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RealNetworks, Inc. (NASDAQ:RNWK)

Q4 2012 Earnings Call

February 6, 2013, 5:00 p.m. ET

Executives

Marj Charlier – VP IR

Robert Glaser – Founder, Chairman, Interim CEO

Tim M. Wan – CFO, Treasurer

Analysts

No questions asked.

Operator

Operator

Welcome and thank you for standing by. And welcome to the RealNetworks conference call. (Operator Instructions).

Now I would like to turn the meeting over to Ms. Marj Charlier, Vice President of Investor Relations. You may begin.

Marj Charlier

Thank you, Operator. And welcome to the RealNetworks' fourth quarter 2012 conference call.

Before we begin, I remind you that some matters discussed today are forward-looking including statements regarding our future revenue, adjusted EBITDA, operating expenses, trends affecting its' businesses, and its' prospects for future growth, cost reductions, and profitability. Other forward-looking statements include the company's plans to reduce expenses, implement its' strategy, and simplify its' businesses as well as new products, value creation, and other benefits from those activities.

All statements other than statements such as 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. A copy of those filings can be obtained from the SEC or from the investor relations section of our corporate website. These forward-looking statements reflect RealNetworks' expectations as of February 6th, 2013. 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.

We will present certain financial measures on this call that will be considered non-GAAP under SEC regulation G. The reconciliation of each non-GAAP financial measures to the most directly comparable GAAP financial measure, please refer to the information included in our press release and in our 8-K dated and submitted to the SEC on February 6th, 2013. Both of which can be found at our corporate website at investor.realnetworks.com under the tab financial information.

With me here today are Rob Glaser, Insurance CEO, and Sherman, and Tim Wan, Chief Financial Officer. Tim will provide a financial review of the fourth quarter and an outlook for the first quarter. And Rob will discuss the progress the company had made over the quarter. After their prepared remarks, they will take a few questions. To get things started, I'll turn this over to Tim. Tim.

Tim W. Wan

Thank you, Marj.

Earlier today, we released financial results for the fourth quarter of 2012. We will file our 10-K for 2012 soon. And I encourage you to review it and other SEC filings for a more thorough discussion and disclosure of our results.

Today, I will review our fourth quarter financial results in detail and give some guidance for the first quarter of 2013.

Total fourth quarter revenue was $67.3 million, reflecting a sequential increase of 14%. Our adjusted EBITDA in Q4 was $3.3 million versus a loss of $6 million in Q3. We are pleased with these results, which exceeded our guidance.

Having said that, I want to put these results in context. They are the results of the following: our successful effort in cost cutting that we have previously announced, better than expected performance of a new product we introduced in the quarter, the Real Player 16, and a series of one-time and seasonal events that exceeded our expectations.

Specifically, this revenue exceeded our guidance largely due to about $7 million in one-time and seasonally affected revenue that is non-recurring on a quarterly basis. This included $4 million related to our SaaS service, about $2.5 million in IP mobile license sales, and an increase in games advertising. We also exceeded our plan for the Real Player 16 by about $2 million.

While fourth quarter revenue exceeded our expectations, year-over-year revenue was down. And we are not out of the woods yet. Until we bring a new generation of product and services to market, we expect that the trends that we have talked about before specifically rising Smartphone use, industry pricing trends affecting our SaaS business, increased saturation of download partner software in the market, and the decline of PC based casual games in favor of social and mobile games platforms will negatively affect our short term results.

Our adjusted EBITDA in Q4 was $3.3 million, primarily reflecting increased revenue. And in particular, the high margin character of many of those items I just mentioned, including the IP mobile license revenue, Real Player update, and games advertising revenue, which contributed about $5 million to EBITDA.

Our continued focus on reducing costs and aligning our cost structure to our revenue profile resulted in quarterly operating expenses of $7 million lower than a year ago excluding restructuring charges.

Overall gross margins improved by 6% points sequentially to 63%. And improved 3% points over the year ago quarter when adjusted for the impairment of deferred cost of about $20 million.

Now for more detail on the business results of the quarter, let's start with emerging products. For the fourth quarter, revenue increased 22% sequentially and 3% year-over-year to a $12.4 million largely due to the release in the quarter of the Real Player 16. Adjusted EBITDA increased sequentially and year-over-year due to higher revenue and lower cost of goods.

For the fourth quarter, core products revenue rose 15% sequentially, but declined 16% year-over-year to $39.2 million.

SaaS revenue rose 10% sequentially, but declined 19% year-over-year primarily due to lower transaction volumes and lower subscribers to our SaaS service overall and the transfer of certain contracts to live wire in Q3 of 2012.

Revenue from professional services and system integration were increased due to the seasonality of that work increasing over 2011 fourth quarter.

Revenue from subscriptions, primarily SuperPass, declined sequentially due to the loss of third quarter Big Brother subscribers and declined year-over-year in line with long term declines we have been experiencing in SuperPass.

Mobile IP and Helix licensing revenue, which tends to fluctuate with device shipments by hardware manufacturers rose 47% sequentially, but declined slightly year-over-year.

Total subscribers to our SaaS service rose sequentially by 1 million to 27.5 million due to the launch of our service with a new carrier in Asia. SaaS subscribers declined year-over-year due primarily to secular and industry trends with rising Smartphone use.

Fourth quarter adjusted EBITDA for core products increased sequentially due to higher revenue. And declined year-over-year due to lower overall revenue.

