Edgar Filing: REALNETWORKS INC

10Q 2013 Q3

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



	FORM 10-Q

(Mark One)



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

For the Quarterly Period Ended September 30, 2013



¨	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)
Washington		91-1628146
(State of incorporation)		(I.R.S. Employer Identification Number)

1501 First Avenue South, Suite 600 Seattle, Washington		98134
(Address of principal executive offices)		(Zip Code)
	(206) 674-2700
	(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically 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 ý No ¨

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):



Large accelerated filer	¨	Accelerated filer	ý

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

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

The number of shares of the registrant’s Common Stock outstanding as of October 31, 2013 was 35,733,174.

TABLE OF CONTENTS



	Page

Part I. Financial Information	3
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3. Quantitative and Qualitative Disclosures About Market Risk	31
Item 4. Controls and Procedures	32
Part II. Other Information	33
Item 1. Legal Proceedings	33
Item 1A. Risk Factors	33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3. Default Upon Senior Securities	41
Item 4. Mine Safety Disclosures	41
Item 5. Other Information	41
Item 6. Exhibits	41
Signature	42
Index to Exhibits	43

PART I. FINANCIAL INFORMATION


Item 1.	Financial Statements

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)



	September 30, 2013			December 31, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	134,879		$	163,198
Short-term investments	83,527			108,216
Trade accounts receivable, net of allowances	26,494			30,754
Deferred costs, current portion	1,622			825
Deferred tax assets, current	3,942			2,869
Prepaid expenses and other current assets	12,152			17,002
Total current assets	262,616			322,864
Equipment, software, and leasehold improvements, at cost:
Equipment and software	94,054			98,041
Leasehold improvements	3,516			22,767
Total equipment, software, and leasehold improvements, at cost	97,570			120,808
Less accumulated depreciation and amortization	73,105			91,492
Net equipment, software, and leasehold improvements	24,465			29,316
Restricted cash equivalents and investments	5,000			10,000
Equity method investment	12,656			19,204
Available for sale securities	34,485			34,334
Other assets	2,844			3,153
Deferred costs, non-current portion	1,032			531
Deferred tax assets, net, non-current portion	1,576			4,911
Other intangible assets, net	14,051			3,275
Goodwill	17,518			6,309
Total assets	$	376,243		$	433,897
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	20,562		$	19,013
Accrued and other current liabilities	58,024			57,530
Deferred revenue, current portion	7,604			8,675
Total current liabilities	86,190			85,218
Deferred revenue, non-current portion	167			169
Deferred rent	613			2,250
Deferred tax liabilities, net, non-current portion	3,166			432
Other long-term liabilities	492			3,100
Total liabilities	90,628			91,169
Commitments and contingencies
Shareholders’ equity:
Preferred stock, $0.001 par value, no shares issued and outstanding:
Series A: authorized 200 shares	—			—
Undesignated series: authorized 59,800 shares	—			—
Common stock, $0.001 par value authorized 250,000 shares; issued and outstanding 35,679 shares in 2013 and 35,324 shares in 2012	36			35
Additional paid-in capital	608,595			603,770
Accumulated other comprehensive loss	(26,959		)	(26,540		)
Retained deficit	(296,057		)	(234,537		)
Total shareholders’ equity	285,615			342,728
Total liabilities and shareholders’ equity	$	376,243		$	433,897

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data)



	Quarters Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Net revenue (A)	$	48,958		$	59,088		$	155,601		$	191,578
Cost of revenue (B)	18,990			25,244			59,015			78,633
Gross profit	29,968			33,844			96,586			112,945
Sale of patents and other technology assets, net of costs (See Note 1)	—			—			—			116,353
Operating expenses:
Research and development	15,707			15,321			45,951			49,167
Sales and marketing	19,427			21,972			59,830			68,462
General and administrative	9,869			8,759			28,506			35,103
Restructuring and other charges	1,877			10,724			4,075			13,872
Lease exit and related charges	—			243			3,066			243
Loss on litigation settlements	11,525			—			11,525			—
Total operating expenses	58,405			57,019			152,953			166,847
Operating income (loss)	(28,437		)	(23,175		)	(56,367		)	62,451
Other income (expenses):
Interest income, net	166			164			992			1,033
Gain (loss) on sale of equity and other investments, net	—			2,210			—			5,288
Equity in net loss of Rhapsody investment	(2,629		)	(1,613		)	(6,209		)	(4,095		)
Other income (expense), net	(118		)	248			(146		)	1,674
Total other income (expenses), net	(2,581		)	1,009			(5,363		)	3,900
Income (loss) before income taxes	(31,018		)	(22,166		)	(61,730		)	66,351
Income tax expense (benefit)	357			48			(210		)	24,583
Net income (loss)	$	(31,375	)	$	(22,214	)	$	(61,520	)	$	41,768
Basic net income (loss) per share	$	(0.88	)	$	(0.63	)	$	(1.73	)	$	1.20
Diluted net income (loss) per share	$	(0.88	)	$	(0.63	)	$	(1.73	)	$	1.19
Shares used to compute basic net income (loss) per share	35,670			34,998			35,490			34,747
Shares used to compute diluted net income (loss) per share	35,670			34,998			35,490			35,000
Comprehensive income (loss):
Unrealized investment holding gains (losses)	$	(1,043	)	$	5,407		$	(28	)	$	1,840
Foreign currency translation adjustments, net of reclassification adjustments	1,235			506			(391		)	(1,730		)
Total other comprehensive income (loss)	192			5,913			(419		)	110
Net income (loss)	(31,375		)	(22,214		)	(61,520		)	41,768
Comprehensive income (loss)	$	(31,183	)	$	(16,301	)	$	(61,939	)	$	41,878
(A) Components of net revenue:
License fees	$	10,503		$	11,957		$	33,494		$	41,137
Service revenue	38,455			47,131			122,107			150,441
	$	48,958		$	59,088		$	155,601		$	191,578
(B) Components of cost of revenue:
License fees	$	2,062		$	3,226		$	6,377		$	9,143
Service revenue	16,928			22,018			52,638			69,490
	$	18,990		$	25,244		$	59,015		$	78,633

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



	Nine Months Ended September 30,
	2013			2012
Cash flows from operating activities:
Net income (loss)	$	(61,520	)	$	41,768
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	15,045			12,478
Stock-based compensation	5,671			6,419
Loss on disposal of equipment, software, and leasehold improvements	—			1,965
Equity in net loss of Rhapsody	6,209			4,095
Deferred income taxes, net	(1,238		)	22,399
Gain on sale of patent and other technology assets, net of costs	—			(116,353		)
Gain on sale of equity and other investments, net	—			(5,288		)
Realized translation gain	(35		)	(1,968		)
Other	51			—
Net change in certain operating assets and liabilities:
Trade accounts receivable	6,466			5,848
Prepaid expenses and other assets	4,772			(2,956		)
Accounts payable	26			3,683
Accrued and other liabilities	(3,750		)	(2,840		)
Net cash provided by (used in) operating activities	(28,303		)	(30,750		)
Cash flows from investing activities:
Purchases of equipment, software, and leasehold improvements	(5,798		)	(6,478		)
Proceeds from sale of patents and other technology assets, net of costs	—			116,353
Proceeds from sale of equity and other investments	—			7,244
Purchases of short-term investments	(85,670		)	(76,191		)
Proceeds from sales and maturities of short-term investments	110,359			51,885
Decrease (increase) in restricted cash equivalents and investments, net	5,000			103
Acquisitions of businesses, net of cash acquired	(22,480		)	—
Net cash provided by (used in) investing activities	1,411			92,916
Cash flows from financing activities:
Proceeds from issuance of common stock (stock options and stock purchase plan)	408			3,240
Tax payments from shares withheld upon vesting of restricted stock	(911		)	(964		)
Payment of contingent consideration	(828		)	—
Net cash provided by (used in) financing activities	(1,331		)	2,276
Effect of exchange rate changes on cash and cash equivalents	(96		)	(73		)
Net increase (decrease) in cash and cash equivalents	(28,319		)	64,369
Cash and cash equivalents, beginning of period	163,198			106,333
Cash and cash equivalents, end of period	$	134,879		$	170,702
Supplemental disclosure of cash flow information:
Cash received from income tax refunds	$	8,354		$	247
Cash paid for income taxes	$	2,988		$	2,015
Non-cash investing activities:
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements	$	1,096		$	116

See accompanying notes to unaudited condensed consolidated financial statements.

