Edgar Filing: REALNETWORKS INC

10-Q

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, 2015



¨	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 30, 2015 was 36,250,994.

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	19
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	42
Item 3. Default Upon Senior Securities	42
Item 4. Mine Safety Disclosures	42
Item 5. Other Information	42
Item 6. Exhibits	42
Signature	43
Index to Exhibits	44

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, 2015			December 31, 2014
ASSETS
Current assets:
Cash and cash equivalents	$	61,831		$	103,253
Short-term investments	50,412			58,453
Trade accounts receivable, net of allowances	20,534			15,257
Deferred costs, current portion	324			702
Deferred tax assets, net, current portion	640			652
Prepaid expenses and other current assets	5,953			8,980
Total current assets	139,694			187,297
Equipment, software, and leasehold improvements, at cost:
Equipment and software	69,437			74,100
Leasehold improvements	3,592			3,590
Total equipment, software, and leasehold improvements, at cost	73,029			77,690
Less accumulated depreciation and amortization	62,353			61,442
Net equipment, software, and leasehold improvements	10,676			16,248
Restricted cash equivalents and investments	3,000			3,000
Investment in and advances to Rhapsody	—			10,000
Available for sale securities	1,756			2,676
Other assets	2,520			2,299
Deferred costs, non-current portion	145			316
Deferred tax assets, net, non-current portion	1,959			999
Other intangible assets, net	2,813			10,109
Goodwill	13,101			17,355
Total assets	$	175,664		$	250,299

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	15,853		$	18,653
Accrued and other current liabilities	23,890			25,286
Deferred tax liabilities, net, current portion	1,602			1,628
Deferred revenue, current portion	3,638			5,301
Total current liabilities	44,983			50,868
Deferred revenue, non-current portion	98			235
Deferred rent	637			1,215
Deferred tax liabilities, net, non-current portion	156			702
Other long-term liabilities	2,228			81
Total liabilities	48,102			53,101
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 36,251 shares in 2015 and 36,099 shares in 2014	36			36
Additional paid-in capital	625,576			617,756
Accumulated other comprehensive loss	(59,274		)	(55,252		)
Retained deficit	(438,776		)	(365,342		)
Total shareholders’ equity	127,562			197,198
Total liabilities and shareholders’ equity	$	175,664		$	250,299

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,
	2015			2014			2015			2014
Net revenue (A)	$	30,823		$	34,157		$	95,374		$	120,706
Cost of revenue (B)	18,090			18,928			54,469			58,500
Extinguishment of liability	—			—			—			(10,580		)
Gross profit	12,733			15,229			40,905			72,786
Operating expenses:
Research and development	10,501			12,784			34,681			40,110
Sales and marketing	11,938			13,283			38,822			51,022
General and administrative	7,021			7,723			21,312			25,617
Restructuring and other charges	3,114			2,048			5,563			3,805
Lease exit and related charges	2,121			154			2,208			703
Total operating expenses	34,695			35,992			102,586			121,257
Operating income (loss)	(21,962		)	(20,763		)	(61,681		)	(48,471		)
Other income (expenses):
Interest income, net	147			80			597			396
Gain (loss) on investments, net	(615		)	—			(222		)	2,371
Equity in net loss of Rhapsody	(735		)	(1,530		)	(13,831		)	(4,170		)
Other income (expense), net	297			325			628			153
Total other income (expenses), net	(906		)	(1,125		)	(12,828		)	(1,250		)
Income (loss) before income taxes	(22,868		)	(21,888		)	(74,509		)	(49,721		)
Income tax expense (benefit)	(1,684		)	290			(1,075		)	1,256
Net income (loss)	$	(21,184	)	$	(22,178	)	$	(73,434	)	$	(50,977	)

Basic net income (loss) per share	$	(0.59	)	$	(0.62	)	$	(2.03	)	$	(1.42	)
Diluted net income (loss) per share	$	(0.59	)	$	(0.62	)	$	(2.03	)	$	(1.42	)
Shares used to compute basic net income (loss) per share	36,191			36,003			36,134			35,912
Shares used to compute diluted net income (loss) per share	36,191			36,003			36,134			35,912

Comprehensive income (loss):
Unrealized investment holding gains (losses), net of reclassification adjustments	$	(596	)	$	(323	)	$	(881	)	$	(3,936	)
Foreign currency translation adjustments, net of reclassification adjustments	(1,144		)	(2,338		)	(3,141		)	(2,147		)
Total other comprehensive income (loss)	(1,740		)	(2,661		)	(4,022		)	(6,083		)
Net income (loss)	(21,184		)	(22,178		)	(73,434		)	(50,977		)
Comprehensive income (loss)	$	(22,924	)	$	(24,839	)	$	(77,456	)	$	(57,060	)

(A) Components of net revenue:
License fees	$	7,049		$	5,925		$	21,259		$	21,168
Service revenue	23,774			28,232			74,115			99,538
	$	30,823		$	34,157		$	95,374		$	120,706
(B) Components of cost of revenue:
License fees	$	1,877		$	2,044		$	5,048		$	6,426
Service revenue	16,213			16,884			49,421			52,074
	$	18,090		$	18,928		$	54,469		$	58,500

