U.S. Markets close in 16 mins

Edited Transcript of RNWK earnings conference call or presentation 7-Nov-18 9:30pm GMT

Q3 2018 RealNetworks Inc Earnings Call

Seattle Nov 8, 2018 (Thomson StreetEvents) -- Edited Transcript of RealNetworks Inc earnings conference call or presentation Wednesday, November 7, 2018 at 9:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Cary L. Baker

RealNetworks, Inc. - Senior VP, Treasurer & CFO

* Laura Bainbridge

RealNetworks, Inc. - IR

* Robert D. Glaser

RealNetworks, Inc. - Founder, Chairman & CEO

================================================================================

Conference Call Participants

================================================================================

* Paul J. Solit

Potomac Capital Management Inc. - President

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Greetings, and welcome to the RealNetworks' Third Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Laura Bainbridge with Investor Relations. Please go ahead.

--------------------------------------------------------------------------------

Laura Bainbridge, RealNetworks, Inc. - IR [2]

--------------------------------------------------------------------------------

Thank you, and welcome to the RealNetworks' Third Quarter 2018 Financial Results Conference Call.

Before we begin, I remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks' future revenue, gross profit, adjusted EBITDA and operating expenses 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.

Statements that express our belief and expectation 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. We describe these and other risks in our SEC filings, including in the risk factors set forth in our most recent report on Form 10-K and in other reports. A copy of those 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, November 7, 2018. The company undertakes no duty to update or revise any forward-looking statement made during this call, whether as a result of new information, future events or any other reason.

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 measures to the most directly comparable GAAP financial measures, 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 has made in recent months. Cary will then provide a financial review of the third quarter of 2018 and the outlook for the fourth quarter of 2018. After today's prepared remarks, Rob and Cary will be pleased to answer questions.

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

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thanks, Laura, and good afternoon, everyone. On today's call, I'll recap our Q3 results, and then Cary will discuss them in greater detail as is customary. I'll then review our growth initiatives particularly focused on SAFR, our new facial recognition platform that we launched in Q3. I also will provide an update on our other growth initiatives, discussed from our recently launch of Scener and summarize Napster's progress. Finally, I'll close with a few comments on the rest of the year before passing the call to Cary.

The third quarter marked the return to sequential revenue growth with revenue of $17.6 million, up 12% over Q2. We're particularly happy that we coupled this growth with continued improvement in overall gross margin, which is now up to 76% for the quarter. This reflects both the margins of our remaining legacy businesses and the high margins from our new growth initiatives.

As you know, we have focused the company on 4 growth initiatives: Kontxt, RMHD, mobile games and SAFR. We have funded these businesses predominantly through the reallocation of internal resources and operating cash flow from legacy products. Now that all 4 have launched, we're getting greater clarity as to which of these we plan to operate as "investment businesses" i.e., pouring on the gas to accelerate growth and which ones will run as regular businesses i.e., their own revenue growth will drive how much we spend on them and how fast they grow.

While we haven't made new final decisions regarding how we're going to allocate resources in our fiscal 2019 plan, it's already clear that SAFR, our state-of-the-art facial recognition platform, is off to a very strong start, and we see tremendous level of interest in the market for SAFR.

The SAFR launch in July was, in effect, a dual launch. We've launched SAFR both as a horizontal platform and with a specific offer for schools, most notably offering SAFR for free to the K-12 schools in the United States or Canada. The purpose of the free offer to schools was twofold; first, we strongly believe that SAFR is a great way to enhance school safety and also recognize that many schools have significant budget constraints.

Our early customers such as UCDS and St. Therese in Seattle report that they're very happy with SAFR and the positive impact that it's had within their school communities. Second, we believe that focusing on such an important social positive use case would raise SAFR's visibility and give us a great way to tell the SAFR story to the broader market.

The latter has worked even better than we expected. Media coverage of SAFR has been very extensive, including feature articles, interviews and reporting in Wired, NBC Nightly News, the front page of The Seattle Times, NPR, Fast Company and the Associated Press, just to name a few. The media halo effect and SAFR's best-of-class ratings by the National Institute of Science and -- of Standards and Technology, NIST, has helped generate worldwide awareness and interest in SAFR.

Later this week, the Consumer Electronics Show, CES, will announce that RealNetworks' SAFR for K-12 schools is a CES 2019 Innovation Award honoree in the Tech For A Better World product category. We're honored to join the small number of products receiving this award. SAFR is now available on the Windows, Mac and iOS platforms with Linux and Android coming soon.

In addition to our K-12 initiative, we see multiple paths to bringing SAFR to market. In particular, we believe that systems integrators and solution providers will be a very important part of the equation.

