RealNetworks, Inc.
Q4 2019 Earnings Call Transcript

Published: 6 Feb 2020

[Operator:]

Greetings and welcome to RealNetworks, Inc. Fourth Quarter and Full Year 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded.I would now like to turn the conference over to your host, Kim Orlando, with ADDO Investor Relations. Thank you. You may begin.

[Kim Orlando:]

Thank you and welcome to the RealNetworks fourth quarter and full year 2019 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, gross profit, adjusted EBITDA and operating expenses on a consolidated basis, and trends affecting its businesses and prospects for future growth and profitability and financial conditions.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 our acquisition of an additional equity stake in Rhapsody International Inc. on January 18, 2019, which does business as Napster.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, including risks and implications associated with combining our business and consolidating our financial statements with Napster. 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 RealNetworks’ expectations as of today, February 5, 2020. 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; and Cary Baker, CFO. Rob will discuss the company's strategy and the progress the company made during 2019 as well as a preview of what's to come. Cary will then provide a more detailed financial review of the fourth quarter and full year of 2019 as well as provide the outlook for the first quarter of 2020. After today's prepared remarks, Rob and Cary will be pleased to answer questions.With that, I will hand the call over to Rob.

[Rob Glaser:]

Thanks, Kim, and good afternoon, everyone. And thanks for joining us today. As I typically do at year-end, I'll take a step back and review our 2019 performance on the whole. I'll then provide a detailed progress update on two key growth initiatives, free-to-play casual mobile games and our SAFR computer vision platform.Last, I'll summarize the results of our business – other businesses and we'll close out with where we plan to focus our efforts in 2020. Strategically, I consider 2019 to have been a very successful year. We achieved significant traction on two of our key growth initiatives, free-to-play casual mobile games and SAFR.Revenue for Games once again improved year-over-year by 17% and 18% respectively for the fourth quarter and full year of 2019. Importantly, Q4 marks our second consecutive quarter of positive operating income for Games. These results are a direct reflection of our early success with free-to-play games, which has become the dominant economic model in the mobile game sector.Our GameHouse team has done a terrific job of delivering free-to-play story-based games that consumers love and that monetize very well. We currently have three free-to-play titles in market and are primarily focused on our two most recent entrants.Delicious World released globally in mid-2019, continues to exceed our expectations and is our highest revenue generating game to-date. More recently, in December, we introduced Delicious Bed & Breakfast through a soft launch in the U.S. the early results of the game have been encouraging and we've now rolled it out throughout Europe and the Americas. We're confident our free-to-play story-based games will continue to drive top line growth and at scale should generate very good return on investment and profitability.Next, SAFR, as I stated at the beginning of last year, SAFR is a top growth focus for the company. In 2019, we made significant progress both in terms of deploying with leading-edge global customers and building important industry partnerships. For instance, we successfully deployed SAFR into building municipality of Praia Grande. SAFR replaced their previous incumbent face recognition system and maybe it will help Praia Grande realize mission-critical benefits, including watch-list based matching of known threats with previously recognized, leading into arrest in some cases. By helping keep Praia Grande SAFR, we lived up to our name.Another example is our partnership with Katai, a leader in high-resolution 360° computational cameras. Katai is integrating SAFR into leading video conferencing systems for a variety of market applications. For instance, Katai equipped with SAFR can now deliver a next-generation video conferencing experience with compelling new features such as user tracking and counting, auto zoom, automatic framing and auto registration.Another customer delighted to serve is WOLFCOM, who's licensed our SAFR SDK to integrate it into their body cameras. Inclusion of SAFR is expected to both increase situational awareness in the field and provide forensic analysis for archive video and evidence management systems.On the industry