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,
	2015			2014
Cash flows from operating activities:
Net income (loss)	$	(73,434	)	$	(50,977	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	7,952			8,876
Stock-based compensation	3,761			4,158
Equity in net loss of Rhapsody	13,831			4,170
Accrued loss (gain) on excess office facilities	2,208			480
Deferred income taxes, net	(1,531		)	(64		)
Loss (gain) on investments, net	222			(2,371		)
Realized translation gain	(264		)	(48		)
Extinguishment of liability	—			(10,580		)
Fair value of warrants, net of mark to market adjustments	(1,078		)	—
Net change in certain operating assets and liabilities:
Trade accounts receivable	(6,279		)	6,553
Prepaid expenses and other assets	3,851			1,353
Accounts payable	(1,628		)	(1,606		)
Accrued and other liabilities	(3,580		)	(5,586		)
Net cash provided by (used in) operating activities	(55,969		)	(45,642		)
Cash flows from investing activities:
Purchases of equipment, software, and leasehold improvements	(1,110		)	(2,054		)
Proceeds from sale of available for sale securities	459			2,754
Purchases of short-term investments	(52,475		)	(63,574		)
Proceeds from sales and maturities of short-term investments	60,516			74,546
Acquisitions, net of cash acquired	(161		)	(733		)
Advance to Rhapsody	(5,000		)	—
Repayment from Rhapsody	5,000			—
Proceeds from the sale of Slingo and social casino business	10,000			—
Other	—			(467		)
Net cash provided by (used in) investing activities	17,229			10,472
Cash flows from financing activities:
Proceeds from issuance of common stock (stock options and stock purchase plan)	297			641
Tax payments from shares withheld upon vesting of restricted stock	(69		)	(403		)
Payment of contingent consideration	—			(696		)
Net cash provided by (used in) financing activities	228			(458		)
Effect of exchange rate changes on cash and cash equivalents	(2,910		)	(1,534		)
Net increase (decrease) in cash and cash equivalents	(41,422		)	(37,162		)
Cash and cash equivalents, beginning of period	103,253			151,235
Cash and cash equivalents, end of period	$	61,831		$	114,073

Supplemental disclosure of cash flow information:
Cash received from income tax refunds	$	1,035		$	292
Cash paid for income taxes	$	1,136		$	1,457
Non-cash investing activities:
Increase (decrease) in accrued purchases of equipment, software, and leasehold improvements	$	(124	)	$	(371	)
Acquisition of intangible assets	$	312		$	—

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, 2015 and 2014



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 (10-Q or Report), RealNetworks, Inc. and Subsidiaries is referred to as “RealNetworks”, the “Company”, “we”, “us”, or “our”. "RealPlayer" and other trademarks of ours appearing in this report are our property.

Basis of Presentation. The unaudited condensed consolidated financial statements include the accounts of the Company and its 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 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, 2015 are not necessarily indicative of the results that may be expected for any subsequent period or for the year ending December 31, 2015. 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, 2014 (the 10-K).

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



Note 2	Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board (FASB) issued a new standard, "Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern". This standard provides guidance around management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures in certain circumstances. The new guidance is effective for all annual and interim periods ending after December 15, 2016. We are currently evaluating the impact, if any, the adoption of this standard will have on our consolidated financial statements.

In May 2014, the FASB issued new revenue recognition guidance. The guidance will require an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new guidance will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new guidance is effective for us on January 1, 2018; with early adoption permitted beginning January 1, 2017. The guidance permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that the guidance will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor determined the effect of the standard on our ongoing financial reporting.

There have been no other recent accounting pronouncements or changes in accounting pronouncements to be implemented that are of significance or potential significance to RealNetworks.



Note 3	Sale of Slingo and Social Casino Business

On July 24, 2015, we entered into an agreement to sell the Slingo and social casino portion of our games business to Gaming Realms plc for $18.0 million. Of this amount, $10.0 million of the total consideration was paid in cash at closing and the remaining $8.0 million will be payable either all in cash or a mix of cash and Gaming Realms plc stock, at our election, on the first and second anniversaries of the closing. The transaction closed on August 10, 2015.

With the transaction, Gaming Realms plc assumed the operations of our Slingo and social casino businesses, including substantially all of the related assets and liabilities, as well as the stock of Backstage Technologies Incorporated.

The disposed assets and liabilities consisted of intangible assets of $5.7 million, net property, plant and equipment of $0.3 million, and other net assets of $0.4 million, as well as a deferred tax liability of $1.6 million related to the indefinite-lived Slingo trade name, which is included as part of the intangible assets disposed of in the sale. Goodwill totaling $3.6 million was also disposed as part of the transaction based on the relative fair values of the business disposed of and the portion of the games reporting unit retained.

As this sale does not represent a strategic shift in our business and we do not believe it will have a major impact on our operations and financial results, it does not meet the criteria for discontinued operations under GAAP. As such, we have recorded the related foreign currency gain of $0.5 million in “Other income and expense” on the Statement of Operations. In addition, we have recognized an income tax benefit of $1.6 million from the reversal of a Slingo deferred tax liability as described above. Based on several factors, including the timing of the receipt of the remaining $8.0 million consideration, we have deferred the remaining gain of $8.0 million and will recognize that gain upon realization.



Note 4	Stock-Based Compensation

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



	Quarters Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
Total stock-based compensation expense	$	1,178	$	1,148	$	3,761	$	4,158

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,
	2015		2014		2015		2014
Expected dividend yield	0	%	0	%	0	%	0	%
Risk-free interest rate	1.27	%	1.30	%	1.26	%	1.20	%
Expected life (years)	3.8		4.5		4.3		3.9
Volatility	35	%	42	%	37	%	40	%

The total stock-based compensation amounts for 2015 and 2014 disclosed above are recorded in their respective line items within operating expenses in the unaudited condensed consolidated statements of operations and comprehensive income (loss). As of September 30, 2015, $11.0 million of total unrecognized compensation cost, net of estimated forfeitures, related to stock awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 2 years.



Note 5	Rhapsody Joint Venture

As of September 30, 2015 we owned approximately 43% of the issued and outstanding stock of Rhapsody and account for our investment using the equity method of accounting.

Rhapsody was initially formed in 2007 as a joint venture between RealNetworks and MTV Networks, a division of Viacom International Inc. (MTVN), to own and operate a business-to-consumer digital audio music service known as Rhapsody.

