e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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| þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended June 30, 2009
OR
| |
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|
| o |
|
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 0-23137
RealNetworks, Inc.
(Exact name of registrant as specified in its charter)
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|
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| Washington
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|
91-1628146 |
| (State of incorporation)
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|
(I.R.S. Employer Identification Number) |
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| 2601 Elliott Avenue, Suite 1000 |
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|
| Seattle, Washington
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|
98121 |
| (Address of principal executive offices)
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|
(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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
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
o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
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| Large accelerated filer þ |
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Accelerated filer o |
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Non-accelerated filer o
(Do not check if a smaller reporting company) |
|
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The number of shares of the registrant’s Common Stock outstanding as of July 31, 2009 was
134,784,251.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
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June 30, |
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December 31, |
|
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2009 |
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2008 |
|
ASSETS |
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|
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Current assets: |
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|
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Cash and cash equivalents |
|
$ |
197,492 |
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|
$ |
232,968 |
|
Short-term investments |
|
|
165,266 |
|
|
|
137,766 |
|
Trade accounts receivable, net of allowances for doubtful accounts and sales returns |
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64,413 |
|
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|
70,201 |
|
Deferred costs, current portion |
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6,111 |
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|
4,026 |
|
Prepaid expenses and other current assets |
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36,699 |
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34,599 |
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|
|
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|
|
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Total current assets |
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469,981 |
|
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|
479,560 |
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Equipment, software, and leasehold improvements, at cost: |
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|
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Equipment and software |
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143,374 |
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135,788 |
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Leasehold improvements |
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30,954 |
|
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30,719 |
|
|
|
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|
|
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Total equipment, software, and leasehold improvements, at cost |
|
|
174,328 |
|
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|
166,507 |
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Less accumulated depreciation and amortization |
|
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114,109 |
|
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|
103,500 |
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Net equipment, software, and leasehold improvements |
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60,219 |
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|
63,007 |
|
Restricted cash equivalents and investments |
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|
14,600 |
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|
14,742 |
|
Equity investments |
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22,384 |
|
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18,582 |
|
Other assets |
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|
3,782 |
|
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|
3,775 |
|
Deferred costs, non-current portion |
|
|
6,980 |
|
|
|
6,120 |
|
Deferred tax assets, net, non-current portion |
|
|
9,442 |
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|
9,236 |
|
Other intangible assets, net |
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|
14,268 |
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|
18,727 |
|
Goodwill |
|
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— |
|
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|
175,264 |
|
|
|
|
|
|
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Total assets |
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$ |
601,656 |
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$ |
789,013 |
|
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|
|
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LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
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Current liabilities: |
|
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|
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Accounts payable |
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$ |
34,666 |
|
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$ |
36,575 |
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Accrued and other liabilities |
|
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117,445 |
|
|
|
118,688 |
|
Deferred revenue, current portion |
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39,816 |
|
|
|
39,835 |
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Related party payable |
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6,930 |
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|
13,155 |
|
Accrued loss on excess office facilities, current portion |
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4,214 |
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|
4,317 |
|
|
|
|
|
|
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Total current liabilities |
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203,071 |
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|
212,570 |
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Deferred revenue, non-current portion |
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|
2,003 |
|
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|
1,961 |
|
Accrued loss on excess office facilities, non-current portion |
|
|
1,010 |
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|
2,893 |
|
Deferred rent |
|
|
4,564 |
|
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|
4,614 |
|
Deferred tax liabilities, net, non-current portion |
|
|
811 |
|
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|
1,379 |
|
Other long-term liabilities |
|
|
11,475 |
|
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|
11,660 |
|
|
|
|
|
|
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Total liabilities |
|
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222,934 |
|
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|
235,077 |
|
|
|
|
|
|
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Noncontrolling interest in Rhapsody America |
|
|
3,627 |
|
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|
378 |
|
Shareholders’ equity: |
|
|
|
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Preferred stock, $0.001 par value, no shares issued and outstanding: |
|
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Series A: authorized 200 shares |
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— |
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— |
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Undesignated series: authorized 59,800 shares |
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— |
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— |
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Common stock, $0.001 par value authorized 1,000,000 shares; issued and outstanding
134,772 shares in 2009 and 134,354 shares in 2008 |
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135 |
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|
134 |
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Additional paid-in capital |
|
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659,550 |
|
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642,705 |
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Accumulated other comprehensive loss |
|
|
(43,573 |
) |
|
|
(48,729 |
) |
Retained deficit |
|
|
(241,017 |
) |
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|
(40,552 |
) |
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|
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Total shareholders’ equity |
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|
375,095 |
|
|
|
553,558 |
|
|
|
|
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Total liabilities and shareholders’ equity |
|
$ |
601,656 |
|
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$ |
789,013 |
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|
|
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|
|
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|
See accompanying notes to unaudited condensed consolidated financial statements.
3
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share data)
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Quarters Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2009 |
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2008 |
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2009 |
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2008 |
|
Net revenue (A) |
|
$ |
135,725 |
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|
$ |
152,648 |
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|
$ |
276,498 |
|
|
$ |
300,211 |
|
Cost of revenue (B) |
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|
55,614 |
|
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|
55,645 |
|
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|
111,635 |
|
|
|
111,038 |
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|
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|
|
|
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Gross profit |
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80,111 |
|
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|
97,003 |
|
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|
164,863 |
|
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|
189,173 |
|
|
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|
|
|
|
|
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Operating expenses: |
|
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|
|
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|
|
|
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Research and development |
|
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28,923 |
|
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|
29,065 |
|
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57,482 |
|
|
|
54,071 |
|
Sales and marketing |
|
|
42,273 |
|
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|
53,054 |
|
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|
85,958 |
|
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|
106,650 |
|
Advertising with related party |
|
|
6,865 |
|
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|
9,240 |
|
|
|
14,288 |
|
|
|
16,580 |
|
General and administrative |
|
|
19,338 |
|
|
|
18,337 |
|
|
|
42,169 |
|
|
|
35,421 |
|
Impairment of goodwill |
|
|
175,583 |
|
|
|
— |
|
|
|
175,583 |
|
|
|
— |
|
Restructuring and other charges |
|
|
— |
|
|
|
— |
|
|
|
794 |
|
|
|
686 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses, net |
|
|
272,982 |
|
|
|
109,696 |
|
|
|
376,274 |
|
|
|
213,408 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss |
|
|
(192,871 |
) |
|
|
(12,693 |
) |
|
|
(211,411 |
) |
|
|
(24,235 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expenses): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income, net |
|
|
754 |
|
|
|
3,375 |
|
|
|
1,937 |
|
|
|
8,333 |
|
Equity in net loss of investments |
|
|
(269 |
) |
|
|
(107 |
) |
|
|
(924 |
) |
|
|
(198 |
) |
Gain on sale of equity investments, net |
|
|
68 |
|
|
|
222 |
|
|
|
205 |
|
|
|
222 |
|
Gain on sale of interest in Rhapsody America |
|
|
— |
|
|
|
3,371 |
|
|
|
— |
|
|
|
7,097 |
|
Other income, net |
|
|
(449 |
) |
|
|
50 |
|
|
|
406 |
|
|
|
818 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income, net |
|
|
104 |
|
|
|
6,911 |
|
|
|
1,624 |
|
|
|
16,272 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before income taxes |
|
|
(192,767 |
) |
|
|
(5,782 |
) |
|
|
(209,787 |
) |
|
|
(7,963 |
) |
Income taxes |
|
|
(1,210 |
) |
|
|
(3,700 |
) |
|
|
(2,759 |
) |
|
|
(7,708 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
|
(193,977 |
) |
|
|
(9,482 |
) |
|
|
(212,546 |
) |
|
|
(15,671 |
) |
Net loss attributable to noncontrolling interest in Rhapsody America |
|
|
5,648 |
|
|
|
8,177 |
|
|
|
12,081 |
|
|
|
16,792 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common shareholders |
|
$ |
(188,329 |
) |
|
$ |
(1,305 |
) |
|
$ |
(200,465 |
) |
|
$ |
1,121 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share available to common shareholders |
|
$ |
(1.40 |
) |
|
$ |
(0.01 |
) |
|
$ |
(1.51 |
) |
|
$ |
0.01 |
|
Diluted net income (loss) per share available to common shareholders |
|
$ |
(1.40 |
) |
|
$ |
(0.01 |
) |
|
$ |
(1.51 |
) |
|
$ |
0.01 |
|
Shares used to compute basic net income (loss) per share available to
common shareholders |
|
|
134,420 |
|
|
|
142,905 |
|
|
|
134,394 |
|
|
|
142,946 |
|
Shares used to compute diluted net income (loss) per share available to
common shareholders |
|
|
134,420 |
|
|
|
142,905 |
|
|
|
134,394 |
|
|
|
156,000 |
|
Comprehensive income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(193,977 |
) |
|
$ |
(9,482 |
) |
|
$ |
(212,546 |
) |
|
$ |
(15,671 |
) |
Unrealized holding losses (gains) on short-term and equity
investments, net of income taxes |
|
|
5,760 |
|
|
|
145 |
|
|
|
3,938 |
|
|
|
(289 |
) |
Foreign currency translation gains (losses) |
|
|
9,207 |
|
|
|
(12,269 |
) |
|
|
1,218 |
|
|
|
(20,331 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
|
(179,010 |
) |
|
|
(21,606 |
) |
|
|
(207,390 |
) |
|
|
(36,291 |
) |
Comprehensive loss attributable to noncontrolling interest |
|
|
5,648 |
|
|
|
8,177 |
|
|
|
12,081 |
|
|
|
16,792 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss attributable to common shareholders |
|
$ |
(173,362 |
) |
|
$ |
(13,429 |
) |
|
$ |
(195,309 |
) |
|
$ |
(19,499 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
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|
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|
(A) Components of net revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License fees |
|
$ |
24,389 |
|
|
$ |
28,613 |
|
|
$ |
50,568 |
|
|
$ |
54,368 |
|
Service revenue |
|
|
111,336 |
|
|
|
124,035 |
|
|
|
225,930 |
|
|
|
245,843 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
135,725 |
|
|
$ |
152,648 |
|
|
$ |
276,498 |
|
|
$ |
300,211 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(B) Components of cost of revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License fees |
|
$ |
9,869 |
|
|
$ |
10,614 |
|
|
$ |
19,115 |
|
|
$ |
20,002 |
|
Service revenue |
|
|
45,745 |
|
|
|
45,031 |
|
|
|
92,520 |
|
|
|
91,036 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
55,614 |
|
|
$ |
55,645 |
|
|
$ |
111,635 |
|
|
$ |
111,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to unaudited condensed consolidated financial statements.
4
REALNETWORKS, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| |
|
|
|
|
|
|
|
|
| |
|
Six Months Ended |
|
| |
|
June 30, |
|
| |
|
2009 |
|
|
2008 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(212,546 |
) |
|
$ |
(15,671 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
15,522 |
|
|
|
25,701 |
|
Stock-based compensation |
|
|
10,818 |
|
|
|
11,520 |
|
(Gain) loss on disposal of equipment, software, and leasehold improvements |
|
|
(34 |
) |
|
|
182 |
|
Equity in net loss of investments |
|
|
924 |
|
|
|
198 |
|
Gain on sale of equity investments, net |
|
|
(205 |
) |
|
|
(222 |
) |
Impairment of goodwill |
|
|
175,583 |
|
|
|
— |
|
Excess tax benefit from stock option exercises |
|
|
(9 |
) |
|
|
(88 |
) |
Accrued loss on excess office facilities |
|
|
(1,986 |
) |
|
|
(1,592 |
) |
Deferred income taxes |
|
|
(682 |
) |
|
|
(2,138 |
) |
Gain on sale of interest in Rhapsody America |
|
|
— |
|
|
|
(7,097 |
) |
Accrued restructuring and other charges |
|
|
(3,675 |
) |
|
|
— |
|
Other |
|
|
24 |
|
|
|
89 |
|
Net change in certain operating assets and liabilities, net of acquisitions: |
|
|
|
|
|
|
|
|
Trade accounts receivable |
|
|
5,716 |
|
|
|
14,614 |
|
Prepaid expenses and other assets |
|
|
(2,268 |
) |
|
|
(17,606 |
) |
Accounts payable |
|
|
(2,043 |
) |
|
|
(24,367 |
) |
Accrued and other liabilities |
|
|
(3,380 |
) |
|
|
(11,801 |
) |
|
|
|
|
|
|
|
Net cash used in operating activities |
|
|
(18,241 |
) |
|
|
(28,278 |
) |
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
Purchases of equipment, software, and leasehold improvements |
|
|
(7,608 |
) |
|
|
(15,231 |
) |
Purchases of short-term investments |
|
|
(66,192 |
) |
|
|
(95,671 |
) |
Proceeds from sales and maturities of short-term investments |
|
|
38,692 |
|
|
|
68,741 |
|
Decrease in restricted cash equivalents and investments, net |
|
|
141 |
|
|
|
839 |
|
Payment of acquisition costs, net of cash acquired |
|
|
(3,154 |
) |
|
|
(10,164 |
) |
Purchase of equity investments |
|
|
(2,000 |
) |
|
|
— |
|
Proceeds from sales of equity investments |
|
|
205 |
|
|
|
1,225 |
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(39,916 |
) |
|
|
(50,261 |
) |
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
Net proceeds from sale of common stock under employee stock purchase plan and
exercise of stock options |
|
|
819 |
|
|
|
6,041 |
|
Excess tax benefit from stock option exercises |
|
|
9 |
|
|
|
88 |
|
Net proceeds from sales of interest in Rhapsody America |
|
|
19,537 |
|
|
|
14,607 |
|
Repurchase of common stock |
|
|
— |
|
|
|
(681 |
) |
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
20,365 |
|
|
|
20,055 |
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and cash equivalents |
|
|
2,316 |
|
|
|
(2,408 |
) |
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents |
|
|
(35,476 |
) |
|
|
(60,892 |
) |
Cash and cash equivalents, beginning of period |
|
|
232,968 |
|
|
|
476,697 |
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period |
|
$ |
197,492 |
|
|
$ |
415,805 |
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
Cash received from income tax refunds |
|
$ |
5,942 |
|
|
$ |
— |
|
Cash paid for income taxes |
|
$ |
3,336 |
|
|
$ |
8,341 |
|
See accompanying notes to unaudited condensed consolidated financial statements.
5
REALNETWORKS, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Quarters and Six Months Ended June 30, 2009 and 2008
Note 1. Summary of Significant Accounting Policies
Description of Business. RealNetworks, Inc. and subsidiaries (RealNetworks or Company) is a
leading global provider of network-delivered digital media products and services. The Company also
develops and markets software products and services that enable the creation, distribution and
consumption of digital media, including audio and video.
Inherent in the Company’s business are various risks and uncertainties, including limited
history of certain of its product and service offerings and its limited history of offering premium
subscription services on the Internet. The Company’s success will depend on the acceptance of the
Company’s technology, products and services and the ability to generate related revenue.
Basis of Presentation. The unaudited condensed consolidated financial statements include the
accounts of the Company and its wholly-owned and majority-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation. Certain
reclassifications have been made to 2009 and 2008 amounts to conform to the current presentation.
The Company has evaluated subsequent events through the date and time the financial statements were
issued on August 6, 2009.
On August 20, 2007, RealNetworks and MTV Networks, a division of Viacom International Inc.
(MTVN), created Rhapsody America LLC (Rhapsody America) to jointly own and operate a
business-to-consumer digital audio music service. RealNetworks held a 51% interest in Rhapsody
America as of June 30, 2009. Rhapsody America’s financial position and operating results have been
consolidated into RealNetworks’ financial statements since its formation in August 2007. The
noncontrolling interest’s proportionate share of income (loss) is included in noncontrolling
interest in Rhapsody America in the unaudited condensed consolidated statements of operations and
comprehensive income (loss). MTVN’s proportionate share of equity is included in noncontrolling
interest in Rhapsody America in the unaudited condensed consolidated balance sheets.
The unaudited condensed consolidated financial statements reflect all adjustments, consisting
only of normal, recurring adjustments that, in the opinion of the Company’s management, are
necessary for a fair presentation of the results of operations for the periods presented. Operating
results for the quarter and six months ended June 30, 2009 are not necessarily indicative of the
results that may be expected for any subsequent quarter or for the year ending December 31, 2009.
Certain information and disclosures normally included in financial statements prepared in
conformity with accounting principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC).
These unaudited condensed consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and related notes included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.
Revenue Recognition. The Company recognizes revenue in accordance with the following
authoritative literature: AICPA Statement of Position (SOP) No. 97-2, Software Revenue Recognition;
SOP No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements; SOP No. 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type Contracts; SEC Staff
Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements; Financial
Accounting Standards Board’s (FASB) Emerging Issues Task Force (EITF) Issue No. 99-19, Reporting
Revenue Gross as a Principal versus Net as an Agent; and EITF Issue No. 00-21, Revenue Arrangements
with Multiple Deliverables. Generally, the Company recognizes revenue when there is persuasive
evidence of an arrangement, the fee is fixed or determinable, the product or services have been
delivered and collectibility of the resulting receivable is reasonably assured.
Consumer subscription products are paid in advance, typically for monthly, quarterly or annual
periods. Subscription revenue is recognized ratably over the related subscription period. Revenue
from sales of downloaded individual tracks, albums and games are recognized at the time the music
or game is made available, digitally, to the end user.
The Company recognizes revenue under the residual method for multiple element software
arrangements when vendor specific objective evidence (VSOE) exists for all of the undelivered
elements of the arrangement, but does not exist for one or more of the delivered elements in the
arrangement, under SOP No. 97-2. Under the residual method, at the outset of the arrangement with a
customer, the Company defers revenue for the fair value of the arrangement’s undelivered elements
such as post contract support (PCS), and recognizes revenue for the remainder of the arrangement
fee attributable to the elements initially delivered, such as
6
software licenses. VSOE for PCS is established on standard products for which no installation
or customization is required based upon amount charged when PCS is sold separately. For multiple
element software arrangements involving significant production, modification or customization of
the software, which are accounted for in accordance with the provisions of SOP No. 81-1, VSOE for
PCS is established if customers have an optional renewal rate specified in the arrangement and the
rate is substantive.
The Company has arrangements whereby customers pay one price for multiple products and
services and in some cases, involve a combination of products and services. For arrangements with
multiple deliverables, revenue is recognized upon the delivery of the individual deliverables in
accordance with EITF Issue No. 00-21. In the event that there is no objective and reliable evidence
of fair value of the delivered items, the revenue recognized upon delivery is the total arrangement
consideration less the fair value of the undelivered items. The Company applies significant
judgment in establishing the fair value of multiple elements within revenue arrangements.
The Company recognizes revenue on a gross or net basis in accordance with EITF Issue No.
99-19. In most arrangements, the Company contracts directly with end user customers, is the primary
obligor and carries all collectibility risk. In such arrangements the Company reports revenue on a
gross basis. In some cases, the Company utilizes third-party distributors to sell products or
services directly to end user customers and carries no collectibility risk. In such instances the
Company reports revenue on a net basis.
Revenue generated from advertising on the Company’s websites and from advertising included in
its products is recognized as revenue as the delivery of the advertising occurs.
Accounting for Gains on Sale of Subsidiary Stock. Effective January 1, 2009, the Company
adopted Statement of Financial Accounting Standards No. 160, Non-controlling Interests in
Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS 160) which requires the
difference between the carrying amount of the parent’s investment in a subsidiary and the
underlying net book value to be recorded as an equity transaction. Prior to the adoption of SFAS
160, the Company elected to recognize any such gain in the consolidated statement of operations in
accordance with SAB 51.
Noncontrolling Interests. The Company records noncontrolling interest expense (benefit) which
reflects the portion of the earnings (losses) of majority-owned entities which are applicable to
the noncontrolling interest partners in accordance with Accounting Research Bulletin No. 51,
Consolidated Financial Statements (ARB 51), SFAS 160, and EITF Topic No. D-98, Classification and
Measurement of Redeemable Securities (EITF D-98). Redeemable noncontrolling interests that are
redeemable at either fair value or are based on a formula that is intended to approximate fair
value follow the Company’s historical disclosure only policy for the redemption feature, and the
current redemption amount of the redeemable noncontrolling interests is disclosed in Note 4.
Redeemable noncontrolling interests that are redeemable at either a fixed price or are based on a
formula that is not akin to fair value are reflected as an adjustment to income (loss) attributable
to common shareholders based on the difference between accretion as calculated using the terms of
the redemption feature and the accretion entry for a hypothetical fair value redemption feature
with the remaining amount of accretion to redemption value recorded directly to equity.
Noncontrolling interest expense (benefit) is included within the condensed consolidated statements
of operations and comprehensive income (loss) for the quarters and six months ended June 30, 2009
and 2008.
As of June 30, 2009 and December 31, 2008, the Company’s noncontrolling interests solely
related to redeemable noncontrolling interests in Rhapsody America. See Note 4 for further
discussion of the redeemable noncontrolling interest treatment.
Note 2. Recent Accounting Pronouncements
With the exception of those discussed below, there have been no recent accounting
pronouncements or changes in accounting pronouncements during the quarter and six months ended June
30, 2009, as compared to the recent accounting pronouncements described in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008, that are of significance, or potential
significance to the Company.
Adopted Accounting Pronouncements
Effective January 1, 2009, the Company adopted SFAS No. 141 (revised 2007), Business
Combinations (SFAS 141(R)). Under SFAS 141(R), an entity is required to recognize the assets
acquired, liabilities assumed, contractual contingencies, and contingent consideration at their
fair value on the acquisition date. It further requires that acquisition-related costs be
recognized separately from the acquisition and expensed as incurred; that restructuring costs
generally be expensed in periods subsequent to the acquisition date; and that changes in accounting
for deferred tax asset valuation allowances and acquired income tax uncertainties after the
measurement period be recognized as a component of provision for taxes. In addition, acquired
in-process research and development
7
is capitalized as an intangible asset and amortized over its estimated useful life. SFAS
141(R) is effective on a prospective basis for all business combinations for which the acquisition
date is on or after January 1, 2009, with the exception of the accounting for valuation allowances
on deferred taxes and acquired contingencies under SFAS 109. With the adoption of SFAS 141(R), any
tax related adjustments associated with acquisitions that closed prior to January 1, 2009 will be
recorded through income tax expense, whereas the previous accounting treatment would require any
adjustment to be recognized through goodwill. The adoption of SFAS 141(R) had no impact on the
Company’s consolidated financial statements as of, and for the quarter and six months ended June
30, 2009.
Effective January 1, 2009, the Company adopted, FASB Staff Position (FSP) No. 142-3,
Determination of the Useful Life of Intangible Assets (FSP No. 142-3) that amends the factors
considered in developing renewal or extension assumptions used to determine the useful life of a
recognized intangible asset under Statement of Financial Accounting Standards No. 142 Goodwill and
Other Intangible Assets (SFAS 142). FSP No. 142-3 requires a consistent approach between the useful
life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used
to measure the fair value of an asset under SFAS No. 141(R). The FSP also requires enhanced
disclosures when an intangible asset’s expected future cash flows are affected by an entity’s
intent and/or ability to renew or extend the arrangement. The adoption did not have a material
impact on the Company’s consolidated results of operations or financial condition as of, and for
the quarter and six months ended June 30, 2009.
Effective January 1, 2009, the Company implemented Statement of Financial Accounting Standards
No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51
(SFAS 160). This standard changed the accounting for and reporting of noncontrolling interest
(previously called minority interest) in the consolidated financial statements. Upon adoption,
certain prior period amounts have been reclassified to conform to the current period financial
statement presentation. These reclassifications have no effect on the Company’s previously reported
financial position or results of operations. Refer to Note 4, Rhapsody America, and Note 13,
Earnings per Share, of this report for additional information on the adoption of SFAS 160.
Effective January 1, 2009, the Company adopted FSP APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (FSP
14-1). FSP 14-1 specifies that the liability and equity components of convertible debt instruments
that may be settled in cash upon conversion (including partial cash settlement) be separately
accounted for in a manner that reflects an issuer’s nonconvertible debt borrowing rate and requires
retrospective application for all periods presented. The adoption did not have a material impact
on the Company’s consolidated results of operations or financial condition for all periods
presented.
Effective for the quarter ending June 30, 2009, the Company adopted SFAS No. 165, Subsequent
Events (SFAS 165). SFAS 165 is intended to establish general standards of accounting for, and
disclosure of, events that occur after the balance sheet date but before financial statements are
issued. It requires the disclosure of the date through which an entity has evaluated subsequent
events and the basis for that date.
Effective for the quarter ending June 30, 2009, the Company adopted FSP No. 115-2 and 124-2,
Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2 and 124-2). FSP 115-2
and 124-2 provides new guidance on the recognition and presentation of an other-than-temporary
impairments, as well as extends certain annual disclosure requirements to interim periods. The
adoption did not have a material impact on the Company’s financial position or results of
operations.
Note 3. Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with SFAS No. 123R — revised
2004, Share-Based Payment (SFAS 123R). Under the fair value provisions of the statement,
stock-based compensation cost is measured at the grant date based on the fair value of the award
and is recognized as expense over the requisite service period, which is the vesting period. The
Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based
awards under SFAS 123R. The Company recognizes compensation cost related to options granted on a
straight-line basis over the applicable vesting period.
