RealNetworks Inc (NASDAQ:RNWK)
Q2 2014 Earnings Conference Call
July 30, 2014 5:00 PM ET
Drew Markham – Investor Relations
Robert Glaser – Chairman and Chief Executive Officer
Tim M. Wan – Chief Financial Officer and Treasurer
William Meyers – Miller Asset Management
Chip Saye – AWH Capital
Welcome to the RealNetworks Second Quarter 2014 Earnings Call. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. Your lines will be in listen-only mode, until today’s question-and-answer session. (Operator Instructions)
I’d like to introduce the first speaker Drew Markham, please begin.
Thank you, Kate, and welcome to the RealNetworks Second 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 growth, market acceptance 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 July 30th, 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 CEO; and Tim Wan, CFO. Rob will discuss company’s strategy and the progress the company has made in recent months, then Tim will provide a financial review of the second quarter and the outlook for the third quarter of 2014. After their prepared remarks, they will be pleased to answer questions.
Now, I'll turn the call over to Rob.
Thanks, Drew. Good afternoon everyone, and thanks for joining us. Today I'll give you an update on our process in tuning around RealNetworks and putting the company on a path to achieve sustainable growth in users, user engagement, revenue and profit.
Specifically I want to talk about four topics. First our new initiatives we are doing focusing particular on RealPlayer Cloud. Second what’s going on with the company’s business as a whole including recent developments in two of our legacy businesses and what we are doing to address those issues, third progress at Rhapsody of which we own 45% and fourth some news about me personally. First our growth initiatives, as you know in the past year we launched at least one major growth initiative in each of our three divisions.
Counting our upcoming Slingo Adventure product which we just announced last week and is currently in private beta. We have shipped four major new products in the past year, RealPlayer Cloud in the Realplayer Group, Casino Plus and Slingo in games and listed in the Mobile Entertainment group.
In recent weeks one of these products has began to show signs of becoming a breakout success and that’s RealPlayer cloud. Today I am proud to report that over 5 million users have both downloaded the RealPlayer Cloud app and established cloud accounts, that’s up 2 million just three months ago and half a million at the end of 2013. Our users now upload an aggregate of over 4.5 terabytes of content each day. RealPlayer Cloud is truly a global product, it’s now available in nine languages and runs on a 11 different hardware and software platforms including most recently the new Amazon Fire Phone.
We have a lot of work to do build on our early momentum for RealPlayer Cloud. We need to continue to rapidly enhance RealPlayer Cloud and to bring it to even more languages, countries and devices. We need to engage with partners and integrate RealPlayer Cloud with their service offerings and we need to continue to drive consumer adoption both our free and premium RealPlayer Cloud services. Net-net we are very encouraged of what we achieved in a short period of time.
If RealPlayer Cloud were start up it would be considered one of the very most successful new companies of 2014. While all of our products both legacy products and new products such as LISTEN and Slingo Adventure and important to us. RealPlayer Cloud is fast becoming the cornerstone product for the new RealNetworks.
Next I want to talk you about what’s going on with our business as a whole, essentially we are in transition from our revenue being driven primarily by legacy businesses, which generally even flat to down revenues to a business driven prior growth initiatives. It’s now clear that high revenue from two of our legacy businesses, licensed more codec to device manufacturers and distributing third-party software with the PC RealPlayer have and we will continue to decline in 2014. Tim, will go through the details in a few minutes.
We’re disappointed that these declines in two of our legacy businesses resulted and will result in lower revenue and greater losses for us in the short run. Having said that these developments do not impact our growth trajectory for the RealPlayer Cloud business or for other growth initiatives.
Indeed in order to ensure that we grow our new businesses to their growth potential, we are in effect doubling down in our sales and business development efforts. During the second quarter, we welcome Mike Mulica who has joined us to lead the integration of our worldwide sales and business development efforts across our RealPlayer Group and Mobile Entertainment products.
