RealNetworks, Inc.
Q2 2021 Earnings Call Transcript

Published: 7 Aug 2021

[Operator:]

Greetings. And welcome to the RealNetworks Incorporated Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Kim Orlando, ADDO Investor Relations. Please proceed.

[Kim Orlando:]

Thank you. And welcome to RealNetworks’ second quarter 2021 financial results conference call. Before we begin, I’d like to remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks’ future revenue, operating expenses and adjusted EBITDA, as well as trends affecting its businesses and prospects for future growth and profitability, liquidity and financial condition. Other forward-looking statements include the company’s plans to implement its strategy, invest in its products and initiatives, and restructuring efforts, as well as the expected growth, profitability and other benefits from these activities. In addition, today’s call contains certain forward-looking statements that relate to the December 2020 sale of Rhapsody International Inc., which does business as Napster to MelodyVR Group PLC and certain forward-looking statements that relate to Scener Inc., including its future growth and profitability and financing activities. Effective as of the third quarter of 2020 Napster is presented as a discontinued operation for accounting and disclosure purposes, and comparable historical periods have been recast to conform to this presentation. Statements that express our belief and expectations and all statements other than statements of historical facts are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. We describe these and other risks in our SEC filings, including in the risk factors set forth in our most recent reports on Form 10-K and Form 10-Q and in other reports. A copy of those filings can be obtained from the SEC or from the Investor Relations section of our corporate website. Forward-looking statements made today reflect RealNetwork’s expectations as of today, August 4, 2021. 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. In addition, we will present certain financial measures on this call that will be considered non-GAAP under the SEC’s Regulation G. For reconciliations 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 Financials tab. With me today are Rob Glaser, Chairman and CEO; Mike Ensing, President and COO; and Christine Chambers, Senior Vice President, CFO and Treasurer. Rob will discuss the company’s strategy and the progress that company made during the second quarter of 2021. Mike will then provide a more detailed update on Real’s AI businesses. And Christine will conclude with a more detailed review of our financial results. After today’s prepared remarks, Rob, Mike and Christine will be pleased to answer questions. With that, I will hand the call over to Rob.

[Rob Glaser:]

Thanks, Kim. Good afternoon, everyone, and thanks for joining us. My remarks today will center on three main topics. First, I’ll highlight our progress and growth as an AI-centric company. Second, I’ll discuss how our strength and balance sheet and continued streamlining of our operations position Real for future growth. And third, I will provide further context on our Q2 results. In Q2, we continued our progress towards becoming a company and business centered on machine learning-based AI products and services. In Q2, we more than doubled our AI revenue compared to Q2 of 2020. As a reminder, this transformation is centered on two AI-based products and services, SAFR, our computer vision platform and KONTXT, our natural language processing platform. SAFR continue to be our AI pace car with revenue increasing 282% year-over-year. KONTXT continue to steady progress increasing 15% year-over-year. This results in a blended average of 101% growth. SAFR and KONTXT together now represent 37% of our total number of services, second revenue in Q2, up from 29% in Q1 2021 and from 18% in 2020 Q2. In a few minutes, Mike Ensing will go into greater depth regarding our progress with both SAFR and KONTXT. Next, I’d like to discuss depth we’ve taken in Q2 to focus Real and resource those AI businesses, and therefore, Real as a whole for growth. As you likely recall, in April, we raised $20.1 million in net proceed through a public offering. We’re primarily using these proceeds to make targeted investments in our AI-based growth conditions. A second step we’ve taken is to support Scener’s progression as an independent company. In Q2, consumers watched over 100 million minutes a month of video using Scener. Moreover, Scener has raised a meaningful amount of money independently with Real and is now substitution financially. As a result, as of June 30th, Scener has moved to a next phase of independence and is no longer part of our consolidated results or operations. Factoring an upcoming investments into Scener, we expect that going forward Real will own approximately 40% of Scener. This important step better aligns our balance sheet with the growth opportunities ahead of us, while also providing Scener with the capital it needs to grow and thrive. I look forward to continue serve on seniors Board along with Mike Ensing. We believe Real shareholders have a great opportunity over time to benefit from Scener successes as an independent company. And now, finally, let’s go through Real’s overall Q2 results and put them in context. Total revenue for the second quarter was $14.6 million, which was down 8% compared to the prior quarter and down 15% compared to the prior year. While our AI businesses grew, as I mentioned above, our games business in Q2 declined both sequentially and year-over-year, as the team is retooling our free-to-play games for future success. While I’m disappointed that our games businesses hit an air pocket, we expect this going into the quarter. We and the games team are working hard to address these issues to set games up for resume growth driven by free-to-play games. On the bottomline, we had mixed results in the aggregate. Our GAAP EPS was a loss of $0.03 per diluted share, compared to a loss of $0.27 per share in the previous quarter and a loss of $0.08 per share in the prior year period. Our adjusted EBITDA loss when excluding Scener operating cost of approximately $600,000, which negative $3.7 million. This compared to a loss of negative $1.1 million includes Scener in Q2 2020 and a loss of negative $1.4 million in Q2 2020. These results reflect judicious increases in investments in AI growth businesses, which we believe will pay off in the form of continued growth in the quarters ahead. As a result, we continue to expect that we will achieve not only continued growth in our AI businesses, but also double-digit consolidated revenue growth in 2022 and 2023. And with that, I will now turn the call over to Mike to discuss our AI businesses in further detail. Mike?

