U.S. Markets closed

Edited Transcript of RNWK earnings conference call or presentation 1-Aug-19 8:30pm GMT

Q2 2019 RealNetworks Inc Earnings Call

Seattle Sep 3, 2019 (Thomson StreetEvents) -- Edited Transcript of RealNetworks Inc earnings conference call or presentation Thursday, August 1, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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

Corporate Participants

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

* Cary L. Baker

RealNetworks, Inc. - Senior VP, CFO & Treasurer

* Robert D. Glaser

RealNetworks, Inc. - Founder, Chairman & CEO

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

Conference Call Participants

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

* Kimberly Orlando

ADDO Investor Relations - SVP

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

Presentation

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

Operator [1]

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

Greetings, and welcome to the RealNetworks, Inc. Second Quarter 2019 Earnings Call. (Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kim Orlando with Investor Relations. Please go ahead.

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

Kimberly Orlando, ADDO Investor Relations - SVP [2]

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

Thank you, and welcome to the RealNetworks' Second 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 contains certain forward-looking statements that relate to our recent acquisition of an additional equity stake in Rhapsody International Inc. which does business as Napster. Statements that are expressed are beliefs 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 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 website.

Forward-looking statements made today reflect RealNetworks' expectations as of today, August 1, 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. Cary will then provide a more detailed financial review of the second quarter of 2019 as well as provide the outlook for the third 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.

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

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

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

Thanks, Kim, and good afternoon, everyone. Thanks for joining us today.

In the second quarter, we achieved solid results overall with 2 businesses performed particularly well: our SAFR facial recognition platform and our free-to-play casual mobile games. I'll start by highlighting our traction with SAFR followed by mobile games, and we'll close with a summary of our Q2 results in the context of our growth initiatives and effective expense management.

We continue to believe that SAFR is our single-largest growth opportunity. Q2 was a very good quarter for our SAFR business. Compared to Q1, we more than doubled our bookings and number of customers. While it's still early and we're not yet breaking out SAFR revenue, we're optimistic that SAFR will become a significant business for Real over time. Our SAFR technology continues to shine. SAFR's combination of speed, compact size and accuracy provides us with significant technical differentiation in the facial recognition market.

SAFR has been evaluated by the U.S. National Institute of Standards and Technology, or NIST, as being world-class in recognition quality, size and speed. In NIST's latest July results, we improved SAFR's speed by 30% just since April. Compared to the other high-accuracy algorithms, SAFR is both twice as fast as the average competitor and is 35% smaller than the second-smallest algorithm in that cohort of high accuracy algorithms.

Another strong competitive advantage is that SAFR is basically bias-free, meaning that it's equally accurate at recognizing any kind of face regardless of ethnicity or appearance. As you may have read, this issue has tripped up some of SAFR's competitors who aren't as rigorously unbiased as we are. The new July NIST test result continues to demonstrate SAFR's remarkable lack of bias, over 5x less biased than the average system that's within our cohort of the most accurate systems.

What's more, based on the independent University of Massachusetts' Labeled Faces in the Wild test, or LFW, we achieved our best score ever in terms of proven accuracy at 99.86%.

Our excellence is being recognized in the market as well. Just last month, we were awarded Best Facial Recognition System for our best-in-class AI technology as part of the June 2019 AI Breakthrough Awards.

To summarize, while it's still early days, we remain very excited about the prospects for SAFR and believe we have a long runway for growth ahead of us.

Now let me turn to our second important growth initiative, our GameHouse division. As you may recall, our strategic focus on our GameHouse division has shifted over the past year to a focus on free-to-play casual mobile games. We continue to benefit from the solid performance of our first free-to-play game, Heart's Medicine 4, launched on iOS in Q4 2018 and in Android in Q1. Towards the end of Q2, we introduced a second free-to-play title, Delicious World, which has exceeded our expectations since release. Delicious World is now available globally on both iOS and Android and is off to a terrific start.

