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RealNetworks, Inc. (NASDAQ:RNWK)

Q1 2014 Earnings Conference Call

May 7, 2014 5:00 p.m. ET

Executives

Drew Markham - Investor Relations

Tim Wan - CFO

Robert Glaser - Chairman and Interim CEO

Analysts

William Meyers - Miller Asset Management

Steven Fitzpatrick - Heymann

Operator

Welcome to the RealNetworks First Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode until the question-and-answer session of today's conference. (Operator Instructions) We'd also like to inform all parties that this call is being recorded. If you have any objections, please disconnect at this time.

I'd like to introduce our first speaker, Drew Markham. Thank you. Sir, you may begin.

Drew Markham

Thank you, Holly, and welcome to the RealNetworks First Quarter 2014 Conference Call. Before we begin, I remind you that some matters discussed today are forward-looking including statements regarding RealNetworks' future revenue, adjusted EBITDA and operating expenses, 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 value creation, market reaction and other benefits from those activities.

All statements, other than statements of historical fact, 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 May 7, 2014. 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 the SEC's Regulation G. For a reconciliation 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 tab Financial Information.

Here with me today are Rob Glaser, Chairman and interim CEO; and Tim Wan, Chief Financial Officer. Rob will discuss company strategy and the progress the company has made in recent months, and then Tim will provide a financial review of the first quarter and the outlook for the second quarter of 2014. After their prepared remarks, we will be pleased to answer questions.

Now, I'll turn the call over to Rob.

Robert Glaser

Thanks, Drew. Good afternoon to everyone, and thanks for joining us. In my comments I'll give you an update on where we're on the process of turning around RealNetworks and putting the company on a path to achieve sustainable growth in users, revenue and profit.

Four months into 2014, we're making significant progress in a number of areas. At the same time there are few other areas where we think our strategy is fundamentally sound and where it's going to take longer than we originally thought to achieve our objectives. The aggregate impact of those two dynamics, plus a few environment issues that Tim will discuss a bit later is that we now think it will take us a few more quarters to return to overall revenue growth than we previously expected.

Today I'll be reporting on four business segments. In addition to three that RealNetworks full owns and operates, I also want to update you on Rhapsody, of which we own approximately 45%.

First, our RealPlayer business; our new RealPlayer Cloud represents dramatic step forward building on our 15 plus years of experience in Internet digital video to deliver a truly compelling and unique new service. Using our advanced SurePlay technology, RealPlayer Cloud enables consumers to take videos from a very wide range of devices and play, save and share that video on just about any platform anywhere in the world.

Our business model for RealPlayer Cloud is a premium model. Everybody gets 2 gigabits of free storage, about an hour of high-def video or about four hours of standard def. We then charge for additional storage. This type of premium business model has worked well for others, indeed, it generates hundreds of million of dollars in annual revenue for documents and file oriented companies such as box.net and Dropbox.

As you will recall we introduced RealPlayer Cloud in the U.S. and Canada in late 2013. During the first quarter, we rolled out RealPlayer Cloud globally and released the product worldwide in English, French, Spanish and German.

Earlier this quarter we released RealPlayer Cloud in Japanese, Portuguese and Italian. This global rollout allows us to reach out to our base of millions of active RealPlayer users around the world.

I'm pleased to report excellent progress in growing our user base. As of today we have over two million users who both downloaded the RealPlayer Cloud app and setup accounts. This is up from 500,000 users at the end of 2013. These consumers are actively using and enjoying the product uploading hundreds of terabytes of content, and many are using across multiple devices.

In addition, we recently announced that RealPlayer Cloud is available on Amazon Fire TV, providing the Amazon RealPlayer communities with a new way to watch their video collection on televisions. This is the third TV device that we support along with Google Chromecast and Roku. While our user base is growing rapidly, we now think that scaling up monetization of RealPlayer Cloud user base will take somewhat longer than we thought before we launched the product.

We certainly think monetization is very important, but for now our primary focus will continue to be increasing the size and engagement of our user base. This is the same philosophy that many Internet companies such as Dropbox, Twitter and Facebook have used successfully over the past few years to create very large user bases that they then monetize successfully.

Moving to on our Mobile Entertainment business, you will recall during the fourth quarter 2013 we announced LISTEN, an innovative new app that combines music sharing, ringback tones and productivity tools for smartphone users, including both iOS and Android users. In addition to make ringback tones easier, more useful and more fun, LISTEN helps you to manage their time better by only getting phone calls when and from whom they want them.