The expected term of the options represents the estimated period of time until exercise and is
based on historical experience of similar awards, including the contractual terms, vesting
schedules, and expectations of future employee behavior. Expected stock price volatility is based
on a combination of historical volatility of the Company’s stock for the related expected term and
the implied volatility of its traded options. The risk-free interest rate is based on the implied
yield available on U.S. Treasury zero-coupon issues with a term equivalent to the expected term of
the stock options. The Company has not paid dividends in the past.
8
The fair value of options granted was determined using the Black-Scholes model and the
following weighted-average assumptions:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters |
|
Six Months |
| |
|
Ended June 30, |
|
Ended June 30, |
| |
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Expected dividend yield
|
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
|
|
0 |
% |
Risk-free interest rate
|
|
|
1.76 |
% |
|
|
2.96 |
% |
|
|
1.64 |
% |
|
|
2.61 |
% |
Expected life (years)
|
|
|
4.2 |
|
|
|
4.2 |
|
|
|
4.2 |
|
|
|
4.2 |
|
Volatility
|
|
|
63 |
% |
|
|
45 |
% |
|
|
63 |
% |
|
|
45 |
% |
Recognized stock-based compensation expense is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters |
|
|
Six Months |
|
| |
|
Ended June 30, |
|
|
Ended June 30, |
|
| |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Cost of revenue |
|
$ |
363 |
|
|
$ |
662 |
|
|
$ |
993 |
|
|
$ |
896 |
|
Research and development |
|
|
2,234 |
|
|
|
2,146 |
|
|
|
4,058 |
|
|
|
4,059 |
|
Sales and marketing |
|
|
1,199 |
|
|
|
1,433 |
|
|
|
2,265 |
|
|
|
3,341 |
|
General and administrative |
|
|
1,800 |
|
|
|
1,790 |
|
|
|
3,502 |
|
|
|
3,224 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation expense |
|
$ |
5,596 |
|
|
$ |
6,031 |
|
|
$ |
10,818 |
|
|
$ |
11,520 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No stock-based compensation was capitalized as part of the cost of an asset during the
quarters or six months ended June 30, 2009 or 2008. As of June 30, 2009, $26.2 million of total
unrecognized compensation cost, net of estimated forfeitures, related to stock options, is expected
to be recognized over a weighted-average period of 2.2 years.
Note 4. Rhapsody America
Formation
On August 20, 2007, RealNetworks and MTVN created Rhapsody America to jointly own and operate
a business-to-consumer digital audio music service. Under the Rhapsody America venture agreements:
| |
• |
|
RealNetworks contributed its Rhapsody service subscribers, RadioPass subscribers,
cash, contracts, revenue from existing Rhapsody subscribers, marketing materials, player
hardware, rhapsody.com and related URLs, certain liabilities, and distribution
arrangements in exchange for a 51% equity interest in Rhapsody America. RealNetworks also
licensed certain assets to Rhapsody America, including Rhapsody content, Rhapsody
technology, the Rhapsody brands and related materials. |
| |
| |
• |
|
MTVN contributed its URGE service subscribers, cash, contracts, marketing
materials, and revenue from existing URGE subscribers, certain liabilities, plus the note
payable described below, in exchange for a 49% equity interest in Rhapsody America. MTVN
has also licensed certain assets to Rhapsody America, including URGE content, brands and
related materials. |
| |
| |
• |
|
In addition to the assets described above, MTVN also contributed a $230 million
five-year note payable in consideration for acquiring MTVN’s interest in the venture. In
February 2009, RealNetworks and MTVN signed an amendment to the Rhapsody America venture
agreement to true-up the original fair values contributed to the venture. The amendment
reduced the MTVN note payable from $230.0 million to $213.8 million over the same
five-year term. Rhapsody America must use the proceeds from the note solely to purchase
advertising from MTVN. As MTVN makes payments on the note, Rhapsody America records
equity and RealNetworks realizes an immediate appreciation in the carrying value of the
Company’s interests in the venture. |
| |
| |
|
|
Effective January 1, 2009, the Company adopted SFAS 160 which requires the
appreciation of gains on the sale of non-controlling interest to be recorded as an equity
transaction. Prior to the adoption of SFAS 160, the Company elected to recognize any such
gain in the consolidated statement of operations in accordance with SAB 51. MTVN made
payments of $7.2 million and $14.4 million during the quarter and six months ended June 30,
2008, respectively. As a result, RealNetworks realized and recorded gains in the condensed
consolidated statements of operations for the quarter and six months ended June 30, 2008 of
$3.7 million and $7.3 million, respectively, as all of the SAB 51 gain criteria were met.
During the quarter and six months ended June 30, 2009, MTVN made payments of $6.9 million
and $14.5 million, respectively, for which the sale of ownership interests in Rhapsody
America have been reflected as an equity transaction
and $3.5 million and $7.4 million, respectively, have been recorded directly to
shareholders’ equity. As of June 30, 2009, $84.0 million in payments have been made on the
note since the formation of Rhapsody America. |
9
Call/Put Rights
Pursuant to the terms of the Rhapsody America limited liability company agreement,
RealNetworks has the right to purchase from MTVN, and MTVN has a right to require RealNetworks to
purchase, MTVN’s interest in Rhapsody America. The Company has evaluated the terms of the call and
put rights under applicable accounting literature, including SFAS No. 133, Accounting for
Derivatives and Hedging Activities, and SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity, and concluded that neither of these rights
represent freestanding financial instruments or derivatives that should be accounted for
separately.
These call and put rights are exercisable upon the occurrence of certain events any time after
January 1, 2011 and during certain periods in each of 2012, 2013 and 2014 and every two years
thereafter, and are not exercisable any time prior to January 1, 2011. If MTVN exercises its put
right, RealNetworks has the right to pay a portion of the purchase price for MTVN’s interest in
cash and shares of RealNetworks capital stock, subject to certain maximum amounts, with the balance
(if any) to be paid with a note. If RealNetworks exercises its call right, MTVN has the right to
demand payment of part of the purchase price for its membership interest in shares of RealNetworks’
capital stock. If a portion of the purchase price for MTVN’s interest is payable in shares of
RealNetworks’ capital stock, such shares could consist of RealNetworks’ common stock representing
up to 15% of the outstanding shares of RealNetworks’ common stock immediately prior to the
transaction, and shares of our non-voting stock representing up to an additional 4.9% of the
outstanding shares of RealNetworks’ common stock immediately prior to the transaction, representing
a maximum total of 19.9% of RealNetworks’ capital stock. If RealNetworks pays a portion of the
purchase price for MTVN’s membership interest in shares of RealNetworks’ common stock and
non-voting stock, RealNetworks other shareholders’ voting and economic interests in RealNetworks
could be diluted, and MTVN will become one of RealNetworks’ significant shareholders.
The redemption prices of MTVN’s interest in Rhapsody America under both the call and put
rights are calculated based on the provisions within the limited liability agreement, as amended,
are impacted by the total appraised value of Rhapsody America and assume repayment of the $213.8
million five-year note payable from MTVN. Once the call right becomes exercisable, the redemption
price of MTVN’s interest in Rhapsody America under the call right will be equal to the greater of
$213.8 million or the appraised value of MTVN’s interest in Rhapsody America at the redemption
date.
Once the put right becomes exercisable, the redemption price of MTVN’s interest in Rhapsody
America under the put right will be based on a formula that is dependent on the appraised value of
Rhapsody America. If the appraised value of Rhapsody America at that time is equal to or greater
than $436.3 million, the implied fair value of the venture at its inception, then the exercise
price of the put is equal to the appraised value. If the appraised value of Rhapsody America at the
redemption date is less than $436.3 million, then the exercise price of the put includes a
preferred return due to MTVN.
For the period from August 20, 2007 (inception of the venture) through September 30, 2008, the
Company determined that the value of the Rhapsody America venture had not declined from its initial
implied fair value and assessed the probability that the put would include a preferred return as
remote. The formula that determined that put redemption amount was considered to approximate fair
value for this period. However, beginning with the fourth quarter of 2008, the current appraised
value of Rhapsody America was determined to have declined to the point where the Company has
determined that the likelihood of the put triggering the preferred return when exercisable was no
longer remote and considered the put formula to no longer approximate fair value. Beginning with
the fourth quarter of 2008, the Company has accounted for the noncontrolling interest as having a
fixed price redemption feature.
The hypothetical current redemption price of MTVN’s interest in Rhapsody America under the put
right at June 30, 2009 before consideration of the remaining payments due on the note was
approximately $27.1 million. The current redemption price has been adjusted under the formula in
the limited liability agreement for the remaining outstanding amounts due of $129.8 million on the
note payable as of June 30, 2009. The Company has elected to accrete any excess of the redemption
value over the carrying amount as an adjustment to income attributable to common shareholders and
has adjusted earnings per share for the current quarter’s accretion of the difference between
accretion as calculated using the terms of the redemption feature and the accretion entry for a
hypothetical fair value redemption feature. For the quarter and six months ended June 30, 2009, the
Company increased the noncontrolling interest on the Condensed Consolidated Balance Sheets by $0.4
million and $1.8 million, respectively, which was an adjustment to income attributable to common
shareholders for the purposes of calculating earnings per share. See Note 13, Earnings Per Share,
for more information on this item. For 2008, this amount was nominal to the condensed consolidated
financial statements.
10
Noncontrolling interest rollforward
Activity in noncontrolling interest and equity attributable to common shareholders is as
follows (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
Noncontrolling interest |
|
|
Total Equity |
|
Balances, December 31, 2007 |
|
$ |
19,613 |
|
|
$ |
875,104 |
|
Net income (loss) |
|
|
(16,792 |
) |
|
|
1,121 |
|
Contribution and other transactions with owners |
|
|
8,110 |
|
|
|
— |
|
Unrealized holding losses on short-term and equity investments, net of taxes |
|
|
— |
|
|
|
(289 |
) |
Foreign currency translation losses |
|
|
— |
|
|
|
(20,331 |
) |
Stock-based transactions and compensation expense, net of taxes |
|
|
— |
|
|
|
16,105 |
|
|
|
|
|
|
|
|
Balances, June 30, 2008 |
|
$ |
10,931 |
|
|
$ |
871,710 |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
| |
|
Noncontrolling interest |
|
|
Total Equity |
|
Balances, December 31, 2008 |
|
$ |
378 |
|
|
$ |
553,558 |
|
Net loss |
|
|
(12,081 |
) |
|
|
(200,465 |
) |
Contribution and other transactions with owners |
|
|
13,475 |
|
|
|
7,237 |
|
Accretion of MTVN’s equity interest in Rhapsody Amercia |
|
|
5 |
|
|
|
(5 |
) |
Accretion of MTVN’s preferred return in Rhapsody Amercia |
|
|
1,850 |
|
|
|
(1,850 |
) |
Unrealized holding losses on short-term and equity investments, net of taxes |
|
|
— |
|
|
|
3,938 |
|
Foreign currency translation losses |
|
|
— |
|
|
|
1,218 |
|
Stock-based transactions and compensation expense, net of taxes |
|
|
— |
|
|
|
11,464 |
|
|
|
|
|
|
|
|
Balances, June 30, 2009 |
|
$ |
3,627 |
|
|
$ |
375,095 |
|
|
|
|
|
|
|
|
Note 5. Fair Value Measurements
Effective January 1, 2008, the Company implemented SFAS No. 157, Fair Value Measurement (SFAS
157), for its financial assets and liabilities that are remeasured and reported at fair value at
each reporting period, and non-financial assets and liabilities that are remeasured and reported at
fair value at least annually. Effective the quarter ended March 31, 2009, the Company implemented
SFAS 157 for our nonfinancial assets and liabilities that are remeasured at fair value on a
non-recurring basis. The adoption of SFAS 157 for our nonfinancial assets and liabilities that are
remeasured at fair value on a non-recurring basis did not impact our financial position or results
of operations as of and for the quarter and six months ended June 30, 2009; however, SFAS 157 could
have an impact in future periods. In addition, we may have additional disclosure requirements in
the event we complete an acquisition or incur impairment of our assets in future periods.
SFAS No. 157 establishes a hierarchy that prioritizes fair value measurements based on the
types of inputs used for the various valuation techniques (market approach, income approach and
cost approach). The levels of the hierarchy are described below:
| |
• |
|
Level 1: Observable inputs such as quoted prices in active markets for identical
assets or liabilities |
| |
| |
• |
|
Level 2: Inputs other than quoted prices that are observable for the asset or
liability, either directly or indirectly; these include quoted prices for similar assets
or liabilities in active markets and quoted prices for identical or similar assets or
liabilities in markets that are not active |
| |
| |
• |
|
Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions |
11
Items Measured at Fair Value on a Recurring Basis
The following table presents information about the Company’s financial assets that have been
measured at fair value (in thousands) on a recurring basis as of June 30, 2009 and December 31,
2008 and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair
value.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Fair Value Measurements as of |
|
| |
|
June 30, 2009 |
|
| |
|
Total |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
| |
|
(In thousands) |
|
Cash equivalents |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds |
|
$ |
143,051 |
|
|
$ |
143,051 |
|
|
$ |
— |
|
|
$ |
— |
|
Short-term investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds |
|
|
90,912 |
|
|
|
90,912 |
|
|
|
— |
|
|
|
— |
|
U.S. government agency securities |
|
|
74,354 |
|
|
|
74,354 |
|
|
|
— |
|
|
|
— |
|
Equity investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Publicly traded investments |
|
|
16,630 |
|
|
|
16,630 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
324,947 |
|
|
$ |
324,947 |
|
|
$ |
— |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Fair Value Measurements as of |
|
| |
|
December 31, 2008 |
|
| |
|
Total |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
| |
|
(In thousands) |
|
Cash equivalents |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds |
|
$ |
157,063 |
|
|
$ |
157,063 |
|
|
$ |
— |
|
|
$ |
— |
|
U.S. government agency securities |
|
|
4,292 |
|
|
|
4,292 |
|
|
|
— |
|
|
|
— |
|
Short-term investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. government agency securities |
|
|
84,330 |
|
|
|
84,330 |
|
|
|
— |
|
|
|
— |
|
Corporate notes and bonds |
|
|
53,436 |
|
|
|
53,436 |
|
|
|
— |
|
|
|
— |
|
Equity investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Publicly traded investments |
|
|
13,903 |
|
|
|
13,903 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
313,024 |
|
|
$ |
313,024 |
|
|
$ |
— |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments in marketable securities classified as short-term investments and equity
investments of public companies are measured at fair value using quoted market prices and are
classified within Level 1 of the valuation hierarchy. The Company carries its equity investments in
private companies at cost and are excluded from the provisions of SFAS 157. The Company has
consistently applied these valuation techniques in all periods presented.
Items Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities of the Company are measured at estimated fair value on a
non-recurring basis. These instruments are subject to fair value adjustments only in certain
circumstances (for example, when there is evidence of impairment). The Company performed a
valuation of its goodwill as of June 30, 2009 using Level 3 inputs and recorded goodwill impairment
charges of $175.6 million during the quarter and six months ended June 30, 2009. See “Note 10.
Goodwill” for a description of the inputs, valuation techniques and other information used to
determine the fair value of the Company’s goodwill as of June 30, 2009 and the related impairments.
Note 6. Cash, Cash Equivalents, Trading Securities, Short-Term Investments, and Restricted Cash
Equivalents and Investments
Cash, cash equivalents, trading securities, short-term investments, and restricted cash
equivalents and investments as of June 30, 2009 consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash |
|
$ |
54,441 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
54,441 |
|
Money market mutual funds |
|
|
143,051 |
|
|
|
— |
|
|
|
— |
|
|
|
143,051 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash and cash equivalents: |
|
|
197,492 |
|
|
|
— |
|
|
|
— |
|
|
|
197,492 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds |
|
|
90,281 |
|
|
|
1,021 |
|
|
|
(390 |
) |
|
|
90,912 |
|
U.S. Government agency securities |
|
|
74,263 |
|
|
|
130 |
|
|
|
(39 |
) |
|
|
74,354 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total short-term investments: |
|
|
164,544 |
|
|
|
1,151 |
|
|
|
(429 |
) |
|
|
165,266 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash, cash equivalents and short-term investments |
|
$ |
362,036 |
|
|
$ |
1,151 |
|
|
$ |
(429 |
) |
|
$ |
362,758 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted cash equivalents and investments |
|
$ |
14,600 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
14,600 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
Cash, cash equivalents, short-term investments, and restricted cash equivalents as of December
31, 2008 consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash |
|
$ |
71,613 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
71,613 |
|
Money market mutual funds |
|
|
156,803 |
|
|
|
260 |
|
|
|
— |
|
|
|
157,063 |
|
U.S. government agency securities |
|
|
4,203 |
|
|
|
89 |
|
|
|
— |
|
|
|
4,292 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash and cash equivalents |
|
|
232,619 |
|
|
|
349 |
|
|
|
— |
|
|
|
232,968 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate notes and bonds |
|
|
54,685 |
|
|
|
154 |
|
|
|
(1,403 |
) |
|
|
53,436 |
|
U.S. Government agency securities |
|
|
83,920 |
|
|
|
410 |
|
|
|
— |
|
|
|
84,330 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total short-term investments |
|
|
138,605 |
|
|
|
564 |
|
|
|
(1,403 |
) |
|
|
137,766 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cash, cash equivalents, and short-term investments |
|
$ |
371,224 |
|
|
$ |
913 |
|
|
$ |
(1,403 |
) |
|
$ |
370,734 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted cash equivalents |
|
$ |
14,742 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
14,742 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At June 30, 2009 and December 31, 2008, restricted cash equivalents and investments represent
cash equivalents and short-term investments pledged as collateral against two letters of credit for
a total of $14.6 million and $14.7 million, respectively, in connection with two lease agreements.
Realized gains or losses on sales of available-for-sale securities for the quarters and six
months ended June 30, 2009 and 2008 were not significant.
Changes in estimated fair values of short-term investments are primarily related to changes in
interest rates and are considered to be temporary in nature.
The contractual maturities of available-for-sale investments at June 30, 2009 are as follows
(in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
Amortized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Fair Value |
|
Within one year |
|
$ |
57,345 |
|
|
$ |
57,484 |
|
Between one year and five years |
|
|
105,664 |
|
|
|
106,250 |
|
Between five years and fifteen years |
|
|
1,535 |
|
|
|
1,532 |
|
|
|
|
|
|
|
|
Total available-for-sale investments |
|
$ |
164,544 |
|
|
$ |
165,266 |
|
|
|
|
|
|
|
|
Note 7. Allowance for Doubtful Accounts Receivable and Sales Returns
Activity in the allowance for doubtful accounts receivable and sales returns is as follows (in
thousands):
| |
|
|
|
|
|
|
|
|
| |
|
Allowance For |
|
| |
|
Doubtful |
|
|
|
|
| |
|
Accounts |
|
|
Sales |
|
| |
|
Receivable |
|
|
Returns |
|
Balances, December 31, 2008 |
|
$ |
3,532 |
|
|
$ |
1,099 |
|
Additions charged to expenses |
|
|
504 |
|
|
|
845 |
|
Amounts written off |
|
|
(1,778 |
) |
|
|
(888 |
) |
|
|
|
|
|
|
|
Balances, June 30, 2009 |
|
$ |
2,258 |
|
|
$ |
1,056 |
|
|
|
|
|
|
|
|
Two customers accounted for 23% and 10% of trade accounts receivable, respectively, as of June
30, 2009. As of December 31, 2008, one customer accounted for 20% of trade accounts receivable. No
one customer accounted for more than 10% of total revenue during the quarters and six months ended
June 30, 2009 and 2008.
Note 8. Equity Investments
As of June 30, 2009 and December 31, 2008, the carrying value of equity investments in
publicly traded companies primarily relates to J-Stream Inc., a Japanese media services company,
and LoEn Entertainment, Inc., a Korean digital music distribution company. These equity investments
are accounted for as available-for-sale. The market for these investments is relatively limited and
the share price is volatile. Although the carrying value of the total equity investments was $22.4
million at June 30, 2009, there can be no assurance that any gain can be realized through the
disposition of these shares.
13
Summary of equity investments is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
June 30, 2009 |
|
|
December 31, 2008 |
|
| |
|
|
|
|
|
Carrying |
|
|
|
|
|
|
Carrying |
|
| |
|
Cost |
|
|
Value |
|
|
Cost |
|
|
Value |
|
Publicly traded investments |
|
$ |
10,765 |
|
|
$ |
16,630 |
|
|
$ |
10,765 |
|
|
$ |
13,903 |
|
Privately held investments |
|
|
7,364 |
|
|
|
5,754 |
|
|
|
5,695 |
|
|
|
4,679 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity investments |
|
$ |
18,129 |
|
|
$ |
22,384 |
|
|
$ |
16,460 |
|
|
$ |
18,582 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 9. Other Intangible Assets
Other intangible assets at June 30, 2009 consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Gross |
|
|
Accumulated |
|
|
|
|
| |
|
Amount |
|
|
Amortization |
|
|
Net |
|
Customer relationships |
|
$ |
34,011 |
|
|
$ |
23,877 |
|
|
$ |
10,134 |
|
Developed technology |
|
|
28,681 |
|
|
|
25,355 |
|
|
|
3,326 |
|
Patents, trademarks and tradenames |
|
|
6,407 |
|
|
|
6,248 |
|
|
|
159 |
|
Service contracts and other |
|
|
5,859 |
|
|
|
5,210 |
|
|
|
649 |
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets |
|
$ |
74,958 |
|
|
$ |
60,690 |
|
|
$ |
14,268 |
|
|
|
|
|
|
|
|
|
|
|
Other intangible assets at December 31, 2008 consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Gross |
|
|
Accumulated |
|
|
|
|
| |
|
Amount |
|
|
Amortization |
|
|
Net |
|
Customer relationships |
|
$ |
34,004 |
|
|
$ |
21,705 |
|
|
$ |
12,299 |
|
Developed technology |
|
|
28,673 |
|
|
|
23,849 |
|
|
|
4,824 |
|
Patents, trademarks and tradenames |
|
|
8,556 |
|
|
|
7,176 |
|
|
|
1,380 |
|
Service contracts and other |
|
|
3,711 |
|
|
|
3,487 |
|
|
|
224 |
|
|
|
|
|
|
|
|
|
|
|
Total other intangible assets |
|
$ |
74,944 |
|
|
$ |
56,217 |
|
|
$ |
18,727 |
|
|
|
|
|
|
|
|
|
|
|
Amortization expense related to other intangible assets during the quarter and six months
ended June 30, 2009 was $2.2 million and $4.5 million, respectively. Amortization expense related
to other intangible assets during the quarter and six months ended June 30, 2008 was $6.9 million
and $13.9 million, respectively.
As of June 30, 2009, estimated future amortization of other intangible assets is as follows
(in thousands):
| |
|
|
|
|
2009 (remaining six months) |
|
$ |
4,073 |
|
2010 |
|
|
4,383 |
|
2011 |
|
|
2,156 |
|
2012 |
|
|
1,924 |
|
2013 |
|
|
1,495 |
|
Thereafter |
|
|
237 |
|
|
|
|
|
Total |
|
$ |
14,268 |
|
|
|
|
|
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS 144), the Company reviews long-lived assets for impairment whenever events or changes
in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability
of these assets is measured by comparing their carrying amount to future undiscounted cash flows
the assets are expected to generate. If long-lived assets are considered to be impaired, the
impairment to be recognized equals the amount by which the carrying value of the assets exceeds
their fair market value. The Company did not record any impairments to long-lived assets during the
quarters and six months ended June 30, 2009 or 2008.
The impairment analysis of long-lived assets is based upon estimates and assumptions relating
to the Company’s future revenue, cash flows, operating expenses, costs of capital and capital
purchases. These estimates and assumptions are complex and subject to a significant degree of
judgment with respect to certain factors including, but not limited to, the cash flows of our
long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and
cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse
changes in the Company’s business climate, among other factors, and their resulting impact on the
estimates and assumptions relating to the value of the Company’s long-lived assets could result in
the need to perform an impairment analysis under SFAS 144 in future periods which could result in a
significant impairment.
14
Note 10. Goodwill
Changes in goodwill are as follows (in thousands):
| |
|
|
|
|
Balance, December 31, 2008 |
|
$ |
175,264 |
|
Effects of foreign currency translation |
|
|
319 |
|
Impairment of goodwill |
|
|
(175,583 |
) |
|
|
|
|
Balance, June 30, 2009 |
|
$ |
— |
|
|
|
|
|
In accordance with SFAS 142, goodwill is required to be tested for impairment annually and if
an event or conditions change that would more likely than not reduce the fair value of a reporting
unit below its carrying value. The Company performs its annual goodwill impairment test during its
fiscal fourth quarter.
A two step process is used to test for goodwill impairment under SFAS 142. The first step is
to determine if there is an indication of impairment by comparing the estimated fair value of each
reporting unit to its carrying value including existing goodwill. Goodwill is considered impaired
if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of
impairment from the first step, a second step is performed to determine the amount of the
impairment. This involves calculating the implied fair value of goodwill by allocating the fair
value of the reporting unit to all assets and liabilities other than goodwill and comparing it to
the carrying amount of goodwill. The Company has four reporting units: Music, Technology Products
and Solutions, Games, and Media Software and Services.