partnership side, we're making excellent progress as well. Following our announcement in October 2019 that we're partnering with NVIDIA, we're now optimizing SAFR for NVIDIA's Jetson hardware platform, which is designed for embedded autonomous devices such as drones and robots. The integration of SAFR into NVIDIA's hardware solutions, dramatically lowers the total cost of ownership making SAFR even more accessible and compelling for a wide range of applications.Our technology leadership continues to pace. The January, 2020 National Institute of Standards and Technology, NIST test results once again showed that SAFR demonstrably surpasses the competition, has much less biased in competing algorithms and is a top ranking algorithm for live video based on a combination of accuracy, speed and compact size.Along the way, we've learned a lot. If I could do 2019 over again, the one thing I think we should have done differently with SAFR is to broaden more security industry’s expertise-driven, which would have accelerated our learning curve. Fortunately, we've eradicated the situation. In the past few months, we've hired several industry experts for both our products and field teams. This is already helping us build on what we've learned in 2019 to consolidate our efforts in 2020. In sum, we remain very bullish about the longer term prospects for SAFR and expect 2020 to be a significant growth year for SAFR.Next, I'd like to briefly discuss the remainder of our business. The rest of our business is largely performed in line with our expectations in 2019 with a notable exception of our China IP business, who are negatively impacted by the situation with Huawei as well as a few other issues specific to our business. The good news that we made the necessary changes to our China business and feel like we have significantly derisked our 2025.China is expected to do represent less than 5% of our revenue. One final point about China is the potential effects of the current virus. At this point, we do not see any reason to change our plan. Our primary focus is the safety and wellbeing of all of our employees and we will continue to monitor the situation.Next, a few words about messaging specifically, our Metcalf and Kontxt products. Messaging is a stable, profitable business for us and we think we will continue – it will continue to be through 2020 and beyond.Next, I'll turn to Napster, an independent company which we consolidate, which is currently our largest business from a revenue standpoint. Napster continues to focus primarily on B2B and has signed up some notable new partnerships which we expect to announce a roll out in the first half of 2020. In summary, as our growth initiatives continue to ramp, we feel very confident about lies ahead for RealNetworks.Our focus for 2020 will be continued driving these key initiatives forward while also running our operations efficiently. We will make ongoing investments to support the key growth initiatives, but at the same time, we will carefully manage costs along the way as we did during the course of 2019. Our progress in this regard can be seen in the $8.3 million or 59% reduction of our adjusted EBITDA loss in the second half of 2019 as compared to the first half of 2019. We expect this trend to continue in 2020.Finally, a few people matters. First, we were pleased to welcome two new directors. Tim Wan and Erik Prusch to the RealNetworks board of directors in early December. As a former RealNetworks executive for 15 years, including a stint as CFO, Tim brings deep knowledge of the company as well as his strong financial and business experience. I’m equally delighted to have Erik join our board. Erik brings great value with over 25 years of executive experience, having successfully led several technology and consumer-facing businesses through periods of innovation and adoption.We're already benefited from having both Tim and Erik on our board. Second, and finally, as you know, Cary Baker is leaving Real later this month to pursue another opportunity. I'd like to thank Cary for his excellent work as our CFO for the past three years. Today will be his last earnings conference. Being a constant professional, Cary has worked with me and the rest of the team to ensure a smooth transition.In that context, I was very happy to announce last month the appointment of Mike Ensing as our interim CFO, while we run a rigorous process to recruit a permanent head. Mike is a highly accomplished CFO with over 25 years of experience and a demonstrated ability to lead financial and operational teams to create results. Mike and Cary have been working closely together for the past few weeks, and I’m confident we won’t skip a beat.So for the final time, let me pass the call to Cary to go through the numbers in detail. Cary?

