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RealNetworks (NASDAQ:RNWK)

Q2 2013 Earnings Call

August 07, 2013 5:00 pm ET

Executives

Drew Markham

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

Analysts

Barbara Coffey - S&P Capital IQ Equity Research

Operator

Welcome to the RealNetworks Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. [Operator Instructions] I would like to introduce our first speaker, Drew Markham. Please begin.

Drew Markham

Thank you, Erin. Good afternoon, and welcome to the RealNetworks Second Quarter 2013 Earnings Call. Joining me today are Rob Glaser, Chairman and Interim Chief Executive Officer of RealNetworks; and Tim Wan, Chief Financial Officer.

By now, you should have a copy of our earnings release, which crossed the wire and filed with the SEC approximately one hour ago.

Complementing the information contained in the release, on this call, we will focus on highlights of the quarter as well as our outlook for next quarter. This discussion, including any commentary during the Q&A, reflect management's views as of today, August 7, and we undertake no obligation to provide updates whether due to new information, future events or any other reasons.

Before we get started, I'd like to emphasize that some matters that we discussed today are forward-looking, including statements regarding our future financial results, trends affecting our businesses, recent and upcoming product launches and investments in our businesses and our expectations for future profitability and growth. All such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from expectations and assumptions discussed today.

For a discussion of these results -- of these risks and uncertainties, please review the forward-looking statements disclosure in our earnings release issued today and in our SEC filings. You can find a copy of our earnings release as filed on Form 8-K and our SEC filings either on the SEC's website or in the Investor Relations section of our RealNetworks website.

During this call, we will also discuss GAAP and non-GAAP financial measures. You can find reconciliations showing the differences between these measures in our earnings release. I encourage you to periodically visit the Investor Relations section of our corporate website at investor.realnetworks.com for important content, including today's earnings call.

Now, I will turn over the call to Tim Wan, our CFO.

Tim M. Wan

Thank you, Drew. Earlier today, we released financial results for the second quarter of 2013. We will file our 10-Q for the quarter 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 second quarter financial results in detail and give some guidance for the third quarter of 2013. Rob will discuss the progress to date, which will include our recent announcement regarding GameHouse Casino Plus and the acquisition of Slingo.

Total second quarter revenue was $49.9 million, reflecting a sequential decrease of 12% and year-over-year decrease of 24%. Our adjusted EBITDA loss in Q2 was $5.8 million versus a loss of $6.5 million in the year earlier quarter and loss of $3 million in the first quarter of 2013. Our adjusted -- our EBITDA exceeded expectations going into the quarter due to our continued discipline in reducing costs while our revenue met the low end of expectations. Our adjusted EBITDA loss in Q2 was $5.8 million, primarily reflecting the reduction in revenue, partially offset by continued efforts in reducing costs both in COGS and in OpEx.

Our quarterly expenses, including COGS, were about $15 million lower in the quarter than 1 year ago adjusting for restructuring charges, primarily due to our current headquarters lease termination. Overall gross margins decreased by 3 percentage points sequentially to 61%, primarily due to product mix but improved 1 percentage point over the year ago quarter.

Adjusting for COGS directly related to revenue decline of $15.6 million and additional expenses from our recent acquisition of Slingo, we have achieved our goal of reducing annualized costs by $45 million.

As I alluded to in my earlier comments, in May, we announced the relocation of our Seattle headquarters. We entered into an 11-year lease at a new location in Seattle and concurrently terminated our existing lease. We expect our new annual rent to be about $3.5 million, resulting in annual cash savings of over $7 million from our current facility. The termination cost for our existing lease is $6.6 million against a remaining obligation of about $10.5 million.

In addition, there are onetime relocation costs of approximately $7.5 million in the second and third quarter of this year, most of which will be capitalized. We are scheduled to relocate by the end of Q3 and we'll realize the savings starting in Q4 of this year.

Combining the relocation savings with our cost reduction efforts, we will have lowered expenses including COGS by approximately $52 million on an annualized cash basis, adjusting for acquisitions and onetime costs.

As we have discussed before, we are working very hard on building new products and services to turn the corner on revenue growth. I'm encouraged with the progress, and Rob will talk about one of the 3 new initiatives we recently announced. Until our new products and services are launched and take hold in the market, we expect the trends that we have talked about before, specifically regarding smartphone use and 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 mobile games platforms, will negatively affect our short-term results.