The Company considered whether a triggering event had occurred during the quarter ended June
30, 2009 in assessing whether an interim impairment analysis of goodwill was warranted. The
Company noted its market
capitalization, before adjusting for a reasonable control premium, was below its carrying value.
In addition, the Company noticed that the trading price per share of the Company’s common stock had
negatively diverged from the broader market during 2009. The Company also noted, more broadly, a
continuation of macroeconomic instability in general as well as continued illiquidity in the
overall credit market. As a result, the Company concluded that due to the sustained divergence in
the Company’s market capitalization and the continued macroeconomic instability, an interim
impairment analysis of goodwill as of June 30, 2009 was warranted.
To estimate the fair value of the reporting units for step one, the Company utilized a
combination of income and market approaches. The income approach, specifically a discounted cash
flow methodology, included assumptions and estimates for, among other things, forecasted revenues,
gross profit margins, operating profit margins, working capital cash flow, growth rates and long
term discount rates, all of which require significant judgments by management. The market
approaches derive fair values by benchmarking metrics and transactions of companies that are
comparable to the Company.
The impairment analysis of goodwill is based upon estimates and assumptions relating to the
Company’s future revenue, cash flows, operating expenses, costs of capital and capital purchases.
These estimates and assumptions are complex and subject to a significant degree of judgment with
respect to certain factors including, but not limited to, the cash flows of our long-term operating
plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.
In performing step one, it was determined that the carrying value for each of the Company’s
reporting units; Music, Technology Products and Solutions, Games, and Media Software and Services
exceeded their respective fair values, indicating that goodwill within each reporting unit was
potentially impaired. The Company also performed a market capitalization reconciliation to ensure
that the resulting outputs of the test and the total Company fair value were reasonable. As
required, the Company initiated the second step of the goodwill impairment test for each of the
reporting units. The Company determined that the implied fair value of goodwill was zero for each
of its reporting units. As a result, the Music, Technology Products and Solutions, Games, and
Media Software and Services reporting units recorded impairments of $37.0 million, $50.5 million,
$41.2 million and $46.8 million, respectively during the quarter ended June 30, 2009. No
impairments were recognized in either the quarter or six months ended June 30, 2008.
15
Note 11. Accrued and Other Liabilities
Accrued and other liabilities consist of (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
June 30, |
|
|
December 31, |
|
| |
|
2009 |
|
|
2008 |
|
Royalties and other fulfillment costs |
|
$ |
54,921 |
|
|
$ |
55,247 |
|
Employee compensation, commissions and benefits |
|
|
21,778 |
|
|
|
21,679 |
|
Sales, VAT and other taxes payable |
|
|
15,414 |
|
|
|
16,801 |
|
Legal fees and contingent legal fees |
|
|
5,734 |
|
|
|
3,290 |
|
Other |
|
|
19,598 |
|
|
|
21,671 |
|
|
|
|
|
|
|
|
Total |
|
$ |
117,445 |
|
|
$ |
118,688 |
|
|
|
|
|
|
|
|
Note 12. Loss on Excess Office Facilities
The accrued loss of $5.2 million for estimated future losses on excess office facilities
located near the Company’s corporate headquarters in Seattle Washington at June 30, 2009, is shown
net of expected future sublease income of $3.5 million, which was committed under sublease
contracts at the time of the estimate. The Company regularly evaluates the market for office space
in the cities where it has operations. If the market for such space declines further in future
periods, the Company may have to revise its estimates further, which may result in additional
losses on excess office facilities.
A summary of activity for accrued loss on excess office facilities is as follows (in
thousands):
| |
|
|
|
|
Accrued loss on excess office facilities, December 31, 2008 |
|
$ |
7,210 |
|
Less amounts amortized from the accrued loss on excess office facilities |
|
|
(1,986 |
) |
|
|
|
|
Accrued loss on excess office facilities, June 30, 2009 |
|
|
5,224 |
|
Less current portion |
|
|
(4,214 |
) |
|
|
|
|
Accrued loss on excess office facilities, non-current portion |
|
$ |
1,010 |
|
|
|
|
|
Note 13. Earnings Per Share
Basic net income (loss) available to common shareholders per share is computed by dividing net
income (loss) attributable to common shareholders less any accretion from MTVN’s preferred return
in Rhapsody America by the weighted average number of common shares outstanding during the period.
Diluted net income (loss) available to common shareholders per share is computed by dividing net
income (loss) attributable to common shareholders less any accretion from MTVN’s preferred return
in Rhapsody America by the weighted average number of common and dilutive potential common shares
outstanding during the period. Share count used to compute basic and diluted net income available
to common share holders per share is calculated as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Net income (loss) available to common shareholders: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to common shareholders |
|
$ |
(188,329 |
) |
|
$ |
(1,305 |
) |
|
$ |
(200,465 |
) |
|
$ |
1,121 |
|
Less accretion of MTVN’s preferred return in
Rhapsody America |
|
|
(416 |
) |
|
|
— |
|
|
|
(1,850 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) available to common shareholders |
|
$ |
(188,745 |
) |
|
$ |
(1,305 |
) |
|
$ |
(202,315 |
) |
|
$ |
1,121 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding used to
compute basic net income (loss) per share available to
common shareholders |
|
|
134,420 |
|
|
|
142,905 |
|
|
|
134,394 |
|
|
|
142,946 |
|
Dilutive potential common shares: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options and restricted stock |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,304 |
|
Convertible debt |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
10,750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used to compute diluted net income (loss)
per share available to common shareholders |
|
|
134,420 |
|
|
|
142,905 |
|
|
|
134,394 |
|
|
|
156,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share available to
common shareholders |
|
$ |
(1.40 |
) |
|
$ |
(0.01 |
) |
|
$ |
(1.51 |
) |
|
$ |
0.01 |
|
Diluted net income (loss) per share available to
common shareholders |
|
$ |
(1.40 |
) |
|
$ |
(0.01 |
) |
|
$ |
(1.51 |
) |
|
$ |
0.01 |
|
During the quarter and six months ended June 30, 2009, 38.7 million and 38.9 million shares of
common stock, respectively, potentially issuable from stock options were excluded from the
calculation of diluted net income per share because of their antidilutive
16
effect. During the quarter and six months ended June 30, 2008, 32.8 million and 33.1 million
shares of common stock, respectively, potentially issuable from stock options were excluded from
the calculation of diluted net income per share because of their antidilutive effect.
Note 14. Commitments and Contingencies
Borrowing Arrangements. The Company’s subsidiary, WiderThan, has entered into lines of credit
with two Korean domestic banks with an aggregate maximum available limit of $1.6 million at
interest rates of approximately 2.9% over the rate earned on the underlying deposits. During the
quarter and six months ended June 30, 2009, the Company did not draw on these lines of credit and
there were no balances outstanding as of June 30, 2009 or December 31, 2008.
The Company’s subsidiary, WiderThan, uses corporate charge cards issued by a Korean domestic
bank with an aggregate line of credit of up to $4.0 million. The charged amounts are generally
payable in the following month depending on the billing cycle and are included in accounts payable
in the accompanying unaudited condensed consolidated balance sheets. In general, the term of the
arrangement is one year, with automatic renewal in April of each year. The arrangement may be
terminated in writing by mutual agreement between the bank and the Company. The Company is not
subject to any financial or other restrictive covenants under the terms of this arrangement.
The Company’s subsidiary, WiderThan, has a letter of credit of up to $1.0 million with a
Korean domestic bank for importing goods, with one-year maturity (renewable every April), which
bears interest at 2.5% over the London Inter-Bank Offer Rate (LIBOR). Borrowings under this letter
of credit are collateralized by import documents and goods being imported under such documentation.
To the extent that the Company has any outstanding balance, the Company is subject to standard
covenants and notice requirements under the terms of this facility, such as covenants to consult
with the lender prior to engaging in certain events, which include, among others, mergers and
acquisitions or sale of material assets or to furnish certain financial and other information. The
Company is not, however, subject to any financial covenant requirements or other restrictive
covenants that restrict the Company’s ability to utilize this facility or to obtain financing
elsewhere. During the quarter and six months ended June 30, 2009, the Company did not draw on the
letter of credit and there was no balance outstanding as of June 30, 2009 or December 31, 2008.
The Company’s subsidiary, WiderThan, has purchase guarantees amounting to $0.8 million from
Seoul Guarantee Insurance which guarantees payments for one year under certain supply contracts the
Company has with a customer in Korea.
Litigation. On June 29, 2009, MCS Music America, Inc. (MCS Music), and other plaintiffs for whom MCS Music
administers copyrights, filed suit for copyright infringement against the Company, Yahoo! Inc. and
Microsoft Corporation in U.S. District Court for the Middle District of Tennessee. The complaint
asserts that the Company’s Rhapsody music service offers certain compositions for distribution
without a license and asks for statutory damages for willful infringement of the copyrights
relating to those compositions. The Company disputes the plaintiffs’ allegations in this action
and intends to vigorously defend itself, including by pursuing the potential availability of
contractual indemnification rights.
On September 30, 2008, the Company filed a declaratory action against Disney
Enterprises, Inc., Paramount Pictures Corp., Sony Pictures Entertainment, Inc., Twentieth Century
Fox Film Corp., NBC Universal, Inc., Warner Bros. Entertainment, Inc., Viacom, Inc. (collectively,
the “Studios”) and the DVD Copy Control Association (DVD CCA) in the Northern District of
California relating to the Company’s RealDVD product (the “RealDVD Litigation”), which, among other
things, allows consumers to securely store DVD content on their hard drives. On the same day,
various movie studios filed suit against the Company in the Central District of California. The
Company’s suit asks the court to find that the RealDVD product does not breach the license
agreement that the Company entered into with the DVD CCA. The movie studios’ suit alleges that by
offering the RealDVD product, RealNetworks has violated the Digital Millennium Copyright Act. The
DVD CCA has filed a counterclaim against the Company alleging that the Company breached its license
with the DVD CCA by developing RealDVD. The movie studios’ suit was subsequently transferred to the
Northern District of California. On October 3, 2008, the movie studios obtained a temporary
restraining order (TRO) requiring the Company to cease distribution of its RealDVD product. The TRO
was extended on October 7, 2008. In April and May 2009, the Court held a preliminary injunction
hearing to address the movie studios’ claim that RealDVD should not be sold pending a final
judicial determination of the underlying claims between the parties. The Company is currently
awaiting the District Court’s decision regarding the preliminary injunction. The Company believes
that RealDVD complies with the law, and the Company intends to vigorously defend the preliminary
injunction request and, if necessary, pursue its declaratory judgment action.
On May 13, 2009, the Company moved to amend its complaint against the Studios in the RealDVD
Litigation to add claims that the Studios and DVD CCA conspired to violate, and have violated,
state and federal antitrust laws by, among other things, unlawfully eliminating competition in the
market for technology that enables a consumer to make a lawful, secure backup copy of a DVD. The
Company has filed similar counterclaims against the DVD CCA. In both instances, the Company is
seeking injunctive relief to stop the anticompetitive activity, and has also asked for monetary
damages. The Company’s motion to amend has not yet been ruled on by the Court, but the motion is
unopposed by the Studios. On June 29, 2009, the DVD CCA moved to dismiss the Company’s antitrust
counterclaims. The hearing on that motion is currently set for September 14, 2009.
17
In June 2008, the Company initiated an arbitration action in Seattle, Washington against
VeriSign, Inc., to seek resolution of disputes regarding the proper interpretation of an Alliance
Agreement entered into between the parties dating back to 2001. VeriSign asserted various
counterclaims against the Company, including claims that the Company breached the Alliance
Agreement and tortiously interfered with VeriSign’s proposed sale of certain business units. On May
7, 2009, the Arbitrator issued a ruling denying the Company’s claims for relief and granting
VeriSign’s claims, including VeriSign’s claim that the Company tortiously interfered with
VeriSign’s proposed sale of certain business units. Subsequent to that ruling, the Arbitrator has
further ruled that the limitation of liability clause contained in the Alliance Agreement does not
apply to the potential damages VeriSign incurred. In response, VeriSign has filed an amended
statement of damages seeking a material amount in damages. A hearing to address VeriSign’s claimed
damages began on July 13, 2009 and was adjourned on July 15th. On September 8, 2009, the
Arbitrator will consider whether to hear further evidence. The Company continues to believe that the limitation of liability clause in the
Alliance Agreement should apply to limit the amount of VeriSign’s claimed monetary damages and that
the Arbitrator does not have jurisdiction over tort claims. No assurance can be made as to the
final outcome of the disputes until all rulings are final and all avenues of review have been
exhausted, but the Company could ultimately be required to pay damages to VeriSign in an amount
that may be material to its financial condition and results of operations. The Company intends to
continue to defend itself vigorously with respect to this matter.
On April 25, 2007, a lawsuit was filed by Greenville Communications, LLC in Greenville,
Mississippi against a number of cell phone carriers, including the Company’s partners T-Mobile USA,
Inc. and Alltel Corporation, alleging that they infringe its patents by providing ringback tone
services. The Company agreed to indemnify T-Mobile and Alltel against the claims based on an
indemnity that is claimed to be owed by Real’s subsidiary, WiderThan. On August 27, 2007, the
Company’s motion to transfer this matter to the District of New Jersey was granted. The parties
have briefed claim construction, but the case has been stayed pending reexamination of the patents
at issue. The Company disputes the plaintiff’s allegations regarding both the validity of its
patents and its claims of infringement against the Company’s partners.
In April 2007, the Copyright Royalty Board (CRB) issued a decision setting new royalty rates
for the use of sound recordings in Internet radio from 2006 through 2010. These rates were appealed
and then affirmed by the D.C. Circuit Court of Appeals on July 10, 2009, except with respect to the
minimum royalty rate per station, which has been remanded to the CRB. Additionally, in a separate
proceeding, the CRB held hearings to determine mechanical royalty rates associated with the
statutory license for digital phonorecord deliveries, including streams and tethered downloads.
These rates have also been subject to industry-wide settlement negotiations. A partial settlement
was reached with respect to on-demand streaming and tethered downloads between the Digital Media
Association (DiMA), the Recording Industry Association of America (RIAA) and the National Music
Publishers Association (NMPA). This settlement, along with CRB’s determination on rates for full
downloads, physical products and ringtones, was published by the CRB, and after some modifications
by the U.S. Copyright Office, was collectively published as the CRB’s final determination in the
Federal Register. The rate for ringtones and the imposition of a late fee on certain royalty
payments contained in the final determination have been appealed by the RIAA. Finally, the Company
has been involved in a proceeding in the Southern District of New York to determine a royalty rate
for the public performance of music contained in the American Society of Composers, Authors and
Publishers (ASCAP) catalogue. In April 2008, the district court issued a preliminary ruling that
sets forth, among other things, a methodology to be used to calculate the royalties owed to ASCAP
and subsequently issue additional rulings. After working with ASCAP to make a final determination
of amounts due under the court’s rulings, the Company reached a partial agreement with ASCAP on
January 12, 2009. The Company believes it has sufficiently accrued for expected royalties under the
agreement, but the Company plans to appeal some aspects of the court’s rulings that underlie the
agreement, and the rulings remain subject to appeal and challenge by other participants.
From time to time the Company is, and expects to continue to be, subject to legal proceedings
and claims in the ordinary course of its business, including employment claims, contract-related
claims, and claims of alleged infringement of third-party patents, trademarks and other
intellectual property rights. These claims, including those described above, even if not
meritorious, could force the Company to spend significant financial and managerial resources. The
Company is not aware of any other legal proceedings or claims that the Company believes will have,
individually or taken together, a material adverse effect on the Company’s business, prospects,
financial condition or results of operations. However, the Company may incur substantial expenses
in defending against third-party claims and certain pending claims are moving closer to trial. The
Company expects that its potential costs of defending these claims may increase as the disputes
move into the trial phase of the proceedings. In the event of a determination adverse to the
Company, the Company may incur substantial monetary liability, and/or be required to change its
business practices. Either of these could have a material adverse effect on the Company’s financial
position, results of operations and cash flows.
18
Note 15. Segment Information
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131),
establishes standards for the way in which public companies disclose certain information about
operating segments in their financial reports. The Company reports four segments consistent with
SFAS 131, based on factors such as how the Company manages its operations and how its Chief
Operating Decision Maker reviews results. The Company’s Chief Operating Decision Maker is
considered to be the Company’s CEO Staff (CEOS), which includes the Company’s Chief Executive
Officer, Chief Financial Officer, Chief Operating Officer, Executive Vice Presidents and Senior
Vice Presidents. The CEOS reviews financial information presented on both a consolidated basis and
on a business segment basis, accompanied by disaggregated information about products and services
and geographical regions for purposes of making decisions and assessing financial performance. The
CEOS reviews discrete financial information regarding profitability of the Company’s Music, Games,
Media Software and Services and Technology Products and Solutions segments and, therefore, the
Company reports these as operating segments as defined by SFAS 131. The accounting policies used to
derive segment results are generally the same as those described in Note 1.
The Music segment includes the operations of Rhapsody America as well as the aspects of the
Company’s music business not included as part of Rhapsody America. The revenue and costs from these
businesses include: digital music subscription services such as Rhapsody and RadioPass and sales of
digital music content and advertising. These products and services are sold and provided primarily
through the Internet, and the Company charges customers’ credit cards at the time of sale. Billing
periods for subscription services typically occur monthly, quarterly or annually, depending on the
service purchased.
The Games segment primarily includes revenue from the sale of individual games on the
Company’s websites RealArcade.com, GameHouse.com and Zylom.com; the sale of games subscription
services; advertising through the Company’s games websites; the sale of games through syndication
on partner sites; and sales of games through wireless carriers.
The Media Software and Services segment primarily includes revenue from sales of the Company’s
SuperPass premium subscription service; sales of RealPlayer Plus and related products; sales and
distribution of third-party software products; and all advertising other than that related directly
to the Company’s Music and Games businesses.
The Technology Products and Solutions segment includes revenue and costs from: sales of
ringback tone, music-on-demand, video-on-demand, messaging, and information services; sales of
media delivery system software and licenses, including Helix system software and related authoring
and publishing tools, both directly to customers and indirectly through original equipment
manufacturer channels; support and maintenance services sold to customers who purchase software
products; sales of broadcast hosting services; and consulting and professional services that are
sold to customers. These products and services are primarily sold to corporate customers.
Amounts that are not included within the above segment descriptions are shown below as
Reconciling Amounts. Included within these amounts are items such as interest income and net
antitrust litigation benefit.
Segment net income (loss) attributable to common shareholders for the quarter ended June 30,
2009 is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Media |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Software and |
|
|
Technology Products |
|
|
Reconciling |
|
|
|
|
| |
|
Music |
|
|
Games |
|
|
Services |
|
|
and Solutions |
|
|
Amounts |
|
|
Consolidated |
|
Net revenue |
|
$ |
40,452 |
|
|
$ |
29,774 |
|
|
$ |
19,291 |
|
|
$ |
46,208 |
|
|
$ |
— |
|
|
$ |
135,725 |
|
Cost of revenue |
|
|
24,945 |
|
|
|
8,801 |
|
|
|
2,590 |
|
|
|
19,278 |
|
|
|
— |
|
|
|
55,614 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
15,507 |
|
|
|
20,973 |
|
|
|
16,701 |
|
|
|
26,930 |
|
|
|
— |
|
|
|
80,111 |
|
Impairment of goodwill |
|
|
37,029 |
|
|
|
41,247 |
|
|
|
46,776 |
|
|
|
50,531 |
|
|
|
— |
|
|
|
175,583 |
|
Other operating expenses |
|
|
26,673 |
|
|
|
26,761 |
|
|
|
18,417 |
|
|
|
25,512 |
|
|
|
36 |
|
|
|
97,399 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(48,195 |
) |
|
|
(47,035 |
) |
|
|
(48,492 |
) |
|
|
(49,113 |
) |
|
|
(36 |
) |
|
|
(192,871 |
) |
Total non-operating income, net |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
104 |
|
|
|
104 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(48,195 |
) |
|
|
(47,035 |
) |
|
|
(48,492 |
) |
|
|
(49,113 |
) |
|
|
68 |
|
|
|
(192,767 |
) |
Income taxes |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1,210 |
) |
|
|
(1,210 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
(48,195 |
) |
|
|
(47,035 |
) |
|
|
(48,492 |
) |
|
|
(49,113 |
) |
|
|
(1,142 |
) |
|
|
(193,977 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
attributable to
noncontrolling interest in
Rhapsody America |
|
|
5,648 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
5,648 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable
to common shareholders |
|
$ |
(42,547 |
) |
|
$ |
(47,035 |
) |
|
$ |
(48,492 |
) |
|
$ |
(49,113 |
) |
|
$ |
(1,142 |
) |
|
$ |
(188,329 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19
Segment net income (loss) attributable to common shareholders for the six months ended June
30, 2009 is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Media |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Software and |
|
|
Technology Products |
|
|
Reconciling |
|
|
|
|
| |
|
Music |
|
|
Games |
|
|
Services |
|
|
and Solutions |
|
|
Amounts |
|
|
Consolidated |
|
Net revenue |
|
$ |
84,505 |
|
|
$ |
62,597 |
|
|
$ |
39,609 |
|
|
$ |
89,787 |
|
|
$ |
— |
|
|
$ |
276,498 |
|
Cost of revenue |
|
|
52,245 |
|
|
|
17,365 |
|
|
|
6,297 |
|
|
|
35,728 |
|
|
|
— |
|
|
|
111,635 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
32,260 |
|
|
|
45,232 |
|
|
|
33,312 |
|
|
|
54,059 |
|
|
|
— |
|
|
|
164,863 |
|
Impairment of goodwill |
|
|
37,029 |
|
|
|
41,247 |
|
|
|
46,776 |
|
|
|
50,531 |
|
|
|
— |
|
|
|
175,583 |
|
Other operating expenses |
|
|
56,490 |
|
|
|
53,912 |
|
|
|
38,366 |
|
|
|
51,849 |
|
|
|
74 |
|
|
|
200,691 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(61,259 |
) |
|
|
(49,927 |
) |
|
|
(51,830 |
) |
|
|
(48,321 |
) |
|
|
(74 |
) |
|
|
(211,411 |
) |
Total non-operating income, net |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
1,624 |
|
|
|
1,624 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(61,259 |
) |
|
|
(49,927 |
) |
|
|
(51,830 |
) |
|
|
(48,321 |
) |
|
|
1,550 |
|
|
|
(209,787 |
) |
Income taxes |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(2,759 |
) |
|
|
(2,759 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
(61,259 |
) |
|
|
(49,927 |
) |
|
|
(51,830 |
) |
|
|
(48,321 |
) |
|
|
(1,209 |
) |
|
|
(212,546 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
attributable to
noncontrolling interest in
Rhapsody America |
|
|
12,081 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
12,081 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable
to common shareholders |
|
$ |
(49,178 |
) |
|
$ |
(49,927 |
) |
|
$ |
(51,830 |
) |
|
$ |
(48,321 |
) |
|
$ |
(1,209 |
) |
|
$ |
(200,465 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment net income (loss) attributable to common shareholders for the quarter ended June 30,
2008 is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Media |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Software |
|
|
Technology Products |
|
|
Reconciling |
|
|
|
|
| |
|
Music |
|
|
Games |
|
|
and Services |
|
|
and Solutions |
|
|
Amounts |
|
|
Consolidated |
|
Net revenue |
|
$ |
37,170 |
|
|
$ |
34,945 |
|
|
$ |
29,238 |
|
|
$ |
51,295 |
|
|
$ |
— |
|
|
$ |
152,648 |
|
Cost of revenue |
|
|
20,693 |
|
|
|
10,655 |
|
|
|
3,707 |
|
|
|
20,590 |
|
|
|
— |
|
|
|
55,645 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
16,477 |
|
|
|
24,290 |
|
|
|
25,531 |
|
|
|
30,705 |
|
|
|
— |
|
|
|
97,003 |
|
Operating expenses |
|
|
32,652 |
|
|
|
28,424 |
|
|
|
15,605 |
|
|
|
32,778 |
|
|
|
237 |
|
|
|
109,696 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(16,175 |
) |
|
|
(4,134 |
) |
|
|
9,926 |
|
|
|
(2,073 |
) |
|
|
(237 |
) |
|
|
(12,693 |
) |
Total non-operating income, net |
|
|
3,371 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
3,540 |
|
|
|
6,911 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(12,804 |
) |
|
|
(4,134 |
) |
|
|
9,926 |
|
|
|
(2,073 |
) |
|
|
3,303 |
|
|
|
(5,782 |
) |
Income taxes |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(3,700 |
) |
|
|
(3,700 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
(12,804 |
) |
|
|
(4,134 |
) |
|
|
9,926 |
|
|
|
(2,073 |
) |
|
|
(397 |
) |
|
|
(9,482 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
attributable to
noncontrolling interest in
Rhapsody America |
|
|
8,177 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
8,177 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable
to common shareholders |
|
$ |
(4,627 |
) |
|
$ |
(4,134 |
) |
|
$ |
9,926 |
|
|
$ |
(2,073 |
) |
|
$ |
(397 |
) |
|
$ |
(1,305 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment net income (loss) attributable to common shareholders for the six months ended June
30, 2008 is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Media |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Software |
|
|
Technology Products |
|
|
Reconciling |
|
|
|
|
| |
|
Music |
|
|
Games |
|
|
and Services |
|
|
and Solutions |
|
|
Amounts |
|
|
Consolidated |
|
Net revenue |
|
$ |
75,249 |
|
|
$ |
66,743 |
|
|
$ |
55,647 |
|
|
$ |
102,572 |
|
|
$ |
— |
|
|
$ |
300,211 |
|
Cost of revenue |
|
|
42,212 |
|
|
|
19,292 |
|
|
|
7,683 |
|
|
|
41,851 |
|
|
|
— |
|
|
|
111,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
33,037 |
|
|
|
47,451 |
|
|
|
47,964 |
|
|
|
60,721 |
|
|
|
— |
|
|
|
189,173 |
|
Operating expenses |
|
|
66,258 |
|
|
|
51,355 |
|
|
|
30,348 |
|
|
|
64,973 |
|
|
|
474 |
|
|
|
213,408 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss) |
|
|
(33,221 |
) |
|
|
(3,904 |
) |
|
|
17,616 |
|
|
|
(4,252 |
) |
|
|
(474 |
) |
|
|
(24,235 |
) |
Total non-operating income, net |
|
|
7,097 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
9,175 |
|
|
|
16,272 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
|
(26,124 |
) |
|
|
(3,904 |
) |
|
|
17,616 |
|
|
|
(4,252 |
) |
|
|
8,701 |
|
|
|
(7,963 |
) |
Income taxes |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(7,708 |
) |
|
|
(7,708 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
(26,124 |
) |
|
|
(3,904 |
) |
|
|
17,616 |
|
|
|
(4,252 |
) |
|
|
993 |
|
|
|
(15,671 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
attributable to
noncontrolling interest in
Rhapsody America |
|
|
16,792 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
16,792 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) attributable
to common shareholders |
|
$ |
(9,332 |
) |
|
$ |
(3,904 |
) |
|
$ |
17,616 |
|
|
$ |
(4,252 |
) |
|
$ |
993 |
|
|
$ |
1,121 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20
The Company’s customers consist primarily of end users located in the U.S., Europe and various
foreign countries. Revenue by geographic region is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
United States |
|
$ |
90,685 |
|
|
$ |
100,898 |
|
|
$ |
187,351 |
|
|
$ |
200,067 |
|
Europe |
|
|
23,469 |
|
|
|
27,196 |
|
|
|
46,134 |
|
|
|
51,363 |
|
Rest of the World |
|
|
21,571 |
|
|
|
24,554 |
|
|
|
43,013 |
|
|
|
48,781 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue |
|
$ |
135,725 |
|
|
$ |
152,648 |
|
|
$ |
276,498 |
|
|
$ |
300,211 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-lived assets, consisting of equipment, software, leasehold improvements, other intangible
assets, and goodwill by geographic region are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
June 30, |
|
|
December 31, |
|
| |
|
2009 |
|
|
2008 |
|
United States |
|
$ |
56,394 |
|
|
$ |
163,730 |
|
Republic of Korea |
|
|
8,156 |
|
|
|
51,508 |
|
Europe |
|
|
7,128 |
|
|
|
37,315 |
|
Rest of the World |
|
|
2,809 |
|
|
|
4,445 |
|
|
|
|
|
|
|
|
Total long-lived assets |
|
$ |
74,487 |
|
|
$ |
256,998 |
|
|
|
|
|
|
|
|
Net assets by geographic location are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
June 30, |
|
|
December 31, |
|
| |
|
2009 |
|
|
2008 |
|
United States |
|
$ |
323,136 |
|
|
$ |
437,565 |
|
Republic of Korea |
|
|
26,401 |
|
|
|
64,824 |
|
Europe |
|
|
18,424 |
|
|
|
45,845 |
|
Rest of the World |
|
|
7,134 |
|
|
|
5,324 |
|
|
|
|
|
|
|
|
Total net assets |
|
$ |
375,095 |
|
|
$ |
553,558 |
|
|
|
|
|
|
|
|
Goodwill is assigned to the Company’s segments as follows (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
June 30, |
|
|
December 31, |
|
| |
|
2009 |
|
|
2008 |
|
Music |
|
$ |
— |
|
|
$ |
37,029 |
|
Games |
|
|
— |
|
|
|
41,526 |
|
Media Software and Services |
|
|
— |
|
|
|
46,776 |
|
Technology products and solutions |
|
|
— |
|
|
|
49,933 |
|
|
|
|
|
|
|
|
Total goodwill |
|
$ |
— |
|
|
$ |
175,264 |
|
|
|
|
|
|
|
|
Note 16. Related Party Transactions
Transactions with MTVN. As part of the formation of Rhapsody America, MTVN contributed a $230
million five-year note payable in partial consideration for acquiring MTVN’s interest in the
venture. In February 2009, RealNetworks and MTVN signed an amendment to the Rhapsody America
venture agreement which reduced the amount payable under the MTVN note to $213.8 million over the
original five-year term. During the quarter and six months ended June 30, 2009, Rhapsody America
received $6.9 million and $14.5 million in cash as note payments and spent $6.9 million and $14.3
million, respectively, in advertising with MTVN. During the quarter and six months ended June 30,
2008, Rhapsody America received $7.2 million and $14.4 million in cash as note payments and spent
$9.2 million and $16.6 million, respectively, in advertising with MTVN.
