RealNetworks, Inc.
Q1 2021 Earnings Call Transcript

Published: 12 May 2021

[Operator:]

Greetings and welcome to the RealNetworks' Incorporated First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. I would now like to turn the conference to today's host, Kim Orlando with ADDO Investor Relations. Please proceed.

[Kimberly Orlando:]

Thank you and welcome to RealNetworks' first 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.

[Robert Glaser:]

Thanks, Kim. Good afternoon, everyone, and thanks for joining us. Today I plan to cover three topics. First, I'll discuss the status of Real's strategic transformation from a digital media technology company to an AI-based company. Next, I'll summarize our first quarter results in the context of the transition. And third, I'll discuss our recent successful fundraising initiative and other activities related to aligning our capital structure with our strategy. Q1 2021 was an important quarter in Real strategic transformation to an AI centric company. This transformation is centered around our two AI-based products and services, SAFR, which is our computer vision platform and KONTXT, which is our natural language processing or NLP platform. Our traditional or foundation businesses will continue to be important to us in two ways. First, they will provide financial balance help us fund our AI initiatives. And second, they will contribute data that will help us improve and differentiate our AI products. During the first quarter, we achieved significant growth in SAFR and KONTXT. Revenue for SAFR increased approximately 160% year-over-year, and KONTXT increased 10% year-over-year. SAFR and KONTXT together grew to represent 29% of our Mobile Services segment revenue in Q1, up from 23% in 2020. Mike will provide additional depth in our progress with SAFR and KONTXT in a few minutes. Second, let me summarize our financial results. Our first quarter revenue was $15.9 million, which was down 10% compared to the prior quarter and down 6% compared to the prior year period. This decline was primarily due to the end of a few carrier contracts related to our ringback tone business. As I mentioned earlier, our year-over-year AI revenue growth in Q1 was strong. On the bottom line, our adjusted EBITDA loss was $3 million, compared to a loss of $4.4 million in Q1 2020. Excluding Scener, which were in the process of spinning out, adjusted EBITDA was a loss of $2.4 million. And I'll discuss Scener further a few minutes. These results reflect continued discipline in how we manage costs in our foundation businesses to enable us to invest in our AI growth opportunities. A word about our games business. After excellent growth in free-to-play games in 2020, we were disappointed with games Q1 results for free-to-play games, which declined slightly compared to the prior quarter. The team is making some changes in order to reinvigorate growth in our two biggest free-to-play titles. We believe that the team will get back onto a growth trajectory that it will likely take a few quarters.

[Michael Ensing:]

Thank you, Rob. I will be discussing both SAFR and KONTXT. Before I provide updates on these businesses, I'd like to briefly outline why we are in these businesses strategically. Each of these businesses are part of large growing markets where we have unique competitive advantages. In the case of SAFR, our competitive advantages are extremely compact, very fast, highly accurate, and low bias algorithm that was developed using proprietary data. In the case of KONTXT, the source of our competitive advantage is that approximately 1 billion SMS, MMS messages we processed daily to base our algorithms upon. This results in highly trained and robust filtering tools. Each one of these products also utilizes leading computer vision and natural language AI talent residing at Real. Now let me turn to update on each one of these businesses. For SAFR, we delivered yet another strong quarter driven by successes in both the U.S Federal and global commercial businesses. In addition, we made significant progress with our SAFR product with our latest release and were rated highly by NIST in their most recent ongoing facial recognition vendor test. In the U.S Federal business, we continue to execute on two direct to Phase II Small Business Innovation Research or SBIR contracts with the United States Air Force. In addition, we were recently awarded a third SBIR with the U.S Air Force to support perimeter protection, and domestic search and rescue missions. Work on this will likely start in Q2 with the bulk of the work being done for the remainder of the calendar year. I'll now turn to a discussion of SAFR's global commercial business and partnerships. As a reminder, the SAFR commercial business focuses on a variety of use cases including secure access, authentication, surveillance watchlist and embedded applications with our SAFR Inside initiative. During the quarter, we made several advancements with key partners. We recently announced a partnership with Geutebrück, an international provider of proprietary, high-performance video security and software and hardware. SAFR has been integrated as an AI layer on top of Geutebrück's video management system to provide advanced video analytics for surveillance operations, saving both time and increasing efficiencies. During the quarter, we furthered our SAFR Inside initiative and expanded our scope with AXIS. In addition to being available on the AXIS Q1615 Mk III box camera, the SAFR Inside technology can be embedded directly on the AXIS P3255 dome camera. SAFR Inside enables network cameras like the AXIS P3255 to reduce video processing server overheads and lowers total cost of ownership.