LISTEN leverages our pioneering leadership in ringback tones and our large global installed base of over 20 million active, over 18 million ringback tone subscribers with more than 20 carriers worldwide to create a hybrid distribution model that combines partnership with carriers with direct-to-consumer marketing. We call this Carrier Enhanced Over The Top or [CAREOT] (ph) for short.

In April, we launched LISTEN for U.S. smartphone users via partnership with T Mobile. LISTEN is also marketed in the U.K. Going forward we are trying to continue to partner with top tier carriers in the U.S. and Europe to put LISTEN out in the markets. We think the transition from our primarily white label business model to a hybrid CAREOT model will take time, probably somewhat longer than we expected when you first selected the strategy 18 months ago.

Having said that, we remain optimistic about both our prospects for LISTEN and the opportunity to flow other products and services into the market through this new CAREOT model. Moreover because we remain the incumbent RBT provider with many of the carriers were targeting for LISTEN, the longer transition won't necessarily have a negative short-term impact on net revenues or profit of our Mobile Entertainment business.

Moving on to our Games business, the major new development that that business assures is new leadership. In April we announced that Atul Bali was appointed President of RealNetworks Game Division. Atul brings almost 20 years of global experience as a widely respected leader in the LAN-based digital gaming spaces. With a deep expertise, strong relationships, proven leadership skills and a passion for games, we believe Atul is precisely the right person to lead the reinvention of our Games business.

As gameplay continues to move from PC to mobile, we are doubling down our efforts to attract and monetize mobile customers. Atul will certainly hit the ground running; he has only been on board for three weeks. So we don't have any major new strategic announcements to make today related to our Games business.

The fourth business I want to report on is Rhapsody, which as I mentioned earlier still owns about 45%. Tim and I serve on the board of Rhapsody and are both reacting, working close with the company to drive its business forward.

Rhapsody is further along in its reinvention and transformation than any of Real's three operating divisions. Last month Rhapsody announced that now has 1.7 million paying subscribers, a 62% year-over-year increase. Key to that has been a series CAREOT-style partnerships in Europe and Latin America with carriers, most notably several affiliates of Telefonica. We believe the growing subscription base for Rhapsody and geographic expansion into Europe and Latin America are positive developments for investing in the digital news business, and further validate the CAREOT strategy I described earlier.

Moving on to the second quarter, we expect that our new products, initiatives and investments in leadership will lay the foundation for long-term growth and profitability. While our new products, especially RealPlayer Cloud have entered the market with great promise, the investments required to get these products to scale both in terms of development and marketing are exceeding what we originally anticipate. We still believe that these long-term opportunities are large and that the ROI on these investments should be favorable.

I certainly wish that the monetization of these investments would come faster, but since we see progress along most of the key metrics that typically lead to successful monetization, we feel like we're definitely in the right track. While we have much hard work ahead of us, I'm confident that we are on a path to revitalize RealNetworks and we remain very excited about that potential.

Now, I'll turn the call over to Tim to review the financials. Tim?

Tim Wan

Thanks, Rob. For the first quarter of 2014, our total revenue was 45.7 million compared to 50.6 million in the previous quarter and 56.8 million in the first quarter of 2013.

As Rob said, we continue to execute on our strategic transition, investing in our core new business initiative and focusing on building a stronger foundation for future growth and profitability.

As we continue to rebuild our businesses, we've done a good job of maintaining our strong gross margins and continue to look for opportunities to reduce our operating expenses; even as we invest in new products in each of our business segments.

Excluding a one-time benefit from the extinguishment of a liability, our combined gross margins in the first quarter were 59%, which is in line with our expectations for the company forward. Adjusting for acquisitions and restructuring charges, our total operating expenses decreased 7% year-over-year as a result of our expense realignment efforts.

However, operating expenses were higher than anticipated, up 5% from the previous quarter primarily reflecting our higher than expected marketing cost directed towards increasing distribution of RealPlayer Cloud and associated products. Our bottom line results reflect our ongoing strategic investment in revitalizing our businesses. Our total adjusted EBITDA for the first quarter of 2014 was a loss of 13.9 million compared to a loss of 3 million for the first quarter of 2013.

The increase in the EBITDA loss for the quarter reflects the decreased revenue and increased marketing expenses associated with the recent product launches.

Now let's look at our quarterly results by business units, starting with the RealPlayer group; for the first quarter RealPlayer group revenue was 15.2 million, down 9% sequentially and 32% from the first quarter of 2013. The decline in sales of our traditional RealPlayer products was expected, as we focus on rolling out our new RealPlayer Cloud products.