Gains revenue for the fourth quarter increased 6% sequentially. But due to seasonality, it declined 27% year-over-year.

The year-over-year declines were due to reduced sales through our White Labels Indication business and traditional job [inaudible] mobile games, which we have been discontinuing since the second half of 2010. And due to the shift in consumer game play from traditional PC games to social and mobile games resulting in lower traffic and unit sales.

Adjusted EBITDA in games increased sequentially, but declined year-over-year due to the decline in revenue.

Corporate costs declined sequentially, but rose year-over-year due to higher restructuring costs. As I mentioned before, from a P&L perspective, operating expenses declined by approximately $7 million year-over-year adjusting for restructuring.

As part of our continued efforts to reduce cost of operations, we have also cut about $3 million in costs that we record as cost of goods sold. These decreases indicate significant progress on our goal of reducing annualized cost by $45 million by the end of the second quarter this year.

We ended the quarter with about $271 million in cash and short-term investments, down $3.2 million from the end of the third quarter. Uses of cash included about $2 million in restructuring costs and a payment of about $4 million relating to certain music royalties, which reduced our accrued and other liabilities. As opposed to Q2 and Q3 of 2012, we did not sell any shares of loan in the quarter.

In addition to the cash and short term investments on our balance sheet, we also have $44.3 million of restricted cash and equity securities in publicly traded companies. So we are still in a strong cash position.

Moving onto our outlook, I will provide some financial guidance for the first quarter. For the first quarter of 2013, we expect total revenue of $50 million to $53 million with all segments declining sequentially and year-over-year. Keep in mind that about $7 million of this sequential decrease will be the results of the non-recurring one-time and seasonal revenue we had in the fourth quarter, which I described earlier.

We expect adjusted EBITDA for the quarter to be a loss of $7 million to $10 million. Again, we expect a sequential decline in EBITDA is due in part to the high margin character of the one-time and seasonal revenue experience in the fourth quarter.

We are continuing with our efforts to reduce annualized expenses by at least $45 million. As you can see, our progress is substantial versus a year ago quarter and Q2 of 2012. We expect to complete the final phase of this initiative in the first half of this year.

Now I'd like to take a moment to expand on the announcement we made last September regarding our corporate operating strategy and the impact that it will have on our reporting segments going forward. Rob will talk more about the operating philosophy and growth plans behind the segment in a moment.

Starting with the first quarter of 2013, we will report our financial results based on our three principal businesses, the Real Player group, Gains, and Mobile Entertainment. Additionally going forward, more of our corporate costs such as finance, HR, legal, and facilities will be assigned to each business unit although certain costs will be retained at the corporate level, such as stock compensation, and compliance related expenses, and other similar items.

Starting with these changes next quarter, we will show our historical results reflecting this new structure, which will provide you with comparability across quarters. In advance of our first quarter earnings report, which we expect to release in early May, we will file a report on form 8-K with a description of the new segments and historical results that reflect those new segments. This should give investors and analysts time to digest the new information.

Now I'd like to turn the call over to Rob. Rob.

Robert Glaser

Thanks, Tim. Good afternoon, everyone and thanks for joining us. First, I’ll make a few brief comments about Q4 2012 and then I’ll turn my focus to 2013 and the year head.

First, 2012. I’m pleased we’re able to return growth profitability in Q4. As Tim mentioned, there were three main factors that drove this result. First, the significant cost cutting we implemented beginning mid-year. Second, the successful release of RealPlayer 16 during the fourth quarter. And third, a few seasonal one-time items.

Now, onto 2013. This year our focus is on competing implementation of the four objectives I laid out when I took over as interim CEO seven months ago. As a reminder, they are, one, any cash burn; two, putting a growth plan into place and into action; three, making Real a much simpler and much more focused company and four, moving quickly and having a strong bide towards action.

If our sole focus as focus number one, we could have said today that we achieved our mission in Q4. However, our focus is on achieving all four of these objectives and thereby creating sustainable growth and profitability. To do that requires a modest amount of investment to create and produce compelling new products and services that are not simply upgrades of our current products.

I’m pleased to report today that we’re making good progress on the other three objects as well. Regarding object two, putting a growth plan into place, we’re making very good progress. We expect to ship at least one major new product or service in each of our three major divisions during 2013. We believe that these new offerings will set us up for a durable return to growth and profitability for each business and therefore, for Real, that works as a whole.

Regarding objective number three, making Real a much simpler, more focused place, we’re also making good progress. As Tim explained a few minutes ago, we’re rolling out a new segment and organizational structure to focus Real on its three main business segments. And as Tim also explained, we’re implementing a significantly more decentralized organizational model to support that structure. We think as a result, we will be more focused, move faster and we’ll be more responsive to the market in each of our three main businesses.

Regarding the fourth point, moving quickly and having a biased towards action, I’m very pleased with the progress we’re making. We’re bringing a real sense of urgency and focus to everything we’re doing and our new decentralized organization is helping. Having said that, as the saying goes, nine women can’t get together and have a baby in one month. Developing new products in our business takes more time, especially when it’s committed as we are to building compelling sustainable products and services.

In sum, I’m very confident that we’re in a path to revitalize Real and that the products and services we’re planning to bring out to market this year will enable to do so.

Moreover, combined with the cost cuts we’ve already made or set in motion, I believe that we’re setting ourselves up both for growth and for sustainable profitability.

With that, operator, let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator instructions).

No questions asked.

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