REALNETWORKS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Quarters and Nine Months Ended September 30, 2013 and 2012

Note 1. Description of Business and Summary of Significant Accounting Policies

Description of Business. RealNetworks, Inc. and subsidiaries is a leading global provider of network-delivered digital media applications and services that make it easy to manage, play and share digital media. The Company also develops and markets software products and services that enable the creation, distribution and consumption of digital media, including audio and video.

Inherent in our business are various risks and uncertainties, including a limited history of certain of our product and service offerings. RealNetworks' success will depend on the acceptance of our technology, products and services and the ability to generate related revenue.

In this Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”.

Basis of Presentation. The unaudited condensed consolidated financial statements include the accounts of RealNetworks and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.

The unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of 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 nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2013. Certain information and disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC).

These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2012 (the 10-K).

Use of Estimates. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In addition, current economic conditions may require the use of additional estimates, and certain estimates we make are subject to a greater degree of uncertainty as a result of the current economic conditions.

Reportable Segments. In the first quarter of 2013 we reorganized the management of our businesses and as a result, we changed our reportable segments. See Note 18, Segment Information, for details.

Accumulated Other Comprehensive Income (Loss). The components of accumulated other comprehensive income (loss), net of any applicable tax, were as follows (in thousands):



	September 30, 2013			December 31, 2012
Unrealized gains on investments, net of tax effects of $(716) and $(846) at September 30, 2013 and December 31, 2012, respectively	$	26,657		$	26,685
Foreign currency translation adjustments	(53,616		)	(53,225		)
Accumulated other comprehensive income (loss)	$	(26,959	)	$	(26,540	)

In the quarter and nine months ended September 30, 2012 we liquidated the investment in certain of our foreign entities and recorded net pre-tax gains of $0.4 million and $2.0 million, respectively, in Other income (expense), net, in the consolidated statement of operations upon the reclassification of the same amount of cumulative foreign exchange translation adjustment from accumulated other comprehensive income (loss) on the balance sheet. The reclassification adjustments had no related income tax expense or benefit.

There were no material reclassification adjustments or related tax effects related to foreign exchange translation amounts in the nine months ended September 30, 2013.

In the quarter and nine months ended September 30, 2012 we realized pre-tax gains of $2.2 million and $4.3 million, respectively, in the consolidated statement of operations, within Gain (loss) on sale of equity and other investments, net, related to the sale of a portion of the equity shares we hold in LoEn Entertainment, Inc., with the same amounts reclassified from accumulated other comprehensive income (loss) on the balance sheet. The reclassification adjustment had no related income tax expense or benefit.

There were no reclassification adjustments or related tax effects related to unrealized gains on investments in the nine months ended September 30, 2013.

For the three months ended September 30, 2013 we recorded income tax expense of $0.6 million and for the nine months ended September 30, 2013 we recorded an income tax benefit of $0.1 million related to unrealized gains (losses) on investment securities, and recognized the corresponding amount as an increase or decrease to accumulated other comprehensive income.

2012 Sale of Patents and Other Technology Assets to Intel Corporation. In the second quarter of 2012, we completed the sale of certain patents, patent applications and related rights held by us, and certain of our assets relating to our next generation video codec technologies to Intel Corporation (Intel). The entire $120.0 million of cash proceeds we received, net of certain direct costs incurred, was recorded as a gain on our statement of operations in the quarter ending June 30, 2012, since the patent assets and other technology had a net book value of zero. The gain recognized of $116.4 million in the nine months ended September 30, 2012 was net of related direct costs for the sale transaction totaling $3.6 million incurred in the first and second quarters of 2012.

Note 2. Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the nine months ended September 30, 2013 to be implemented that are of significance or potential significance to RealNetworks.

Note 3. Acquisitions

In the quarter ended June 30, 2013, we acquired 100% of the voting interests in Slingo, Inc., a social casino games company based in the U.S., for total cash consideration of $15.6 million. The tangible and intangible assets and liabilities recognized are reported within the Games segment. The identifiable intangible assets associated with the acquisition totaled $8.0 million. Of this total, $4.5 million is related to tradenames and trademarks determined to have indefinite useful lives and will be evaluated annually in our fourth quarter for impairment, or more frequently, if circumstances indicate an impairment may exist. The remaining $3.5 million includes developed game technology and existing customer relationships with finite lives, and will be amortized over their useful lives. We recorded a net deferred tax liability of $2.7 million related to the intangible assets acquired. Goodwill totaling $9.8 million was recorded, representing the intangible assets that do not qualify for separate recognition for accounting purposes, primarily related to the assembled workforce and expected synergies in the rapidly growing social casino games market. The goodwill is not deductible for income tax purposes. For the nine months ended September 30, 2013, the amount of revenue and income (loss) before income taxes from this acquired business was not significant.

In the quarter ended September 30, 2013, we acquired 100% of the voting interests in Muzicall Limited, a ringback tone company based in London, for total cash consideration of $6.7 million. The tangible and intangible assets and liabilities recognized are reported in the Mobile Entertainment segment. The identifiable intangible assets associated with the acquisition totaled $5.4 million, and include tradenames and trademarks, developed technology, user base and carrier relationships. All identifiable intangible assets from this acquisition have finite lives, and will be amortized over their useful lives. We recorded a net deferred tax asset of $3.4 million related to the assets acquired, and a full valuation allowance. Goodwill totaling $1.3 million was recorded, representing the intangible assets that do not qualify for separate recognition for accounting purposes, primarily related to the assembled workforce and expected synergies in the ringback tone industry. The goodwill is not deductible for income tax purposes. For the nine months ended September 30, 2013, the amount of revenue and income (loss) before income taxes from this acquired business was not significant. This acquisition is intended to accelerate our growth initiatives within the Mobile Entertainment segment.

Note 4. Stock-Based Compensation

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



	Quarters Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Total stock-based compensation expense	$	1,613	$	2,354	$	5,671	$	6,419

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



	Quarters Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Expected dividend yield	0	%	0	%	0	%	0	%
Risk-free interest rate	0.96	%	0.48	%	0.82	%	0.51	%
Expected life (years)	3.8		4.1		4.0		4.1
Volatility	48	%	58	%	48	%	58	%

The total stock-based compensation amounts for 2013 and 2012 disclosed above are recorded in their respective line items within operating expenses in the consolidated statement of operations. No stock-based compensation was capitalized as part of the cost of an asset as of September 30, 2013 or December 31, 2012. As of September 30, 2013, we had $8.1 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 3 years.

Note 5. Rhapsody Joint Venture

RealNetworks initially formed in 2007 a joint venture with MTV Networks, a division of Viacom International Inc. (MTVN), to own and operate a business-to-consumer digital audio music service known as Rhapsody. Prior to March 31, 2010, we held a 51% interest in Rhapsody and MTVN owned the remaining 49%. On March 31, 2010, restructuring transactions involving Rhapsody were completed, and as a result, effective March 31, 2010 RealNetworks owned approximately 47% of Rhapsody. Subsequent to the restructuring transaction, we account for our investment in Rhapsody using the equity method of accounting for investments.

As of September 30, 2013 we owned approximately 45% of the issued and outstanding stock of Rhapsody.

