RealNetworks Inc.'s (RNWK) CEO Robert Glaser on Q2 2017 Results - Earnings Call Transcript

| About: RealNetworks, Inc. (RNWK)

RealNetworks Inc. (NASDAQ:RNWK)

Q2 2016 Earnings Conference Call

Aug 3, 2016 05:00 PM PT

Executives

Drew Markham - Vice President and Deputy General Counsel

Robert Glaser - CEO

Marjorie Thomas - CFO and Treasure

Analysts

Eric Wold - B. Riley

William Meyers - Miller Asset Management

Operator

Welcome to the RealNetworks' Second Quarter 2016 Earnings Call. At this time all lines are on a listen-only mode until the question-and-answer session of the conference call. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to introduce our first speaker, Drew Markham. Please begin.

Drew Markham

Thank you, and welcome to the RealNetworks second quarter 2016 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, profitability and other benefits of 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 website.

These forward-looking statements reflect RealNetworks' expectations as of today, August 3, 2016. 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 reason.

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.

With me today are Rob Glaser, Chairman and CEO; and Marjorie Thomas, our CFO. Rob will discuss company strategy and the progress the company has made in recent months. Then Marj will provide a financial review of the second quarter of 2016 and the outlook for the third quarter. After their prepared remarks, they will be pleased to answer questions.

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

Robert Glaser

Thanks Drew. Good afternoon, everyone and thanks for joining us today. Today, I'll review and discuss our results for the second quarter 2016. In this call, I want to focus on four major topics. One, our continued progress in stabilizing RealNetworks' business, reducing cost and positioning us for a return to growth and profitability; two, our continued expansion of our Mobile Services business, most notably through a new business relationship with Telefónica Vivo, the largest mobile carrier in Brazil; three, our release of two promising new titles in our Games business; and four, continued progress in our Rhapsody business.

First, our progress in stabilizing Real and positioning the company for future growth and a return to profitability. Our revenue in Q2 was $29.7 million, up slightly over Q1 and essentially stable over the last four quarters. We're starting to see new products kick-in across our businesses, Games, Mobile Services and Consumer Media, that we believe set us up to return to growth by the end of 2016.

We also continued to make significant strides in lowering our operating expenses. We've reduced operating cost by $6.9 million or 25% and lowered our headcount by 116 people compared to a year ago, excluding the Slingo and social casino businesses we sold a year ago. These savings allow us to move closer to profitability, while we continue to allocate our resources to invest in new products and services.

As a result, we've seen a significant improvement in the bottom line year-over-year, with an EBITDA loss of $4.8 million in 2016, down from a loss of $12.5 million a year ago. Our goal remains to return to profitability by the end of the year.

Second, our continued expansion in our Mobile Services business, including new gains with major carriers. Today, we're announcing two new business relationships with Telefónica Vivo, the largest mobile operator in Brazil, with over 70 million subscribers. One involves Real's Ringback Tone or RBT platform becoming Vivo's new standard platform, replacing the longstanding incumbent on mobile. As a result of this new relationship, we now have over 18 million RBT subscribers as customers, up from about 15 million at the beginning of 2016.

Our second new relationship with Telefónica Vivo involves our RealTimes platform. We're partnering with a local systems integrator to bring RealTimes to Vivo customers across Brazil. This agreement was recently signed and will be launching later in Q3.

This adds to our growing roster of carrier partners for RealTimes, including Verizon in the U.S., KDDI in Japan and Vodafone in Europe, all of whom are integrating RealTimes into their own suite of cloud-based services.

Of particular note this quarter is that we just rolled out our first installation of RealTimes with Vodafone in Spain, with other countries to come in the months ahead. While we're pleased with the continued progress rolling out both RealTimes and RBT products to carriers, we continue to pursue new carrier relationships as well as other types of partnerships.

Next, I would like to talk about our progress with our GameHouse business. As you know, we realigned our Games segment to focus on casual games by selling our social casino business to Gaming Realms for $18 million a year ago.