Mike and his team will be using our hybrid carrier enhanced over the top or carried strategy. In comes with Mike new role, we also announced an expansion of Max Pellegrini responsibilities. Max will now lead product and marketing efforts for both our RealPlayer and Mobile Entrainment divisions. Together, Mike and Max will drive to go to market strategy for our RealPlayer and Mobile Entertainment products and services with particular focus on RealPlayer Cloud.
We’re also strengthening our CU team in games. At the beginning of the quarter, we brought in Atul Bali to serve as President of our overall games business. Than a few weeks ago, we brought back Rutger Peters and Erik Goossens, the co-founders of Zylom which we acquired in 2006, to run the Casual Games part of that business.
We expected our new products initiatives, investments and 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 our substantial.
We certainly listed our new products and business investments would monetize faster. But we firmly believe they were making the right decision and building a strong foundation and creating a large environment user base, that will monetize overtime. This strategy is to be used successfully by a number of excellent companies in recent years such as Facebook and Twitter and Dropbox.
Since we see progress along most of the key metrics with RealPlayer Cloud that typically lead to successful monetization, we feel like we are definitely on the right track. Third, I like to provide an update on Rhapsody a leader on online music services of which Real owns about 45% as I mentioned earlier.
Tim and I serve on the board of Rhapsody and we’re both very active in working close with the company to drive its business forward. Today Rhapsody is further long and returning to growth than any of Real’s three operating divisions. We continue to be encouraged by Rhapsody’s progress. Yesterday Rhapsody announced that it now has more than $2 million paying subscribers up from $1.7 million just three months ago. A key part of Rhapsody’s progress has been the release of an innovative new product, Rhapsody unRadio. In partnership in the U.S with T-Mobile and also in France into our French name with SFR.
We’re encouraged by both the growing subscriber base for Rhapsody and positive secular trends as digital music moves away from individual track sales and towards streaming and subscription services. We think the Rhapsody is on a path to create significant value and we will continue to do whatever we can to help the Rhapsody team achieve that potential.
Fourth, we announced today that the board of RealNetworks had asked me and I’ve agreed to become Real’s permanent CEO. Since I’ve been back for two years, I don’t anticipate this change affecting how Real works and what our strategy is, but I do want to take this opportunities to convey how honored I am that the board has chosen to take the step now.
I also welcome this opportunity to reiterate my faith and our team and our future and my personal commitment to do everything I can to help us fully realize our potential. I truly believe RealNetworks our products, our mission, our customers and especially our team.
The senior team we have assembled is the finest group we’ve assembled in the 20th year history of the company. And I continue to be impressed by the commitment, integrity, intellect and creativity for the team members I interact with around the globe. Looking together, I’m confident that we will revitalize Real create a successful, sustainable growing and profitable business and build the leading Internet company, of which we’ve been all be deeply proud.
With that I’ll turn the call over to Tim to review the financials.
Tim M. Wan
Thanks, Rob. For the second quarter of 2014, our total revenue was at $40.8 million compared to $45.7 million in the previous quarter and $49.9 million in the second quarter of 2013. As Rob said, we’ve continue to execute on our strategic transition and investing in our core new business initiatives and focusing on building a stronger foundation for future growth and profitability.
Throughout the process of rebuilding our businesses we’ve continue to allocate our resources and capital in a way to maximize long-term growth. We have continued to reduce our operating expenses and reinvested in new product innovation in each of our business segments. Because our new initiatives particularly more time to monetizing scale, we will continue to manage expenses tightly in the coming quarters. During the second quarter, our combined gross margins were 49% down from 59% in the previous quarter, excluding a one-time benefit from the extinguishment of the liability.
This decline is primarily due to two factors, an economic impact on our distribution of third-party software products and lower codec distribution, which I’ll go into more detail when discussing the RealPlayer group results. Adjusting for acquisitions and restructuring charges, our total operating expenses decreased at 14% year-over-year, as a result of our expense realignment effort and lower marketing expenses.
