RealNetworks, Inc.
Q3 2021 Earnings Call Transcript

Published: 3 Nov 2021

[Operator:]

Greetings. Welcome to RealNetworks, Inc. Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to Brian Prenoveau, Investor Relations. Thank you. You may begin.

[Brian Prenoveau:]

Thank you. And welcome to RealNetworks’ third 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 has been 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, November 3, 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 third 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, we’ll open the call to questions. With that, I will hand the call over to Rob.

[Rob Glaser:]

Thanks, Brian, and welcome aboard. Good afternoon, everyone, and thanks for joining us. My remarks today will first center on three topics. Then I’ll cover high level financial results. First, I’ll provide an update on our overall strategy. Second, I’ll highlight our progress in Real’s strategic transformation to an AI center company. And third, I’ll discuss our Games business and the new leadership that we brought in to address that situation. First, the update on an overall strategy. Earlier this year, we told the public that it was our plan to pivot Real to become an AI center company. We also described our growth plans and expectations for 2022 and 2023, which included our belief that our Games business would again be a significant contributor growth beginning in 2022. The core of the strategy hasn’t changed. Our AI business is SAFR and KONTXT are continuing to grow and we believe that they will drive significant growth in the future. That said, issues with our Games business, which I’ll discuss shortly now lead us to believe that Games will likely not be a significant growth contribute in 2022 as we retool it for future success. As a result while we’re still putting our 2022 plan together, I think it’s fair to say that while we believe we will have significant growth in 2022, you should view our expectations of double-digit growth as now excluding Games from the calculations. Now onto our AI businesses. We have two main AI products and services, SAFR, which is our computer vision platform and KONTXT, which is our natural language processing platform. In Q3, more than double SAFR revenue compared to Q3 2022. SAFR continues to be the biggest driver of growth in our AI businesses with quarterly revenue increasing 124% year-over-year compared to 2020. KONTXT compared to continued steady progress increasing 12% year-over-year. SAFR and KONTXT together and I represent 31% of our total mobile services segment revenue, compared to 37% in Q2 2021 and 19% in Q3 2020. While our AI businesses in aggregate were sequentially down from Q2 2021, we expect short-term fluctuations as we’re building out our AI businesses, especially SAFR. We remain bullish about the progress we’re making. In April, we raised 20 – we raised $20.1 million to a public offering and intend to use the proceeds to make targeted investments in our AI-based growth businesses. We believe the steps we’re taking with Real’s AI businesses will position Real for success and long-term growth. In a few minutes, Mike Ensing will go into greater detail regarding our progress with SAFR and KONTXT. Next an update in our Games business, after a promising start for to play games, we’ve been disappointed by the stalled progress in recent quarters. We came to feel that we needed to make a leadership change and undertook a rigorous assessment and search process. As a result of this process, we brought in an outstanding new leader Simonetta Lulli Gómez as GameHouse new CEO. We announced this change to the team a few weeks ago, and yesterday made the change public. Simonetta has a deep background and track record of success in the Games industry and is passionate about GameHouse’s mission of creating great games and experiences for female casual gamers. This demographic makes up over 60% of the total players from the top 100 games in the upstairs. We believe there’s a lot of opportunity and a lot of growth available to RealNetworks from continuing to own this business. Simonetta is the right leader at the right time to reinvigorate the business and deleted to significant growth and profit. We recognize that leadership changes involve a ramping up period, hence my earlier comments about our expectations for 2022. Finally, I’ll turn briefly to our Real financials. Total revenue for the third quarter was $14.3 million, which was down 2%, compared to the prior quarter and 13% down, compared to the prior year. While our AI businesses grew, our Games business declined both sequential and year-over-year prompting the change that I just discussed. On the bottom line, we have good results when you look through non-operating items. Our GAAP EPS was a loss of 16% per share compared to $0.03 per share loss in the previous quarter and $0.08 share loss in the prior year period. Our adjusted EBITDA loss was negative $2.7 million. This compared to loss of $4.7 million Q2 2021 and a loss of $1.9 million in Q3 of 2020. Christine will provide a bridge between the GAAP and EBITDA numbers in a few minutes. We continue to have a strong balance sheet with $29 million of cash available to us, which we’ll use judiciously to set us up for future growth. And with that, I’ll now turn the call over to Mike Ensing to discuss our AI businesses in further detail. Mike?