In Q2, our GameHouse unit launched two new first party titles; Heart's Medicine - Time to Heal; and Fabulous - Angela's Fashion Fever. Both titles are off to strong starts, demonstrating that GameHouse has been able to maintain high quality while ramping up title production. Over time, we believe these new games have the potential to develop into valuable franchises, just like our successful Delicious franchise. All three embody the GameHouse original approach of combining fun and exciting game-play with compelling storytelling to create a new genre of entertainment experiences.

Fourth and finally, let me touch on our Rhapsody affiliate. You will recall on our last quarterly call that Mike Davis had just joined us as Rhapsody CEO. Mike is off to a fast start, most visibly by the rebranding of the service in the U.S. as Napster. This name change leverages Napster's strong worldwide name recognition, which we've already benefited from in over 30 countries in Europe and Latin America.

While the digital music market is highly competitive, we continue to see significant opportunity for Rhapsody, as the entire music industry moves to make streaming the primary model for music distribution and consumption around the world.

Before closing, I want to mention one other notable item. A few weeks ago, we announced the addition of Chris Jones to the RealNetworks Board. Chris is a 25-year Microsoft veteran who brings a great deal of relevant experience and insight to our Board. We're delighted to have him join us.

Today, we're also announcing that Mike Galgon has informed us that he will not be standing for reelection to our Board next month, primarily due to increased demands on his time from his new venture, Pioneer Square Labs. Mike has been a great director and I want to thank him for his many contributions to RealNetworks.

To summarize, I am very pleased that we've stabilized Real's topline revenue while dramatically cutting our burn. This took a little longer than I'd hoped when I came back to Real, but is nonetheless a major accomplishment of which our team should feel very proud.

The next step is to reignite Real's growth and to leverage that growth to return the company to the black. While this will be a heavy lift, I am confident that we have the four P's, people, product, partnerships and persistence, to deliver sustainable growth and the very important fifth P, profitability.

So with that, let me turn the call over to Marj to review the financials.

Marjorie Thomas

Thanks, Rob. Let's go through the results for the second quarter of 2016. For the second quarter, revenue was $29.7 million compared to $28.2 million in the previous quarter and $31.8 million in the second quarter of 2015, excluding the revenue from the Slingo and social casino games business, which was sold during the third quarter of 2015.

Revenue stability since the third quarter of 2015, along with our significant cost reduction steps, is reflected in the year-over-year improvement in EBITDA. Our total adjusted EBITDA for the second quarter of 2016 was a loss of $4.8 million, much improved from the loss of $8.1 million for the previous quarter and the $12.5 million loss for the second quarter of 2015, again excluding the results of the Slingo and social casino games

business.

We reduced operating expenses by $6.9 million or 25% in the second quarter of 2016 compared to the second quarter of 2015, excluding stock compensation, restructuring charges and the Slingo and social casino games business.

Our headcount, as Rob mentioned, net of some increases in the Games business, has decreased by 116 since a year ago. This reduction along with a number of other initiatives has helped us right-size the business.

You will also recall, following the realignment in Q1, we now manage our business and report revenue and operating results in the following three segments: Mobile Services, Consumer Media and Games.

Let's look at our quarterly results by our new business segments. Our Mobile Services business takes our former Mobile Entertainment product portfolio and Mobile RealTimes products that are primarily sold through mobile carriers and related partners.

For the second quarter of 2016, Mobile Services revenue was $17.3 million, up 5% sequentially from the prior quarter and down 7% from the second quarter of 2015. The sequential increase in revenue was primarily due to an increase in our Music on Demand business in Korea. The year-over-year decrease was caused by the Music on Demand business in Korea and lower Ringback Tone's revenue, offset by an increase in RealTimes revenue.

We have lowered the operating expenses relating to Mobile Services by $3.3 million or 27% year-over-year. The segment had a negative contribution margin in the second quarter of $3.1 million. Our plan is to continue to win carrier deals like the Vivo deal, grow our base of subscribers, return to topline growth and drive profitability in this business.

Our Consumer Media segment combines the PC RealPlayer products and the IP video codec, including our new RMHD codec technology. Our Consumer Media revenue was $6.4 million, up 12% sequentially from the prior quarter and down 12% from the second quarter of 2015.