Games revenue grew in Q2 by 18% over the prior year period, primarily due to our emerging success in free-to-play games, and we think that Q3 will benefit from a full quarter of revenue from both FTP titles. In sum, while it's still early, we're optimistic about our free-to-play games, which should help drive growth sequential and the year-over-year top line growth in games.

Let me now talk briefly about the rest of our businesses, starting with our largest revenue business, Napster. Absent the impact of purchase accounting, Napster extended its streak for consecutive quarters of positive contribution margin to 8. We're in the early stage to leveraging the Napster platform to provide a menu of platform services, aka PaaS, or platform as a service, for customers who may not need to get both the full platform stack and content licenses from us. Napster continues to make strides as a PaaS provider, adding 3 new partnerships in Q2. Details of which will be forthcoming once the new customers launch their Napster-based services.

Our other businesses largely deliver results in line with our expectations, with the exception of our IP business in China. In that business, we ran into some headwinds related to the macro issues unique to that region, including significantly lower revenue year-over-year from Huawei, a company which, as you know, is dealing with its own unique issues. We expect our China IP business to struggle for a few more quarters until our RMHD next-generation IP platform kicks in at scale.

Overall, Q2 revenue of $44.2 million was within our guidance range, bolstered by our strength in SAFR and free-to-play games, offset by shortfalls in China IP and a few small areas. While we transition to a set of businesses driven by these growth engines, we remain committed to carefully managing our costs, especially in our legacy businesses.

In summary, we feel confident in the strategic direction and our growth process heading to the second half of the year led by both SAFR and free-to-play casual mobile games.

With that, I'll turn the call over to Cary to discuss our second quarter results in greater detail. Cary?

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

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

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

Thanks, Rob, and good afternoon, everyone. In my remarks today, I will first review our consolidated second quarter results followed by a more detailed discussion of our segment business performance. I will then review our expectations for the third 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 second quarter of 2019 is our first full quarter reflecting the consolidation of Napster's financial statements following our acquisition of Napster on January 18, 2019.

Turning to our results. For the second quarter, revenue was $44.2 million compared to $39.5 million in the prior quarter and $15.7 million in the prior year. Napster accounted for $28.6 million of our second quarter revenue compared to $24.3 million in the prior quarter. In addition, our second quarter revenue included $100,000 reduction to Napster's revenue as a result of purchase accounting. We expect an additional $100,000 reduction in revenue over the remaining quarters of 2019 related to purchase accounting.

Looking at these results in greater detail. Revenue within the Consumer Media segment was up $100,000 sequentially and down $1.3 million year-over-year. The sequential increase was primarily attributable to increased revenues in our IP codec business due to the timing of revenue recognition, while the year-over-year decline largely reflects general underperformance in our China IP business. Mobile services revenue was up slightly on a sequential basis and up $300,000 year-over-year. On a sequential and year-over-year basis, the revenue improvements reflect growth for both SAFR and Kontxt, partially offset by a decline in our legacy Ringback Tones product.

Games revenue for the second quarter was up $300,000 sequentially and up $900,000 year-over-year. On a sequential and year-over-year basis, the revenue reflect -- the revenue improvement reflects growth in our mobile games business, particularly the success of our free-to-play games. The revenue improvements were partially offset by a decline in our legacy PC subscription business.

During the quarter, we launched 3 new GameHouse original stories titles, one of which is our second free-to-play game compared to 2 launches in the prior year period and 3 launches in the prior quarter.

Finally, Napster revenue was $28.6 million, of which approximately half was direct-to-consumer and half was from distribution partners. Consolidated gross profit was $17 million for the second quarter compared to $14.6 million in the prior quarter and $11.1 million in the prior year period. As a percentage of revenue, gross margin was 38% compared to 37% in the prior quarter and 71% in the prior year. The sequential increase was primarily due to a lower purchase and accounting adjustment of $100,000 compared to $600,000 in Q1.