[Mike Ensing:]

Thank you, Rob. I’d like to briefly discuss progress made in our two AI based businesses SAFR and KONTXT. Starting with SAFR, we are pleased with the progress that SAFR made in the third quarter. Year-over-year, the business increased revenue 124%. Year-over-year revenue increased in both the commercial and federal segments of the business. Revenue decreased sequentially, largely driven by the APAC region. COVID-19 was a factor in APAC as several countries had lockdown and travel restrictions in the quarter impacting bookings and deployments, also is important to realize that revenue recognition in this business can be lumpy. As discussed on prior calls, SAFR is focused on several use cases including real time automated surveillance, touchless access control, digital identity authentication, and embedded solutions. We continue to make progress across these use cases and I would like to highlight a couple of 2021 projects within the access control and digital identity authentication spaces. Within the access control and Federal segment, SAFR’s recognition platform has been chosen by Bowler Pons for an initial phase to enhance biometric access control solutions for the Department of Defense. Bowler Pons is a leading systems integrator focused on federal space with service expanding engineering, cybersecurity, program and project management and information technology. The SAFR solution is focused on improving access control within the DoD and will enable multi-location management. The SAFR platform includes advanced technologies develop to combat presentation attacks and help keep access control solutions safe from spoofing attempts both simple and advanced. SAFR’s compact solution makes it especially valuable for customers seeking to embed face recognition, liveness spoofing detection, and other face and person centric analytics directly in devices operating at the edge. Within the authentication space, we recently announced that SAFR was selected as an authentication facial recognition technology provider to support the Japanese government’s evolution from paper documents to digital My Number ID cards with a face based authentication infrastructure. My Number cards represent a new digital identification system designed to streamline and expand access to government services for Japan’s citizens and residents. The initial rollout of My Number cards provides access to Japan’s universal healthcare system by allowing citizens to confirm their identity and medical information with specialized card readers and facial recognition features. As part of the new initiative, residents will no longer require multiple ID cards to access different government services. The solution will be rolled out to thousands of hospitals, clinics and pharmacies over the next several years. We are pleased with our overall technical and solution and benefit to Japan citizens. However, we note that the deployment has been slowed by factors, including COVID-19 in Japan. We view the My Number project as a major proof point for SAFR in the authentication space and will build upon it in the quarters to come. Next, I’ll turn to a discussion on KONTXT, our natural language processing platform. Our team at KONTXT has been intently focused on continuing to develop AI based products and services to help facilitate improved messaging based services for our customers. By leveraging more than 1 billion SMS and MMS messages processed daily, along with our long-term telecom industry relationships, we’ve been able to develop robust AI based filtering tools to develop – to deliver enhanced experience for our customers. Over the last several months, we have significantly enhanced our core KONTXT platform by both expanding functionality and capabilities. First, we have developed new 10DLC interconnect support, allowing KONTXT to scan 10DLC roots, further preventing spam and fraudulent messages. For background 10DLC stands for 10-digit long codes and is a sanctioned communication method adopted by major telcos used largely for omni-channel messaging campaigns. We have also released a new image hashing service for MMS. We can now scan and block spam and images sent to end users. In addition, we upgraded our core machine learning method resulting in greater breadth of spam campaigns caught. Finally, we have developed brand phishing and smishing IP that leverages machine learning to detect whether a brand content or URL is being used within fraudulent messages. We continue to innovate in this space further developing our current products and working on the next generation of products to enhance benefits to both current and new customers. In summary, we continue to be pleased with our progress and 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 communicating continued execution against our strategy in the quarters to come. With that, I will now turn the call over to Christine to discuss our third 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 third quarter results followed by a more detailed discussion of our segment business performance. As a reminder, we completed the deconsolidation of Scener as of June 30, 2021, and as such, cost related to Scener are no longer included in our financial results. Now turning to our results. Total revenue for the third quarter was $14.3 million compared to $14.6 million in the prior quarter and $16.6 million in the prior year period. Similar to the trends of this year, 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 decreased approximately $600,000, both sequentially and year-over-year. Year-over-year SAFR revenue more than doubled, however, on a sequential basis, SAFR revenue decreased. This is primarily due to decline in international commercial sales. We do want to remind you that sales on a quarter-to-quarter basis can be lumpy due to the timing of contract finalization and revenue recognition. Revenue in the Consumer Media segment increased $700,000 sequentially and $200,000 year-over-year. The sequential and year-over-year increases are primarily due to the timing of contract renewals. Games revenue for the third quarter was down $300,000 sequentially and down $1.8 million year-over-year. On a sequential and year-over-year basis, the decreases were due to sales decline in both our legacy and free-to-play mobile games. As Rob discussed earlier in the call, we’re excited about new leadership in the Games segment and the direction they can take the business, while recognizing that progress from a revenue growth perspective may stay – may still take a few quarters. Consolidated gross profit for the third quarter was $11.2 million, a sequential increase of $200,000, but down $1.3 million compared to the prior year period. As a percentage of revenue, gross margin was 78% compared to 75% in the prior quarter and prior year period. Total operating expenses for the third quarter was $17.7 million, an increase of $1 million from the prior quarter and $2.3 million from the prior year period. The increase was primarily due to a $2 million one-time award modification in stock compensation. And to a lesser extent, higher restructuring charges, both related to the recent leadership changes in games. Net loss from continuing operations was $7.7 million or $0.16 per diluted share compared to a net loss of $1.3 million or $0.03 per diluted share in the prior quarter and a net loss of $3.2 million or $0.08 per diluted share in the prior year period. Included in net loss in the third quarter of 2021 was $1.2 million non-cash loss, primarily related to our investment in Napster stock, a $2 million one-time stock award modification and $700,000 related to restructuring charges associated with the recent leadership changes in Games. All are excluded from adjusted EBITDA, which for the third quarter was a loss of $2.7 million and was compared to a loss of $4.3 million in the prior quarter and a loss of $1.9 million in the prior year period. Now turning to our third quarter segment results in more detail. Mobile Services segment contribution margin was a loss of $1.3 million compared to losses of $1.4 million in the prior quarter and $600,000 in the prior year period. The year-over-year change was driven by lower ringback tones revenue and higher operating expenses from SAFR and KONTXT. Consumer Media segment contribution margin was a gain of $900,000 compared to a loss of $800,000 in the prior quarter and $100,000 in the prior year period. On a sequential basis and year-over-year basis, the increase was primarily due to increased revenue from software licenses and lower expenses due to the deconsolidation of Scener. Games contribution margin was a loss of $400,000 compared to a loss of $200,000 in the prior quarter and a gain of $600,000 in the prior year period. Revenue declines were the primary driver of the year-over-year decline in games contribution margin. Now turning to our balance sheet. At September 30, 2021, we had $29 million in unrestricted cash and cash equivalents compared to $29.9 million at June 30, 2021 and $23.9 million at December 31, 2020. The cash from April’s equity offering provides us with a flexibility to make prudent investments in our AI businesses. At September 30, 2021, we had no debt and no borrowings outstanding on our revolving credit facility. Our balance sheet remains strong and we have ample flexibility to invest in the areas of growth we are most excited about. Now turning to our outlook. For the fourth quarter ending December 31, 2021, we currently expect total revenue to be in the range of $12.5 million to $15 million and adjusted EBITDA loss to be in the range of $5.5 million to $3.5 million. The low end of the ranges reflects supply chain issues and chip set shortages that may impact our IP Codec business in China. This also means that for the full year, we now expect total revenue will be down from 2020 levels. Per Rob’s comments earlier, the decline year-over-year is in large part due to a decline in games revenue. 2021 continues to be an investment year with a focus on reigniting overall top line growth in 2022 and beyond. We look forward to seeing the benefits of our investments in our AI focus products begin to manifest in 2022, when we expect to see meaningful double digit revenue growth, excluding gains from the calculations. With that, we’ll now open the call for questions. Operator>

