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Edited Transcript of RNWK earnings conference call or presentation 2-May-19 8:30pm GMT

Q1 2019 RealNetworks Inc Earnings Call

Seattle May 11, 2019 (Thomson StreetEvents) -- Edited Transcript of RealNetworks Inc earnings conference call or presentation Thursday, May 2, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Cary L. Baker

RealNetworks, Inc. - Senior VP, CFO & Treasurer

* Robert D. Glaser

RealNetworks, Inc. - Founder, Chairman & CEO

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Conference Call Participants

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* Paul J. Solit

Potomac Capital Management Inc. - President

* Kimberly Orlando

ADDO Investor Relations - SVP

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Presentation

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Operator [1]

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Greetings, and welcome to the RealNetworks, Inc. First Quarter 2019 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kim Orlando with Investor Relations. Thank you. Mr. Orlando (sic) [Ms. Orlando], you may begin.

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Kimberly Orlando, ADDO Investor Relations - SVP [2]

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Thank you, and welcome to the RealNetworks First Quarter 2019 Financial Results Conference Call. Before we begin, I'd like to remind you that some matters discussed today are forward-looking including statements regarding RealNetworks future revenue, gross profit, adjusted EBITDA and operating expenses on a consolidated basis and trends affecting its businesses and prospects for future growth and profitability. Other forward-looking statements include the company's plans to implement its strategy and invest in its products and initiatives as well as the expected growth, profitability and other benefits from these activities.

In addition, today's call contain certain forward-looking statements that relate to our recent acquisitions of an additional equity stake in Rhapsody International, Inc, which does business as Napster.

Statements that express our belief and expectations and all statements other than statements of historical facts are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially from these forward-looking statements, including risks and implications associated with combining our business and consolidating our financial statements with Napster.

We described these and other risks in our SEC filings, including in the risk factors set forth in our most recent form 10-K and in other reports.

A copy of these filings can be obtained from the SEC or from the Investor Relations section of our corporate website.

Forward-looking statements made today reflect RealNetworks' expectations as of today, May 2, 2019. The company undertakes no duty to update or revise any forward-looking statements made during this call whether as a result of new information, future events or any other reasons.

In addition, we will present certain financial measures on this call that will be considered non-GAAP under the SEC's Regulation G. For reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to the information included in our press release and in our Form 8-K dated and submitted to the SEC today. Both of which can be found on our corporate website at investor.realnetworks.com under the tab, Financial Information.

With me today are Rob Glaser, Chairman and CEO; and Cary Baker, CFO. Rob will discuss the company's strategy and the progress the company made during the quarter as well as preview of what's to come. Cary will then provide a more detailed financial overview of the first quarter of 2019 as well as provide the outlook for the second quarter of 2019. After today's prepared remarks, Rob and Cary will be pleased to answer questions.

With that, I will hand the call over to Rob.

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Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [3]

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Thanks, Kim, and good afternoon, everyone, and thanks for joining us today. In today's comments, I will first summarize our quarterly results then I will take a deeper dive into Napster -- into SAFR followed by the discussion of Napster and a few additional updates on some of our other growth initiatives. I will then close with a summary of our go-forward strategy for the remainder of 2019. .

First, Q1. Note that this is our first time reporting Napster's results with the partial quarter on Q1. Our first full quarter of Napster will be Q2. Q1 revenue came in a little bit light relative to guidance. There were 2 reasons for this. The first is that we couldn't count $600,000 of Napster revenue due to purchase accounting rules that Cary will explain. The second is that our legacy China RMVB business had a bad quarter. This doesn't affect our next generation of RMHD codec, which is continuing to gain traction, but it did affect our top line, and because it's very high margin, also our bottom line.

By and large, every business came in at or around expectations. On the bottom line, we generated positive net income of $1.5 million helped by accounting associated with the Napster transaction. Our adjusted EBITDA came in within the range we guided on January. Cary will go through these numbers in more detail in a few minutes.