RealNetworks continues to provide certain operational transition services to Rhapsody. These transition services are expected to be completed in 2013, and are discussed further in Footnote 19, Related Party Transactions.

We recorded our share of losses of Rhapsody of $2.6 million and $6.2 million for the quarter and nine months ended September 30, 2013, respectively. Our share of losses of Rhapsody for the quarter and nine months ended September 30, 2012 were $1.6 million and $4.1 million, respectively.

The carrying value of our Rhapsody investment was $12.7 million as of September 30, 2013.

Summarized financial information for Rhapsody, which represents 100% of their financial information (in thousands):



	Quarters Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Net revenue	$	35,190		$	36,389		$	103,831		$	109,368
Gross profit	7,800			9,266			24,412			28,757
Net loss	(5,621		)	(3,424		)	(14,812		)	(9,031		)

Note 6. Fair Value Measurements

We measure certain financial assets at fair value on a recurring basis, including cash equivalents, short-term investments, and equity investments of publicly traded companies. The fair value of these financial assets was determined based on three levels of inputs:


•	Level 1: Quoted prices in active markets for identical assets or liabilities


•	Level 2: Directly or indirectly observed inputs for the asset or liability, including quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active


•	Level 3: Significant unobservable inputs that reflect our own estimates of assumptions that market participants would use

Items Measured at Fair Value on a Recurring Basis

The following table presents information about our financial assets that have been measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012, and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands).



	Fair Value Measurements as of
	September 30, 2013
	Total		Level 1		Level 2		Level 3
Cash equivalents:
Money market funds	$	23,038	$	2	$	23,036	$	—
Corporate notes and bonds	72,493		—		72,493		—
Short-term investments:
Corporate notes and bonds	60,041		—		60,041		—
U.S. government agency securities	23,486		22,658		828		—
Restricted cash equivalents and investments	5,000		—		5,000		—
Equity investments in publicly traded securities	34,485		34,485		—		—
Total	$	218,543	$	57,145	$	161,398	$	—



	Fair Value Measurements as of
	December 31, 2012
	Total		Level 1		Level 2		Level 3
Cash equivalents:
Money market funds	$	10,680	$	—	$	10,680	$	—
Corporate notes and bonds	81,235		—		81,235		—
Short-term investments:
Corporate notes and bonds	65,502		—		65,502		—
U.S. government agency securities	42,714		42,113		601		—
Restricted cash equivalents and investments	10,000		—		10,000		—
Equity investments in publicly traded securities	34,334		34,334		—		—
Total	$	244,465	$	76,447	$	168,018	$	—

Our equity investments in publicly traded companies consist of 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 aggregate cost basis of these securities totaled $8.6 million as of September 30, 2013 and $8.6 million at December 31, 2012.

Items Measured at Fair Value on a Non-recurring Basis

Certain of our assets and liabilities are measured at estimated fair value on a non-recurring basis, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the nine months ended September 30, 2013 and 2012, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.

Note 7. Cash, Cash Equivalents, Short-Term Investments, Restricted Cash Equivalents and Investments

Cash and cash equivalents, short-term investments, and restricted cash equivalents and investments as of September 30, 2013, consisted of the following (in thousands):



	Amortized Cost		Estimated Fair Value
Cash and cash equivalents:
Cash	$	39,348	$	39,348
Money market mutual funds	23,038		23,038
Corporate notes and bonds	72,494		72,493
Total cash and cash equivalents	134,880		134,879
Short-term investments:
Corporate notes and bonds	60,005		60,041
U.S. government agency securities	23,478		23,486
Total short-term investments	83,483		83,527
Total cash, cash equivalents and short-term investments	$	218,363	$	218,406
Restricted cash equivalents and investments	$	5,000	$	5,000

Cash and cash equivalents, short-term investments, and restricted cash equivalents and investments as of December 31, 2012 consisted of the following (in thousands):



	Amortized Cost		Estimated Fair Value
Cash and cash equivalents:
Cash	$	71,283	$	71,283
Money market mutual funds	10,680		10,680
Corporate notes and bonds	81,237		81,235
Total cash and cash equivalents	163,200		163,198



Short-term investments:
Corporate notes and bonds	65,426		65,502
U.S. Government agency securities	42,693		42,714
Total short-term investments	108,119		108,216
Total cash, cash equivalents, and short-term investments	$	271,319	$	271,414
Restricted cash equivalents and investments	$	10,000	$	10,000

Restricted cash equivalents and investments amounts as of September 30, 2013, and December 31, 2012 relate to cash and investments pledged as collateral against letters of credit in connection with lease agreements.

Realized gains or losses on sales of short-term investment securities for the quarters and nine months ended September 30, 2013 and 2012 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of September 30, 2013 and December 31, 2012 were not significant.

Investments with remaining contractual maturities of five years or less are classified as short-term because the investments are marketable and highly liquid and we have the ability to utilize them for current operations. Contractual maturities of short-term investments as of September 30, 2013 (in thousands):



	Estimated Fair Value
Within one year	$	57,321
Between one year and five years	26,206
Total short-term investments	$	83,527

Note 8. Allowance for Doubtful Accounts Receivable and Sales Returns

Activity in the allowance for doubtful accounts receivable and sales returns (in thousands):



	Allowance For
	Doubtful Accounts Receivable			Sales Returns
Balances, December 31, 2012	$	1,010		$	653
Addition (reduction) to allowance	210			(47		)
Amounts written off	(61		)	(21		)
Foreign currency translation	20			—
Balances, September 30, 2013	$	1,179		$	585

One customer accounted for 13% of trade accounts receivable and one other customer accounted for 12% of trade accounts receivable, as of September 30, 2013. No one customer accounted for more than 10% of trade accounts receivable as of December 31, 2012.

One customer accounted for approximately 12%, or $6.0 million, and 14% or $21.1 million, of consolidated revenue during the quarter and nine months ended September 30, 2013, respectively. The revenue from this customer is reflected in our RealPlayer Group and Games segments. One other customer accounted for approximately 14%, or $6.8 million, and 11% or $17.3 million, of consolidated revenue during the quarter and nine months ended September 30, 2013, respectively, in our Mobile Entertainment segment. One customer accounted for 11%, or $6.4 million, of revenue during the quarter ended September 30, 2012. No one customer accounted for more than 10% of consolidated revenue during the nine months ended September 30, 2012.

Note 9. Other Intangible Assets

Other intangible assets (in thousands):



		Gross Amount		Accumulated Amortization		Net
Amortizing intangible assets:
	Customer relationships	$	34,753	$	30,168	$	4,585
	Developed technology	28,949		24,554		4,395
	Patents, trademarks and tradenames	3,965		3,558		407
	Service contracts and other	5,637		5,473		164
		$	73,304	$	63,753	$	9,551
Non-amortizing intangible assets:
	Trademarks and tradenames					$	4,500
	Total other intangible assets, September 30, 2013					$	14,051

For current year increases in other intangible assets, see Note 3, Acquisitions, for details on our acquisitions of Slingo, a social casino games business, in the quarter ended June 30, 2013, and Muzicall, a ringback tone business, in the quarter ended September 30, 2013.

Note 10. Goodwill

Changes in goodwill (in thousands):



Balance, December 31, 2012	$	6,309
Increases due to current year acquisitions	11,352
Effects of foreign currency translation	(143		)
Balance, September 30, 2013	$	17,518

Goodwill by segment (in thousands):



	September 30, 2013
RealPlayer Group	$	580
Mobile Entertainment	2,115
Games	14,823
Total goodwill	$	17,518

For current year increases in goodwill, see Note 3, Acquisitions, for details on our acquisitions of Slingo, a social casino games business, in the quarter ended June 30, 2013, and Muzicall, a ringback tone business, in the quarter ended September 30, 2013.

