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

Q3 2019 RealNetworks Inc Earnings Call

Seattle Nov 11, 2019 (Thomson StreetEvents) -- Edited Transcript of RealNetworks Inc earnings conference call or presentation Wednesday, October 30, 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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* 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 RealNetworks Third Quarter 2019 Earnings Call. (Operator Instructions) Please note, this conference is being recorded.

I would now like to turn the conference over to your host, Kimberly Orlando with Investor Relations. Please go ahead, madam.

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Kimberly Orlando, ADDO Investor Relations - SVP [2]

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Thank you, and welcome to the RealNetworks Third 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 and financial conditions. Other forward-looking statements include the company's plans to implement its strategy, invest in its products and initiatives and restructuring efforts as well as the expected growth, profitability and other benefits from these activities.

In addition, today's call contains certain forward-looking statements that relate to our acquisition of an additional equity stake in Rhapsody International Inc. earlier this year, which does business as Napster. 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, including risks and implications associated with combining our business and consolidating our financial statements with Napster. We describe these and other risks in our SEC filings, including in the risk factors set forth in our most recent reports on Form 10-K and Form 10-Q 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, October 30, 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 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 reconciliations 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 Financials tab.

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 a preview of what's to come. Terry will then provide a more detailed financial review of the third quarter of 2019 as well as provide the outlook for the fourth quarter of 2019. After today's prepared remarks, Rob and Cary will be pleased to answer questions.

And 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 the third quarter, we continued to achieve solid traction with 2 key growth initiatives, our SAFR, facial and object recognition platform and free-to-play casual mobile games. I'll begin with a detailed discussion on SAFR, and then we'll discuss our progress with the free-to-play games. I'll then close with a summary of our Q3 results, including our significant adjusted EBITDA improvement over Q2, which came as a result of this progress, plus our ongoing expense management.

We believe that SAFR remains our largest long-term growth opportunity. The substantial progress we have made over the past year continues to reinforce our confidence that SAFR has the potential to become a significant business for Real over time. Our primary focus today with SAFR is for specific security-related verticals, airports, public safety, retail and casinos. We are primarily reaching these markets through partners and integrators. We believe that this is the right long-term strategy to ensure we have the greatest leverage in reach. The notable downside is that it typically increased the length of time it takes to get our SAFR-based solutions into the market and deploy band customers.

Our global network of systems integration partners continues to grow and now includes Secure and L8 Networks in Brazil, Konica Minolta in Europe, Net One Partners and Nextware in Japan, ACA Pacific and Sali Evo Tech in Indonesia and ADT Caps in Korea. We've also continued to deepen our technical integration and commercial partnerships with video management solution providers, such as Genetec, Milestone Systems and Digifort. Largely because of this global network of partners, our early customers are also quite global and include 1 of the 10 largest banks in Brazil; SK Telecom in South Korea; NRT, which is a leading U.S.-based fintech and gaming service company; and a law enforcement agency in the city of Calcutta, India. Another high-profile successful employment of SAFR also came in India when SAFR was deployed to help secure Indian Prime Minister Modi's Independence Day Speech at Red Fort in New Delhi on August 15, 2019.

We continue to enhance the SAFR technology platform to ensure that it's world-class. Testing by the National Institute of Standard Technology, or NIST, shows that our core SAFR facial recognition platform remains one of the world's highest performance solutions for live video based on its combination of accuracy, speed and compactness. NIST test results also demonstrate that SAFR is consistently excellent across variances in skin tone, ethnicity and gender. Several companies -- several of our competitors have actually been shown to have significant problems with bias when applied to different race to our thinkers. We're sure in this regard as the NIST results demonstrate.

In addition to our own technical excellence, we are close to partnering technology leaders. This week, we announced a partnership with NVIDIA, the world's leading GPU manufacturer, through our recent collaboration with NVIDIA's Metropolis Partners program. NVIDIA customers now have access to SAFR for AI-based smart cities, public safety and retail applications and to make these spaces both smarter and safer. And we believe that our work with NVIDIA will meaningfully help expand SAFR's reach.

