Realnetworks 10Q 2020 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


			FORM 10-Q


ý			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2020


¨			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-37745

RealNetworks, Inc.

(Exact name of registrant as specified in its charter)

Washington

91-1628146

(State of incorporation)

(I.R.S. Employer

Identification Number)

1501 First Avenue South, Suite 600

Seattle, Washington

98134

(Address of principal executive offices)

(Zip Code)

(206) 674-2700

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, Par Value $0.001 per share

RNWK

The NASDAQ Stock Market

Preferred Share Purchase Rights

RNWK

The NASDAQ Stock Market

The number of shares of the registrant’s Common Stock outstanding as of May 4, 2020 was 38,235,224.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1.Financial Statements

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)


	March 31, 2020		December 31, 2019
ASSETS
Current assets:
Cash and cash equivalents	$	19,046	$	16,805

Trade accounts receivable, net of allowances of $650 and $597	26,991		29,507
Deferred costs, current portion	865		823

Prepaid expenses and other current assets	8,873		7,445
Total current assets	55,775		54,580
Equipment, software, and leasehold improvements, at cost:
Equipment and software	30,419		32,167
Leasehold improvements	2,903		3,311
Total equipment, software, and leasehold improvements, at cost	33,322		35,478
Less accumulated depreciation and amortization	30,801		32,657
Net equipment, software, and leasehold improvements	2,521		2,821
Operating lease assets	10,961		11,592
Restricted cash equivalents	5,374		5,374


Other assets	1,150		1,891
Deferred costs, non-current portion	1,156		1,021
Deferred tax assets, net	752		761
Other intangible assets, net of accumulated amortization of $66,431 and $67,863	18,016		19,286
Goodwill	62,202		62,428
Total assets	$	157,907	$	159,754

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,996	$	4,927
Accrued royalties, fulfillment and other current liabilities	77,127		77,303

Deferred revenue, current portion	6,437		6,620
Notes payable	4,797		7,331
Total current liabilities	93,357		96,181
Deferred revenue, non-current portion	287		96
Deferred tax liabilities, net	1,116		1,172
Long-term lease liabilities	7,770		8,466
Long-term debt	3,900		3,900
Other long-term liabilities	8,420		11,666
Total liabilities	114,850		121,481
Commitments and contingencies
Shareholders’ equity:
Preferred stock, $0.001 par value:
Series A: authorized 200 shares	—		—
Series B: authorized 8,100 shares; issued and outstanding 8,065 shares in 2020 and 0 shares in 2019	8		—
Undesignated series: authorized 51,700 shares	—		—
Common stock, $0.001 par value authorized 250,000 shares; issued and outstanding 38,231 shares in 2020 and 38,227 shares in 2019	38		38
Additional paid-in capital	654,442		644,070
Accumulated other comprehensive loss	(62,230)		(61,323)
Retained deficit	(548,652)		(544,010)
Total shareholders’ equity	43,606		38,775
Noncontrolling interests	(549)		(502)
Total equity	43,057		38,273
Total liabilities and equity	$	157,907	$	159,754

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data)


	Quarter Ended March 31,
	2020		2019
Net revenue	$	43,145	$	39,472
Cost of revenue	24,176		24,870
Gross profit	18,969		14,602
Operating expenses:
Research and development	8,618		8,833
Sales and marketing	8,117		8,142
General and administrative	7,113		8,364
Restructuring and other charges	209		167
Total operating expenses	24,057		25,506
Operating loss	(5,088)		(10,904)
Other income (expenses):
Interest expense	(262)		(166)
Interest income	5		77
Gain (loss) on equity investment, net	—		12,338
Other income (expenses), net	795		127
Total other income (expenses), net	538		12,376
Income (loss) before income taxes	(4,550)		1,472
Income tax expense	139		258
Net income (loss) including noncontrolling interests	(4,689)		1,214
Net income (loss) attributable to noncontrolling interests	(47)		(319)
Net income (loss) attributable to RealNetworks	$	(4,642)	$	1,533

Net income (loss) per share attributable to RealNetworks- Basic	$	(0.12)	$	0.04
Net income (loss) per share attributable to RealNetworks- Diluted	$	(0.12)	$	0.04
Shares used to compute basic net income (loss) per share	38,229		37,820
Shares used to compute diluted net income (loss) per share	38,229		37,912

Comprehensive income (loss):

Foreign currency translation adjustments, net of reclassification adjustments	$	(907)	$	(87)
Total other comprehensive income (loss)	(907)		(87)
Net income (loss) including noncontrolling interests	(4,689)		1,214
Comprehensive income (loss) including noncontrolling interests	(5,596)		1,127
Comprehensive income (loss) attributable to noncontrolling interests	(47)		(319)
Comprehensive income (loss) attributable to RealNetworks	$	(5,549)	$	1,446

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


	Three Months Ended March 31,
	2020		2019
Cash flows from operating activities:
Net income (loss) including noncontrolling interests	$	(4,689)	$	1,214
Adjustments to reconcile net income (loss) including noncontrolling interests to net cash used in operating activities:
Depreciation and amortization	1,436		1,482
Stock-based compensation	380		1,384







(Gain) loss on equity investment, net	—		(12,338)
Foreign currency (gain) loss	(767)		(151)

Fair value adjustments to contingent consideration liability	(300)		—




Net change in certain operating assets and liabilities:
Trade accounts receivable	2,256		(143)
Prepaid expenses, operating lease and other assets	(535)		(1,063)
Accounts payable	149		(259)
Accrued, lease and other liabilities	(2,554)		555
Net cash used in operating activities	(4,624)		(9,319)
Cash flows from investing activities:
Purchases of equipment, software, and leasehold improvements	(94)		(482)



Proceeds from sales and maturities of short-term investments	—		24

Acquisition, net of cash acquired	—		12,260




Net cash (used in) provided by investing activities	(94)		11,802
Cash flows from financing activities:
Proceeds from issuance of preferred stock	10,000		—
Tax payments from shares withheld upon vesting of restricted stock	—		(271)
Proceeds from notes payable and revolving credit facility	8,768		9,733
Repayments of notes payable and revolving credit facility	(11,172)		(8,437)


Other financing activities	—		450

Net cash provided by financing activities	7,596		1,475
Effect of exchange rate changes on cash, cash equivalents and restricted cash	(637)		(207)
Net increase in cash, cash equivalents and restricted cash	2,241		3,751
Cash, cash equivalents and restricted cash, beginning of period	22,179		37,191
Cash, cash equivalents, and restricted cash end of period	$	24,420	$	40,942

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(In thousands)


	Common Stock					Additional Paid-In Capital		Accumulated Other Comprehensive Income (Loss)		Retained Earnings (Deficit)		Total Shareholders’ Equity		Non-controlling Interests		Total Equity
		Shares		Amount

Balances, January 1, 2019	37,728	$	37	$	641,930	$	(61,118)	$	(524,009)	$	56,840	$	—	$	56,840

Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock	190	—		(271)		—		—		(271)		—		(271)
Napster acquisition	—	—		(1,346)		—		—		(1,346)		570		(776)
Stock-based compensation	—	—		1,384		—		—		1,384		—		1,384

Foreign currency translation adjustments	—	—		—		(87)		—		(87)		—		(87)
Net income (loss)	—	—		—		—		1,533		1,533		(319)		1,214
Other equity transactions	—	—		362		—		—		362		88		450
Balances, March 31, 2019	37,918	$	37	$	642,059	$	(61,205)	$	(522,476)	$	58,415	$	339	$	58,754


	Preferred Stock				Common Stock						Additional Paid-In Capital		Accumulated Other Comprehensive Income (Loss)		Retained Earnings (Deficit)		Total Shareholders’ Equity		Non-controlling Interests	Total Equity
		Shares		Amount	Shares		Amount

Balances, January 1, 2020	—	$	—	38,227	$	38	$	644,070	$	(61,323)	$	(544,010)	$	38,775	$	(502)	$	38,273
Common stock issued for exercise of stock options, employee stock purchase plan, and vesting of restricted shares, net of tax payments from shares withheld upon vesting of restricted stock	—	—		4	—		—		—		—		—		—		—

Stock-based compensation	—	—		—	—		380		—		—		380		—		380

Foreign currency translation adjustments	—	—		—	—		—		(907)		—		(907)		—		(907)

Net income (loss)	—	—		—	—		—		—		(4,642)		(4,642)		(47)		(4,689)
Issuance of Preferred B Stock	8,065	8		—	—		9,992		—		—		10,000		—		10,000
Balances, March 31, 2020	8,065	$	8	38,231	$	38	$	654,442	$	(62,230)	$	(548,652)	$	43,606	$	(549)	$	43,057

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Quarters Ended March 31, 2020 and 2019


Note 1			Description of Business and Summary of Significant Accounting Policies

Description of Business. RealNetworks provides digital media software and services to consumers, mobile carriers, device manufacturers, system integrators, and other businesses. Consumers use our digital media products and services to store, organize, play, manage and enjoy their digital media content, either directly from us or through our distribution partners. As of January 18, 2019, we hold an 84% interest in the Napster music business, which offers a comprehensive set of digital music products and services designed to provide consumers with broad access to digital music.

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 and cash flow.

In this Quarterly Report on Form 10-Q (10-Q or Report), RealNetworks, Inc., together with its subsidiaries, is referred to as "RealNetworks," the "Company," "we," "us," or "our." "RealPlayer," "RMHD," "RealMedia," "GameHouse," "Kontxt," "SAFR" and other trademarks of ours appearing in this report are our property.

Basis of Presentation. The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries in which it has a more than 50% voting interest. Noncontrolling interests primarily represent third-party ownership in the equity of Napster and are reflected separately in the Company's financial statements. Intercompany balances and transactions have been eliminated in consolidation.

The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. Operating results for the quarter ended March 31, 2020 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2020. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).

Liquidity and Capital Resources. Our unrestricted cash and cash equivalents balance at March 31, 2020 was $19.0 million and our operating loss for the quarter ended March 31, 2020 was $5.1 million. We have evaluated our current liquidity position in light of our history of declining revenue and operating losses as well as our near-term expectations of net negative cash flows from operating activities. While we currently believe existing unrestricted cash balances along with current availability on our revolving line of credit will be sufficient to allow us to meet our obligations for the next 12 months, our assessment is subject to inherent risks and uncertainties. Moreover, our operating forecast is partly dependent on factors that are outside of our control. Compounding these risks, uncertainties, and other factors are the potential effects of the recent coronavirus pandemic and related impacts on global commerce and financial markets. These conditions, when evaluated within the guidance of ASC 205-40, raise substantial doubt about our ability to meet our obligations over the 12 months from the date of this filing and, therefore, to continue as a going concern. Our financial statements do not include any adjustment relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

We have active plans to mitigate these conditions. Specifically, we plan to reduce negative cash flow through operating expense reductions, as well as through the deferral of certain obligations where we believe that we have the legal basis to do so. In addition, we are evaluating various strategic opportunities, which may include selling certain businesses or product lines, soliciting external investment into certain of our businesses, or seeking other strategic partnerships. Our plans are subject to inherent risks and uncertainties, which become significantly magnified when the effects of the current pandemic and related financial crisis are included in the assessment. Accordingly, there can be no assurance that our plans can be effectively implemented and, therefore, that the conditions can be effectively mitigated.

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2019 (the 10-K).

Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.


Note 2			Recent Accounting Pronouncements

Recently issued accounting pronouncements not yet adopted

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 in fiscal years beginning after December 15, 2022, with early adoption permitted. We do not currently expect the adoption to have a material impact on our consolidated financial statements and related disclosures.

In June 2016, the FASB issued new guidance amending existing guidance for the accounting of credit losses on financial instruments. Under the new guidance, the valuation allowance for credit losses is expected to be incurred over the financial asset’s contractual term. We reviewed the new credit loss standard and determined that it applies to our accounts receivable, which are typically of short duration and for which we have not historically experienced significant credit losses. This guidance is effective for us in fiscal years beginning after December 15, 2022 with a cumulative effect of adoption recorded as an adjustment to retained earnings. We are in the process of evaluating the effect that this new guidance will have on our consolidated financial statements and related disclosures.


Note 3			Revenue Recognition

We generate all of our revenue through contracts with customers. Revenue is either recognized over time as the service is provided, or at a point in time when the product is transferred to the customer, depending on the contract type. Our performance obligations typically have an original duration of one year or less.

Disaggregation of Revenue

The following table presents our disaggregated revenue by source and segment (in thousands):


	Quarter Ended March 31, 2020
	Consumer Media		Mobile Services		Games		Napster
Business Line
Software License	$	2,020	$	831	$	—	$	—
Subscription Services	929		5,859		2,770		26,323
Product Sales	222		—		2,978		—
Advertising and Other	324		—		889		—
Total	$	3,495	$	6,690	$	6,637	$	26,323

	Quarter Ended March 31, 2019
	Consumer Media		Mobile Services		Games		Napster
Business Line
Software License	$	735	$	599	$	—	$	—
Subscription Services	1,088		6,340		2,985		24,337
Product Sales	219		—		1,988		—
Advertising and Other	444		—		737		—
Total	$	2,486	$	6,939	$	5,710	$	24,337

The following table presents our disaggregated revenue by sales channel (in thousands):


	Quarter Ended March 31, 2020
	Consumer Media		Mobile Services		Games		Napster
Sales Channel
Business to Business	$	2,343	$	6,584	$	1,095	$	12,851
Direct to Consumer	1,152		106		5,542		13,472
Total	$	3,495	$	6,690	$	6,637	$	26,323

	Quarter Ended March 31, 2019
	Consumer Media		Mobile Services		Games		Napster
Sales Channel
Business to Business	$	1,178	$	6,817	$	1,036	$	12,095
Direct to Consumer	1,308		122		4,674		12,242
Total	$	2,486	$	6,939	$	5,710	$	24,337

Contract Balances

The timing of revenue recognition may differ from the timing of invoicing to our customers. We record accounts receivable when the right to consideration becomes unconditional, except for the passage of time. For certain contracts, payment schedules may exceed one year; for those contracts we recognize a long-term receivable. As of March 31, 2020 and December 31, 2019, our balance of long-term accounts receivable was $0.5 million and $0.3 million, respectively, and is included in other long-term assets on our condensed consolidated balance sheets. The increase in this balance from December 31, 2019 to March 31, 2020 is primarily due to a contract renewal in the first quarter of 2020. During the quarter ended March 31, 2020, we recorded no impairments to our contract assets.

