Item 1A. Risk Factors
You should carefully consider the risks described below together with all of the other information included in this Form 10-Q. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks actually occurs, our business, financial condition or operating results, and the trading price of our common stock, could be materially harmed.
Risks Related to the COVID-19 Pandemic
Our operating plans and financial condition have been adversely affected by the various impacts of the COVID-19 pandemic, and we expect to experience continued adverse effects in future periods in connection with the ongoing public health and safety, governmental, and economic implications.
In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a global pandemic. As the virus spread throughout 2020, across the U.S. and the world, authorities implemented numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, business limitations, and shutdowns. In addition to the pandemic's widespread impact on public health and global society, reactions to the pandemic as well as measures taken to contain the virus initially caused significant turmoil to the global economy and financial markets. To address the public health and safety concerns, we took steps to support the health and well-being of our employees, customers, partners and communities, including working remotely and learning to operate our businesses in a fundamentally different way.
To date, we have had to change certain strategy and product plans in order to address implications of the pandemic to our businesses, in particular, to our growth initiatives. Although forced to furlough some employees in the early days of the pandemic, we were able to bring those employees back to work during the second quarter of 2020. We also reduced expenditures throughout 2020 in an effort to efficiently manage our businesses in the restricted and uncertain climate. We continue to face risk, however, related to fixed facilities costs given the uncertain post-pandemic future of the use of physical office space. In addition, the initial turmoil in financial markets contributed to significant downward pressure on our stock price early in the pandemic. In the ongoing remote work environment, we also face continued challenges in marketing new products, which in the past have relied on the intangible benefits of an in-person demo and sales experience. We cannot provide assurance that the actions we have taken will be sufficient, or that conditions will improve as the pandemic, including the emergence of variants of COVID-19 such as the delta and omicron variants, and reactions thereto, continue to evolve. Public health officials and medical professionals have warned that COVID-19 cases may continue to spike. It is unclear how long any resurgence will last, how severe it will be, and what safety measures governments will impose in response to it.
The COVID-19 pandemic and the resultant economic instability and financial market turmoil has added complexity, uncertainty and risk to nearly all aspects of our business. We are unable to fully predict the near-term and long-term impacts that the pandemic will have on our results from operations, financial condition, liquidity and cash flows for fiscal year 2022 or beyond.
Risks Related to our Strategy
Our growth initiatives could take longer than planned, be unsuccessful, or deplete our cash resources, any of which would have a material adverse effect on the performance of our businesses and financial results, and could cause us to pursue additional debt or other funding sources.
In recent years, we have developed new products and technologies, and funded initiatives, intended to create growth in our businesses, while simultaneously taking steps to reduce costs and increase profitability. These growth initiatives have impacted all segments of our organization, requiring us to allocate limited resources among our diverse business units. Our financial sustainability is largely dependent on the success of our growth initiatives, and there are many risks to that success, some of which are internal to our company, including our ability to develop and monetize our products and services, and some of which are externally driven and outside of our control, such as the potential impact of macroeconomic pressures, including
high inflation rates and supply chain interruptions, and global pandemics. In addition, progress with our growth initiatives was and may continue to be negatively impacted by various reactions to COVID-19, such as travel restrictions, community lockdowns, tightening of corporate budgets, reduction in consumer confidence, and instability in financial markets. We cannot predict the duration or severity of these reactions or impacts to our business and, if prolonged, our cash reserves may prove insufficient, requiring us to pursue additional debt or other funding sources.
Given the ambitious and significant nature of our growth initiatives, there is substantial risk that we may be unsuccessful in implementing our plans in a timely manner, our cash reserves may be depleted or insufficient to fully implement our plans, our growth initiatives may not gain adequate momentum, or the combination of our growth initiatives and cost reductions may not prove to be profitable. Moreover, our acceptance of outside funding for any of our growth businesses, such as our April 2021 public offering, exposes us to new risks and potential liabilities, including possible payment obligations and securities liability. Our business would suffer, and our operational results and financial outlook would be negatively impacted to a significant degree, in the event that any of our growth initiatives fail.
In August 2019, RealNetworks and Napster entered into the Loan Agreement with a third-party financial institution. Following the December 2020 sale of Napster to MelodyVR Group PLC, the Loan Agreement was amended to remove Napster as a co-borrower and, among other modifications, to reduce the amount available under the revolving line of credit to a maximum of $6.5 million. The Loan Agreement, as amended, contains customary covenants, including financial covenants, minimum EBITDA levels, and maintaining a minimum unrestricted cash balance. We have not had a debt facility in our recent past, therefore the entry into this facility introduced new risks to the company, including the risk that constraints around covenants may lead to less flexibility in operational decision making, the risk of default and various implications thereof, and the potential increase in liabilities on our balance sheet in the event that we draw down the line of credit. The
borrowing base for the Revolver is comprised of eligible accounts receivable and direct to consumer deposits. Based on the
amount of eligible accounts receivable and direct to consumer deposits at September 30, 2022, the amount available for
borrowing was $3.7 million. At September 30, 2022, we had no outstanding draws on the Revolver. The Revolver, which was set to mature on August 1, 2022, was extended until August 1, 2024. The assignment of the Loan Agreement to Merger Sub, the surviving entity under the terms of the Merger Agreement, upon the closing of the Merger requires the consent of the lender; however, there is no guarantee that our lender will consent to such assignment, or otherwise waive any event of default under the Loan Agreement due to the change in control of the Company upon the closing of the Merger.
In April 2020, following an assessment of eligibility and upon approval by our Board of Directors, RealNetworks issued a promissory note in the principal amount of $2.9 million pursuant to the Paycheck Protection Program, or PPP, of the CARES Act. RealNetworks applied for forgiveness of its PPP loan in January 2021, and received notice that the PPP loan was forgiven in June 2021.
The inability to obtain additional debt, whether through draws on the revolving line of credit or through a new debt facility, or the need to raise funds through other means, could negatively impact our liquidity and ability to invest in our growth initiatives. Moreover, we could be compelled to consider funding that would impact our governance structure. Our pursuit of debt or other sources of liquidity could impair our financial results and stock price.
We need to successfully monetize our new products and services in order to sustain and grow our businesses, and manage our cash resources.
In order to sustain our current level of business and to implement our growth initiatives, we must successfully monetize our new products and services, including through existing and new relationships with distribution partners, establishing new sales channels, and managing new supply chains. Our digital media products and services must be attractive and useful to distribution partners and end users. The successful acceptance and monetization of these products and services, therefore, is subject to unpredictable and volatile factors beyond our control, including end-user preferences, competing products and services, the rapid pace of change in the market, the effectiveness of our distribution channels, macro-economic conditions, and significant global crises. Any failure by us to timely and accurately anticipate consumers’ changing needs and preferences, emerging technological trends and data privacy norms, or changes in the competitive or regulatory landscape for our products and services could result in a failure to monetize our new products or the loss of market opportunities, both of which we have experienced at various times in our past.