Following certain restructuring transactions effective March 31, 2010, we began accounting for our investment in Rhapsody using the equity method of accounting. As part of the 2010 restructuring transactions, RealNetworks contributed $18.0 million in cash, the Rhapsody brand and certain other assets, including content licenses, in exchange for shares of convertible preferred stock of Rhapsody, carrying a $10.0 million preference upon certain liquidation events.

We recorded our share of losses of Rhapsody of $0.7 million and $13.8 million for the quarter and nine months ended September 30, 2015, and $1.5 million and $4.2 million for the quarter and nine months ended September 30, 2014. Because of the $10.0 million liquidation preference on the preferred stock we hold in Rhapsody, under the equity method of accounting we did not record any share of Rhapsody losses that would reduce our carrying value of Rhapsody, which is impacted by Rhapsody equity transactions, below $10.0 million, until Rhapsody's book value was reduced below $10.0 million which occurred in the first quarter of 2015. As of December 31, 2014, the carrying value of our Rhapsody equity investment was $10.0 million. As of September 30, 2015, the carrying value of our Rhapsody equity investment is zero, as we do not record any share of Rhapsody losses that would reduce our carrying value of Rhapsody below zero unless we commit to provide financial support for Rhapsody.

In March 2015, RealNetworks extended a $5.0 million loan to Rhapsody, as did the other 43% owner of Rhapsody. The loans had original maturity dates of June 2018, or earlier, if Rhapsody's certain loan to an external strategic partner was repaid in full. The loans to Rhapsody bore interest at the greater of prime plus 5.25% or 9% per annum. During June 2015, Rhapsody's external strategic partner repaid half of its loan to Rhapsody and the maturity date of the second half was extended to August 2015. In August 2015, the second half of the loan to Rhapsody was repaid and Rhapsody then repaid its loan to us and the other 43% owner in full. In addition, Rhapsody paid approximately $0.2 million of accrued interest to us in September 2015.

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



	Quarters Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Net revenue	$	52,769		$	44,148		$	149,156		$	128,578
Gross profit	9,552			7,739			25,395			24,730
Net loss	(6,335		)	(7,965		)	(27,320		)	(14,312		)



Note 6	Fair Value Measurements

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, 2015 and December 31, 2014, and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands).



	Fair Value Measurements as of								Amortized Cost as of
	September 30, 2015								September 30, 2015
	Level 1		Level 2		Level 3		Total
Cash and cash equivalents:
Cash	$	36,321	$	—	$	—	$	36,321	$	36,321
Money market funds	1,064		—		—		1,064		1,064
Corporate notes and bonds	—		24,446		—		24,446		24,446
Total cash and cash equivalents	37,385		24,446		—		61,831		61,831
Short-term investments:
Corporate notes and bonds	—		49,812		—		49,812		49,822
U.S. government agency securities	600		—		—		600		600
Total short-term investments	600		49,812		—		50,412		50,422
Restricted cash equivalents and investments	—		3,000		—		3,000		3,000
Equity investment in publicly traded securities	1,756		—		—		1,756		362
Warrant issued by Rhapsody (included in Other assets)	—		—		1,078		1,078		—
Total	$	39,741	$	77,258	$	1,078	$	118,077	$	115,615



	Fair Value Measurements as of								Amortized Cost as of
	December 31, 2014								December 31, 2014
	Level 1		Level 2		Level 3		Total
Cash and cash equivalents:
Cash	$	30,105	$	—	$	—	$	30,105	$	30,105
Money market funds	11,629		—		—		11,629		11,630
Corporate notes and bonds	—		61,519		—		61,519		61,520
Total cash and cash equivalents	41,734		61,519		—		103,253		103,255
Short-term investments:
Corporate notes and bonds	—		51,453		—		51,453		51,438
U.S. government agency securities	7,000		—		—		7,000		7,000
Total short-term investments	7,000		51,453		—		58,453		58,438
Restricted cash equivalents and investments	—		3,000		—		3,000		3,000
Equity investment in publicly traded securities	2,676		—		—		2,676		428
Total	$	51,410	$	115,972	$	—	$	167,382	$	165,121

Restricted cash equivalents and investments amounts as of September 30, 2015, and December 31, 2014 relate to cash pledged as collateral against a letter of credit in connection with a lease agreement.

Realized gains or losses on sales of short-term investment securities for the quarters and nine months ended September 30, 2015 and 2014 were not significant. Gross unrealized gains and gross unrealized losses on short-term investment securities as of September 30, 2015 and December 31, 2014 were also 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, 2015 (in thousands):



	Estimated Fair Value
Within one year	$	49,064
Between one year and five years	1,348
Total short-term investments	$	50,412

Our equity investment in a publicly traded company as of September 30, 2015 and December 31, 2014 consisted of J-Stream Inc., a Japanese media services company. This equity investment is accounted for as available for sale.

During the first half of 2015, we sold a portion of J-Stream shares we held, resulting in cash proceeds of $0.5 million and a pre-tax gain of $0.4 million. In March 2014, we sold a portion of the J-Stream shares we held, resulting in cash proceeds of $2.8 million and a pre-tax gain of $2.4 million. The gains on the sale of these securities are reported in Other income (expense), net, in the unaudited condensed consolidated statements of operations and comprehensive income (loss).