We record deferred revenue when cash payments are received in advance of our completion of the underlying performance obligation. As of March 31, 2020 and December 31, 2019, we had a deferred revenue balance of $6.7 million, primarily due to deferred revenue associated with monthly subscriptions.

Practical Expedients

For those contracts for which we recognize revenue at the amount to which we have the right to invoice for service performed, we do not disclose the value of any unsatisfied performance obligations. We also do not disclose the remaining unsatisfied performance obligations which have an original duration of one year or less. Additionally, we immediately expense sales commissions when incurred as the amortization period would have been less than one year. These costs are recorded within sales and marketing expense.


Note 4			Stock-Based Compensation

Total stock-based compensation expense recognized in our unaudited condensed consolidated statements of operations and comprehensive income (loss) includes amounts related to stock options, restricted stock, and employee stock purchase plans and was as follows (in thousands):


	Quarter Ended March 31,
	2020		2019
Total stock-based compensation expense	$	380	$	1,384

The fair value of RealNetworks options granted determined using the Black-Scholes model used the following weighted-average assumptions:


	Quarter Ended March 31,
	2020		2019
Expected dividend yield	0	%	0	%
Risk-free interest rate	0.90	%	2.51	%
Expected life (years)	4.0		3.8
Volatility	45	%	41	%

The total stock-based compensation amounts for 2020 and 2019 disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). Included in the expense for the three months ended March 31, 2019 was stock compensation expense recorded in the first quarter of 2019 related to our 2018 incentive bonuses paid in fully vested restricted stock units, which were authorized and granted in the first quarter of 2019. Our 2019 incentive bonuses were paid fully in cash, reducing stock compensation expense in the three months ended March 31, 2020 when compared to the three months ended March 31, 2019.

As of March 31, 2020, $1.9 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 2.8 years.


Note 5			Acquisitions

Napster

On January 18, 2019, RealNetworks acquired an additional 42% interest in Rhapsody International, Inc. (doing business as Napster) which brought our aggregate ownership to 84% of Napster's outstanding equity, thus giving RealNetworks a majority voting interest.

Napster continues to operate as an independent business with its own board of directors, strategy and leadership team.For fiscal periods following the closing of the acquisition, we consolidate Napster's financial results into our financial statements, where Napster is reported as a separate segment. Napster, however, remains a distinct legal entity and RealNetworks assumes no ownership or control over the assets or liabilities of Napster.

The 16% of Napster that we do not own is accounted for as a noncontrolling interest in our consolidated financial statements. As part of the transaction, we recorded a gain of $12.3 million recognized in Other income (expenses) in the Consolidated statement of operations in the first quarter of 2019.

The terms of the transaction included initial cash consideration of $1.0 million and additional contingent consideration. Initial cash consideration of $0.2 million was paid at closing and the remainder of the initial cash consideration is included in accrued royalties, fulfillment and other current liabilities and will be paid with existing cash balances. With regards to contingent consideration, over the five years following the acquisition, RealNetworks will pay the lesser of the following:

(a) an additional $14.0 million to seller, or

(b) if RealNetworks sells the interest to a third party for less than $15.0 million, the actual amount received by RealNetworks, minus the $1.0 million initial payment.

In the event that RealNetworks sells such equity interest for consideration in excess of $15.0 million, RealNetworks will pay seller additional consideration, dependent on the sale price, which shall in no event exceed an additional $25.0 million. In order for seller to receive the full $40.0 million, the proceeds from the sale of Napster received by RealNetworks for the 42% equity interest acquired would have to exceed $60.0 million. These contingent consideration amounts were part of the total consideration at estimated fair value.

The fair value of the contingent consideration was estimated using multiple scenarios for each tranche of contingent consideration and then probability weighting each scenario and discounting them to an estimated fair value of $11.6 million at the time of acquisition. The contingent consideration is adjusted quarterly to fair value through earnings. See Note 6 Fair Value Measurements for details on the adjustment to this liability.

We recorded intangible assets of $23.7 million, consisting of trade name and trademarks, developed technology, customer relationships, and partner relationships.

We recorded goodwill of $45.5 million, representing the intangible assets that do not qualify for separate recognition for accounting purposes, including the expected growth in Napster's business to business model and the assembled workforce. Future performance of the Napster business will factor into our intangibles and goodwill impairment analysis.


Note 6			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 March 31, 2020 and December 31, 2019, and indicates the fair value hierarchy of the valuation inputs utilized to determine fair value (in thousands):


	Fair Value Measurements as of										Amortized Cost as of
	March 31, 2020										March 31, 2020
	Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents:
Cash	$	18,460	$	—	$	—	$	18,460	$	18,460
Money market funds	586		—		—		586		586


Total cash and cash equivalents	19,046		—		—		19,046		19,046




Restricted cash equivalents	3,500		1,874		—		5,374		5,374

Total assets	$	22,546	$	1,874	$	—	$	24,420	$	24,420
Liabilities:
Accrued royalties, fulfillment and other current liabilities
Napster acquisition contingent consideration	$	—	$	—	$	5,396	$	5,396	N/A
Other long-term liabilities
Napster acquisition contingent consideration	—		—		6,904		6,904		N/A
Total liabilities	$	—	$	—	$	12,300	$	12,300	N/A


	Fair Value Measurements as of										Amortized Cost as of
	December 31, 2019										December 31, 2019
	Level 1		Level 2		Level 3		Total
Assets:
Cash and cash equivalents:
Cash	$	14,887	$	—	$	—	$	14,887	$	14,887
Money market funds	1,918		—		—		1,918		1,918


Total cash and cash equivalents	16,805		—		—		16,805		16,805




Restricted cash equivalents	3,500		1,874		—		5,374		5,374


Total assets	$	20,305	$	1,874	$	—	$	22,179	$	22,179
Liabilities:
Accrued royalties, fulfillment and other current liabilities
Napster acquisition contingent consideration	$	—	$	—	$	2,800	$	2,800	N/A
Other long-term liabilities
Napster acquisition contingent consideration	—		—		9,800		9,800		N/A
Total liabilities	$	—	$	—	$	12,600	$	12,600	N/A

Restricted cash equivalents as of March 31, 2020 and December 31, 2019 relate to cash pledged as collateral against letters of credit in connection with lease agreements and our Loan and Security Agreement ("Loan Agreement") requires us to maintain a minimum balance of $3.5 million unrestricted cash at the bank. See Note 8 Notes Payable and Long-term debt for additional details.

Accrued royalties, fulfillment and other current liabilities and Other long-term liabilities as of March 31, 2020 include the estimated fair value of the contingent consideration for the Napster acquisition, which was determined using a fair value measurement categorized within Level 3 of the fair value hierarchy. As discussed in Note 5 Acquisitions, this liability is adjusted quarterly to fair value through earnings. During the quarter ended March 31, 2020, we recorded the change in fair value of the contingent consideration of $0.3 million, as a decrease to the total liability on the consolidated balance sheet and as a reduction of general and administrative expense on the consolidated statement of operations.

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). During the three months ended March 31, 2020 and 2019, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.


Note 7			Accrued royalties, fulfillment and other current liabilities

Accrued royalties, fulfillment and other current liabilities (in thousands):


	March 31, 2020		December 31, 2019
Royalties and other fulfillment costs	$	54,415	$	55,750
Employee compensation, commissions and benefits	5,777		6,858

Sales, VAT and other taxes payable	2,319		2,547
Operating lease liabilities - current	4,788		4,805
Other	9,828		7,343
Total accrued royalties, fulfillment and other current liabilities	$	77,127	$	77,303

Included in royalties and other fulfillment costs are Napster's accrued music royalties totaling $52.9 million and $54.2 million at March 31, 2020 and December 31, 2019, respectively. Napster’s agreements and arrangements with rights holders for the content used in its business are complex and the determination of royalty accruals involves significant judgments, assumptions, and estimates of the amounts to be paid.

The variables involved in determining royalty accruals include unmatched royalty accruals, revenue to be recognized, the type of content used and the country it is used in, outstanding royalty audits, and identification of appropriate license holders, among other variables. In addition, some rights holders have allowed the use of their content while negotiations of the terms and conditions are ongoing. In certain jurisdictions, rights holders have several years to claim royalties for musical composition.

While Napster bases its estimates on historical experience and on various assumptions that management believes to be reasonable under the circumstances, actual results may differ materially from these estimates in the event of modified assumptions or conditions.

Related to Napster's accrued music royalties are amounts that are advanced to certain music publishers for royalty amounts that have been agreed as being owed, but for which the underlying rights holder have not yet been specifically matched. These prepaid royalty amounts totaling $2.2 million and $2.0 million at March 31, 2020 and December 31, 2019, respectively, are included in Prepaid expenses and other current assets on the unaudited condensed consolidated balance sheets. When these amounts are ultimately matched and invoiced to Napster, the prepaid royalty amount and the related accrued royalty liability are offset on the unaudited condensed consolidated balance sheets.


Note 8			Notes Payable and Long-term debt

In August 2019, RealNetworks and Napster entered into a Loan and Security Agreement (Loan Agreement) with a third-party financial institution. Under the terms of the Loan Agreement, the bank extended a revolving line of credit not to exceed $10.0 million in the aggregate. Available advances on the revolving line of credit, which will be used for working capital and general corporate purposes, are based on a borrowing base that comprises accounts receivable and direct to consumer deposits. Borrowings under the Loan Agreement are secured by a first priority security interest in the assets of RealNetworks and Napster. Advances bear interest at a rate equal to one-half of one percentage point (0.5%) above the greater of the prime rate or 5.5%, with monthly payments of interest only and principal due at the end of the two-year term. The Loan Agreement contains customary covenants, including financial covenants, minimum EBITDA levels to be updated annually, and maintaining a minimum balance of $3.5 million unrestricted cash at the bank.

As of March 31, 2020, RealNetworks had $3.9 million outstanding debt from the revolving line of credit, which was loaned to Napster bearing interest and fees commensurate with our costs. See Note 13 Related Party Transactions for additional details.

We paid and capitalized $0.6 million of financing fees to enter into the revolving line of credit, and the financing fees will be amortized over the term of the debt. The current and non-current unamortized fees were $0.3 million and $0.1 million at March 31, 2020 and are included in Deferred costs, current and non-current on our condensed consolidated balance sheets.

In 2017, Napster entered into a Non-Recourse Purchase of Eligible Receivables Agreement (NRP Agreement) with an international bank (Purchaser) in which Napster will sell and assign on a continuing basis its eligible receivables to the Purchaser in return for 90% of the receivables upfront, up to a maximum amount of $15.0 million in advances. The interest rate is 2.25% above the 1-month-EURIBOR with a minimum 0.0% rate applying to the 1-month-EURIBOR rate. As of March 31, 2020, Napster had $4.8 million borrowings outstanding with an interest rate of 2.25%.


Note 9			Restructuring Charges

Restructuring and other charges in 2020 and 2019 consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts, which primarily relate to severance costs due to workforce reductions. Included in employee separation costs was restructuring expense of $0.1 million related to and reported in the Napster segment.

Restructuring charges are as follows (in thousands):


	Employee Separation and Other Costs
Costs incurred and charged to expense for the three months ended March 31, 2020	$	209
Costs incurred and charged to expense for the three months ended March 31, 2019	$	167

Changes to the accrued restructuring liability (which is included in Accrued royalties, fulfillment and other current liabilities) for 2020 are as follows (in thousands):


	Employee Separation Costs		Asset Related and Other Costs		Total
Accrued liability at December 31, 2019	$	322	$	174	$	496
Costs incurred and charged to expense for the three months ended March 31, 2020, excluding noncash charges	239		—		239
Cash payments	(341)		(174)		(515)
Accrued liability at March 31, 2020	$	220	$	—	$	220


Note 10			Income (Loss) Per Share

Basic net income (loss) per share (EPS) is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) attributable to RealNetworks by the weighted average number of common and dilutive potential common shares outstanding during the period. Basic and diluted EPS (in thousands, except per share amounts):


	Quarter Ended March 31,
	2020		2019
Net income (loss) attributable to RealNetworks	$	(4,642)	$	1,533

Weighted average common shares outstanding used to compute basic EPS	38,229		37,820
Dilutive effect of stock based awards	—		92
Weighted average common shares outstanding used to compute diluted EPS	38,229		37,912

Basic EPS attributable to RealNetworks	$	(0.12)	$	0.04
Diluted EPS attributable to RealNetworks	$	(0.12)	$	0.04

During the quarters ended March 31, 2020 and 2019, 7.9 million and 6.8 million shares of common stock, respectively, of potentially issuable shares from common stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect. In February 2020, Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of 8,064,516 shares of Series B Preferred Stock. The Series B Preferred Stock is convertible into common stock on a one-to-one basis subject to the limitation described in Note 13 Related Party Transactions. During the quarter ended March 31, 2020, these shares were also excluded from the calculation of diluted EPS because of their antidilutive effect.


