Overview
RealNetworks invented the streaming media category in 1995 and continues to build on its foundation of digital media expertise and innovation, creating a new generation of products and services to enhance and secure our daily lives. We manage our business and report revenue and operating income (loss) in three segments: (1) Consumer Media (2) Mobile Services, and (3) Games. Within our Consumer Media segment, revenue is derived from the software licensing of our video compression and enhancement, or codec, technologies, including primarily from our prior-generation codec RealMedia Variable Bitrate, or RMVB, as well as our newer codec technology, RealMedia High Definition, or RMHD. We also generate revenue from the sale of our PC-based RealPlayer products, including RealPlayer Plus and related products. These products and services are delivered directly to consumers and through partners, such as OEMs and mobile device manufacturers. Our Mobile Services business generates revenue primarily from the sale of subscription services, which include our intercarrier messaging service and ringback tones, as well as through software licenses for the integration of our RealTimes platform and certain system implementations. We generate a significant portion of our revenue from sales within our Mobile Services business to a few mobile carriers. Our Mobile Services segment also includes our computer vision platform, SAFR, which includes facial recognition technology that leverages artificial intelligence-based machine learning. Our Games business generates revenue primarily through the development, publishing, and distribution of casual games under the GameHouse and Zylom brands. Games are offered via mobile devices, digital downloads, and subscription play. We derive revenue from player purchases of in-game virtual goods within our free-to-play games and from advertising on games sites. In addition, we derive revenue from the sale of individual games and subscription offerings.RealNetworks allocates to its Consumer Media, Mobile Services, and Games reportable segments certain corporate expenses which are directly attributable to supporting these businesses, including, but not limited to, a portion of finance, IT, legal, human resources and headquarters facilities. Remaining expenses, which are not directly attributable to supporting these businesses, are reported as corporate items. These corporate items also can include restructuring charges and stock compensation expense. As described in Note 4, Acquisitions and Dispositions,RealNetworks acquired an additional 42% interest inRhapsody International, Inc. (doing business as Napster) onJanuary 18, 2019 bringing our ownership of Napster's outstanding stock to 84%, thus giving us a majority voting interest. For fiscal periods following the closing of the acquisition, we consolidated Napster's financial results into our financial statements, where Napster was reported as a separate segment.RealNetworks entered into a Support Agreement datedAugust 25, 2020 by and among its 84%-owned subsidiary, Napster, and MelodyVR Group PLC, referred to as MelodyVR, an English public limited company. The Support Agreement was executed in connection with an Agreement and Plan of Merger, or Merger Agreement, by and among Napster, MelodyVR, and a wholly owned subsidiary of MelodyVR that effectuated the merger. The Merger Agreement called for the merger of MelodyVR's merger sub 19 -------------------------------------------------------------------------------- with and into Napster, with Napster surviving and becoming a wholly owned subsidiary of MelodyVR. Other than as Securityholder Representative,RealNetworks is not a party to the Merger Agreement. The transaction closed onDecember 30, 2020 at which time MelodyVR assumed Napster's assets and liabilities, primarily relating to music licensing. MelodyVR paid consideration of approximately$26 million to certain holders of debt and equity of Napster, comprised of$12 million in cash, shares of MelodyVR, and a$3 million 18-month indemnity escrow. The shares of MelodyVR thatRealNetworks received may not be sold or transferred, except in limited circumstances, for a period of one year. Certain proceeds from the transaction were used to fully repay the advance to Napster on the revolving line of credit, as discussed in Note 9. Debt, pay Napster's transaction expenses, and pay amounts to certain of Napster's common stockholders. The final value toRealNetworks from the transaction is subject to the eventual payout of the indemnity escrow. Effective on the execution of the Agreement and Plan of Merger onAugust 25, 2020 , Napster was treated as discontinued operations for accounting and disclosure purposes. As such, Napster's operating results for the years endedDecember 31, 2020 and 2019 and financial condition as ofDecember 31, 2019 have been recast to conform to this presentation. Upon the close of the transaction, a gain on sale of approximately$1.9 million was recognized in discontinued operations. COVID-19 InMarch 2020 , theWorld Health Organization declared the outbreak of the novel coronavirus that causes COVID-19 to be a global pandemic. As the virus spread throughout theU.S. and the world, authorities