Our growth initiatives are highly dependent on the performance of mobile telecommunications carriers, distributors, and resellers. We distribute our messaging platform services, such as KONTXT, through a limited number of mobile telecommunications carriers. Our SAFR sales channel includes distributors and resellers, as well as sales directly to end users. The financial condition, performance, and demand of our products and services through these mobile telecommunications carriers, distributors, and resellers could deteriorate, weakening our ability to sell our products and services, causing a material negative impact on our financial results. Furthermore, the growth of our SAFR business is inherently uneven and the timing of signing contracts and revenue recognition for SAFR can result in highly variable results over time, making it difficult to predict future results.
Moreover, in order to grow our new businesses, we must make long-term investments, develop or obtain appropriate intellectual property and commit significant resources before knowing whether the products and services that we are developing or have introduced will meet the demands of the relevant market. As we have experienced, we may not realize a sufficient return, or may experience losses, on these investments. If this happens, it could cause further strain on our limited cash resources and negatively affect our ability to pursue other needed growth or strategic opportunities.
Sustaining and growing our businesses, and managing our cash resources, are subject to these risks inherent in developing, distributing and monetizing our new products and services. Our failure to manage these risks could further impair our operations and financial results to a material degree, and could cause an unsustainable depletion of our cash resources.
Our businesses, including in connection with our growth initiatives, face substantial competitive challenges that may impair our success, thus negatively impacting our future growth.
Our digital media products and services, including both longstanding and new products/services, some of which are central to our growth initiatives, face a wide variety of competitors, many of which have longer operating histories, greater name or brand recognition, deeper and more expansive market penetration, more employees, and significantly greater resources than we do. In addition, current and potential competitors may include relatively new businesses that develop or use innovative technologies, products or features that could disrupt the market for technologies, products or features that we currently develop and market or seek to develop and market. In attempting to compete with any or all of these competitors, we may experience, as we have in the past, some or all of the following consequences, any of which would adversely affect our operating results and the trading price of our stock:
•reduced prices or margins;
•loss of current and potential customers, or partners and potential partners who distribute our products and services or who provide content that we distribute to our customers;
•changes to our products, services, technologies, licenses or business practices or strategies;
•lengthened sales cycles;
•inability to meet demands for more rapid sales or development cycles;
•industry-wide changes in content distribution to customers or in trends in consumer consumption of digital media products and services;
•pressure to prematurely release products or product enhancements; or
•degradation in our stature or reputation in the market, including due to adverse publicity.
Our Consumer Media technologies for media playback and production (RealPlayer, RealMedia VB and RealMedia HD) compete with alternative media playback technologies and audio and video content formats that have obtained broad market penetration. RealMedia VB and RealMedia HD are codecs, technology that enables compression and decompression of the media content in a (usually proprietary) format. We license our codec technology primarily to computer, smartphone and other mobile device manufacturers, and also to other partners that can support our efforts to build a strong ecosystem, like content providers and integrated circuit developers. To compete effectively, codec technologies must appeal to, and be adopted for use by, a wide range of parties: producers and providers of media content, consumers of media content, and device manufacturers who pre-load codec technologies onto their devices. Our ability to sustain or grow this business, which has recently experienced downward pressure, is dependent on the successful promotion and adoption of our codec technologies to a wide and diverse target market, which is a complex and highly uncertain undertaking. If we are unable to compete successfully, our Consumer Media business could decline as it has in the recent past or on a more accelerated basis.
The market for our Mobile Services business is highly competitive and continues to rapidly evolve. Our SaaS services face competition from a proliferation of applications and services, many of which carriers can deploy or offer to their subscribers, or which consumers can acquire independently of their carrier. We expect pricing pressure in this business to continue to materially impact our operating results in this business. Our Mobile Services growth initiatives compete with a wide variety of companies, as small startups and well established, heavily resourced global companies race to develop AI-based technologies and launch products in the computer vision market. The success of these initiatives is highly dependent on our ability to differentiate our product offering within this highly competitive environment.
The branded services in our Games business compete with other developers, aggregators and distributors of mobile, online, and downloadable games. Our competitors vary in size and capabilities, some of which have high volume distribution channels and greater financial resources than we do; while others may be smaller and more able to quickly or efficiently adjust to market conditions. We also face significant price competition in the casual games market, as our competitors increasingly focus on free-to-play games or reduce prices more aggressively. We expect competition to continue to intensify in this market. Our games development studios compete primarily with other developers of mobile, online, and downloadable games, and must continue to develop popular and high-quality game titles. Our Games business must also continue to execute on opportunities to expand the play of our games on a variety of non-PC platforms, including mobile, in order to maintain our competitive position and to grow the business. Moreover, continued growth in our Games business is in part dependent on the availability of funds to invest in marketing, which availability cannot be assured.
Issues with the use of artificial intelligence, or AI, in our offerings could result in reputational harm or liability.
Certain of our growth initiatives are centered around AI-based products and solutions, of which our two main products are SAFR and KONTXT, and we expect these initiatives to comprise an increasing percentage of our go-forward business. As with many disruptive innovations, AI presents risks and challenges that could affect its adoption, and therefore our business. AI algorithms may be flawed. Datasets may be insufficient or contain biased information. Any inappropriate or controversial data practices by us, our distribution network, our end users, or others could impair the acceptance of AI solutions. These deficiencies could undermine the decisions, predictions, or analysis AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. If we enable or offer AI solutions that are controversial because of their impact on privacy, employment, or other social issues, we may experience brand or reputational harm. Potential government regulation related to AI ethics may also increase the burden and cost of research and development in this area, subjecting us to brand or reputational harm, competitive harm or legal liability.
Risks Related to our Operations
The distribution and license of our technology products and services are governed by contracts with third parties, the terms of which subject us to significant risks that could negatively impact our revenue, expenses and assumption of liability related to such contracts.
In our Consumer Media and Mobile Services segments, we distribute and license most of our technology products and services pursuant to contracts with third parties, such as mobile carriers and their partners, online service providers, and OEMs and device manufacturers, many of whom may have stronger negotiating leverage due to their size and reach. These contracts govern the calculation of revenue generated and expenses incurred, how we recognize revenue and expenses in our financial statements, and the allocation of risk and liabilities arising from the product or service or distribution thereof. Terms impacting revenue, over which we may have limited if any control, may involve revenue sharing arrangements, end user pricing, usage levels, and exclusivity, all of which significantly affect the level of revenue that we may realize from the relationship. Moreover, contract terms around marketing and promotion of our products and other expense allocation could result in us bearing higher expenses or achieving weaker performance than we had anticipated from the relationship.
In addition, although our contracts with third parties are typically for a fixed duration, they could be terminated early; and they may be renegotiated on less favorable terms or may not be renewed at all by the other party. We must, therefore, seek additional contracts with third parties on an ongoing basis to sustain and grow our business. We expect to face continuing and increased competition for the technology products and services we provide, and there is no assurance that the parties with which we currently have contracts will continue or extend current contracts on the same or more favorable terms, or that we will obtain alternative or additional contracts for our technology products and services. As we have experienced over the past several years relating to our technology sales in China, the further loss of existing contracts, the failure to enter new contracts, or the deterioration of customer creditworthiness or the terms in our contracts with third parties could continue to materially harm our operating results, financial condition, and cash flow.
Nearly all of our contracts in which we provide to another party services or rights to use our technology include some form of obligation by us to indemnify the other party for certain liabilities and losses incurred by them, including liabilities resulting from third party claims for damages that arise out of the use of our technology. These indemnification terms provide us with certain procedural safeguards, including the right to control the defense of the indemnified party. We have in the past incurred costs to defend and settle such claims. Claims against which we may be obligated to defend others pursuant to our contracts could in the future result in payments that could materially harm our business and financial results.