[Mike Ensing:]

Thank you, Rob. The focus of my remarks today will be to elaborate on the progress we have made during the quarter in our two AI-based businesses, SAFR and KONTXT. As Rob highlighted, we once again delivered a strong quarter in SAFR, driven by success in both the global commercial and U.S. Federal markets, along with several product investment -- advancements. On the global commercial front, we grew revenue significantly year-over-year. In addition to this revenue growth, we signed a reseller agreement with NTT DoCoMo, Japan’s leading mobile operator. Well, NTT DoCoMo already leverages SAFR’s facial recognition platform to enhance safety and security in Japan. NTT DoCoMo will further utilize SAFR to expand its nationwide 5G network to include artificial intelligence. We are thrilled that NTT DoCoMo chose SAFR over several competitors as a key partner to implement it strategy. NTT DoCoMo expect to dedicate significant sales and engineering resources to drive the SAFR technology within its 5G network. We look forward to both companies benefit -- benefiting from the partnership. Similar to the commercial business, our U.S. Federal revenues also grew significantly year-over-year. During the quarter we executed against two previously announced SBIRs and built a significant pipeline focused on additional SBIRs beyond our current customer base, larger R&D opportunities and full deployments. On the product side, we made several key advancements during the quarter. In April, we released Version 3.4 SAFR, which introduced new passive liveness detection and anti-spoofing features to enhance security for access control applications. In addition, we released a new post-event searching feature, which enables users to conduct forensic analysis within our software to enhance our investigative capabilities. Further, we will be enabling the full porting of the SAFR-embedded solution to two popular SOC’s. This advancement will take the SAFR algorithms to the edge and run our advanced computer vision platform on smart devices. Testing has shown that our edge solution can attain the same accuracy as our existing server-based solution. This allows SAFR to run on the edge as a smart IoT device, further driving down the cost of hardware and the total cost of ownership for our customers. Next, I’ll turn to a discussion of KONTXT, our natural language processing platform. Our team at KONTXT has been intently focused on continuing to deliver AI-based products and services to help facilitate improved messaging-based services for our customers. By leveraging the 1 billion plus SMS and MMS messages we processed daily, along with our long-term telecom industry relationships, we’ve been able to develop robust AI-based filtering tools to deliver enhanced experience for our customers. We continue to innovate in this space working on the next-generation of products like KONTXT for Voice as outlined on the last earnings call. We look forward to the further development of the KONTXT platform to enhance benefits to both current and new customers. In summary, we are pleased with the development of the SAFR business across both the commercial and federal markets, and remain optimistic on the future growth prospects for both SAFR and KONTXT. It’s evident that our transformation to an AI-centric company is largely underway and we look forward to communicate and continued execution against our strategy in the quarters to come. With that, I will now turn the call over to Christine to discuss our second quarter 2021 financial results in greater detail. Christine?