Now turning to SAFR. We had a very good quarter technologically, strategically and operationally pushing SAFR forward. We continue to believe that SAFR is the single biggest opportunity in front of us, and we're moving forward accordingly.

As a reminder, SAFR, which stands for Secure, Accurate Facial Recognition utilizes AI-based machine learning to deliver world-class facial recognition platform.

From a technical standpoint, we continue to shine. Our accuracy is now up to 99.86% based on the independent UMass, labeled faces in the wild test, which is our best result ever.

In the April 2019 National Institute of Standards and Technology, NIST test results, the SAFR algorithm tested as both the fastest and the most compact among the most accurate algorithms. Compared to the other algorithms that are also tops in accuracy, we are 62% faster than the average and 44% smaller than the second smallest algorithm.

This combination of accuracy, speed and a small size makes us the best solution in the market for recognizing video which bursts out of cameras at 30 frames per second. And our compact size means that we are by far the best solution for embedded or edge deployments.

From a strategies standpoint, our most significant recent SAFR initiative is the launch last month of SAFR for security. This new solution integrates SAFR with market-leading video management systems to create a great product for security professionals. SAFR for security gives security professionals a much better way to do their jobs by providing them enhanced visibility and situational awareness in real-time across how ever many cameras they're monitoring, be it dozens, hundreds or even thousands. Concurrent with the launch of SAFR for security, we announced and developed integrations with several VMS providers, including market leaders such as Genetec, Milestone Systems and Digifort.

We expected to be delivering integrated solutions to end customers beginning in Q2. For an operational standpoint, we're delighted to welcome Jay Burrell as RealNetworks' Chief Revenue Officer for Computer Vision. Jay's extensive background in leadership positions in both start-ups and enterprises is a perfect fit for SAFR, which after all, is a start-up leveraging the strengths and assets of a global enterprise.

In sum, while we have a lot of work ahead of us, we're very excited about SAFR, are pleased with our progress in Q1 and think SAFR represents a tremendous opportunity for RealNetworks going forward.

Let me now talk about some of our other initiatives starting with Napster. As you may recall, in January, we became the 84% owner of the popular music streaming service by purchasing the stake formerly owned by Columbus Nova. We did this based on the belief of fundamentally Napster's aligned with powerful macro trends. According to the Recording Industry Association of America, The RIAA, the recording music market had been in decline for over a decade until it reach its inflection point with the return to growth in 2016 following the rapid expansion of the streaming music category. Napster's focus in this market is on creating a compelling N10 platform and primarily delivery on a B2B basis to partners worldwide.

Napster has a solid pipeline of B2B platform as a service potential deals and partnerships. In Q1, Napster announced 2 such deals, one with Univision and the other with Music Aficionado. Napster recently appointed Angel Gambino as its Chief Commercial Officer reporting directly to Napster's CEO, Bill Patrizio. We think Napster has a lot of opportunity in front of it, and while the competitive environment is significant, the underlying market trends should provide an ongoing flow of new opportunities for Napster.

Next, I want to touch briefly on Kontxt, our next-generation anti-spam and messaging classification platform. Kontxt uses machine learning to identify and classify the origin and intent of messages. This information allows aggregators, mobile network operators and intercarrier networks to block spam and phishing and to prioritize, route and appropriately price messages.

Kontxt went live with Syniverse, our long-standing messaging partner late last year. Our second Kontxt customers, OpenMarket, is currently in trial and will be going into commercial deployment later this year. We have learned the Kontxt deployments take time but once it get going, they're sticky and can scale up significantly.

The last new initiative I want to touch on is our GameHouse division. Over the past year, GameHouse has pivoted its strategy from primarily focusing on a premium mobile games to focusing on free-to-play mobile games.

Q1 is our first full quarter of global, dual platform deployment of our free-to-play game, Heart's Medicine 4, or HM4. HM4 exceeded its forecast as it continue to ramp up nicely.

Our second free-to-play game, Delicious World, is now live in 10 countries on iOS and Android and is performing well as we tune it for global release later this year. We also have a few other promising free-to-play games in the pipeline.