In February 2015, Rhapsody issued warrants to purchase Rhapsody common shares to each of RealNetworks and Rhapsody's one other 43% stockholder. The warrants were issued as compensation for past services provided by RealNetworks and the other 43% stockholder, and both warrants covered the same number of underlying shares. The exercise price of the warrants was equal to the fair value of the underlying shares on the issuance date, and we used the Black-Scholes option-pricing model to calculate the fair value of the warrant, using an expected term of 5 years and expected volatility of 55%. On the date of issuance, we recognized and recorded the $1.2 million fair value of the warrant issued to RealNetworks within Other assets in the unaudited condensed consolidated balance sheets, and as an expense reduction within General and administrative expense in the unaudited condensed consolidated statements of operations and comprehensive income (loss). The warrants are free-standing derivatives and as such their fair value is determined each quarter using updated inputs in the Black-Scholes option-pricing model. During the nine months ended September 30, 2015, the decrease in the fair value of the warrants from that originally recorded was approximately $0.1 million.

Items Measured at Fair Value on a Non-recurring Basis

Certain of our assets and liabilities are measured at estimated fair value on a non-recurring basis, using Level 3 inputs. These instruments are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). During the nine months ended September 30, 2015 and 2014, we did not record any impairments on those assets required to be measured at fair value on a non-recurring basis.

See Note 12, Lease Exit and Related Charges, for a discussion of the losses related to reductions in the use of RealNetworks' office space, which were recorded at the estimated fair value of remaining lease obligations, less expected sub-lease income.



Note 7	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, 2014	$	1,288		$	353
Addition (reduction) to allowance	155			(213		)
Amounts written off	(94		)	(7		)
Foreign currency translation	(194		)	—
Balances, September 30, 2015	$	1,155		$	133

One customer accounted for 50% and one customer accounted for 13% of trade accounts receivable as of September 30, 2015. At December 31, 2014, one customer accounted for 21% and one other customer accounted for 15% of trade accounts receivable.

One customer accounted for 28% or $8.7 million of consolidated revenue during the quarter ended September 30, 2015, which is reflected in our Mobile Entertainment segment. One customer accounted for 25% of consolidated revenue, or $24.2 million, during the nine months ended September 30, 2015, also reflected in our Mobile Entertainment segment.

One customer accounted for 24% of consolidated revenue, or $8.2 million, during the quarter ended September 30, 2014 and 20%, or $24.6 million, during the nine months ended September 30, 2014 and is reflected in our Mobile Entertainment segment.



Note 8	Other Intangible Assets

Other intangible assets (in thousands):



		September 30, 2015						December 31, 2014
		Gross Amount		Accumulated Amortization		Net		Gross Amount		Accumulated Amortization		Net
Amortizing intangible assets:
	Customer relationships	$	30,074	$	28,971	$	1,103	$	33,853	$	31,643	$	2,210
	Developed technology	23,982		23,022		960		28,261		25,699		2,562
	Patents, trademarks and tradenames	3,945		3,357		588		3,817		3,528		289
	Service contracts	5,276		5,114		162		6,312		5,764		548
		63,277		60,464		2,813		72,243		66,634		5,609
Non-amortizing intangible assets:
	Trademarks and tradenames	—		—		—		4,500		—		4,500
	Total	$	63,277	$	60,464	$	2,813	$	76,743	$	66,634	$	10,109

An asset purchase relating to our Games business was completed in the first quarter of 2015 and resulted in an intangible asset of $0.5 million being recorded.

As discussed in Note 3 Sale of Slingo and Social Casino Business, $5.7 million worth of intangible assets, net, related to the third quarter of 2015 sale of our Slingo and social casino portion of our games business.

No impairments of other intangible assets were recognized in either of the nine months ended September 30, 2015 or 2014.



Note 9	Goodwill

Changes in goodwill (in thousands):



Balance, December 31, 2014	$	17,355
Decreases due to current year disposals	(3,620		)
Effects of foreign currency translation	(634		)
Balance, September 30, 2015	$	13,101

Goodwill by segment (in thousands):



	September 30, 2015
RealPlayer Group	$	955
Mobile Entertainment	1,848
Games	10,298
Total goodwill	$	13,101

No impairment of goodwill was recognized in either of the nine months ended September 30, 2015 or in 2014.



Note 10	Accrued and Other Current Liabilities

Accrued and other current liabilities (in thousands):



	September 30, 2015		December 31, 2014
Royalties and other fulfillment costs	$	3,672	$	4,868
Employee compensation, commissions and benefits	8,134		7,711
Sales, VAT and other taxes payable	5,744		5,896
Other	6,340		6,811
Total accrued and other current liabilities	$	23,890	$	25,286



Note 11	Restructuring Charges

Restructuring and other charges in 2015 and 2014 consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. The expense amounts in both years relate primarily to severance costs due to workforce reductions.

On November 4, 2015, we commenced the elimination of approximately 60 positions worldwide and recorded $2.3 million in charges associated with this reduction in force in the quarter ended September 30, 2015.

Restructuring charges are as follows (in thousands):



	Employee Separation Costs
Costs incurred and charged to expense for the nine months ended September 30, 2015	$	5,563
Costs incurred and charged to expense for the nine months ended September 30, 2014	$	3,805

Changes to the accrued restructuring liability (which is included in Accrued and other current liabilities) for 2015 (in thousands) are as follows:



	Employee Separation Costs
Accrued liability at December 31, 2014	$	449
Costs incurred and charged to expense for the nine months ended September 30, 2015	5,563
Cash payments	(2,840		)
Accrued liability at September 30, 2015	$	3,172



Note 12	Lease Exit and Related Charges

As a result of the reduction in use of RealNetworks' office space, lease exit and related charges have been recognized representing rent and contractual operating expenses over the remaining life of the leases. In the quarter ended September 30, 2015, we recorded $2.1 million of losses relating to an approximate 43% reduction of office space at our corporate headquarters in Seattle, Washington. We continue to regularly evaluate the market for office space. If the market for such space changes further in future periods, we may have to revise our estimates which may result in future adjustments to expense for excess office facilities.