[Christine Chambers:]

Thanks, Mike, and good afternoon, everyone. I'm thrilled to be joined Real to lead the finance organization during this exciting period of growth and opportunity. In my remarks today, I will first review our consolidated first 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 is 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. Now turning to our results. Total revenue for the first quarter was $15.9 million, compared to $17.6 million in the prior quarter and $16.8 million in the prior year period, a strong growth in our AI businesses were more than offset by declines in some of our foundation businesses, primarily due to a few ringback tone contracts that did not renew in 2021. Looking at these results in greater detail, revenue within the Consumer Media segment was down $100,000 sequentially, and down $200,000 year-over-year. The sequential decrease was primarily due to declines in our PC products when compared to the successful Real Player 20 upgrade campaign in Q2 2020, which will partially offset by the timing of renewals and shipments of our IP codec business. Year-over-year, the decrease was primarily due to the timing of our IP contracts, and the result of revenue from multiyear deals booked in the prior year period. Mobile Services revenue was down $1.4 million on a sequential basis and down $700,000 on a year-over-year basis. The sequential decline was primarily due to lower ringback tones and SAFR federal revenue added to the fourth quarter of 2020. Year-over-year, the decrease was primarily due to declines in our ringback tone product partially offset by higher sales in SAFR and KONTXT. Games revenue for the first quarter was down $300,000 sequentially, and was essentially flat year-over-year. On a sequential basis, the decrease was due to a slight decline in both our free-to-play and legacy games. Compared to the prior year period, growth in our free-to-play was offset by lower revenue in our legacy games. Consolidated gross profit for the first quarter was $12.2 2 million, down $1.4 million compared to the prior quarter and down $500,000 compared to the prior year period. As a percentage of revenue, gross margin was 77%, which was flat compared to the prior quarter and up from 76% in the prior year period. Total operating expenses for the first quarter were $18.4 million, an increase of $10.3 million from the prior quarter and $900,000 from the prior year period. These numbers can fluctuate because they include several noncore items. When normalizing for noncore items, including restructuring costs and gains resulting from the fair value adjustments on the contingent consideration liability for the Napster transaction, first Quarter operating results were at $1.2 million or 8% compared to the prior quarter, and we're down $1.5 million or 8% compared to the prior year period. Net loss attributed to RealNetworks was $10.4 million, or minus $0.27 per diluted share, compared to net income of $6.1 million or $0.16 per diluted share in the prior quarter, and a net loss of $4.6 million or $0.12 per diluted share in the prior year period. Please also note that in addition to the noncore items discussed earlier, net loss in the first quarter of 2021, included a pre-tax loss of $4.3 million related to the fair value assessment of our interest in MelodyVR stock which is now trading as Napster Group PLC. Adjusted EBITDA for the first quarter was a loss of $3 million compared to a loss of $900,000 in the prior quarter, and a loss of $4.4 million in the prior year period. As Rob mentioned, adjusted EBITDA for the first quarter, including $600,000 of cost related to Scener was $2.4 million. Turning to our first quarter segment results in more detail. Consumer Media segment contribution was $600,000 compared to $700,000 in the prior quarter, and $400,000 in the prior year. On a sequential basis, the decrease is due to lower revenues. On a year-over-year basis, the improvement reflects decreased operating expenses as a result of our ongoing expense management. Mobile Services segment contribution was a loss of $1.6 million compared to a loss of $200,000 in the prior quarter, and a loss of $2.5 million in the prior year period. The sequential decrease was primarily due to lower revenue in our ringback tones business and SAFR federal contracts, and slightly higher operating expenses primarily related to our investment and SAFR and KONTXT. Year-over-year, the contribution margin improvement was primarily driven by lower operating expenses. As a result of our ongoing expense management focused on our foundation businesses partially offset by high marketing expenses related to SAFR. Game segment contribution margin was a loss of $100,000 compared to a gain of $300,000 in the prior quarter, and a gain of $100,000 in the prior year period. On a sequential and year-over-year basis, the decrease was due to lower revenue, along with our investments in mobile games. At the corporate level, unallocated corporate expenses of $5 million, increased by $9.8 million compared to the prior quarter, and increased by $2.4 million compared to the prior year period. Again, these numbers can fluctuate because they include several noncore items. When normalizing for noncore items including restructuring costs and gains resulting from the fair value adjustments on the contingent consideration liability from the Napster transaction, first quarter unallocated corporate expenses were up $700,000 compared to the prior quarter, and was flat compared to the prior year period. Further information on our noncore items and other items can be found in the 10-Q. Now turning to our balance sheet. At March 31, 2021, we had $17 million in unrestricted cash and cash equivalents compared to $23.9 million at December 31, 2020. The decrease was primarily due to cash flows used in operating activity, and seasonal working capital timing. At March 31, 2021, our total debt was $2.9 million, and we had no borrowings outstanding on our revolving credit facility. As Rob highlighted, on April 29, we strengthened our balance sheet with the closing of an underwritten public offering that resulted in net proceeds to the company of approximately $20.3 million. Now turning to our outlook. We are pleased to be in a position to reinstate financial guidance for our continuing operations today, given our confidence in the long-term plan. For the second quarter ending June 30, 2021, we currently expect total revenue to be in the range of $14 million to $15.5 million, which reflects softness in our games business and a sequential decline in the IP licensing part of the foundation business due to timing, partially offset by growth in our AI businesses. Further, we expect adjusted EBITDA loss to be in the range of $6 million to $4.5 million, including senior expenses of up to $750,000 and an adjusted EBITDA loss in the range of $5.25 million to $3.75 million, excluding Scener. This includes approximately a $1 million of new investment in light of our capital raise in April. We believe the second quarter will reflect the troughs of the year for both revenue and adjusted EBITDA. For the full year ending December 31, 2021, we currently expect total revenue to be relatively flat with 2020. 2021 will be an investment year with a focus on reigniting overall top line growth in 2022 and beyond. As such, we fully expect our full year 2021 adjusted EBITDA loss to be greater than it was in 2020. We look forward to seeing the benefits of our investments begin to bear fruit 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'll now open the call for questions. Operator?