In our SAFR business we have contracted with the U.S. Government through the Small Business Innovation Research (SBIR) program. This subjects us to certain contracting rules, standards, and audits. If we fail to meet our obligations under such government contracts, we could face civil or criminal penalties, or administrative sanctions including suspension or debarment from future government business, termination of contract, refunding or suspension of payments, forfeiture of profits or payment of fines. In addition, future federal contracts may be subject to increased contracting rules, standards, and audits which could have an adverse impact on our operating results if we fail to meet these obligations.
In our Games segment, we rely on third-party platforms to distribute our games and collect revenue from players. We are subject to the standard terms and conditions that these platform providers have for application developers, which govern the content, promotion, distribution, operation of games and other applications on their platforms, as well as the terms of the payment processing services provided by the platforms, and which the platform providers can change unilaterally on short notice or without notice. If our platform providers do not perform their obligations in accordance with our platform agreements, our operations and financial condition could be adversely impacted.
Our operating results are difficult to predict and may fluctuate, which may contribute to weakness or volatility in our stock price.
The trading price for our common stock has been in steady decline for many years, though, particularly more recently, has also been vulnerable to significant volatility caused by general market conditions or unusual stock-specific trading activity. There can be no assurance that our common stock will not experience additional, and potentially more significant, volatility in
the future caused by unpredictable external factors, including due to the broad range of causes described in these risk factors. In addition, as a result of the rapidly changing markets in which we compete, and restructuring, impairment and other one-time events specific to us or our consumers, our operating results may fluctuate or decline from period to period, which may contribute to weakness or volatility in our stock price. For example, the timing of contract signing and the rules for revenue recognition in our SAFR business produce results that are inherently variable and difficult to predict. Our results from this business are likely to be volatile and may not reflect a steady pace of growth, which could result in fluctuations in our stock price. Moreover, the general difficulty in forecasting our operating results and identifying meaningful performance metrics, especially when factoring in our growth initiatives, could result in actual results that differ materially from expected results, our published guidance, or analyst expectations, again causing weakness and volatility in our stock price and/or the trading volume of our shares. Compounding these internal factors are external factors, such as the significant instability in global financial markets experienced during the COVID-19 pandemic, that will impact our operating results and stock price, potentially driving our stock price to record lows as occurred in 2020 or to significant activity levels as occurred in early 2021. More recently, inflation rates in the U.S. have increased to levels not seen in several years, which may result in decreased demand for our products and services, increases in our operating costs including our labor costs, constrained credit and liquidity, reduced government spending and volatility in financial markets. The Federal Reserve has raised, and may again raise, interest rates in response to concerns over inflation risk. The global economy has slowed in recent periods, and the recent interest rate increases may result in further economic slowdowns, which could negatively affect our business and operating results.
The difficulty in forecasting our operating results may also cause over- or under-investment in certain growth initiatives, as such investment is often planned based on expected financial results, thus causing more severe fluctuations in operating results and, likely, further volatility in our stock price.
Further, because our common stock is listed on The Nasdaq Capital Market, we must meet Nasdaq's continued listing requirements, in particular, financial requirements that include maintaining a minimum bid price of at least $1.00. On February 18, 2022, the Company received a letter from the Listing Qualifications Department of The Nasdaq Global Select Market indicating that, based upon the closing bid price of our common stock for the 30 consecutive business day period from January 4, 2022 through February 15, 2022, we did not meet the minimum bid price of $1.00 per share required for continued listing on Nasdaq. We had a compliance period of 180 calendar days ending August 17, 2022 in which to regain compliance. On August 16, 2022 the Company applied to transfer its securities from The Nasdaq Global Select Market to The Nasdaq Capital Market and requested a second 180-day period to regain compliance with the minimum bid price requirement. On August 30, 2022, the Company received a second letter from the Listing Qualifications Department approving the Company’s application to list its common stock on The Nasdaq Capital Market and advising that the Company had been granted an additional 180 calendar days, or until February 13, 2023, to regain compliance. In order to regain compliance with Nasdaq’s minimum bid price requirement, our common stock must maintain a minimum closing bid price of $1.00 for at least ten consecutive business days prior to February 13, 2023.
The second letter has no immediate impact on the listing of our common stock, which will continue to be listed and traded on Nasdaq during the second 180-day compliance period. In the event that, prior to February 13, 2023, the Merger does not close and our shares are not delisted from the Nasdaq in connection with the Merger, our Board of Directors is considering the implementation of various measures intended to support compliance. If the Company does not regain compliance within the allotted compliance period, Nasdaq will provide notice that the Company’s common stock will be subject to delisting. The Company would then be entitled to appeal that determination to a Nasdaq hearings panel. There can be no assurance that the Company will regain compliance with the minimum bid price requirement during the second 180-day period.
Although we expect to restore our compliance with the listing requirements, we can provide no assurance that any action taken by us would be successful, or that any such action would stabilize the market price or improve the liquidity of our common stock. Should a delisting occur, a shareholder would likely find it significantly more difficult to dispose of our common stock, or to obtain accurate quotations as to the value of our common stock, and our ability to raise future capital through the sale of our common stock could be severely limited.
Any impairment to our goodwill, definite-lived, and right-of-use operating lease and equity method assets could result in a material charge to our earnings.
In accordance with GAAP, we test goodwill for possible impairment on an annual basis or more frequently in the event of certain indications of possible impairment. We review definite-lived and operating lease assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. We review equity method investments for impairment whenever events or changes in circumstances indicate a decline in fair value below carrying value is other-than-temporary. These events or circumstances could include a significant change in the business climate, including a significant sustained decline in a reporting unit’s fair value, changes in our operating plans and forecasts, legal factors, operating performance indicators, competition, sale or disposition of a significant portion of our business, a significant sustained decline in our market capitalization and other factors. If we were to determine that an impairment had occurred, we would be required to record an impairment charge, which could have a material negative, and unanticipated, impact on our financial results.
Changes in the value of our investment in Scener could adversely affect our financial condition and results of operations.
As of September 30, 2022, we hold a $1.9 million investment in Scener. See Note 12 of the Notes to the Consolidated Financial Statements for further discussion of our Scener investment. Our Scener investment is accounted for under the equity method and if we determine that this investment has experienced a decline in value, we will be required to record an impairment charge which could have a material negative, and unanticipated, impact on our financial results. See the risk factor “Any impairment to our goodwill, definite-lived, and right-of-use operating lease and equity method assets could result in a material charge to our earnings” for further discussion on risks related to impairment testing. Additionally, this business is subject to laws, regulations, market conditions and other risks inherent in its operations. We do not control the day-to-day operations of this investment; however, how Scener is managed could impact our results of operations. Since its inception, Scener has continued to record operating losses and will require outside funding in order to meet its anticipated cash needs in the immediate future. Scener is an early stage company that has been focusing on growth rather than revenue. In recent months, companies in this stage have become disfavored by many investors. Considering the change in market conditions, there is a significant risk that Scener will find it difficult to continue to raise growth capital and will need to seek strategic alternatives. RealNetworks has no legal obligation to provide further funding or other financial support to Scener. If Scener is unable to obtain funding, monetize their operations, or find successful strategic alternatives, it could adversely affect our financial condition and results of operations.
