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Executives

Marj Charlier

Tim M. Wan - Chief Financial Officer, Principal Accounting Officer and Treasurer

Robert Glaser - Founder, Chairman, Interim Chief Executive Officer and Chairman of Strategic Transactions Committee

RealNetworks (RNWK) Q1 2013 Earnings Call May 1, 2013 5:00 PM ET

Operator

Welcome and thank you for standing by. [Operator Instructions] And now I would like to turn the meeting over to Ms. Marj Charlier. Ma'am, you may begin.

Marj Charlier

Thank you, Brandon, and welcome to the RealNetworks First Quarter 2013 Conference Call.

Before we begin, I remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks' 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 the new products, value creation, and other benefits from those activities.

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. A copy of these 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 May 1, 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 can be considered non-GAAP under SEC Regulation G. For 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 Form 8-K dated and submitted to the SEC on May 1, 2013, both of which can be found at our corporate website at www.investor.realnetworks.com under the tab Financial Information.

Here with me today are Rob Glaser, Interim CEO and Chairman; and Tim Wan, Chief Financial Officer. Tim will provide a financial review of the first quarter and the outlook for the second quarter, and Rob will discuss the progress that the company had made over the quarter. We will not be taking questions live on this call today. But I encourage you to call Tim or me, directly following the call, and we'll address whatever questions you have. Our phone numbers are on the press release we issued today.

Now to get things started, I will turn this over to Tim. Tim?

Tim M. Wan

Thank you, Marj. Earlier today, we released the financial results for the first quarter of 2013. We will file our 10-Q for the quarter soon and I encourage you to review other SEC filings for a more thorough discussion and disclosure of our results.

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

Total first quarter revenue was $56.8 million, reflecting a sequential and year-over-year decrease of 15%. Our adjusted EBITDA loss in Q1 was $3 million versus a loss of $7.4 million in the year-earlier quarter and positive EBITDA of $3.3 million in the fourth quarter of 2012.

Our revenue and our EBITDA exceeded expectations going into the quarter, largely due to better-than-expected revenue performance by a couple of our divisions, and our continued discipline in reducing cost. I will discuss the specifics of that over-performance as I continue through the numbers.

While first quarter revenue exceeded our expectations, we still have not turned the quarter and revenue growth. Until new products and services, that we are currently working on, are launched and take hold in the market, we expect that the trends, that we have talked about before, will negatively affect our results. Those trends have been rising smartphone use and industry pricing trends affecting our Mobile Entertainment business, and the decline of PC-based casual games. In addition we have decided to minimize investment in, and to harvest our SuperPass business, so we expect that revenue in the RealPlayer Group will be affected by a decline in the business over the next year or 2.

Our adjusted EBITDA loss in Q1 was $3 million, primarily reflecting the reduction in revenue, partially offset by continued effort in reducing cost, both in COGS and OpEx. Our quarterly expenses, including COGS, were about $9 million lower in the quarter than a year ago, including roughly similar restructuring charges in both quarters and adjusting for onetime items in Q1 of last year. Overall gross margins improved by 1 percentage point sequentially, to 64%, and improved 5 percentage points over the year-ago quarter, reflecting the belt tightening we had done in COGS.

Before I go into detail about the results of each of our businesses, I'd like to explain the changes we have made in our segments, starting with the first quarter. In September 2012, we announced a corporate-level strategy to operate our 3 principal businesses as standalone business units, and to reallocate operating expenses to increase efficiency and accountability. Starting with the quarter we are reporting today, we are presenting our financial results in the following 3 segments: RealPlayer Group, which will primarily include RealPlayer, SuperPass and Mobile IP sales; Mobile Entertainment, which will include our mobile carrier SaaS services, professional services and system integration revenue, and Helix software; and Games, which includes all our games-related businesses. Simply put, the main changes in segmentation involved moving SuperPass and Mobile IP out of the core group into the RealPlayer Group. This new segmentation provides a clear separation of our consumer-facing technology businesses from our enterprise and mobile carrier businesses. There's no change in the Games segment.

In addition, we are now allocating certain corporate expenses that are directly attributable to supporting the business, including some cost of finance, legal, human resources and headquarter facilities to our segments rather than lumping them all together in our corporate segment. We believe the allocation of these costs to the business units will increase accountability for financial and operational performance at the segment level. Please note that we filed an 8-K with the SEC on April 22 to give you a historical view of our results adjusted for this new segmentation.

Now, for more detail on the business results of the quarter, let's start with the RealPlayer Group. For the first quarter, revenue increased 1% year-over-year to $22.4 million, but declined 13% sequentially, due to declines in the Mobile IP business and the continuing and expected decline of SuperPass revenue. Adjusted EBITDA fell sequentially and year-over-year due to lower revenue and investment in new products.

For the first quarter, Mobile Entertainment revenue fell 20%, both sequentially and year-over-year, to $20.5 million. SaaS revenue declined 18% sequentially, primarily due to seasonality and lower subscribers to our SaaS services overall, and 20% year-over-year due to lower transaction volumes and fewer subscribers, plus the transfer of certain contracts to Livewire in Q3 of 2012. First quarter adjusted EBITDA for Mobile Entertainment increased sequentially and year-over-year due to the lower COGS and operating expenses.