Note 11. Accrued and Other Current Liabilities

Accrued and other current liabilities (in thousands):



	September 30, 2013		December 31, 2012
Royalties and other fulfillment costs	$	16,648	$	19,435
Employee compensation, commissions and benefits	11,821		13,368
Accrued legal settlements	11,525		—
Sales, VAT and other taxes payable	8,449		10,959
Deferred tax liabilities—current	453		3,894
Accrued lease exit and related charges	591		2,463
Other	8,537		7,411
Total accrued and other current liabilities	$	58,024	$	57,530

Note 12. Restructuring Charges

Restructuring and other charges in 2013 and 2012 consist of costs associated with the ongoing reorganization of our business operations and focus on aligning our operating expenses with our revenue profile. The expense amounts in both years relate primarily to severance costs due to workforce reductions.

In the third quarter of 2012 we announced we would be eliminating approximately 160 positions worldwide. This action has been concluded as of the end of the second quarter of 2013. In the third quarter of 2013, we incurred restructuring charges as a result of reduced headcount from the termination of certain SaaS contracts. We expect this action to be completed within the first half of 2014. For the quarter and nine months ended September 30, 2013 we recorded $1.1 million and $2.9 million, respectively, of restructuring charges for employee separation costs related to these actions and for other actions taken in 2013.

In the second and third quarter of 2013 we also incurred restructuring charges related to the relocation of our Seattle headquarters. For the quarter and nine months ended September 30, 2013, we recorded $0.8 million and $1.2 million, respectively, of restructuring charges related to this action, which are classified as Asset Related and Other Costs in the table below.

Details of restructuring charges for the nine months ended September 30, 2013 and 2012 are in the table below. The amount accrued at September 30, 2013 for employee separation includes costs for those employees who were separated in the quarter ended September 30, 2013 and are expected to be paid out in the quarter ended December 31, 2013. The amount accrued for contract assignment is expected to be paid out by the end of 2013.

For details on costs associated with the termination of our Seattle headquarters lease see Note 13, Lease exit and related charges.

Restructuring charges by type of cost (in thousands):




	Employee Separation Costs		Contract Assignment Costs	Asset Related and Other Costs	Total
Costs incurred and charged to expense for the nine months ended September 30, 2013	$	2,891	—	1,184	$	4,075
Costs incurred and charged to expense for the nine months ended September 30, 2012	$	8,099	3,629	2,144	$	13,872

Changes to the accrued restructuring cost liability (in thousands):



	By Type of Cost
	Employee Separation Costs			Contract Assignment Costs		Total
Accrued liability as of December 31, 2012	$	731		$	1,700	$	2,431
Costs incurred and charged to expense for the nine months ended September 30, 2013	2,891			—		2,891
Cash payments	(2,806		)	—		(2,806		)
Accrued liability as of September 30, 2013	$	816		$	1,700	$	2,516

Note 13. Lease Exit and Related Charges

As a result of the reduction in use of RealNetworks' office space, primarily in our former corporate headquarters in Seattle, Washington, and certain other locations, losses have been recognized representing rent and contractual operating expenses over the remaining life of the leases, and related write-downs of leasehold improvements to their estimated fair value.

In the second quarter of 2013, we entered into a new lease in a new location for our Seattle headquarters and concurrently entered into an amendment to our then-current headquarters office lease that provided for an early termination of such lease.

The new Seattle building lease is for an initial term of 11 years and commenced on August 15, 2013. We have the option to extend the lease for two additional five-year terms, with certain increases in base rent.

The amendment to our former headquarters office lease provided for an early termination of such lease effective in three stages, with the termination of a majority of the premises on August 31, 2013, and the final stage being complete by December 31, 2013. Prior to the execution of the amendment, the lease had been scheduled to expire in September 2014. In connection with the early termination of the lease, we agreed to pay the landlord termination fees totaling approximately $6.6 million in 2013. In the quarter and nine months ended September 30, 2013, we paid the landlord $3.1 million and $6.3 million, respectively, in termination fees. The initial payment of $3.2 million was expensed and paid within the second quarter of 2013, and is therefore not included in the rollforward below. The second payment of $3.1 million was accrued in the second quarter of 2013 and subsequently paid in the third quarter of 2013, and is included in the rollforward of the accrued loss below.

Changes to accrued lease exit and related charges (in thousands):



Accrued loss December 31, 2012	$	4,213
Additions and adjustments to the lease exit charges accrual, including sublease income estimate revision	1,331
Less amounts paid, net of sublease amounts	(4,953		)
Accrued loss September 30, 2013 (included in Accrued and other current liabilities)	$	591

Note 14. Income Taxes

As of September 30, 2013, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the 10-K. We do not anticipate that our total unrecognized tax benefits will significantly change within the next twelve months.

We file numerous consolidated and separate income tax returns in the U.S including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject to U.S federal income tax examinations for tax years before 2008 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993.

Note 15. Earnings (Loss) Per Share

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



	Quarters Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Net income (loss) available to common shareholders	$	(31,375	)	$	(22,214	)	$	(61,520	)	$	41,768
Weighted average common shares outstanding used to compute basic EPS	35,670			34,998			35,490			34,747
Dilutive effect of stock based awards	—			—			—			253
Weighted average common shares outstanding used to compute diluted EPS	35,670			34,998			35,490			35,000
Basic EPS	$	(0.88	)	$	(0.63	)	$	(1.73	)	$	1.20
Diluted EPS	$	(0.88	)	$	(0.63	)	$	(1.73	)	$	1.19

During the quarter and nine months ended September 30, 2013, respectively, 4.6 million and 4.4 million of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.

During the quarter and nine months ended September 30, 2012, respectively, 4.3 million and 5.3 million of potentially issuable shares from stock awards were excluded from the calculation of diluted EPS because of their antidilutive effect.

Note 16. Commitments and Contingencies

Commitments. See Note 13, Lease exit and related charges, for details on office lease commitments.

Litigation. In October 2013, we executed settlement agreements relating to certain of our outstanding litigation matters; specifically, the matters brought against us by VoiceAge Corporation and Callertone Innovations, Inc., which are more fully described below. During the fourth quarter of 2013 we paid an aggregate of $11.5 million, representing our total obligation under these settlements. This amount was accrued as of September 30, 2013, and is identified in our Condensed Consolidated Statements of Operations as "Loss on litigation settlements."

On July 3, 2012, a lawsuit was filed against us by VoiceAge Corporation in the Supreme Court of the State of New York, wherein VoiceAge asserted that we had breached our payment obligations under the terms of a patent license agreement between us and VoiceAge in respect of distribution of specified codec technology, and sought a material amount of damages. We removed the proceedings to New York federal court, and discovery took place from January 4 to May 15, 2013. In June 2013, VoiceAge submitted a motion for summary judgment, which was denied by the Supreme Court of the State of New York on August 5, 2013. On October 24, 2013, we executed a settlement agreement with VoiceAge to settle and dismiss with prejudice all outstanding claims in the lawsuit.

On October 28, 2011 and November 1, 2011, respectively, two lawsuits were filed by Callertone Innovations, LLC in the U.S. District Court for the District of Delaware. The first lawsuit was against T-Mobile USA, Inc. and the second lawsuit was against MetroPCS Wireless, Inc. and MetroPCS Communications, Inc., which we collectively refer to as MetroPCS. The lawsuits alleged that T-Mobile and MetroPCS, respectively, infringed Callertone's patents by providing ringback tone services. We agreed to indemnify each of T-Mobile and MetroPCS against the claims based on an indemnity that was claimed to be owed by us. The respective complaint was served on T-Mobile on January 16, 2012 and on MetroPCS on January 14, 2012. We filed our answers to each complaint on April 9, 2012. In each matter, we disputed the plaintiff's allegations regarding both the validity of its patents and its claims of infringement against T-Mobile and MetroPCS, respectively. A claims construction

hearing was held on September 6, 2013. On October 21, 2013, we executed a settlement agreement with Callertone to settle and dismiss with prejudice all outstanding claims in each of the lawsuits.