Our bottom line results reflect the ongoing strategic investment and needed to revitalize our businesses. Our total adjusted EBITDA for the second quarter of 2014 was a loss of $13.1 million compared to a loss of $5.8 million for the second quarter of 2013. The increase in EBITDA loss for the quarter reflects the decreased revenue from our traditional product lines and continued investments in our growth initiatives.
Now, let’s look at our quarterly results by business units, starting with RealPlayer group. For the second quarter, RealPlayer revenue was $8.6 million down 44% sequentially and 53% from the second quarter of 2013. The significant decline in revenue of the RealPlayer business was primarily due to recent development in our high margin distribution and licensing areas.
First a change to our economics for our third-party software distribution business a number of companies including us have seen continued pricing pressure in the marketplace. We have a plan in place to deliver a new third-party product are balances the appropriate economics while maintaining a great customer experience.
Second, our codec licensing in Asia was weaker than expected due to lower distribution from one of the largest Korean device manufacturers. This decline reflects the dynamic in ever changing landscape in the mobile marketplace today. However, our team is working hard and diversifying that revenue stream with new partnerships like the recently announced Xiaomi deal in China.
As Rob mentioned, our focus for this business continues to be centered on increasing distribution of the RealPlayer Cloud and monetizing consumers overtime. The business model for the RealPlayer Cloud premium up to certain level of storage capacity and then has a 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 second quarter was a loss of $6.9 million.
Our Mobile Entertainment revenue was $23.2 million, up 16% sequentially and up 25% from the second quarter of 2013. The sequential increase reflects seasonal systems integration work and continued strength in our Korean business. We expect our new LISTEN product to be an important driver of our future Mobile Entertainment revenue as we continue to rollout with existing carriers and pursue relationships with new carriers. Adjusted EBITDA in the second quarter for the Mobile Entertainment business was 800,000.
Games revenue was $9.1 million down 14% sequentially and 29% from the second quarter of 2013. The decline reflects the ongoing industry-wide transition from PC games to social and mobile games resulting in lower subscriptions and unit sales of our traditional products.
As Rob discussed, we are optimistic with the upcoming launch of Slingo Adventure and we expect our new Slingo Adventure to be central to our future games business. The adjusted EBITDA for our games business in the second quarter was a loss of $1.8 million.
We continue to maintain a strong cash position despite our continued restructuring in capital investments. At the end of the second quarter, we have $195 million in unrestricted cash and cash equivalents and short-term investments.
Looking forward, we expect total revenues of $33 million to $36 million in the third quarter of 2014, with all our business segments declining sequentially. We continue to focus on being disciplined with our operating expenses even as we make significant investments and support of our new products, which investments are higher than previously anticipated. Taking all these factors into consideration, we expect our total adjusted EBITDA for the third quarter to be a loss of $18 million to $20 million.
In closing, while I’m not pleased with our financial results, we make solid progress on executing our plan to revitalized RealNetworks by reenergizing our business units and continuing to our new products and enhanced features.
One, we have over $5 million users of the RealPlayer Cloud. Two, we are integrating our worldwide sales and business development efforts for RealPlayer Cloud and Mobile Entertainment products. Three, we are preparing to launch our Slingo Adventure on multiple platforms in the near future. And four, our financial investment and Rhapsody continues to look promising. Moreover, we still have a strong cash position and valuable asset on our balance sheet and we will continue to invest in our business and take advantage of strategic opportunities as they arise.
Now Robin, I would be happy to answer some questions. Operator?
(Operator Instructions) Our first is from Matt Schoen [ph]. Your line is open.
I just wanted to ask for the RealPlayer Cloud, I notice in the RealPlayer group subscription revenue actually declined quarter-over-quarter, which you wouldn’t expect considering the growth in subs you add. So, I’m kind of curious why will user start upgrading what are your current conversion rates in, what can you guys do to get more users to upgrade their accounts into paying accounts?