In summary, we believe we have a solid runway for growth ahead of us and are very encouraged by the robustness of our pipeline. We remain very excited about the long-term prospects for safer.

Now I'll turn to our second important growth initiative, free-to-play casual mobile games. Q2 revenue for Games once again improved both sequentially and year-over-year, by 18% and 30%, respectively, which was a direct result of our emerging success in free-to-play games. Our performance was driven primarily by our second free-to-play title, Delicious World, which has exceeded our expectations since its global rollout on both iOS and Android at the end of Q2. After less than 6 months of global release, Delicious World is on track to be our largest casual game ever both in terms of revenue and in terms of audience size, and the latter is measured by daily active users. We've also continued to benefit from the solid performance of our first free-to-play game, Heart's Medicine 4, which launched on iOS in Q4 2018 and on Android Q1 2019. And in the first week of October, our third free-to-play title, Delicious Bed & Breakfast was soft-launched in the U.S. We're optimistic that we can sustain our early success in free-to-play casual games, and that this will translate both for continued growth and over time, to significant and sustainable profitability.

Before I conclude, I'd like to briefly discuss the remainder of our businesses. Napster, currently our largest business from revenue standpoint, extended its tweak of positive contribution margin to 9 consecutive quarters, absent the impact of purchase accounting. We continue to make progress with our B2B strategy for Napster. A recent highlight is Sony Music Entertainment Japan's launch of mora qualitas, the first high-resolution streaming music service powered by Napster. We look forward to sharing additional platform service partnerships in the coming quarters, as new customers launch their Napster-based services.

Consistent with the prior quarter, our other businesses delivered results generally in line with the expectations we conveyed on our last call. Our IP business in China remains soft, primarily due to factors that are macro and specific to that region, including a significantly longer -- lower year-over-year revenue from Huawei. And most of our other legacy businesses have been tracking to our plan.

Overall, our Q2 revenue was $45 million slightly up from Q2. Our adjusted EBITDA loss of $3.2 million was substantially improved by over $3 million compared to the prior quarter. As our growth initiatives continue to gain traction, we're continuing to also manage our expense within our current cost structure and with the goal of improving our profitability over time.

In summary, we're very pleased with the progress of our 2 key growth initiatives. While it took longer to scale up than we originally hoped, we feel already very good about the path that they're both on.

And with that, I'll turn it over to Cary to discuss our third quarter results in more 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 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 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 Consumer Media 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.

Turning to our results. For the third quarter, revenue was $45 million compared to $44.2 million in the prior quarter and $17.6 million in the prior year. Napster accounted for $27.3 million of our third quarter revenue compared to $28.6 million in the prior quarter.

Looking at these results in greater detail. Revenue within the Consumer Media segment was up $1 million sequentially and down $1.1 million year-over-year. The sequential increase was primarily attributable to increased revenue in our IP codec business due to onetime payments and the timing of revenue recognition, while the year-over-year decline largely reflects general underperformance in our China IP business. Mobile Services revenue was down slightly on a sequential basis and down $500,000 year-over-year. The decrease on both a sequential and year-over-year basis was primarily due to a decline in our legacy Ringback Tones products. Games revenue for the third quarter was up $1.1 million sequentially and up $1.7 million year-over-year, which reflects the success of our free-to-play mobile games. We continue to see solid performance from our 2 free-to-play games, along with encouraging early results from the soft launch of our third free-to-play game.