While it's early yet, we're very optimistic that we are on a path to success and potentially great success.

To recap, we'll continue to make SAFR our single largest strategic and financial new product investment and are very bullish on SAFR prospects. Napster, our single largest business in terms of top line revenue, will continue to be a major focus as well. Kontxt and free-to-play games initiatives are other 2 most significant growth opportunities for 2019 and beyond, and we will scale our investments in these areas as they continue to put points on the board.

In summary, we feel better about our strategic position than we have in any times since I came back in 2012, and we think our results in 2019 will start to demonstrate why this is the case. With that, I'll turn it over to Cary to discuss our first quarter results in some greater detail. Cary?

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [4]

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Thanks, Rob, and good afternoon, everyone. In my remarks today, I will first review our consolidated first quarter results, followed by a more detailed discussion of our segment business performance. I will then review our expectations for the second quarter of 2019. Before diving into the results, please note that year-over-year and sequential comparisons are not always apples-to-apples due to the periodic variability in our revenues. Certain of our businesses, including the IP licensing part of our Consumer Media business and mobile games within our Games business can fluctuate quarter-to-quarter, but we will continue to update you on these timing impacts and their implications. Additionally, the acquisition of Napster resulted in consolidation of Napster's financial statements, effective January 18 for a partial quarter.

Turning to our results. For the first quarter, revenue was $39.5 million compared to $16.6 million in the prior quarter and $19.7 million in the prior year. Napster accounted for $24.3 million of our first quarter revenue.

Revenue came in just below our guidance range despite being operationally in line with expectations, primarily due to a $600,000 reduction to Napster's revenue as a result of purchase accounting.

We expect an additional $300,000 of similar purchase accounting revenue reduction for the remainder of the year.

Looking at these results in greater detail, revenue within the Consumer Media segment was down $1.6 million sequentially and down $3 million year-over-year. The decrease on both a sequential and year-over-year basis was primarily due to lower revenues from our IP codec business, particularly from declines in our legacy RMVB business in China as well as declines in our legacy subscription products.

Mobile services revenue was up slightly on a sequential basis and down $1.8 million year-over-year. Compared to the prior year, the decrease was largely driven by onetime revenues from our Ringback Tone contracts signed in the first quarter of 2018 and the timing of revenue from RealTimes.

Games revenue for the first quarter was up $100,000 sequentially and up $200,000 year-over-year. On a sequential and year-over-year basis, the revenue improvement reflects growth in our mobile games business, particularly the initial success of our first free-to-play game as well as in-game advertising.

Additionally, we launched 3 new GameHouse Original Stories titles in the first quarter compared to 2 launches in the prior year period and 3 launches in the prior quarter.

Finally, Napster revenue was $24.3 million, of which approximately half was a direct-to-consumer and the other half from distribution partners. As Rob discussed, the B2B market will be our primary focus of Napster going forward. Consolidated gross profit was $14.6 million in the first quarter compared to $12.8 million in the prior quarter and $14.5 million in the prior year.

As a percentage of revenue, gross margin was 37% compared to 77% in the prior quarter and 74% in the prior year. The decrease on both a sequential and year-over-year basis was primarily due to the consolidation of Napster, with Napster's gross margin for the first quarter of 2019 at 16%.

The reduction in our consolidated gross margin primarily reflects Napster's label and publisher royalties for its worldwide music services. These costs can vary from period-to-period due to significant judgments, assumptions and estimates of the amount to be paid. Excluding the impact of Napster, lower IP license revenue from Consumer Media also contributed to the year-over-year decline in gross margin.

Operating expenses in the quarter were $25.5 million compared to $18.4 million in the prior quarter and $19.5 million in the prior year. Napster's operating expenses were $5.5 million for the first quarter of 2019.

Total operating expenses in the quarter -- first quarter of 2019 included $800,000 of transaction cost related to the acquisition of Napster.

Adjusted EBITDA for the first quarter was within our guidance range at a loss of $7.9 million compared to a loss of $4.1 million in the prior quarter and a loss of $3 million in the prior year period. Included in adjusted EBITDA was a $600,000 reduction to Napster's revenue from purchase accounting and $800,000 of transaction-related cost.