The Company also agreed to grant options to acquire shares of RealNetworks, Inc. common stock
to Rhapsody America employees as part of the venture with MTVN and has included the expense
associated with these options in its statement of operations and comprehensive income. MTVN’s share
of the expense associated with the stock options granted to Rhapsody America employees is
calculated based on its ownership percentage and is billed directly by the Company to MTVN under a
separate agreement. The Company charged $0.1 million and $0.4 million to MTVN during the quarter
and six months ended June 30, 2009, respectively, related to stock options expense incurred during
those periods. The Company charged $0.2 million to MTVN during the quarter and six months ended
June 30, 2008, related to stock options expense incurred during those periods.
21
RealNetworks also provides various support services, including items such as facilities,
information technology systems, personnel and overhead, directly to Rhapsody America. The
allocation of other support service costs are based on various measures depending on the service
provided, including employee headcount, time employees spend on providing services to Rhapsody
America, server usage or number of users of a service. The allocations of these costs are billed
directly to Rhapsody America. RealNetworks has treated these allocations as intercompany
transactions and all such transactions were eliminated in consolidation.
Transactions with LoEn Entertainment, Inc. During the fourth quarter of 2008, the Company paid
$9.9M to acquire approximately 11% of the outstanding shares of LoEn Entertainment, Inc. (LoEn).
The Company paid market price for approximately 2.8 million common shares of LoEn which are traded
on the Korean Securities Dealers Automated Quotations. The Company’s investment in LoEn
is treated as an equity investment of a public company and is marked-to-market each period with
resulting gains/losses recognized in equity as unrealized holding gains/losses on investment.
During the quarter and six months ended June 30, 2009, the Company recorded revenue from LoEn of
approximately $3.5 million and $5.9 million, respectively. This revenue consisted primarily of
sales of application service provider services, which includes sales of ringback tones,
music-on-demand, video-on-demand, and inter-carrier messaging services. Associated with these
transactions, RealNetworks also recorded accounts receivable of approximately $3.4 million as of
June 30, 2009. Accounts payable and cost of revenue balances as
of and for the quarter and the
six months ended June 30, 2009 were nominal.
Note 17. Repurchase of Common Stock
In May 2008, the Company’s Board of Directors authorized a new share repurchase program for
the repurchase of up to an aggregate of $50.0 million of its outstanding common stock. During the
quarter ended June 30, 2008, the Company purchased 0.2 million shares of its common stock at an
average cost of $6.87 per share for an aggregate value of $1.5 million. There were no shares
repurchased during the quarter and six months ended June 30, 2009. All of the previously authorized
share repurchase programs were completed prior to 2009.
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:
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• |
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future revenues, income taxes, tax benefits, net income (loss) per diluted share,
acquisition costs and related amortization, and other measures of results of operations; |
| |
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• |
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the potential outcomes and effects of claims and legal proceedings, including those
relating to RealDVD and our ongoing arbitration with VeriSign, on our business, prospects,
financial condition or results of operations; |
| |
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• |
|
the effects of our acquisitions, including WiderThan, Sony NetServices GmbH, Exomi Oy and
Trymedia, and our position as a technology services provider for leading wireless carriers; |
| |
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• |
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plans, strategies and expected opportunities for growth, increased profitability and
innovation in 2009 and future years; |
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• |
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the creation of new strategic partnerships and broadening of existing strategic
partnerships and the advantages and growth we will achieve as a result of such partnerships; |
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the expected financial performance, growth and profitability of our businesses; |
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• |
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the performance, governance, management, accounting and integration of our Rhapsody
America venture; |
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the dilutive impact on our shareholders if the call or put rights contained in the
limited liability agreement for Rhapsody America are exercised and result in the issuance of
additional shares of our common stock; |
22
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• |
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our intention to separate our Games business, distribute shares of the newly created
games company to its shareholders, and the potential sale of up to 20% of the shares of the
new games company in an initial public offering; |
| |
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• |
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the migration of our Media Software and Services businesses from general purpose
subscription businesses toward premium services and free-to-consumer services, the
popularity of the RealPlayer and our expected introduction of new products and innovations
in our Media Software and Services business; |
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• |
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our ability to grow our Music business, including opportunities for us to become the
platform of choice for the consumer electronics industry, the integration of our Rhapsody
DNA into the digital devices of an expanding list of partners and our plans to introduce
additional innovations; |
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the effect of future interoperability on our Music business, the significance of growth
opportunities in the digital music market and our expectations for short-term progress and
long-term success in our Music business; |
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the effects of legislation, regulations, administrative proceedings, court rulings,
settlement negotiations and other factors that may impact music publishing royalty rates; |
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our financial position and the availability of resources; |
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our expectations regarding acquisition activity in 2009 and our focus on the integration
of completed acquisitions; |
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our relationships with our employees; |
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• |
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the effects of U.S. and foreign income taxes on our business, prospects, financial
condition or results of operations; |
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• |
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the impairment of our assets and anticipated effects on our customers, business,
prospects, financial condition or results of operations; |
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the effect of economic and market conditions on our business, prospects, financial
condition or results of operations; |
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the effect of volatility in foreign exchange rates on our business, prospects, financial
condition or results of operations; |
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future competition; and |
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the degree of seasonality in our revenue. |
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 section Item 1 of
Part II entitled “Legal Proceedings” and Item 1A of Part II entitled “Risk Factors.” RealNetworks
undertakes no obligation to update publicly any forward-looking statements as a result of new
information, future events or otherwise, unless required by law. Readers should, however, carefully
review the risk factors included in other reports or documents filed by RealNetworks from time to
time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q
and any Current Reports on Form 8-K.
Overview
We are a leading creator of digital media services and software. Our mission is to deliver
world class digital entertainment — music, games or video — wherever and whenever consumers want
them. Consumers use our services and software, such as Rhapsody, RealArcade and RealPlayer to find,
play, purchase and manage digital music, games and video. Businesses use our digital media
applications and services to create, secure and deliver digital media to their customers via PCs,
mobile phones, portable music players and other consumer electronics devices. These customers
include broadcasters, cable and wireless communication companies, media companies and enterprises,
such as AT&T and Verizon in the U.S., Vodafone in Europe, and SK Telecom in Korea.
Our strategy is to continue to (1) develop technology that provides meaningful differentiation
to our chosen markets in digital entertainment services; (2) build a direct relationship with, and
grow, our worldwide user base and use feedback from our customers to rapidly innovate and improve
our products; and (3) create strong business partnerships with device makers, media companies,
service providers and other distribution channels and leverage those partnerships to drive scale
and profitability. We intend to continue to
23
expand our products and services beyond the personal computer to mobile devices and to create
compelling digital media experiences on a variety of entertainment devices.
We manage our business, and correspondingly report segment revenue and profit (loss), based on
four segments: Music, Games, Media Software and Services, and Technology Products and Solutions,
each of which is described further below under “Revenue by Segment” and “Costs of Revenue by
Segment.” Our Music business is conducted primarily through Rhapsody America, a joint venture with
the MTVN division of Viacom, Inc.
In the quarter ended June 30, 2009, our total revenue declined 11%, or $16.9 million, to
$135.7 million compared with $152.6 million in the quarter ended June 30, 2008. This decline was
primarily due to declines in revenue in our Media Software and Services, Games and Technology
Products and Solutions segments totaling $9.9 million, $5.2 million and $5.1 million, respectively,
partially offset by an increase in revenue of approximately $3.3 million in our Music segment.
Further contributing to the decline from the year-earlier period was the effect of changes in
foreign currency exchange rates across our businesses of approximately $6.3 million. As in recent
prior periods, volatility in foreign exchange rates, particularly in the euro and Korean won,
continued to impact our revenue. We expect the comparability of our period-over-period
operating results to be impacted by the volatility of foreign currency exchange rates. See “Results
of Operations—Revenue by Segment” below for further explanations of changes in our segment revenue
for the quarter and the six months ended June 30, 2009.
In each of our consumer segments, which include our Music, Games and Media Software and
Services segments, we derive revenue through (1) subscriptions, (2) sales of content downloads,
software and licenses, and (3) the sale of advertising and the distribution of third-party products
on our websites and in our games. In the quarter ended June 30, 2009, we derived 61% of our total
consumer revenue from subscriptions, 23% from sales of content downloads, software and licenses,
and 16% from advertising and the distribution of third party products. In the second quarter of
2008, we derived 55% of our total consumer revenue from subscriptions, 22% from content downloads,
software and licenses, and 23% from advertising and the distribution of third party products. In
our business-to-business Technology Products and Solutions segment, we produce revenue primarily by
providing services that enable wireless carriers to deliver audio and video content to their
customers and through the sale of software licenses to broadband and mobile carriers In the second
quarter of 2009, we derived 77% of our Technology Products and Solutions revenue from ASP services
provided to wireless carriers, and 23% from software licenses and services. In the second quarter
of 2008, we derived 79% of our Technology Products and Solutions revenue from ASP services, and 21%
from software licenses and services.
In the quarter ended June 30, 2009, we also recorded an impairment to our goodwill within each
of our reporting units of an aggregate $175.6 million. Additional details about the valuation of
our goodwill, the impairment analysis and related information is included below in “Results of
Operations—Impairment of Goodwill.”
We believe that our operating results recently have been reduced by the uncertainty and
adverse conditions in the global economy. The economic downturn has resulted in declines in overall
consumer and corporate spending as well as consumer access to credit, and the digital entertainment
products and services we provide may be considered discretionary purchases for consumers. As a
result, we may continue to experience softening in consumer demand and increased price-sensitivity
for our products and services, including the products and services we provide indirectly to
consumers through our business customers. A continuation of these trends could materially adversely
affect our revenue in future periods.
As of June 30, 2009, we had cash, cash equivalents and short-term investments of $362.8
million and $14.6 million in restricted cash. We intend to use our strong cash position to
continue to seek acquisition opportunities to further our strategic initiatives, to make selective
internal investments in new products or technologies and to enhance our competitive position. In
recent years, we have focused our acquisition efforts principally on the identification and
acquisition of targets (1) with technologies and products complementary to ours in order to
accelerate and supplement our research and development efforts, (2) to increase the distribution of
our products and services into new geographies, (3) to gain significant new customers and (4) with
existing or a reasonably expected ability to achieve profitability.
In May 2008, we announced our intent to separate our casual games business into an independent
company and to distribute shares of the newly created games company to our shareholders. We also
announced that we may precede the spin-off with an initial public offering and sale of up to 20%
of the shares of the new games company. In February 2009, we announced that we postponed work
with our outside advisors, stopped external spending on the proposed transaction and wrote off the
capitalized transaction-related costs in the fourth quarter of 2008. While we still intend to
create a separate games company, current conditions do not support such a transaction.
24
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenue and
expenses during the reported period. Our critical accounting policies and estimates are as follows:
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Revenue recognition; |
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Estimating music publishing rights and music royalties; |
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Estimating recoverability of deferred costs; |
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Estimating allowances for doubtful accounts and sales returns; |
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Estimating losses on excess office facilities; |
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• |
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Determining whether declines in the fair value of investments are other-than-temporary
and estimating fair market value of investments in privately held companies; |
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Valuation of long-lived assets; |
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Valuation of goodwill; |
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• |
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Stock-based compensation; |
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Noncontrolling interest; |
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Accounting for gains on sale of subsidiary stock; |
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• |
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Accounting for taxes collected from customers; and |
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• |
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Accounting for income taxes. |
Revenue Recognition. We recognize revenue in accordance with the following authoritative
literature: AICPA Statement of Position (SOP) No. 97-2, Software Revenue Recognition; SOP No. 98-9,
Software Revenue Recognition with Respect to Certain Arrangements; SOP No. 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type Contracts; Securities and Exchange
Commission (SEC) Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial
Statements; Financial Accounting Standards Board’s Emerging Issues Task Force (EITF) Issue No.
00-21, Revenue Arrangements with Multiple Deliverables; and EITF Issue No. 99-19, Reporting Revenue
Gross as a Principal versus Net as an Agent. Generally we recognize revenue when there is
persuasive evidence of an arrangement, the fee is fixed or determinable, the product or services
have been delivered and collectibility of the resulting receivable is reasonably assured.
Consumer subscription products are paid in advance, typically for monthly, quarterly or annual
periods. Subscription revenue is recognized ratably over the related subscription period. Revenue
from sales of downloaded individual music tracks, albums and games are recognized at the time the
music or game is made available, digitally, to the end user.
We recognize revenue under the residual method for multiple element software arrangements when
vendor-specific objective evidence (VSOE) exists for all of the undelivered elements of the
arrangement, but does not exist for one or more of the delivered elements in the arrangement, under
SOP No. 97-2. Under the residual method, at the outset of the arrangement with a customer, we defer
revenue for the fair value of the arrangement’s undelivered elements such as post contract support
(PCS), and recognize revenue for the remainder of the arrangement fee attributable to the elements
initially delivered, such as software licenses. VSOE for PCS is established on standard products
for which no installation or customization is required based upon amount charged when PCS is sold
separately. For multiple element software arrangements involving significant production,
modification, or customization of the software, which are accounted for in accordance with the
provisions of SOP No. 81-1, VSOE for PCS is established if customers have an optional renewal rate
specified in the arrangement and the rate is substantive.
25
We have arrangements whereby customers pay one price for multiple products and services and in
some cases, involve a combination of products and services. For arrangements with multiple
deliverables, revenue is recognized upon the delivery of the individual deliverables in accordance
with EITF Issue No. 00-21. In the event that there is no objective and reliable evidence of fair
value of the delivered items, the revenue recognized upon delivery is the total arrangement
consideration less the fair value of the undelivered items. We apply significant judgment in
establishing the fair value of multiple elements within revenue arrangements.
We recognize revenue on a gross or net basis in accordance with EITF Issue No. 99-19. In many
arrangements, we contract directly with end user customers, are the primary obligor and carry all
collectibility risk. In such arrangements we report the revenue on a gross basis. In some cases, we
utilize third-party distributors to sell products or services directly to end user customers and
carry no collectibility risk. In such instances we report the revenue on a net basis.
Revenue generated from advertising appearing on our websites and from advertising included in
our products is recognized as revenue as the delivery of the advertising occurs.
Music Publishing Rights and Music Royalty Accruals. We must make estimates of amounts owed
related to our music publishing rights and music royalties for our domestic and international music
services. Material differences may result in the amount and timing of our expense for any period if
management made different judgments or utilized different estimates. Under copyright law, we may be
required to pay licensing fees for digital sound recordings and compositions we deliver. Copyright
law generally does not specify the rate and terms of the licenses, which are determined by
voluntary negotiations among the parties or, for certain compulsory licenses where voluntary
negotiations are unsuccessful, by arbitration. There are certain geographies and agencies for which
we have not yet completed negotiations with regard to the royalty rate to be applied to the current
or historic sales of our digital music offerings. Our estimates are based on contracted or
statutory rates, when established, or management’s best estimates based on facts and circumstances
regarding the specific music services and agreements in similar geographies or with similar
agencies. While we base our estimates on historical experience and on various other assumptions
that management believes to be reasonable under the circumstances, actual results may differ
materially from these estimates under different assumptions or conditions.
Recoverability of Deferred Costs. We defer costs on projects for service revenue and system
sales. Deferred costs consist primarily of direct and incremental costs to customize and install
systems, as defined in individual customer contracts, including costs to acquire hardware and
software from third parties and payroll costs for our employees and other third parties.
We recognize such costs in accordance with our revenue recognition policy by contract. For
revenue recognized under the completed contract method, costs are deferred until the products are
delivered, or upon completion of services or, where applicable, customer acceptance. For revenue
recognized under the percentage of completion method, costs are recognized as products are
delivered or services are provided in accordance with the percentage of completion calculation. For
revenue recognized ratably over the term of the contract, costs are recognized ratably over the
term of the contract, commencing on the date of revenue recognition. At each balance sheet date, we
review deferred costs to ensure they are ultimately recoverable. Any anticipated losses on
uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract
exceeds its estimated total revenue.
Allowances for Doubtful Accounts and Sales Returns. We make estimates of the uncollectible
portion of our accounts receivable. We specifically analyze the age of accounts receivable and
historical bad debts, customer credit-worthiness and current economic trends when evaluating the
adequacy of the allowance for doubtful accounts. Similarly, we make estimates of potential future
product returns related to current period revenue. We analyze historical returns, current economic
trends, and changes in customer demand and acceptance of our products when evaluating the adequacy
of the sales returns allowance. Significant judgments and estimates are made and used in connection
with establishing allowances for doubtful accounts and sales returns in any accounting period.
Material differences may result in the amount and timing of our revenue for any period if we were
to make different judgments or utilize different estimates or actual future experience was
different from the judgments and estimates.
Accrued Loss on Excess Office Facilities. We made significant estimates in determining the
appropriate amount of accrued loss on excess office facilities. If we made different estimates, our
loss on excess office facilities could be significantly different from that recorded, which could
have a material impact on our operating results. Our original estimate has been revised in previous
periods in response to changes in market conditions for commercial real estate in the area where
the excess office facilities are located, or to reflect negotiated changes in sublease rates
charged to occupying tenants.
Impairment of Investments. We periodically evaluate whether any declines in the fair value of
our investments are other-than-temporary. Significant judgments and estimates are made to assess
whether an other-than-temporary decline in fair value of investments has occurred and to estimate
the fair value of investments in privately held companies. Material differences may result in
26
the amount and timing of any impairment charge if we were to make different judgments or
utilize different estimates or actual future experience was different from the judgments and
estimates.
Valuation of Long-Lived Assets. Long-lived assets consist primarily of property, plant and
equipment, as well as amortizable intangible assets acquired in business combinations. Long-lived
assets are amortized on a straight line basis over their estimated useful lives. We review
long-lived assets for impairment whenever events or changes in circumstances indicate the carrying
amount of such assets may not be recoverable. Recoverability of these assets is measured by
comparison of their carrying amount to future undiscounted cash flows the assets are expected to
generate. If long-lived assets are considered to be impaired, the impairment to be recognized
equals the amount by which the carrying value of the assets exceeds their fair market value. The
impairment analysis of long-lived assets is based upon estimates and assumptions relating to our
future revenue, cash flows, operating expenses, costs of capital and capital purchases. These
estimates and assumptions are complex and subject to a significant degree of judgment with respect
to certain factors including, but not limited to, the cash flows of our long-term operating plans,
market and interest rate risk, and risk-commensurate discount rates and cost of capital.
Significant or sustained declines in future revenue or cash flows, or adverse changes in our
business climate, among other factors, and their resulting impact on the estimates and assumptions
relating to the value of our long-lived assets could result in the need to perform an impairment
analysis in future interim periods which could result in a significant impairment. While we believe
our estimates and assumptions are reasonable, due to their complexity and subjectivity, these
estimates and assumptions could vary period to period.
Valuation of Goodwill. We assess the impairment of goodwill on an annual basis, in our fourth
quarter, or whenever events or changes in circumstances indicate that the fair value of the
reporting unit to which goodwill relates is less than the carrying value. We consider a synthesis
of the following important factors that could trigger an impairment review include the following:
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poor economic performance relative to historical or projected future operating results; |
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significant negative industry, economic or company specific trends; |
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market and interest rate risk; |
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changes in the manner of our use of the assets or the plans for our business; and |
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loss of key personnel. |
In
addition, we perform a reconciliation of our market capitalization plus a reasonable control
premium to the aggregated implied fair value of all of our reporting units.
If we were to determine that the fair value of a reporting unit was less than its carrying
value, including goodwill, based upon the annual test or the existence of one or more of the above
indicators of impairment, we would measure impairment based on a comparison of the implied fair
value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of
goodwill is determined by allocating the fair value of a reporting unit to its assets (recognized
and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual
fair value after this allocation is the implied fair value of the goodwill of the reporting unit.
To the extent the carrying amount of reporting unit goodwill is greater than the implied fair value
of reporting unit goodwill, we would record an impairment charge for the difference. Judgment is
required in determining our reporting units and assessing fair value of the reporting units.
The impairment analysis of goodwill is based upon estimates and assumptions relating to our
future revenue, cash flows, operating expenses, costs of capital and capital purchases. These
estimates and assumptions are complex and subject to a significant degree of judgment with respect
to certain factors including, but not limited to, the cash flows of our long-term operating plans,
market and interest rate risk, and risk-commensurate discount rates and cost of capital.