Tim M. Wan
Sure. Matt, that subscription line that you see in the supplemental financials include really two things, the subscription revenue from both the RealPlayer Cloud and a legacy business that we continue to run, but has been on a declining to directly SuperPass. So, we currently haven’t broken out the subscription – a number of subscribers related to RealPlayer Cloud yet, but at some point when it does get to a certain number, we will be breaking that number out from a disclosure standpoint. And Rob will talk more about what we can do more of in terms of RealPlayer Cloud.
And just the one thing on the legacy subscription business, the SuperPass product is about a 10 year old product its actually little more, its predecessor product was chronicle goal path if we can add 2000. So, when we decided to discontinue some of the content services offering, we were doing around that product most notably the Big Brother product, which we did annually for several years.
We knew that subscription stream would decline. So, we don’t breakout today a several line item for RealPlayer Cloud and there is Tim mentioned at some future point we likely will. But in this period what we are predominantly focusing on three things that we think set as up for that success. The first and foremost of course have a great product and we’re going to great product something else matters.
The second is to drive that product on a global basis to get as many users as we can whether there is free users or whether there are premium users. Obviously, premium users are better, but the marketing techniques to get free users are typically quite different the once you get premium users. And then the third pieces to drive engagement on the, I believe that who are with the product and are more likely to move to a premium form of the product.
Now the fourth thing, of course within to combine those and to our other market distribution channels to drive paying customers, because at the end of the day that’s our business model. But I think there is a lot of data points to say that if you focused on getting growth and getting significant scale you’re in a much stronger position to drive amortization, then if you focus narrow than monetization at the expense were getting consumer.
So, we are certainly scaling up our effort to drive monetization, I would say there is two aspects of that one is the direct-to-consumer aspects under Max Pellegrini there’s a great team under Max it is working on that. And then there is the team that Michael Mulica’s in the process of building with the carrier partners and other big distribution partners.
Now, we are makes free and premium in there as well. But clearly in those relationships, we think the fact we’ve got a great end user product will be very compelling and we had opportunities to use those distribution channels to drive the premium as well as the preside. So, we certainly understand that’s important, but we are trying to take sort of a best practices approach rather than achieve great short-term, more cash on the short-term at the expense of building the strong foundation in the best possible way.
Okay. I appreciate the clarity. That’s all for me.
Tim M. Wan
Thanks Matt. Operator next question.
Our next question is from William Meyers. Your line is open.
William Meyers – Miller Asset Management
Hi, thanks for taking the question. It’s also on RealPlayer Cloud and I realize it’s in the early stage of monetization. But I am wondering whether on the cost of the cloud that will be presumably reflected in your charges to people who are paying for it. Is the infrastructure cost, the major cost or is the acquisition of customers cost for major cost or how are the costs looking at this point anyway?
Well, against early days. So at this point the biggest cost associated with that business, which is not – its not a COGS cost at all, the fixed cost of building and deploying, the product and service. We have a significant global team in meaningful footprint to your teams. In Seattle, Zagreb and Croatia and in Beijing, they work directly on the product. And those costs on an OpEx basis or the single biggest costs associated with that business.
On a variable which goes to your point of scale and model. We believe that the – we will get some scale economics associated with the business that will actually positively effect COGS as well. And I honestly we’re still on the tuning pace because one of the things we don’t yet know is, when you look at active users use a large part of their cloud.
We clearly are priced in a way where we make money on those users and you look users that are free users, and we are encouraging towards possibly lose money on those customers to the basic economic, what we don’t yet know is the right sort of tipping in tutor points that drive people from the free to the paid the drive realities of the people will engage more users, and we’re learning those things and we learn some super good things in the nine months in our markets, and frankly it’s really only been three or four months where we had a dedicated team that heads down focused on modernization. Because they given that the scale of what we are doing rolling it out in on 11 different platforms now in nine different languages and GEO’s over the world.
We focused on reliability and got great experience and then spun out the modernization team on the direct to consumer side really in respect four months ago. And they made good progress, but we choose not to disclose the numbers yet, because there is a lot more to go before the numbers become meaningful at the overall scale of the RealNetworks.