Note 11			Commitments and Contingencies

We have been in the past and could become in the future 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 March 2016, Napster was notified of a putative consumer class action lawsuit relating to an alleged failure to pay so-called “mechanical royalties” on behalf of the plaintiffs and “other similarly-situated holders of mechanical rights in copyrighted musical works.” On April 7, 2017, the plaintiffs and Napster agreed to settlement terms during a mediation session. The long form Settlement Agreement was executed effective on January 16, 2019. The damages payable under the Settlement Agreement will be calculated on a claims-made basis. In May 2019, public notice was posted about the settlement informing purported class members that they could make claims or object to the settlement, and the claims period ended on December 31, 2019. The final calculation is not yet complete, but based on preliminary results, the claimed damages are not expected to be material. Valid claims are currently expected to be paid by Napster in the third quarter of 2020.


Note 12			Segment Information

We manage our business and report revenue and operating income (loss) in 4 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; (3) Games, which includes all our games-related businesses, including sales of in-game virtual goods, mobile games, games licenses, games subscription services, and in-game advertising and advertising on game sites; and (4) Napster, which includes on-demand music streaming and music services.

RealNetworks allocates to its Consumer Media, Mobile Services and Games reportable segments certain corporate expenses which are directly attributable to supporting these 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 these businesses, are reported as corporate items. These corporate items may also include restructuring charges and stock compensation charges. As stated in Note 5 Acquisitions, Napster operates as an independent company and, therefore, RealNetworks allocates no corporate expenses to the Napster segment.

RealNetworks reports four reportable segments based on factors such as how we manage our operations and how the 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, in the 10-K.

Segment results for the quarters ended March 31, 2020 and 2019 (in thousands):


Consumer Media	Quarter Ended March 31,

	2020		2019
Revenue	$	3,495	$	2,486
Cost of revenue	611		833
Gross profit	2,884		1,653
Operating expenses	2,458		3,119
Operating income (loss)	$	426	$	(1,466)


Mobile Services	Quarter Ended March 31,

	2020		2019
Revenue	$	6,690	$	6,939
Cost of revenue	1,696		2,048
Gross profit	4,994		4,891
Operating expenses	7,588		7,561
Operating income (loss)	$	(2,594)	$	(2,670)


Games	Quarter Ended March 31,

	2020		2019
Revenue	$	6,637	$	5,710
Cost of revenue	1,794		1,670
Gross profit	4,843		4,040
Operating expenses	4,923		5,037
Operating income (loss)	$	(80)	$	(997)


Napster	Quarter Ended March 31,

	2020		2019
Revenue	$	26,323	$	24,337
Cost of revenue	20,072		20,396
Gross profit	6,251		3,941
Operating expenses	6,461		5,532
Operating income (loss)	$	(210)	$	(1,591)


Corporate	Quarter Ended March 31,
	2020		2019
Cost of revenue	$	3	$	(77)
Operating expenses	2,627		4,257
Operating income (loss)	$	(2,630)	$	(4,180)

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):


	Quarter Ended March 31,
	2020		2019
United States	$	22,420	$	18,970
Europe	14,838		15,384

Rest of the World	5,887		5,118
Total net revenue	$	43,145	$	39,472

Long-lived assets (consisting of goodwill, equipment, software, leasehold improvements, operating lease assets, and other intangible assets) by geographic region (in thousands) are as follows:


	March 31, 2020		December 31, 2019
United States	$	81,524	$	83,342
Europe	10,220		10,504

Rest of the World	1,956		2,281
Total long-lived assets	$	93,700	$	96,127


Note 13			Related Party Transactions

As described in Note 5 Acquisitions, on January 18, 2019, RealNetworks acquired an additional 42% interest in Rhapsody International, Inc., (doing business as Napster), bringing our aggregate ownership interest to 84% of Napster's outstanding equity, thus giving RealNetworks a majority voting interest in Napster. Following this acquisition of a controlling interest, we consolidate Napster's financial results into our financial statements for fiscal periods beginning with our first quarter of 2019. Rhapsody America LLC was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International, Inc., to own and operate a business-to-consumer digital audio music service originally branded as Rhapsody. The service has been significantly expanded and was re-branded in 2016 as Napster.

Following certain restructuring transactions effective March 31, 2010, we began accounting for the 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, carrying a $10.0 million preference upon certain liquidation events. Although we now consolidate Napster for reporting purposes, our convertible preferred stock and the related rights remain contractually binding instruments between RealNetworks and Napster.

In December 2016, RealNetworks and the other then-owner of 42% of Napster each entered into an agreement to loan up to $5.0 million to Napster for general operating purposes, which loans were fully funded as of the end of January 2017 for an aggregate of $10.0 million. Included in RealNetworks' January 2019 acquisition of the additional 42% interest in Napster, RealNetworks assumed the seller's $5.0 million note, resulting in RealNetworks holding $10.0 million of notes receivable from Napster. The terms of the notes were modified subsequent to the original December 2016 execution, including a provision, effective July 2018, that requires repayment at the greater of (a) principal plus accrued interest at an annual rate of 15% or (b) a preference of three times the principal amount.

In May 2019, RealNetworks extended a short-term loan to Napster in the principal amount of $1.1 million. In August 2019, RealNetworks established a two-year term on this short-term loan and, as discussed in Note 8 Notes Payable and Long-term debt, loaned Napster an additional $3.9 million and charged Napster for associated fees. As a result, the principal amount on this two-year note is $5.4 million. Both the two-year note and the $10.0 million loan are subordinate to RealNetworks' and Napster's third party debt.

In each of February 2015 and February 2017, Napster issued warrants to purchase shares of its common stock to each of RealNetworks and the other then-owner of 42% of Napster. The warrants have a 10-year contractual term and were issued as compensation for past services provided by these two significant stockholders of Napster. As part of RealNetworks' January 2019 acquisition of the additional 42% interest in Napster, RealNetworks assumed the warrants held by the seller.

Upon RealNetworks' acquisition of a controlling interest in Napster, the notes and warrants were effectively settled and eliminated in our consolidated financial statements as they represent preexisting relationships between RealNetworks and Napster. However, the notes and warrants remain contractually binding instruments between RealNetworks and Napster.

In 2019, Mr. Glaser directly invested $0.8 million in one of our subsidiaries in exchange for shares of preferred stock of that entity. The subsidiary is developing a platform that transforms the experience of viewing video entertainment into a social, connected playground. As of March 31, 2020, RealNetworks owned approximately 82% of the subsidiary's outstanding equity, and we consolidate its financial results into our financial statements. The financial results of the subsidiary are reported in our Consumer Media segment.

In February 2020, we entered into a Series B Preferred Stock Purchase Agreement with Mr. Glaser, pursuant to which Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of 8,064,516 shares of Series B Preferred Stock. The Series B Preferred Stock is non-voting and is convertible into common stock on a one-to-one basis, provided, however, that no conversion is permitted in the event that such conversion would cause Mr. Glaser’s beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our Second Amended and Restated Shareholder Rights Plan dated November 30, 2018. The Series B Preferred Stock has no liquidation preference and no preferred dividend.


Note 14			Subsequent Events

The Coronavirus Aid, Relief and Economic Security (CARES) Act, signed into law in March 2020, established the Paycheck Protection Program (PPP). Through the PPP, loan amounts are forgiven to the extent proceeds are used to cover documented payroll, rent, and utility costs over an 8-week measurement period following loan funding. In April 2020, RealNetworks issued a promissory note in the principal amount of $2.9 million and in May 2020, Napster issued a promissory note in the principal amount of $1.7 million, both pursuant to the PPP. The notes have a maturity of 2 years, an interest rate of 1.0%, 0 pre-payment penalty, a six-month deferment period, and are eligible for forgiveness pursuant to program guidelines. We cannot provide assurance, however, that all or any portion of the principal and interest on these loans will be forgiven.

On April 6, 2020, RealNetworks Asia Pacific Co., Ltd. received notice of a civil lawsuit filed by Korean Music Copyright Association (KOMCA) seeking damages of $2.6 million. Also named as a defendant in the lawsuit is Kakao M Corp (formerly known as LOEN Entertainment Corp.), one of the largest media publishing companies in Korea, which operates the Melon music platform. The claim is for a late payment penalty under a music licensing contract, pursuant to which, from 2004 to 2017, RealNetworks licensed music for its services to LOEN for its Melon platform. The current lawsuit relates solely to the late payment of music licensing fees under the contract; the underlying music licensing fees were paid by Kakao M to KOMCA in a separate settlement prior to KOMCA’s filing of this lawsuit. While we believe we have meritorious defenses to this lawsuit and intend to vigorously defend RealNetworks, litigation is inherently uncertain and we cannot predict the outcome of this matter. We have not recorded an accrual related to this settlement as of March 31, 2020 as it is early in the litigation and any potential liability cannot be reasonably estimated.

On April 23, 2020, the Company received a letter from the Listing Qualifications Department of the Nasdaq Global Market (Nasdaq) indicating that, based upon the closing bid price of RealNetworks’ common stock for the 30 consecutive business day period between March 11, 2020 through April 23, 2020, we did not meet the minimum bid price of $1.00 per share required for continued listing on Nasdaq. In April 2020, in response to the unprecedented turmoil in U.S. and world financial markets, Nasdaq tolled the compliance periods for its bid price and market value of publicly held shares requirements through June 30, 2020. As a result of Nasdaq's general grant of this grace period, we have a compliance period of 180 calendar days starting July 1, 2020 and ending December 28, 2020 in which to regain compliance. In order to regain compliance with Nasdaq’s minimum bid price requirement, the Company’s common stock must maintain a minimum closing bid price of $1.00 for at least ten consecutive business days during the compliance period. In the event RealNetworks does not regain compliance by the end of the compliance period, we may be eligible for a second compliance period pursuant to Nasdaq's existing rules.

The letter has no immediate impact on the listing of the RealNetworks’ common stock, which will continue to be listed and traded on Nasdaq during the general grace period and the 180-day compliance period. RealNetworks’ Board will consider the implementation of various measures intended to support compliance, including a reverse split of our common stock in an effort to increase the trading price of the RealNetworks’ shares.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, estimates, and projections about RealNetworks’ industry, products, management’s beliefs, and certain assumptions made by management. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. All statements contained in this report that do not relate to matters of historical fact should be considered forward-looking statements. Forward-looking statements include statements with respect to:

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

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

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

•the effects of our past acquisitions, including our January 18, 2019 acquisition of a controlling interest in Napster, and expectations for future acquisitions and divestitures;

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

•our expected financial position, including liquidity, cash usage and conservation, the availability of funding or other resources, and the potential for forgiveness of certain loans;

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

•the continuation and expected nature of certain customer relationships;

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

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

•the effects of U.S. and foreign income and other taxes on our business, prospects, financial condition or results of operations; and

•the effect of economic and market conditions, including global pandemics and financial crises, on our business, prospects, financial condition or results of operations.

These statements are not guarantees of future performance and actual actions or results may differ materially. These statements are subject to certain risks, uncertainties and assumptions that are difficult to predict, including those noted in the documents incorporated herein by reference. Particular attention should also be paid to the cautionary language in Item 1A entitled “Risk Factors.” RealNetworks undertakes no obligation to update publicly any forward-looking statements as a result of new information, future events or otherwise, unless required by law. Readers should, however, carefully review the risk factors included in other reports or documents filed by RealNetworks from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.

Overview

Our Segments

RealNetworks invented the streaming media category in 1995 and continues to build on its foundation of digital media expertise and innovation, creating a new generation of products and services to enhance and secure our daily lives. We manage our business and report revenue and operating income (loss) in four segments: (1) Consumer Media (2) Mobile Services, (3) Games, and (4) Napster.

Within our Consumer Media segment, revenue is primarily derived from the software licensing of our video compression, or codec, technology, principally our prior-generation codec RealMedia Variable Bitrate, or RMVB, but also including some early revenue from sales of our latest technology, RealMedia High Definition, or RMHD. We also generate revenue from the sale 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 subscription services, which include our intercarrier messaging service and ringback tones, as well as through software licenses for the integration of our RealTimes platform and certain system implementations. We generate a significant portion of our revenue from sales within our Mobile Services business to a few mobile carriers. Our Mobile Services segment also includes our computer vision platform, SAFR, which includes facial recognition technology that leverages artificial intelligence-based machine learning. To date, our SAFR business has not generated a significant level of revenue.

Our Games business generates revenue primarily through the development, publishing, and distribution of casual games under the GameHouse and Zylom brands. Games are offered via mobile devices, digital downloads, and subscription play. We derive revenue from player purchases of in-game virtual goods within our free-to-play games and from advertising on games sites. In addition, we derive revenue from the sale of individual games and subscription offerings.

As described in Note 5 Acquisitions, RealNetworks acquired an additional 42% interest in Napster on January 18, 2019 bringing our ownership of Napster's outstanding stock to 84%, thus having a majority voting interest. For fiscal periods following the closing of the acquisition, we consolidate Napster's financial results into our financial statements, where Napster is reported as a separate segment. In connection with the acquisition, we recorded goodwill and definite-lived intangible assets, which we assess for impairment each quarter and which would be negatively impacted if Napster's business were to continue to decline or if it were to suffer significant financial distress.

The Napster segment provides music products and services that enable consumers to access digital music content from a variety of devices. The Napster subscription service offers unlimited access to a catalog of tens of millions of music tracks by way of on-demand streaming and conditional downloads. Napster currently offers music services and generates revenue primarily through subscriptions sold directly to consumers, through distribution partners, or through various music platform services primarily under co-branded arrangements. Napster generates a significant portion of revenue from sales to a few partners.