implemented numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, business limitations, and shutdowns. In addition to the pandemic's widespread impact on public health and global society, reactions to the pandemic as well as measures taken to contain the virus have caused significant turmoil to the global economy and financial markets. Moreover, similar to other companies, we have taken steps to support the health and well-being of our employees, customers, partners and communities, which include working remotely and learning to operate our business in a fundamentally different way. As the pandemic and containment measures generally evolved throughout 2020, we have had to reevaluate our operating plans, resulting in some significant pivots for our growth initiatives. Moreover, as we continue to operate our business as efficiently as possible, we have taken steps to more aggressively reduce costs and reallocate resources. We are unable to predict the impacts that the COVID-19 pandemic will have on our results from operations, financial condition, liquidity and cash flows for fiscal 2021, due to the numerous uncertainties, including the duration and severity of the pandemic and containment measures. We will continue to monitor and evaluate the effects to our businesses and adjust our plans as needed. Financial Results As ofDecember 31, 2020 , we had$23.9 million in unrestricted cash and cash equivalents compared to$8.5 million as ofDecember 31, 2019 . The 2020 increase in cash and cash equivalents fromDecember 31, 2019 was primarily due to$10.0 million in cash proceeds from the first quarter 2020 issuance of Series B Preferred Stock and proceeds from a promissory note issued in the second quarter of 2020 pursuant to the Payment Protection Program (PPP) of the CARES Act, withRealNetworks receiving$2.9 million . A subsidiary ofRealNetworks , Scener, also received$2.1 million in the third quarter of 2020, in return for issuing SAFE Notes, as described in Note 5. Fair Value Measurements. During the fourth quarter of 2020, we received cash proceeds from the sale of Napster as described in Note 4. Acquisitions and Dispositions. The increase was partially offset by funds used in our operations, which totaled$8.1 million . The following discussion reflectsRealNetworks' results from continuing operations. Consolidated results of operations were as follows (dollars in thousands): 2020-2019 % 2020 2019 Change Change Total revenue$ 68,062 $ 65,802 $ 2,260 3 % Cost of revenue 16,465 17,226 (761) (4) % Gross profit 51,597 48,576 3,021 6 % Gross margin 76 % 74 % 2 % Total operating expenses 56,621 75,640 (19,019) (25) % Operating loss$ (5,024) $ (27,064) $ 22,040 81 % 2020 compared with 2019 20
-------------------------------------------------------------------------------- In 2020, our consolidated revenue increased by$2.3 million , or 3%. The increase in revenue was primarily due to increases in our Games segment of$3.1 million , which was partially offset by decreases of$0.6 million in Consumer Media revenue and$0.3 million in Mobile Services revenue. See below for further information regarding fluctuations by segment. Gross margin increased to 76% from 74% due to the combination of higher revenues and cost reduction efforts. Operating expenses decreased by$19.0 million in 2020 compared with 2019 primarily due to reductions to the contingent consideration liability of$9.6 million , lower salaries and other people related expenses of$7.2 million , decreased professional fees of$1.1 million , and lower facility costs of$0.9 million . See Note 5. Fair Value Measurements for additional information on the change in the contingent consideration liability. 21 -------------------------------------------------------------------------------- Segment Operating Results Consumer Media Consumer Media segment results of operations were as follows (dollars in thousands): 2020-2019 % 2020 2019 Change Change Total revenue$ 12,581 $ 13,170 $ (589) (4) % Cost of revenue 2,273 3,031 (758) (25) % Gross profit 10,308 10,139 169 2 % Gross margin 82 % 77 % 5 % Total operating expenses 8,889 11,186 (2,297) (21) % Operating income (loss)$ 1,419 $ (1,047) $ 2,466 NM Total Consumer Media revenue decreased by$0.6 million , or 4% as compared to the prior year, due to decreased software license revenues of$0.6 million and decreased subscription services of$0.6 million , partially offset by increased product sales of$0.5 million from RealPlayer Plus. Advertising and other revenue increased$0.1 million when compared to the prior year due to the non-recurring recognition of previously deferred third-party software product distribution revenue in the amount of$0.6 million , which was largely offset by lower advertising revenue. Software License For our software license revenues, the$0.6 million decrease was primarily due to the recognition of revenue on a contract that was effectuated and fully recognized for$1.0 million in 2019. Also contributing to the decrease was the timing of shipments and payments for approximately$0.9 million in 2019. These decreases were partially offset by renewals from existing customers in 2020. The bulk of these licenses for our codec technology are with companies based inChina