Stock-Based Compensation. We account for stock-based compensation in accordance with
Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment (SFAS 123R). Under
the provisions of SFAS 123R, which we adopted as of January 1, 2006, stock-based compensation cost
is estimated at the grant date based on the award’s fair-value as calculated by the Black-Scholes
option-pricing model and is recognized as expense over the requisite service period, which is the
vesting period. The Black-Scholes model requires various highly judgmental assumptions including
volatility in our common stock price and expected option life. If any of the assumptions used in
the Black-Scholes model change significantly, stock-based compensation expense may differ
materially in the future from the amounts recorded in our consolidated statement of operations. We
are required to estimate forfeitures at the time of grant and revise those estimates in subsequent
periods if actual forfeitures differ from those estimates. We use
27
historical data to estimate pre-vesting option forfeitures and record stock-based compensation
expense only for those awards that are expected to vest. Prior to the adoption of SFAS 123R, we
measured compensation expense for our employee stock-based compensation plans using the intrinsic
value method prescribed by Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock
Issued to Employees. Under APB No. 25, when the exercise price of our employee stock options was
equal to the market price of the underlying stock on the date of the grant, no compensation expense
was recognized.
Noncontrolling Interests. We record noncontrolling interest expense (benefit) which reflects
the portion of the earnings (losses) of majority-owned entities which are applicable to the
noncontrolling interest partners in accordance with Accounting Research Bulletin No. 51,
Consolidated Financial Statements (ARB 51), Statement of Financial Accounting Standards No. 160,
Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS
160) and EITF Topic No. D-98, Classification and Measurement of Redeemable Securities (EITF D-98).
Redeemable noncontrolling interests that are redeemable at either fair value or are based on a
formula that is intended to approximate fair value follow our historical disclosure only policy for
the redemption feature, and the current redemption amount of the redeemable noncontrolling
interests is disclosed in Note 4. Redeemable noncontrolling interests that are redeemable at either
a fixed price or are based on a formula that is not akin to fair value are reflected as an
adjustment to income attributable to common shareholders based on the difference between accretion
as calculated using the terms of the redemption feature and the accretion entry for a hypothetical
fair value redemption feature with the remaining amount of accretion to redemption value recorded
directly to equity. Noncontrolling interest expense (benefit) is included within the consolidated
statement of operations and comprehensive income (loss) for the quarters ended June 30, 2009 and
2008.
As of June 30, 2009 and December 31, 2008, respectively, our noncontrolling interests solely
related to redeemable noncontrolling interests in Rhapsody America. See Note 4 of our condensed
consolidated financial statements for further discussion of the redeemable noncontrolling interest
treatment.
Accounting for Gains on Sale of Subsidiary Stock. Effective January 1, 2009, we adopted SFAS
160 which requires the difference between the carrying amount of the parent’s investment in a
subsidiary and the underlying net book value to be recorded as equity transactions. Prior to the
adoption of SFAS 160, we elected to recognize any such gain in the consolidated statement of
operations in accordance with SAB 51.
Accounting for Income Taxes. We use the asset and liability method of accounting for income
taxes. Under this method, income tax expense is recognized for the amount of taxes payable or
refundable for the current year. In addition, deferred tax assets and liabilities are recognized
for the expected future tax consequences of temporary differences between the financial reporting
and tax basis of assets and liabilities and for operating losses and tax credit carryforwards.
Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured
using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences and operating loss and tax credit carryforwards are expected to be recovered or
settled. We must make assumptions, judgments and estimates to determine current provision for
income taxes, deferred tax assets and liabilities and any valuation allowance to be recorded
against deferred tax assets. Our judgments, assumptions, and estimates relative to the current
provision for income tax take into account current tax laws, our interpretation of current tax laws
and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes
in tax law or our interpretation of tax laws and future tax audits could significantly impact the
amounts provided for income taxes in our consolidated financial statements.
Each reporting period we must periodically assess the likelihood that our deferred tax assets
will be recovered from future taxable income, and to the extent that recovery is not more likely
than not, a valuation allowance must be established. The establishment of a valuation allowance and
increases to such an allowance result in either increases to income tax expense or reduction of
income tax benefit in the statement of operations and comprehensive income. Factors we consider in
making such an assessment include, but are not limited to past performance and our expectation of
future taxable income, macroeconomic conditions and issues facing our industry, existing contracts,
our ability to project future results and any appreciation of our investments and other assets.
We have not provided for U.S. deferred income taxes or withholding taxes on certain non-U.S.
subsidiaries’ undistributed earnings. These earnings are intended to be permanently reinvested in
operations outside of the U.S. If these amounts were distributed to the U.S., in the form of
dividends or otherwise, we could be subject to additional U.S. income taxes. It is not practicable
to determine the U.S. federal income tax liability or benefit on such earnings due to the
availability of foreign tax credits and the complexity of the computation if such earnings were not
deemed to be permanently reinvested.
We file numerous consolidated and separate income tax returns in the United States Federal,
state, local, and foreign jurisdictions. With few exceptions, we are no longer subject to United
States Federal, state, local, or foreign income tax examinations for years before 1993. We are
currently subject to United States Federal and various state audits for certain tax years
subsequent to 1993.
28
Results of Operations
Revenue by Segment
Revenue by segment is as follows (dollars in thousands):
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Quarters Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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2009 |
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Change |
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2008 |
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2009 |
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Change |
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2008 |
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Music |
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$ |
40,452 |
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|
9 |
% |
|
$ |
37,170 |
|
|
$ |
84,505 |
|
|
|
12 |
% |
|
$ |
75,249 |
|
Games |
|
|
29,774 |
|
|
|
(15 |
) |
|
|
34,945 |
|
|
|
62,597 |
|
|
|
(6 |
) |
|
|
66,743 |
|
Media Software and Services |
|
|
19,291 |
|
|
|
(34 |
) |
|
|
29,238 |
|
|
|
39,609 |
|
|
|
(29 |
) |
|
|
55,647 |
|
Technology Products and Solutions |
|
|
46,208 |
|
|
|
(10 |
) |
|
|
51,295 |
|
|
|
89,787 |
|
|
|
(12 |
) |
|
|
102,572 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue |
|
$ |
135,725 |
|
|
|
(11 |
)% |
|
$ |
152,648 |
|
|
$ |
276,498 |
|
|
|
(8 |
)% |
|
$ |
300,211 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue by segment as a percentage of total net revenue is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Music |
|
|
30 |
% |
|
|
24 |
% |
|
|
31 |
% |
|
|
25 |
% |
Games |
|
|
22 |
|
|
|
23 |
|
|
|
23 |
|
|
|
22 |
|
Media Software and Services |
|
|
14 |
|
|
|
19 |
|
|
|
14 |
|
|
|
19 |
|
Technology Products and Solutions |
|
|
34 |
|
|
|
34 |
|
|
|
32 |
|
|
|
34 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Music. Music revenue primarily includes revenue from sales of our Rhapsody and RadioPass
subscription services; sales of digital music content through our MP3 music store; and advertising
from our music websites. These products and services are sold and provided primarily through the
Internet and distribution partners, and we charge customers’ credit cards at the time of sale. We
charge our subscription customers either monthly, quarterly or annually, depending on the service
purchased. In the quarter ended June 30, 2009, subscription revenue comprised 82% of total Music
revenue, sales of music downloads comprised 14%, and advertising and other revenue comprised 4%,
compared with 79%, 11% and 10%, respectively, in the quarter ended June 30, 2008. For the six
months ended June 30, 2009, subscription revenue comprised 81% of total Music revenue, sales of
music downloads comprised 14%, and advertising and other revenue comprised 4%, compared with 79%,
13% and 8%, respectively, in the six months ended June 30, 2008.
In the quarter ended June 30, 2009, total Music revenue rose to $40.5 million, or 9%, from
$37.2 million in the year-earlier quarter due to increases in subscription revenue and sales of
music downloads. Revenue from our subscription music services rose 14%, to $33.3 million in the
quarter ended June 30, 2009, compared with $29.2 million in the quarter ended June 30, 2008.
Subscription revenue growth was primarily driven by an increase in subscribers from the launch of
the Rhapsody service with Verizon Wireless in the middle of 2008 and the one-time migration of
Yahoo! Music Unlimited subscribers to our Rhapsody music service, which was completed during the
third quarter of 2008. Revenue from digital music tracks sold during the quarter ended June 30,
2009 rose to $5.6 million from $4.2 million, an increase of 34%, largely due to increased usage of
our MP3 store by consumers since its re-launch on June 30, 2008. Advertising revenue in the quarter
declined by 58% to $1.6 million from $3.8 million due to a decline in demand for online advertising
and in sponsorship revenue. No other single factor contributed materially to the change in total
Music revenue during the period.
During the six months ended June 30, 2009, total Music revenue rose to $84.5 million, or 12%,
from $75.2 million in the year-earlier period due to increases in subscription revenue and sales of
music downloads. Revenue from our subscription music services rose 16%, to $69.0 million in the
six months ended June 30, 2009, compared with $59.4 million in the year-earlier period.
Subscription revenue growth was primarily driven by an increase in subscribers from the launch of
the Rhapsody service with Verizon Wireless in the middle of 2008 and the one-time migration of
Yahoo! Music Unlimited subscribers to our Rhapsody music service, which was completed during the
third quarter of 2008. Revenue from digital music tracks sold during the six months ended June 30,
2009 rose to $12.1 million from $9.5 million, an increase of 28%, largely due to increased usage of
our MP3 store by consumers since its re-launch on June 30, 2008. Advertising revenue in the six
months declined by 47% to $3.4 million from $6.4 million due to a decline in demand for online
advertising and in sponsorship revenue. No other single factor contributed materially to the
change in total Music revenue during the period.
29
Games. Games revenue primarily includes revenue from the sale of individual games on our
websites RealArcade.com, GameHouse.com and Zylom.com; sales of games subscription services;
advertising through our games websites; the sale of games through syndication on partner sites; and
sales of games through wireless carriers. In the quarter ended June 30, 2009, sales of game
downloads comprised 43% of total Games revenue; subscription revenue comprised 37%; and advertising
and other revenue comprised 20%, compared with 46%, 33%, and 21%, respectively, in the quarter
ended June 30, 2008. In the six months ended June 30, 2009, sales of game downloads comprised 43%
of total Games revenue; subscription revenue comprised 37%; and advertising and other revenue
comprised 20%, compared with 47%, 33%, and 20%, respectively, in the year-earlier period.
Total Games revenue decreased by 15% to $29.8 million during the quarter ended June 30, 2009,
compared with $34.9 million for the same quarter ended 2008. Revenue from sales of downloadable
games declined 19% to $12.9 million in the second quarter of 2009 from $16.0 million in the second
quarter of 2008, largely due to lower average sales prices for individual games sold on our
websites. Subscription revenue declined 6% to $11.0 million in the quarter ended June 30, 2009
from $11.7 million in the year-earlier quarter primarily due to a decline in subscribers to our
games subscription services. Games revenue from advertising and other decreased 20% to $5.8
million in the quarter ended June 30, 2009, from $7.3 million in the year-earlier quarter due to a
decline in demand for online advertising. No other single factor contributed materially to the
change in total Games revenue during the period.
During the six months ended June 30, 2009, total Games revenue decreased by 6% to $62.6
million compared with $66.7 million for the same period ended 2008. This decrease was partially
offset by revenue associated with our acquisition of Trymedia (consummated on April 1, 2008), which
contributed approximately $3.6 million during the first quarter of 2009. Revenue from sales of
downloadable games, which includes materially all the revenue contributed from the acquisition of
Trymedia, declined 14% to $26.9 million in the six months ended June 30, 2009 from $31.2 million in
the year-earlier period, largely due to lower average sales prices for individual games sold on our
websites. No other single factor contributed materially to the change in total Games revenue
during the period.
Media Software and Services. Media Software and Services revenue primarily includes revenue
from sales of our SuperPass premium subscription service; sales of RealPlayer Plus and related
products; distribution of third-party software products; and all advertising other than that
related directly to our Music and Games businesses. In the quarter ended June 30, 2009,
subscription revenue comprised 53%, advertising and other revenue comprised 38%, and sales of
RealPlayer Plus and related products comprised 9% of total Media, Software and Services revenue,
compared with 51%, 42% and 7%, respectively, in the year-earlier quarter. In the six months ended
June 30, 2009, subscription revenue comprised 54%, advertising and other revenue comprised 36%, and
sales of RealPlayer Plus and related products comprised 10% of total Media, Software and Services
revenue, compared with 53%, 40% and 7%, respectively, in the year-earlier period.
Total Media Software and Services revenue declined 34% to $19.3 million during the quarter
ended June 30, 2009, compared with $29.2 million in the quarter ended June 30, 2008. This decrease
was due primarily to a 41% decline in advertising and other revenue to $7.3 million compared with
$12.4 million in the quarter ended June 30, 2008 resulting from a decline in the distribution of
third party products as well as reduced demand for online advertising. Revenue from the
distribution of third party products in the year-ago period was positively impacted by our campaign
to encourage users to upgrade their RealPlayer software to a newer version. Revenue from our
subscription services declined 31% to $10.1 million compared with $14.7 million in the year-earlier
quarter. The prior-year quarter benefited from a special run of CBS’s Big Brother program, which
attracted an increase in sign-ups to our SuperPass service. No other single factor contributed
materially to the change in total Media Software and Services revenue during the period.
During the six months ended June 30, 2009, total Media Software and Services revenue declined
29% to $39.6 million compared with $55.6 million in the year-earlier period. This decrease was due
primarily to a 35% decline in advertising and other revenue to $14.4 million from $22.3 million as
compared to the six months ended June 30, 2008 resulting from a decline in the distribution of
third party products as well as reduced demand for online advertising. Revenue from the
distribution of third party products in the year-ago period was positively impacted by our campaign
to encourage users to upgrade their RealPlayer software to a newer version. Revenue from our
subscription services declined 28% to $21.3 million during the six months ended June 30, 2009
compared with $29.4 million in the year-earlier period. The prior-year period benefited from a
special run of CBS’s Big Brother program, which attracted an increase in sign-ups to our SuperPass
service. No other single factor contributed materially to the change in total Media Software and
Services revenue during the period.
Technology Products and Solutions. Technology Products and Solutions revenue is derived from
the sale of products and ASP services that enable communications businesses to distribute digital
media content to PCs, mobile phones, and other non-PC devices. ASP revenue comprises revenue from
sales of ringback tones, music-on-demand, video-on-demand, and inter-carrier messaging
30
services, primarily sold to wireless carriers. Software, and services revenue consists of
sales of Helix system software and related authoring and publishing tools, digital rights
management technology, messaging gateways, and consulting services, and support and maintenance
services that we sell to mobile carriers and broadband communications companies. These products and
services are primarily sold to corporate, government and educational customers. We do not require
collateral from our customers, but we often require payment before or at the time products and
services are delivered. Many of our customers are given standard commercial credit terms, and for
these customers we do not require payment before products and services are delivered. In the
quarter ended June 30, 2009, ASP revenue comprised 77% of total Technology Products and Solutions
revenue, and software and services revenue comprised 23%, compared with 79% and 21%, respectively,
in the year-earlier period. For the six months ended June 30, 2009, ASP revenue comprised 78% of
total Technology Products and Solutions revenue, and software and services revenue comprised 22%,
compared with 79% and 21%, respectively, in the year-earlier period.
Total Technology Products and Solutions revenue declined to $46.2 million, or 10%, in the
quarter ended June 30, 2009, compared with $51.3 million in the year-earlier quarter primarily due
to a decline in the exchange rate for the Korean won as well as a decline in revenue derived from
minimum revenue guarantees associated with an ASP customer contract. The rise in the value of the
U.S. dollar against the Korean won negatively affected second quarter 2009 revenue by approximately
$3.8 million across both our ASP and software and services revenues. No other single factor
contributed materially to the change in total Technology Products and Solutions revenue during the
period.
For the six months ended June 30, 2009, total Technology Products and Solutions revenue declined to
$89.8 million, or 12% compared with $102.6 million in the year-earlier period primarily due to a
decline in the exchange rate for the Korean won as well as a decline in revenue derived from
minimum revenue guarantees associated with an ASP customer contract. The rise in the value of the
U.S. dollar against the Korean won negatively affected both ASP and software and services revenue
during the six months ended June 30, 2009 by a total of approximately $10.6 million. No other
single factor contributed materially to the change in total Technology Products and Solutions
revenue during the period.
Geographic Revenue
Revenue by geographic region is as follows (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
Change |
|
|
2008 |
|
|
2009 |
|
|
Change |
|
|
2008 |
|
United States |
|
$ |
90,685 |
|
|
|
(10 |
)% |
|
$ |
100,898 |
|
|
$ |
187,351 |
|
|
|
(6 |
)% |
|
$ |
200,067 |
|
Europe |
|
|
23,469 |
|
|
|
(14 |
) |
|
|
27,196 |
|
|
|
46,134 |
|
|
|
(10 |
) |
|
|
51,363 |
|
Rest of the world |
|
|
21,571 |
|
|
|
(12 |
) |
|
|
24,554 |
|
|
|
43,013 |
|
|
|
(12 |
) |
|
|
48,781 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue |
|
$ |
135,725 |
|
|
|
(11 |
)% |
|
$ |
152,648 |
|
|
$ |
276,498 |
|
|
|
(8 |
)% |
|
$ |
300,211 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue in the U.S. declined 10% to $90.7 million for the quarter ended June 30, 2009,
compared with $100.9 million in the year-earlier quarter. During the six months ended June 30,
2009, revenue in the U.S. declined 6% to $187.4 million compared with $200.1 million in the
year-earlier period. The decreases were due primarily to a reduction in revenue from the
distribution of third party products and a reduction in SuperPass revenue, partially offset by
increases in music subscription revenue. See the sections ”Revenue by Segment — Media Software
and Services” and “Revenue by Segment — Music” above for further discussion of these changes.
Revenue in Europe decreased 14% to $23.5 million from $27.2 million in the quarter ended June
30, 2009, compared with the year-earlier quarter. During the six months ended June 30, 2009,
revenue in Europe decreased 10% to $46.1 million from $51.4 million compared with the year-earlier
period. These decreases were due primarily to a decline in revenue derived from minimum revenue
guarantees associated with a customer contract. See the sections ”Revenue by Segment —Technology
Products and Solutions” above for further discussion of these changes.
Revenue in the rest of world declined 12% to $21.6 million from $24.6 million for the quarter
ended June 30, 2009, compared with the year-earlier quarter. During the six months ended June 30,
2009, revenue in the rest of world declined 12% to $43.0 million from $48.8 million compared with
the year-earlier period. These decreases were due primarily to foreign currency fluctuations of the
U.S. dollar against the Korean won which negatively affected second quarter 2009 revenue by
approximately $3.8 million and revenue for the six months ended June 30, 2009 by approximately
$10.6 million. See the section ”Revenue by Segment —Technology Products and Solutions” above for
further discussion of these changes.
31
License and Service Revenue
We also present our revenue based on License fees and Service revenue as set forth below
(dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
Change |
|
|
2008 |
|
|
2009 |
|
|
Change |
|
|
2008 |
|
License fees |
|
$ |
24,389 |
|
|
|
(15 |
)% |
|
$ |
28,613 |
|
|
$ |
50,568 |
|
|
|
(7 |
)% |
|
$ |
54,368 |
|
Service revenue |
|
|
111,336 |
|
|
|
(10 |
) |
|
|
124,035 |
|
|
|
225,930 |
|
|
|
(8 |
) |
|
|
245,843 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue |
|
$ |
135,725 |
|
|
|
(11 |
)% |
|
$ |
152,648 |
|
|
$ |
276,498 |
|
|
|
(8 |
)% |
|
$ |
300,211 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License fees and Service revenue as a percentage of total revenue are as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
2008 |
|
2009 |
|
2008 |
License fees |
|
|
18 |
% |
|
|
19 |
% |
|
|
18 |
% |
|
|
18 |
% |
Service revenue |
|
|
82 |
|
|
|
81 |
|
|
|
82 |
|
|
|
82 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net revenue |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
License Fees. License fees primarily include revenue from sales of content such as game
licenses and digital music tracks; sales of our media delivery system software; sales of premium
versions of our RealPlayer and related products and messaging gateways to mobile carriers. License
fees include revenue from all of our reporting segments.
License revenue decreased 15% to $24.4 million during the quarter ended June 30, 2009,
compared with $28.6 million in the quarter ended June 30, 2008. The decrease was primarily due to
a decline in revenue from the sale of downloadable games and media system delivery software
totaling approximately $4.5 million. This decrease was partially offset by an increase in sales of
digital music tracks of approximately $1.1 million. No other single factor contributed materially
to the change in total License revenue during the period.
During the six months ended June 30, 2009. License revenue decreased 7% to $50.6 million,
compared with $54.4 million in the year-earlier period. The decrease was primarily due to a decline
in revenue from the sale of downloadable games and media system delivery software totaling
approximately $6.5 million. This decrease was partially offset by an increase in sales of digital
music tracks of approximately $2.3 million. No other single factor contributed materially to the
change in total License revenue during the period.
Service Revenue. Service revenue primarily includes revenue from sales of digital media
subscription services such as SuperPass, Rhapsody, RadioPass, GamePass and FunPass; sales of ASP
services as described in the section “Revenue — Technology Products and Solutions”; distribution
of third-party software; and advertising. Service revenue includes revenue from all of our
reporting segments.
Service revenue declined 10% to $111.3 million during the quarter ended June 30, 2009,
compared with $124.0 million in the quarter ended June 30, 2008. The decrease was primarily due to
a decline in advertising revenue and revenue from SuperPass subscriptions totaling approximately
$8.7 million and $4.7 million, respectively. In addition, revenue from ASP services declined
approximately $4.6 million due primarily to the change in exchange rates for the Korean won. These
declines were partially offset by a $4.2 million increase in revenue from subscription music
services. No other single factor contributed materially to the change in total Service revenue
during the period.
During the six months ended June 30, 2009, Service revenue declined 8% to $225.9 million,
compared with $245.8 million in the year-earlier period. The decrease was primarily due to a
decline in advertising revenue and revenue from SuperPass subscriptions totaling approximately
$11.9 million and $8.3 million, respectively. In addition, revenue from ASP services declined
approximately $10.9 million due primarily to the change in exchange rates for the Korean won.
These declines were partially offset by a $10.0 million increase in revenue from subscription music
services. No other single factor contributed materially to the change in total Service revenue
during the period.
Deferred Revenue
Deferred revenue consists of unrecognized revenue and prepayments related to application
services, unearned subscription services, support contracts, prepayments under OEM arrangements and
other prepayments for which the earnings process has not been completed. Total deferred revenue
remained relatively unchanged at June 30, 2009 compared with December 31, 2008.
32
Cost of Revenue by Segment
Cost of revenue by segment is as follows (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
Change |
|
|
2008 |
|
|
2009 |
|
|
Change |
|
|
2008 |
|
Music |
|
$ |
24,945 |
|
|
|
21 |
% |
|
$ |
20,693 |
|
|
$ |
52,245 |
|
|
|
24 |
% |
|
$ |
42,212 |
|
Games |
|
|
8,801 |
|
|
|
(17 |
) |
|
|
10,655 |
|
|
|
17,365 |
|
|
|
(10 |
) |
|
|
19,292 |
|
Media Software and Services |
|
|
2,590 |
|
|
|
(30 |
) |
|
|
3,707 |
|
|
|
6,297 |
|
|
|
(18 |
) |
|
|
7,683 |
|
Technology Products and Solutions |
|
|
19,278 |
|
|
|
(6 |
) |
|
|
20,590 |
|
|
|
35,728 |
|
|
|
(15 |
) |
|
|
41,851 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue |
|
$ |
55,614 |
|
|
|
— |
% |
|
$ |
55,645 |
|
|
$ |
111,635 |
|
|
|
1 |
% |
|
$ |
111,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue as a percentage of segment revenue is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
2008 |
|
2009 |
|
2008 |
Music |
|
|
62 |
% |
|
|
56 |
% |
|
|
62 |
% |
|
|
56 |
% |
Games |
|
|
30 |
|
|
|
30 |
|
|
|
28 |
|
|
|
29 |
|
Media Software and Services |
|
|
13 |
|
|
|
13 |
|
|
|
16 |
|
|
|
14 |
|
Technology Products and Solutions |
|
|
42 |
|
|
|
40 |
|
|
|
40 |
|
|
|
41 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue |
|
|
41 |
% |
|
|
36 |
% |
|
|
40 |
% |
|
|
37 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Music Revenue. Cost of Music revenue consists primarily of cost of content and
delivery of the content included in our music subscription service offerings; royalties paid on
sales and streams of music; hardware devices and accessories; and fees paid to third-party vendors
for support services.
Cost of Music revenue increased 21% to $24.9 million during the quarter ended June 30, 2009,
compared with $20.7 million during the quarter ended June 30, 2008. The increase was due to the
increased number of subscribers to our music services resulting in increased content costs of
approximately $3.5 million. No other single factor contributed materially to the change during the
period. Cost of Music revenue as a percentage of Music revenue increased due to a shift in revenue
to lower margin subscription services.