Games revenue for the first quarter declined 11% sequentially, due to seasonality, and declined 27% year-over-year to $13.9 million. The year-over-year declines were due to the shift in consumer game play from traditional PC Games to social and mobile games, resulting in lower subscriptions and unit sales, and due to reduced sales through our white label Syndication business and traditional Java mobile games which have been discontinued. Adjusted EBITDA in Games is flat year-over-year.

Corporate cost increased slightly, sequentially, adjusted for restructuring items and declined year-over-year. From a P&L perspective, operating expenses declined by $6.2 million year-over-year, adjusting for a onetime legal settlement accrual in the year-ago quarter -- first quarter. As part of our continued efforts to reduce cost of our operations, we have cut another $3.3 million in COGS, not including those reductions that occur strictly as a result of lower revenue. These decreases indicate significant progress on our goal reducing annualized cost by $45 million by the end of the second quarter of this year.

We ended the quarter with about $260.6 million in cash and short term investments, down $10.8 million from the end of 2012. Uses of cash included about $3 million in restructuring cost and capital purchases, $3 million related to our EBITDA loss; and about $4 million in working capital changes, which typically occur in the first quarter as vendor prepayment and other accrued liabilities are generally paid in Q1.

Current liabilities declined by $8 million. 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 $48.6 million in restricted cash and equity securities in publicly traded companies. So we are still in a strong cash position. Further, as you know, we also own approximately 45% of Rhapsody, one of the leading music online subscription services of the world.

Moving on to our Q2 outlook. I will provide some financial guidance for the second quarter. Keep in mind our plans call for new product services to launch in the second half of this year. And until those products take hold in the market, our revenue outlook will continue to be challenged. For the second quarter of 2013, we expect total revenue of $49 million to $52 million, with all segments declining sequentially and year-over-year.

We expect adjusted EBITDA for the quarter to be a loss of $7 million to $10 million.

We are continuing with our efforts to reduce annualized expenses by at least $45 million. As you can see, our progress is substantial versus the year-ago quarter, and Q2 of 2012. We expect to the final phase of this initiative by the time we hold our next earnings conference call. In addition, in the second quarter, we expect to finalize and announce plans to reduce our facilities cost in Seattle that we anticipate will save several millions a year.

Our outlook for the second quarter does not include any cost reductions or onetime charges that could result from these plans. We will provide information about the changes in an 8-K, that we will file with the SEC when we finalize our plans.

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 Q1 2013, then I'll turn my focus to the rest of the year.

Regarding Q1, I'm pleased that our results significantly exceeded the guidance we gave 3 months ago. We're continuing to work very hard at both managing cost aggressively, and driving forward the investments in new products and services necessary to return RealNetworks to growth and to sustainable profitability.

Now, onto the rest of 2013. As I've mentioned, on each of the 3 earnings call I've been on since returning as interim CEO, our focus is on implementation of 4 objectives: One, ending cash burn; two, putting a growth plan into place and into action; three, making Real a much and focused company; and four, moving quickly having strong bias towards action.. As Tim mentioned, we've made large cut to our operating expenses. If our sole focus were objective number one, we could have run Real profitability in Q1. However, this would not set us up for sustainable growth, which is why we're making a few targeted investments in what we believe will be compelling new brands and services that are not simply upgrades of our current products. As Tim described a few minutes ago, we've organized the company around 3 major divisions, each of which has full P&L responsibility for all its product, marketing and operating activities. Those divisions as Tim mentioned are: Mobile Entertainment, which is centered our mobile services, such as ringback tones that, in aggregate -- over 25 million paying monthly subscribers worldwide; the RealPlayer Group, which is centered around the RealPlayer, which has over 26 million monthly active PC users; and Games, which has 2 pillars, a global network of over 14 million monthly casual game users on the web and a promising new business in social casino games. As we mentioned in our last call, we expect to ship at least 1 major new product or service in each of our 3 divisions during 2013. We've also continued to strengthen our leadership team with executives with the background and skills necessary to drive our transformation. A most recent example of this was the hiring of Max Pellegrini 2 months ago, as President of our Mobile Entertainment division.

As a result of these changes, we believe we are more focused, are moving faster and are more responsive to the market in each of our 3 businesses. Moreover, we believe that our upcoming new product offering will set us up for durable return to growth and profitability for each of our 3 businesses, and therefore, for RealNetworks as a whole.

In addition to how we've set up our business segments, we also continue to make progress in making Real simpler, more efficient and more focused in other ways. For instance, rather than waiting for our current lease to expire in late 2014, we expect to, shortly, announce a plan to move to an excellent new headquarters facility that will reenergize our team work environment, while also saving several million dollars a year into facilities cost.

I'm sure that some of you are impatient for even more visible progress. Well, I am, too. But as I said last time, 9 women can't get together and have a baby in 1 month. Developing new products in our business takes a little time, especially when one is committed to build compelling and sustainable products and services, as we are. Having said that, I assure you that the babies are definitely kicking. In sum, I'm very confident that we're in path to revitalize Real and that the products and services we're planning to bring to market this year will enable us to do so. Moreover, combined with the cost cuts we already made or set in motion, including the upcoming real estate savings I just mentioned, I believe that we're setting ourselves up both for growth and for sustainable profitability.

So in closing, thank you for your interest. We look forward to following up with you individually and talking again at our next call in 3 months.

Tim M. Wan

Thank you, everyone, and thank you, operator.

Operator

Thank you and this does conclude today's conference. You may disconnect at this time.

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