and, in the near term, it is possible we may see continued pressure on pricing and renewals, and potential further declines in sales. Subscription Services For our subscription services revenues, the decrease of$0.6 million was primarily due to further declines in our legacy subscription products, which we expect to continue. Cost of revenue decreased by$0.8 million , or 25%. This was primarily due to reductions in salaries and other people related expenses of$0.7 million . Operating expenses decreased by$2.3 million , or 21%, compared to the prior year, primarily due to lower salaries and benefits, from headcount reductions, of$1.9 million as well as lower infrastructure costs of$0.5 million . Mobile Services Mobile Services segment results of operations were as follows (dollars in thousands): 2020-2019 % 2020 2019 Change Change Total revenue$ 26,889 $ 27,143 $ (254) (1) % Cost of revenue 6,725 7,500 (775) (10) % Gross profit 20,164 19,643 521 3 % Gross margin 75 % 72 % 3 % Total operating expenses 24,787 29,340 (4,553) (16) % Operating loss$ (4,623) $ (9,697) $ 5,074 52 % Mobile Services revenue declined by$0.3 million , or 1%, and was primarily driven by a decrease of$2.2 million in subscription services revenue, offset by an increase of$2.0 million in software license revenue. Software license For our software license revenues, the$2.0 million increase was primarily the result of revenue from sales of our SAFR product, with a$1.9 million increase over the prior year. Subscription service For our subscription services, the$2.2 million decrease was driven by fewer subscribers to our ringback tones resulting in a decrease in revenue of$2.7 million . These decreases were offset by an increase in revenue from our intercarrier messaging platform business of$0.4 million . 22 -------------------------------------------------------------------------------- Cost of revenue decreased by$0.8 million or 10% as compared to the prior year, due primarily to reductions in salaries and benefits of$0.6 million related to headcount reductions. Operating expenses decreased by$4.6 million or 16% primarily due to decreased salaries, benefits and other people related costs of$2.8 million , lower marketing costs of$1.4 million , and lower infrastructure costs of$0.7 million .
Games
Games segment results of operations were as follows (dollars in thousands):
2020-2019 % 2020 2019 Change Change Total revenue$ 28,592 $ 25,489 $ 3,103 12 % Cost of revenue 7,451 6,975 476 7 % Gross profit 21,141 18,514 2,627 14 % Gross margin 74 % 73 % 1 % Total operating expenses 19,936 20,220 (284) (1) % Operating income (loss)$ 1,205 $ (1,706) $ 2,911 NM Games revenue increased by$3.1 million , or 12% as compared to the prior year primarily due to increases of$4.4 million in product sales revenues and other revenues, partially offset by a decrease of$1.3 million in subscription services revenues, described more fully below. Our Games segment has shifted its focus toward free-to-play games that offer in-game purchases of virtual goods, the revenue from which is included within product sales, and away from premium mobile games that require a one-time purchase or subscription. Subscription Services Our subscription sales decreased$1.3 million as a result of lower subscribers in 2020 as compared to 2019. Product sales Our product sales increased$4.1 million as a result of higher in-game purchases of$6.5 million compared to the prior-year period, offset by lower sales of games of$2.4 million as we have shifted toward free-to-play games that offer in-game purchases of virtual goods and away from premium mobile games that require a one-time purchase. Advertising and other Our advertising and other revenues increased$0.4 million as compared to the prior-year period primarily as a result of offering more in-game advertising within our free-to-play games, partially offset by decreases in advertising revenue from premium mobile games. Cost of revenue increased by$0.5 million , or 7%, due to higher app store fees of$1.0 million , partially offset by lower publisher license and service royalties. Operating expenses decreased by$0.3 million , primarily due to lower salaries and other people related costs of$1.0 million , professional services fees and development costs of$1.0 million and infrastructure expenses of$0.2 million , partially offset by higher marketing fees of$1.9 million . Corporate Corporate segment results of operations were as follows (dollars in thousands): 2020-2019 % 2020 2019 Change Change Cost of revenue$ 16 $ (280) $ 296 NM Total operating expenses 3,009 14,894 (11,885) (80) % Operating income (loss)$ (3,025) $ (14,614) $ 11,589 79 % Operating expenses decreased by$11.9 million , or 80%. The decrease was primarily due to lower salaries and other people related costs of$1.6 million and lower professional service fees of$0.6 million . The overall decrease was also impacted by$9.6 million related to the change in fair value of the contingent consideration liability. See Note 5. Fair Value Measurements for additional information. 23