Additionally, our investment in Scener is non-marketable. Since there is no active market for the exchange of our Scener stock, our ability to liquidate this investment will likely be dependent on a liquidity event. Valuations of privately-held companies are inherently complex and uncertain due to the lack of readily available market data for such securities. As such, we may not be able to achieve a return on our investment in a timely manner, if at all. Any of these factors could adversely impact our results of operations and the value of our investment.
Continued loss of revenue from our subscription services is likely to cause further harm to our operating results.
Our operating results have been and will continue to be adversely impacted by the loss of subscription revenue related to our more traditional products and services. Subscribers cancel their subscriptions to our services for many reasons, including a perception that they do not use the services sufficiently or that the service does not provide enough value, a lack of attractive or exclusive content generally or as compared with competitive service offerings, or because customer service issues are not satisfactorily resolved. Revenue from our SuperPass subscription service, for example, has continued to decline over several periods, due to changes in consumer preferences and changes on our part to focus on other products and services we offer, and we expect this trend to continue.
Given our declining revenue and operating losses, including the COVID-19 pandemic and related impacts to global financial markets, management has concluded that substantial doubt exists concerning our ability to continue as a going concern.
Our unrestricted cash and cash equivalents balance at September 30, 2022 was $9.2 million, $5.4 million of which was held by our foreign subsidiaries, and our operating loss for the nine months ended September 30, 2022 was $16.7 million. Due to our history of declining revenue and operating losses, as well as our near-term expectations of net negative cash flows from operating activities, including the COVID-19 pandemic and the impacts to global financial markets, management has concluded that substantial doubt is deemed to exist about the company’s ability to continue as a going concern through the next 12 months. Our financial statements do not include any adjustment relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. Our ability to continue as a going concern will require us to improve cash flow by implementing some combination of the following: reduce operating expenses; improve working capital; sell businesses, product lines or assets; effectuate strategic alliances; repatriate cash, which may trigger significant taxes and may not otherwise be accomplished efficiently; or obtain outside investment. Our limited cash resources and our potential inability to continue as a going concern may materially adversely affect our share price, inhibit our ability to obtain outside investment or strategic alliances.
Difficulty recruiting and retaining key personnel could significantly impair our operations or jeopardize our ability to meet our growth objectives.
Our success depends substantially on the contributions and abilities of certain key personnel, and we cannot provide assurance that we will be able to retain them in the near term or recruit them in the future. In 2020 and 2022, we experienced a significant level of executive turnover, as we have experienced in the past and could experience in the future, which could impact our ability to retain key personnel. Also, qualified individuals are in high demand and competition for such qualified personnel in our industry, particularly engineering talent, is extremely intense, and we may incur significant costs to attract or retain them. Changes in immigration or other policies in the U.S. or other jurisdictions that make it more difficult to hire and retain key talent, or to assign individuals to any of our locations as needed to meet business needs, could adversely affect our ability to attract key talent or deploy individuals as needed, and thereby adversely affect our business and financial results. Further, the increased availability of work-from-home arrangements by other organizations in the competing environment primarily driven by the COVID-19 pandemic, repeated restructuring of our businesses and related cost-reduction efforts, as well as declines and volatility in our stock price, may cause instability in our workforce that will make it more difficult to retain and recruit key personnel. Given these factors, there can be no assurance that we will be able to attract and retain the key personnel necessary to sustain our business or support future growth.
Acquisitions and divestitures involve costs and risks that could harm our business and impair our ability to realize potential benefits from these transactions.
As part of our business strategy, we have acquired and sold technologies and businesses in the past and expect that we will continue to do so in the future. The failure to adequately manage transaction costs and address the financial, legal and operational risks raised by acquisitions and divestitures of technology and businesses could harm our business and prevent us from realizing the benefits of these transactions. In addition, we may identify and acquire target companies, but those companies may not be complementary to our current operations and may not leverage our existing infrastructure or operational experience, which may increase the risks associated with completing acquisitions.
For example, our January 18, 2019 acquisition of a controlling interest in Napster represented a significant acquisition for RealNetworks. To effectuate the acquisition and incorporate Napster's financial results into our financial statements, we incurred significant transaction-related costs throughout fiscal year 2019 and early in 2020. Moreover, the 2020 sale of our Napster stake in connection with the merger of Napster and MelodyVR resulted in further significant transaction-related expenses, certain ongoing indemnification obligations, and the payment of a portion of proceeds to a third party.
Transaction-related costs and financial risks related to completed and potential future purchase or sale transactions may harm our financial position, reported operating results, or stock price. Previous acquisitions have resulted in significant expenses, including amortization of purchased technology, amortization of acquired identifiable intangible assets and incurring charges for the impairment of goodwill and other intangible assets, which are reflected in our operating expenses. New acquisitions and any potential additional future impairment of the value of purchased assets, including goodwill, could have a material negative impact on our future operating results. In compliance with GAAP, we evaluate these assets for impairment at least annually. Factors that may be considered a change in circumstances, indicating that our goodwill or definite-lived assets may not be recoverable, include reduced future revenue and cash flow estimates due to changes in our forecasts, and unfavorable changes to valuation multiples and discount rates due to changes in the market. If we were to conclude that any of these assets were impaired, we would have to recognize an impairment charge that could materially impact our financial results.
Purchase and sale transactions also involve operational risks that could harm our existing operations or prevent realization of anticipated benefits from a transaction. These operational risks include:
• difficulties and expenses in assimilating the operations, products, technology, information systems, and/or personnel of the acquired company;
• retaining key management or employees of the acquired company;
• entrance into unfamiliar markets, industry segments, or types of businesses;
• operating, managing and integrating acquired businesses in remote locations or in countries in which we have little or no prior experience;
• diversion of management time and other resources from existing operations;
• impairment of relationships with employees, affiliates, advertisers or content providers of our business or acquired business;
• assumption of known and unknown liabilities of the acquired company, including intellectual property claims; and
• potential impacts to our system of internal controls and disclosure controls and procedures.
Risks Related to Regulations and Other External Factors
Government regulation of the Internet, computer vision and facial recognition technologies, AI and other related technologies exposes us to regulatory risks and unfavorable developments resulting from any changes in the regulatory landscape or in the industry or broader market conditions in which RealNetworks operates.