Net income attributable to RealNetworks was $1.5 million or $0.04 per share compared to a net loss of $6.9 million or $0.18 per share in the prior quarter and a net loss of $5.2 million or $0.14 per share in the prior year period. It's important to note that net income for the first quarter of 2019 included a gain of $12.3 million from the acquisition of Napster.

Turning to our first quarter segment results in more detail. Consumer Media segment contribution margin was a loss of $1.4 million compared to a loss of $400,000 in the prior quarter and a gain of $600,000 in the prior year period. Compared to the prior quarter and prior year period, the decline largely reflects lower revenue in our IP licensing business.

Mobile services segment contribution margin was a loss of $2.4 million compared to a loss of $1.9 million in the prior quarter and a loss of $700,000 in the prior year period. Compared to the prior quarter and the prior year period, the decline reflects lower revenue mainly related to our legacy businesses and additional spend related to our growth initiatives.

Games segment contribution margin was a loss of $900,000 compared to a loss of $800,000 in the prior quarter and a loss of $1.1 million in the prior year period. Compared to the prior quarter, the decline primarily reflects additional investments in mobile games. Napster's contribution margin was a loss of $500,000 for the first quarter of 2019. Included in Napster contribution margin was a $600,000 reduction to revenue related to purchase accounting and $200,000 of transaction costs.

At the corporate level, unallocated corporate expenses of $4.3 million increased by $1.3 million compared to the prior quarter and $1 million compared to the prior year period. The sequential increase was primarily due to the timing of stock-based compensation expense and professional fees related to the acquisition of our majority interest in Napster. Compared to the prior year period, the increase was primarily due to higher professional fees related to the Napster acquisition.

Now turning to our balance sheet. At March 31, 2019, we had $36.9 million in unrestricted cash and cash equivalents compared to $35.6 million in the prior quarter. The cash used in operating activities during the quarter was offset by Napster's cash balance of $10.1 million at the time of the acquisition.

I'll now turn to our outlook for the second quarter. Please note that beginning in the first quarter of 2019, we included Napster as an additional business segment in our consolidated financial statements from the acquisition date of January 18, 2019. As such, we have accounted for Napster including the noncontrolling interest and deal-related expenses in our guidance, which is as follows: total second quarter revenue is expected to be in the range of $43 million to $46 million, and adjusted EBITDA loss is expected to be in the range of minus $4.5 million to minus $7.5 million.

One final point regarding guidance. While we don't guide to cash, with our new product starting to deliver revenue, and the absence of transaction cost, we would expect the operations to use significantly less cash in the second half of this year. In summary, we remain encouraged by the progress we have made in the trial and deployment of our key technologies and the disciplined approach to investments in our growth initiatives.

We believe our strategy to drive top line growth is progressing, although with longer-than-anticipated sales and the implementation cycles. We expect to recognize additional revenue related to our growth initiatives in 2019 and expect our improved cost structure better positions us to scale revenue across our organization.

With that, we will now open the call for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Ladies and gentlemen, it doesn't look like anyone has polled for questions. I'd like to turn the floor back over to Rob Glaser for closing comments. Oh wait, I'm sorry, we have one question, I apologize. The question is from P.J. Solit, Potomac.

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Paul J. Solit, Potomac Capital Management Inc. - President [2]

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Let me ask you a big-picture question. I guess you had a company that wasn't too far from breakeven back a few quarters ago. We've added Napster in, which was profitable, and we've still got a pretty meaningful projection in the second quarter for negative EBITDA. I guess can you help me understand is that just all investment in SAFR? Or how should we look at that? And how should we look at the payback on that?