During the six months ended June 30, 2009, cost of Music revenue increased 24% to $52.2
million compared with $42.2 million during the year-earlier period. The increase was primarily due
to the increased number of subscribers to our Rhapsody music services resulting in increased
content costs of approximately $8.4 million. No other single factor contributed materially to the
change during the period. Cost of Music revenue as a percentage of Music revenue increased due to a
shift in revenue to lower margin subscription services.
Cost of Games Revenue. Cost of Games revenue consists primarily of royalties paid on sales of
games and subscription service offerings; and fees paid to third-party vendors for support
services.
Cost of Games revenue decreased 17% to $8.8 million during the quarter ended June 30, 2009,
compared with $10.7 million during the quarter ended June 30, 2008. During the six months ended
June 30, 2009, cost of Games revenue decreased 10% to $17.4 million compared with $19.3 million
during the year-earlier period. The decline in royalty costs in proportion to royalty revenue accounted
for materially all of the decline in cost of Games revenue during each of the periods.
Cost of Media Software and Services Revenue. Cost of Media Software and Services revenue
consists primarily of cost of royalties and delivery of content included in our SuperPass
subscription service offerings; amounts paid for licensed technology; and fees paid to third-party
vendors for support services.
Cost of Media Software and Services revenue declined 30% to $2.6 million from $3.7 million for
the quarter ended June 30, 2009, compared with the quarter ended June 30, 2008. Content costs were
higher in the prior year’s quarter primarily as a result of the additional content costs associated
with the special run of CBS’s Big Brother program which accounted for materially all of the decline
in cost of Media Software and Services revenue.
Cost of Media Software and Services revenue declined 18% to $6.3 million from $7.7 million for
the six months ended June 30, 2009, compared with the year earlier period. Content costs were
higher in the prior year primarily as a result of the additional content
33
costs associated with the special run of CBS’s Big Brother program which accounted for
materially all of the decline in cost of Media Software and Services revenue. Cost of Media
Software and Services revenue as a percentage of revenue increased in the quarter ended June 30,
2009, due to a decline in revenue from higher-margin items, such as distribution of third-party
software and advertising, as a percentage of total revenue.
Cost of Technology Products and Solutions. Cost of Technology Products and Solutions revenue
includes amounts paid for licensed technology; costs of product media, fees paid to mobile service
carriers and third-party vendors for order fulfillment; cost of personnel providing support and
consulting services, and expenses incurred in providing our ASP hosting services.
Cost of Technology Products and Solutions revenue decreased 6% to $19.3 million during the
quarter ended June 30, 2009, compared with $20.6 million in the year-earlier quarter, due primarily
to a reduction in intangible asset amortization associated with impairments taken in the fourth
quarter of 2008 of approximately $1.3 million. No other single factor contributed materially to the
change during the period.
During the six months ended June 30, 2009, cost of Technology Products and Solutions revenue
decreased 15% to $35.7 million compared with $41.9 million in the year-earlier period, due
primarily to a reduction in intangible asset amortization of approximately $2.7 million associated
with impairments taken in the fourth quarter of 2008. In addition, costs of approximately $2.5
million to provide content for our ASP services declined in proportion to the related revenue. No
other single factor contributed materially to the change during the period.
Cost of License and Service Revenue
Cost of revenue is as follows (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
Change |
|
|
2008 |
|
|
2009 |
|
|
Change |
|
|
2008 |
|
License fees |
|
$ |
9,869 |
|
|
|
(7 |
)% |
|
$ |
10,614 |
|
|
$ |
19,115 |
|
|
|
(4 |
)% |
|
$ |
20,002 |
|
Service revenue |
|
|
45,745 |
|
|
|
2 |
|
|
|
45,031 |
|
|
|
92,520 |
|
|
|
2 |
|
|
|
91,036 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue |
|
$ |
55,614 |
|
|
|
— |
% |
|
$ |
55,645 |
|
|
$ |
111,635 |
|
|
|
1 |
% |
|
$ |
111,038 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue as a percentage of related revenue is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
2008 |
|
2009 |
|
2008 |
License fees |
|
|
40 |
% |
|
|
37 |
% |
|
|
38 |
% |
|
|
37 |
% |
Service revenue |
|
|
41 |
|
|
|
36 |
|
|
|
41 |
|
|
|
37 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue |
|
|
41 |
% |
|
|
36 |
% |
|
|
40 |
% |
|
|
37 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of License Fees. Cost of license fees includes royalties paid on sales of games, music
and other third-party products; amounts paid for licensed technology; and amortization of acquired
technology.
Cost of license fees declined 7% to $9.9 million from $10.6 million during the quarter ended
June 30, 2009, compared with the quarter ended June 30, 2008, due to a reduction in content costs
associated with the sale of downloadable games by approximately $1.1 million, partially offset by
an increase in royalties paid on the sale of digital music tracks of approximately $0.9 million.
No other single factor contributed materially to the changes during the period.
During the six months ended June 30, 2009, cost of license fees declined 4% to $19.1 million
from $20.0 million during the year-earlier period due to lower content costs associated with the
sale of downloadable games, partially offset by an increase in royalties paid on the sale of
digital music tracks. No other single factor contributed materially to the changes during the
period.
Cost of Service Revenue. Cost of service revenue includes the cost of content and delivery of
the content included in our digital media subscription and mobile service offerings; cost of
in-house and contract personnel providing support; amortization of acquired technology; fees for
consulting services; and royalties and expenses incurred in providing our ASP hosting services.
Content costs are expensed over the period the content is available to our subscription services
customers.
34
Cost of service revenue increased 2% to $45.7 million during the quarter ended June 30, 2009,
compared with $45.0 million in the quarter ended June 30, 2008. The increase was due primarily to
increased content costs resulting from the increased number of subscribers to our Rhapsody music
subscription services of approximately $3.5 million, as well as $2.4 million in increased costs
associated with providing consulting and other services to our TPS customers. These increases were
partially offset by a decrease in the amortization of intangibles associated with impairments taken
in the fourth quarter of 2008 of approximately $1.7 million. No other single factor contributed
materially to the changes during the period. Cost of service revenue as a percentage of service
revenue for the quarter ended June 30, 2009, increased due to the increased concentration of
revenue derived from services versus advertising, which has higher margins.
During the six months ended June 30, 2009, cost of service revenue increased 2% to $92.5
million compared with $91.0 million in the year-earlier period. The increase was due primarily to
increased content costs resulting from the increased number of subscribers to our Rhapsody music
subscription services of approximately $8.4 million, as well as $2.3 million in increased costs
associated with providing consulting and other services to our TPS customers. These increases
were partially offset by a decrease in the amortization of intangibles associated with impairments
taken in the fourth quarter of 2008 of approximately $3.5 million.. No other single factor
contributed materially to the changes during the period. Cost of service revenue as a percentage of
service revenue for the six months ended June 30, 2009, increased due to the increased
concentration of revenue derived from services versus advertising, which has higher margins.
Operating Expenses
Research and Development
Research and development expenses consist primarily of salaries and related personnel costs,
expense associated with stock-based compensation, and consulting fees associated with product
development. To date, all research and development costs have been expensed as incurred because
technological feasibility for software products is generally not established until substantially
all development is complete. Research and developments costs and changes are as follows (dollars in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
Change |
|
2008 |
|
2009 |
|
Change |
|
2008 |
Research and development |
|
$ |
28,923 |
|
|
|
— |
% |
|
$ |
29,065 |
|
|
$ |
57,482 |
|
|
|
6 |
% |
|
$ |
54,071 |
|
As a percentage of total net revenue |
|
|
21 |
% |
|
|
|
|
|
|
19 |
% |
|
|
21 |
% |
|
|
|
|
|
|
18 |
% |
Research and development expenses, including non-cash stock-based compensation, were
materially unchanged from the quarter ended June 30, 2009 compared with the year-earlier period.
During the six months ended June 30, 2009, research and development expenses, including
non-cash stock-based compensation, increased 6% to $57.5 million compared with $54.1 million in the
year-earlier period primarily due to an increase in personnel and related costs of approximately
$2.1 million. No other single factor contributed materially to the increase in costs during this
period.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries and related personnel costs, sales
commissions, amortization of certain intangible assets capitalized in our acquisitions, credit card
fees, subscriber acquisition costs, consulting fees, trade show expenses, advertising costs and
costs of marketing collateral. Sales and marketing costs and changes are as follows (dollars in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
Change |
|
2008 |
|
2009 |
|
Change |
|
2008 |
Sales and marketing
|
|
$ |
42,273 |
|
|
|
(20 |
)% |
|
$ |
53,054 |
|
|
$ |
85,958 |
|
|
|
(19 |
)% |
|
$ |
106,650 |
|
As a percentage of total net revenue
|
|
|
31 |
% |
|
|
|
|
|
|
35 |
% |
|
|
31 |
% |
|
|
|
|
|
|
36 |
% |
Sales and marketing expenses, including non-cash stock-based compensation, decreased 20% to
$42.3 million in the second quarter of 2009 from $53.1 million in the second quarter of 2008
primarily due to a reduction in personnel and related costs of approximately $5.6 million, as well
as a decrease in marketing and other professional services expenses of approximately $3.0 million.
Further contributing to the decrease were lower costs associated with the amortization of
intangibles of approximately $2.7 million
35
due to impairment costs taken in the fourth quarter of 2008. No other single factor
contributed materially to these changes during the period.
During the six months ended June 30, 2009, sales and marketing expenses, including non-cash
stock-based compensation, decreased 19% to $86.0 million compared to $106.7 million in the
year-earlier period primarily due to a reduction in personnel and related costs of approximately
$9.8 million, as well as a decrease in marketing and other professional services expenses of
approximately $6.8 million. Further contributing to the decrease were lower costs associated with
the amortization of intangibles of approximately $5.4 million due to impairment costs taken in the
fourth quarter of 2008. No other single factor contributed materially to these changes during the
period.
Advertising with Related Party
On August 20, 2007, RealNetworks and MTVN jointly created Rhapsody America. MTVN owns 49% of
Rhapsody America. Under the joint venture agreement, as amended, Rhapsody America is obligated to
purchase $213.8 million in advertising and related integrated marketing on MTVN cable channels over
the term of the agreement. During the quarter and six months ended June 30, 2009, Rhapsody America
spent $6.9 million and $14.3 million in advertising with MTVN, respectively. During the quarter and
six months ended June 30, 2008, Rhapsody America spent $9.2 million and $16.6 million in
advertising with MTVN, respectively.
General and Administrative
General and administrative expenses consist primarily of salaries and related personnel costs,
fees for professional and temporary services and contractor costs, stock-based compensation, and
other general corporate costs. General and administrative costs and changes are as follows (dollars
in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
Six Months Ended |
| |
|
June 30, |
|
June 30, |
| |
|
2009 |
|
Change |
|
2008 |
|
2009 |
|
Change |
|
2008 |
General and administrative
|
|
$ |
19,338 |
|
|
|
5 |
% |
|
$ |
18,337 |
|
|
$ |
42,169 |
|
|
|
19 |
% |
|
$ |
35,421 |
|
As a percentage of total net revenue
|
|
|
14 |
% |
|
|
|
|
|
|
12 |
% |
|
|
15 |
% |
|
|
|
|
|
|
12 |
% |
General and administrative expenses, including non-cash stock-based compensation, increased 5%
to $19.3 million in the second quarter of 2009 from $18.3 million in the second quarter of 2008.
During the six months ended June 30, 2009, general and administrative expenses, including non-cash
stock-based compensation, increased 19% to $42.2 million compared with $35.4 million in the
year-earlier period. The changes for both periods were primarily due to increases in legal and other
professional services expenses. No other single factor contributed materially to the increases
during the periods.
Impairment of Goodwill
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142), goodwill is
required to be tested for impairment annually and if an event or conditions change that would more
likely than not reduce the fair value of a reporting unit below its carrying value. We perform our
annual goodwill impairment test during our fiscal fourth quarter.
A two step process is used to test for goodwill impairment under SFAS 142. The first step is
to determine if there is an indication of impairment by comparing the estimated fair value of each
reporting unit to its carrying value including existing goodwill. Goodwill is considered impaired
if the carrying value of a reporting unit exceeds the estimated fair value. Upon an indication of
impairment from the first step, a second step is performed to determine the amount of the
impairment. This involves calculating the implied fair value of goodwill by allocating the fair
value of the reporting unit to all assets and liabilities other than goodwill and comparing it to
the carrying amount of goodwill. We have four reporting units; Music, Technology Products and
Solutions, Games, and Media Software and Services.
We considered whether a triggering event had occurred during the quarter ended June 30, 2009
in assessing whether an interim impairment analysis of goodwill was warranted. We noted our market capitalization, before
adjusting for a reasonable control premium, was below its carrying value. In addition, we noticed
that the trading price per share of our common stock had negatively diverged from the broader
market during 2009. We also noted, more broadly, a continuation of macroeconomic instability in
general as well as continued illiquidity in the overall credit market. As a
36
result, we concluded that due to the sustained divergence in our market capitalization and the
continued macroeconomic instability, an interim impairment analysis of goodwill as of June 30, 2009
was warranted.
To estimate the fair value of the reporting units for step one, we utilized a combination of
income and market approaches. The income approach, specifically a discounted cash flow methodology,
included assumptions and estimates for, among other things, forecasted revenues, gross profit
margins, operating profit margins, working capital cash flow, growth rates and long term discount
rates, all of which require significant judgments by management. The market approaches derive fair
values by benchmarking metrics and transactions of companies that are comparable to us.
In performing step one, it was determined that the carrying value for each of our reporting
units; Music, Technology Products and Solutions, Games, and Media Software and Services exceeded
their respective fair values, indicating that goodwill within each reporting unit was potentially
impaired. We also performed a market capitalization reconciliation to ensure that the resulting
outputs of the test and the total fair value were reasonable. As required, we initiated the second
step of the goodwill impairment test for each of the reporting units. We determined that the
implied fair value of goodwill was zero for each of our reporting units. As a result, the Music,
Technology Products and Solutions, Games, and Media Software and Services reporting units recorded
impairments of $37.0 million, $50.5 million, $41.2 million and $46.8 million, respectively during
the quarter ended June 30, 2009. No impairments were recognized in either the quarter or six months
ended June 30, 2008.
The impairment analysis of goodwill is based upon estimates and assumptions relating to our
future revenue, cash flows, operating expenses, costs of capital and capital purchases. These
estimates and assumptions are complex and subject to a significant degree of judgment with respect
to certain factors including, but not limited to, the cash flows of our long-term operating plans,
market and interest rate risk, and risk-commensurate discount rates and cost of capital.
Other Income (Expenses), Net
Other income, net consists primarily of: interest income on our cash, cash equivalents, and
short-term investments, which are net of interest expense from amortization of offering costs
related to our convertible debt and equity in net loss of investments. Other income, net and
quarter-over-quarter changes are as follows (dollars in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Quarters Ended |
|
|
Six Months Ended |
|
| |
|
June 30, |
|
|
June 30, |
|
| |
|
2009 |
|
|
Change |
|
|
2008 |
|
|
2009 |
|
|
Change |
|
|
2008 |
|
Interest income, net |
|
$ |
754 |
|
|
|
(78 |
)% |
|
$ |
3,375 |
|
|
$ |
1,937 |
|
|
|
(77 |
)% |
|
$ |
8,333 |
|
Equity in net loss of investments |
|
|
(269 |
) |
|
|
151 |
|
|
|
(107 |
) |
|
|
(924 |
) |
|
|
367 |
|
|
|
(198 |
) |
Gain on sale of equity investments, net |
|
|
68 |
|
|
|
(69 |
) |
|
|
222 |
|
|
|
205 |
|
|
|
8 |
|
|
|
222 |
|
Gain on sale of interest in Rhapsody America |
|
|
— |
|
|
|
(100 |
) |
|
|
3,371 |
|
|
|
— |
|
|
|
(100 |
) |
|
|
7,097 |
|
Other income, net |
|
|
(449 |
) |
|
|
998 |
|
|
|
50 |
|
|
|
406 |
|
|
|
50 |
|
|
|
818 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income, net |
|
$ |
104 |
|
|
|
98 |
% |
|
$ |
6,911 |
|
|
$ |
1,624 |
|
|
|
90 |
% |
|
$ |
16,272 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net declined during the quarter ended June 30, 2009, due primarily to
lower interest income, and the change in accounting that resulted in no longer recording a gain on
the sale of a noncontrolling interest in Rhapsody America in the quarter. See “Notes to Unaudited
Condensed Consolidated Financial Statements — Rhapsody America” (Note 4). Lower interest income
resulted from lower average cash and investments combined with lower average interest rates.
Income Taxes
During the quarters ended June 30, 2009 and 2008, we recognized income tax expense of $1.2
million and $3.7 million, respectively, related to U.S. and foreign income taxes. During the six
months ended June 30, 2009 and 2008, we recognized income tax expense of $2.8 million and $7.7
million, respectively, related to U.S. and foreign income taxes. The decreases in income tax
expense and in tax expense as a percentage of pre-tax loss during the quarter and six months ended
June 30, 2009, were the result of greater losses compared to the same periods of the prior year
combined with losses not benefited in certain U.S. and foreign jurisdictions. Tax expense was also
negatively impacted by the non-deductible portion of the goodwill impairment of $175.2 million
during the quarter and six months ended June 30, 2009.
As of June 30, 2009, there have been no material changes to our uncertain tax positions
disclosures as provided in Note 16 of our 2008 Annual Report on Form 10-K. We do not anticipate
that total unrecognized tax benefits will significantly change within the next twelve months.
37
We file numerous consolidated and separate income tax returns in the United States Federal,
state, local, and foreign jurisdictions. With few exceptions, we are no longer subject to United
States Federal, state, local, or foreign income tax examinations for years before 1993. We are
currently under U.S. Federal audit for the consolidated group RealNetworks, Inc. and Subsidiaries
for the year ended December 31, 2007. RealNetworks, Inc. and its combined subsidiaries are also
under audit by the California Franchise Tax Board for the years ended December 31, 2005 and 2006,
and by the State of New York for the years ended December 31, 2005 through 2007.
New Accounting Pronouncements
With the exception of those discussed below, there have been no recent accounting
pronouncements or changes in accounting pronouncements during the quarter and six months ended June
30, 2009, as compared to the recent accounting pronouncements described in our Annual Report on
Form 10-K for the year ended December 31, 2008, that are of significance, or potential significance
to us.
Adopted Accounting Pronouncements
Effective January 1, 2009, we adopted, FSP No. 142-3, Determination of the Useful Life of
Intangible Assets (FSP No. 142-3) that amends the factors considered in developing renewal or
extension assumptions used to determine the useful life of a recognized intangible asset under SFAS
No. 142. FSP No. 142-3 requires a consistent approach between the useful life of a recognized
intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair
value of an asset under SFAS No. 141(R). The FSP also requires enhanced disclosures when an
intangible asset’s expected future cash flows are affected by an entity’s intent and/or ability to
renew or extend the arrangement. The adoption did not have a material impact on our consolidated
results of operations or financial condition.
Effective January 1, 2009, we adopted SFAS No. 141 (revised 2007), Business Combinations (SFAS
141(R)). Under SFAS 141(R), an entity is required to recognize the assets acquired, liabilities
assumed, contractual contingencies, and contingent consideration at their fair value on the
acquisition date. It further requires that acquisition-related costs be recognized separately from
the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods
subsequent to the acquisition date; and that changes in accounting for deferred tax asset valuation
allowances and acquired income tax uncertainties after the measurement period be recognized as a
component of provision for taxes. In addition, acquired in-process research and development is
capitalized as an intangible asset and amortized over its estimated useful life. SFAS 141(R) is
effective on a prospective basis for all business combinations for which the acquisition date is on
or after January 1, 2009, with the exception of the accounting for valuation allowances on deferred
taxes and acquired contingencies under SFAS 109. With the adoption of SFAS 141(R), any tax related
adjustments associated with acquisitions that closed prior to January 1, 2009 will be recorded
through income tax expense, whereas the previous accounting treatment would require any adjustment
to be recognized through goodwill. The adoption of SFAS 141(R) had no impact on our consolidated
financial statement as of and for the quarter and six months ended June 30, 2009.
Effective January 1, 2009, we implemented Statement of Financial Accounting Standards No. 160,
Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 (SFAS
160). This standard changed the accounting for and reporting of minority interest (now called
noncontrolling interest) in our consolidated financial statements. Upon adoption, certain prior
period amounts have been reclassified to conform to the current period financial statement
presentation. These reclassifications have no effect on our previously reported financial position
or results of operations. Refer to Note 4, Rhapsody America, and Note 13, Earnings per Share, of
this Form 10-Q for additional information on the adoption of SFAS 160.
Effective for the quarter ending June 30, 2009, we adopted SFAS No. 165, Subsequent Events
(SFAS 165). SFAS 165 is intended to establish general standards of accounting for, and disclosure
of, events that occur after the balance sheet date but before financial statements are issued. It
requires the disclosure of the date through which an entity has evaluated subsequent events and the
basis for that date.
Effective for the quarter ending June 30, 2009, we adopted FSP No. 115-2 and 124-2,
Recognition and Presentation of Other-Than-Temporary Impairments (FSP 115-2 and 124-2). FSP 115-2
and 124-2 provides new guidance on the recognition and presentation of an other-than-temporary
impairments, as well as extends certain annual disclosure requirements to interim periods. The
adoption did not have a material impact on our financial position or results of operations.
38
Liquidity and Capital Resources
The following summarizes working capital, cash, cash equivalents, short-term investments, and
restricted cash (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
June 30, |
|
December 31, |
| |
|
2009 |
|
2008 |
Working capital
|
|
$ |
266,910 |
|
|
$ |
266,990 |
|
Cash, cash equivalents, and short-term investments
|
|
|
362,758 |
|
|
|
370,734 |
|
Restricted cash
|
|
|
14,600 |
|
|
|
14,742 |
|
Cash, cash equivalents, and short-term investments decreased primarily due to cash used in
operations of approximately $18.2 million, as well as purchases of equipment, software and
leasehold improvements of approximately $7.6 million partially offset from sales of interests in
Rhapsody America of approximately $19.5 million.
The following summarizes cash flows (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
Six Months Ended |
| |
|
June 30, |
| |
|
2009 |
|
2008 |
Cash used in operating activities
|
|
$ |
(18,241 |
) |
|
$ |
(28,278 |
) |
Cash used in investing activities
|
|
|
(39,916 |
) |
|
|
(50,261 |
) |
Cash provided by financing activities
|
|
|
20,365 |
|
|
|
20,055 |
|
Cash used in operating activities consisted of net loss adjusted for certain non-cash items
including depreciation, amortization, stock-based compensation, purchases of trading securities,
deferred income taxes, noncontrolling interests, gain on sale of interest in Rhapsody America, and
the effect of changes in certain operating assets and liabilities, net of acquisitions.
Cash used in operating activities in the six months ended June 30, 2009 was $18.2 million and
consisted of a net loss of $212.5 million, adjustments for cash provided by non-cash items of
$196.3 million and cash used in activities related to changes in certain operating assets and
liabilities, net of acquisitions, of $2.0 million. Adjustments for cash provided by non-cash items
primarily consisted of $175.6 million of impairments of goodwill, $15.5 million of depreciation and
amortization expense and $10.8 million of stock-based compensation, partially offset by $3.7
million for payments made related to our restructuring and other impairments, which were accrued
for in the fourth quarter of 2008.
Changes in certain operating assets and liabilities, net of acquisitions, in the six months
ended June 30, 2009 primarily consisted of a decrease in accounts payable of $2.0 million related
to the timing of payments made to certain third party content providers, partially offset by a
decrease in accrued and other liabilities of $3.4 million related to a reduction in amounts payable
to MTVN for related party advertising incurred during the quarter ended June 30, 2009 as compared
to the quarter ended December 31, 2008, partially offset by a decrease in accounts receivable of
$5.7 million related to the timing of customer collections.
Cash used in operating activities in the six months ended June 30, 2008 was $28.3 million and
consisted of net loss of $15.7 million, adjustments for non-cash items provided by operations of
$26.6 million, offset by cash used in activities related to changes in certain operating assets and
liabilities, net of acquisitions, of $39.2 million. Adjustments for cash provided by non-cash items
primarily consisted of $25.7 million of depreciation and amortization and $11.5 million of stock
based compensation, partially offset by $7.1 million of gain on the sales of interests in Rhapsody
America.
Changes in certain operating assets and liabilities, net of acquisitions, in the six months
ended June 30, 2008, primarily consisted of a decrease of $11.8 million in accrued and other
liabilities due primarily to a reduction in amounts payable to MTVN for related party advertising
incurred during the quarter ended March 31, 2008 as compared to the quarter ended December 31,
2007, a decrease of $24.4 million in accounts payable related to the timing of payments to certain
vendors, an increase of $17.6 million in prepaid expenses and other assets primarily related to
increases in prepaid royalties and deferred costs, partially offset by a decrease in accounts
receivable of $14.6 million due the timing of cash receipts and reduced revenue.
In the six months ended June 30, 2009, investing activities used cash primarily for purchases
of equipment, software, and leasehold improvements of $7.6 million and acquisition costs of $3.2
million, from the last payment of accrued anniversary and performance payments relating to the
acquisition of Zylom. Purchases, net of sales and maturities of short-term investments used cash of
$27.5 million during 2009. In the six months ended June 30, 2008, investing activities used cash of
$26.9 million from purchases, net of sales and maturities, as well as purchases of equipment,
software, and leasehold improvements of $15.2 million and $10.2
39
million of acquisition costs, net of cash acquired for the purchase of TryMedia and the
anniversary and performance payments related to the Zylom acquisition.