Changes to accrued lease exit and related charges (which is included in Accrued and other current liabilities) for 2015 (in thousands) are as follows:



Accrued loss at December 31, 2014	$	234
Additions and adjustments to the lease loss accrual, including estimated sublease income	2,764
Less amounts paid, net of sublease amounts	(240		)
Accrued loss at September 30, 2015	2,758
Less current portion (included in Accrued and other current liabilities)	(988		)
Accrued loss, non-current portion (included in Other long term liabilities)	$	1,770



Note 13	Shareholders’ Equity

Accumulated Other Comprehensive Income (Loss)

Changes in components of accumulated other comprehensive income (in thousands):



		Quarters Ended September 30,						Nine Months Ended September 30,
		2015			2014			2015			2014
Investments
	Accumulated other comprehensive income (loss), beginning of period	$	1,967		$	2,784		$	2,252		$	6,397
	Unrealized gains (losses), net of tax effects of $(56), $0, $0 and $0	(596		)	(323		)	(488		)	(1,565		)
	Reclassification adjustments for losses (gains) included in other income (expense), net of tax effects of $0, $0, $(1) and $(4)	—			—			(393		)	(2,371		)
	Net current period other comprehensive income (loss)	(596		)	(323		)	(881		)	(3,936		)
	Accumulated other comprehensive income (loss) balance, end of period	$	1,371		$	2,461		$	1,371		$	2,461
Foreign currency translation
	Accumulated other comprehensive income (loss), beginning of period	$	(59,501	)	$	(53,901	)	$	(57,504	)	$	(54,092	)
	Translation adjustments	(880		)	(2,338		)	(2,877		)	(2,099		)
	Reclassification adjustments for losses (gains) included in other income (expense)	(264		)	—			(264		)	(48		)
	Net current period other comprehensive income (loss)	(1,144		)	(2,338		)	(3,141		)	(2,147		)
	Accumulated other comprehensive income (loss) balance, end of period	$	(60,645	)	$	(56,239	)	$	(60,645	)	$	(56,239	)
Total accumulated other comprehensive income (loss), end of period		$	(59,274	)	$	(53,778	)	$	(59,274	)	$	(53,778	)



Note 14	Income Taxes

As of September 30, 2015, there have been no material changes to RealNetworks’ uncertain tax positions disclosures as provided in Note 14 of the 2014 10-K. However, as a result of the closure of our United States federal audit for the year ended December 31, 2012, we anticipate a decrease in the Company’s total unrecognized tax benefit by an amount up to $3.3 million within the next 12 months, which will have no impact on the financial statements since the Company maintains a valuation allowance on its deferred tax assets.

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



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,
	2015			2014			2015			2014
Net income (loss)	$	(21,184	)	$	(22,178	)	$	(73,434	)	$	(50,977	)

Weighted average common shares outstanding used to compute basic EPS	36,191			36,003			36,134			35,912
Dilutive effect of stock based awards	—			—			—			—
Weighted average common shares outstanding used to compute diluted EPS	36,191			36,003			36,134			35,912

Basic EPS	$	(0.59	)	$	(0.62	)	$	(2.03	)	$	(1.42	)
Diluted EPS	$	(0.59	)	$	(0.62	)	$	(2.03	)	$	(1.42	)

During the quarter and nine months ended September 30, 2015, 5.7 million and 6.0 million shares of common stock, respectively, 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, 2014, 6.3 million and 6.2 million shares of common stock, respectively, 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

We may become subject to legal proceedings, governmental investigations and claims in the ordinary course of business, including employment claims, contract-related claims, and claims of alleged infringement of third-party patents, trademarks and other intellectual property rights. Such claims, even if not meritorious, could force us to expend significant financial and managerial resources. In addition, given the broad distribution of some of our consumer products, any individual claim related to those products could give rise to liabilities that may be material to us. In the event of a determination adverse to us, we may incur substantial monetary liability, and/or be required to change our business practices. Either of these could have a material adverse effect on our consolidated financial statements.



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 received in the past, and may receive in the future, claims for indemnification from carrier customers.

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



Note 18	Segment Information

We have three reportable segments: (1) RealPlayer Group, which includes our RealTimes and RealPlayer Cloud products, our RealPlayer media player software and related products and our SuperPass service; (2) Mobile Entertainment, which includes our SaaS services, our LISTEN product, and the residual components of our Helix business; and (3) Games, which includes all our games-related businesses, including licenses, online games subscription services, advertising on games sites and social network sites, microtransactions from online and social games, and mobile games. See Note 3, Sale of Slingo and Social Casino Business, for information on the third quarter 2015 sale of this business.

We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments. 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 reported as corporate items. Also reported in our corporate segment were restructuring charges as well as lease exit and related charges, and in 2014 the extinguishment of the liability associated with our historical music business.

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 Chief Executive Officer, Chief Financial Officer, our Presidents and General Counsel. The CEOS reviews financial information presented on both a consolidated basis and on a business segment basis. The accounting policies used to derive segment results are the same as those described in Note 1, Description of Business and Summary of Significant Accounting Policies, in the 10-K.