RealNetworks allocates to its Consumer Media, Mobile Services, and Games reportable segments certain corporate expenses which are directly attributable to supporting these 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 these businesses, are reported as corporate items. These corporate items may also include restructuring charges and stock compensation expense. As stated in Note 5 Acquisitions, Napster operates as an independent company and, therefore, RealNetworks allocates no corporate expenses to the Napster segment.

COVID-19

In March 2020, the World Health Organization declared the outbreak of the novel coronavirus that causes COVID-19 to be a global pandemic. As the virus spread throughout the U.S. and the world, authorities implemented numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, business limitations, and shutdowns. In addition to the pandemic's widespread impact on public health and global society, reactions to the pandemic as well as measures taken to contain the virus have caused significant turmoil to the global economy and financial markets. Moreover, similar to other companies, we have taken steps to support the health and well-being of our employees, customers, partners and communities, which include working remotely and learning to operate our businesses in a fundamentally different way.

Even as implications of the pandemic and containment measures generally evolved throughout the first quarter of 2020, the impact on our financial results for the first quarter of 2020 was relatively minor. We have, however, had to reevaluate our operating plans, resulting in some significant pivots for our growth initiatives. Moreover, as we continue to operate our businesses as efficiently as possible, we have taken steps to more aggressively reduce costs and reallocate resources. We are unable to predict the near-term and long-term impacts that the COVID-19 pandemic will have on our results from operations, financial condition, liquidity and cash flows for the remainder of fiscal 2020 due to numerous uncertainties, including the

duration and severity of the pandemic and containment measures, but we will continue to monitor and evaluate the effects to our businesses and adjust our plans as needed.

Financial Results

As of March 31, 2020, we had $19.0 million in unrestricted cash and cash equivalents, compared to $16.8 million as of December 31, 2019. The 2020 increase in cash and cash equivalents compared to the prior year end amount was due to the $10.0 million in cash proceeds from our recent issuance of Series B Preferred Stock, partially offset by our ongoing cash flows used in operating activities, which totaled $4.6 million in the first three months of 2020, and Napster's net repayment of debt of $2.4 million under the NRP Agreement. In April 2020, RealNetworks issued a promissory note in the principal amount of $2.9 million and in May 2020, Napster issued a promissory note in the principal amount of $1.7 million, both pursuant to the PPP of the CARES Act.

Condensed consolidated results of operations were as follows (in thousands):


	Quarter Ended March 31,
	2020			2019			$ Change		% Change
Total revenue	$	43,145		$	39,472		$	3,673	9	%
Cost of revenue	24,176			24,870			(694)		(3)	%
Gross profit	18,969			14,602			4,367		30	%
Gross margin	44		%	37		%

Operating expenses	24,057			25,506			(1,449)		(6)	%
Operating loss	$	(5,088)		$	(10,904)		$	5,816	53	%

In the first quarter of 2020, our total consolidated revenue increased $3.7 million as compared with the year-earlier period. For the first quarter of 2020 compared to the prior year period, Napster segment revenues increased by $2.0 million, primarily due to the inclusion of Napster for the three months ended March 31, 2020, whereas the three months ended March 31, 2019 includes Napster from the acquisition date of January 18, 2019 through the end of the quarter. Our Consumer Media segment revenues increased by $1.0 million and our Games segment revenues increased by $0.9 million, partially offset by the revenue decline in our Mobile Services segment of $0.2 million. See below for further discussion of our segment results.

Cost of revenue decreased by $0.7 million for the quarter ended March 31, 2020 as compared with the year-earlier period, primarily due to the savings of $0.4 million in our Mobile Services segment, $0.3 million in Napster segment and $0.2 million in our Consumer Media segment, partially offset by $0.1 million increase in our Games segment.

Operating expenses decreased by $1.4 million in the quarter ended March 31, 2020 as compared with the year-earlier period, primarily due to the reductions of $1.8 million in salaries, benefits and infrastructure expenses. In the first quarter of 2020, we incurred expenses of $0.2 million for costs associated with our acquisition of Napster, compared with $0.8 million in the first quarter of 2019. Operating expenses within Corporate in the first quarter of 2020 also included the favorable change in fair value of the Napster contingent consideration liability of $0.3 million. These decreases were partially offset by $0.9 million increase in Napster segment primarily due to the inclusion of a full quarter of expenses in the first quarter of 2020 compared to the prior year.

Segment Operating Results

Consumer Media

Consumer Media segment results of operations were as follows (in thousands):


	Quarter Ended March 31,

	2020			2019			$ Change		% Change
Revenue	$	3,495		$	2,486		$	1,009	41	%
Cost of revenue	611			833			(222)		(27)	%
Gross profit	2,884			1,653			1,231		74	%
Gross margin	83		%	66		%
Operating expenses	2,458			3,119			(661)		(21)	%
Operating income (loss)	$	426		$	(1,466)		$	1,892	NM

Total Consumer Media revenue for the quarter ended March 31, 2020 increased $1.0 million as compared to the same quarter in 2019, due primarily to higher software license revenues of $1.3 million, partially offset by lower subscription services revenues of $0.2 million, described more fully below. The overall increase in revenues was also offset by lower product sales, advertising and other revenues of $0.1 million.

Software License

For our software license revenues, the $1.3 million increase was primarily due to the timing of contract renewals and shipments to existing customers. The bulk of these licenses for our codec technology are with companies based in China and, in the near term, it is possible we may see continued pressure in pricing and renewals, and declines in sales.

Subscription Services

For our subscription services revenues, the $0.2 million decrease was primarily due to continuing declines in our legacy subscription products, which will continue to organically decline.

Cost of revenue for the quarter ended March 31, 2020 decreased $0.2 million compared with the year-earlier period. This was primarily due to reductions in salaries and benefits.

Operating expenses decreased $0.7 million as compared with the year-earlier period, primarily due to reductions in salaries and benefits from headcount reductions, and marketing expenses.

Mobile Services

Mobile Services segment results of operations were as follows (in thousands):


	Quarter Ended March 31,

	2020			2019			$ Change		% Change
Revenue	$	6,690		$	6,939		$	(249)	(4)	%
Cost of revenue	1,696			2,048			(352)		(17)	%
Gross profit	4,994			4,891			103		2	%
Gross margin	75		%	70		%
Operating expenses	7,588			7,561			27		—	%
Operating loss	$	(2,594)		$	(2,670)		$	76	3	%

Total Mobile Services revenue decreased by $0.2 million in the quarter ended March 31, 2020 compared with the prior-year period. The revenue decrease was due to lower subscription services revenues of $0.4 million, partially offset by a $0.2 million increase in software license revenues, described more fully below.

Software License

For our software license revenues, the increase was primarily due to revenue from sales of our SAFR product.

Subscription Services

The decline in our subscription services revenue was due to lower revenue of $0.7 million in our ringback tones business, partially offset by an increase in our messaging platform business of $0.3 million.

Cost of revenue decreased by $0.4 million in the quarter ended March 31, 2020 compared with the prior-year period, due primarily to reductions in salaries and benefits related to headcount reductions and lower third-party customer services fees.

Operating expenses remained flat for the quarter ended March 31, 2020 compared with the year-earlier period. An increase in salaries and benefits of $0.5 million was offset by lower marketing and infrastructure expenses.

Games

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


	Quarter Ended March 31,

	2020			2019			$ Change		% Change
Revenue	$	6,637		$	5,710		$	927	16	%
Cost of revenue	1,794			1,670			124		7	%
Gross profit	4,843			4,040			803		20	%
Gross margin	73		%	71		%
Operating expenses	4,923			5,037			(114)		(2)	%
Operating income (loss)	$	(80)		$	(997)		$	917	92	%

Total Games revenue increased $0.9 million for the quarter ended March 31, 2020 as compared with the year-earlier period due primarily to increases of $1.0 million in product sales revenues and $0.1 million in advertising and other revenues, partially offset by a $0.2 million decrease in our subscription services revenues, described more fully below. Our Games segment continues to shift its focus toward free-to-play games that offer in-game purchases of virtual goods, the revenue from which is included within product sales, and away from premium mobile games that require a one-time purchase.

Subscription Services

Our subscription sales decreased $0.2 million as a result of lower subscribers in the first quarter of 2020.

Product Sales

Our product sales increased $1.0 million as a result of higher in-game purchases of $1.6 million compared to the prior-year period, partially offset by lower sales of games of $0.6 million as we continue to shift toward free-to-play games that offer in-game purchases of virtual goods and away from premium mobile games that require a one-time purchase.

Advertising and Other

Our advertising and other revenues increased $0.1 million as compared to the prior-year period primarily as a result of offering more in-game advertising within our free-to-play games.

Cost of revenue increased $0.1 million in the quarter ended March 31, 2020 when compared with the prior-year period due to higher app store fees of $0.3 million, partially offset by lower publisher license and service royalties of $0.2 million.

Operating expenses decreased $0.1 million in the quarter ended March 31, 2020 when compared with the prior-year period, due to lower professional services fees of $0.3 million and salaries and benefits of $0.3 million, partially offset by higher marketing expenses of $0.5 million.

Napster

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


	Quarter Ended March 31,
	2020			2019			$ Change		% Change
Revenue	$	26,323		$	24,337		$	1,986	8	%
Cost of revenue	20,072			20,396			(324)		(2)	%
Gross profit	6,251			3,941			2,310		59	%
Gross margin	24		%	16		%
Operating expenses	6,461			5,532			929		17	%
Operating loss	$	(210)		$	(1,591)		$	1,381	87	%

As described in Note 5 Acquisitions, we acquired control and began consolidating Napster effective January 18, 2019. Our consolidated results include Napster from the acquisition date forward.

Subscription Services

Napster's subscription revenues for the quarter ended March 31, 2020 increased $2.0 million compared to the same quarter of 2019 due to a $1.3 million increase in direct to consumer revenues and a $0.7 million increase in sales through

distribution partners. The increase was primarily due to the inclusion of a full quarter of revenues and an early termination fee from a platform partner in the first quarter of 2020, offset in part by lower subscribers. Direct to consumer revenue was reduced in the first quarter of 2019 by $0.6 million due to a fair value reduction in deferred revenue at the time of acquisition.

Cost of revenues primarily consist of content royalties related to music label and publishing rights for the domestic and international music streaming services. These costs can vary materially from period to period due to the significant judgments, assumptions, and estimates of the amounts to be paid. Napster's cost of revenues for the quarter ended March 31, 2020 decreased $0.3 million primarily due to lower royalties, partially offset by the inclusion of a full quarter of cost of revenues in the first quarter of 2020 compared to the prior year period.

Operating expenses increased by $0.9 million in the quarter ended March 31, 2020 primarily due to the inclusion of a full quarter of expenses in the first quarter of 2020 compared to the prior year period.

Corporate

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


	Quarter Ended March 31,

	2020		2019		$ Change		% Change
Cost of revenue	$	3	$	(77)	$	80	NM


Operating expenses	2,627		4,257		(1,630)		(38)	%
Operating loss	$	(2,630)	$	(4,180)	$	1,550	37	%

Operating expenses decreased by $1.6 million in the quarter ended March 31, 2020 compared with the year-earlier period, primarily due to a reduction in salaries and benefits in the first quarter of 2020. The overall change was also impacted by lower Napster acquisition costs of $0.4 million and a favorable change in the fair value of the Napster contingent consideration liability of $0.3 million, as further discussed in Note 6 Fair Value Measurements.

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 (in thousands):


	Quarter Ended March 31,
	2020		2019		$ Change		% Change
Research and development	$	8,618	$	8,833	$	(215)	(2)	%
Sales and marketing	8,117		8,142		(25)		—	%
General and administrative	7,113		8,364		(1,251)		(15)	%
Restructuring and other charges	209		167		42		25	%


Total consolidated operating expenses	$	24,057	$	25,506	$	(1,449)	(6)	%

Research and development expenses decreased by $0.2 million in the quarter ended March 31, 2020 as compared with the year-earlier period, primarily due to lower infrastructure expenses of $0.3 million.

Sales and marketing expenses remained flat in the quarter ended March 31, 2020 as compared with the year-earlier period In the first quarter of 2020, a $0.7 million reduction in salaries and benefits was partially offset by a $0.4 million increase in marketing expenses, primarily due to increased efforts towards free-to-play games, and $0.2 million increase in professional services fees.

General and administrative expenses decreased by $1.3 million in the quarter ended March 31, 2020 as compared with the year-earlier period. In the first quarter of 2020, we incurred expenses of $0.2 million for costs associated with our acquisition of Napster, compared with $0.8 million in the first quarter of 2019. The overall decrease was also impacted by lower salaries and benefits of $0.5 million and a favorable change in the fair value of the Napster contingent consideration liability of $0.3 million, as further discussed in Note 6 Fair Value Measurements.

Restructuring and other charges consist of costs associated with the ongoing reorganization of our business operations and expense re-alignment efforts. For additional details on these charges, see Note 9 Restructuring Charges.

Other Income (Expense)

Other income (expense), net was as follows (in thousands):


	Quarter Ended March 31,
	2020		2019		$ Change
Interest expense	$	(262)	$	(166)	$	(96)
Interest income	5		77		(72)
Gain (loss) on equity investment, net	—		12,338		(12,338)
Other income (expense), net	795		127		668
Total other income (expense), net	$	538	$	12,376	$	(11,838)

Interest expense relates to RealNetworks and Napster's notes payable and long-term debt, described in detail in Note 8 Notes Payable and Long-term debt.