We are subject to regulations and laws specific to the marketing, sale and delivery of goods and services. These laws and regulations, which continue to evolve, cover taxation, user privacy, data collection and protection, cybersecurity, copyrights, electronic contracts, sales procedures, automatic subscription renewals, credit card processing procedures, consumer protections, digital games distribution, AI technologies and services, broadband Internet access, and content restrictions. We cannot guarantee that we have been or will be fully compliant in every jurisdiction, as it is not entirely clear how existing laws and regulations governing issues such as privacy, data protection, taxation and consumer protection apply or will be enforced with respect to the products and services we sell. Moreover, as Internet commerce continues to evolve, increasing regulation and/or enforcement efforts by federal, state and foreign agencies and the prospects for private litigation claims related to our data collection, privacy policies or other e-commerce practices become more likely. In addition, the adoption of any laws or regulations or the imposition of other legal requirements that adversely affect our ability to market, sell, and deliver our products and services could decrease our ability to offer or customer demand for our service offerings, resulting in lower revenue. Moreover, both in the U.S. and worldwide, obligations relating to privacy, data protection, and cybersecurity are rapidly evolving. Certain jurisdictions have and more jurisdictions may impose stricter laws relating to privacy, data protection or cybersecurity that may impact accepted business practices and impose obligations that may conflict with each other or may conflict with our policies, practices, or features of our products and services. For example, the European Union adopted the General Data Protection Regulation, or GDPR, effective as of May 2018 regarding the collecting, handling, and storage of personal data, and California has adopted the California Consumer Privacy Act of 2018 and will substantially expand privacy
protection when the California Privacy Rights Act of 2020 goes into effect on January 1, 2023. We cannot provide assurance that the changes that we have adopted to our business practices will be compliant or that new compliance frameworks such as these or other obligations relating to privacy, data protection, or cybersecurity will not require us to modify our policies, practices, or features of our goods or services, results in claims, complaints, or demands of private parties or investigations, other proceedings by regulatory authorities, or fines or other liabilities, or otherwise have a negative impact on our financial results.
In addition, through the operation of our SAFR product, we are subject to regulations and laws generally and specifically applicable to the provision of facial recognition technology. New laws and regulations are under discussion and those that exist are untested, thus we cannot guarantee that we have been or will be fully compliant in every jurisdiction. Moreover, the voluntary development of norms, standards, and best practices by companies providing facial recognition and similar technology could require modifications to our technology or practices that may be costly or incompatible with our financial model.
In the future, and as we pursue further sales of our SAFR product to governmental agencies, regulations, or changes in laws and regulations or their existing interpretations or applications, could require us to further change our business practices, raise compliance costs or other costs of doing business and result in additional historical or future liabilities for us, resulting in adverse impacts on our business and our operating results. Moreover, as we seek to increase our sales to government entities, we may experience increased costs that relate to compliance with government regulations, including increased costs related to compliance with government data security regulations.
As a consumer-facing business, we receive complaints from our customers regarding our consumer marketing efforts and our customer service practices. Some of these customers may also complain to government agencies, and from time to time, those agencies have made inquiries to us about these practices. In addition, we may receive complaints or inquiries directly from governmental agencies that have not been prompted by consumers. We cannot provide assurance that governmental agencies will not bring future claims, as they have on occasion in the past, regarding our marketing, or consumer services or other practices.
We face financial and operational risks associated with doing business in non-U.S. jurisdictions and operating a global business, that have in the past and could in the future have a material adverse impact on our business, financial condition and results of operations.
A material portion of our revenue is derived from sales outside of the U.S. and most of our employees are located outside of the U.S. Consequently, our business and operations depend significantly on global and national economic conditions and on applicable trade regulations and tariffs. For example, our business in China could be negatively affected by an actual or perceived lack of stability or consistency in U.S.-China trade policy. The growth of our business is also dependent in part on successfully managing our international operations. Our non-U.S. sales, purchases and operations are subject to risks inherent in conducting business abroad, many of which are outside our control, including the following:
•periodic local or geographic economic downturns and unstable political conditions;
•price and currency exchange controls;
•fluctuation in the relative values of currencies;
•difficulty in repatriating funds, whether as a result of tax laws or otherwise;
•high inflation rates;
•compliance with current and changing tax laws, and the coordination of compliance with U.S. tax laws and the laws of any of the jurisdictions in which we do business;
•difficulties in complying with global laws related to the collection, storage, use, transfer, and other processing of customer and employee data;
•difficulties protecting intellectual property;
•compliance with labor laws and other laws governing employees;
•local labor disputes;
•changes in trading policies, regulatory requirements, tariffs and other barriers, or the termination or renegotiation of existing trade agreements including as a result of U.S. and other sanctions against Russia as a result of the Russian conflict with Ukraine;
•impact of changes in immigration or other policies impacting our ability to attract, hire, and retain key talent;
•potential implications resulting from the outbreak of disease on a global scale or localized in countries in which we do business or have employees;
•global supply chain interruptions, and
•difficulties in managing a global enterprise, including staffing, collecting accounts receivable, and managing suppliers, distributors, and representatives.
Because consumers may consider the purchase of our digital entertainment products and services to be a discretionary expenditure, their decision whether to purchase our products and services may be influenced by macroeconomic factors that affect consumer spending such as unemployment, access to credit, negative financial news, and declines in income. In addition, mobile telecommunication carriers and other business partners may reduce their business or advertising spending with us or for
our products and services they distribute to users in the face of adverse macroeconomic conditions, such as financial market volatility, government austerity programs, tight credit, and declines in asset values. We have in the past recorded material asset impairment charges due in part to weakness in the global economy, and we may need to record additional impairments to our assets in future periods in the event of renewed weakness and uncertainty in the global or a relevant national economy. Accordingly, any significant weakness in the national and/or global economy could materially impact our business, financial condition and results of operations in a negative manner.
Our international operations involve risks inherent in doing business globally, including difficulties in managing operations due to distance, language, cultural differences, local economic conditions, outbreak of diseases, different or conflicting laws and regulations, taxes, and exchange rate fluctuations. The functional currency of our foreign subsidiaries is typically the local currency of the country in which each subsidiary operates. We translate our subsidiaries’ revenues into U.S. dollars in our financial statements, and continued volatility in foreign exchange rates may result in lower reported revenue or net assets in future periods. If we do not effectively manage any of the risks inherent in running our international businesses, our operating results and financial condition could be harmed. As another example, the COVID-19 pandemic has resulted in travel and work restrictions globally, and may further disrupt our ability to produce and sell products. As a result of the ongoing remote work environment, we face continued challenges in marketing new products, which in the past have relied on the intangible benefits of an in-person demo and sales experience. We continue to monitor the impacts of the pandemic to our business, as well as rapidly evolving expectations regarding its severity and duration. We are unable to predict the full effects of this pandemic on our operations and financial results. Additionally, we face uncertainty from the collateral effects of sanctions and other actions taken against Russia as a result of the Russian conflict with Ukraine. While our direct business with customers in Russia is not material, the macroeconomic effects of sanctions or other actions against Russia now or in the future could negatively affect our business. For example, we have operations, as well as current and potential new customers, in Europe. If economic conditions in Europe and other key markets for our platform continue to remain uncertain or deteriorate further, it could adversely affect our customers’ ability or willingness to subscribe to our platform, delay prospective customers’ purchasing decisions, reduce the value or duration of their subscriptions or affect renewal rates, all of which could harm our operating results. These effects include increases in the cost of energy and in inflation generally.
Our business is conducted in accordance with existing international trade relationships, and trade laws and regulations. Changes in geopolitical relationships and laws or policies governing the terms of foreign trade, such as the recent rise in protectionist politics and economic nationalism, could create uncertainty regarding our ability to operate and conduct commercial relationships in affected jurisdictions, which could have a material adverse effect on our business and financial results. Additionally, our global operations may also be adversely affected by political events, domestic or international terrorist events and hostilities or complications due to natural or human-caused disasters. These uncertainties could have a material adverse effect on the continuity of our business and our results of operations and financial condition.