[Christine Chambers:]

Thanks, Mike, and good afternoon, everyone. In my remarks today, I will first review our consolidated second quarter results, followed by a more detailed discussion of our segment business performance. Please note that sequential and year-over-year comparisons are not always apples-to-apples, as certain of our businesses can fluctuate quarter-to-quarter. In addition, Napster has been deconsolidated as of December 30, 2020, and it’s being treated as a discontinued operation for accounting and disclosure purposes. Therefore, our results presented today relate to the continuing operations of RealNetworks, which exclude Napster. Further, we completed the deconsolidation of Scener as of June 30, 2021, and as such, costs related to Scener are included in our second quarter 2021 financial results, but will not continue going forward. Now turning to our results. Total revenue for the second quarter was $14.6 million, compared to $15.9 million in the prior quarter and $17.1 million in the prior year period. Similar to last quarter, strong growth in our AI businesses was more than offset by declines in our games and foundation businesses. Looking at these results in greater detail, Mobile Services revenue was up $400,000 on a sequential basis and down $100,000 year-over-year. The sequential increase was primarily driven by highest SAFR revenue in both the global commercial and U.S. Federal space. This was partially offset by lower revenue from our inter-carrier messaging business. Year-over-year the decrease was largely due to lower revenues from our ringback tone and inter-carrier messaging businesses, partially offset by higher SAFR revenue, both the global commercial and U.S. Federal markets. Revenue within the Consumer Media segment was down $1.2 million sequentially and down $1.1 million year-over-year. The sequential and year-over-year decreases were primarily due to timing of contract renewals in our IP codec business, as a result of revenue from multiyear deals, looked in the prior quarter and prior year period, respectively. Games revenue for the second quarter was down $500,000 sequentially and down $1.3 million year-over-year. On a sequential and year-over-year basis, the decrease was due to sales decline in both our legacy and free-to-play games as the team continues to work towards reinvigorating growth in our two biggest free-to-play titles Delicious World and Delicious Bed & Breakfast. Consolidated gross profit for the second quarter was $11 million, down $1.2 million compared to the prior quarter and down $1.8 million compared to the prior year period. As a percentage of revenue, gross margin was 75%, compared to 77% in the prior quarter and flat compared to the prior year. Total operating expenses for the second quarter was $16.7 million, a decrease of $1.7 million from the prior quarter and an increase of $1.1 million from the prior year period. These numbers can fluctuate because they include certain non-core items. When normalizing for non-core items including restructuring costs and fair value adjustments on the contingent consideration liability from the January 2019 purchase of Napster. Second quarter operating expenses were down 300K or 2% compared to the prior quarter and were up $1.2 million or 8% compared to the prior year period, driven by focused investments as a result of our capital raise in April to drive growth in our AI businesses. Net loss from continuing operations attributable to RealNetworks was $1.3 million or minus $0.03 per diluted share, compared to a net loss of $10.4 million or $0.27 per diluted share in the prior quarter and a net loss of $3.1 million or $0.08 per diluted share in the prior year periods. Included in the net loss attributable to RealNetworks in the second quarter of 2021 was a one-time gain on the forgiveness of debt of $2.9 million from the principal and interest on the Paycheck Protection Program loan that was approved during the quarter and a one=time gain of $2 million related to the deconsolidation of Scener. Adjusted EBITDA for the second quarter, including $600,000 of operating costs relating to Scener was a loss of $4.3 million, compared to a loss of $2.3 million in the prior quarter and a loss of $1.4 million in the prior year period. Adjusted EBITDA, excluding the 600K of operating costs related to Scener was a loss of $3.7 million. Now turning to our second quarter segment results in more detail. Mobile Services segment contribution margin was a loss of $1.4 million, compared to a loss of $1.6 million in the prior quarter, and a loss of $900,000 in the prior year period. The sequential improvement was driven by higher revenue from our SAFR business lines and partially offset by higher operating expenses, primarily related to our investments in SAFR and KONTXT. On a year-over-year basis, the increase was due to investments in our AI growth initiatives, SAFR and KONTXT. Consumer Media segment contribution margin was a loss of $800,000, compared to a gain of $600,000 in the prior quarter and $500,000 in the prior year period. On a sequential basis and year-over-year basis, the decrease was primarily due to the timing of contract renewals in our IP codec business as a result of revenue from multiyear deals booked in the prior quarter and prior year period, respectively, in addition to expenses related to Scener. Games segment contribution margin was a loss of $200,000, compared to a loss of $100,000 in the prior quarter and a gain of $600,000 in the prior year period. On a sequential and year-over-year basis, the decrease was mostly due to lower revenue in our legacy and free-to-play games. At the corporate level, unallocated corporate expenses of $3.2 million decreased by $1.8 million compared to the prior quarter and increased by $400,000 compared to the prior year period. These numbers can fluctuate because they include certain non-core items. When normalizing for non-core items, including restructuring costs and fair value adjustments on the contingent consideration liability from the January 29 purchase of Napster, second quarter unallocated corporate expenses were down $400,000 compared to the prior quarter and were up $500,000 compared to the prior year period, due to focused investments as a result of a capital raise in April. Further information can be found in the 10-Q. Now turning to our balance sheet, at June 30, 2021, we had $29.9 million in unrestricted cash and cash equivalents, compared to $17 million at March 31, 2021, and $23.9 million at December 31, 2020. The increase from March 31, 2021 was primarily driven by the closing of an underwritten public offering on April 29 that resulted in net proceeds to the company approximately $20.1 million, offset in part by cash used in operating activities. At June 30, 2021, we had no debt and no borrowings outstanding on our revolving credit facility. During the quarter we also use $2.5 million of cash and transferred 47.8 million ordinary shares of Napster valued at the December 2020 Napster sale closing date to settle our contingent consideration liability for our January 29 purchase of Napster. In addition, we strengthened our balance sheet through the removal of Scener’s associated liabilities, which resulted in a non-cash gain of approximately $2 million during the second quarter. Now turning to our outlook. For the third quarter ending September 30, 2021, we currently expect total revenue to be in the range of $13.5 million to $15.5 million and adjusted EBITDA loss in the range of $5 million to $3.5 million, excluding Scener, which has been deconsolidated as of June 30, 2021. For the full year ending December 31, 2021, we now expect total revenue will be relatively flat to slightly down from 2020 levels, due primarily to softness in our Games business. 2021 will continue to be an investment year with a focus on reigniting overall topline growth in 2022 and beyond. As such, we expect a full year 2021 adjusted EBIT loss to be greater than it was in 2020. We look forward to seeing the benefits our -- of our investments begin to manifest in 2022 and 2023, when we expect to see meaningful double-digit revenue growth driven by our AI-focused products, SAFR and KONTXT, as well as free-to-play games. With that, we will now open the call for questions. Operator?