Both the sequential increase and year-over-year decline relate primarily to our IP business. Due to the nature of many of our IP contracts, revenue recognition can be lumpy for this business.

As we've discussed, 2016 is a renewal year for many of our existing IP customers, and we expect renewals to drive revenue growth in the fourth quarter and beyond. At the same time, we have reduced the operating expenses related to Consumer Media by $2.6 million or 37% year-over-year. The segment had a positive contribution margin in the second quarter of $921,000.

Our casual games revenue was $6 million comparable to the prior quarter and the second quarter of 2015, excluding the results of the Slingo and social casino games business. Year-over-year, mobile games revenue has grown 67%, showing the strength of our GameHouse original series Rob referred to. This was offset by declines in subscriptions and advertising. Sequentially, the early indications of our new games released in Q2 are promising, but overall, Games revenue remained stable.

We expect to release new games in coming periods including new episodes of our successful Delicious games. While the segment had a negative contribution margin in the second quarter of $317,000, we believe Games is well-positioned for growth in the coming periods and expect this contribution margin to improve.

The remaining unallocated corporate operating expenses decreased by $1.2 million or 30% in the second quarter of 2016 compared to the same period in 2015. The decrease was due to cost reductions that we have made over the course of recent quarters in our corporate function.

As to our cash balance, we had $78.8 million in unrestricted cash, cash equivalents and short-term investments at the end of the second quarter. This decrease of $8 million from our position at the end of Q1.

As noted, our EBITDA loss for the quarter was $4.8 million. We also had approximately $1.4 million in restructuring related payments as well as about $1.8 million in capital expenditures, taxes and working capital movement to further reduce cash.

We believe our efforts to rebalance resources, reduce cost and optimize our investments are paying off, and we continue to monitor our cash burn. While we expect Q3 to be another stable revenue quarter, we expect our new Mobile Services wins to start producing revenue in the fourth quarter.

Because some of these Mobile Services customers are new and the timing of things like subscriber reports, which are necessary for us to determine our revenue can lag, we don't expect to begin recognizing this revenue until the fourth quarter. These recent wins, along with expected growth in our other segments, make us confident in our ability to grow in Q4.

For Q3, we expect total revenue of $28 million to $30 million, with an adjusted EBITDA loss in the range of $5 million to $7 million. For the remainder of 2016 and into 2017, each business unit has a clear agenda, driving growth that will lead to sustainable profitability for the company.

Those are our prepared remarks, and now Rob and I would be pleased to answer any of your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Speakers, we have one question in queue and it's coming from Mr. Eric Wold of B. Riley. Sir, your line is now open.

Eric Wold

Thank you very much. One question, I guess, for Rob -- I guess, Rob and Marj. Help me kind of draw the path between Q3 guidance and the comments of achieving profitability by year end. I guess two questions on that. One, when you mention getting to profitability by year-end, is that positive EBITDA or is that bottom line profitability?

And two, depending on the answer to that, you've got to go from, looking at the midpoint of your Q3 guidance, go from negative $6 million of EBITDA or probably negative $9 million plus of net income, all the way to positive by Q4. Just help us understand the visibility you have into that happening and should that happen, is that based on one-time revenues or one-time contribution, or is that a sustainable level in 2017? Thank you.

Robert Glaser

Eric, it's Rob. So, I'll take a cut at that and then Marj can speak to that. When we've been talking about return to profitability, we've been referring to EBITDA. We haven't been referring to non-cash stuff that goes into GAAP and a few of the other things that are different between EBITDA and GAAP. Obviously, after we get to EBITDA profitability, the next goal would be GAAP profitability, but -- and obviously, positive cash flow is probably somewhere in the middle there. But that's that milestone.

In terms of talking about Q4, we usually don't talk two quarters out, but since we at the beginning of the year said it was our plan to get back to profitability by the end of the year. I think we should -- need to connect a few dots here.