On a year-over-year basis, the decline was primarily due to the consolidation of Napster with Napster's gross margin for the second quarter of 2019 at 19%, while RealNetworks' gross profit margin without Napster was 73%.

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. Excluding the impact of Napster, lower IP license revenue from Consumer Media also impacted gross margin in the second quarter of 2019.

Operating expenses for the quarter increased to $26.4 million compared to $25.5 million in the prior quarter and $17.9 million in the prior year. Napster's operating expenses were $6.6 million for the second quarter of 2019. Total operating expenses in the second quarter of 2019 included $400,000 of transaction costs related to the acquisition of Napster as well as $700,000 of restructuring costs.

Adjusted EBITDA for the second quarter was a loss of $6.3 million compared to a loss of $7.9 million in the prior quarter and a loss of $5.8 million in the prior year period. Included in adjusted EBITDA was the $100,000 reduction for Napster's revenue from purchase accounting and the $400,000 transaction-related costs.

Net loss attributable to RealNetworks was $9.2 million or $0.24 per share compared to net income of $1.5 million or $0.04 per share in the prior quarter and a net loss of $6.9 million or $0.18 per share in the prior year period.

Turning to our second quarter segment results in more detail. Consumer Media segment contribution margin was a loss of $1 million compared to a loss of $1.4 million in the prior quarter and a loss of $500,000 in the prior year period. On a sequential basis, the improvement reflects higher revenue and decreased operating expenses. 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 $2.2 million compared to a loss of $2.4 million in the prior quarter and a loss of $2.1 million in the prior year period. The sequential improvement is primarily due to reductions in cost of revenue and operating expenses. Compared to the prior year period, the decline reflects increased operating expenses primarily related to investments in our SAFR and Kontxt growth initiatives, which were partially offset by higher revenue.

Games segment contribution margin was a loss of $800,000 compared to a loss of $900,000 in the prior quarter and a loss of $1.3 million in the prior year period. The sequential and year-over-year contribution margin improvements were primarily a result of our shift and focus to free-to-play casual mobile games, which generated higher revenue.

Napster's contribution margin was a gain of $100,000 for the second quarter of 2019. Included in Napster's contribution margin was the $100,000 reduction to revenue related to purchase accounting. This compares to a loss of $500,000 in the prior quarter, which included the $600,000 reduction to revenue related to purchase accounting.

At the corporate level, unallocated corporate expenses of $4.1 million decreased by $100,000 compared to the prior quarter and decreased by $1.7 million compared to the prior year period. The sequential decline was primarily due to higher stock-based compensation expense in the prior quarter. Compared to the prior year period, the increase was primarily due to higher professional fees related to the Napster acquisition. As mentioned, our second quarter operating expenses at the corporate level also included $700,000 of restructuring costs.

Now turning to our balance sheet. At June 30, 2019, we had $26.3 million in unrestricted cash and cash equivalents compared to $36.9 million at March 31, 2019. The sequential decrease was primarily driven by the net loss. In addition, Napster paid off its revolver loan of $4.9 million during the quarter.

I'll now turn to our outlook for the third 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 [fuel]-related expenses in our guidance, which is as follows: total third 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 $2.5 million to minus $5.5 million.

Lastly, while we do not guide the 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 significantly less cash in the second half of 2019.

In summary, we believe our strategy to drive top line growth is gaining traction as we continue to make progress on our key initiatives, specifically SAFR and free-to-play mobile games. In addition, our disciplined approach to managing our cost structure positions us well to scale revenue across our organization. We look forward to updating you on our progress in the quarters to come.

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

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

Operator [5]

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

(Operator Instructions)

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Rob Glaser for closing remarks.

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

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

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

Thank you all for joining us today, either live or on demand. We look forward to following up with you all in the days ahead, and certainly, talking on our next call in a quarter, if not sooner. Thanks again, everybody, and have a good afternoon.

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

Operator [7]

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

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.