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Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [3]

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This is Rob. So I'll break it down in a few different ways. One, I think with regards to the Napster's numbers, Cary described them, and there's a few phenomena, some accounting dynamics that actually tip the Napster profitability in a slight way that aren't cash related, but they do create an optics where sort of we see -- if you taking out some of those revenues and the like, something that was profitable becomes breakeven or slightly unprofitable but that's not -- that's not a change to the underlying business, that's just some accounting issues. So when you strip that away, and you talk about the rest of Real, I think 2 views are going on. One, as you say, we are sensibly, and I would say, appropriately making investments in SAFR that will pay back, we believe, very significantly, and we're in the period that's the kind of the interim period where the expenses are more front loaded and the benefits are more phased over time. We aren't guiding on that particular business, but we feel very optimistic about the business. I've said publicly that it has the best pipeline of opportunity of any business we built since the early days of streaming. I have to go back that far in terms of the pipeline as robust and diversely robust of any business we have that translates that pipeline into revenues, obviously, the job of our whole company, but particularly the leadership and Jay Burrell and bringing it -- if you look Jay's background, you look at the scale of things that Jay has built and been a part of him in the past. I think it gives you a sense of the scope of our ambition and our level of optimism. In fact, the Jay's levels of optimism since he's joined us, not having previously been a stakeholder. He's been somebody who we've known for a while as a really good guy. But he saw the situation and decided that it was -- it merited him jumping in with both feet. The other thing which I touched on and Cary also will touched on is that one of our legacy business, and that's the RMVB business, or the historical video codec, ended up having a more significant pullback in revenue than we thought. That is a particularly high margin business. So in that business, any sensitivity impact you'd see in terms of legacy revenues going down would have a significant impact on the portfolio profitability overall.

So I'd say it's those 2 factors. And while we're very glad we are an 84% owner of Napster. Napster did not end up contributing meaningful offset EBITDA in Q1. And while we don't guide on sub businesses, I think that some of the dynamics and the onetime -- both the purchase accounting dynamics and the onetime cost dynamics are what Cary touched on as well. Cary, don't you want to add anything beyond that?

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [4]

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No, I think that covers it. P.J, you'll see in our earnings release that we break down the segments. Napster is now a segment that report on. So you can see the contribution from Napster for at least this partial quarter.

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Paul J. Solit, Potomac Capital Management Inc. - President [5]

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I guess just to follow up on that. I mean I love that you guys think there's such a huge opportunity in SAFR, especially because my investment thesis sort of value some of the parts didn't even include too much value for that. So I hope you're right. What can you share with us though that's giving you the confidence? And will that play out that you got a platform at some point that meaningfully changes it from a burn to profitability or breakeven? Or is it just kind of slow and it's going to take a few years to get where you want it to go just one customers at a time.

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Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [6]

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Well, I'll answer it at a meta level. We've thought about but decided not to change the way we report our segments in 2019. I mean 2019 we've obviously added the Napster segment, so that's kind of a separate thing, but we didn't change the Consumer Media mobile services split of the rest of the business. So Game is unchanged, Napster is added and there's other 2 sectors that are unchanged. So you won't see separate impact on SAFR during 2019. We've had a conversation about how we will report out the business in 2020, and we'll obviously make that decision the end of 2019, beginning at 2020. Frankly, I would hope that by the time we get to that, it's a no-brainer that we would start to disclose SAFR as a separate business. But until we've done -- until we're there, we're not there yet, I guess I would say. It's a very, very significant market. There are many competitors in there -- I don't want to suggest otherwise, but the level of engagement we're seeing with customers and partners. We are now with SAFR for security. We're entering a very vibrant market that in our view has a high level of interest and readiness for facial recognition. I was just personally along with a number of members of the team at a show called ISC West, which is the -- I think the largest security show in U.S. North America. And literally in addition to our booth, which was a very solid attendance, I must have seen 50 booths that had facial recognition as one of their attributes.