Segment results for the quarters and nine months ended September 30, 2015 and 2014 (in thousands):

RealPlayer Group



	Quarters Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Revenue	$	6,565		$	6,565		$	21,922		$	30,336
Cost of revenue	3,902			3,566			12,331			10,704
Gross profit	2,663			2,999			9,591			19,632
Operating expenses	11,492			12,392			36,868			42,668
Operating income (loss)	$	(8,829	)	$	(9,393	)	$	(27,277	)	$	(23,036	)

Mobile Entertainment



	Quarters Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Revenue	$	16,414		$	19,190		$	49,409		$	62,285
Cost of revenue	11,518			12,626			34,103			38,874
Gross profit	4,896			6,564			15,306			23,411
Operating expenses	5,219			7,086			16,153			26,126
Operating income (loss)	$	(323	)	$	(522	)	$	(847	)	$	(2,715	)

Games



	Quarters Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Revenue	$	7,844		$	8,402		$	24,043		$	28,085
Cost of revenue	2,513			2,573			7,593			8,419
Gross profit	5,331			5,829			16,450			19,666
Operating expenses	6,431			8,658			23,833			27,193
Operating income (loss)	$	(1,100	)	$	(2,829	)	$	(7,383	)	$	(7,527	)

Corporate



	Quarters Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
Cost of revenue	$	157		$	163		$	442		$	503
Extinguishment of liability	—			—			—			(10,580		)
Operating expenses	11,553			7,856			25,732			25,270
Operating income (loss)	$	(11,710	)	$	(8,019	)	$	(26,174	)	$	(15,193	)

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



	Quarters Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
United States	$	11,460	$	12,280	$	36,112	$	47,800
Europe	3,670		5,749		11,561		21,129
Republic of Korea	9,569		9,728		28,268		31,114
Rest of the World	6,124		6,400		19,433		20,663
Total net revenue	$	30,823	$	34,157	$	95,374	$	120,706

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



	September 30, 2015		December 31, 2014
United States	$	18,303	$	33,421
Europe	5,617		6,696
Republic of Korea	324		547
Rest of the World	2,346		3,048
Total long-lived assets	$	26,590	$	43,712



Note 19	Related Party Transactions

See Note 5, Rhapsody Joint Venture, and Note 6, Fair Value Measurements, for details on transactions involving Rhapsody.


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

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


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


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


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


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


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


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


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


•	the continuation and expected nature of certain customer relationships;


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


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


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


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

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

Overview

We manage our business and report revenue and operating income (loss) in three segments: (1) RealPlayer Group, (2) Mobile Entertainment, and (3) Games. Within our RealPlayer Group, we have intensified our focus on leveraging current and prospective partners, especially wireless carriers, to increase distribution of RealTimes, our photo and video sharing technology which we launched in the second quarter of 2015. We continue to develop innovative ways to enable our partners to integrate RealTimes capabilities into their products and services. Although our new RealTimes and RealPlayer Cloud products have begun to generate some revenue, this group's revenue is derived mainly from the sale and license of our RealPlayer software and related products. Our Mobile Entertainment business generates revenue primarily from the sale of its SaaS services, which include ringback tones, music on demand, and intercarrier messaging. Our Games business, through its GameHouse and Zylom brands, derives revenue from sales of games licenses, online games subscription services, advertising on games sites and social networks, and sales of mobile games.

We sold the Slingo and social casino portion of our games business to Gaming Realms plc, a London-based online gaming company, for $18.0 million in August 2015. The purpose of the sale was to derive value from this business and to allow greater focus on our traditional casual games business. This transaction is further described in Note 3, Sale of Slingo and Social Casino Business, to the unaudited condensed consolidated financial statements included in Item 1 of Part I of this Form 10-Q.

We allocate certain corporate expenses which are directly attributable to supporting our businesses, including but not limited to a portion of finance, legal, human resources and headquarters facilities, to our reportable segments. The allocation of these costs to our business units ensures accountability for financial and operational performance within each of our reportable

segments. Our most significant expenses relate to cost of revenue, compensating employees, and selling and marketing our products and services.

For the quarter and nine months ended September 30, 2015, our consolidated revenue declined by $3.3 million and $25.3 million, respectively, compared to the same periods in 2014. Revenue declined by $2.8 million and $12.9 million in Mobile Entertainment and $0.6 million and $4.0 million in Games. In our RealPlayer Group, revenue was $6.6 million, unchanged from the prior year's quarter, and declined by $8.4 million compared to the nine months ended September 30, 2014.

Revenue from our legacy products continues to decline as a result of certain ongoing 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 continue to experience pricing pressure from carriers for our intercarrier messaging services and we ceased investing in our Helix product in the fourth quarter of 2014. Our Games business revenue has declined in recent periods due to lower subscriptions, however, with the recent sale of our Slingo and social casino games business, we expect some growth in our casual games business, which currently has over 100,000 subscribers. In our RealPlayer Group segment, revenue has been negatively impacted as a result of our 2014 transition to a new third party distribution partner at significantly lower rates compared to our previous partner, and lower distribution in our RealPlayer Plus licensing business as we continue to move away from our legacy products.

As of September 30, 2015, we had $112.2 million in unrestricted cash, cash equivalents and short-term investments, compared to $161.7 million as of December 31, 2014. The 2015 decrease of cash, cash equivalents, and short-term investments from December 31, 2014 was due primarily to our ongoing negative cash flows used in operating activities that included significant cash expenditures related to new product launches, which totaled $56.0 million in the first nine months of 2015.

Over the past several quarters, we have developed a plan to embrace cloud and mobile solutions as customer preferences have changed. We have 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 have continued to invest in our business units, with a focus on our RealPlayer business. For example, during the first half of 2014, we released RealPlayer Cloud worldwide and in May of 2015, we launched RealTimes, our newest, feature-rich photo and video service. In the third quarter of 2015, we began to intensify our focus on current and prospective partners, especially wireless carriers, to increase distribution of RealTimes. We continue to develop innovative ways to enable our partners to integrate RealTimes capabilities into their products and services. Our investment in RealTimes thus far has negatively impacted our operating results, and we expect to invest further. In our games business, the latest title in our Delicious-branded series of casual games released in the second quarter of 2015 has continued to perform well as our Games Group remains focused on growing and leveraging the Delicious franchise.