As Rob mentioned, the business model is free, up to a certain level of storage capacity and then have the tier subscription fee. We expect RealPlayer Cloud upsell rates to increase over time, and for this groundbreaking product to be a major driver of our future revenue. Adjusted EBITDA for the RealPlayer group in the first quarter was a loss of 5.5 million. The loss is larger than anticipated reflecting our marketing efforts focused on driving distribution of RealPlayer Cloud.

Our Mobile Entertainment revenue was 19.9 million, down 10% sequentially and 3% from the first quarter of 2013. The sequential decline reflects a one-time seasonal professional services revenue in Q4. We expect our newly launched LISTEN product to be an important driver of our future Mobile Entertainment revenue as we begin to rollout that with new carriers. Adjusted EBITDA in the first quarter for Mobile Entertainment business was a loss of 300,000.

Games revenue was 10.6 million down 9% sequentially and 24% from the first quarter of 2013. The decline reflects the ongoing industry-wide transition from traditional PC games to social and mobile games resulting in lower subscriptions and unit sales.

As Rob discussed, we continue to significantly resize and refocus this business unit and expect our new Slingo, GameHouse Casino products to be central to our future Games business. The adjusted EBITDA for our Games business in the first quarter was a loss of 1.7 million.

We continue to maintain a strong cash position despite our continued restructuring in capital investments. At the end of the first quarter we had 209.6 million in unrestricted cash, cash equivalent and short-term investments. This includes proceeds from the sale of a portion of our J-Stream investment.

Looking forward, we expect total revenue of 38 million to 41 million in the second quarter of 2014 with our RealPlayer and Games business segment declining sequentially partially offset by an increase in Mobile Entertainment. We continue to focus on being disciplined with our operating expenses even as we make significant investments in support of our new products, which are higher than previously anticipated. Taking all these factors into consideration, we expect our total adjusted EBITDA for the second quarter to be a loss of 13 million to 16 million.

This guidance reflects anticipated pressure in our businesses of distributing third-party products with RealPlayer; while unfortunate, this pressure does not affect any of our growth initiative. As a result of these pressures along with slower monetization wrap up of our new products that Rob discussed earlier, we currently do not expect to see year-over-year revenue growth in 2014 compared to 2013.

In closing, while I am not pleased with our financial results, we make solid progress on executing our plans to revitalize RealNetworks by energizing our business unit and launching new products in the first quarter. We have over 2 million users of RealPlayer Cloud. We recently signed a major distribution agreement for our LISTEN app with T-Mobile. And we are launching our Slingo casino game on multiple platforms in the near-future. Moreover we still have a strong cash position and valuable asset on our balance sheet and we will continue to invest in our business to take advantage of strategic opportunities as they arise.

Now, Rob and I'll be happy to answer some questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from William Meyers from Miller Asset Management. Go ahead, sir, your line is open.

William Meyers - Miller Asset Management

Yes. Thanks for taking the questions. I would appreciate more detail on the question of monetization of the Cloud product, are you saying that expenses are more than you anticipated but that revenues is ramping as you thought or are you saying that you're purposefully delaying the ramping of revenue? Any color on that -- on your parameters, that would be really helpful. Thanks

Robert Glaser

[The expense] (ph) for Tim, and I'll start on the monetization revenue side.

Tim Wan

Sure. I'd say, what we said is the cost of develop as well as the marketing expenses were higher than anticipated, and I'll let now Rob turn to the monetization related to the RealPlayer Cloud.

Robert Glaser

Yeah. I mean basically we can monetize this customer in four different ways. We can monetize by having them fill their buckets and then need more storage. We can monetize by doing partnership deals with carriers and the like who will include the product and service in this carrier type way that I described. We can monetize by going directly to the market with the paid premium form of the product, and we can monetize by taking that user base and selling other products and services, advertising them etcetera.

The nature of all four of those monetization methods is they are time-based, which is to say, you have to have a large base to make them interesting and relevant and you have to have the product out there. So what's happened frankly is you always model these things as rigorously as you can, but then you learn things when you would actually get into the market. You learn specifically about what the average usage rate is and what the amount of time it is to go from trying the product, habituating the product and filling their bucket.

You learn how viral the product is naturally and then things you can need to do to enhance the product thoroughly. So I look at the fact that we went from no users to 2 million accounts in six months as a very, very positive harbinger for the future. And if we weren't a public company reporting in quarters we would probably wouldn't do anything other than put our press releases praising the fact that we have 2 million registered users inside of six months of launching the product, which -- that's a result that 99.9% of start-ups would give their eye teeth for.