-------------------------------------------------------------------------------- Consolidated Operating Expenses Our operating expenses consist primarily of salaries and related personnel costs including stock-based compensation, consulting fees associated with product development, sales commissions, amortization of certain intangible assets capitalized in our acquisitions, professional service fees, advertising costs, restructuring charges, and lease exit costs. Operating expenses were as follows (dollars in thousands): 2020-2019 % 2020 2019 Change Change Research and development$ 24,319 $ 27,850 $ (3,531) (13) % Sales and marketing 21,042 23,016 (1,974) (9) % General and administrative 17,331 21,820 (4,489) (21) %
Fair value adjustments to contingent consideration liability
(8,600) 1,000 (9,600) NM Restructuring and other charges 2,529 1,954 575 29 % Total consolidated operating expenses$ 56,621 $ 75,640 $ (19,019) (25) % Research and development expenses decreased by$3.5 million , or 13%, in the year ended 2020 as compared to 2019 primarily due to a decrease in salaries and other people related costs of$2.0 million , lower professional service fees and development costs of$1.2 million and lower infrastructure costs of$0.4 million . Sales and marketing expenses decreased by$2.0 million , or 9%, in the year ended 2020, compared with 2019. The decrease was primarily due to a decrease in salaries and other people related costs of$2.9 million . The decrease was partially offset by higher marketing and professional fees of$0.8 million . General and administrative expenses decreased by$4.5 million , or 21%, in the year ended 2020, compared with 2019. The decrease was primarily due to lower salaries and other people related costs of$2.4 million , lower professional fees of$1.1 million and lower facility expenses of$0.8 million . The fair value adjustments to the contingent consideration liability changed by$9.6 million in the year ended 2020, compared with 2019. See Note 5. Fair Value Measurements for additional information. Restructuring and other charges consist of costs associated with the ongoing reorganization of our business operations and our ongoing expense re-alignment efforts. For additional details on these charges, see Note 10. Restructuring and Other Charges. Other Income (Expenses) Other income (expenses), net was as follows (dollars in thousands): 2020-2019 % 2020 2019 Change Change Interest expense$ (20) $ -$ (20) NM Interest income 38 98 (60) (61) % Gain on equity and other investments, net 111 12,338 (12,227) (99) % Other income (expense), net (164) 102 (266) NM Total other income (expense), net$ (35) $ 12,538 $ (12,573) NM Interest expense relates toRealNetworks long-term debt, as described in detail in Note 9. Debt. Gain on equity and other investments, net for the year endedDecember 31, 2020 includes unrealized gains on equity securities of$0.7 million , partially offset by net losses in equity investments of$0.6 million . Gain on equity and other investments, net for the year endedDecember 31, 2019 includes$12.3 million related toRealNetworks' gain on consolidation of Napster, as described in more detail in Note 4. Acquisitions and Dispositions. The fluctuation in Other income (expense), net primarily relates to foreign exchange gains and losses. Income Taxes During the years endedDecember 31, 2020 and 2019, we recognized income tax expense from continuing operations of$0.1 million and$0.7 million , respectively, related toU.S. and foreign income taxes. In general, the amount of tax expense or benefit allocated to continuing operations is determined without regard to the tax effects of other categories of income or loss, such as discontinued operations. However, an exception to the general rule is provided in Topic 740 when there is a pre-tax loss from continuing operations and there are items charged or credited to other 24 -------------------------------------------------------------------------------- categories, including discontinued operations, in the current year. Pursuant to Topic 740, the gain from discontinued operations was considered in determining the$0.1 million tax expense allocated to the loss from continuing operations. The income tax expense from continuing operations for the year endedDecember 31, 2020 and 2019 was largely the result of foreign withholding taxes and income taxes in foreign jurisdictions. We assess the likelihood that our deferred tax assets will be recovered based upon our consideration of many factors, including the current economic climate, our expectations of future taxable income, our ability to project such income, and the appreciation of our investments and other assets. We maintain a partial valuation allowance of$128.3 million for our deferred tax assets due to uncertainty regarding their realization as ofDecember 31, 2020 . The net decrease in the valuation allowance sinceDecember 31, 2019 of$32.5 million was the result of a decrease in current year deferred tax assets, mainly related to the disposition of Napster, for which the Company maintained a valuation allowance. We generate income in a number of foreign jurisdictions, some of which have higher tax rates and some of which have lower tax rates relative to theU.S. federal statutory rate. Changes to the blend of income between jurisdictions with higher or lower effective tax rates than theU.S. federal statutory rate could affect