Our first announced partnership is with Seventh, a leader in video monitoring and access control solutions in Brazil. Through this partnership, we will bring SAFR to Seventh's portfolio of integrators and resellers in Latin America.

Just this week, we announced our second SI partner, a strategic distribution partnership with Net One Partners, a wholly-owned subsidiary of Net One Systems, the largest network integrator in Japan. Net One Partners will provide SAFR to leading information and communication technology providers, also known as ICTs, who develop applications across industries. Use cases for SAFR are diverse and include supporting multifactor entry and exit management, demographic analytics and secure commercial infrastructure, to name a few. We expect to announce additional partnerships for SAFR in the U.S. and EMEA in the weeks and months ahead.

One point that's important to note is that in the SI channel, it takes time to translate design wins into commercial solutions and scalable revenue. We're planning accordingly.

In sum, we're very encouraged by SAFR's launch and initial traction in the marketplace. We're proud to do our part to make today's schools a safer place for children. And we're very encouraged by the level of engagement we're seeing with partners and in customers around the world. We think we've just scratched the surface with SAFR, which could possibly end up being the single most significant product and business in our portfolio.

Let me now turn to our other growth initiatives. I'll start with Kontxt, our anti-spam and content classification platform for text messaging. We continue to make steady progress, although we continue to find the adoption and deployment cycle slower than we had hoped. We've now signed our second commercial customer and continue to make progress in several trials around the world.

I'd identify a similar market dynamic regarding RMHD, our next-generation video codec. Our commercial efforts in this phase are focused on the Chinese market as we previously discussed.

Building a codec ecosystem takes time. Our partnership with CIBN, one of China's leading broadcasters and CIBN's mobile affiliate, Stars China, continue to be at the center of how we're building out that ecosystem. Also important is our work with original equipment and chipset manufacturers to create a robust ecosystem of devices and platforms that embed and support RMHD video codec.

Apologies for that. Spam call, I think. So we were talking about RMHD, and we're talking about our efforts to create a robust ecosystem of devices and platforms that embed and support our RMHD codec. Our major technological achievement this quarter was the completion of a working FPGA implementation of RMHD, which sets the stage for RMHD-based hardware products.

Our fourth growth initiative is mobile games, which had a very big Q3, both financially and strategically. In Q3, we shipped Amber's Airline, which was very well received and has performed well commercially. The game combines time management gameplay with a unique and compelling storyline, following the footsteps of our other 33 GameHouse Original Stories.

In recent weeks, we've achieved 2 significant milestones in our efforts to broaden our mobile game business. First, we completed the global rollout of our GameHouse Original Stories subscription service on both iOS and Android. While it's still early in the life for our mobile subscription service, we see real opportunities, both directly with consumers and through partnerships with mobile operators.

The second significant mobile game initiative is our launch of our first free-to-play game, Heart's Medicine 4. At the beginning of October, we launched HM 4 globally on iOS. Initial results are very encouraging in terms of both consumer engagement and monetization. We expect to know a lot more by the time of our next quarterly call.

In sum, after a few bumpy quarters in games, we're optimistic about the growth of our games business. But as always, I would note that performance in a particular quarter can be influenced by the timing of individual game launches.

Lastly, I'd like to touch on a different kind of new initiative, Scener. Scener is a new social platform that lets fans of great streaming shows and movies go deeper with synchronized social video commentary. We sometimes refer to it as Twitch for Netflix and YouTube. It revolutionizes the experience of watching premium over-the-top content by enriching it with video content from experts, comedians and fellow fans.

Scener came out of a growth initiative process we started about 2.5 years ago and we're very excited about its prospects. However, unlike our other growth initiatives, we believe that Scener is best positioned for success by collaborating with investment partners. In this scenario, we would retain equity and will provide support and advice to Scener, which will be an independent company.

I'll end our discussion of specific businesses with a quick note on Napster. In the third quarter, Napster reported its fifth consecutive quarter of positive operating income. Year-to-date, Napster generated over $14 million in positive operating income. Napster's pivot to focusing primarily on servicing the market through B2B partnerships continues to make progress.

Finally, let me touch on the rest of the year. At the beginning of the year, we believed that 2018 would be a year of overall growth and that we would return to profitability by year-end. As a result of some bumps in the middle of the year, we don't think we'll achieve these objectives in 2018.

As reported, we grew meaningfully in Q3 and we expect to grow again in Q4. Having said that, as Cary will detail in a few minutes, we don't think this will have been enough to make 2018 a growth year, and we think it's unlikely we'll hit our profitability goal for Q4.

We're disappointed if this is the case. But because we feel very optimistic about our prospects for continued growth going forward and are particularly bullish about SAFR, we think that making a modest net investment for the rest of the year is the right tradeoff to make and the right way to optimize for the future.