Now for more detail on the business results of the quarter, let's start with the RealPlayer Group. For the second quarter, revenue declined 18% sequentially and 17% year-over-year to $18.4 million. The sequential declines were due to selective marketing efforts in download partner, seasonality in the mobile IP business and the continued and expected decline in SuperPass revenue. The year-over-year declines were due to decline in the mobile IP business and the continued and expected decline of SuperPass. Adjusted EBITDA fell sequentially and year-over-year due to lower revenue and increasing investments in new products slated for release later this year.

For the second quarter, Mobile Entertainment revenue fell 9% sequentially and 29% year-over-year to $18.6 million due to contract terminations and lower transaction volumes and fewer subscribers plus the transfer of a contract to Livewire in Q3 2012. Second quarter adjusted EBITDA for Mobile Entertainment fell sequentially due to changes in product mix, resulting in lower gross margin, but improved year-over-year due to lower COGS and operating expenses.

Games revenue for the second quarter declined 7% sequentially and 26% year-over-year to $12.9 million. The sequential declines were due to the expected declining trends in PC games. The year-over-year declines were due to the shift in consumer game play from traditional PC games to social mobile games, resulting in lower subscription and unit sales as we discontinue our white label syndication and traditional Java mobile games business. Adjusted EBITDA in Games was flat year-over-year.

Corporate costs were flat sequentially, adjusted for relocation and restructuring costs and improved year-over-year due to cost realignment efforts.

We entered the quarter with $236.7 million in cash and short-term investments, down $23.9 million from the first quarter of 2013. Uses of cash included $15.6 million in the acquisition of Slingo, $4.4 million related to our headquarter relocation and $3.9 million related to our EBITDA loss and other net working capital changes.

We did not sell any shares of LoEn or [indiscernible] in the quarter.

In addition to the cash and short-term investments on our balance sheet, we also have $46.2 million of restricted cash and equity securities in publicly traded companies, so we are still in a strong liquidity position.

Further, as you know, we also own approximately 45% of Rhapsody, one of the leading music online subscription service in the world.

Moving on to our Q3 outlook. I will provide some financial guidance for the third quarter. Keep in mind, our plans call for new products and services to launch in the second half of this year, and until those new products take hold in the market, our revenue outlook will continue to be challenged.

For the third quarter of 2013, we expect total revenues of $47 million to $50 million with all segments flat to declining sequentially and declining year-over-year. We expect adjusted EBITDA for the quarter to be a loss of $8 million to $11 million.

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

Robert Glaser

Thanks, Tim. Good afternoon, everyone, and thank you for joining us. Since Tim just went through the numbers in great detail, I'm going to focus my comments on our most recent announcements.

As I had mentioned in each of the 4 earnings calls I've been on since returning as interim CEO, our focus is on completing the implementation of 4 objectives: one, ending cash burn; two, putting a robust growth plan into place and into action; three, making a Real a much simpler and more focused company, and four, moving quickly and having a strong bias towards action.

In today's call, I will talk in some detail for the first time about objective #2, as well as to our Games division. As I mentioned earlier this year, we expect to ship at least 1 major new product or service in each of our 3 divisions during 2013. This statement is unchanged from what we said in our last earnings call 3 months ago. The big change from 3 months ago is that the first of those major new products, GameHouse Casino Plus, has just come to market.

Let me recap what we announced last week and also put it into a strategic context. So far, casino games is a large and growing market. It is estimated to have been approximately $1.6 billion industry in 2012, growing to $2.6 billion in 2015. RealNetworks entered the market about 18 months ago, with GameHouse Slots, and more recently, GameHouse Casino. These products are highly regarded, but they have only a very small share of the market. When I came back to Real 13 months ago, I reviewed our casino games product trends with the team and came to the conclusion that social casino games is a good market to be in, but that our products needed to be more innovative and differentiated to stand out in a crowded market. Together, we all came up with the idea of creating more of the excitement that consumers associate with casino games like connecting our products with the way for consumers to win real money. Thus, was born GameHouse Casino Plus and the Golden Dreams Sweepstakes.

After successful test in the state of Illinois and in July, we launched GameHouse Casino Plus and the Golden Dreams Sweepstakes nationally on August 1. The full promotion is available now on the Facebook platform in 31 states plus Washington, D.C. We have also announced plans to bring these offerings to mobile platforms in the future.

Less than one week into launch, it's too soon to make specific announcements. But we are encouraged by the results to date. We will have more to say on our next results call.