Also there is always competitive considerations in that as well. But, the big picture we don’t have published COGS targets, we have internal COGS targets. And we – in our strategic review in the context of Max’s new role and Mike Mulica new role, we did a very rigorous of COGS and we’re able to make some significant improvements even now with the scale and I am optimistic in the future we’ll go even further.
Last thing, I’ll say about that, which is not directly and your question is, we are definitely open to partnering in a wide range of ways, with cloud service providers as well. I mean we use Amazon services our hosting provider and that was an intentional decision because we’ve decided we didn’t thing we needed to own the physical and restructures business, and like a decision like a Facebook or Google or Microsoft or an Apple make, where they own their own infrastructure by and large. We decided not to play that way, we see a lots of opportunities with carriers that with own infrastructure to partnership with some of the major horizontal players. And we are open minded overtime as long as we can deliver a great consumer experience, what extend the product will be based on our cloud versus what you might call a bring your own cloud type project.
And in that scenario, while we’d still have some variable costs, as they have been in part of the variable costs will be borne by the sort of the cloud platform itself.
William Meyers – Miller Asset Management
Okay, I appreciate the details of your answer and I was going to ask whether you’re doing your own infrastructure. So, I am glad you tell me you are at using Amazon web services. If I could just ask one other question changing the topic a little bit. Could you give more of an update on how the LISTEN product is doing?
Yes, I would characterize LISTEN in three ways. The product is a well regarded product consumers like it a great deal. Second, we are finding that – because it is a carrier-by-carrier and a country-by-country approach. We are finding some countries where we are add or at some cases ahead of our goal for carrier sign-up. And we are finding some other countries where really more slowly unlike RealPlayer Cloud that we can simply deploy globally. LISTEN requires collaboration with the career. And what we are finding in some cases is that there is a desire on the carrier's part first to prove the model in some GEO, in a major GEO [indiscernible] broadly. So, it’s our present plan to take a targeted GEO approach and to pick two or three major GEOs and go deep in those, endeavor to get high market share concentration in those GEOs. And we’re not saying publicly which ones they are the significant countries obviously to make it, make sense. We’re not talking about Lincoln Stein here.
But we intend to move in that direction. So, I think that portends a slightly slower rollout, then if all the carriers were lining up like dominos, and that was not explicit in my comments sort of implicit in by I’d say the way we discussed it. But I guess I would say big picture it’s a product that it’s getting very strong with use in the marketplace, but it’s – because it is needs carrier alignment like RealPlayer Cloud which benefits some carrier line of additional requirement, which includes – market uptake is going to be more of a GEO by GEO one and moving more of a phase way on it.
William Meyers – Miller Asset Management
Okay, thank you very much.
Tim M. Wan
Thank you. Operator, one more question please.
Our next question please is from Chip Saye with AWH Capital. Your line is open.
Chip Saye – AWH Capital
Yes, good afternoon. Tim, we spoke a while back, I don’t know if you remember that.
Tim M. Wan
Yes. Hi, Chip.
Chip Saye – AWH Capital
Yeah, how are you doing? Have a question along lines or some of the questions we asked then it was the spending in the cash balance and your willingness to spend I understand there is commitment to RealPlayer Cloud and giving enough lead time to develop and then convert those customers over to paying customers, for premium customers. What about maybe the games division I know you have Slingo coming out pretty soon. But how long would you continue to fund those businesses, if that business if it doesn’t show adjusted EBITDA profit?
Tim M. Wan
Sure, I think you know this is certainly with the Slingo launch we will take a very pragmatic approach, most of the product launch I think will start reviewing the data and assessing the viability of that business and see what we can do with it’s – the game has a huge following it was a very successful game for Zynga and Facebook – on the Facebook platform it’s a 18 year-old game with a unique set of IP.
So where we’re optimistic that upon launch of Slingo Adventure a really a reinvention of that title across Facebook and across all the mobile devices, iOS and Android we think we got something very compelling but of course we’ll monitor that very closely.