So with that, let me hand the call over to Cary to go through the numbers in detail.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Thanks, Rob, and good afternoon, everyone. In my remarks today, I will first review our consolidated third quarter results, followed by a more detailed discussion of our segment business performance. I will then review our expectations for the fourth quarter of 2018.

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 as well as the adoption of the new revenue accounting standard in the first quarter of 2018.

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 implementations.

Turning to our results from continuing operations. For the third quarter, revenue was $17.6 million, up 12% from $15.7 million in the prior quarter and down 5% from $18.6 million in the prior year period. We are encouraged by the return of sequential revenue growth in all 3 of our segments.

Looking at these results in greater detail. Revenue within the Consumer Media segment was up $800,000 sequentially and up $500,000 year-over-year. The sequential improvement primarily reflects increased revenue from our IP codec business. Relative to the prior year period, increased software license revenues were offset in part by a decrease in legacy subscription products.

Mobile Services revenue was up $600,000 sequentially and down $300,000 year-over-year. On a sequential basis, the improvement was related to the timing of revenue recognition of legacy ringback tones and Inter-Carrier Messaging contracts. On a year-over-year basis, the decrease was primarily driven by declines in our legacy ringback tones and RealTimes products.

Finally, Games revenue for the third quarter was up $400,000 sequentially and down $1.2 million year-over-year. The sequential improvement reflects growth in our mobile games business led by the strong performance of our first installment of Amber's Airline. Year-over-year, revenue was primarily impacted by one fewer mobile game launched in the current year quarter. The year-over-year decline was partially offset by new revenue initiatives including in-game advertising within our mobile games.

Consolidated gross profit was $13.3 million in the third quarter, up $2.2 million from the prior quarter and up $100,000 over the prior year period. As a percentage of revenue, gross margin was 76%, up from 71% in both the prior quarter and the prior year period. The sequential increase was due in part to increased leverage on higher revenues. On a year-over-year basis, the improvement was primarily due to lower developer royalties and App Store fees in our Games business.

Operating expenses in the quarter were $18.3 million, up 2% on a sequential basis and up 3% from the prior year period, driven by investments in our sales and marketing and research and development to support our growth initiatives, predominantly related to SAFR and partially offset by our ongoing cost reduction efforts in our legacy businesses, including reduced headcount.

Adjusted EBITDA for the third quarter was a loss of $3.4 million compared to a loss of $5.7 million in the prior quarter and a loss of $2.6 million in the prior year period. Net loss was $6 million or $0.16 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 $4.5 million or $0.12 per share in the prior year period.

Turning to our third quarter segment results in more detail. Consumer Media's segment contribution margin was $400,000 compared to a loss of $500,000 in the prior quarter and a gain of $40,000 in the prior year period. Compared to the prior quarter and the prior year period, contribution margin was benefited by higher revenue.

Mobile Services segment contribution margin was a loss of $1.3 million, down from a loss of $2.1 million in the prior quarter and up from a loss of $600,000 in the prior year period. Compared to the prior quarter, the improvement reflects increased revenue. Compared to the prior year, the decline reflects lower revenue and increased professional service fees and marketing spend related to our growth initiatives.

Games segment contribution margin was a loss of $1.1 million compared to a loss of $1.3 million in the prior quarter and a loss of $400,000 in the prior year period. On a sequential basis, the improvement primarily reflects increased revenue related to the launch of Amber's Airline. Compared to the prior year quarter, the year-over-year decline was driven primarily by lower revenue related to the number of game launches in their respective periods and increased personnel expenses as a result of the Blue Giraffe acquisition. This was partially offset by improved gross margin in the quarter.

At the corporate level, unallocated corporate expenses of $2.5 million increased by $100,000 compared to the prior quarter and decreased by $400,000 compared to the prior year period. The year-over-year variance reflects lower people-related, professional services and facilities expense as a result of our ongoing cost reduction efforts.

Now turning to our balance sheet. We ended the quarter with $39.1 million in unrestricted cash, cash equivalents and short-term investments, reflecting a sequential decrease of $3 million, primarily driven by the net loss.

I'll now turn to our outlook for the fourth quarter. We remain encouraged by the progress we have made in the trial and deployment of our key technologies. We believe our strategic initiatives to drive top line growth are progressing although with longer-than-anticipated sales and implementation cycles.

We expect to recognize additional revenue related to our growth initiatives in Q4 and more meaningfully so in 2019. We expect our improved cost structure better positions us to leverage revenue growth in the future though we no longer expect to achieve breakeven adjusted EBITDA in the fourth quarter.