[Operator:]

Thank you. Our first question comes from Mark Argento with Lake Street Capital. Please proceed.

[Mark Argento:]

Hi. Good afternoon, guys. Thanks for taking my questions. Got a few different ones here, start with SAFR. Just wondering if you could kind of walk us through the NTT DoCoMo deal, sounds very interesting. How a contract like that will scale up to DoCoMo reselling the product into their channel, are they deploying it primarily through existing relationships, maybe you could kind of dig into that, trying to better understand the size and opportunity of a contract like that?

[Mike Ensing:]

Yeah. So, thanks for the question, Mark. So, yeah, they will sell both within their existing channel and additional customers. It is an approximately two-year agreement and then there are established fees -- license fees to us as part of the agreement.

[Mark Argento:]

Okay. And is that -- they’re effectively resell goods, so they’re selling corporate solutions or solutions to corporations, is that…

[Mike Ensing:]

Yeah.

[Mark Argento:]

… the target on markets?

[Mike Ensing:]

Yes. Yeah. Yeah. It’s enterprise focus.

[Mark Argento:]

Got it. Helpful. And then in terms of how quickly they -- could they get out in market and start selling for long scale up period in terms of own educate the sales force or implementation…

[Mike Ensing:]

Yeah. No. I think they can scale up pretty quickly here, Mark.

[Mark Argento:]

All right. And then, just turning -- just a couple questions on the Scener business. So I’m assuming now that you guys are at roughly a 40% ownership or will be shortly that’s what precipitated the deconsolidation of the numbers in the financial statements?

[Rob Glaser:]

Well, the whole calculation -- this is Rob. For how you deconsolidated business is a multivariate equation, as I have learned in painstaking detail from a legal and finance teams, but this is something that has been carefully scrutinized by our finance team and our legal team. Scener has a independent leadership team. It -- Mike and I are on a Board -- on the Board. But we are not a majority of the Board. There’s a number of different factors and in the context of how the company is developing independently, we kind of set sales going this direction and the apparently when the boat gets a certain amount of offshore, you get to characterize it this way. And I would try to understand these things, so they can generalize and I’ve learned some generalizable things. But it’s -- I think, suffice to say that, as of June 30, the boat is far from shore for us to consider it an independent company for consolidation purposes.

[Mark Argento:]

Great. And so you guys, is it technology that originally came out of RealNetworks or did you guys invest into the business, remind us, give us a little history there?