We may be unable to adequately protect our proprietary rights or leverage our technology assets, and may face risks associated with third-party claims relating to intellectual property rights associated with our products and services.
Our ability to compete across our businesses partly depends on the superiority, uniqueness and value of our technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. Our efforts to protect our intellectual property rights may not assure our ownership rights in our intellectual property, protect or enhance the competitive position of our products, services and technology, or effectively prevent misappropriation of our technology.
From time to time, we receive claims and inquiries from third parties alleging that our technology used in our business may infringe the third parties’ proprietary rights. These claims, even if not meritorious, could force us to make significant investments of time, attention and money in defense, and give rise to monetary damages, penalties or injunctive relief against us. We may be forced to litigate, to enforce or defend our patents, trademarks or other intellectual property rights, or to determine the validity and scope of other parties' proprietary rights in intellectual property. To resolve or avoid such disputes, we may also be forced to enter into royalty or licensing agreements on unfavorable terms or redesign our product features, services and technology to avoid actual or claimed infringement or misappropriation of technology. Any such dispute would likely be costly and distract our management, and the outcome of any such dispute (such as additional licensing arrangements or redesign efforts) could fail to improve our business prospects or otherwise harm our business or financial results.
Disputes regarding the validity and scope of patents or the ownership of technologies and rights associated with streaming media, digital distribution, and online businesses are common and likely to arise in the future. We also routinely receive challenges to our trademarks and other proprietary intellectual property that we are using in our business activities. We are likely to continue to receive claims of third parties against us, alleging contract breaches, infringement of copyrights or patents, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition or violations of privacy rights.
Introduction of new technology and changes in consumer behavior could harm our business and results of operations.
The expectations and needs of technology consumers are constantly evolving. Our future success depends on a variety of factors, including our continued ability to innovate and introduce new products and services, enhance and integrate our products and services in a timely and cost-effective manner, extend our core technology into new applications, and anticipate emerging standards, business models, software delivery methods and other technological developments.
The introduction of, or limitations on, certain technologies may reduce the effectiveness of our products. For example, some of our products rely on tracking, third-party cookies or other identifiers to help our customers more effectively advertise and detect and prevent fraudulent activity. Consumers can control the use of these technologies through their browsers, operating systems, device settings or “ad-blocking” software or applications. Increased use of such methods, software or applications could harm our business.
Our success in the media and entertainment industry depends on our ability to adapt to shifting patterns of content consumption. The ways in which consumers view content, and technology and business models in our industry, continue to evolve rapidly, and new distribution platforms, as well as increased competition from new entrants and emerging technologies, have added to the complexity of maintaining predictable revenue streams. Moreover, Internet-connected devices and operating systems controlled by third parties increasingly contain features that allow device users to disable functionality that allows for the delivery of advertising on their devices, including through Apple’s Identifier for Advertising, or IDFA, or Google’s Advertising ID, or AAID, for Android devices. Device and browser manufacturers may include or expand these features as part of their standard device specifications. For example, Apple Inc. has imposed new requirements for consumer disclosures regarding privacy practices, and has implemented a new application tracking transparency framework that requires opt-in consent for certain types of tracking. This transparency framework was launched in April 2021. This transparency framework has and may continue to negatively impact the effectiveness of our advertising practices. We are further dependent on the interoperability of our sites with popular mobile operating systems that we do not control, such as iOS and Android, and any changes in such systems that degrade the functionality of our sites or give preferential treatment to competitive products could adversely affect the usage of our sites on mobile devices. In the event that it is more difficult for our customers to access and use our sites on their mobile devices, or if our customers choose not to access or to use our sites on their mobile devices or to use mobile products that do not offer access to our sites, our customer growth could be harmed and our business, financial condition and operating results may be materially and adversely affected.
Disruptions or failures of, or cybersecurity attacks on, our systems or networks, or those of our third-party service providers, may cause such systems and networks to fail, become unavailable, unsecured or perform poorly, or may lead to disclosure of sensitive customer data.
Our ability to provide our products and services to our customers and operate our business depends on the continued operation and security of our information systems and networks and those of our service providers. A significant or repeated reduction in the performance, security or availability of our information systems and network infrastructure or those of our service providers could harm our ability to conduct our business, and harm our reputation and ability to attract and retain users, customers, advertisers and content providers. Many of our products are interactive Internet applications that by their very nature require communication between a client and server to operate.
We have on occasion experienced system errors and failures that caused interruption in availability of products or content or an increase in response time. Problems with our systems or networks, or third-party systems and networks that we utilize, could result from a failure to adequately maintain and enhance these systems and networks, natural disasters and similar events, power failures, intentional actions to disrupt systems and networks and many other causes.
We sell many of our products and services through online sales transactions directly with consumers, and their credit card information is collected and stored by our payment processors. The systems of our third party service providers may not prevent future improper access to or use, disclosure or other processing of credit card information, personal information or other information relating to individuals, or other sensitive or confidential information that we or our third-party service providers process. A security breach, incident, or cyberattack impacting us or our third-party service providers–including any such matter that leads to the disclosure or other unauthorized processing of consumer account information, or any event that leads to the perception that any such matter has occurred; any failure by us to comply with our posted privacy policy or existing or new privacy legislation; or any other actual or asserted obligations relating to privacy, data protection or cybersecurity, could result in unauthorized access to, damage to, disablement or encryption of, use or misuse of, disclosure of, modification of, destruction of, or loss of our data or our customers' data–could disrupt our ability to operate our products and services; could harm our reputation; could impact the market for our products and services; or could subject us to claims, demands, litigation, regulatory investigations and other proceedings, resulting in potentially significant fines and other liabilities. Further, because there are many different security attack techniques and such techniques continue to evolve and are generally not detected until after an incident has occurred, we may be unable to implement adequate preventative measures, anticipate attempted security breaches or other security incidents, or react in a timely manner.
Security breaches, ransomware and other computer malware, phishing, and cyberattacks have become more prevalent and sophisticated in recent years, making it increasingly difficult to successfully defend against them or implement adequate preventive measures. Furthermore, we currently hold contracts with both U.S. and foreign governments, including the U.S. military, and expect to expand our portfolio of government contracts going forward, which may increase the risk that we will
become a target for such attacks. As the risk of attack increases, our costs associated with network security and other aspects of cyber security may also increase. Our security measures or those of our third-party service providers could fail and result in unauthorized access to, damage to, disablement or encryption of, use or misuse of, disclosure of, modification of, destruction of, or loss of the data that we or they maintain or otherwise process. In addition, our remediation efforts may not be successful. We also may face difficulty or delay in identifying, remediating, and otherwise responding to cyberattacks and other security breaches and incidents. Furthermore, concerns about our practices or the ultimate use of our products and services with regard to the collection, use, retention, security, or disclosure or other processing of personal information or other matters relating to privacy, data protection or cybersecurity, including with respect to AI, could make us a more attractive target for malicious attacks and increase the resulting damage to our reputation and negative effect on our operating results if a cyberattack or other security breach occurs or is perceived to have occurred.
We cannot ensure that any limitation of liability provisions we may have in our customer and user agreements, contracts with third-party vendors and service providers, and other contracts relating to a security compromise or breach or other privacy or security incident would be enforceable or adequate or would otherwise protect us from any liabilities or damages with respect to any particular claim.