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



	Quarters ended September 30,											Nine months ended September 30,
	2015			2014			$ Change			% Change		2015			2014			$ Change			% Change
Total revenue	$	30,823		$	34,157		$	(3,334	)	(10	)%	$	95,374		$	120,706		$	(25,332	)	(21	)%
Cost of revenue	18,090			18,928			(838		)	(4	)%	54,469			58,500			(4,031		)	(7	)%
Extinguishment of liability	—			—			—			N/A		—			(10,580		)	10,580			(100	)%
Gross profit	12,733			15,229			(2,496		)	(16	)%	40,905			72,786			(31,881		)	(44	)%
Gross margin	41		%	45		%						43		%	60		%
Operating expenses	34,695			35,992			(1,297		)	(4	)%	102,586			121,257			(18,671		)	(15	)%
Operating income (loss)	$	(21,962	)	$	(20,763	)	$	(1,199	)	(6	)%	$	(61,681	)	$	(48,471	)	$	(13,210	)	(27	)%

In the third quarter of 2015, our total consolidated revenue declined by $3.3 million, compared with the year-earlier period. The reduction in revenue resulted from a decline of $2.8 million in Mobile Entertainment and $0.6 million in Games, due to the factors described above. Gross margin decreased to 41% from 45% during the quarter ended September 30, 2015, in large part due to lower margins realized by our Mobile Entertainment and RealPlayer groups, as described in more detail in Segment Operating Results below. Operating expenses decreased by $1.3 million in the quarter ended September 30, 2015, compared with the prior year, primarily due to reduced personnel and related costs of $5.4 million offset in part by increases in restructuring and lease exit charges of $3.0 million and in other operating expenses compared to the prior year period.

For the nine months ended September 30, 2015, our total consolidated revenue declined by $25.3 million, compared with the year-earlier period. The reduction in revenue primarily resulted from a decline of $12.9 million in our Mobile Entertainment

segment, mostly attributable to a decline in our ringback tone and music on demand businesses. Revenue decreased by $8.4 million in our RealPlayer Group due to the transition to a new third party distribution arrangement in the second quarter of 2014 at significantly lower rates compared to our previous partner. Additionally, Games revenue decreased by $4.0 million, primarily due to a decline in sales of Games subscriptions and download PC games. Gross margin decreased to 43% from 60% for the year-earlier period primarily due to the extinguishment of the liability in the first quarter of 2014 described below and to higher bandwidth costs related to our RealPlayer Cloud and RealTimes products. Operating expenses decreased by $18.7 million in the nine months ended September 30, 2015, compared with the prior year primarily due to reductions in personnel and related costs of $16.1 million and to reduced marketing spend of $4.1 million.

During the quarter ended March 31, 2014 certain accrued royalty liabilities of $10.6 million associated with our historical music business, which had originally been recorded based on statutory rates, were extinguished.

Segment Operating Results

RealPlayer Group

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



	Quarters ended September 30,											Nine months ended September 30,
	2015			2014			$ Change			% Change		2015			2014			$ Change			% Change
Revenue	$	6,565		$	6,565		$	—		—	%	$	21,922		$	30,336		$	(8,414	)	(28	)%
Cost of revenue	3,902			3,566			336			9	%	12,331			10,704			1,627			15	%
Gross profit	2,663			2,999			(336		)	(11	)%	9,591			19,632			(10,041		)	(51	)%
Gross margin	41		%	46		%						44		%	65		%
Operating expenses	11,492			12,392			(900		)	(7	)%	36,868			42,668			(5,800		)	(14	)%
Operating income (loss)	$	(8,829	)	$	(9,393	)	$	564		6	%	$	(27,277	)	$	(23,036	)	$	(4,241	)	(18	)%

Total RealPlayer Group revenue for the quarter ended September 30, 2015 remained consistent when compared with the year-earlier period. Declines in our legacy subscription products of $0.8 million were offset by an increase of intellectual property license revenue of $0.5 million and an increase in RealTimes subscription revenue.

Total RealPlayer Group revenue decreased by $8.4 million in the nine months ended September 30, 2015, compared with the year-earlier period. This decrease was primarily a result of our transition to a new third party distribution arrangement at significantly lower rates compared to our previous partner which caused a decrease in our third party distribution revenue of $8.4 million.

Cost of revenue increased by $0.3 million during the quarter ended September 30, 2015, compared with the year-earlier period. This increase was primarily due to higher bandwidth costs related to our RealTimes product of $0.6 million, partially offset by savings in license and subscription royalty expenses.

Cost of revenue increased by $1.6 million during the nine months ended September 30, 2015, compared with the year-earlier period. Bandwidth costs increased by $2.5 million compared with the year-earlier period, partially offset by lower RealPlayer license royalties of $0.9 million.

Gross margin during the quarter and nine months ended September 30, 2015 declined primarily as a result of our transition to a new third party distribution arrangement at significantly lower rates compared to our previous partner and the increase in bandwidth costs to support our RealTimes service.

Operating expenses decreased by $0.9 million in the quarter ended September 30, 2015, compared with the year-earlier period. The decrease was primarily due to reductions in personnel and related costs of $1.1 million, offset in part by an increase in marketing costs.

Operating expenses decreased by $5.8 million in the nine months ended September 30, 2015, compared with the year-earlier period primarily due to decreased marketing spend of $3.4 million related to our transition to a new third party distribution arrangement, along with reductions in personnel and related costs of $2.1 million.