Gain (loss) on equity investment, net, for the quarter ended March 31, 2019, included a $12.3 million gain related to RealNetworks' consolidation of Napster, as described in more detail in Note 5 Acquisitions.

Other income increased $0.7 million primarily due to foreign exchange gains.

Income Taxes

We recognized income tax expense of $0.1 million and $0.3 million during the quarters ended March 31, 2020 and 2019, respectively, related to U.S. and foreign income taxes.

As of March 31, 2020, RealNetworks has $5.0 million in uncertain tax positions. We currently anticipate the expiration of the statute of limitations within the next twelve months that may decrease the Company's total unrecognized tax benefit by an amount up to $1.3 million.

The majority of our tax expense is due to income in our foreign jurisdictions. In addition, we have not benefited from losses in the U.S. and certain foreign jurisdictions in the first quarter of 2020. We generate income in a number of foreign jurisdictions, some of which have higher or lower tax rates relative to the U.S. federal statutory rate. Our tax expense could fluctuate significantly on a quarterly basis to the extent income is less than anticipated in countries with lower statutory tax rates and more than anticipated in countries with higher statutory tax rates. For the quarter ended March 31, 2020, decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to the U.S. federal statutory rate was offset by increases in tax expense from income generated in foreign jurisdictions having comparable, or higher tax rates in comparison to the U.S. federal statutory rate. The effect of differences in foreign tax rates on the Company's tax expense for the first quarter of 2020 was minimal.

We file numerous consolidated and separate income tax returns in the U.S., including federal, state and local returns, as well as in foreign jurisdictions. With few exceptions, we are no longer subject to United States federal income tax examinations for tax years prior to 2013 or state, local or foreign income tax examinations for years prior to 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.

New Accounting Pronouncements

See Note 2 Recent Accounting Pronouncements, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this 10-Q.

Liquidity and Capital Resources

The following summarizes working capital, cash and cash equivalents, and restricted cash (in thousands):


	March 31, 2020		December 31, 2019
Working capital	$	(37,582)	$	(41,601)
Cash and cash equivalents	19,046		16,805
Restricted cash equivalents	5,374		5,374

Cash and cash equivalents increased from December 31, 2019 due to the $10.0 million in cash proceeds from the issuance of Series B Preferred Stock, partially offset by our ongoing cash flows used in operating activities, which totaled $4.6 million in the first three months of 2020, and Napster's net repayment of debt of $2.4 million.

The following summarizes cash flow activity (in thousands):


	Three Months Ended March 31,
	2020		2019
Cash used in operating activities	$	(4,624)	$	(9,319)
Cash (used in) provided by investing activities	(94)		11,802
Cash provided by financing activities	7,596		1,475

Cash used in operating activities consisted of net income (loss) including noncontrolling interests adjusted for certain non-cash items such as depreciation and amortization, stock-based compensation, gain on equity investment, fair value adjustments to contingent consideration liability and the effect of changes in certain operating assets and liabilities.

Cash used in operating activities was $4.7 million lower in the three months ended March 31, 2020 as compared to the same period in 2019. This improvement was due to our lower operating loss recorded for the three months ended March 31, 2020 compared to the prior year period.

For the three months ended March 31, 2020, cash used by investing activities consisted of fixed asset purchases of $0.1 million.

For the three months ended March 31, 2019, cash provided by investing activities of $11.8 million was primarily due to our acquisition of Napster on January 18, 2019. Our initial cash consideration paid at closing of $0.2 million was offset by the cash, cash equivalents and restricted cash on Napster's balance sheet at that date. The increase was offset in part by fixed asset purchases of $0.5 million.

Cash provided by financing activities for the three months ended March 31, 2020 was $7.6 million. This cash inflow was primarily due to the $10.0 million in cash proceeds from the issuance of Series B Preferred Stock, offset by Napster's net repayment of debt of $2.4 million. See Note 8 Notes Payable and Long-term debt and Note 13 Related Party Transactions for additional details.

Cash provided by financing activities for the three months ended March 31, 2019 was $1.5 million. This cash inflow was primarily due to net proceeds from Napster's borrowing activities of $1.3 million. See Note 8 Notes Payable and Long-term debt for additional details.

Three customers accounted for more than 10% of trade accounts receivable as of March 31, 2020, with the customers accounting for 19%, 13% and 13% each. Three customers individually comprised more than 10% of trade accounts receivable at December 31, 2019, with the customers accounting for 31%, 11% and 10% each. One customer in our Napster segment accounted for 12% of consolidated revenue, or $5.4 million, during the three months ended March 31, 2020. Two customers in our Napster segment accounted for 14% of consolidated revenue, or $5.5 million, and 12%, or $4.5 million, respectively, during the three months ended March 31, 2019.

While we currently have no planned significant capital expenditures for the remainder of 2020 other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases.

As discussed in Note 5 Acquisitions, we acquired a controlling interest in Napster on January 18, 2019. We paid initial cash consideration of $0.2 million in the first quarter of 2019 and the remaining $0.8 million of initial cash consideration is accrued as a current liability. We also have recognized a liability for the estimated fair value of the contingent consideration related to the acquisition. As discussed in Note 5 Acquisitions, this fair value amount was estimated using multiple scenarios for each tranche of contingent consideration, probability weighting each scenario, and discounting to arrive at an estimated fair value. This fair value calculation is directly impacted by the total estimated enterprise value of Napster. The contingent consideration will be adjusted quarterly to fair value through earnings, and as of March 31, 2020, the estimated fair value of the contingent consideration was $12.3 million, with $5.4 million recognized as a current liability and $6.9 million as a long-term liability. Any future amounts RealNetworks pays for contingent consideration could vary materially from the estimated amounts we have accrued as of March 31, 2020.

In August 2019, RealNetworks and Napster entered into the Loan Agreement with a third-party financial institution. Under the terms of the Agreement, which are further described in Note 8 Notes Payable and Long-term debt, the bank extended a two-year revolving line of credit not to exceed $10.0 million in the aggregate. As of March 31, 2020, $3.9 million had been drawn on the revolving line of credit, and any further advances will be used for working capital and general corporate purposes.

In April 2020, RealNetworks issued a promissory note in the principal amount of $2.9 million pursuant to the Paycheck Protection Program of the CARES Act. In May 2020, Napster issued its own promissory note in the principal amount of $1.7 million pursuant to the program. Each note, as further described in Note 14 Subsequent Events, has a maturity of 2 years, an interest rate of 1.0%, and is eligible for forgiveness pursuant to the terms of the program. We cannot provide assurance, however, that all or any portion of the principal and interest on these loans will be forgiven.

We have evaluated our current liquidity position in light of our history of declining revenue and operating losses as well as our near-term expectations of net negative cash flows from operating activities. We currently believe existing unrestricted cash balances, along with current availability on our revolving line of credit, will be sufficient to allow us to meet our obligations for the next 12 months. However, our assessment is subject to inherent risks and uncertainties. Moreover, our operating forecast is partly dependent on factors that are outside of our control. Compounding these risks, uncertainties, and other factors are the potential effects of the recent coronavirus pandemic and related impacts on global commerce and financial markets. These conditions, when evaluated within the guidance of ASC 205-40, raise substantial doubt about our ability to meet our obligations over the ensuing 12 months and, therefore, to continue as a going concern.

We have active plans to mitigate these conditions. Specifically, we plan to reduce negative cash flow through operating expense reductions, as well as through the deferral of certain obligations where we believe that we have the legal basis to do so. In addition, we are evaluating various strategic opportunities, which may include selling certain businesses or product lines, soliciting external investment into certain of our businesses, or seeking other strategic partnerships. Our plans are subject to inherent risks and uncertainties, which are accentuated by the effects of the current pandemic and related financial crisis. Accordingly, there can be no assurance that our plans can be effectively implemented and, therefore, that the conditions can be effectively mitigated.

Napster will also require outside funding in order to meet its anticipated cash needs over the next 12 months. RealNetworks has no contractual or implied legal obligation to provide funding or other financial support to Napster, and any funding to Napster under the Loan Agreement must be effectuated by RealNetworks. Significant financial distress at Napster could have negative implications in our assessment of goodwill and long-lived assets on RealNetworks' balance sheet.

In the future, we may seek to raise additional funds through public or private equity financing or through other sources. Such sources of funding may or may not be available to us on 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.

Our cash equivalents consist of money market funds.

We conduct our operations primarily in four functional currencies: the U.S. dollar, Brazilian real, 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 March 31, 2020, approximately $11.5 million of the $19.0 million of cash and cash equivalents was held by our foreign subsidiaries outside the U.S.

Off-Balance Sheet Arrangements

We do not maintain accruals associated with certain guarantees, as discussed in Note 19 Guarantees, to the consolidated financial statements included in Item 8 of Part II of our 2019 10-K. Thus, these guarantee obligations 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 estimates are discussed in Part II, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" section of our annual report on Form 10-K for the year ended December 31, 2019.

Due to the coronavirus pandemic, there has been uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require updates to our estimates or judgments or require us to revise the carrying value of our assets or liabilities. These estimates may change as new events occur and additional information is obtained. Actual results could differ materially from these estimates under different assumptions or conditions.

Item 3. 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 RealNetworks and Napster's notes payable and long-term debt. RealNetworks and Napster's borrowing arrangements have floating rate interest payments and thus have a degree of interest rate risk, if interest rates increase. Based on the outstanding notes payable and long-term debt as of March 31, 2020, a hypothetical 10% increase/decrease in interest rates would not increase/decrease our annual interest expense or cash flows by more than a nominal amount.

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.

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. The majority of our foreign currency denominated cash is held in euro, Chinese yuan and Japanese yen. A hypothetical 10% increase or decrease in those currencies relative to the U.S. dollar as of March 31, 2020 would not result in a material impact on our financial position, results of operations or cash flows.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2020. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Based upon that evaluation, our chief executive officer and chief financial officer concluded that, as of March 31, 2020, our disclosure controls and procedures were effective.

(b) Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the first quarter of 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

See Note 11 Commitments and Contingencies, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q.

Item 1A. Risk Factors

You should carefully consider the risks described below together with all of the other information included in this Form 10-Q. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or operating results, and the trading price of our common stock, could be materially harmed.

Our operating plans, financial condition, and stock price have been adversely affected by the COVID-19 pandemic, and we could experience more severe adverse affects in future periods.

To date, we have had to change certain strategy and product plans in order to address implications of the pandemic to our businesses, in particular, to our growth initiatives. We have also been forced to furlough some employees and otherwise reduce current expenditures. In addition, the severe turmoil in financial markets has contributed to a decline in the trading price of our common stock, resulting in our current noncompliance with the continued listing requirements of the The Nasdaq Stock Market. We cannot provide assurance that these actions or conditions will improve or continue as the pandemic, and reactions thereto, continue to evolve.

The COVID-19 pandemic and the resultant economic instability and financial market turmoil has added a layer of uncertainty and risk to nearly all aspects of our business. We are unable to predict the near-term and long-term impacts that the pandemic will have on our results from operations, financial condition, liquidity and cash flows for the remainder of fiscal 2020 or beyond.

Our growth initiatives could take longer than planned, be unsuccessful, or deplete our cash resources, any of which would have a material adverse effect on the performance of our businesses and financial results, and could cause us to pursue additional debt or other funding sources.

In recent years, we have developed new products and technologies, and funded initiatives, intended to create growth in our businesses, while simultaneously taking steps to reduce costs and increase profitability. These growth initiatives, several of which have been unsuccessful over recent years, have impacted all segments of our organization, requiring us to allocate limited resources among our diverse business units. Our financial sustainability is largely dependent on the success of our growth initiatives, and there are many risks to that success, some of which are internal to our Company, including our ability to develop and monetize our products and services, and some of which are externally driven and outside of our control, such as the impact of macroeconomic pressures and global pandemics. In particular, we expect that progress with our growth initiatives will be negatively impacted by various reactions to the recent global outbreak of the coronavirus that causes COVID-19, such as travel restrictions, community lockdowns, tightening of corporate budgets, reduction in consumer confidence, and significant instability in financial markets. We cannot predict the duration or severity of these reactions or impacts to our business and, if prolonged, our cash reserves may prove insufficient, requiring us to pursue additional debt or other funding sources.

Given the ambitious and significant nature of our growth initiatives, there is substantial risk that we may be unsuccessful in implementing our plans in a timely manner, our cash reserves may be depleted or insufficient to fully implement our plans, our growth initiatives may not gain adequate momentum, or the combination of our growth initiatives and cost reductions may not prove to be profitable. In any such case, our business would suffer, and our operational and financial results would be negatively impacted to a significant degree.

In August 2019, RealNetworks and Napster entered into a loan agreement with a third-party financial institution. Under the terms of that agreement, the bank extended a revolving line of credit not to exceed $10.0 million in the aggregate. The loan agreement contains customary covenants, including financial covenants, minimum EBITDA levels, and maintaining an unrestricted cash balance of $3.5 million. We have not had a debt facility in place in our recent past, therefore the entry into this facility introduces new risks to the company, including the risk that constraints around covenants may lead to less flexibility in

operational decision making, the risk of default and various implications thereof, and the potential increase in liabilities on our balance sheet in the event that we draw down the line of credit.

