2.75 million of Napster's outstanding indebtedness on their revolving credit facility. As of the date of this filing, we have not been required to pay any portion of this commitment. For additional details, refer to Note 4. Napster Joint Venture.
We could in the future become subject to legal proceedings, governmental investigations and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.
In the ordinary course of business, RealNetworks is subject to potential obligations for standard warranty and indemnification provisions that are contained within many of our customer license and service agreements. Our warranty provisions are consistent with those prevalent in our industry, and we do not have a history of incurring losses on warranties; therefore, we do not maintain accruals for warranty-related obligations. With regard to indemnification provisions, nearly all of our carrier contracts obligate us to indemnify our carrier customers for certain liabilities that may be incurred by them. We have received in the past, and may receive in the future, claims for indemnification from some of our carrier customers.
In relation to certain patents and other technology assets we sold to Intel in the second quarter of 2012, we have specific obligations to indemnify Intel for breaches of the representations and warranties that we made and covenants that we agreed to in the asset purchase agreement for certain potential future intellectual property infringement claims brought by third parties against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.
We manage our business and report revenue and operating income (loss) in three segments: (1) Consumer Media, which includes licensing of our codec technology and our PC-based RealPlayer products, including RealPlayer Plus and related products; (2) Mobile Services, which includes our SaaS services and our integrated RealTimes® platform which is sold to mobile carriers; and (3) Games, which includes all our games-related businesses, including sales of mobile games, sales of
games licenses, online games subscription services, advertising on games sites and social network sites, and microtransactions from online and social games.
We allocate to our reportable segments certain corporate expenses which are directly attributable to supporting the businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. Also reported in our corporate segment are restructuring, lease exit and related charges, as well as stock compensation charges.
RealNetworks reports the three reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker (CODM) reviews results. The CODM reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1. Description of Business and Summary of Significant Accounting Policies.
Segment results for the years ended December 31, 2017, 2016 and 2015 were as follows (in thousands):
Consumer Media
Mobile Services
Games
Corporate
Our customers consist primarily of consumers and corporations located in the U.S., Europe and various foreign countries (Rest of the World). Revenue by geographic region (in thousands):
Long-lived assets (consists of equipment, software, leasehold improvements, other intangible assets, and goodwill) by geographic region (in thousands):
See Note 4. Napster Joint Venture and Note 5. Fair Value Measurements for details on transactions involving Napster.
The following table summarizes the unaudited statement of operations for each quarter of 2017 and 2016 (in thousands, except per share data):
(1)
The sum of the quarterly net income per share amounts will not necessarily equal net income per share for the year due to the use of weighted average quarterly shares and the effects of rounding.
(2)
Included in third quarter 2016 net income was a $4.0 million pretax gain related to the 2015 sale of Slingo, described in Note 3. Acquisitions and Disposals, and a $2.0 million pretax gain related to the sale of an intangible asset, described in Note 7. Other Intangible Assets.
(3)
Included in fourth quarter 2017 net income was a $4.5 million pretax gain related to the 2015 sale of Slingo, described in Note 3. Acquisitions and Disposals.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
RealNetworks, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of RealNetworks, Inc. and subsidiaries (the Company) as of December 31, 2017 and 2016, the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 27, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company's auditor since 1994
Seattle, Washington
February 27, 2018
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Shareholders and Board of Directors
RealNetworks, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited RealNetworks, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively, the consolidated financial statements), and our report dated February 27, 2018 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Seattle, Washington
February 27, 2018
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of the principal executive officer and principal financial officer, has evaluated the effectiveness of our “disclosure controls and procedures” (as such term is defined under Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act)). Based on their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that we file or submit under the Exchange Act (1) is recorded, processed, summarized, and reported within the time period specified in the Securities and Exchange Commission rules and forms and (2) is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation, our management concluded that, as of December 31, 2017, RealNetworks maintained effective internal control over financial reporting.
KPMG LLP, an independent registered public accounting firm, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2017. This attestation is included within Item 8.
Changes in Internal Control over Financial Reporting
Our management, with the participation of the principal executive officer and principal financial officer, has evaluated the changes to our internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2017 as required by paragraph (d) of Rules 13a-15 and 15d-15 of the Exchange Act and has concluded that there were no such changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information
Not applicable.
PART III.
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this item is incorporated by reference to the information contained in part in the sections captioned “Proposal 1-Election of Directors,” “Board of Directors,” and “Voting Securities and Principal Holders” of the Proxy Statement relating to RealNetworks’ 2018 Annual Meeting of Shareholders or in an amendment to this 10-K, to be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2017.