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 infringed Greenville's patents by providing ringback tone services. We agreed to indemnify T-Mobile and Alltel against the claims based on an indemnity that was claimed to be owed by us. On August 27, 2007, our motion to transfer this matter to the U.S. District Court for the District of New Jersey was granted. The parties briefed claims construction, but the case was subsequently stayed pending reexamination of the patents at issue. On December 10, 2009, the U.S. Patent and Trademark Office issued notice of its intent to issue reexamination certificates for the patents in the suit. The District Court lifted the stay on the litigation on January 29, 2010 and discovery resumed. On September 28, 2011, the District Court held a claims construction hearing, and on May 10, 2012, the District Court issued a non-infringement judgment that was favorable to us and the other defendants. On December 4, 2012, Greenville appealed the claims construction order and the judgment, and the defendants filed a reply brief on January 28, 2013. On May 17, 2013, the U.S. Court of Appeals for the Federal Circuit affirmed the judgment of non-infringement of the District Court. Greenville has filed a petition for re-hearing with the U.S. Court of Appeals. Due to the uncertainties inherent in this matter, we are unable to estimate the range of possible loss that could result from this litigation.

Although the matters described above have been either settled, as in the lawsuits filed by VoiceAge and Callertone, or the appeals process has been nearly exhausted, as in the Greenville matter, we could in the future become subject to legal proceedings, governmental investigations and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we could incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.

Note 17. Guarantees

In the ordinary course of business, RealNetworks is subject to potential obligations for standard warranty and indemnification provisions that are contained within many of our customer license and service agreements. Our warranty provisions are consistent with those prevalent in our industry, and we do not have a history of incurring losses on warranties; therefore, we do not maintain accruals for warranty-related obligations. With regard to indemnification provisions, nearly all of our carrier contracts obligate us to indemnify our carrier customers for certain liabilities that may be incurred by them. We have in the past received claims for indemnification from some of our carrier customers. See Note 16, Commitments and Contingencies, for a discussion of current indemnification claims.

As discussed in Note 1, Description of Business and Summary of Significant Accounting Policies, we sold certain patents and other technology assets to Intel in the second quarter of 2012. We have specific obligations to indemnify Intel for breaches of the representations and warranties that we made and covenants that we agreed to in the asset purchase agreement executed in connection with the transaction, and for certain potential future intellectual property infringement claims brought by third parties against Intel. The amount of any potential liabilities related to our indemnification obligations to Intel will not be determined until a claim has been made, but we are obligated to indemnify Intel up to the amount of the gross purchase price that we received in the sale.

Note 18. Segment Information

In the first quarter of 2013 we reorganized the management of our businesses and as a result, we now report the following three segments: (1) RealPlayer Group, which includes sales of our RealPlayer media player software and related products, such as the distribution of third party software products, advertising on RealPlayer websites, and sales of RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass and our recently launched RealPlayer Cloud service; (2) Mobile Entertainment, which includes our SaaS services, systems integration, and professional services to mobile carriers, and sales of technology licenses of our software products such as Helix; and (3) Games, which includes all our games-related businesses, including sales of games licenses, online games subscription services, advertising on games sites and social network sites, microtransactions from online and social games, and sales of mobile games.

In addition, we now also allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments, rather than retaining those expenses in our corporate segment. These corporate expenses include but are not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are retained in aggregate in our corporate segment. All restructuring, lease exit and related charges, and, for 2013, the loss on litigation settlements, are included in the corporate segment. In 2012, the sale of

patent and other technology assets, net of costs, was included in the corporate segment. The historical financial information presented has been recast to reflect the new segments and the new corporate expense presentation.

RealNetworks reports three reportable segments based on factors such as how we manage our operations and how our Chief Operating Decision Maker reviews results. Our Chief Operating Decision Maker is considered to be the CEO Staff (CEOS), which includes the interim Chief Executive Officer, Chief Financial Officer, President, Executive Vice President, General Counsel and certain Senior Vice Presidents. The CEOS reviews financial information presented on both a consolidated basis and on a business segment basis, accompanied by certain disaggregated information about products and services, geographical regions and corporate expenses for purposes of making decisions and assessing financial performance. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.

Segment results for the quarters and nine months ended September 30, 2013 and 2012 (in thousands):

RealPlayer Group



	Quarters Ended September 30,					Nine Months Ended September 30,
	2013			2012		2013		2012
Revenue	$	17,641		$	21,392	$	58,407	$	65,631
Cost of revenue	3,264			6,735		12,984		16,026
Gross profit	14,377			14,657		45,423		49,605
Operating expenses	14,449			13,082		44,656		41,849
Operating income (loss)	$	(72	)	$	1,575	$	767	$	7,756

Mobile Entertainment



	Quarters Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenue	$	19,948		$	22,820		$	59,035		$	74,600
Cost of revenue	11,972			12,740			33,974			43,093
Gross profit	7,976			10,080			25,061			31,507
Operating expenses	9,453			11,936			26,976			40,591
Operating income (loss)	$	(1,477	)	$	(1,856	)	$	(1,915	)	$	(9,084	)

Games



	Quarters Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenue	$	11,369		$	14,876		$	38,159		$	51,347
Cost of revenue	3,216			4,989			10,397			17,332
Gross profit	8,153			9,887			27,762			34,015
Operating expenses	11,513			12,023			35,120			39,962
Operating income (loss)	$	(3,360	)	$	(2,136	)	$	(7,358	)	$	(5,947	)

Corporate



	Quarters Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Cost of revenue	$	538		$	780		$	1,660		$	2,182
Sale of patents and other technology assets, net of costs	—			—			—			116,353
Operating expenses	22,990			19,978			46,201			44,445
Operating income (loss)	$	(23,528	)	$	(20,758	)	$	(47,861	)	$	69,726

Our customers consist primarily of consumers and corporations located in the U.S., Europe and various foreign countries. Revenue by geographic region (in thousands):



	Quarters Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
United States	$	21,039	$	29,101	$	70,525	$	89,529
Europe	8,750		12,470		29,278		43,021
Rest of the world	19,169		17,517		55,798		59,028
Total net revenue	$	48,958	$	59,088	$	155,601	$	191,578

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



	September 30, 2013		December 31, 2012
United States	$	41,634	$	27,915
Europe	8,830		2,350
Rest of the world	5,570		8,635
Total long-lived assets	$	56,034	$	38,900

Note 19. Related Party Transactions

Transactions with Rhapsody. See Note 5, Rhapsody Joint Venture, for details on the 2010 restructuring transaction involving Rhapsody. Subsequent to the restructuring transaction, we are obligated to provide Rhapsody with certain support services. These support services are expected to be completed in 2013. The support services include information technology and limited operational support provided directly to Rhapsody. The amount of these and other support service costs were based on various measures depending on the service provided, including vendor fees, an allocation of fixed costs and time employees spend on providing services to Rhapsody. RealNetworks allocates the cost of providing these support services and records such allocation as a reduction to the related expense in the period for which it was incurred. During the quarter and nine months ended September 30, 2013, we charged Rhapsody $0.2 million and $0.6 million, respectively, for the support services. During the quarter and nine months ended September 30, 2012, we charged Rhapsody $0.2 million and $0.7 million, respectively, for the support services.

Transactions with LoEn Entertainment, Inc. In 2008 RealNetworks acquired at market prices common shares of LoEn Entertainment, Inc., whose shares are traded on the Korean Securities Dealers Automated Quotations. As of September 30, 2013 we owned approximately 9% of the outstanding shares of LoEn. Our investment in LoEn is treated as an available for sale investment and is marked-to-market each period with resulting unrealized gains or losses recognized in accumulated other comprehensive income/loss. During the quarter and nine months ended September 30, 2013, we recorded revenue from LoEn of $6.8 million and $17.3 million, respectively. During the quarter and nine months ended September 30, 2012, we recorded revenue from LoEn of $4.0 million and $12.0 million, respectively. Revenue consisted primarily of sales of application service provider services, which include sales of ringback tones, music on demand, video on demand, and intercarrier messaging services. Associated with these transactions, we also recorded accounts receivable of $3.4 million as of September 30, 2013. Accounts payable and cost of revenue amounts associated with LoEn as of and for the periods ended September 30, 2013 and 2012 were nominal.