[Rob Glaser:]

Yeah. So the history of the intrapreneur, now entrepreneur, who created the core platform that became Scener was somebody who worked at Real. We’d actually acquired his company some years before. He’s a sort of very catalytic thinker. And I and a few other people were close with him as he incubated the idea. Originally, he was working with the RealPlayer team. And as the idea develops, it became clear to us that the best opportunity for this idea was as an independent path. It was doing pretty well as -- on a sort of started independent and joined incubator called Launch, which was helpful to the team to kind of learn sort of how to be more independent and entrepreneurial in their not just their technology, but sort of how they set ran the business. And then the pandemic hit and it exploded, blew up in terms of usage. And I think, at one point, he said that a grew -- usage grew 100X over the previous couple quarters, it was just what was great product, right place, right time, everyone was at home, locked down, but still wanting to stay connected to their friends. So Scener, which allowed people to do a watch parties on a wide range of service started with Netflix and now supports over a dozen was well positioned to take advantage of that wave. And one of the exciting things about it is, its continued, it hasn’t, the -- any thought that one might have had this was going to be something that would be a temporary phenomenon, people would go back to their old way of doing things. So I think it’s like a lot of other things in the pandemic. Pandemic has changed patterns. He has introduced new methods of communicating. I think, just to print, like, think about Zoom calls, yes, face-to-face meetings will come back, but it’s not like people are going to stop doing meetings by Zoom and alike. And similarly, people will go over to their friend’s house to watch shows or they’ll go into movie theaters. But this is a new modality of how people can watch shows with their friends and the Scener team is really well positioned for that fundamental trends. So we’re glad we incubated it. We’re glad we spin it out. We liked the team very much. We believe in the opportunity. It has an independent capital needs. Basically this sort of model, if you think of any of these free consumer services, the big ones like the Facebook’s of the world, or the Twitter’s of the world, Instagrams, et cetera, you’re an investment mode for several years as you’re scaling the audience and then once the audience gets to a certain size, there’s a bunch of ways to monetize it. So it has a different investment profile than the kinds of businesses that we build and run within Real. So it made sense to just spin it out and I believe it will serve both us and Scener well for us we have done that.

[Mark Argento:]

Great. I’ll be interesting to watch the progress there and hopefully maybe can become a valuable asset economically for you guys as well. So just get back to SAFR and AI, in general. Mike, can you talk a little bit about your go-to-market strategy, maybe the -- a little bit on the sales team there? I think, maybe you made some hires, kind of where you’re sitting in terms of the go-to-market team right now?

[Mike Ensing:]

Yeah, Mark. So we have actually made some contract hires to strengthen leadership in that space. We are still very focused globally, leveraging our global sales team. As you see in the results, we talk about strength in APAC and Japan and very good strength there. And then, we’re actually continued to build our sales force and our resources within the Federal segment.

[Mark Argento:]

All right. I think that does it for me. I appreciate it. Thanks, guys.

[Mike Ensing:]

Thank you.

[Rob Glaser:]

Thanks, Mark.

[Operator:]

[Christine Chambers:]

This is Christine Chambers, I would like to -- yep, I would like to just correct…

[Rob Glaser:]

Yeah, Christine.

[Christine Chambers:]

…one statement that we made earlier and just that our adjusted EBITDA loss when excluding Scener operating costs of approximately $600,000 was $3.7 million. And this compares to a loss of $2.4 million, excluding Scener in Q1 2021 and a loss of $1.1 million in Q2 2020.

[Operator:]

Thank you. At this time, I would like to turn the call back over to Mr. Robert Glaser for closing comments.

[Rob Glaser:]

Thank you, Operator. Well, thank you all for joining us today. I hope everyone’s summer is going well and that everyone is staying healthy. One thing we did not comment on in this call and sometimes comes in question is, how our businesses progressing in the context of the state we’re in the pandemic, we’re all trying to be safe and careful and we’re observing all of the necessary health and safety precautions while still running the business. As you know from early in the pandemic, we’ve been able to move things forward in many parts of our business, even in spite of the uncertainty and we’ll continuing to do so. And we didn’t see, if feel we need to call it any specific aspects of the business, we will let you know in future quarters if there are any other glitches or other things changes associated with that. But we are moving forward with plans that are predicated on the current complex world continuing to be complex for a while, but hopefully everyone’s able to stay safe and healthy during this period and we all get vaccinated and get our world back on a healthy path. So with that, I want to thank everybody for joining us today. Thank the team at Real for everything the team is doing to move our business forward. Thank our partners and the audience listening today and we will be in touch soon.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation and have a great day.