So if you put this in a broader context, if you compare this to a start-up, this would be one of the most, like, 1% successful new start-up services. We understand obviously that investors are looking multiple ways. We're trying to do the right things striking a balance to be open with investors, because obviously we report numbers including revenue and bottom line every quarter, but we are also trying to put enough of the metrics out there for you to have broader context.

William Meyers - Miller Asset Management

Okay. That was really helpful, and congratulations on the two million users. That is impressive and hopefully that will continue to ramp. If I could ask one more question. Could you give us a little bit more color on the ringback segment and how that's going to work?

Robert Glaser

Well, the LISTEN product, which is now available to a few of our T-Mobile customer who have access to a T-Mobile phone you can use and try and see it. It's available for Android and iOS as a download in the stores, but it's only active on the T-Mobile network. So you can see the full product if you have T-Mobile. Your people who call you don't have to have T-Mobile by the way, but you have to be on it. In the U.S. currently T-Mobile is the first carrier we have activated.

So we are very happy to be in market with T-Mobile. The product is solid, getting good reviews and we are starting the feedback loop, and a couple of months after we started the market in the U.K. A similar phenomenon of you got to kind of ramp these things up. And in particular, the difference between LISTEN and RealPlayer Cloud is LISTEN we need the carriers to cooperate with us to let us to insert LISTEN into the Cloud path. That was a disadvantage and an advantage. It's is a disadvantage because it can -– it mean that the rollout tends to be slower, it tends to be more carrier-by-carrier rather than net fully national in any given country, but the advantage is we are one of the team leaders globally in this business. In the U.S. we are probably the leader. We manage T-Mobile, Verizon and AT&T's ringback tones.

So we are in a very strong position. Several other countries, Korea, for instance we are in a leadership position, several countries in Europe where we have the most significant position in ringback tones, so it means that we are in a very strong position to convert that white-label user base over to this kind of LISTEN model, but it might take a little time. As I mentioned in my comments, of it takes longer that's obviously in one hand a little frustrating because we want to get our great new products out there. On the other hand because we are incumbent in about 20 of these carriers, we felt like we are losing the business. We are just participating in it in a different way.

William Meyers - Miller Asset Management

Okay. Thanks. That's very helpful.

Robert Glaser

Great. Operator, we're ready for the next question.

Operator

I show no more questions at this time. (Operator Instructions)

Robert Glaser

Well, if there are no more -- oh, there is one.

Operator

Our next question comes from Stephen Fitzpatrick from Heymann. Go ahead, sir, your line is open.

Steven Fitzpatrick - Heymann

Hey, guys.

Robert Glaser

Hey, Stephen.

Steven Fitzpatrick - Heymann

Hey. I got a question. I know that you -- I know Rob, specifically, works close with the guy that is SynchronousAnd Synchronous has a lot of relationships with carriers, Vodafone, Verizon, AT&T. Is there any strategic partnership that can be done there to get RealPlayer Cloud up and running? Because I know one of Synchronous' big things is to provide a cloud-based service for all Verizon customers. And it seems like -- I know Rob has a great relationship with Synchronous because I know people there. Any thoughts there, or is that not a possibility?

Robert Glaser

Well, it's an excellent question. So we and Synchronous have worked very closely together. We started the relationship around our music service, around the Rhapsody and Napster music service. In February around the time of Mobile World Congress, we announced the integration of Napster which is a primary international brand we are using as well as Rhapsody with the Synchronous Cloud product. That was a joint decision that was made by us and Synchronous to have Napster and music be the first integration point, but it's a very logical question that we could also integrate other products and in a way that would be a very good fit with this CAREOT model I described.

So, nothing specific to announce. That announcement between Rhapsody and Synchronous was made in February, and if I was going to talk about a second development aside the overall subscriber growth for Rhapsody, I would have mentioned that one because it's a very promising, early, but promising relationship, and as you say Synchronous has great infrastructure relationships with carriers and we look forward to them being a terrific partner for us in the music business that we are part of, and potentially other things in the future as well.

Steven Fitzpatrick - Heymann

Okay, thanks.

Robert Glaser

Thanks, Stephen.

Operator

I show no additional questions at this time. (Operator Instructions)

Robert Glaser

Well, there are no additional questions. Operator, I think we will close the call. Thank you everyone for dialing in and joining us for this call.

Operator

Today's call is now concluded. Thank you for participating. You may disconnect at this time.

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