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:


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


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


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


•	the prospects for creation and growth of strategic partnerships and the resulting financial benefits from such partnerships;


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


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


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


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


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


•	the continuation and expected nature of certain customer relationships;


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


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


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

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

Overview

In the first quarter of 2013 we reorganized the management of our businesses and as a result, we now report the following three segments: (1) RealPlayer Group, (2) Mobile Entertainment, and (3) Games. Within our RealPlayer Group, revenue is derived from the sale of our RealPlayer media player software and related products, such as the distribution of third party software products, advertising on RealPlayer websites, and sales of RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass and our recently launched RealPlayer Cloud service. The Mobile Entertainment business primarily includes revenue from SaaS services, systems integration, and professional services to mobile carriers, and sales of technology licenses of our software products such as Helix. The Games business primarily includes revenue from sales of games licenses, online games subscription services, advertising on games sites and social network sites, microtransactions from online and social games, and sales of mobile games.

In addition, we now also allocate certain corporate expenses which are directly attributable to supporting the business, including but not limited to a portion of finance, legal, human resources and headquarters facilities, to our reportable segments rather than retaining those expenses in our corporate segment. The allocation of these costs to the business units will increase accountability for financial and operational performance within each of our reportable segments. RealNetworks' most significant expenses relate to cost of revenue, compensating employees, and selling and marketing our products and services. The historical financial information presented has been recast to reflect the new segments and the new corporate expense presentation.

In the quarter and nine months ended September 30, 2013, our consolidated revenue declined by $10.1 million and $36.0 million, respectively, compared to the same periods in 2012, with each of our three segments suffering revenue declines. For the quarter, revenue fell by $3.8 million in our RealPlayer Group, $3.5 million in Games, and $2.9 million in Mobile Entertainment. For the year to date period, the overall decline was due to a $15.6 million decrease in Mobile Entertainment revenue, a $13.2 million decrease in Games revenue, and a $7.2 million decrease in RealPlayer Group revenue.

Revenue from our legacy products continues to decline as a result of certain changes in our businesses and market-driven factors. Our SaaS business within Mobile Entertainment continues to be negatively impacted by the proliferation of smartphone applications and services, some of which do not depend on our carrier customers for distribution to consumers. In addition, we are still experiencing pricing pressure from carriers for our intercarrier messaging services. In our Games segment, our business continues to be challenged as consumer game play continues to shift from downloadable PC games to social networks and mobile devices. Since 2011, we have been focusing on developing social and mobile games and monetizing those game play experiences.

Over the past twelve months we have developed a growth plan, implemented strategic initiatives, and executed certain restructuring efforts, all in an effort to grow our businesses, move towards profitability, and streamline our operations. In line with our growth plan, we continue to invest in each of our three business units. From an organic growth perspective, we have invested in the internal development of major new products, including the August 2013 launch from our Games business of GameHouse Casino Plus with the Golden Dreams Sweepstakes feature, and the September 2013 launch from our RealPlayer Group of our RealPlayer Cloud integrated video player and cloud service. Complementing these internal development efforts, we have made certain targeted acquisitions including the second quarter 2013 acquisition of U.S.-based Slingo, Inc., creator of a highly popular social casino game that combines bingo and slots, for total cash consideration of $15.6 million. We expect this acquisition to enhance our footprint in the social casino games arena. In addition, during the third quarter, we acquired U.K.-based Muzicall Limited, a provider of services for mobile carriers and media companies in Europe, for total cash consideration of $6.7 million. This acquisition is intended to accelerate our growth initiatives within the Mobile Entertainment segment. We expect to continue to invest in our growth initiatives.

One of our key strategic initiatives is to better align our operating expenses with our revenue profile. In line with this, during the third quarter of 2012 we initiated a restructuring that eliminated approximately 160 positions worldwide. During the third quarter of 2013, we moved our Seattle headquarters, which required certain one-time lease termination and move costs, but which will allow us to meaningfully reduce our future annual facilities cost. These and other restructuring efforts have contributed to an overall decline in our operating expenses. During the quarter and nine months ended September 30, 2013, our total operating expenses saw a $1.4 million increase and $13.9 million decrease, respectively, compared to the same periods in 2012. Excluding the impact of restructuring, lease exit and related charges, and the loss on litigation settlements discussed below, total operating expenses declined $1.0 million and $18.4 million in the quarter and nine months ended September 30, 2013, respectively, compared with the year-earlier periods.

In October 2013, we executed settlement agreements relating to our most significant outstanding litigation matters, as described in Note 16, Commitments and Contingencies. The settlements resulted in an aggregate payment during the fourth quarter of 2013 of $11.5 million, which was accrued and recorded in our financial statements in the third quarter of 2013.

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



	Quarters Ended September 30,											Nine months ended September 30,
	2013			2012			$ Change			% Change		2013			2012			$ Change			% Change
Total revenue	$	48,958		$	59,088		$	(10,130	)	(17	)%	$	155,601		$	191,578		$	(35,977	)	(19	)%
Cost of revenue	18,990			25,244			(6,254		)	(25	)%	59,015			78,633			(19,618		)	(25	)%
Gross profit	29,968			33,844			(3,876		)	(11	)%	96,586			112,945			(16,359		)	(14	)%
Gross margin	61		%	57		%						62		%	59		%
Sale of patent assets and other technology assets, net of costs	—			—			—			—	%	—			116,353			(116,353		)	(100	)%
Operating expenses	58,405			57,019			1,386			2	%	152,953			166,847			(13,894		)	(8	)%
Operating income (loss)	$	(28,437	)	$	(23,175	)	$	(5,262	)	(23	)%	$	(56,367	)	$	62,451		$	(118,818	)	(190	)%

In the third quarter of 2013, our total consolidated revenue declined by $10.1 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $3.8 million in our RealPlayer Group segment, a decline of $3.5

million in our Games segment, and a $2.9 million decline in our Mobile Entertainment segment, due to the factors described above. Gross margin increased to 61% from 57% for the year earlier quarter as a result of lower personnel and related costs in the third quarter of 2013 that resulted from our ongoing expense alignment efforts. Operating expenses increased by $1.4 million in the quarter ended September 30, 2013, compared with the prior year. Excluding the impact of restructuring, lease exit and related charges, and the loss on litigation settlements, operating expenses decreased by $1.0 million in the quarter ended September 30, 2013, compared to the same period of the prior year.

For the nine months ended September 30, 2013, our total consolidated revenue declined by $36.0 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $15.6 million in our Mobile Entertainment segment, a decline of $13.2 million in our Games segment, and a decline of $7.2 million in our RealPlayer Group segment, due to the factors described above. Gross margin increased to 62% from 59% for the year earlier quarter, primarily as a result of lower personnel and related costs in the first nine months of 2013 that resulted from our ongoing expense alignment efforts. Operating expenses decreased by $13.9 million in the nine months ended September 30, 2013, compared with the prior year, primarily due to reductions in personnel and related costs that resulted from our ongoing expense alignment efforts. Excluding the impact of restructuring, lease exit and related charges, and the loss on litigation settlements, operating expenses decreased by $18.4 million in the nine months ended September 30, 2013, compared to the same period of the prior year.

The 2012 gain from the sale of patents and other technology assets to Intel is net of certain direct expenses incurred for the sale transaction.

See “Segment Operating Results” below for more information and discussion regarding changes in the operating results for each of our reporting segments.