The information required by this Item is incorporated by reference to the information contained in the section captioned “Executive Compensation” of the Proxy Statement relating to RealNetworks’ 2018 Annual Meeting of Shareholders or in an amendment to this 10-K, to be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2017.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by this item is incorporated by reference to the information contained in the section captioned “Voting Securities and Principal Holders” of the Proxy Statement relating to RealNetworks’ 2018 Annual Meeting of Shareholders or in an amendment to this 10-K, to be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2017.
Equity Compensation Plans
As of December 31, 2017, we had awards outstanding under four equity compensation plans. These plans, which have all been approved by our shareholders, include the RealNetworks, Inc. 1995 Stock Option Plan (1995 Plan), the RealNetworks, Inc. 1996 Stock Option Plan, as amended and restated (1996 Plan), the RealNetworks, Inc. 2005 Stock Incentive Plan, as amended and restated (2005 Plan), and the RealNetworks, Inc. 2002 Director Stock Option Plan (2002 Plan). In addition, we maintain the RealNetworks, Inc. 2007 Employee Stock Purchase Plan, as amended and restated October 2010 (2007 ESPP).
In 2005, our shareholders approved the 2005 Plan and upon this approval of the 2005 Plan, we terminated the 1995 Plan, the 1996 Plan, and the 2002 Plan. In 2007, our shareholders approved an amended and restated 2005 Plan, and upon this approval, we terminated the RealNetworks, Inc. Director Compensation Stock Plan. As a result of the termination of these Plans, all new equity awards will be issued under the 2005 Plan. In 2007, our shareholders also approved the 2007 ESPP.
The following table aggregates the data from our plans (in thousands):
(1)
On January 1, 2008, the 2007 ESPP became effective. Column (c) above excludes an aggregate of 0.3 million shares of the Company’s common stock that are authorized for issuance pursuant to the 2007 ESPP.
(2)
Includes shares available for future issuances pursuant to the RealNetworks, Inc. 2007 Director Compensation Stock Plan (2007 Director Plan), a sub-plan that operates and is administered under the 2005 Plan. Under the 2007 Director Plan, outside directors may elect to receive all or a portion of his or her quarterly director compensation in shares of the Company’s common stock in lieu of cash. Shares issued to directors under the 2007 Director Plan are issued from the shares reserved under the 2005 Plan.
(3)
The total securities in column (a) include 6,076 stock options and 192 restricted stock units and awards. The weighted average exercise prices in columns (b) relate to the stock options only; restricted stock units and awards have no exercise price.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
The information required by this item is incorporated by reference to the information contained in the section captioned “Executive Compensation-Policies and Procedures with Respect to Related Person Transactions” and “Election of Directors-Director Independence” of the Proxy Statement relating to RealNetworks’ 2018 Annual Meeting of Shareholders or in an amendment to this 10-K, to be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2017.
Item 14.
Item 14.
Principal Accountant Fees and Services
The information required by this item is incorporated by reference to the information contained in the section captioned “Proposal 2-Ratification of Appointment of Independent Registered Public Accounting Firm” of the Proxy Statement relating to RealNetworks’ 2018 Annual Meeting of Shareholders or in an amendment to this 10-K, to be filed with the Securities and Exchange Commission within 120 days after the fiscal year ended December 31, 2017.
PART IV.
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)(1) Index to Consolidated Financial Statements
The following consolidated financial statements of RealNetworks, Inc. and subsidiaries are filed as part of this report:
Consolidated Balance Sheets - December 31, 2017 and 2016
Consolidated Statements of Operations and Comprehensive Income (Loss) - Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Cash Flows - Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Shareholders’ Equity - Years Ended December 31, 2017, 2016, and 2015
Notes to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
(a)(2) Financial Statement Schedules
All financial statement schedules have been omitted since they are either not required, not applicable, or because the information required is included in the consolidated financial statements or the notes thereto.
(a)(3) Index to Exhibits
See Index to Exhibits below.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on February 27, 2018.
REALNETWORKS, INC.
BY:
/s/ ROBERT GLASER
Robert Glaser
Chairman of the Board and Chief Executive Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby constitutes and appoints Robert Glaser and Michael Parham, and each of them severally, his or her true and lawful attorneys-in-fact and agents, with full power to act without the other and with full power of substitution and resubstitution, to execute in his or her name and on his or her behalf, individually and in each capacity stated below, any and all amendments and supplements to this Report, and any and all other instruments necessary or incidental in connection herewith, and to file the same with the Commission.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated below on February 27, 2018.
Exhibit Index