[Operator:]

Thank you. Our first question is from Mark Argento with Lake Street Advisors. Please proceed.

[Mark Argento:]

Hi, good afternoon, and congrats on a decent quarter. Just wanted to drill down a little bit on some of the different things going on with the SAFR business in particular, the deal with the My Number ID over in Japan. Just a couple questions there. Was that a deal that you guys sourced through NTT DoCoMo or how did you end up in the mix and how competitive the situation was that.

[Mike Ensing:]

Yes. It was a pretty competitive situation. We actually sourced the deal through another partner of ours called network that we’ve had a longstanding relationship with.

[Rob Glaser:]

And in terms of the competitive aspect of it, yes, it was competitive. The Japanese government, as I understand, it has split the implementation among four different system technology partners. So we want in the business with one of the four and it’s my understanding that we are the only international computer vision technology platform, face recognition platform used in the mix. So the others were all domestic Japanese providers. So we were very excited about that. We don’t know obviously what the broader competitive dynamics were both within the one we won, in terms of the selection process and also within the other ones, but we were delighted to get a significant piece of such a large strategic piece of business. And as far as I know is the only international product.

[Mike Ensing:]

There is one international – other international.

[Rob Glaser:]

There was one other, okay. Sorry about that. But not with our integrator – different integrator.

[Mike Ensing:]

Correct.

[Mark Argento:]

And the solution, are you guys you’re providing the SAFR AI algorithm or what are you actually doing for the system integrator for the partner providing.

[Mike Ensing:]

Yes. Good question. So we’re providing the algorithm that actually gets embedded on these reader devices.

[Mark Argento:]

Got it. And then do you – is there, I mean, obviously, I’m guessing there’s a licensing component to it. And then is there any kind of maintenance that goes along with that as you continue to fine tune the elbow or how does such to the high level look from structure.