In April 2020, RealNetworks issued a promissory note in the principal amount of $2.9 million pursuant to the PPP of the CARES Act. In May 2020, Napster issued its own promissory note in the principal amount of $1.7 million pursuant to the program. On April 23, 2020, the Small Business Administration issued new guidance that questioned whether a public company with substantial market value and access to capital markets would qualify to participate in the PPP. Subsequently, on April 28, 2020 the Secretary of the Treasury and Small Business Administrator announced that the government will review all PPP loans of more than $2 million for which the borrower applies for forgiveness. While RealNetworks believes we fully qualify for the loan, should we be audited or reviewed by the U.S. Department of the Treasury as a result of filing an application for forgiveness or otherwise, such audit or review could result in the diversion of management’s time and attention and legal and reputational costs. If we were to be audited and receive an adverse finding in such audit, we could be required to return the full amount of the PPP loan, which could reduce our liquidity, and potentially subject us to fines and penalties.

The inability to obtain additional debt, whether through draws on our current line of credit or through a new debt facility, or the raising of funds through other means, could negatively impact our going concern assessment or our governance structure in the future. The occurrence of these or any of the risks described above would impair our financial results and stock price.

Our 84% equity interest in Napster could result in material negative implications to our financial condition and stock price.

From March 31, 2010, when we completed the restructuring of our digital audio music service joint venture, Rhapsody America LLC, now doing business under the Napster brand, until January 18, 2019, we did not have a majority voting interest in Napster. During that period, we accounted for Napster using the equity method of accounting and disclosed only strategic, business and financial information regarding Napster in our financial statements and disclosures, in accordance with accounting principles generally accepted in the United States, or GAAP. Historically, Napster generated significant accounting losses and, applying the equity method of accounting, we recognized our share of such losses on our investment. As we had no implicit or explicit commitment to provide future financial support to Napster, we did not record any further share of Napster losses that would reduce our carrying value of Napster below zero.

On January 18, 2019, we acquired an additional 42% of the outstanding equity of Rhapsody International, Inc., which we refer to as Napster as noted above, from a third party in a distressed sale resulting in our ownership of an aggregate of 84% of Napster's outstanding stock. See Note 5 Acquisitions for additional information. We also now have the right to nominate directors constituting a majority of the Napster board of directors, however, Napster will continue to operate as an independent business with its own board of directors, strategy, and leadership team. Accordingly, although we have no legal or constructive obligation to fund Napster losses and it is our intention to have Napster continue to operate as an independent company, RealNetworks has in the past extended loans to Napster and may do so in the future.

Due to our majority voting interest and the consolidation of Napster's results and financial position with ours, Napster's current liabilities are included in RealNetworks' consolidated balance sheet, including accrued but unbilled music royalties related to past services, the ultimate payment of which is uncertain. These liabilities, although not a legal or constructive obligation of RealNetworks, result in consolidated working capital being negative, which causes management to consider whether liquidity risks exist. While we believe that these liabilities are separate obligations of Napster and RealNetworks assumes no responsibility for these liabilities, in the remote event that any such liquidity issues become significant or are deemed material to our consolidated financial statements, there could be material negative implications to our financial condition and the trading price of our stock.

As discussed in Note 5 Acquisitions, at the time of acquiring Napster, we recorded contingent consideration, which involves the application of judgments and estimates, including but not limited to, the estimation of expected future cash flows and related discount rates. Also due to the acquisition of the controlling interest in Napster, beginning with the first quarter of 2019, we consolidate Napster’s financial results into the RealNetworks financial statements. Accordingly, we must receive Napster’s quarterly financial statements and related information in a timely manner in order to prepare our quarterly and annual consolidated financial statements and disclosures in our quarterly reports on Form 10-Q and annual reports on Form 10-K. Any failure in receiving Napster's financial statements and related information in a timely and materially accurate manner could cause our reports to be filed in an untimely and/or inaccurate manner, which would preclude us from utilizing certain registration statements and could negatively impact our stock price.

We need to successfully monetize our new products and services in order to sustain and grow our businesses, and manage our constrained cash resources.

In order to sustain our current level of business and to implement our growth initiatives, we must successfully monetize our new products and services, including through existing and new relationships with distribution partners. Our digital media products and services must be attractive and useful to distribution partners and end users. The successful acceptance and monetization of these products and services, therefore, is subject to unpredictable and volatile factors beyond our control, including end-user preferences, competing products and services, the rapid pace of change in the market, the effectiveness of our distribution channels, and significant global crises. Any failure by us to timely and accurately anticipate consumers’

changing needs and preferences, emerging technological trends and data privacy norms, or changes in the competitive or regulatory landscape for our products and services could result in a failure to monetize our new products or the loss of market opportunities, both of which we have experienced at various times in our past.

Moreover, in order to grow our new businesses, we must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether the products and services that we are developing or have introduced will meet the demands of the relevant market. As we have experienced, we may not realize a sufficient return, or may experience losses, on these investments, thereby further straining our limited cash resources and negatively affecting our ability to pursue other needed growth or strategic opportunities.

Sustaining and growing our businesses, and managing our constrained cash resources, are subject to these risks inherent in developing, distributing and monetizing our new products and services. Our failure to manage these risks could further impair our operations and financial results to a material degree, and could cause an unsustainable depletion of our cash resources.

Furthermore, our products and services have been in the past and may be in the future subject to legal challenge. Responding to any such claims may require us to enter into royalty and licensing agreements on unfavorable terms, require us to stop distributing or selling, or to redesign our products or services, or to pay damages, any of which could constrain our growth plans and cash resources.

Our businesses, including in connection with our growth initiatives, face substantial competitive challenges that may impair our success, thus negatively impacting our future growth.

Our digital media products and services, including legacy and products/services central to our growth initiatives, face a wide variety of competitors, many of which have longer operating histories, greater name or brand recognition, deeper and more expansive market penetration, more employees, and significantly greater resources than we do. In addition, current and potential competitors may include relatively new businesses that develop or use innovative technologies, products or features that could disrupt the market for technologies, products or features we currently or are seeking to develop and market. In attempting to compete with any or all of these competitors, we may experience, as we have in the past, some or all of the following consequences, any of which would adversely affect our operating results and the trading price of our stock:

•reduced prices or margins;

•loss of current and potential customers, or partners and potential partners who distribute our products and services or who provide content that we distribute to our customers;

•changes to our products, services, technologies, licenses or business practices or strategies;

•lengthened sales cycles;

•inability to meet demands for more rapid sales or development cycles;

•industry-wide changes in content distribution to customers or in trends in consumer consumption of digital media products and services;

•pressure to prematurely release products or product enhancements; or

•degradation in our stature or reputation in the market.

Our Consumer Media technologies for media playback and production (RealPlayer, RealMedia VB and RealMedia HD) compete with alternative media playback technologies and audio and video content formats that have obtained broad market penetration. RealMedia VB and RealMedia HD are codecs, technology that enables compression and decompression of the media content in a (usually proprietary) format. We license our codec technology primarily to computer, smartphone and other mobile device manufacturers, and also to other partners that can support our efforts to build a strong ecosystem, like content providers and integrated circuit developers. To compete effectively, codec technologies must appeal to, and be adopted for use by, a wide range of parties: producers and providers of media content, consumers of media content, and device manufacturers who pre-load codec technologies onto their devices. Our ability to sustain or grow this business, which has recently experienced some downward pressure, is dependent on the successful promotion and adoption of our codec technologies to a wide and diverse target market, which is a complex and highly uncertain undertaking. If we are unable to compete successfully, our Consumer Media business could decline as it has in the recent past or on a more accelerated basis.

The market for our Mobile Services business is highly competitive and continues to rapidly evolve. Our SaaS services face competition from a proliferation of applications and services, many of which carriers can deploy or offer to their subscribers, or which consumers can acquire independently of their carrier. We expect pricing pressure in this business to continue to materially impact our operating results in this business. We also compete with a wide variety of companies, as small startups and well established, heavily resourced global companies continue to develop technologies and launch products in the facial recognition market. The success of this newly launched business is highly dependent on our ability to differentiate our product offering within this competitive environment.

The branded services in our Games business compete with other developers, aggregators and distributors of mobile, online, and downloadable games. Our competitors vary in size and capabilities, some of which have high volume distribution channels and greater financial resources than we do; while others may be smaller and more able to quickly or efficiently adjust

to market conditions. We also face significant price competition in the casual games market, and some of our competitors may be able to offer games for free, or reduce prices more aggressively. We expect competition to continue to intensify in this market. Our games development studios compete primarily with other developers of mobile, online, and downloadable games, and must continue to develop popular and high-quality game titles. Our Games business must also continue to execute on opportunities to expand the play of our games on a variety of non-PC platforms, including mobile, in order to maintain our competitive position and to grow the business. Moreover, continued growth in our Games business is in part dependent on the availability of funds to invest in marketing, which availability cannot be assured.

The distribution and license of our technology products and services are governed by contracts with third parties, the terms of which subject us to significant risks that could negatively impact our revenue, expenses and assumption of liability related to such contracts.

In our Consumer Media and Mobile Services segments, we distribute and license most of our technology products and services pursuant to contracts with third parties, such as mobile carriers and their partners, online service providers, and OEMs and device manufacturers, many of whom may have stronger negotiating leverage due to their size and reach. These contracts govern the calculation of revenue generated and expenses incurred, how we recognize revenue and expenses in our financial statements, and the allocation of risk and liabilities arising from the product or service or distribution thereof. Terms impacting revenue, over which we may have limited if any control, may involve revenue sharing arrangements, end user pricing, usage levels, and exclusivity, all of which significantly affect the level of revenue that we may realize from the relationship. Moreover, contract terms around marketing and promotion of our products and other expense allocation could result in us bearing higher expenses or achieving weaker performance than we had anticipated from the relationship.

In addition, although our contracts with third parties are typically for a fixed duration, they could be terminated early; and they may be renegotiated on less favorable terms or may not be renewed at all by the other party. We must, therefore, seek additional contracts with third parties on an ongoing basis to sustain and grow our business. We expect to face continuing and increased competition for the technology products and services we provide, and there is no assurance that the parties with which we currently have contracts will continue or extend current contracts on the same or more favorable terms, or that we will obtain alternative or additional contracts for our technology products and services. As we have recently experienced in our China business, the further loss of existing contracts, the failure to enter new contracts, or the deterioration of customer creditworthiness or the terms in our contracts with third parties could materially harm our operating results, financial condition, and cash flow.

Nearly all of our contracts in which we provide to another party services or rights to use our technology include some form of obligation by us to indemnify the other party for certain liabilities and losses incurred by them, including liabilities resulting from third party claims for damages that arise out of the use of our technology. These indemnification terms provide us with certain procedural safeguards, including the right to control the defense of the indemnified party. We have in the past incurred costs to defend and settle such claims. Claims against which we may be obligated to defend others pursuant to our contracts could in the future result in payments that could materially harm our business and financial results.

Our operating results are difficult to predict and may fluctuate, which may contribute to continued weakness in our stock price, which could, in turn, jeopardize our ability to comply with Nasdaq's continued listing requirements threatening the continued listing of our common stock.

The trading price for our common stock has been steadily declining. In addition, as a result of the rapidly changing markets in which we compete, and restructuring, impairment and other one-time events specific to us, our operating results may fluctuate or continue to decline from period to period, which may contribute to continued weakness or volatility of our stock price. Moreover, the general difficulty in forecasting our operating results and identifying meaningful performance metrics, especially when factoring in our growth initiatives, could result in actual results that differ materially from expected results, again causing continued weakness and volatility in our stock price. Compounding these internal factors, external factors such as the significant recent instability in global financial markets caused in part by a global pandemic, will impact our operating results and stock price, potentially driving our stock price to record lows.

The difficulty in forecasting our operating results may also cause over or under investment in certain growth initiatives, as such investment is often planned based on expected financial results, thus causing more severe fluctuations in operating results and, likely, further volatility in our stock price.

Further, because our common stock is listed on the Nasdaq Global Market, we must meet Nasdaq's continued listing requirements. On April 23, 2020, the Company received a letter from the Listing Qualifications Department of the Nasdaq Global Market indicating that, based upon the closing bid price of our common stock for the 30 consecutive business day period between March 11, 2020 through April 23, 2020, we did not meet the minimum bid price of $1.00 per share required for continued listing on Nasdaq. In April 2020, in response to the unprecedented turmoil in U.S. and world financial markets, Nasdaq tolled the compliance periods for its bid price and market value of publicly held shares requirements through June 30, 2020. As a result of Nasdaq's general grant of this grace period, we have a compliance period of 180 calendar days starting July 1, 2020 and ending December 28, 2020 in which to regain compliance. In order to regain compliance with Nasdaq’s minimum

bid price requirement, our common stock must maintain a minimum closing bid price of $1.00 for at least ten consecutive business days prior to December 28, 2020. In the event that we do not regain compliance by this date, we may be eligible for a second compliance period pursuant to Nasdaq's existing rules.

The letter has no immediate impact on the listing of our common stock, which will continue to be listed and traded on Nasdaq during the general grace period and the 180-day compliance period. Our Board of Directors will consider the implementation of various measures intended to support compliance, including a reverse split of our common stock in an effort to increase the trading price of such shares.

Although we expect to restore our compliance with the listing requirements, we can provide no assurance that any action taken by us would be successful, or that any such action would stabilize the market price or improve the liquidity of our common stock. Should a delisting occur, a shareholder would likely find it significantly more difficult to dispose of our common stock, or to obtain accurate quotations as to the value of our common stock, and our ability to raise future capital through the sale of our common stock could be severely limited.

Any impairment to our goodwill and definite-lived assets could result in a material charge to our earnings.