our effective tax rate. For the year endedDecember 31, 2020 , decreases in tax expense from income generated in foreign jurisdictions with lower tax rates in comparison to theU.S. federal statutory rate were offset by increases in tax expense from income generated in foreign jurisdictions having comparable, or higher tax rates in comparison to theU.S. federal statutory rate. As ofDecember 31, 2020 and 2019,RealNetworks had$0.7 million and$5.0 million in uncertain tax positions, respectively. The decrease in uncertain tax positions is primarily the result of the Napster Disposition, for which unrecognized tax positions were removed relating to federal research and development tax credit carryforward risks, as well as transfer pricing risks in certain foreign jurisdictions. The remaining unrecognized tax benefits are due to federal research and development tax credit carryforward risks. As ofDecember 31, 2020 , there are no unrecognized tax benefits remaining that would affect our effective tax rate if recognized, as the offset would increase the valuation allowance. We do not anticipate that the total amount of unrecognized tax benefits will significantly change within the next twelve months. We file numerous consolidated and separate income tax returns in theU.S. including federal, state and local, as well as foreign jurisdictions. With few exceptions, we are no longer subject toU.S. federal income tax examinations for tax years before 2013 or state, local, or foreign income tax examinations for years before 1993. We are currently under audit by various states and foreign jurisdictions for certain tax years subsequent to 1993. Liquidity and Capital Resources The following summarizes working capital, cash and cash equivalents, and restricted cash (in thousands): December 31, 2020
2019
Working capital, excluding cash and cash equivalents$ 1,148 $ (5,808) Cash and cash equivalents 23,940 8,472 Restricted cash equivalents 1,630 4,880 The 2020 improvement in working capital fromDecember 31, 2019 was primary due to the investment in MelodyVR received as proceeds on the sale of Napster, partially offset by the reclassification of the contingent consideration liability from other long-term liabilities to current liabilities. Cash and cash equivalents increased$15.5 million fromDecember 31, 2019 due to$10.0 million in cash proceeds from the first quarter 2020 issuance of Series B Preferred Stock, cash proceeds received from the sale of Napster during the fourth quarter of 2020, as described in Note 4. Acquisitions and Dispositions, proceeds of$2.9 million from the PPP promissory note, and issuance of SAFE Notes of$2.1 million . These increases were partially offset by cash used in operations. The decrease in restricted cash equivalents is due to a reduction in the restricted amounts required by our amended Loan Agreement of$2.0 million and the release of restricted funds held for the corporate headquarters lease, which have been satisfied with a letter of credit. See Note 9. Debt for additional information on amendments to our revolving line of credit. The following summarizes cash flow activity from continuing operations (in thousands): Years Ended December 31, 2020 2019 Cash used in operating activities$ (8,083) $ (21,315) Cash provided by (used in) investing activities (408)
11,324
Cash provided by financing activities 11,034
4,068
Cash used in operating activities consisted of net loss from continuing operations adjusted for certain non-cash items such as depreciation and amortization, stock-based compensation, gain on equity and other investments, fair value adjustments to the
25 -------------------------------------------------------------------------------- contingent consideration liability, loss on impairment of operating lease assets and the effect of changes in certain operating assets and liabilities. Cash used in operating activities was$13.2 million lower in the year endedDecember 31, 2020 as compared to 2019. Cash used in operations was lower primarily due to our lower operating loss recorded for year 2020 compared to the prior year. For the year endedDecember 31, 2020 , cash used in investing activities of$0.4 million was primarily due to fixed asset purchases. For the year endedDecember 31, 2019 , cash provided by investing activities of$11.3 million was due primarily to the net cash received from the Napster acquisition inJanuary 2019 . Our initial cash consideration paid at closing of$0.2 million was offset by the cash, cash equivalents and restricted cash on Napster's balance sheet at the acquisition date. The increase was offset in part by fixed asset purchases of$0.9 million . Financing activities for the year endedDecember 31, 2020 provided cash totaling$11.0 million . This cash inflow was primarily due to the issuance of Series B preferred stock of$10.0 million and proceeds of$2.9 million from the PPP promissory note, and the receipt by Scener, a subsidiary ofRealNetworks , of$2.1 million from the issuance of SAFE Notes. These inflows were partially offset by repayment on our revolving credit facility of$3.9 million . See Note 9. Debt and Note 19. Related Party Transactions for additional details. Financing activities for the year endedDecember 31, 2019 