Finally, Napster revenue was down $1.3 million sequentially, mainly due to declining subscribers, partially offset by higher platform partner revenue. Third quarter consolidated gross profit was $18.7 million compared to $17 million in the prior quarter and $13.3 million in the prior year period. As a percentage of revenue, gross margin was 42% compared to 38% in the prior quarter and 76% in the prior year. The sequential increase was primarily due to higher revenue and cost reduction measures in our Consumer Media segment. On a year-over-year basis, the decline was primarily due to the consolidation of Napster. With Napster's gross margin for the third quarter of 2019 at 19%, while RealNetworks gross margin without Napster was 76%. As a reminder, the reduction in our consolidated gross margin primarily reflects Napster's label and publisher royalties for its worldwide music services. These costs can vary materially from period-to-period due to significant judgments, assumptions and estimates of the amounts to be paid.

Operating expenses for the quarter decreased to $25 million from $26.4 million in the prior quarter and increased from $18.3 million in the prior year. Napster's operating expenses were $6.5 million for the third quarter of 2019. Adjusted EBITDA for the third quarter substantially improved to a loss of $3.2 million compared to a loss of $6.3 million in the prior quarter and a loss of $3.3 million in the prior year period. Net loss attributable to RealNetworks was $6 million or $0.16 per share compared to a net loss of $9.2 million or $0.24 per share in the prior quarter and a net loss of $6 million or $0.16 per share in the prior period.

Turning to our third quarter segment results in more detail. Consumer Media segment contribution margin was $300,000 compared to a loss of $1 million in the prior quarter and a contribution of $400,000 in the prior year period. On a sequential basis, the improvement reflects higher revenue and decreased operating expenses as a result of our ongoing expense management. Compared to the prior year period, the decline reflects lower revenue, partially offset by lower operating expenses.

Mobile Services segment contribution margin was a loss of $1.9 million compared to a loss of $2.2 million in the prior quarter and a loss of $1.3 million in the prior year period. The sequential improvement is due to lower operating expenses. Compared to the prior year period, the decline is due to lower revenue and increased operating expenses, primarily related to investments in SAFR. Games segment contribution margin was $200,000 compared to a loss of $800,000 in the prior quarter and a loss of $1.1 million in the prior year period. The sequential and year-over-year contribution margin improvements were primarily a result of our transition to free-to-play mobile games, which generated higher revenue.

Napster's contribution margin nominally declined from the prior year period -- for the prior quarter, though it remained positive. At the corporate level, unallocated corporate expenses of $3.5 million decreased by $600,000 compared to the prior quarter and increased by $1 million compared to the prior year period. The sequential decline was primarily due to lower professional fees related to the acquisition of Napster as well as lower facilities expense. Compared to the prior year period, the increase was primarily due to the Napster acquisition. Our third quarter operating expenses at the corporate level also included $700,000 of restructuring costs.

Now turning to our balance sheet. At September 30, 2019, we had $18.1 million in unrestricted cash and cash equivalents compared to $26.3 million at June 30, 2019. The sequential decrease was primarily driven by the net loss. In addition, we entered into a new loan agreement in August for a $10 million revolving credit facility to be used for working capital and general corporate purposes. As of September 30, 2019, we had $6.1 million available for borrowing on the revolver.

I'll now turn to our outlook for the fourth 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 fourth quarter revenue is expected to be in the range of $40 million to $43 million, and adjusted EBITDA loss is expected to be in the range of minus $2 million to minus $5 million. Lastly, while we do not guide to cash, with our new products starting to deliver revenue and the majority of the Napster transaction costs behind us, we continue to expect our operations will use less cash going forward.

In summary, we are encouraged by the momentum of our key initiatives, specifically SAFR and free-to-play mobile games to drive top line growth and scale revenue across our organization. We also remain intently focused and committed to managing our costs. We look forward to updating you on our continued progress in the quarters to come.

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

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Operator [5]

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At this time, we will be conducting a question-and-answer session. (Operator Instructions)

There are no questions registered at this time. And I would like to turn the conference back over to Rob Glaser for any closing remarks.

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

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Thank you, operator. We look forward to having follow-up conversations with investors as investors reach out to us. And also, I want to thank everyone for joining us today, and we will be back with you at our next earnings call if we don't be in touch with you before. Thanks again, everyone.

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Operator [7]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.