These weren't 50 competitors, to be clear. We were in several booths with partners. Other technologies were available. So there was a huge level of interest in facial recognition within that one market segment. That market is a significant opportunity for us, it's not the only market segment for us. So facial recognition is one of these horizontal technologies we saw with streaming in the mid-late '90s where you get involved early on at a fundamental trend, and if you feel the great product, if you position it the right way or run really hard, you can build a big business. It's unusual for a company to do that in the public market, that's more typically -- some of you would associate with a pure startup. But we happen to be a public company previously, and so we will be providing a level of information that is greater than what most start-ups do, perhaps less transparent in the early quarters than an investor might like who's trying to evaluate the exact progress of that. But in each of these calls, we will talk specifically about SAFR and how it's going. I'm sure we'll highlight customers and partners and use cases. And hopefully, that mosaic will give you senses -- so why we're investing as we are, and what the opportunities we see. And then at some future point at scale, then we obviously would break it out and tell you the stable of details we provide for other segments.

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Paul J. Solit, Potomac Capital Management Inc. - President [7]

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Okay. And then given the cash balance, $36.9 million, do you view that as sufficient to get you where you need to go in this business? Or do you envision possibly monetizing some other assets? I guess and relating to that, if the answer is yes, how does that affect your view on a share repurchase in a market that's clearly not giving you much value for SAFR or a couple of other things?

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Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [8]

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Well, you asked a lot of questions that you would not expect us to answer publicly in terms of whether there are businesses that we sell or not and whether we would have a share repurchase program or not. But let me just say the following. We're super focused on creating shareholder value. I think I'm sort of known to be somebody who is focused on that in perhaps a longer-time horizon than the public markets. But I don't think if you've listened to our previous calls, you've ever heard us talk about since I have come back at least, our business opportunity with a level of focus and bullishness of SAFR, I would say prior to this, we're talking about opportunities, we're talking about 3 or 4 opportunities where we thought one might emerge. And what you heard from us today, we're seeing clear although early signs than one is emerging, which we obviously -- Napster is our single largest business. We doubled down on that for a reason. We believe in that business, particularly under the circumstances where we had the opportunity to buy that double down stake. We believe in the opportunities associated with Kontxt. We believe in the free-to-play games opportunity, and the one we believe in the most is SAFR. So that level of engagement probably isn't fully satisfying somebody who wants every understanding of what we're doing, but in the public market context, that seems like about the appropriate level of transparency, I would say, for us to engage on. And Cary, if you would to add anything before we go next question.

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [9]

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No. I think that's fine. That's an appropriate answer.

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Operator [10]

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(Operator Instructions) The next question is from [Eric Slate, ACME].

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Unidentified Analyst, [11]

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Yes. A little confused. So with the merger of the 2 companies, how much cash do you have on the balance sheet?

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [12]

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$36.9 million, [Eric].

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Unidentified Analyst, [13]

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Okay. And how much you burned quarter-to-quarter? Because I got confused with the merger of the -- did I read it right, how many million was burned?

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [14]

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Yes. So we included in that $36.9 million is we -- as part of the acquisition, we picked up $10.1 million of cash on Napster's balance sheet. So our burn to go from quarter-to-quarter was a little bit less than that $10.1 million.

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Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [15]

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But there were no (inaudible) unusual onetime phenomenon associated with that.

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Unidentified Analyst, [16]

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Okay. So the bottom line was like $7 million, $8 million, I think. If I read this -- I'm just trying to assimilate what I was reading. And in next quarter, you guide $4.5 million to -- how much a loss are you guiding for next quarter?

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [17]

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EBITDA loss of $4.5 million to $7.5 million.

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Unidentified Analyst, [18]

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So how will that impact the $36 million, would we look at $31 million in the next quarter, that type of thing.

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Cary L. Baker, RealNetworks, Inc. - Senior VP, CFO & Treasurer [19]

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Well, we don't guide to cash. Adjusted EBITDA as it is designed to be a proxy for what we use in the business, but it doesn't incorporate changes in working capital or anything else.

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Operator [20]

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There are no further questions at this time, I'd like to turn the floor back over to Rob Glaser for closing comments.

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Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [21]

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We thank you, operator, and thanks, everyone for joining us today. Now is an exciting time for us in our company and look forward to regularly updating you on what we're doing and talking to some of you in the interim and for those we don't, take care and look forward to being back with you all again in 3 months, if not sooner.

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Operator [22]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a nice day.