Financing activities provided cash from the proceeds of sales of interests in Rhapsody America
of $19.5 million in 2009 and $14.6 million in 2008. Sales of common stock under our employee stock
purchase plan and exercise of stock options of also provided cash of $6.0 million in 2008.
We currently have no planned significant capital expenditures for 2009 other than those in the
ordinary course of business. In the future, we may seek to raise additional funds through public or
private equity financing, or through other sources such as credit facilities. 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.
The downturn in the economy could result in negative impacts to our liquidity arising from
lower interest income in future periods due to the continued decline in interest rates, an
increased risk that we may not be able to access cash balances held in U.S. or foreign financial
institutions or that investments in debt securities issued by financial institutions may be
rendered worthless due to the nationalization or failure of such financial institutions, and an
increased inability to sell the securities and the institutional money market funds we hold as
short-term investments. These risks and the potential impact of these risks on our financial
condition and results of operations are discussed further below in “Risk Factors — Risks Related
to Our Business in General.” If any of these risks are realized, we may experience a material
adverse impact on our financial condition and results of operations in future periods.
Our contractual obligations include office leases and contractual payments due to content and
other service providers. We believe that our current cash, cash equivalents, and short-term
investments will be sufficient to meet our anticipated cash needs for working capital and capital
expenditures for at least the next 12 months.
We do not hold derivative financial instruments or equity securities in our short-term
investment portfolio. Our cash equivalents and short-term investments consist of high quality
securities, as specified in our investment policy guidelines. The policy limits the amount of
credit exposure to any one non-U.S. Government or non-U.S. Agency issue or issuer to a maximum of
5% of the total portfolio. These securities are subject to interest rate risk and will decrease in
value if interest rates increase. Because we have historically had the ability to hold our fixed
income investments until maturity, we do not expect our operating results or cash flows to be
significantly affected by a sudden change in market interest rates in our securities portfolio.
We conduct our operations in ten primary functional currencies: the U.S. dollar, the Korean
won, the Japanese yen, the British pound, the Euro, the Mexican peso, the Brazilian real, the
Australian dollar, the Hong Kong dollar, and the Singapore dollar. Historically, neither
fluctuations in foreign exchange rates nor changes in foreign economic conditions have had a
significant impact on our financial condition or results of operations. We currently do not hedge
the majority of our foreign currency exposures and are therefore subject to the risk of exchange
rate fluctuations. We invoice our international customers primarily in U.S. dollars, except in
Korea, Japan, Germany, France, the United Kingdom and Australia, where we invoice our customers
primarily in won, yen, euros, pounds, and Australian dollars, respectively. 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.
Off-Balance Sheet Agreements
Our only significant off-balance sheet arrangements relate to operating lease obligations for
office facility leases and other contractual obligations related primarily to minimum contractual
payments due to content and other service providers.
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 our short-term investment portfolio. We do not hold derivative financial
instruments or equity investments in our short-term investment portfolio. Our short-term
investments consist of high quality debt securities as specified in our investment policy.
Investments in both fixed and
40
floating rate instruments carry a degree of interest rate risk. The fair value of fixed rate
securities may be adversely impacted due to a rise in interest rates, while floating rate
securities may produce less income than expected if interest rates fall. Additionally, a declining
rate environment creates reinvestment risk because as securities mature the proceeds are reinvested
at a lower rate, generating less interest income. Due in part to these factors, our future interest
income may be adversely impacted due to changes in interest rates. In addition, we may incur losses
in principal if we are forced to sell securities that have declined in market value due to changes
in interest rates. Because we have historically had the ability to hold our short-term investments
until maturity and the substantial majority of our short-term investments mature within one year of
purchase, we would not expect our operating results or cash flows to be significantly impacted by a
sudden change in market interest rates. There have been no material changes in our investment
methodology regarding our cash equivalents and short-term investments during the quarter ended June
30, 2009. Based on our cash, cash equivalents, short-term investments, and restricted cash
equivalents at June 30, 2009, a hypothetical 10% increase/decrease in interest rates would
increase/decrease our annual interest income and cash flows by approximately $0.2 million.
Investment Risk. As of March 31, 2009, we had investments in voting capital stock of both
publicly traded and privately-held technology companies for business and strategic purposes. Our
investments in publicly traded companies are accounted for as available-for-sale, carried at
current market value and are classified as long-term as they are strategic in nature. We
periodically evaluate whether any declines in fair value of our investments are
other-than-temporary based on a review of qualitative and quantitative factors. For investments
with publicly quoted market prices, these factors include the time period and extent by which its
accounting basis exceeds its quoted market price. We consider additional factors to determine
whether declines in fair value are other-than-temporary, such as the investee’s financial
condition, results of operations, and operating trends. The evaluation also considers publicly
available information regarding the investee companies. For investments in private companies with
no quoted market price, we consider similar qualitative and quantitative factors as well as the
implied value from any recent rounds of financing completed by the investee. Based upon an
evaluation of the facts and circumstances during the quarters ended June 30, 2009 and 2008, we
determined that no additional other-than-temporary decline in fair value had occurred and therefore
no impairment charges were recorded.
Foreign Currency Risk. We conduct business internationally in several currencies. As such, we
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. A
portion of these risks is managed through the use of financial derivatives, but fluctuations could
impact our results of operations and financial position.
Generally, our practice is to manage foreign currency risk for the majority of material
short-term intercompany balances through the use of foreign currency swaps. These contracts require
us to exchange currencies at rates agreed upon at the contract’s inception. Because the impact of
movements in currency exchange rates on forward contracts offsets the related impact on the
short-term intercompany balances, these financial instruments help alleviate the risk that might
otherwise result from certain changes in currency exchange rates. We do not designate our foreign
exchange forward contracts related to short-term intercompany accounts as hedges and, accordingly,
we adjust these instruments to fair value through results of operations. However, we may
periodically hedge a portion of our foreign exchange exposures associated with material firmly
committed transactions, long-term investments, highly predictable anticipated exposures and net
investments in foreign subsidiaries. Some of our unhedged exposures are reconciled through our
statement of operations on a mark-to-market basis each quarter, so to the extent we continue to
experience adverse economic conditions, we may record losses related to such unhedged exposures in
future periods that may have a material adverse effect on our financial condition and results of
operations.
Our foreign currency risk management program reduces, but does not entirely eliminate, the
impact of currency exchange rate movements.
In aggregate, our foreign currency denominated assets are greater than our foreign currency
denominated liabilities. Primarily as a result of the U.S. dollar strengthening against the Korean
won and euro in 2008, we recorded a reduction to our reported net assets of approximately $20.3
million as reflected in Accumulated Other Comprehensive Income (Loss) for the six months ended June
30, 2008. During the six months ended June 30, 2009, we recorded an increase to our reported net
assets of approximately $1.2 million
Additionally, 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
Korean won and euros. A hypothetical 10% increase or decrease in the Korean won and euro relative
to the U.S. dollar from June 30, 2009 would result in an unrealized gain or loss of approximately
$4.5 million.
Foreign currency transaction gains and losses were not material for the quarters and six
months ended June 30, 2009 and 2008.
41
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Based on an evaluation as of the end of
the period covered by this report, the Company’s principal executive officer and principal
financial officer have concluded that the Company’s disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
“Exchange Act”)) were effective to ensure that information required to be disclosed by the Company
in reports that it files or submits under the Exchange Act (1) is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange Commission rules and
forms, and (2) is accumulated and communicated to the Company’s management, including its principal
executive officer and principal financial officer, as appropriate to allow timely decisions
regarding required disclosure.
(b) Changes in Internal Controls. There have not been any changes in the Company’s internal
control over financial reporting (as such term is defined in Rule 13a-15(f) and 15d-15(f) under the
Exchange Act) during the quarter ended March 31, 2009 that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
|
| Item 1. Legal Proceedings |
On June 29, 2009, MCS Music America, Inc. (MCS Music), and other plaintiffs for whom MCS Music
administers copyrights, filed suit for copyright infringement against us, Yahoo! Inc. and Microsoft
Corporation in U.S. District Court for the Middle District of Tennessee. The complaint asserts
that our Rhapsody music service offers certain compositions for distribution without a license and
asks for statutory damages for willful infringement of the copyrights relating to those
compositions. We dispute the plaintiffs’ allegations in this action and intend to vigorously
defend ourselves, including by pursuing the potential availability of contractual indemnification
rights.
On September 30, 2008, we filed a declaratory action against Disney Enterprises, Inc.,
Paramount Pictures Corp., Sony Pictures Entertainment, Inc., Twentieth Century Fox Film Corp., NBC
Universal, Inc., Warner Bros. Entertainment, Inc., Viacom, Inc. (collectively, the “Studios”) and
the DVD Copy Control Association (DVD CCA) in the Northern District of California relating to the
Company’s RealDVD product (the “RealDVD Litigation”), which, among other things, allows consumers
to securely store DVD content on their hard drives. On the same day, various movie studios filed
suit against us in the Central District of California. Our suit asks the court to find that the
RealDVD product does not breach the license agreement that we entered into with the DVD CCA. The
movie studios’ suit alleges that by offering the RealDVD product, we have violated the Digital
Millennium Copyright Act. The DVD CCA has filed a counterclaim against us alleging that we breached
the license with the DVD CCA by developing RealDVD. The movie studios’ suit was subsequently
transferred to the Northern District of California. On October 3, 2008, the movie studios obtained
a temporary restraining order (TRO) requiring us to cease distribution of the RealDVD product. The
TRO was extended on October 7, 2008. In April and May 2009, the Court held a preliminary injunction
hearing to address the movie studios’ claim that RealDVD should not be sold pending a final
judicial determination of the underlying claims between the parties. We are currently awaiting the
District Court’s decision regarding the preliminary injunction. We believe that RealDVD complies
with the law, and we intend to vigorously defend the preliminary injunction request and, if
necessary, pursue its declaratory judgment action.
On May 13, 2009, we moved to amend our complaint against the Studios in the RealDVD Litigation to
add claims that the Studios and DVD CCA conspired to violate, and have violated, state and federal
antitrust laws by, among other things, unlawfully eliminating competition in the market for
technology that enables a consumer to make a lawful, secure backup copy of a DVD. We have filed
similar counterclaims against the DVD CCA. In both instances, we are seeking injunctive relief to
stop the anticompetitive activity, and are also asking for monetary damages. Our motion
to amend has not yet been ruled on by the Court, but the motion is unopposed by the Studios. On
June 29, 2009, the DVD CCA moved to dismiss our antitrust counterclaims. The hearing on
that motion is currently set for September 14, 2009.
In June 2008, we initiated an arbitration action in Seattle, Washington against VeriSign,
Inc., to seek resolution of disputes regarding the proper interpretation of an Alliance Agreement
entered into between the parties dating back to 2001. VeriSign asserted various counterclaims
against us, including claims that we breached the Alliance Agreement and tortiously interfered with
VeriSign’s proposed sale of certain business units. On May 7, 2009, the Arbitrator issued a ruling
denying our claims for relief and granting VeriSign’s claims, including VeriSign’s claim that we
tortiously interfered with VeriSign’s proposed sale of certain business units. Subsequent to that
ruling, the Arbitrator has further ruled that the limitation of liability clause contained in the
Alliance Agreement does not apply to the potential damages VeriSign incurred. In response, VeriSign
has filed an amended statement of damages seeking a material amount in damages. A hearing to
address VeriSign’s claimed damages began on July 13, 2009 and was adjourned on July
15th. On September 8, 2009, the Arbitrator will consider whether to hear further
evidence. We continue to believe that the limitation of
liability clause in the Alliance Agreement should apply to limit the amount of VeriSign’s claimed
monetary damages and that the Arbitrator does not have jurisdiction over tort claims. No assurance
can be made as to the final outcome of the disputes until all rulings are final and all avenues of
review have been exhausted, but we could ultimately
42
be required to pay damages to VeriSign in an amount that may be material to our financial
condition and results of operations. We intend to continue to defend ourself vigorously with
respect to this matter.
On April 25, 2007, a lawsuit was filed by Greenville Communications, LLC in Greenville,
Mississippi against a number of cell phone carriers, including our partners T-Mobile USA, Inc. and
Alltel Corporation, alleging that they infringe its patents by providing ringback tone services. We
agreed to indemnify T-Mobile and Alltel against the claims based on an indemnity that is claimed to
be owed by our subsidiary, WiderThan. On August 27, 2007, our motion to transfer this matter to the
District of New Jersey was granted. The parties have briefed claim construction, but the case has
been stayed pending reexamination of the patents at issue. We dispute the plaintiff’s allegations
regarding both the validity of its patents and its claims of infringement against our partners.
In April 2007, the Copyright Royalty Board (CRB) issued a decision setting new royalty rates
for the use of sound recordings in Internet radio from 2006 through 2010. These rates were appealed
and then affirmed by the D.C. Circuit Court of Appeals on July 10, 2009, except with respect to the
minimum royalty rate per station, which has been remanded to the CRB. Additionally, in a separate
proceeding, the CRB held hearings to determine mechanical royalty rates associated with the
statutory license for digital phonorecord deliveries, including streams and tethered downloads.
These rates have also been subject to industry-wide settlement negotiations. A partial settlement
was reached with respect to on-demand streaming and tethered downloads between the Digital Media
Association (DiMA), the Recording Industry Association of America (RIAA) and the National Music
Publishers Association (NMPA). This settlement, along with CRB’s determination on rates for full
downloads, physical products and ringtones, was published by the CRB, and after some modifications
by the U.S. Copyright Office, was collectively published as the CRB’s final determination in the
Federal Register. The rate for ringtones and the imposition of a late fee on certain royalty
payments contained in the final determination have been appealed by the RIAA. Finally, we have been
involved in a proceeding in the Southern District of New York to determine a royalty rate for the
public performance of music contained in the American Society of Composers, Authors and Publishers
(ASCAP) catalogue. In April 2008, the district court issued a preliminary ruling that sets forth,
among other things, a methodology to be used to calculate the royalties owed to ASCAP and
subsequently issued additional rulings. After working with ASCAP to make a final determination of
amounts due under the court’s rulings, we reached a partial agreement with ASCAP on January 12,
2009. We believe we have sufficiently accrued for expected royalties under the agreement, but we
plan to appeal some aspects of the court’s rulings that underlie the agreement, and the rulings
remain subject to appeal and challenge by other participants
From time to time we are, and expect to continue to be, subject to legal proceedings 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. These claims, including those described above and in Note 14 to the financial
statements included in this report, even if not meritorious, could force us to spend significant
financial and managerial resources. We are not aware of any other legal proceedings or claims that
we believe we will have, individually or taken together, a material adverse effect on our business,
prospects, financial condition or results of operations. However, we may incur substantial expenses
in defending against third-party claims and certain pending claims are moving closer to trial. We
expect that its potential costs of defending these claims may increase as the disputes move into
the trial phase of the proceedings. 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 financial position and results of operations.
Item 1A. Risk Factors
You should carefully consider the risks described below together with all of the other
information included in this quarterly report on Form 10-Q. The risks and uncertainties described
below are not the only ones facing our company. If any of the following risks actually occurs, our
business, financial condition or operating results could be harmed. In such case, the trading price
of our common stock could decline, and investors in our common stock could lose all or part of
their investment.
Risks Related to Our Music, Games and Media Software and Services Businesses
Our Music, Games and Media Software and Services businesses face substantial competitive and other
challenges that may prevent us from being successful in, and negatively impact future growth in,
those businesses.
Many of our current and potential competitors in our Music, Games and Media Software and
Services businesses have longer operating histories, greater name recognition, more employees and
significantly greater resources than we do. Our competitors across the breadth of our product lines
in these businesses include a number of large and powerful companies, such as Apple, Amazon.com
43
and Microsoft. To effectively compete in the markets for our Music, Games and Media Software
and Services businesses, we may experience 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
provide content we distribute to our customers, |
| |
| |
• |
|
changes to our products, services, technologies, licenses or business practices or
strategies, |
| |
| |
• |
|
lengthened sales cycles, |
| |
| |
• |
|
pressure to prematurely release products or product enhancements, or |
| |
| |
• |
|
degradation in our stature and reputation in the market. |
In addition, we face the following risks relating to our Music, Games and Media Software and
Services businesses:
Music. Our online music services offered through our Rhapsody America joint venture with MTVN
face significant competition from traditional offline music distribution competitors and from other
online digital music services, as well as online theft or “piracy.” Some of these competing online
services have spent substantial amounts on marketing and have received significant media attention,
including Apple’s iTunes music download service, which it markets closely with its popular iPod
line of portable digital audio players and its iPhone. Microsoft also offers premium music services
in conjunction with its Windows Media Player and also markets a portable music player and related
download software and music service called Zune. We also expect increasing competition from online
retailers such as Amazon.com, online community websites such as MySpace.com and Facebook.com, as
well as other providers of free, ad-supported music services, some of whom are successfully growing
consumer awareness of their services. Our online music services also face significant competition
from “free” peer-to-peer services which allow consumers to directly access a wide variety of
unlicensed content. Enforcement efforts have not effectively shut down these services and the
ongoing presence of these “free” services substantially impairs the marketability of legitimate
services like ours. To compete in this crowded market, we develop and work with partners to develop
new and often unique marketing programs designed to build awareness of our music products and
services and to attract subscribers. However, many of these marketing programs are unproven and may
result in significant expenses we may not recoup due to the program’s failure to increase awareness
or the number of subscribers to our music services. Rhapsody America may not be able to compete
effectively in this highly competitive and rapidly evolving market, which may negatively impact the
future growth of our Music business.
Games. Our RealArcade, GameHouse, and Zylom branded services compete with other online
aggregators and distributors of online and downloadable casual PC games. Some of these competitors
have high volume distribution channels and greater financial resources than we do. Our Games
business also competes with many other smaller companies that may be able to adjust to market
conditions faster than us. We also face an increasingly price competitive casual games market, and
some of our competitors may be able to compete on price more effectively than us. We expect
competition to intensify in this market from these and other competitors and no assurance can be
made that we will be able to continue to grow our revenue. Our development studios compete
primarily with other developers of online, downloadable and mobile casual PC games and must
continue to develop popular and high-quality game titles and to execute on opportunities to expand
the play of our games on a variety of non-PC platforms to maintain our competitive position and
help maintain the growth of our Games business.
Media Software and Services. Our media software and services (primarily our
SuperPass subscription service) face competition from existing competitive alternatives and other
emerging services and technologies, such as user generated content services like YouTube and
alternative streaming media playback technologies including Microsoft Windows Media Player and
Adobe Flash. Content owners are increasingly marketing their content on their own websites rather
than licensing to other distributors such as us. We face competition in these markets from
traditional media outlets such as television, radio, CDs, DVDs, videocassettes and others. We also
face competition from emerging Internet media sources and established companies entering into the
Internet media content market, including Time Warner’s AOL subsidiary, NBC Universal, Microsoft,
Apple, Adobe, Yahoo! and broadband internet service providers. We expect this competition to
continue to be intense as the market and business models for Internet video content mature and more
competitors enter these new markets. Competing services may be able to obtain better or more
favorable access to compelling video content than us, may develop better offerings than us and may
be able to leverage other assets or technologies to promote or distribute their offerings
successfully. If we are unable to compete successfully, the future growth of our Media Software and
Services business will be negatively impacted. In addition, our overall ability to sell
subscription services depends in part on the use of RealNetworks’ formats on the Internet, and
declines in the use of our formats may negatively affect our subscription revenue and increase
costs of obtaining new subscribers. Both Microsoft and Adobe are aggressively seeking to grow their
format usage.
44
The success of our subscription services businesses depends upon our ability to increase
subscription revenue and to license compelling content on commercially reasonable terms.
Our operating results could be adversely impacted by the loss of subscription revenue,
including the revenue generated from the online music services offered by our Rhapsody America
joint venture. Internet subscription businesses are a relatively new media delivery model, and we
cannot predict with accuracy our long-term ability to maintain or increase subscription revenue.
Subscribers may 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
(including Internet piracy), or because customer service issues are not satisfactorily resolved. In
recent periods, we have seen an increase in the number of gross customer cancellations of our
subscription services due in part to an increasingly large subscriber base, an increase in
involuntary credit card cancellations resulting in termination of service and increased prevalence
and awareness of alternative “free” on-demand streaming music services. In addition, we must
continue to obtain compelling digital media content for our video, music, and games services in
order to maintain and increase usage and overall customer satisfaction for these products. Our
online music service offerings available through our Rhapsody America venture depend on music
licenses from the major music labels and publishers, and the failure to renew these licenses under
terms that are commercially reasonable and acceptable to us would harm Rhapsody America’s ability
to generate revenues from its subscription services.
Music publishing royalty rates for music subscription services offered through RealNetworks and
Rhapsody America are not yet fully established; an unexpected modification or application of
settlement terms could negatively impact our operating results.
Publishing royalty rates associated with music subscription services in the U.S. and abroad
are not fully established and public performance licenses are negotiated individually with
performance rights organizations (PROs). A court issued several rulings that set forth how
royalties are to be calculated and address other matters relating to the application of the new
rates to be paid to one of the PROs, the American Society of Composers, Authors and Publishers
(ASCAP). After working with ASCAP to make a final determination of amounts owed under the court’s
rulings, we reached a partial agreement with ASCAP on January 12, 2009. While we believe we have
sufficiently accrued for expected royalties to be paid under the agreement, we plan to appeal some
aspects of the court’s rulings that underlie the agreement, and the rulings remain subject to
appeal and challenge by other participants. We also have license agreements to reproduce musical
compositions with the Harry Fox Agency, an agency that represents music publishers, and with many
independent music publishers as required in the creation and delivery of on-demand streams and
tethered downloads, but these license agreements generally do not include final royalty rates. The
license agreements anticipate industry-wide agreement on rates, which was reached among the Digital
Media Association (DiMA), the Recording Industry Association of America (RIAA) and the National
Music Publishers Association (NMPA). This settlement, along with the determination by the Copyright
Royalty Board (CRB) on rates for full downloads, physical products and ringtones, was published by
the CRB, and after some modifications by the U.S. Copyright Office, was collectively published as
part of the CRB’s final determination in the Federal Register. The rate for ringtones and the
imposition of a late fee on certain royalty payments contained in the
final determination have been
appealed by the RIAA. If terms of the settlement are modified or applied in a manner that we do not
expect, we could incur increased expenses that could negatively impact our operating results. The
publishing rates associated with our international music streaming services are also not yet
determined and may be higher than our current estimates.
An appeal of, or other industry settlement relating to, the April 2007 Copyright Royalty Board
decision regarding Internet radio royalties and minimum payments could result in material expenses
that would harm our operating results and our ability to provide popular radio services.
In April 2007, the CRB issued a decision setting new royalty rates for the use of sound
recordings in Internet radio from 2006 through 2010. These rates were appealed and then affirmed by
the D.C. Circuit Court of Appeals on July 10, 2009, except with
respect to the minimum royalty rate
per station, which has been remanded to the CRB. The ultimate determination of the minimum royalty
rate per station may be unfavorable to us, which could adversely impact our operating results and
our ability to provide our radio services in the future.
Our RealDVD PC application is currently the subject of pending litigation, and we could incur
significant expenses or be further prevented from selling RealDVD.
On September 30, 2008, we announced the availability of RealDVD, a PC application that allows
consumers to store, manage and play their DVDs on their computers. On the same day, we filed a
motion for declaratory judgment against the DVD Copy Control Association and Disney Enterprises,
Inc., Paramount Pictures Corp., Sony Pictures Entertainment, Inc., Twentieth Century Fox Film
Corp., NBC Universal, Inc., Warner Bros., Entertainment, Inc. and Viacom, Inc. seeking a
determination that, among other things, our RealDVD product complies with the DVD Copy Control
Association’s license agreement. Various movie studios filed suit against us alleging that RealDVD
violates the Digital Millennium Copyright Act (DMCA) and also asked for and were granted a
temporary restraining order preventing us from selling RealDVD until a full preliminary injunction
hearing could be held. Although we believe
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that our RealDVD product fully complies with the DVD Copy Control Association’s license
agreement and the DMCA, and enables consumers to exercise their legitimate, fair use rights to
securely store DVD content on their hard drives, we may not ultimately prevail on our claims. These
claims could be costly and time-consuming to assert and defend and could require us to pay
significant litigation expenses or damages or result in a preliminary or permanent injunction
against the sale of RealDVD, any of which would harm our operating results.
We may not be successful in maintaining and growing our distribution of digital media products.
We cannot predict whether consumers will continue to download and use our digital media
products consistent with past usage, especially in light of the fact that Microsoft bundles its
competing Windows Media Player with its Windows operating system and the popularity of the Adobe
Flash format. Our inability to maintain continued high volume distribution of our digital media
products could hold back the growth and development of related revenue streams from these market
segments, including the distribution of third-party products and sales of our subscription
services, and therefore could harm our business and our prospects.
We face risks with respect to certain matters in the governance and management of our Rhapsody
America joint venture and the integration and operation of assets that have been combined to form
Rhapsody America.