One thing I would say is – I would differentiate we made some earlier comments in the earnings call I believe it was two calls ago where we are candid about the fact that the Casino launch with the sweepstakes which was a sort of we made a certain size bet in that business we decided that rather than having that via pillar by itself that it would be a – would an asset we would use, we would leverage Slingo to help with that asset and to some extent vice versa.
The thing I would say is that the Casino business is a crowded business there is lot of players the good news is everyone knows the game. The bad news is the game is going to be pretty commoditized and you have a the way it’s played out is most of the big players in that are the [indiscernible] big brands in physical Casinos it was not apparent but that was going to be model certainly a year and year a half ago when we put our chips down so to speak. But its become more clear that’s the case.
Slingo on the other hand is a proprietary brand it has proprietary patented IP associated in his game play dynamic that is unique the hybrid of slots and bingo the name of course conveys that. And we’ve seen the scale it can reach win market with the right product. So we’re optimistic about that product I would also say that the leaders we brought into revitalize the casual business Rutger and Erik are very, very sharp cookies they’re very scrappy they came into resulting for me and Atul. And then they put together a plan that we’re all excited about, and then we decided to bring them into basically drive that business. So, the digital piece of that Iceberg is not as apparent we feel very good about our ability to sort of reinvent that business without additional capital investment leveraging that the cash flows of the current businesses there.
So I think the Slingo Adventure product I’m part of the close beta, so I had opportunity to go at a level 26 in it. And I like the product I think it’s a good product obviously [indiscernible] so far. But the team has build to really deep product that I think has significant potential. The games business obviously has an element of culture and style and fashion and we’re not whimsy to it, but we know the Slingo brand resonates with the lot of consumers and we intend to leverage that in a significant way on both Facebook and on mobile. And I think we’re making good one at it.
Chip Saye – AWH Capital
Okay, thanks a lot for that. Second question in on RealPlayer Cloud encouraged by the growth in the number of accounts and then usage in the product you seem to be hearing more and more about it anecdotally, question on cash spend on that I know that’s going to be focused for the next year or so maybe beyond I just want to know how do you think about the $195 million in cash that you have at your use for development there. And is it something like the entire amount would be for development of RealPlayer Cloud and to build out. Can you just speak to that?
Tim M. Wan
Well, I would say the following we are very metric driven around here. And so we look at what’s the growth of users, what’s growth of usage, what are we seeing in different GEO’s as we test different marketing programs as we rollout or begin engaging in partnerships with large scale players like mobile carriers and handset manufactures. So, we have pretty, as you very explicit and very carefully crafted budgets around that. We treat that money seriously and we treated as shareholder money and its matter of public record than I’m a large shareholder.
So, we are quite disciplined about that, that’s has been I would say if you look at where we are today compared to the year-ago frankly even three months to six months ago. We have in emerging growth platforms to build on and these growth platforms, I don’t know if you tell you that if their handle correctly they can be to extremely valuable.
And I think it’s way too early to consider the burden or and or to do [indiscernible] you like that. But we like trajectory run from your equity standpoint from the consumer satisfaction and the feedback we’re getting from the market in the product. And we think we have some of them still running opportunity they were going to run very harder. We are going to very harder and discipline ways I mentioned in earlier call. We are not spending Brazilians to dollars building out our own physical infrastructure. So, we have more of a variable cost structure on the OpEx and that’s very helpful.
The labor cost through building out the product, obviously we’re going to hire more people, but there is a large fixed cost that as you get scale of your opportunity amortized that. So, while we are not putting our particular numbers on our balance sheet use beyond were simplest in there single quarter numbers we are going to be very careful and very disciplined.
Chip Saye – AWH Capital
Well, thanks very much. That’s all I had.
Thanks, Jeff. Thank you operator. Thank you everyone for joining the call.
Tim M. Wan
Take care everyone, thanks for joining us and we’ll talk to you soon.
Thank you. This closes today’s conference, thank you for your attendance. You may disconnect at this time.
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