In accordance with GAAP, we test goodwill for possible impairment on an annual basis or more frequently in the event of certain indications of possible impairment. We review definite-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. These events or circumstances could include a significant change in the business climate, including a significant sustained decline in a reporting unit’s fair value, changes in our operating plans and forecasts, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of our business, a significant sustained decline in our market capitalization and other factors. If we were to determine that an impairment had occurred, we would be required to record an impairment charge, which could have a material negative, and unanticipated, impact on our financial results. At the time of acquiring a controlling stake in Napster, we recorded goodwill and definite-lived intangibles that totaled $69.2 million. See Note 5 Acquisitions, for further information related to Napster. The total carrying value of our goodwill and definite-lived intangible assets as of March 31, 2020 was $80.2 million. Continued significant financial distress at Napster would likely have negative implications in our assessment of goodwill and definite-lived intangible assets on RealNetworks' balance sheet.

Continued loss of revenue from our subscription services is likely to cause further harm to our operating results.

Our operating results have been and will continue to be adversely impacted by the loss of subscription revenue related to our more traditional products and services. Subscribers cancel their subscriptions to our services for many reasons, including a perception that they do not use the services sufficiently or that the service does not provide enough value, a lack of attractive or exclusive content generally or as compared with competitive service offerings, or because customer service issues are not satisfactorily resolved. Revenue from our SuperPass subscription service, for example, has continued to decline over several periods, due to changes in consumer preferences and changes on our part to focus on other products and services we offer, and we expect this trend to continue.

Given our declining revenue and operating losses, compounded by the COVID-19 pandemic and related impacts to global financial markets, management has concluded that substantial doubt exists concerning our ability to continue as a going concern.

Our unrestricted cash and cash equivalents balance at March 31, 2020 was $19.0 million, $11.5 million of which was held by our foreign subsidiaries, and our operating loss for the quarter ended March 31, 2020 was $5.1 million. As further discussed in Part II, Item 8, “Note 1—Description of Business and Summary of Significant Accounting Policies” to our Consolidated Financial Statements in this Annual Report on Form 10-K, due to our history of declining revenue and operating losses, as well as our near-term expectations of net negative cash flows from operating activities, compounded by the COVID-19 pandemic and severe impacts to global financial markets, management has concluded that substantial doubt is deemed to exist about the company’s ability to continue as a going concern through the next 12 months. Our financial statements do not include any adjustment relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. Our ability to continue as a going concern will require us to improve cash flow by implementing some combination of the following: reduce operating expenses; improve working capital; defer certain obligations where we believe we have the legal basis to do so; draw upon our line of credit; sell businesses, product lines or assets; effectuate strategic alliances; efficiently repatriate cash; or obtain outside investment. Our limited cash resources and our potential inability to continue as a going concern may materially adversely affect our share price, inhibit our ability to obtain outside investment or strategic alliances.

Government regulation of the Internet, facial recognition technology, and other related technologies is evolving, and unfavorable developments could have an adverse effect on our operating results.

We are subject to regulations and laws specific to the marketing, sale and delivery of goods and services. These laws and regulations, which continue to evolve, cover taxation, user privacy, data collection and protection, copyrights, electronic contracts, sales procedures, automatic subscription renewals, credit card processing procedures, consumer protections, digital games distribution, broadband Internet access and content restrictions. We cannot guarantee that we have been or will be fully

compliant in every jurisdiction, as it is not entirely clear how existing laws and regulations governing issues such as privacy, taxation and consumer protection apply or will be enforced with respect to the products and services we sell. Moreover, as Internet commerce continues to evolve, increasing regulation and/or enforcement efforts by federal, state and foreign agencies and the prospects for private litigation claims related to our data collection, privacy policies or other e-commerce practices become more likely. In addition, the adoption of any laws or regulations or the imposition of other legal requirements that adversely affect our ability to market, sell, and deliver our products and services could decrease our ability to offer or customer demand for our service offerings, resulting in lower revenue. For example, the European Union's General Data Protection Regulation (GDPR), effective in May 2018, created a variety of new compliance obligations, with significant penalties for noncompliance. Moreover, in the U.S., certain states have and more states may impose stricter privacy laws that may impact accepted business practices. We cannot provide assurance that the changes that we have adopted to our business practices will be compliant or that new compliance frameworks such as this will not have a negative impact on our financial results.

In addition, through the operation of our SAFR product, we are subject to regulations and laws generally and specifically applicable to the provision of facial recognition technology. New laws and regulations are under discussion and those that exist are untested, thus we cannot guarantee that we have been or will be fully compliant in every jurisdiction. Moreover, the voluntary development of norms, standards, and best practices by companies providing facial recognition and similar technology could require modifications to our technology or practices that may be costly or incompatible with our financial model.

Future regulations, or changes in laws and regulations or their existing interpretations or applications, could require us to further change our business practices, raise compliance costs or other costs of doing business and result in additional historical or future liabilities for us, resulting in adverse impacts on our business and our operating results.

As a consumer-facing business, we receive complaints from our customers regarding our consumer marketing efforts and our customer service practices. Some of these customers may also complain to government agencies, and from time to time, those agencies have made inquiries to us about these practices. In addition, we may receive complaints or inquiries directly from governmental agencies that have not been prompted by consumers. We cannot provide assurance that governmental agencies will not bring future claims, as they have on occasion in the past, regarding our marketing, or consumer services or other practices.

We face financial and operational risks associated with doing business in non-U.S. jurisdictions and operating a global business, that have in the past and could in the future have a material adverse impact on our business, financial condition and results of operations.

A material portion of our revenue is derived from sales outside of the U.S. and most of our employees are located outside of the U.S. Consequently, our business and operations depend significantly on global and national economic conditions and on applicable trade regulations and tariffs. For example, our business in China could be negatively affected by an actual or perceived lack of stability or consistency in U.S.-China trade policy. The growth of our business is also dependent in part on successfully managing our international operations. Our non-U.S. sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:

•periodic local or geographic economic downturns and unstable political conditions;

•price and currency exchange controls;

•fluctuation in the relative values of currencies;

•difficulty in repatriating cash, whether as a result of tax laws or otherwise;

•compliance with current and changing tax laws, and the coordination of compliance with U.S. tax laws and the laws of any of the jurisdictions in which we do business;

•difficulties protecting intellectual property;

•compliance with labor laws and other laws governing employees;

•local labor disputes;

•changes in trading policies, regulatory requirements, tariffs and other barriers, or the termination or renegotiation of existing trade agreements;

•impact of changes in immigration or other policies impacting our ability to attract, hire, and retain key talent;

•potential implications resulting from the outbreak of disease on a global scale or localized in countries in which we do business or have employees; and

•difficulties in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors and representatives.

Because consumers may consider the purchase of our digital entertainment products and services to be a discretionary expenditure, their decision whether to purchase our products and services may be influenced by macroeconomic factors that affect consumer spending such as unemployment, access to credit, negative financial news, and declines in income. In addition, mobile telecommunication carriers and other business partners may reduce their business or advertising spending with us or for our products and services they distribute to users in the face of adverse macroeconomic conditions, such as financial market volatility, government austerity programs, tight credit, and declines in asset values. We have in the past recorded material asset

impairment charges due in part to weakness in the global economy, and we may need to record additional impairments to our assets in future periods in the event of renewed weakness and uncertainty in the global or a relevant national economy. Accordingly, any significant weakness in the national and/or global economy could materially impact our business, financial condition and results of operations in a negative manner.

Our international operations involve risks inherent in doing business globally, including difficulties in managing operations due to distance, language, cultural differences, local economic conditions, outbreak of diseases, different or conflicting laws and regulations, taxes, and exchange rate fluctuations. The functional currency of our foreign subsidiaries is typically the local currency of the country in which each subsidiary operates. We translate our subsidiaries’ revenues into U.S. dollars in our financial statements, and continued volatility in foreign exchange rates, particularly if the U.S. dollar strengthens against the euro, may result in lower reported revenue or net assets in future periods. If we do not effectively manage any of the risks inherent in running our international businesses, our operating results and financial condition could be harmed. As another example, the COVID-19 pandemic has resulted in travel and work restrictions globally, and may significantly disrupt our ability to produce and sell products. We are monitoring the impacts of the pandemic to our business, as well as rapidly evolving expectations regarding its severity and duration. We are unable to predict the full effects of this pandemic on our operations and financial results.

Our business is conducted in accordance with existing international trade relationships, and trade laws and regulations. Changes in geopolitical relationships and laws or policies governing the terms of foreign trade, such as the recent rise in protectionist politics and economic nationalism, could create uncertainty regarding our ability to operate and conduct commercial relationships in affected jurisdictions, which could have a material adverse effect on our business and financial results. Additionally, our global operations may also be adversely affected by political events, domestic or international terrorist events and hostilities or complications due to natural or human-caused disasters. These uncertainties could have a material adverse effect on the continuity of our business and our results of operations and financial condition.

Difficulty recruiting and retaining key personnel could significantly impair our operations or jeopardize our ability to meet our growth objectives.

Our success depends substantially on the contributions and abilities of certain key personnel, and we cannot provide assurance that we will be able to retain them in the near term or recruit them in the future. Executive-level turnover, as we have experienced in the past and could experience in the future, could impact our ability to retain key personnel. Also, qualified individuals are in high demand and competition for such qualified personnel in our industry, particularly engineering talent, is extremely intense, and we may incur significant costs to attract or retain them. Changes in immigration or other policies in the U.S. or other jurisdictions that make it more difficult to hire and retain key talent, or to assign individuals to any of our locations as needed to meet business needs, could adversely affect our ability to attract key talent or deploy individuals as needed, and thereby adversely affect our business and financial results. Further, repeated restructuring of our businesses and related cost-reduction efforts, as well as declines in our stock price, have caused instability in our workforce that makes it more difficult to retain and recruit key personnel. Given these factors, there can be no assurance that we will be able to attract and retain the key personnel necessary to sustain our business or support future growth.

These risks also apply to our material subsidiaries, most notably Napster, which has experienced a high level of turnover in recent periods.

Acquisitions and divestitures involve costs and risks that could harm our business and impair our ability to realize potential benefits from these transactions.

As part of our business strategy, we have acquired and sold technologies and businesses in the past and expect that we will continue to do so in the future.The failure to adequately manage transaction costs and address the financial, legal and operational risks raised by acquisitions and divestitures of technology and businesses could harm our business and prevent us from realizing the benefits of these transactions. In addition, we may identify and acquire target companies, but those companies may not be complementary to our current operations and may not leverage our existing infrastructure or operational experience, which may increase the risks associated with completing acquisitions.

For example, our January 18, 2019 acquisition of a controlling interest in Napster represents a significant acquisition for RealNetworks. We incurred significant transaction-related costs to effectuate the acquisition, which were recorded throughout fiscal year 2019 and in the first quarter of 2020. Furthermore, although Napster will continue to operate independently and its business will not be integrated into our businesses, we still face risks related to the acquisition such as the consolidation of Napster's financial results into our financial statements.

Transaction-related costs and financial risks related to completed and potential future purchase or sale transactions may harm our financial position, reported operating results, or stock price. Previous acquisitions have resulted in significant expenses, including amortization of purchased technology, amortization of acquired identifiable intangible assets and the incurrence of charges for the impairment of goodwill and other intangible assets, which are reflected in our operating expenses. New acquisitions and any potential additional future impairment of the value of purchased assets, including goodwill, could have a material negative impact on our future operating results. In compliance with GAAP, we evaluate these assets for

impairment at least annually. Factors that may be considered a change in circumstances, indicating that our goodwill or definite-lived assets may not be recoverable, include reduced future revenue and cash flow estimates due to changes in our forecasts, and unfavorable changes to valuation multiples and discount rates due to changes in the market. If we were to conclude that any of these assets were impaired, we would have to recognize an impairment charge that could materially impact our financial results. With regard to Napster, the goodwill that we recorded in connection with the January 2019 acquisition could be deemed impaired in the event that Napster's cash position or profitability further deteriorates.

Purchase and sale transactions also involve operational risks that could harm our existing operations or prevent realization of anticipated benefits from a transaction. These operational risks include:

•difficulties and expenses in assimilating the operations, products, technology, information systems, and/or personnel of the acquired company;

•retaining key management or employees of the acquired company;

•entrance into unfamiliar markets, industry segments, or types of businesses;

•operating, managing and integrating acquired businesses in remote locations or in countries in which we have little or no prior experience;

•diversion of management time and other resources from existing operations;

•impairment of relationships with employees, affiliates, advertisers or content providers of our business or acquired business;

•assumption of known and unknown liabilities of the acquired company, including intellectual property claims; and

•potential impacts to our system of internal controls and disclosure controls and procedures.

We may be unable to adequately protect our proprietary rights or leverage our technology assets, and may face risks associated with third-party claims relating to intellectual property rights associated with our products and services.

Our ability to compete across our businesses partly depends on the superiority, uniqueness and value of our technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. Our efforts to protect our intellectual property rights may not assure our ownership rights in our intellectual property, protect or enhance the competitive position of our products, services and technology, or effectively prevent misappropriation of our technology.

From time to time, we receive claims and inquiries from third parties alleging that our technology used in our business may infringe the third parties’ proprietary rights. These claims, even if not meritorious, could force us to make significant investments of time, attention and money in defense, and give rise to monetary damages, penalties or injunctive relief against us. We may be forced to litigate, to enforce or defend our patents, trademarks or other intellectual property rights, or to determine the validity and scope of other parties' proprietary rights in intellectual property. To resolve or avoid such disputes, we may also be forced to enter into royalty or licensing agreements on unfavorable terms or redesign our product features, services and technology to avoid actual or claimed infringement or misappropriation of technology. Any such dispute would likely be costly and distract our management, and the outcome of any such dispute (such as additional licensing arrangements or redesign efforts) could fail to improve our business prospects or otherwise harm our business or financial results.