We and MTVN have formed Rhapsody America LLC, a Delaware limited liability company. We own,
through a wholly owned subsidiary, 51% of the limited liability company membership interests of
Rhapsody America and MTVN owns, through a wholly owned subsidiary, the remaining 49%. We are
entitled to appoint the general manager to manage the day-to-day operations of Rhapsody America.
Rhapsody America is governed by a limited liability company agreement which, among other things,
requires unanimous approval of the members for certain key operational activities, such as adopting
a budget and authorizing certain capital expenditures, and for significant company events, such as
mergers, asset sales, distributions, affiliate transactions and issuance, sale and repurchase of
membership interests of Rhapsody America. If we are not able to agree with MTVN on any of those
items, if the members are unable to agree on any other significant operational or financial matter
requiring approval of the members, or if there is any event that adversely impacts our relationship
with MTVN, the business, results of operations and financial condition of Rhapsody America may be
adversely affected and, consequently, our business may suffer. In addition, MTVN may have or
develop economic or other business interests or goals that are inconsistent with our or Rhapsody
America’s business interests or goals.
Neither we nor the current management of Rhapsody America has extensive experience in managing
and operating complex joint ventures of this nature, and the integration and operational activities
may strain our internal resources, distract us from managing our day-to-day operations, and impact
our ability to retain key employees in Rhapsody America. The nature of our and MTVN’s contributions
of services and assets to Rhapsody America required detailed cost allocation agreements that are
complex to implement and manage and may result in significant costs that could adversely affect our
operating results. The allocation of these support service costs is based on various measures
depending on the service provided, and require significant internal resources. Many of the
allocation methodologies are complicated, which may result in inaccuracies in the total charges to
be billed to Rhapsody America. In addition, the variable nature of these costs to be allocated to
Rhapsody America may result in fluctuations in the period-over-period results of our Music
business.
We and MTVN have certain contractual rights relating to the purchase and sale of MTVN’s membership
interest in Rhapsody America that may be settled in part through the issuance of additional shares
of our capital stock, which would dilute our other shareholders’ voting and economic interests in
us, and may require us to pay MTVN a price that exceeds the appraised value of its proportionate
interest in Rhapsody America.
Pursuant to the terms of the Rhapsody America limited liability company agreement, we have a
right to purchase from MTVN, and MTVN has a right to require us to purchase, MTVN’s membership
interest in Rhapsody America. These call and put rights are exercisable upon the occurrence of
certain events and during certain periods in each of 2012, 2013 and 2014 and every two years
thereafter and may be settled, in part, through the issuance of shares of our capital stock,
subject to specified limitations. If a portion of the purchase price for MTVN’s membership interest
is payable in shares of our capital stock, such shares could represent up to 15% of the outstanding
shares of our common stock immediately prior to the transaction. In addition, we may also be
obligated to issue shares of our non-voting stock representing up to an additional 4.9% of the
outstanding shares of our common stock immediately prior to the transaction. If we pay a portion of
the purchase price for MTVN’s membership interest in shares of our common stock and non-voting
stock, our other shareholders’ voting and economic interests in us will be diluted, and MTVN will
become one of our significant shareholders. In certain situations, if MTVN exercises its right to
require us to purchase its membership interests in Rhapsody America, we may be required to pay MTVN
a price that provides a return to MTVN that is higher than the appraised value of MTVN’s
proportionate interest in Rhapsody America, and as a result, we would pay greater than fair value
to acquire MTVN’s interest.
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Risks Related to Our Technology Products and Solutions Business
Contracts with our carrier customers subject us to significant risks that could negatively impact
our revenue or otherwise harm our operating results.
We derive a material portion of our revenue from carrier application services. Many of our
carrier application services contracts provide for revenue sharing arrangements, but we have little
control over the pricing decisions of our carrier customers. Furthermore, most of these contracts
do not provide for guaranteed minimum payments or usage levels. Because most of our carrier
customer contracts are nonexclusive, it is possible that our wireless carriers could purchase
similar application services from third parties, and cease to use our services in the future. As a
result, our revenue derived under these agreements could be substantially reduced depending on the
pricing and usage decisions of our carrier customers.
In addition, none of our carrier application services contracts obligates our carrier
customers to market or distribute any of our applications. Despite the lack of marketing
commitments, revenue related to our application services is, to a large extent, dependent upon the
marketing and promotion activities of our carrier customers. In addition, many of our carrier
contracts are short term and allow for early termination by the carrier with or without cause.
These contracts are therefore subject to renegotiation of pricing or other key terms that could be
adverse to our interests, and leave us vulnerable to non-renewal by the carriers. The loss of
carrier customers, a reduction in marketing or promotion of our applications, or the termination,
non-renewal or renegotiation of contract terms that are less favorable to us would likely result in
the loss of future revenues from our carrier application services.
Finally, certain of our carrier contracts obligate us to indemnify the carrier customer 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 accepted tenders of indemnification from two of our carrier customers
related to one pending patent infringement proceeding, and we are vigorously defending them. This
pending proceeding or future claims against which we may be obligated to defend our carrier
customers could result in paying amounts pursuant to these obligations that could materially harm
our operating results.
Our ongoing arbitration proceeding with VeriSign, Inc. could ultimately result in a damages award
in favor of VeriSign that may be material to our financial condition and results of operations.
In June 2008, we initiated an arbitration action in Seattle, Washington against VeriSign,
Inc., to seek resolution of disputes regarding the proper interpretation of an Alliance Agreement
entered into between the parties dating back to 2001. VeriSign asserted various counterclaims
against us, including claims that we breached the Alliance Agreement and tortiously interfered with
VeriSign’s proposed sale of certain business units. On May 7, 2009, the Arbitrator issued a ruling
denying our claims for relief and granting VeriSign’s claims, including VeriSign’s claim that we
tortiously interfered with VeriSign’s proposed sale of certain business units. Subsequent to that
ruling, the Arbitrator has further ruled that the limitation of liability clause contained in the
Alliance Agreement does not apply to the potential damages VeriSign incurred. In response, VeriSign
has filed an amended statement of damages seeking a material amount in damages. A hearing to
address VeriSign’s claimed damages began on July 13, 2009 and was adjourned on July
15th. On September 8, 2009, the Arbitrator will consider whether to hear further
evidence. While we continue to believe that the
limitation of liability clause in the Alliance Agreement should apply to limit the amount of
VeriSign’s claimed monetary damages and that the Arbitrator does not have jurisdiction over tort
claims, we could ultimately be required to pay damages to VeriSign in an amount that may be
material to our financial condition and results of operations. No assurance can be made as to the
final outcome of the disputes until all rulings are final and all avenues of review have been
exhausted.
The mobile entertainment market is highly competitive.
The market for mobile entertainment services, including ringback tone and music-on-demand
solutions, is highly competitive. Current and potential future competitors include major media
companies, Internet portal companies, content aggregators, wireless software providers and other
pure-play wireless entertainment publishers. In connection with music-on-demand in particular, we
may in the future compete with current providers of music-on-demand services for online or other
non-mobile platforms, some of which have greater financial resources than we do. In addition, the
major music labels may demand more aggressive revenue sharing arrangements or impose an alternative
business model less favorable to us. In addition, while most of our carrier customers do not offer
internally developed application services that compete with ours, if our carrier customers begin
developing these application services internally, we could be forced to lower our prices or
increase the amount of service we provide in order to maintain our business with those carrier
customers. Increased competition has in the past resulted in pricing pressure, forcing us to lower
the selling price of our services.
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A majority of the revenue that we generate in our Technology Products and Solutions business is
dependent upon our relationship with a few customers, including SK Telecom; any deterioration of
these relationships could materially harm our business.
We generate a significant portion of our revenue from sales of our mobile entertainment
services to a few of our mobile carrier customers, including SK Telecom, a leading wireless carrier
in South Korea. In the near term, we expect that we will continue to generate a significant portion
of our total revenue from these customers, particularly SK Telecom. If these customers fail to
market or distribute our applications or terminate their business contracts with us, or if our
relationships with these customers deteriorate in any significant way, we may be unable to replace
the affected business arrangements with acceptable alternatives. Furthermore, our relationship with
SK Telecom may be affected by the general state of the economy of South Korea. Failure to maintain
our relationships with these customers could have a material negative impact on our revenue and
operating results.
Our traditional system software licensing business has been negatively impacted by competitive
factors, and we may not experience improved sales of our system software products.
We believe that our traditional system software sales have been negatively impacted primarily
by the competitive effects of Microsoft, which markets and often bundles its competing technology
with its market leading operating systems and server software. Although the settlement agreement we
entered into with Microsoft relating to our claims regarding Microsoft’s anticompetitive practices
contained substantial cash payments to us and a series of technology agreements, Microsoft will
continue to be an aggressive competitor with our traditional systems software business. We cannot
be sure whether the portions of the settlement agreement designed to limit Microsoft’s ability to
leverage its market power will be effective, and we cannot predict when, or if, we will experience
increased demand for our system software products in a way that improves our operating results or
shareholder return on an investment in our stock.
Risks Related to Our Business in General
Our operating results are difficult to predict and may fluctuate, which may contribute to
volatility in our stock price.
The trading price for our common stock has been volatile, ranging from $1.97 to $7.28 per
share during the 52-week period ended June 30, 2009. As a result of the rapidly changing markets in
which we compete, our operating results may fluctuate from period-to-period, which may continue to
contribute to the volatility of our stock price. In past periods, our operating results have been
affected by personnel reductions and related charges, charges relating to losses on excess office
facilities, and impairment charges for certain of our equity investments, goodwill and other
long-lived assets. Our operating results may be adversely affected by similar or other charges or
events in future periods, including, but not limited to:
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impairments of long-lived assets, |
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integrating and operating newly acquired businesses and assets, |
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the seasonality of our business, which has experienced increased revenues in the
fourth quarter of our fiscal year, and |
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the general difficulty in forecasting our operating results and metrics, which could
result in actual results that differ significantly from expected results. |
Certain of our expense decisions (for example, research and development and sales and
marketing efforts) are based on predictions regarding business and the markets in which we compete.
Fluctuations in our operating results, particularly when experienced beyond what we expected, could
cause the trading price of our stock to continue to fluctuate.
Uncertainty and adverse conditions in the economy could have a material adverse impact on our
business, financial condition and results of operations.
The national and global economic downturn has resulted in a decline in overall consumer and
corporate spending, declines in consumer and corporate access to credit, fluctuations in foreign
exchange rates, declines in the value of assets and increased liquidity risks, all of which could
materially impact our business, financial condition and results of operations. We provide digital
entertainment services to consumers, and payment for our products and services may be considered
discretionary on the part of many of our current and potential customers. As a result, consumers
considering whether to purchase our products or services may be influenced by macroeconomic factors
that affect consumer spending such as unemployment, continuing increases in fuel costs, conditions
in the residential real estate and mortgage markets and access to credit. To the extent conditions
in the economy remain uncertain or the economy continues to deteriorate, our business could be
impacted as customers choose to leave our services, to reduce their service level or to stop
purchasing our products. In addition, our efforts to attract new customers may be adversely
affected. Declines in consumer spending may also negatively impact our business customers,
including our mobile carrier customers, who may experience decreases in demand for the services we
provide that are offered to their subscribers. We are also experiencing a decline in advertising
revenue as businesses are reducing their sales and marketing spending in response to the
contracting economy. A significant decrease in the demand for our products or services or declines
in our advertising revenue could have a material adverse impact on our operating results and
financial condition.
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Uncertainty and adverse economic conditions may also lead to a decreased ability to collect
payment for our products and services due primarily to a decline in the ability of consumers to use
or access credit, including through credit cards, which is how most of our customers pay for our
products and services. We also expect to continue to experience volatility in foreign exchange
rates, which could negatively impact the amount of revenue and net assets we record in future
periods. The functional currency of our foreign subsidiaries is 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 or the Korean won, may result in lower reported revenue. If
economic conditions continue to deteriorate or remain uncertain for a sustained period of time, we
may also record additional impairments to our assets in future periods. Economic conditions may
also negatively impact our liquidity due to (1) declines in interest income, (2) an increased risk
that we may not be able to access cash balances held in U.S. or foreign financial institutions or
that our investments in debt securities issued by financial institutions may become worthless due
to the nationalization or failure of such financial institutions, and (3) decreased ability to sell
the securities and the institutional money market funds we hold as short-term investments. In
addition, the decline in the trading price of shares of our common stock may make it difficult to
use our common stock as purchase price consideration for future acquisitions and to raise funds
through equity financings. If any of these risks are realized, we may experience a material adverse
impact on our financial condition and results of operations.
New products and services may not achieve market acceptance or may be subject to legal challenge
that could negatively affect our operating results.
The process of developing new, and enhancing existing, products and services is complex,
costly and uncertain. Our business depends on providing products and services that are attractive
to subscribers and consumers, which, in part, is subject to unpredictable and volatile factors
beyond our control, including end-user preferences and competing products and services. Any failure
by us to timely respond to or accurately anticipate consumers’ changing needs and emerging
technological trends could significantly harm our current market share or result in the loss of
market opportunities. In addition, we must make long-term investments, develop or obtain
appropriate intellectual property and commit significant resources before knowing whether our
predictions will accurately reflect consumer demand for our products and services, which may result
in no return or a loss on our investments. Furthermore, new products and services may be subject to
legal challenge. Responding to these potential 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.
We depend upon our executive officers and key personnel, but may be unable to attract and retain
them, which could significantly harm our business and results of operations.
Our success depends on the continued employment of certain executive officers and key
employees, including Robert Glaser, our founder, Chairman of the Board and Chief Executive Officer.
The loss of the services of Mr. Glaser or other key executive officers or employees could harm our
business.
Our success is also dependent upon our ability to identify, attract and retain highly skilled
management, technical, and sales personnel, both in our domestic operations and as we expand
internationally. Qualified individuals are in high demand and competition for such qualified
personnel in our industry is intense, and we may incur significant costs to retain or attract them.
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.
Acquisitions involve costs and risks that could harm our business and impair our ability to realize
potential benefits from acquisitions.
As part of our business strategy, we have acquired technologies and businesses in the past and
expect that we will continue to do so in the future. Since late 2006 through the second quarter of
2008, we completed the acquisition of substantially all of WiderThan and the acquisitions of Sony
NetServices GmbH, Exomi Oy, Game Trust and substantially all of the assets of Trymedia Systems,
Inc. The failure to adequately manage the costs and address the financial, legal and operational
risks raised by acquisitions of technology and businesses could harm our business and prevent us
from realizing the benefits of the acquisitions.
Acquisition-related costs and financial risks related to completed and potential future
acquisitions 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 non-cash charges for
the impairment of goodwill and other intangible assets in the fourth quarter of 2008, 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 significant negative
impact on our future operating results.
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Acquisitions also involve operational risks that could harm our existing operations or prevent
realization of anticipated benefits from an acquisition. These operational risks include:
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integrating and managing businesses based in countries in which we have little or no
prior experience; |
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diversion of management time and other resources from existing operations to
integration activities for acquired businesses; |
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impairment of relationships with employees, affiliates, advertisers or content
providers of our business or acquired business; and |
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assumption of known and unknown liabilities of the acquired company, including
intellectual property claims. |
An impairment in the carrying value of our long-lived assets could adversely affect our financial
condition and results of operations.
Long-lived assets consist primarily of equipment, software and leasehold improvements, as well
as amortizable intangible assets acquired in business combinations. Long-lived assets are amortized
on a straight line basis over their estimated useful lives. In accordance with SFAS 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, we review long-lived assets for impairment
whenever events or changes in circumstances indicate the carrying amount of such assets may not be
recoverable. If the carrying amount of an asset is not recoverable, an impairment loss is
recognized based on the excess of the carrying amount of the long-lived asset over its respective
fair value, which is generally determined as the present value of estimated future undiscounted
cash flows. During the quarter ended December 31, 2008, we concluded that the net book value
related to certain intangible assets exceeded the fair value attributable to such intangible
assets. As a result, we recorded charges of $57.6 million as impairments of long-lived assets
within our consolidated statements of operations and comprehensive income in 2008. No such
impairments were recognized in either the quarter or six months ended June 30, 2009.
The impairment analysis of long-lived assets is based upon estimates and assumptions relating
to our future revenue, cash flows, operating expenses, costs of capital and capital purchases.
These estimates and assumptions are complex and subject to a significant degree of judgment with
respect to certain factors including, but not limited to, the cash flows of our long-term operating
plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.
Significant or sustained declines in future revenue or cash flows, or adverse changes in our
business climate, among other factors, and their resulting impact on the estimates and assumptions
relating to the value of our long-lived assets could result in the need to perform an impairment
analysis in future interim periods which could result in a significant impairment. While we
believe our estimates and assumptions are reasonable, due to their complexity and subjectivity,
these estimates and assumptions could vary period to period.
We need to develop relationships and technical standards with manufacturers of non-PC media and
communication devices and interoperability of our services with these devices to grow our business.
Access to the Internet through devices other than a PC, such as personal digital assistants,
cellular phones, television set-top devices, game consoles, Internet appliances and portable music
and games devices has increased dramatically and is expected to continue to increase. If a
substantial number of alternative device manufacturers do not license and incorporate our
technology and services into their devices, we may fail to capitalize on the opportunity to deliver
digital media to non-PC devices which could harm our business prospects. In addition, in order for
our services, in particular, the digital music services offered through Rhapsody America, to
continue to grow, we must design services that interoperate effectively with a variety of hardware
devices. To achieve this interoperability, we and Rhapsody America depend on significant
cooperation with manufacturers of these products and with software manufacturers that create the
operating systems for such hardware devices to achieve our objectives. If we do not successfully
make our products and technologies compatible with emerging standards and the most popular devices
used to access digital media or successfully design our service to interoperate with the music
playback devices that our customers own, we may miss market opportunities and our business and
results will suffer.
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We may be unable to adequately protect our proprietary rights or leverage our patent portfolio, and
may face risks associated with third-party claims relating to our intellectual property.
Our ability to compete partly depends on the superiority, uniqueness and value of our patent
portfolio and other 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. However, 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 and services or effectively prevent
misappropriation of our technology. As 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 may be forced to litigate to
enforce or defend our patents and other intellectual property rights or to determine the validity
and scope of other parties’ proprietary rights, enter into royalty or licensing agreements on
unfavorable terms or redesign our product features and services. Any such dispute would likely be
costly and distract our management, and the outcome of any such dispute could fail to improve our
business prospects or otherwise harm our business.
From time to time we receive claims and inquiries from third parties alleging that our
technology may infringe the third parties’ proprietary rights, especially patents. Third parties
have also asserted and most likely will continue to assert claims against us alleging infringement
of copyrights, trademark rights, trade secret rights or other proprietary rights, or alleging
unfair competition or violations of privacy rights. Currently we are investigating or litigating a
variety of such pending claims, some of which are described in Note 14 to the financial statements
included in this report.
Our business and operating results will suffer 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. A
significant or repeated reduction in the performance, reliability, security or availability of our
information systems and network infrastructure could harm our ability to conduct our business, and
harm our reputation and ability to attract and retain users, customers, advertisers and content
providers. 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 could result from our failure to adequately maintain and enhance these systems and
networks, natural disasters and similar events, power failures, HVAC failures, intentional actions
to disrupt our systems and networks and many other causes. The vulnerability of a large portion of
our computer and communications infrastructure is enhanced because much of it is located at a
single leased facility in Seattle, Washington, an area that is at heightened risk of earthquake,
flood, and volcanic events. 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.
The growth of our business is dependent in part on successfully implementing our international
expansion strategy.
Our international operations involve risks inherent in doing business on an international
level, including difficulties in managing operations due to distance, language, and cultural
differences, different or conflicting laws and regulations, taxes, and exchange rate fluctuations.
Any of these factors could harm operating results and financial condition. Our foreign currency
exchange risk management program reduces, but does not eliminate, the impact of currency exchange
rate movements.
We may be subject to market risk and legal liability in connection with the data collection
capabilities of our products and services.
Many of our products are interactive Internet applications that by their very nature require
communication between a client and server to operate. To provide better consumer experiences and to
operate effectively, our products send information to our servers. Many of the services we provide
also require that a user provide certain information to us. We have an extensive privacy policy
concerning the collection, use and disclosure of user data involved in interactions between our
client and server products. Any failure by us to comply with our posted privacy policy and existing
or new legislation regarding privacy issues could impact the market for our products and services,
subject us to litigation, and harm our business.
We may be subject to assessment of sales and other taxes for the sale of our products, license of
technology or provision of services.
Currently we do not collect sales, value-added tax (VAT), transactional or other taxes on the
sale of our products, license of technology or provision of services in states and countries other
than those in which we have offices, employees or other taxable presence. However, one or more
states or foreign countries may seek to impose sales, VAT, transactional or other tax collection
obligations on us in the future. A successful assertion by one or more states or foreign countries
that we should be collecting sales, VAT, transactional or other taxes on the sale of our products,
licenses of technology, provision of services or from our Internet commerce activities could result
in substantial tax liabilities for past sales, discourage customers from purchasing our products
from us or otherwise substantially harm our business.
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Currently, decisions by the U.S. Supreme Court restrict the ability of states to force remote
sellers to collect state and local sales and use taxes. However, a number of states and the U.S.
Congress have been considering various initiatives that could limit or supersede the Supreme
Court’s position regarding sales and use taxes on products and services sold through the Internet.
If these initiatives are successful, we could be required to collect and remit sales and use taxes
in additional states. States are also continuing to define the taxability of digital goods.
Taxation of digital goods is subject to complex evolving tax rules that could result in additional
taxation of our products and services. The imposition of additional tax obligations related to our
business activities by state and local governments could materially adversely affect our operating
results, create administrative burdens for us and decrease our future sales.
In those countries where we have taxable presence, we collect VAT on sales of “electronically
supplied services” provided to European Union residents, including software products, games, data,
publications, music, video and fee-based broadcasting services. The collection and remittance of
VAT subjects us to additional currency fluctuation risks.
We may be subject to additional income tax assessments.
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.
Risks Related to Our Previously Announced Separation of Our Games Business
We announced our intention to separate our global Games business into an independent company and to
distribute shares of the newly created games company to our shareholders. If such transactions are
postponed for a significant period of time or not completed, our stock price and business may be
adversely affected, and we may not realize the anticipated benefits of the separation transactions.
In May 2008, we announced our intention to separate our global Games business into an
independent company and to distribute shares of the newly created games company to our
shareholders. We also indicated that we may precede the spin-off with an initial public offering
and sale of up to 20% of the shares of the new games company. In February 2009, we announced that
we postponed work with our outside advisors, stopped external spending on the proposed transactions
and wrote off the capitalized transaction-related costs in the fourth quarter of 2008. While we
still intend to create a separate games company, current conditions do not support the separation
transactions.
In addition, our business and operations may be harmed to the extent there is customer or
employee uncertainty surrounding the future direction of our product and service offerings and
strategy for our Games business. Even if we resume working with our outside advisors on the
separation transactions, we may not complete the transactions, which are subject to a number of
factors including market conditions, the final approval of our board of directors, the
effectiveness of a registration statement, the receipt of a favorable letter ruling from the
Internal Revenue Service and the execution of inter-company agreements. If the separation
transactions are not completed, we and our shareholders will not realize the anticipated financial,
operational and other benefits from such transactions.
Risks Related to the Securities Markets and Ownership of Our Common Stock
Our directors and executive officers beneficially own more than 38% of our stock, which gives them
significant control over certain major decisions on which our shareholders may vote, may discourage
an acquisition of us, and any significant sales of stock by our officers and directors could have a
negative effect on our stock price.
Our executive officers, directors and affiliated persons beneficially own more than 38% of our
common stock. Robert Glaser, our Chief Executive Officer and Chairman of the Board, beneficially
owns more than 38% of our common stock himself. As a result, our executive officers, directors and
affiliated persons will have significant influence to:
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elect or defeat the election of our directors; |
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amend or prevent amendment of our articles of incorporation or bylaws; |
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effect or prevent a merger, sale of assets or other corporate transaction; and |
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control the outcome of any other matter submitted to the shareholders for vote. |
Management’s stock ownership 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.
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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 transaction 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:
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adopt a plan of merger; |
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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; |
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authorize our voluntary dissolution; or |
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take any action that has the effect of any of the above. |
In addition, Mr. Glaser has special rights under our articles of incorporation to appoint or
remove members of the strategic transaction 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.
We have adopted a shareholder rights plan, which was amended and restated in December 2008,
that provides that shares of our common stock have associated preferred stock purchase rights. The
exercise of these rights would make the acquisition of RealNetworks by a third-party more expensive
to that party and has 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Default Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
As disclosed in our Current Report on Form 8-K filed with the SEC on July 8, 2009, we rescheduled
our 2009 annual meeting of shareholders for September 21, 2009.
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Item 6. Exhibits
Exhibits Required by Item 601 of Regulation S-K
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| Exhibit |
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| Number |
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Description |
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31.1
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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 |
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31.2
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Certification of Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer 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 |
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32.1
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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 |
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32.2
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Certification of Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer of RealNetworks, Inc.,
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 |
54
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on
August 6, 2009.
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REALNETWORKS, INC.
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By: |
/s/ Michael Eggers
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Michael Eggers |
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Title: Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) |
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55
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 Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer 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 Michael Eggers, Senior Vice President, Chief
Financial Officer and Treasurer of RealNetworks, Inc.,
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 |
56