Moreover, our insurance coverage may not provide adequate coverage for liabilities we incur or indemnification claims we receive relating to any privacy or security incident or breach, or an insurer may deny coverage of claims. In the future, we may not be able to secure insurance for such matters on commercially reasonable terms, or at all. The successful assertion of one or more large claims against us that exceed available insurance coverage, or the occurrence of changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could adversely affect our business, financial condition, and results of operations.
Changes in regulations applicable to the Internet and e-commerce that increase the taxes on the services we provide could materially harm our business and operating results.
As Internet commerce continues to evolve, increasing taxation by state, local or foreign tax authorities becomes more likely. For example, taxation of electronically delivered products and services or other charges imposed by government agencies may also be imposed. We collect transactional taxes and we believe we are compliant and current in all jurisdictions where we have a collection obligation for transaction taxes. Any regulation imposing greater taxes or other fees for products and services could result in a decline in the sale of products and services and the viability of those products and services, harming our business and operating results. A successful assertion by one or more states or foreign tax authorities that we should collect and remit sales or other taxes on the sale of our products or services could result in substantial liability for past sales.
In those countries where we have a tax obligation, we collect and remit value-added tax, or VAT, on sales of “electronically supplied services” provided to European Union and United Kingdom residents. The collection and remittance of VAT subjects us to additional currency fluctuation risks.
Changes in accounting standards and subjective assumptions, estimates, and judgments by management related to complex accounting matters and changes in personnel responsible for internal controls could significantly affect our financial results or financial condition.
We prepare our financial statements in conformity with GAAP. GAAP accounting principles are subject to interpretation or changes by the Financial Accounting Standards Board, or FASB, and the SEC, and new accounting pronouncements and varying interpretations of accounting standards and practices have occurred in the past and are expected to occur in the future. Moreover, our financial statements require the application of judgments and estimates regarding a wide range of matters that are relevant to our business, such as revenue recognition, and asset impairment and fair value determinations. Changes in accounting standards or practices, or in our judgments and estimates underlying accounting standards and practices, could harm and/or materially impact our operating results and/or financial condition.
Our disclosure controls and procedures (DCPRs) are designed to ensure that information required to be disclosed in reports we file is accumulated and communicated to management and recorded, processed, summarized and reported as specified in the rules and forms of the SEC. In addition, we perform annual system and process evaluation and testing of our internal controls over financial reporting (ICFRs). Changes in our staffing, including turnover and reductions in the number of personnel participating in our DCPRs and ICFRs processes, may increase the likelihood that any errors and/or fraud go undetected and result in inaccurate financial information being issued.
We may be subject to additional income tax assessments and changes in applicable tax regulations could adversely affect our financial results.
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes, income taxes payable, and net deferred tax assets. In the ordinary course of business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in our historical financial statements. An audit or litigation can result in significant additional income taxes payable in the U.S. or foreign jurisdictions which could have a material adverse effect on our financial condition and results of operations.
Risks Related to our Governance and Capital Structure
The July 27, 2022 announcement and pendency of the Merger Agreement may have an adverse effect on our business results, and a failure to complete the Merger could have a material and adverse effect on our business, results of operations, financial condition, cash flows, and stock price.
The Merger Agreement is subject to a number of conditions that must be fulfilled in order to complete the Merger, including approval by our stockholders (not including the Founder Shareholders). These conditions to the consummation of the Merger may not be fulfilled and, accordingly, the Merger may not be completed or may be significantly delayed. In addition, if the Merger is not completed by the date that is 90 days following the effectiveness of the proxy statement filed in connection therewith, either Greater Heights or the Company may choose to terminate the Merger Agreement if the failure to consummate the transactions contemplated by the Merger Agreement is not primarily caused by any failure to fulfill any obligation under the Merger Agreement by the party electing to terminate the Merger Agreement. Furthermore, the consummation of the Merger may be significantly delayed due to various factors, including the receipt of a competing acquisition proposal, regulatory or litigation related to the Merger.
If the Merger is not consummated or is significantly delayed, our ongoing business, financial condition and results of operations may be materially adversely affected. We have incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement. If the Merger is not completed or is significantly delayed, we would have recognized these expenses without realizing the expected benefits of the Merger.
Additionally, our business may have been and may in the future be adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger. If the Merger Agreement is terminated, our stockholders cannot be certain that we will be able to find a party willing to engage in a transaction on more attractive terms than the Merger Agreement, or at all, and our results of operations may be adversely impacted by the costs incurred, and by the diversion of management attention, in connection with the Merger. Moreover, the market price of our common stock might decline to the extent that the current market price reflects a market assumption that the Merger will be completed. Any of the foregoing, or other risks arising in connection with the failure of or delay in consummating the Merger, could have a material adverse effect on our business, financial condition and results of operations.
While the Merger is pending, we are subject to business uncertainties and contractual restrictions that could harm our business relationships, financial condition, operating results, cash flows, and business.
Uncertainty about the effect of the Merger may have an adverse effect on our business, financial condition and results of operations. These uncertainties may impair our ability to attract, retain and motivate key personnel and maintain relationships with third parties pending the consummation of the Merger. Additionally, these uncertainties could cause third parties with whom we deal to seek to change, or fail to extend, existing business relationships with us.
The pursuit of the Merger and preparation for a potential closing thereof may place a burden on our management and internal resources. Significant diversion of management attention away from ongoing business concerns and any difficulties encountered in the closing process could have a material adverse effect on the Company’s business, financial condition and results of operations.
In addition, the Merger Agreement restricts us from taking certain actions without Greater Heights’ consent while the Merger is pending. If the Merger is not completed, our inability to take such actions while the Merger is pending could have a material adverse effect on our business, financial condition and results of operations.
Litigation may arise in connection with the Merger, which could be costly, prevent consummation of the Merger, divert management’s attention and otherwise materially harm our business.
As of the date of this Quarterly Report on Form 10-Q, three complaints have been filed in United States District Court for the Southern District of New York relating to the Merger, captioned Kohler v. RealNetworks, Inc., et al., 1:22-cv-08377 (filed September 30, 2022); Anderson v. RealNetworks, Inc., et al., 1:22-cv-08422 (filed October 3, 2022); and Stein v. RealNetworks, Inc., et al., 1:22-cv-08440 (filed October 4, 2022). These three complaints are referred to as the “Merger Actions.” The Merger Actions, which name as defendants RealNetworks, Inc. and the members of our Board of Directors, allege that the Company’s preliminary proxy statement on Schedule 14A (filed by us with the SEC on September 19, 2022 (the “Preliminary Proxy Statement”)) is materially incomplete and misleading in violation of Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. The Kohler action also alleges that the Merger is unfair because our directors and certain members of our senior
management will receive merger consideration for their stock equity, stock options, and restricted stock units, and because certain members of our senior management will receive severance packages should their employment be terminated under certain circumstances. The Merger Actions seek corrective disclosures, an injunction of the Merger, recission or rescissory damages (if the Merger is consummated), damages, and attorneys’ fees and costs. Similar complaints could be filed.
The Company has also received demand letters from purported shareholders of the Company alleging that the Preliminary Proxy Statement contains disclosure deficiencies and/or incomplete information in connection with the Merger.