[Cary Baker:]

Thanks, Rob, and good afternoon, everyone. In my remarks today, I will first review our consolidated fourth quarter results, followed by more detailed discussion of our segment business performance. I will then review our consolidated full year 2019 results and our expectations for the first quarter of 2020.Before diving into the results, please note that year-over-year and sequential comparisons are not always apples-to-apples due to the periodic variability in our revenues. Certain of our businesses, including the IP licensing part of Consumer Media business and mobile games within our Games business, can fluctuate quarter-to-quarter. But we will continue to update you on these timing impacts and their implications.Turning to our results. For the fourth quarter, revenue was $43.4 million compared to $45 million in the prior quarter and $16.6 million in the prior year. Napster accounted for $26.1 million of our fourth quarter revenue compared to $27.3 million in the prior quarter.Looking at these results in greater detail. Revenue within the Consumer Media segment was up $800,000 sequentially and up $400,000 year-over-year. The sequential and year-over-year increases were primarily driven by timing of shipments, payments and renewals in our IP codec business, which were partially offset by continuing declines in our legacy PC products.Mobile Services revenue was down $600,000 on both a sequential and year-over-year basis, primarily due to decline in our legacy products. Games revenue for the fourth quarter was down $600,000 sequentially and up $1 million year-over-year. On a sequential basis, the decline was primarily related to the strategic shift toward free-to-play games as we launched one fewer premium game title in the fourth quarter compared to the prior quarter. Year-over-year, the revenue increase was driven by continued strong performance from our free-to-play mobile games.Finally, Napster revenue was down $1.2 million sequentially, mainly due to declining subscribers, which was partially offset by increased revenues from our platform partners. Fourth quarter consolidated gross profit of $18.7 million was flat compared to the prior quarter and was up $5.9 million compared to the prior year period.As a percentage of revenue, gross margin was 43% compared to 42% in the prior quarter and 77% in the prior year. On a year-over-year basis, the decline was primarily due to the consolidation of Napster. With Napster’s gross margin for the fourth quarter of 2019 at 21%, while RealNetworks gross margin without Napster was 76%.As a reminder, the reduction in our consolidated gross margin primarily reflects Napster’s label and publisher royalties for its worldwide music services. These costs can vary meaningfully from period-to-period due to significant judgments, assumptions and estimates of the amounts to be paid.Total operating expenses for the fourth quarter were $24.6 million a decrease from $25 million in the prior quarter and an increased from $18.4 million in the prior year. Included in fourth quarter total operating expenses were Napster’s operating expenses up $7.1 million.Adjusted EBITDA for the fourth quarter improved to a loss of $2.7 million compared to a loss of $3.2 million in the prior quarter and a loss of $4.1 million in the prior year period. Net loss attributable to RealNetworks was $6.4 million or $0.17 per diluted share compared to a net loss of $6 million or $0.16 per diluted share in the prior quarter and a net loss of $6.9 million or $0.18 per diluted share in the prior year period.Turning to our fourth quarter segment results in more detail. Consumer Media segment contribution margin was $1.3 million compared to $300,000 in the prior quarter and a loss of $400,000 in the prior year period. On both a sequential basis and year-over-year basis, the improvement reflects higher revenue and decreased operating expenses as a result of our ongoing expense management.Mobile Services segment contribution margin was a loss of $2.7 million compared to a loss of $1.9 million in the prior quarter and a loss of $1.9 million in the prior year period. The sequential and year-over-year decline is due to lower revenues, primarily in our legacy products along with increased operating expenses primarily related to our investments in SAFR.Games segment contribution margin was $200,000, which was roughly flat compared to the prior quarter and compared to a loss of $800,000 in the prior year period. The year-over-year contribution margin improvement was primarily a result of our transition to free-to-play mobile games.Napster’s contribution was $200,000 compared to $40,000 in the prior quarter, primarily due to revenue mix. At the corporate level, unallocated corporate expenses of $3 million decreased by $500,000 compared to the prior quarter and were flat compared to the prior year period. The sequential decrease was due to reduced operating expenses, primarily from lower people related costs.Our fourth quarter operating expenses at the corporate level also included $400,000 of restructuring costs compared to $700,000 in the prior quarter and $600,000 in the prior year period.Now let’s look at a full year 2019 results. Revenue for the full year was $172.1 million compared to $69.5 million in the prior year. Napster accounted for $106.3 million of our 2019 revenue. Consumer Media revenue was $13.2 million down $5 million compared to 2018. Mobile Services revenue was $27.1 million down $2.5 million compared to the prior year. And Games revenue was $25.5 million up $3.8 million compared to the prior year.Gross profit was $69 million for the full year compared to $51.8 million in the prior year. Napster accounted for $20.4 million of our gross profit in 2019. Gross margin for the full year was 40% compared to 74% last year. The decline was primarily due to the consolidation of Napster. With Napster’s gross margin for the full year of 2019 at 19%, while RealNetworks gross margin without Napster was 74%. Operating expenses for the year were $101.4 million compared to $74.1 million in 2018. Napster accounted for $25.8 million of our 2019 operating expenses.Adjusted EBITDA for the year was a loss of $20.1 million compared to a loss of $16.2 million in the prior year. Net loss attributable to RealNetworks was $20 million for 2019 or $0.53 per diluted share compared to a net loss of $25 million or $0.66 per diluted share in 2018.Now turning to our balance sheet. At December 31, 2019, we had $16.8 million in unrestricted cash and cash equivalents compared to $18.1 million at September 30, 2019. The sequential decrease was primarily driven by the net loss. At December 31, 2019, our total long-term debt was $3.9 million and we had $6.1 million available for borrowing on a revolving credit facility. Now that our new products are starting to deliver revenue and the Napster transaction costs are behind us. We continue to expect our operations will use less cash going forward.I’ll now turn to our outlook for the first quarter ending March 31, 2020. Total revenue is expected to be in the range of $40 million to $43 million. And adjusted EBITDA loss is expected to be in the range of minus $4 million to minus $1 million.In summary, the progress we have made over the course of 2019, helped lay the groundwork for a productive 2020. We expect the momentum of our key initiatives, specifically free-to-play mobile games and SAFR will continue to drive incremental revenue for many years to come.With that, we will now open the call for questions. Operator?

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions]

[Operator:]

As there are no further questions left in the queue. I would like to turn the floor back over to Mr. Rob Glaser for any closing remarks.

[Rob Glaser:]

Thank you, operator. Again, I want to thank everyone for joining us. I want to thank Cary one last time for his excellent work over these past three years. I look forward to staying in touch there. And look forward to being in touch with all of you in the days and weeks ahead and certainly three months from now.

[Operator:]

This concludes today’s teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.