On July 31, we also announced the acquisition of Slingo, which is the key part of our differentiation strategy -- which is another key part of our differentiation strategy in the social casino space. Slingo is a very rare piece of games IP, a casino game that is both proprietary and popular. A unique and patented combination of slots and bingo, Slingo first came to market in 1997 and has been a success on many different digital platforms. Most recently, it's been a hit on Facebook, peaking at over 50 million monthly average users before its publisher, Zynga, pulled back on marketing in the face of Slingo's plans to sell the business. Nonetheless, Slingo remains very popular on Facebook with over 4.5 million monthly active users in month of July. And Slingo Supreme is one of the top 3 paid casino games on the iPhone and iPad.

Now that we own Slingo and all associated rights, we're hard at work on new versions of Slingo for Facebook, iPhone, iPad and Android. We're developing these new products as fast as we can without compromising on quality. In fact, we've already made a small down payment on our commitment to the Slingo community by introducing a new Slingo-themed slot machine in the GameHouse Casino Plus.

While it's very early days, we feel good about the prospect of success in social casino games based on our 2-pronged differentiated strategy: GameHouse Casino Plus with the Golden Dreams Sweepstakes; and Slingo.

In the months ahead, we'll have more to say about the growth strategies for our other 2 divisions: Mobile Entertainment and the Real Player Group. While the details are different, the philosophy is the same: revitalize growth by bringing compelling and differentiated products to market.

In sum, we believe that our recently announced and upcoming new product offerings will set us up for a durable return to growth and profitability for each of our 3 business, and therefore, for RealNetworks as a whole. In addition to setting up each of our business segments for growth, we will also continue to make progress on making Real simpler, more efficient and more focused in other ways.

Our move into our new headquarters later this month is another example of this. Tim touched on the financial impact of the move, saving us $7 million on a run rate basis. I also think there'll be cultural benefits as well. I believe that the way the new headquarter is set up will reinforce our efforts to re-energize our team and to create a more collaborative environment.

In sum, I'm very confident that we're on a path to revitalize Real and that the products and services we're bringing and planning to bring to market this year will enable us to do so. While it will take time, we have much hard work ahead of us. I believe we're setting us up for growth and sustainable profitability.

So with that, operator, let's open up the call for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Barbara Coffey with S&P.

Barbara Coffey - S&P Capital IQ Equity Research

Yes. Can you speak a little bit about your go-to-market strategy for the Games division and how you plan to promote these new games and services?

Robert Glaser

It's Rob. What we have said about our promotional plans and go-to market plan is that we're going to start on Facebook, which is where we have launched today, and the new GameHouse Casino Plus is available around the world. The Golden Dreams Sweepstakes is available in about 70% of our U.S. customer base, so in 31 states plus the District of Columbia. And that is the first platform it's on. We also plan to bring the products offering, both the Casino Plus and the connection to the Golden Dreams Sweepstakes onto mobile platforms, iPhone, iPad and Android. But we have not specified a date for that. With regard to marketing methods, it will be a combination of earned media, which we generated a significant amount of public attention within the national technology press and some elements of the business press last week in our launch activities. We have additional phase of that plan that we think will give us an opportunity to reach more people, especially more of our consumers in the weeks and months ahead. And then obviously, we do a series of direct marketing programs on the various platforms themselves. So the nature of it is that we'd probably be -- if you look at the way that the team has marketed in the past, it was reliant solely, let's say, or almost solely on the direct marketing that was platform specific. We're going to continue that activity. But we think because of the unique differentiated element of this, there's lots of opportunity for social engagement outside of those platforms as well as opportunity for earned media because it's a compelling story to tell and we're going to be out there energetically in the weeks and months ahead telling the story.

Barbara Coffey - S&P Capital IQ Equity Research

Okay. And as you look at the new product offering for the other units, would you like to put any kind of timetable around when those might be released?

Robert Glaser

I'm happy to restate what we said, which is that with the products will be in market this year. And since we're having this conversation in the early part of August, that bounds us to the remaining 5 months of the year. But we are not making more specific statements on these calls or in any other public for as to go to market. Other than that, we remain confident that the product will come to market this year.

Operator

We have no further questions at this time.

Tim M. Wan

Great. Thank you very much. Thank you, all, for joining the call today.

Robert Glaser

Thanks, everyone. Look forward to talking with you soon.

Operator

Thank you for your participation on today's call. You may disconnect your line at this time.

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