We believe that the allegations contained in the Merger Actions and demand letters are without merit. However, the results of any such potential legal proceedings are difficult to predict and could delay or prevent the Merger from being competed in a timely manner. Moreover, any litigation could be time consuming and expensive, could divert our management’s attention away from our regular business and, any lawsuit adversely resolved against us or members of our Board of Directors, could have a material adverse effect on our business, financial condition and results of operations.
One of the conditions to the consummation of the Merger is the absence of any law enacted, issued or promulgated by a governmental authority or any issuance or granting of any decree, ruling injunction or other order (whether temporary, preliminary or permanent) by a governmental authority that has the effect of making illegal, enjoining or otherwise prohibiting the consummation of the Merger. Consequently, if a plaintiff secures a court order of injunctive or other relief or a regulatory authority issues an order or other directive having the effect of making the Merger illegal or otherwise enjoining prohibiting consummation of the Merger, then such injunctive or other relief may prevent the Merger from becoming effective in a timely manner or at all, which could have the adverse consequences set forth above.
The Merger Agreement limits our ability to pursue alternatives to the Merger and may discourage other companies from trying to acquire the Company for greater consideration than what Greater Heights has agreed to pay pursuant to the Merger Agreement.
The Merger Agreement contains provisions that make it more difficult for us to sell our business to a party other than Greater Heights. The Merger Agreement provides that the Company must comply with customary non-solicitation restrictions, including certain restrictions on its ability to solicit alternative acquisition proposals from third parties, to provide non-public information to third parties and to engage in negotiations with third parties regarding alternative acquisition proposals. Subject to certain customary “fiduciary out” exceptions, the Company’s Board of Directors is required to recommend that the Company shareholders adopt the Merger Agreement and to call a meeting of the Company shareholders to vote on a proposal to approve the Merger and adopt the Merger Agreement.
The Merger Agreement also allows either the Company or Greater Heights to terminate the Merger Agreement in certain circumstances, including a recommendation change by the Company’s board and a failure to obtain requisite shareholder approval. If the Merger Agreement is terminated under certain circumstances as provided in the Merger Agreement, the Company could be required to pay Greater Heights a termination fee equal to one of (i) $1,043,971, (ii) the lesser of (A) $521,981.50 or (B) Greater Heights' fees and expenses incurred in connection with the Merger Agreement and the Merger, or (iii) the lesser of (A) Greater Heights’ fees and expenses incurred in connection with the Merger Agreement and the Merger and (B) $500,000, depending on the circumstances of the termination. While both the Company and Greater Heights believe these provisions and agreements are reasonable and customary and are not preclusive of other offers, the restrictions, including the added expense of the termination fees that may become payable by the Company to Greater Heights in certain circumstances, might discourage a third party that has an interest in acquiring all or a significant part of the Company from considering or proposing that acquisition, even if that party were prepared to pay consideration with a higher per share value than the consideration payable in the Merger pursuant to the Merger Agreement.
Our Chairman of the Board and Chief Executive Officer beneficially owns 38.5% of our common stock, which gives him significant control over certain major decisions on which our shareholders may vote or which may discourage our acquisition by a third party.
Mr. Glaser beneficially owns 38.5% of our common stock. As a result, Mr. Glaser and his affiliates will have significant influence to:
•elect or defeat the election of our directors;
•amend or prevent amendment of our articles of incorporation or bylaws;
•effect or prevent a merger, sale of assets or other corporate transaction; and
•control the outcome of any other matter submitted to the shareholders for vote.
Furthermore, on February 10, 2020, we entered into a Series B Preferred Stock Purchase Agreement with Mr. Glaser pursuant to which Mr. Glaser invested approximately $10.0 million in RealNetworks in exchange for the issuance to him of approximately 8 million shares of our Series B Preferred Stock, par value $0.001 per share. The rights, preferences, limitations, and powers of the Series B Preferred Stock are set forth in and governed by the designation of rights and preferences of Series B Preferred Stock filed with the Secretary of State of the State of Washington. Those rights, preferences, limitations, and powers include the right to proportional adjustment and the right to any dividends or distributions declared with regard to our
common stock, but the Series B Preferred Stock has no voting or consent rights, has no liquidation preference, has no preferred dividend, and has limitations on transferability. Each share of Series B Preferred Stock is convertible into one share of our common stock, however no conversion is permitted in the event that it would cause Mr. Glaser’s beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our shareholder rights plan dated November 30, 2018, as amended.
The stock ownership of Mr. Glaser, as well as his potential acquisition of the Company, may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of RealNetworks, which in turn could reduce our stock price or prevent our shareholders from realizing a premium over our stock price.
Provisions of our charter documents, shareholder rights plan, and Washington law could discourage our acquisition by a third party.
Our articles of incorporation provide for a strategic transactions committee of the Board of Directors. Without the prior approval of this committee, and subject to certain limited exceptions, the Board of Directors does not have the authority to:
•adopt a plan of merger;
•authorize the sale, lease, exchange or mortgage of assets representing more than 50% of the book value of our assets prior to the transaction or on which our long-term business strategy is substantially dependent;
•authorize our voluntary dissolution; or
•take any action that has the effect of any of the above.
Mr. Glaser has special rights under our articles of incorporation to appoint or remove members of the strategic transactions committee at his discretion that could make it more difficult for RealNetworks to be sold or to complete another change of control transaction without Mr. Glaser’s consent. RealNetworks has also entered into an agreement providing Mr. Glaser with certain contractual rights relating to the enforcement of our charter documents and Mr. Glaser’s roles and authority within RealNetworks. These rights and his role as Chairman of the Board of Directors, together with Mr. Glaser’s significant beneficial ownership, create unique potential for concentrated influence of Mr. Glaser over potentially material transactions involving RealNetworks and decisions regarding the future strategy and leadership of RealNetworks. Pursuant to its authority in the articles of incorporation to limit the powers of the committee, the strategic transactions committee resolved to not require its approval of the Merger.
We adopted a shareholder rights plan in December 1998, which was amended and restated in December 2008, amended in April 2016 and February 2018, again amended and restated in November 2018, and further amended in July 2022. The plan provides that shares of our common stock have associated preferred stock purchase rights, the exercise of which would make the acquisition of RealNetworks by a third party more expensive to that party, having the effect of discouraging third parties from acquiring RealNetworks without the approval of our Board of Directors, which has the power to redeem these rights and prevent their exercise. The Company's Board of Directors approved an amendment and supplement to the Rights Plan (the "Rights Amendment") which prevents the approval, execution, delivery or performance of the Merger Agreement, or the consummation of the Merger, from, among other things, being subject to the terms of the Rights Plan. The Rights Amendment further provides that the rights will expire in their entirety immediately prior to the effective time of the Merger without any payment being made in respect thereof.
Washington law imposes restrictions on some transactions between a corporation and certain significant shareholders. The foregoing provisions of our charter documents, shareholder rights plan, our agreement with Mr. Glaser, and Washington law, as well as our charter provisions that provide for a classified board of directors and the availability of “blank check” preferred stock, could have the effect of making it more difficult or more expensive for a third party to acquire, or of discouraging a third party from attempting to acquire, control of us. These provisions may therefore have the effect of limiting the price that investors might be willing to pay in the future for our common stock.