Segment Operating Results

RealPlayer Group

The RealPlayer Group segment primarily generates revenue and incurs costs from sales of RealPlayer and its related products, such as the distribution of third party software products, advertising on RealPlayer websites, and sales of RealPlayer Plus software licenses to consumers, sales of intellectual property licenses, and consumer subscriptions such as SuperPass. In addition, late in the third quarter, we launched RealPlayer Cloud, an integrated video player and cloud service which offers additional storage via subscription plans.

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



	Quarters Ended September 30,											Nine months ended September 30,
	2013			2012			$ Change			% Change		2013			2012			$ Change			% Change
Revenue	$	17,641		$	21,392		$	(3,751	)	(18	)%	$	58,407		$	65,631		$	(7,224	)	(11	)%
Cost of revenue	3,264			6,735			(3,471		)	(52	)%	12,984			16,026			(3,042		)	(19	)%
Gross profit	14,377			14,657			(280		)	(2	)%	45,423			49,605			(4,182		)	(8	)%
Gross margin	81		%	69		%						78		%	76		%
Operating expenses	14,449			13,082			1,367			10	%	44,656			41,849			2,807			7	%
Operating income (loss)	$	(72	)	$	1,575		$	(1,647	)	(105	)%	$	767		$	7,756		$	(6,989	)	(90	)%

Total RealPlayer Group revenue decreased by $3.8 million in the quarter ended September 30, 2013, compared with the year-earlier period. This decrease was primarily a result of lower subscriptions revenue of $3.4 million due to fewer subscribers, primarily attributable to our SuperPass product.

Total RealPlayer Group revenue decreased by $7.2 million for the nine months ended September 30, 2013, compared with the year-earlier period. This decrease was primarily a result of lower subscriptions revenue of $8.7 million due to fewer subscribers, primarily attributable to our SuperPass product. Partially offsetting this decrease was an increase in revenue of $2.5 million from distribution of third party software.

Gross margin during the quarter ended September 30, 2013 increased by 12 percentage points, due primarily to a higher proportion of lower margin revenue in the prior year.

Operating expenses increased by $1.4 million for the quarter ended September 30, 2013, compared with the year-earlier period. Personnel and related costs increased $1.3 million during the quarter ended September 30, 2013, primarily due to investment in our new RealPlayer Cloud service. Further contributing to the increase was an expense benefit of $1.1 million in

the third quarter of 2012 related to the investigation by the Washington State Attorney General's office, as disclosed in the 2012 10-K. Partially offsetting the increases during the quarter was a decrease of $2.1 million in marketing expense.

Operating expenses increased by $2.8 million for the nine months ended September 30, 2013, compared with the year-earlier period. Personnel and related costs increased $4.1 million, primarily due to investment in our new RealPlayer Cloud service. Further contributing to the increase was increased depreciation of $0.8 million. Partially offsetting these increases was a decrease of $1.3 million related to the expense in 2012 for the final settlement of the Washington State Attorney General's office matter, as disclosed in the 2012 10-K. Further offsetting the increases for the nine months ended September 30, 2013 was a decrease in marketing expense of $1.4 million.

Mobile Entertainment

The Mobile Entertainment segment primarily generates revenue and incurs costs from the sales of SaaS services, such as ringback tones, intercarrier messages, music on demand and video on demand; professional services and systems integration services to mobile carriers and mobile handset companies; and Helix software.

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



	Quarters Ended September 30,											Nine months ended September 30,
	2013			2012			$ Change			% Change		2013			2012			$ Change			% Change
Revenue	$	19,948		$	22,820		$	(2,872	)	(13	)%	$	59,035		$	74,600		$	(15,565	)	(21	)%
Cost of revenue	11,972			12,740			(768		)	(6	)%	33,974			43,093			(9,119		)	(21	)%
Gross profit	7,976			10,080			(2,104		)	(21	)%	25,061			31,507			(6,446		)	(20	)%
Gross margin	40		%	44		%						42		%	42		%
Operating expenses	9,453			11,936			(2,483		)	(21	)%	26,976			40,591			(13,615		)	(34	)%
Operating income (loss)	$	(1,477	)	$	(1,856	)	$	379		20	%	$	(1,915	)	$	(9,084	)	$	7,169		79	%

In the quarter ended September 30, 2013, we acquired Muzicall, a ringback tone company based in London, for total cash consideration of $6.7 million. This acquisition is intended to accelerate our growth initiatives within the Mobile Entertainment segment.

Total Mobile Entertainment revenue decreased by $2.9 million in the quarter ended September 30, 2013, compared with the year-earlier period. The decline during the quarter was primarily due to reduced revenue from our SaaS offerings of $2.5 million, resulting from lost revenue upon the termination of certain SaaS contracts totaling $3.8 million over the last five quarters. Slightly offsetting this decrease was our purchase of Muzicall, which resulted in an increase of $1.1 million in ringback tones revenue.

Total Mobile Entertainment revenue decreased by $15.6 million in the nine months ended September 30, 2013, compared with the year-earlier period. The decline during the nine months ended September 30, 2013 was primarily due to reduced revenue from our SaaS offerings of $13.6 million. The decline in SaaS revenue was due to $10.2 million of lost revenue upon the termination of certain SaaS contracts over the last five quarters, $4.6 million lower revenue due to fewer subscribers on existing contracts, and pricing pressures from carriers across our tones business, intercarrier messaging, and other carrier services, during the nine months ended September 30, 2013. Slightly offsetting these decreases was an increase in ringback tones revenue of $1.1 million, resulting from our purchase of Muzicall.

Gross margin during the quarter ended September 30, 2013 declined by 4 percentage points, due primarily to a higher proportion of lower margin revenue in the current year.

Operating expenses declined by $2.5 million and $13.6 million for the quarter and nine months ended September 30, 2013, compared with the year-earlier periods, primarily due to reductions in personnel and related costs of $3.9 million and $13.7 million during the quarter and nine months ended September 30, 2013, respectively, that resulted from our ongoing expense alignment efforts. Partially offsetting these declines was an increase in total operating expense of $1.2 million during the quarter and nine months ended September 30, 2013, as a result of the acquisition of Muzicall during the quarter.

Games

The Games segment primarily generates revenue and incurs costs from the creation, distribution and sales of games licenses, online games subscription services, advertising on game sites and social network sites, games syndication services, and microtransactions from online and social games, and sales of mobile games.

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



	Quarters Ended September 30,											Nine months ended September 30,
	2013			2012			$ Change			% Change		2013			2012			$ Change			% Change
Revenue	$	11,369		$	14,876		$	(3,507	)	(24	)%	$	38,159		$	51,347		$	(13,188	)	(26	)%
Cost of revenue	3,216			4,989			(1,773		)	(36	)%	10,397			17,332			(6,935		)	(40	)%
Gross profit	8,153			9,887			(1,734		)	(18	)%	27,762			34,015			(6,253		)	(18	)%
Gross margin	72		%	66		%						73		%	66		%
Operating expenses	11,513			12,023			(510		)	(4	)%	35,120			39,962			(4,842		)	(12	)%
Operating income (loss)	$	(3,360	)	$	(2,136	)	$	(1,224	)	(57	)%	$	(7,358	)	$	(5,947	)	$	(1,411	)	(24	)%

In the quarter ended June 30, 2013, we acquired Slingo, a social casino games company based in the U.S., for total cash consideration of $15.6 million. This acquisition is intended to enhance our footprint in the social casino games arena. Associated with this will be incremental costs for investment in new products over the next year, which will directly impact our operating income (loss) before taxes.

Total Games revenue decreased by $3.5 million in the quarter ended September 30, 2013, compared with the year-earlier period. Lower revenue from license sales, our subscription products, and advertising contributed $1.9 million, $1.2 million, and $1.0 million respectively, to the decline during the period. Slightly offsetting these decreases was an increase of $0.7 million in games revenue as a result of the acquisition of Slingo.