Mobile Entertainment

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



	Quarters ended September 30,											Nine months ended September 30,
	2015			2014			$ Change			% Change		2015			2014			$ Change			% Change
Revenue	$	16,414		$	19,190		$	(2,776	)	(14	)%	$	49,409		$	62,285		$	(12,876	)	(21	)%
Cost of revenue	11,518			12,626			(1,108		)	(9	)%	34,103			38,874			(4,771		)	(12	)%
Gross profit	4,896			6,564			(1,668		)	(25	)%	15,306			23,411			(8,105		)	(35	)%
Gross margin	30		%	34		%						31		%	38		%
Operating expenses	5,219			7,086			(1,867		)	(26	)%	16,153			26,126			(9,973		)	(38	)%
Operating income (loss)	$	(323	)	$	(522	)	$	199		38	%	$	(847	)	$	(2,715	)	$	1,868		69	%

Total Mobile Entertainment revenue decreased by $2.8 million in the quarter ended September 30, 2015, compared with the year-earlier period. This decrease was due to a decrease of $1.6 million in our ringback tones and intercarrier messaging businesses, and to a decrease in Helix licensing revenue of $1.1 million as we ceased investing in this business in the fourth quarter of 2014.

Total Mobile Entertainment revenue decreased by $12.9 million in the nine months ended September 30, 2015, compared with the year-earlier period. The decline was primarily due to a decrease in our SaaS business of $9.0 million, where ringback tone revenue declined by $6.0 million and music on demand revenue declined by $2.1 million. Further, our Helix licensing revenue declined by $3.1 million as we ceased investing in this business in the fourth quarter of 2014.

Cost of revenue decreased by $1.1 million and $4.8 million in the quarter and nine months ended September 30, 2015, compared with the year-earlier period, primarily related to reductions in personnel and related costs.

Gross margin declined for the quarter and nine months ended September 30, 2015, due to a decline in higher margin revenues such as in our ringback tones business.

Operating expenses decreased by $1.9 million and $10.0 million for the quarter and nine months ended September 30, 2015, compared with the year-earlier period, primarily due to reductions in personnel and related costs of $1.7 million and $6.9 million respectively. Additionally, our marketing spend decreased by $1.0 million for the nine months ended September 30, 2015.

Games

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



	Quarters ended September 30,											Nine months ended September 30,
	2015			2014			$ Change			% Change		2015			2014			$ Change			% Change
Revenue	$	7,844		$	8,402		$	(558	)	(7	)%	$	24,043		$	28,085		$	(4,042	)	(14	)%
Cost of revenue	2,513			2,573			(60		)	(2	)%	7,593			8,419			(826		)	(10	)%
Gross profit	5,331			5,829			(498		)	(9	)%	16,450			19,666			(3,216		)	(16	)%
Gross margin	68		%	69		%						68		%	70		%
Operating expenses	6,431			8,658			(2,227		)	(26	)%	23,833			27,193			(3,360		)	(12	)%
Operating income (loss)	$	(1,100	)	$	(2,829	)	$	1,729		61	%	$	(7,383	)	$	(7,527	)	$	144		2	%

Total Games revenue decreased by $0.6 million in the quarter ended September 30, 2015, compared with the year-earlier period primarily due to lower revenue from our PC games business, including our subscription products and advertising of $1.1 million and $0.6 million, respectively, which were offset by an increase in our mobile games revenue of $1.5 million.

Total Games revenue decreased by $4.0 million in the nine months ended September 30, 2015, compared with the year-earlier period. The decline was primarily related to a decrease of subscription revenue of $3.8 million.

Cost of revenue remained constant in the quarter ended September 30, 2015, compared with the year-earlier period.

Cost of revenue decreased by $0.8 million in the nine months ended September 30, 2015, compared with the year-earlier period. The decreases were due primarily to declines in advertising costs of $0.6 million, royalties related to our downloadable PC games of $0.6 million, and bandwidth costs. These decreases were offset in part by an increase in mobile license royalties of $0.8 million, as a result of our higher mobile games revenue.

Gross margin showed little fluctuation during the quarter and nine months ended September 30, 2015.

Operating expenses declined by $2.2 million and $3.4 million in the quarter and nine months ended September 30, 2015, respectively, compared with the year-earlier period. The decreases were primarily due to reductions in personnel and related costs of $1.8 million and $2.8 million, respectively, largely due to the sale of our social and casino games business.

Corporate

We allocate certain corporate expenses which are directly attributable to supporting the business to our reportable segments. These allocated corporate expenses include, but are not limited to a portion of finance, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting the business, are reported as corporate items. All restructuring, extinguishment of liability, and lease exit and related charges, are included in the corporate segment.

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



	Quarters ended September 30,											Nine months ended September 30,
	2015			2014			$ Change			% Change		2015			2014			$ Change			% Change
Cost of revenue	$	157		$	163		$	(6	)	(4	)%	$	442		$	503		$	(61	)	(12	)%
Extinguishment of liability	—			—			—			N/A		—			(10,580		)	10,580			(100	)%
Operating expenses	11,553			7,856			3,697			47	%	25,732			25,270			462			2	%
Operating income (loss)	$	(11,710	)	$	(8,019	)	$	(3,691	)	(46	)%	$	(26,174	)	$	(15,193	)	$	(10,981	)	(72	)%

Operating expenses increased by $3.7 million in the quarter ended September 30, 2015 compared with the year-earlier period. The increase was primarily due to an increase in restructuring and lease exit charges of $3.0 million and depreciation related to the reduced office space at our Seattle headquarters of $0.7 million.

Operating expenses increased by $0.5 million in the nine months ended September 30, 2015, compared with the year-earlier period. The increase was primarily due to an increase in restructuring and lease exit charges of $3.3 million, offset by reduced personnel and related costs.

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,
	2015		2014		$ Change			% Change		2015		2014		$ Change			% Change
Research and development	$	10,501	$	12,784	$	(2,283	)	(18	)%	$	34,681	$	40,110	$	(5,429	)	(14	)%
Sales and marketing	11,938		13,283		(1,345		)	(10	)%	38,822		51,022		(12,200		)	(24	)%
General and administrative	7,021		7,723		(702		)	(9	)%	21,312		25,617		(4,305		)	(17	)%