One of the things that Marj said in the script that I think you can -- help you with is that some of our carrier contracts actually go live in Q3, but we don't recognize the revenue until Q4. We tend to be, obviously, follow GAAP completely with some of these GAAP rules, we tend to handle in very conservative ways. So, if you have a new customer that you have no payment history with, I am told that you basically not only serve the customer and invoice them, but you actually have to get paid.

So, in certain cases, we start serving them in Q3 and we get paid in Q4, and then you -- but you don't recognize any revenue in Q3, even though you deliver the service. That's counterintuitive to me, but I have been through it enough with the team to understand it. So, that's a significant part of why the guidance is what it is for Q3 and the statements about growth and profitability are what they are for Q4.

There are some other characteristics as well, that's probably the one that is most overt that I can point to. And I'll say, if it's helpful to you, if you look at the progress we made between Q1 and Q2, the improvements to the bottom line, we've made significant cost cuts. We got some significant improvement in economics. So, while we're guiding as we are in Q3, and I think if you look at our track record, I think we have achieved or exceeded guidance I think every quarter I've been back. Maybe there was one where we had a little jitter in one of those. But our focus when we make guidance is to put numbers out there that certainly represent numbers that we have a high level of confidence we're going to achieve. Sometimes, like in this quarter, we overachieve them.

And we'd love it would be great if we overachieve Q3 and the extrapolation function would be very obvious to see. But in any event, we stand behind our statements about returning to growth and also our goal of achieving profitability. But until we've achieved that goal, we haven't achieved that goal.

And then your last question is, certainly, profitability that isn't sustainable isn't interesting or value creating. Certain businesses have a little bit of seasonality to them, but [indiscernible] of seasonality, it would be our intent to return to profitability permanently.

Eric Wold

Thank you, Rob. Appreciate it.

Operator

Thank you. Our next question comes from William Meyers of Miller Asset Management. Sir, your line is now open.

William Meyers

Hi, thanks. I am interested in the -- let's see, RMHD codec, whether that contributed to your Consumer Media segment revenue in the quarter and any other comments you might have on that.

Robert Glaser

Great. Well, so, let me talk about RMHD in a couple of contexts. One, it's a technology that we have available in commercial form only in the Chinese market. So, we've started to roll it out. It's in the Chinese version of RealPlayer. We have an experimental version available in the U.S., but we haven't in any meaningful way, rolled it out in the U.S. And we are starting to -- there is content that is being deployed in China, in the RMHD format, it's starting to grow with a lot of our partners there. So, we are on track with rolling out RMHD in China, which was basically the plan for 2016.

In terms of future rollouts of that, we've stated our intent to bring it to the U.S. in the future, but we haven't characterized when that is, other than we don't expect that to be meaningful from a content volume or from an economic standpoint in 2016 in the U.S.

With regard to revenue, a little more complicated question because some of our contracts in China are IP license revenues that includes both RMVB and the previous RealNetworks video product and RMHD. So, we don't break them out separately. So, if you look at the revenue you see in there, it certainly would include both, but I think it's fair to say that we're not expecting a major ramp in 2016. The nature of these codec deals and these IP licensing deals in general, is in the first phase, you want to get design wins to drive volume. And after you drive volume, the monetization comes later. So, when we're describing what we see as growth opportunities for the company in 2016, it's not based on getting a huge bump in 2016 from IP licensing. In any event, any IP licensing in China is sort of embedded in the overall business there.

We don't break out the sub-segments in Consumer Media between RealPlayer and the IP business. We manage them in independent ways, but the external breakout is for the combination of the two.

Marj, do you want to add anything to that?

Marjorie Thomas

No, I think you nailed it, Rob.

William Meyers

Okay. Thanks.

Operator

Thank you. We currently show no questions at this time. [Operator Instructions]

Robert Glaser

Well, I guess, we can do last call here. If there aren't any more questions, operator, I guess, we can finish the call for today. Marj and I will be available to talk to investors. And some of you we already have scheduled calls with, and others, please reach out to Marj's office as you would normally do.

For everyone else, I want to thank you for joining us today and look forward to again talking with you in three months' time, and in many cases, before then. Thanks.

Operator

Thank you. That concludes today's conference. Thank you for participating. You may now disconnect.

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