[Q - Mark Argento:]

Hey, Rob, Mike and Christine. A couple of questions. Wanted to dig into the AI business a little bit more. Looks like the SAFR business has grown really nicely up, triple digits. Can you talk a little bit about the wins that you're having in that business, highlighted the AXIS camera deal. Maybe talk about some of the opportunities you're targeting these, systems integration deals, where there's big RFPs out there, maybe talk a little bit about the pipeline and how you see that business building in the coming quarters.

[Robert Glaser:]

Mike, do you want to take that one?

[Michael Ensing:]

Sure. Yes, I'll take that. So first of all, from a sort of use case perspective, worse -- and this is talking. So two segments, we're focused on, the Federal segment and then the commercial Segment. On the Federal segment, I talked a little bit on the call about the most recent SBIR that we've won that will begin executing work on. And then there are some other significant opportunities in that pipeline. On the commercial side, we're seeing opportunities across several different use cases. So one is access control. Second, is authentication, and third is surveillance watchlist. And then, as I mentioned, we're expanding the relationship with AXIS, and now available, one of their most popular dome cameras, and we're pretty excited about the prospects that will provide. We're also excited about just different types of partnerships, the Atos relationship could bring significant traction in Europe. Similarly, the conversion relationship. So, our strategy right now is going significantly after these use cases. And one of the advantages that we have is our global sales force. And that actually helps create diversification of sort of opportunity. And then also going after this very significant partner relationships, as I described.

[Mark Argento:]

Okay. And how big is the sales force currently to own the SAFR products?

[Michael Ensing:]

It's approximately -- well, we probably don’t

[Robert Glaser:]

Yes, we don't break out information on size of sales teams. But it's definitely a leverage model. Our goal is to have partners that bring us opportunities, and have our sales team be organized to take advantage of those opportunities primarily through partners. So we're not -- it's not our plan, the business plan, in the general case to build out sales forces that are calling on every end customer, but rather to put it together network of partners and to leverage those partners in a scale way. And then as some of the bigger opportunities where the ones where it's the first of a category, first of a kind engage more directly in order to build up a repeatable book of business in that vertical or in that region. So it's sort of a combo strategy of and leverage the partners.

[Mark Argento:]

So you're using a combination of systems integrators and distributors slash bars as the go-to-market versus the direct sales force?

[Robert Glaser:]

Yes, and I would say the federal business is a little bit different, because in the first phase of the federal business, the SBIR process is one that does has been involved direct engagement, because you have to actually directly engage the government on those. But similarly in the federal and its engagements, we expect over time to be working with partners primarily.

[Mark Argento:]

Got it. And just shifting over to KONTXT that business didn't grow quite as robustly as SAFR did. Is that more of a kind of a fair step? I mean, you're signing -- I'm assuming you got to sign large carriers. So when you get one, it's going to step up big or maybe just got to educate me a little bit on how that business could potentially roll out.

[Michael Ensing:]

Rob, do you take that or do you want me to …?

[Robert Glaser:]

Sure. Happy to go. Yes, I would split KONTXT in a couple different categories. We announced a partnership with Syniverse early on as our first partner we asked for KONTXT, and we've rolled out some additional partnerships as well. And in the case of Syniverse, they have some large carriers that they set up, and as you say, in some cases, once you get a carrier going, you sort of -- you kind of fill that bucket, and then you go on to the next one. So we don't necessarily have to sign up more partners. But our partners have to sign up more customers. So it's sort of you can kind of win either way. And in some of the additional KONTXT lines, like for instance, we talked about, the KONTXT for VOICE, there's a similar opportunity of signing up additional partners for those. So it's -- again, we tend to get paid by volume. But sometimes the volumes will have peers associated with them. So in the general case, the greater volume we do, the more money we wait, but it's not necessarily one-to-one. So if somebody is using our products at a given band , we won't necessarily get more money until somebody else comes online, or that customer kind of graduates through different band. Its generally how it works.