With that as a backdrop, for the fourth quarter, we currently expect total revenue in the range of $17.5 million to $19.5 million, and adjusted EBITDA loss is expected to be in the range of minus $2 million to minus $4 million.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from P.J. Solit with Potomac Capital Management.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

A couple of questions. First off, the Napster year-to-date operating profit number, did you say $14 million?

--------------------------------------------------------------------------------

Cary L. Baker, RealNetworks, Inc. - Senior VP, Treasurer & CFO [3]

--------------------------------------------------------------------------------

This is Cary. Yes, that's correct. Year-to-date 2018 operating income is over $14 million.

--------------------------------------------------------------------------------

Paul J. Solit, Potomac Capital Management Inc. - President [4]

--------------------------------------------------------------------------------

Okay. What does that imply what the quarter was?

--------------------------------------------------------------------------------

Cary L. Baker, RealNetworks, Inc. - Senior VP, Treasurer & CFO [5]

--------------------------------------------------------------------------------

We will have that included in our 10-Q which will be filed tomorrow morning.

--------------------------------------------------------------------------------

Paul J. Solit, Potomac Capital Management Inc. - President [6]

--------------------------------------------------------------------------------

Okay. And am I right that in the next couple of quarters, that could potentially turn to a top line growth situation as you anniversary the de-emphasis of the consumer?

--------------------------------------------------------------------------------

Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [7]

--------------------------------------------------------------------------------

Well, I'm pretty sure that neither we nor Napster has done any guidance for the future. I think it's fair to say that we think the strategy is working well. And over time, you'd want a strategy that was working well to not only generate stable revenue but growing revenue. But we have not characterized the timetable for that. And we have no -- we don't forward guide on Napster, as least historically we haven't, but we sure understand the question.

--------------------------------------------------------------------------------

Paul J. Solit, Potomac Capital Management Inc. - President [8]

--------------------------------------------------------------------------------

Got you, yes. Clearly, with $14 million year-to-date of operating income, you've created some real value there. The B2B strategy looks to be validated. In terms of the Scener, so it sounds like you want to take outside capital and -- as a separate company and put a value and fund that business. Where are you in that process? Do you have a bank? And where are we, I guess?

--------------------------------------------------------------------------------

Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [9]

--------------------------------------------------------------------------------

Well, we just announced Scener, I guess, it's almost 2 months ago, so it's still early in the process of getting the word out on what Scener is. So I would say that when we have something concrete to talk about, we'll be happy to talk about it. But at this point, we've been focusing on getting the product to market, reach good initial customer success and happiness in traction, and then we gain those kinds of conversations.

--------------------------------------------------------------------------------

Paul J. Solit, Potomac Capital Management Inc. - President [10]

--------------------------------------------------------------------------------

Okay. And then regarding -- you mentioned not reaching breakeven EBITDA this quarter and the fourth quarter, making some investments in some promising areas, which is it's fine. What kind of time line do you now see for reaching that? Is it possible that it's in the first quarter?

--------------------------------------------------------------------------------

Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [11]

--------------------------------------------------------------------------------

So historically, we have guided within the next -- we've done next quarter guidance that's quantitative and nothing beyond that. And then at the beginning of the year, we sort of step back and say what we think is going to happen that year. So the next time, I think we would be talking -- answering that question or addressing that question would be at our earnings call at the conclusion of the calendar 2018 so in about 3 months' time. So we don't intend to talk about more than the current calendar year even at a macro level.

--------------------------------------------------------------------------------

Paul J. Solit, Potomac Capital Management Inc. - President [12]

--------------------------------------------------------------------------------

Okay. And then lastly, you've done a great job, you're positioning the company as a high-margin, lots of optionality, interesting scalable businesses. You've got almost no enterprise value, I think, partially due to sort of the market and some specific supply of shares. In my mind, given that you're not too far away from a breakeven situation, this would be the perfect time to create some value by allocating a little bit of capital. And I understand you don't want to certainly blow your $39 million of cash, but I think even $5 million or $10 million here could create quite a bit of value. So I just wanted to put that out there and I guess just wonder if you have any reaction to that.

--------------------------------------------------------------------------------

Robert D. Glaser, RealNetworks, Inc. - Founder, Chairman & CEO [13]

--------------------------------------------------------------------------------

We don't typically talk about those topics publicly but we're always happy to get investor input and feedback. And we appreciate that in that context.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

There are no further questions. I would like to turn the floor over to Rob for closing comments.

--------------------------------------------------------------------------------

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

--------------------------------------------------------------------------------

Well, thank you, operator. We thank everybody for joining us today, either live or on-demand and look forward to talking with a number of you in the days ahead. And with that, I want to thank everybody for paying attention and for their interest, and we look forward to talking to you soon.

--------------------------------------------------------------------------------

Operator [16]

--------------------------------------------------------------------------------

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.