[Rob Glaser:]

We generally don’t comment on individual deal structures. I would say that our goal, where we can do it is to get businesses, business relationships that are scalable, which is to say, where the more of our product is used. The more customers pay us that can be manifested based on for device based camera deals, based on the number of cameras that are – were deployed on for identity based solutions. We like deals where we can get paid based on the number of identities associated with the platform. And that’s obviously sometimes we can get that. So it’s disaspirational, but we sort of take the long view, which is if we can get deeply integrated into large scale operations, there’s plenty of opportunities to scale up. So we love attached with something that has scalability with usage associated with it. And then – and that’s more of a statement about SAFR in the case of KONTXT, because it’s SaaS based. It tends to be a monthly services revenue associated with volumes, but on the SAFR side, it’s a more diverse set of ways of doing business at least today.

[Mark Argento:]

Got it. And the integration work you’re doing sounds, like, there’s a working with one of the integration hardwares and systems integrator, we are integrating the technology into the hardware. Is that like a main brand hardware provider, or is there any kind of scalability or any kind of leverage that you get potentially from that relationship like you have with like access on the camera side, where they could take you in other try to figure out any kind of leverage points to the relationship.

[Rob Glaser:]

So Nextware is a very – it’s a pretty scalable system integrator and I think working with them will allow us to drive scale.

[Mark Argento:]

Great. And then pivoting over, you had mentioned that you’re working with, I think, it was Bowler Pons, it’s a systems integrator go lot of DOD on the access control side there. Maybe talk a little bit about your expectations on how that rolls out. Is it kind of in beta testing or is there specific RFPs or the government, the coronavirus piece that you guys have been responding to with them? I’m trying to gauge kind of how that could roll out or scale up.

[Mike Ensing:]

Yes. So this is a 12-month POC that we expect that will go very, very well. And then there would be significant rollout potential beyond that.

[Rob Glaser:]

I would say in general to again, I appreciate you want to ask about specific deals that we have talked about a few of them Bowler Pons and My Number card being two of them. Generally what we see is that customers start with deployment that is a subset of their intended scale deployment in part, because of the newness of the technology, in part because of the number of piece to be integrated with. And there’s sort of a prove out period. Sometimes they have formally are called POC, sometimes they’re faced rollouts. And then in success, there’s opportunities to scale up further. Sometimes they scale up opportunities are very much larger 10x with the initial deployment would be, not always that ratio, but it depends on what they’re trying to do. So we think what we’re doing is we’re planting seed corn, if you will and hoping that a high percentage of it fertilizes and grows and scales, but that’s the nature of these businesses in the early days.

[Mark Argento:]

Great. That’s helpful. And just last one on the KONTXT business, it’s been kind of plugging along, kind of low double-digit growth 12% of number, it serves me? What’s the opportunity to start to see maybe that, that business, the growth rate there accelerate is there, you got to sign more carriers, you need to go deeper into existing carriers. What’s the dynamic there that maybe could unlock some growth?

[Rob Glaser:]

Well, it’s hard to talk about that without going into deals that are in process products that are under development. Let me just say that I very much share the goal describing that of accelerating the growth of that business. We – it’s always a tradeoff between servicing your current customers well and growing with them and developing derivative products that go into new market segments that might have additional customers or broader portfolio of customers. And I’d say the big difference today between SAFR and KONTXT is, SAFR is an opportunity the technology gets deployed or can be deployed in multiple use cases, in many different scenarios and what we’re doing with KONTXT today, it’s focusing on the messaging business SMS and MMS today. What would – Mike talked about with the image hashing is actually a significant broadening of the appeal of the product and the utility of the product, because there’s a lot of image spam that wasn’t getting caught, because the spam content was being embedded in an image. And so being able to do a set of tricks to actually extract that that spam from the image and do it in a scalable way, because the volumes are pretty high and figure out how to efficiently do that and add that to our mix. I think has increased the viability and use and value our product and created new opportunities for us associated with it. And we just – we’ll keep, we’ll continue to grow the business with the current portfolio of customers we have with the current portfolio markets we serve. And then we’re going to look at additional markets where our really, really great Natural Language Processing technology is applicable. And we’ll – we still see significant growth opportunities in that business and we would love it to grow faster.

[Mark Argento:]

Great. Appreciate the color. Thanks, everybody.

[Rob Glaser:]

Great.

[Mike Ensing:]

Thank you, Mark.

[Operator:]

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Rob for closing comments.

[Rob Glaser:]

Well, thanks to everybody. I guess the last thing I’ll say is Mike and Christine made a few references to some of the things we’re seeing around supply chain disruptions, and some of the impact we’re seeing on some of the pandemic. We still know we’re not in a full back to normal world. We – the world’s made a lot of progress and hope everyone on this call is healthy and that your friends and family are, and colleagues are as well. As we continue to go through this post vaccination, but not post pandemic phase we’re in, hope everyone stays safe. We’re going to keep driving the business forward, continuing to make investments that we think are going to scale us to success and profit in the future, and look forward to continue engage with you in the weeks, months and quarters ahead.

[Operator:]

Thank you. This does conclude today’s conference. You may disconnect your lines at this time and thank you for your participation.