Nearly all of our contracts by which we provide to another party services or rights to use our technology include some form of obligation by us to indemnify the other party for certain liabilities and losses incurred by them, including liabilities resulting from third party claims for damages that arise out of the use of our technology. Claims against which we may be obligated to defend others pursuant to our contracts expose us to the same risks and adverse consequences described above regarding claims we may receive directly alleging that our trademarks or technology used in our business may infringe a third party's proprietary rights.

Disputes regarding the validity and scope of patents or the ownership of technologies and rights associated with streaming media, digital distribution, and online businesses are common and likely to arise in the future. We also routinely receive challenges to our trademarks and other proprietary intellectual property that we are using in our business activities. We are likely to continue to receive claims of third parties against us, alleging contract breaches, infringement of copyrights or patents, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition or violations of privacy rights.

Our business and operating results will suffer and we may be subject to market risk and legal liability if our systems or networks fail, become unavailable, unsecured or perform poorly so that current or potential users do not have adequate access to our products, services and websites.

Our ability to provide our products and services to our customers and operate our business depends on the continued operation and security of our information systems and networks and those of our service providers. A significant or repeated reduction in the performance, security or availability of our information systems and network infrastructure or that of our service providers could harm our ability to conduct our business, and harm our reputation and ability to attract and retain users,

customers, advertisers and content providers. Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate.

We sell many of our products and services through online sales transactions directly with consumers, and their credit card information is collected and stored by our payment processors. The systems of our third party service providers may not prevent future improper access or disclosure of credit card information or personally identifiable information. We have an extensive privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client, third party payment providers, and server products. A security breach that leads to disclosure of consumer account information, or any failure by us to comply with our posted privacy policy or existing or new privacy legislation, could harm our reputation, impact the market for our products and services, or subject us to litigation. We have on occasion experienced system errors and failures that caused interruption in availability of products or content or an increase in response time. Problems with our systems and networks, or the third party systems and networks that we utilize, could result from a failure to adequately maintain and enhance these systems and networks, natural disasters and similar events, power failures, intentional actions to disrupt systems and networks and many other causes. Many of our services do not currently have fully redundant systems or a formal disaster recovery plan, and we may not have adequate business interruption insurance to compensate us for losses that may occur from a system outage.

Changes in regulations applicable to the Internet and e-commerce that increase the taxes on the services we provide could materially harm our business and operating results.

As Internet commerce continues to evolve, increasing taxation by state, local or foreign tax authorities becomes more likely. For example, taxation of electronically delivered products and services or other charges imposed by government agencies may also be imposed. We collect transactional taxes and we believe we are compliant and current in all jurisdictions where we have a collection obligation for transaction taxes. Any regulation imposing greater taxes or other fees for products and services could result in a decline in the sale of products and services and the viability of those products and services, harming our business and operating results. A successful assertion by one or more states or foreign tax authorities that we should collect and remit sales or other taxes on the sale of our products or services could result in substantial liability for past sales.

In those countries where we have a tax obligation, we collect and remit value added tax, or VAT, on sales of “electronically supplied services” provided to European Union residents. The collection and remittance of VAT subjects us to additional currency fluctuation risks.

Changes in accounting standards and subjective assumptions, estimates, and judgments by management related to complex accounting matters could significantly affect our financial results or financial condition.

We prepare our financial statements in conformity with GAAP. These accounting principles are subject to interpretation or changes by the Financial Accounting Standards Board, or FASB, and the SEC, and new accounting pronouncements and varying interpretations of accounting standards and practices have occurred in the past and are expected to occur in the future. Moreover, our financial statements require the application of judgments and estimates regarding a wide range of matters that are relevant to our business, such as revenue recognition, asset impairment and fair value determinations, the acquisition method of accounting and its related estimated fair value amounts, stock-based compensation, music publisher and royalty accruals, and intangible asset valuations. Changes in accounting standards or practices, or in our judgments and estimates underlying accounting standards and practices, could harm our operating results and/or financial condition. Changes to existing accounting rules or to our judgments and estimates underlying those rules could materially impact our reported operating results and financial condition.

We may be subject to additional income tax assessments and changes in applicable tax regulations could adversely affect our financial results.

We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes, income taxes payable, and net deferred tax assets. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in our historical financial statements. An audit or litigation can result in significant additional income taxes payable in the U.S. or foreign jurisdictions which could have a material adverse effect on our financial condition and results of operations.

Our Chairman of the Board and Chief Executive Officer beneficially owns 38.5% of our common stock, which gives him significant control over certain major decisions on which our shareholders may vote or which may discourage an acquisition of us.

Robert Glaser, our Chairman of the Board and Chief Executive Officer, beneficially owns 38.5% of our common stock. As a result, Mr. Glaser and his affiliates will have significant influence to:

•elect or defeat the election of our directors;

•amend or prevent amendment of our articles of incorporation or bylaws;

•effect or prevent a merger, sale of assets or other corporate transaction; and

•control the outcome of any other matter submitted to the shareholders for vote.

Furthermore, on February 10, 2020, we entered into a Series B Preferred Stock Purchase Agreement with Mr. Glaser pursuant to which Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of approximately 8.0 million shares of our Series B Preferred Stock, par value $0.001 per share. The rights, preferences, limitations, and powers of the Series B Preferred Stock are set forth in and governed by the designation of rights and preferences of Series B Preferred Stock filed with the Secretary of State of the State of Washington. Those rights, preferences, limitations, and powers include the right to proportional adjustment and the right to any dividends or distributions declared with regard to our common stock, but the Series B Preferred Stock has no voting or consent rights, has no liquidation preference, has no preferred dividend, and has limitations on transferability. Each share of Series B Preferred Stock is convertible into one share of our common stock, however no conversion is permitted in the event that it would cause Mr. Glaser’s beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our shareholder rights plan dated November 30, 2018.

The stock ownership of Mr. Glaser may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of RealNetworks, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price.

Provisions of our charter documents, shareholder rights plan, and Washington law could discourage our acquisition by a third party.

Our articles of incorporation provide for a strategic transactions committee of the board of directors. Without the prior approval of this committee, and subject to certain limited exceptions, the board of directors does not have the authority to:

•adopt a plan of merger;

•authorize the sale, lease, exchange or mortgage of assets representing more than 50% of the book value of our assets prior to the transaction or on which our long-term business strategy is substantially dependent;

•authorize our voluntary dissolution; or

•take any action that has the effect of any of the above.

Mr. Glaser has special rights under our articles of incorporation to appoint or remove members of the strategic transactions committee at his discretion that could make it more difficult for RealNetworks to be sold or to complete another change of control transaction without Mr. Glaser’s consent. RealNetworks has also entered into an agreement providing Mr. Glaser with certain contractual rights relating to the enforcement of our charter documents and Mr. Glaser’s roles and authority within RealNetworks. These rights and his role as Chairman of the Board of Directors, together with Mr. Glaser’s significant beneficial ownership, create unique potential for concentrated influence of Mr. Glaser over potentially material transactions involving RealNetworks and decisions regarding the future strategy and leadership of RealNetworks.

We have adopted a shareholder rights plan, which was amended and restated in December 2008, amended in April 2016 and February 2018, and again amended and restated in November 2018. The plan provides that shares of our common stock have associated preferred stock purchase rights, the exercise of which would make the acquisition of RealNetworks by a third party more expensive to that party, having the effect of discouraging third parties from acquiring RealNetworks without the approval of our board of directors, which has the power to redeem these rights and prevent their exercise.

Washington law imposes restrictions on some transactions between a corporation and certain significant shareholders. The foregoing provisions of our charter documents, shareholder rights plan, our agreement with Mr. Glaser, and Washington law, as well as our charter provisions that provide for a classified board of directors and the availability of “blank check” preferred stock, could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock.

Our January 2019 acquisition of a majority stake in Napster subjects our consolidated financial condition to new risks and uncertainties, including the following:

Napster’s financial results and growth are subject to risks involving revenue concentration, strategic focus, and market competition.

In recent years, Napster’s business has shifted from a predominant reliance on a direct to consumer subscription model to delivering its music streaming content to users through business partners. With this shift in strategy, Napster’s revenue has become concentrated among fewer partners, its sales cycle has become longer and more complex, and its competitive landscape has shifted. All of these factors contribute to risks and uncertainties that could impair the implementation of Napster’s growth strategy thus causing declines in Napster’s revenue and gross margin. Any such declines would negatively impact our consolidated financial results.

As Napster’s direct to consumer subscription base declines due to intense competition in the music streaming market, its growth has become dependent on successful implementation of its platform-as-a-service strategy. Reliance on fewer key partnerships brings risk to Napster’s revenue base, and developing relationships with distribution partners requires a significant investment of time and resources, with partnerships taking longer to execute than anticipated and terms becoming increasingly complex as negotiations continue. The result is a higher degree of risk in Napster’s revenue base, compressed margins, and more uncertainty in its strategy.

Napster’s access to content and dependence on third-party licenses cause substantial risk and uncertainty to its business and could, therefore, harm our financial results.

Napster’s business relies on its ability to access content in a cost-efficient and dependable manner. To secure the rights necessary to stream music to its users, Napster must obtain licenses from record labels, aggregators, artists, publishers, performing rights organizations, collecting societies, and other copyrights owners and their agents. These rights holders, to the extent that Napster is able to identify them, possess different levels of bargaining power, require payment by Napster of varying royalty rates, and may or may not continue to make licenses available to Napster. Uncertainty with regard to, and any significant changes in, royalty rates, content availability, or Napster’s ability to identify and negotiate with these rights holders could have a material adverse effect on Napster’s revenue, profitability, and ability to provide its services. This, in turn, could harm our financial condition and stock price.

Related to Napster’s ability to access the content necessary to provide its streaming services is its dependence on third-party licenses, including the major record labels that hold the rights to stream a significant number of sound recordings. Specifically, three major labels dominate the market, and the loss of access to content controlled by any one of these labels would materially limit Napster’s offering, which would likely result in the loss of users, through both consumer subscriptions and business partnerships. Any such loss could materially impact Napster’s revenue and cause negative implications to our consolidated financial results.

The various complexities involved in Napster’s music royalty accrual could negatively impact our financial results.

As is common in the music streaming industry, Napster’s ability to determine and appropriately accrue music royalty liabilities involves a significant degree of risk and uncertainty. This accrual requires, among other things, identification of rights holders, application of statutory and contractual royalty rates, contractual terms such as advances and minimum guarantees, estimation of market share, user information and geographies, and a significant degree of judgment. Also, in certain jurisdictions, rights holders may have several years to claim royalties for musical compositions, in respect of which ownership has not already been claimed. While Napster bases its estimates on contractual rates, historical experience and on various other assumptions that management believes to be reasonable, actual results may differ materially from these estimates under different assumptions or conditions. The complexity, subjectivity, and variability around Napster’s royalty accrual could result in actual royalty costs exceeding amounts accrued, negatively impacting Napster’s profitability and our financial results.

Also common in the industry are royalty audits, lawsuits filed by rights holders, and other third-party assertions related to use of content on our platform. Napster has been the target of these types of actions in the past and expects to continue to be in the future. These matters create uncertainty, are costly, and can require a significant amount of management’s attention. Moreover, negotiations and disclosures related to these types of matters and disputes can cause damage to key business relationships, which could materially harm Napster’s business and prospects, thus impairing our consolidated financial results.

Underlying the complexity and risk involved in Napster’s ability to determine its music royalty liabilities, is the reliability of its systems of internal control and disclosure controls and procedures. We cannot provide assurance that these systems are or will continue to be effective. Although a subsidiary of ours, Napster has not historically been subject to public reporting requirements or the level of visibility and scrutiny that accompanies public reporting. In the event that Napster’s system of internal controls, particularly relating to its music royalty accrual, is found to be ineffective, it would likely have significant implications to Napster’s financial results and, therefore, to our consolidated financial results, and could be implicated in our required testing of internal controls pursuant to the Sarbanes-Oxley Act of 2002.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable

(b) Not applicable

Item 3. Default Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

On May 5, 2020, Rhapsody International, Inc., which does business as Napster, executed a promissory note in favor of Bank of America, NA in the principal amount of $1.7 million, with an interest rate of 1.0% per annum, a two-year maturity, no pre-payment penalty, and a deferment period of six months. The note was issued pursuant to the Paycheck Protection Program established by the Coronavirus Aid, Relief, and Economic Security, or CARES, Act of 2020. The note is subject to customary events of default and is eligible for forgiveness pursuant to program guidelines.

Item 6. Exhibits

See Index to Exhibits below

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-Q Report to be signed on its behalf by the undersigned, thereunto duly authorized.

REALNETWORKS, INC.

By:

/s/ Judd Lee

Judd Lee

Title:

Senior Vice President, Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)

Dated: May 7, 2020

INDEX TO EXHIBITS


Exhibit Number			Description







31.1			Certification of Robert Glaser, Chairman and Chief Executive Officer of RealNetworks, Inc., pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2			Certification of Judd Lee, Chief Financial Officer of RealNetworks, Inc., pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1			Certification of Robert Glaser, Chairman and Chief Executive Officer of RealNetworks, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2			Certification of Judd Lee, Chief Financial Officer of RealNetworks, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS			XBRL Instance Document

101.SCH			XBRL Taxonomy Extension Schema Document

101.CAL			XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB			XBRL Taxonomy Extension Label Linkbase Document

101.PRE			XBRL Taxonomy Extension Presentation Linkbase Document

101.DEF			XBRL Taxonomy Extension Definition Linkbase Document

* Portions of the exhibit have been omitted.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. junior Avg

Realnetworks (RNWK) 10-Q2020 Q1 Quarterly report

Content analysis