Total Games revenue decreased by $13.2 million during the nine months ended September 30, 2013, compared with the year-earlier period. Lower revenue from license sales, subscription products, and advertising contributed $6.4 million, $4.6 million, and $2.7 million, respectively, to the decline during the period. Slightly offsetting these decreases was an increase of $1.4 million in games revenue as a result of the acquisition of Slingo.

Cost of revenue decreased by $1.8 million and $6.9 million during the quarter and nine months ended September 30, 2013, respectively, compared with the year-earlier periods. The decreases were due to the decrease in partner royalties expense, which has a direct correlation with the decrease in Games revenue. Gross margins increased during the quarter and nine months ended September 30, 2013 due to lower margin projects that occurred in the prior year periods.

Operating expenses declined by $0.5 million and $4.8 million during the quarter and nine months ended September 30, 2013, respectively, compared with the year-earlier period. During the quarter-ended September 30, 2013, the decrease was mainly due to reductions in personnel and related costs of $1.6 million, resulting from our ongoing expense alignment efforts. Partially offsetting this decline was an increase in total operating expense of $1.3 million as a result of the acquisition of Slingo during the quarter. During the nine months ended September 30, 2013, the decrease was primarily due to reductions in personnel and related costs of $4.4 million, and reductions in marketing expense of $1.8 million. Partially offsetting these declines was an increase in total operating expense of $2.1 million as a result of the acquisition of Slingo.

Corporate

We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments, rather than retaining those expenses in our corporate segment. These allocated corporate expenses include but are not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are retained in aggregate in our corporate segment. All restructuring, lease exit and related charges, and, for 2013, the loss on litigation settlements, are included in the corporate segment.

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



	Quarters Ended September 30,											Nine months ended September 30,
	2013			2012			$ Change			% Change		2013			2012		$ Change			% Change
Cost of revenue	$	538		$	780		$	(242	)	(31	)%	$	1,660		$	2,182	$	(522	)	(24	)%
Sale of patent and other technology assets, net of costs	—			—			—			N/A		—			116,353		(116,353		)	(100	)%
Operating expenses	22,990			19,978			3,012			15	%	46,201			44,445		1,756			4	%
Operating income (loss)	$	(23,528	)	$	(20,758	)	$	(2,770	)	(13	)%	$	(47,861	)	$	69,726	$	(117,587	)	(169	)%

The 2012 gain from the sale of patents and other technology assets to Intel Corporation of $116.4 million in the nine months ended September 30, 2012 reflects the cash proceeds of $120.0 million less $3.6 million of direct transaction expenses incurred during the first and second quarters.

Operating expenses increased by $3.0 million during the quarter ended September 30, 2013, compared with the year-earlier period. The increase during the quarter was primarily due to the litigation settlements of $11.5 million that were accrued during the quarter ended September 30, 2013, as discussed above. Partially offsetting this increase was a decrease in restructuring and lease exit and related costs of $9.1 million.

Operating expenses increased $1.8 million during the nine months ended September 30, 2013, compared with the year-earlier period. The increase during the nine months ended was primarily due to the litigation settlements of $11.5 million that were accrued during the quarter ended September 30, 2013, as discussed above. Partially offsetting this increase was a decrease in restructuring and lease exit and related costs of $7.0 million, in addition to reductions in personnel and related costs of $4.2 million, resulting from our ongoing expense alignment efforts.

Consolidated Operating Expenses

Our operating expenses consist primarily of salaries and related personnel costs including stock based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, and restructuring charges. Operating expenses were as follows (dollars in thousands):



	Quarters Ended September 30,									Nine months ended September 30,
	2013		2012		$ Change			% Change		2013		2012		$ Change			% Change
Research and development	$	15,707	$	15,321	$	386		3	%	$	45,951	$	49,167	$	(3,216	)	(7	)%
Sales and marketing	19,427		21,972		(2,545		)	(12	)%	59,830		68,462		(8,632		)	(13	)%
General and administrative	9,869		8,759		1,110			13	%	28,506		35,103		(6,597		)	(19	)%
Restructuring and other charges	1,877		10,724		(8,847		)	(82	)%	4,075		13,872		(9,797		)	(71	)%
Lease exit and related charges	—		243		(243		)	(100	)%	3,066		243		2,823			NM
Loss on litigation settlements	11,525		—		11,525			100	%	11,525		—		11,525			100	%
Total consolidated operating expenses	$	58,405	$	57,019	$	1,386		2	%	$	152,953	$	166,847	$	(13,894	)	(8	)%

Research and development expenses increased by $0.4 million in the quarter ended September 30, 2013, compared with the year-earlier period, primarily due to investment in new products that were launched during the quarter.

Research and development expenses decreased by $3.2 million in the nine months ended September 30, 2013, compared with the year-earlier period. While we are investing in new products, we saw an overall decrease in the nine months ended September 30, 2013 due to a decrease in personnel and related costs of $4.3 million, resulting from our ongoing expense alignment efforts.

Sales and marketing expenses decreased by $2.5 million in the quarter ended September 30, 2013, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $1.4 million resulting from our ongoing expense alignment efforts, and to lower marketing expense of $1.4 million.

Sales and marketing expenses decreased by $8.6 million in the nine months ended September 30, 2013, compared with the year-earlier period. The decline was primarily due to a decrease in personnel and related costs of $6.2 million resulting from our ongoing expense alignment efforts.

General and administrative expenses increased by $1.1 million in the quarter ended September 30, 2013, compared with the year-earlier period. The increase was due to an expense benefit of $1.1 million in the third quarter of 2012 related to the investigation by the Washington State Attorney General's office, as disclosed in the 2012 10-K.

General and administrative expenses decreased by $6.6 million in the nine months ended September 30, 2013, compared with the year-earlier period. Contributing to the decrease for the period was a decrease in personnel and related costs of $4.4 million, and to $1.3 million related to the expense in 2012 for the final settlement of the Washington State Attorney General's office matter, as disclosed in the 2012 10-K.

Restructuring and other charges and Lease exit and related charges consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense alignment efforts. The restructuring expense amounts in both years primarily relate to severance costs due to workforce reductions. We recorded expenses for Lease exit and related charges in the nine months ended September 30, 2013 of $3.1 million. For additional details on these charges see Note 12, Restructuring Charges and Note 13, Lease Exit and Related Charges.

Loss on litigation settlements recorded during the quarter ended September 30, 2013 relates to settlement agreements executed in October 2013, for which we paid in full an aggregate amount of $11.5 million during the fourth quarter of 2013, as discussed in Note 16, Commitments and Contingencies.

Other Income (Expenses)

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



	Quarters Ended September 30,											Nine months ended September 30,
	2013			2012			$ Change			% Change		2013			2012			$ Change			% Change
Interest income, net	$	166		$	164		$	2		1	%	$	992		$	1,033		$	(41	)	(4	)%
Gain (loss) on sale of equity investments, net	—			2,210			(2,210		)	(100	)%	—			5,288			(5,288		)	(100	)%
Equity in net loss of Rhapsody	(2,629		)	(1,613		)	(1,016		)	(63	)%	(6,209		)	(4,095		)	(2,114		)	(52	)%
Other income (expense), net	(118		)	248			(366		)	(148	)%	(146		)	1,674			(1,820		)	(109	)%
Total other income (expense), net	$	(2,581	)	$	1,009		$	(3,590	)	(356	)%	$	(5,363	)	$	3,900		$	(9,263	)	(238	)%

The decrease in Other income (expense), net, of $3.6 million for the quarter ended September 30, 2013 was primarily due to the gain on sale of certain equity and other investments of $2.2 million in the prior year.

The decrease in Other income (expense), net, of $9.3 million for the nine months ended September 30, 2013 was primarily due to the gain on sale of certain equity and other investments of $5.3 million in the prior year and to non-cash gains in the nine months ended