provided cash totaling$4.1 million , which was primarily from borrowings on our revolving credit facility of$3.9 million . See Note 9. Debt for additional details. While we currently have no planned significant capital expenditures for 2021 other than those in the ordinary course of business, we do have contractual commitments for future payments related to office leases. See Note 15. Leases for additional details.RealNetworks is a party to a Loan Agreement with a third-party financial institution, as discussed in Note 9. Debt. Under the Agreement, as amended, borrowings may not exceed$6.5 million and are reduced by a$1.0 million standby letter of credit entered into with the bank in connection with certain lease agreements. AtDecember 31, 2020 , we had no outstanding draws on the revolving line of credit. InFebruary 2020 , we entered into a Series B Preferred Stock Purchase Agreement withMr. Glaser , Chairman of the Board and Chief Executive Officer ofRealNetworks , pursuant to whichMr. Glaser invested approximately$10.0 million inRealNetworks in exchange for the issuance to him of 8,064,516 shares of Series B Preferred Stock. The Series B Preferred Stock is non-voting and is convertible into common stock on a one-to-one basis, provided, however, that no conversion is permitted in the event that such conversion would causeMr. Glaser's beneficial ownership of our common stock to exceed the 38.5% threshold set forth in our Second Amended and Restated Shareholder Rights Plan datedNovember 30, 2018 . The Series B Preferred Stock has no liquidation preference and no preferred dividend. In 2019,Mr. Glaser directly invested$0.8 million in one of our subsidiaries, Scener, in exchange for shares of preferred stock of that entity. The subsidiary is developing a platform that transforms the experience of viewing video entertainment into a social, connected playground. As ofDecember 31, 2020 ,RealNetworks owned approximately 82% of the subsidiary's outstanding equity, and we consolidate its financial results into our financial statements. The financial results of the subsidiary are reported in our Consumer Media segment. In the near term, we expect to see continued net negative cash flow from operating activities. We believe that our unrestricted current cash and cash equivalents and unused capacity on our revolving line of credit will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Notwithstanding this availability of cash and access to additional funding, management has considered and will continue to evaluate implementation of a variety of cash conservation measures. In the future, we may seek to raise additional funds through public or private equity financing, or through other sources. Such sources of funding may or may not be available to us at commercially reasonable terms. The sale of additional equity securities could result in dilution to our shareholders. In addition, in the future, we may enter into cash or stock acquisition transactions or other strategic transactions that could reduce cash available to fund our operations or result in dilution to shareholders. Contractual Obligations We have contractual obligations for Long-term debt and for Long-term lease liabilities, both of which are recorded on our balance sheet. For details on the maturity of Long-term debt, please refer to Note 9. Debt and for future minimum lease payments please refer to Note 15. Leases. Please also refer to Note 16. Commitments and Contingencies. For income tax liabilities for uncertain tax positions, we cannot make a reasonably reliable estimate of the amount and period of any related future payments. As ofDecember 31, 2020 , we had$0.7 million of gross unrecognized tax benefits for uncertain tax positions. 26 -------------------------------------------------------------------------------- Off-Balance Sheet Arrangements We do not maintain accruals associated with certain guarantees, as discussed in Note 17. Guarantees; those guarantee obligations constitute off-balance sheet arrangements. Critical Accounting Policies and Estimates The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Our critical accounting policies and estimates are as follows: •Revenue recognition; •Valuation of definite-lived assets, right-of-use operating lease assets, and goodwill; and •Accounting for income taxes. Revenue Recognition. We recognize revenue from contracts with customers as control of the promised good or service is transferred. Please refer to Note 3. Revenue Recognition for further details regarding our recognition policies. Valuation of Definite-Lived Assets, Right-of-Use Operating Lease Assets, andGoodwill . Assets acquired and liabilities assumed in a business acquisition are measured at fair value under the purchase accounting method and any goodwill is recognized as the excess of the total purchase price over the fair value of assets acquired and liabilities assumed. The fair value estimates are based upon estimates and assumptions relating to future revenues, cash flows, operating expenses and costs of capital. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of long-term operating plans and risk-commensurate discount rates and cost of capital. Our definite-lived assets consist primarily of property, plant and equipment. Definite-lived assets are amortized on a straight line basis over their estimated useful lives. We review definite-lived assets and right-of-use operating lease assets for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If definite-lived assets or right-of-use operating lease assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the assets exceeds their fair market value. We test goodwill for impairment on an annual basis, in our fourth quarter, or more frequently if circumstances indicate reporting unit carrying values may exceed their fair values. As part of this test, we first perform a qualitative assessment to determine if the fair value of a reporting unit is more likely than not less than the reporting unit's carrying amount including goodwill. If this assessment indicates impairment is more likely than not, we then compare the carrying value of the reporting unit to the estimated fair value of the reporting unit. If the carrying value of the reporting unit exceeds the estimated fair value, we then calculate the implied estimated fair value of goodwill for the reporting unit and compare it to the carrying amount of goodwill for the reporting unit. If the carrying amount of goodwill exceeds the implied estimated fair value, an impairment charge to current operations is recorded to reduce the carrying value to implied estimated value. The impairment analysis of definite-lived assets, right-of-use operating lease assets, and goodwill may be based upon estimates and assumptions relating to our future revenue, cash flows, operating expenses, costs of capital and capital purchases. These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital. Significant or sustained declines in future revenue or cash flows, or adverse changes in our business climate, among other factors, and their resulting impact on the estimates and assumptions relating to the value of our definite-lived, right-of-use lease, and goodwill assets could result in the need to perform an impairment analysis in future periods which could result in a significant impairment. While we believe our estimates and assumptions are reasonable, due to their complexity and subjectivity, these estimates and assumptions could vary from period to period. Changes in these estimates and assumptions could materially affect the estimate of future cash flows and related fair values of these assets and result in significant impairments, which could have a material adverse effect on our financial condition or results of operations. For further discussion, please see the risk factor entitled, "Any impairment to our goodwill, definite-lived, and right-of-use operating lease assets could result in a material charge to our earnings" under Item 1A Risk Factors. Accounting for Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred income tax expense and deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit 27
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carryforwards are expected to be recovered or settled. We must make assumptions, judgments and estimates to determine the current and deferred provision for income taxes, deferred tax assets and liabilities and any valuation allowance to be recorded against deferred tax assets. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and future tax audits could materially impact the amounts provided for income taxes in our consolidated financial statements. Each reporting period we must periodically assess the likelihood that our deferred tax assets will be recovered from future sources of taxable income, and to the extent that recovery is not more likely than not, a valuation allowance must be established. The establishment of a valuation allowance and increases to such an allowance result in either increases to income tax expense or reduction of income tax benefit in the statement of operations and comprehensive income. In certain instances, changes in the valuation allowance may be allocated directly to the related components of shareholders' equity on the consolidated balance sheet. Factors we consider in making such an assessment include, but are not limited to, past performance and our expectation of future taxable income, macroeconomic conditions and issues facing our industry, existing contracts, our ability to project future results and any appreciation of our investments and other assets. As ofDecember 31, 2020 , approximately$8.4 million of the$23.9 million of cash and cash equivalents are held by our foreign subsidiaries outside theU.S. We have reevaluated our historical assertion that undistributed foreign earnings were indefinitely reinvested and for which deferred taxes were not provided. As a result of the enactment of the Tax Act and as ofDecember 31, 2020 , we are no longer indefinitely reinvesting substantially all of the Company's foreign earnings outside of theU.S. As a result of this change, we have recorded deferred taxes of$0.9 million as ofDecember 31, 2020 to reflect local country and foreign withholding taxes associated with a future repatriation of such foreign earnings. Recently Issued Accounting Standards See Note 2. Recent Accounting Pronouncements.
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