[Mark Argento:]

Got it. All right. And then just a quick kind of balance sheet/expense question. So it sounded like the prepared remarks, you think we're going to spend about an incremental $1 million in terms of investment into AI? I think you said, Q2. Is that kind of a good pace moving forward from that incremental spend, and kind of juxtaposing that against Canada EBITDA losses. I think you suggested they'd be up in a year over a year. So kind of $1 million, $1.5 million a quarter. So maybe they'll -- maybe the incremental spends, $4 million or $5 million, $6 million bucks this year. You can pull out a thought there.

[Robert Glaser:]

Yes, we're not breaking down any numbers beyond Q2 in terms of giving a Q3 number or Q4 number, or very detailed Q4 number. We have said that EBITDA loss in 2021 is expected to be larger than the 2020 loss. But we haven't subdivided there. I would say in terms of the EBITDA loss, we did also say that we expect Q2 to be a trough quarter, both in terms of revenue and in terms of EBITDA loss. And so the question will be if you look at Q3 and Q4, what the net effect is of growing revenue, for instance, the AI revenue versus and the margin associate with that versus the incremental investment. We basically said that when you net those out, we don't expect EBITDA losses in Q3 to be larger than the Q2 EBITDA loss. That's why we call it a trough quarter. But in terms of dimensionalizing, how much of that is because of the revenue growing? And how much of that is because the investment is staying about constant? We didn't break that down.

[Mark Argento:]

Yes, I guess the reason for the question is I'm just trying to understand kind of where you think you are in terms of the evolution of getting the AI business to scale, because another $20 million in investment, another $5 million in investment, that's why I asked the question, right? That's fine. Maybe we could just talk a little bit about the -- when you're talking about trough in Q2 on the revenue line as well, is that how much visibility do you have in the business and as much as obviously, you can see -- you could have some contracts coming off in terms of the ringtone business, but then also can see a ramp up in the other parts of the business? Do you have pretty good visibility in quarter -- quarter in and quarter out, in terms of the revenues of the business?

[Robert Glaser:]

I will let Mike speak to that. Mike?

[Michael Ensing:]

Yes. So, we do from a foundation perspective, we do have long-term contracts, and very, very good visibility, and then from even an AI component, strong visibility to a large portion of the revenues. Yes, so there's pretty good visibility.

[Robert Glaser:]

Yes. And then additionally, obviously, you have a pipeline, you have a methodology for business that hasn't closed yet. We’ve visibility on what the closing expectation is for future revenue. And then, the, I would say, in my view that and you haven't broken this out this, this time, we may or may not in the future. Sometimes the final form of deal takes has a different impact in terms of booking versus GAAP revenue. And there was nothing that in this quarter that caused us to slip to talking about that. But at some point in the future, we might consider talking about bookings, where you would say, well, we achieved this much in bookings and this match in terms of GAAP income and then revenue and then EBITDA falling off of that. But in this quarter, we didn't break that out. It just really depends on the nature of those deals and centers. And there in the pipeline, what the size of the opportunity is. But you don't necessarily know how it's going to fall in terms of what the final deal structure is going to be.

[Mark Argento:]

Understood. Great. Well, appreciate the additional color. Thanks.

[Robert Glaser:]

Okay.

[Michael Ensing:]

Thanks, Mark.

[Robert Glaser:]

So, operator I know we're running a little bit over time. Did we want to wrap for today? And then I know we running a little bit late for that. Is that okay? Shall we wrap -- close down for today and then take the other follow-up offline?

[Operator:]

That's correct, sir. That's fine.

[Robert Glaser:]

Great. Well, I want to thank everybody for joining us today. It's an exciting time for RealNetworks. We very much appreciate everyone's support and want to thank all of our stakeholders, our investors, of course, our customers and our employees and staff. The pandemic has been an extraordinary time for us all and we feel very good about where we are as the certain parts of the world through the U.S pandemic, we feel empathy for our colleagues in parts of the world, such as India, that are really right in the middle of it, in the teeth of it right now. And wishing the best and try to be as supportive as we can be for our customers as well as our staff and team places like India. Hopefully the world will continue to conquer this pandemic. And we were moved to more normal world and more and more of the world in the months ahead. And we look forward to talking to everybody in 3 months, if not sooner.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.