RealNetworks, Inc.
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Welcome to the RealNetworks' first quarter 2015 earnings call. [Operator Instructions]. I would now like to introduce our first speaker, Ms. Drew Markham. You may begin.

[Drew Markham:]

Thank you, operator, and welcome to the RealNetworks first quarter 2015 conference call. Before we begin, I remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks' future revenue, adjusted EBITDA, operating expenses and cash usage, and trends affecting its businesses and prospects for future growth and profitability. Other forward-looking statements include the company's plans to implement its strategy, invest in its products, and pursue its initiatives, as well as the expected benefits from these activities. All statements other than statements of historical fact are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. We describe these and other risks in our SEC filings. A copy of those filings can be obtained from the SEC or from the Investor Relations section of our corporate website. These forward-looking statements reflect RealNetworks' expectations as of today, May 6, 2015. The company undertakes no duty to update or revise any forward-looking statements made during this call, whether as a result of new information, future events, or any other reason. We will present certain financial measures on this call that will be considered non-GAAP under the SEC's regulation G. For a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure, please refer to the information included in our press release and in our Form 8-K dated and submitted to the SEC today, both of which can be found on our corporate website at investor.realnetworks.com, under the tab “financial information.” With me today are Rob Glaser, Chairman and CEO; and Marjorie Thomas, our Chief Financial Officer. Rob will discuss company strategy and the progress the company has made in recent months. Then Marge will provide a financial review of the first quarter and the outlook for the second quarter of 2015. After their prepared remarks, they will be pleased to answer questions. Now, I'll turn the call over to Rob.

[Robert Glaser:]

Thank you, Drew, and thanks, everyone. Good afternoon, and thanks for joining us. Today, I’ll give you an update on the progress we made in the first quarter in turning RealNetworks around and putting the company on a path to achieve sustainable growth in users, user engagement, revenue, and profit. I’ll talk about three topics. First, the progress of our most important new initiative, RealPlayer Cloud, second, the progress of the Rhapsody affiliate, and third, our efforts to both invest in growth opportunities and maintain financial discipline. First, RealPlayer Cloud. Moving into 2015, we’ve strengthened our foundation for the success of RealPlayer Cloud or RPC for short. As of today, I’m very pleased to announce that we have over 11.5 million RealPlayer Cloud registered users, up from about 2 million a year ago. RealPlayer Cloud currently runs on 13 different platforms, allowing seamless sharing across devices and in 10 different language versions, making it a truly global product. We plan to leverage the foundation we’ve laid with RPC in three ways that are not externally visible today but will become clearer in the months ahead. One is by a significant investment in continued product innovation. While RPC 1.0 is a terrific product, we see an opportunity to go well beyond RPC 1.0 to address significant unmet consumer needs in innovative and compelling ways. We expect to bring our innovations to market quite soon. The second way is via partnerships, building relationships with other technology and distribution companies such as mobile operators who can deeply benefit from the RPC technology and product and can bring us significant distribution and promotion. The third way is to invest in marketing initiatives to build consumer awareness and to significantly grow both our free and premium user bases. We schedule these earnings calls once a quarter, and they don’t always fall on the precise day that would allow us to explain everything we’re doing without tipping our hands or pre-announcing our plans. Suffice it to say, we’re excited about what’s coming. Second, I want to provide an update on Rhapsody, the online music service company which we own a significant stake in some of the Real team support through our role on the board of directors, including my role as co-chairman. During 2014, you will recall that Rhapsody achieved year over year subscriber growth of over 60%. During the first quarter of 2015, the company’s momentum continued to build. Indeed, in February, Rhapsody announced that it has achieved a worldwide paid subscriber base of over 2.5 million users. Rhapsody has successfully made the transition from being a PC service to being mobile first. Indeed, over 70% of its worldwide subscriber base is using Rhapsody exclusively on mobile devices. A key part of the progress has been globalizing Rhapsody through carrier partnerships. Under the Rhapsody and Napster brands, our service is now available in 32 countries. Moreover, Rhapsody continues to broaden its distribution channels, including a new relationship with Twitter, which allows Rhapsody’s users to easily share full songs in their native Twitter feed. This exemplifies how Rhapsody is innovating and taking advantage of trends in media consumption to reach new customers. We believe Rhapsody is creating a significant value for RealNetworks shareholders. Third, I want to talk about our commitment to both invest in our key growth opportunities and to maintain financial discipline. Over the past two years, we’ve achieved significant efficiencies in how we run our company. For instance, adjusting for restructuring charges and the warrant issue trust from Rhapsody, our quarterly operating expenses decreased by $11.4 million or 25% from Q1 2014 to Q1 2015. We continue to look for ways to gain efficiencies, even as we invest in our growth initiatives, and we will continue to do so. Through these efforts, we plan to significantly cut our cash burn in the second half of 2015 as we start to translate our new initiatives into both user and revenue growth. Of course I wish that our growth initiatives would drive new scale and revenue even faster. Having said that, our largest investment and main growth initiative, RealPlayer Cloud, follows a premium business model. This means that it scales up in terms of users and usage first, before we see revenue scale up. This model has yielded great results for a number of excellent companies and we remain optimistic regarding our prospects to achieve a similar result in the months and quarters ahead. With that, let me turn the call over to Marge to review the financials.

[Marjorie Thomas:]

Thanks, Rob. Let’s take a look at the results for the first quarter of 2015. For the first quarter, our total revenue was $30.6 million, compared to $35.5 million in the previous quarter and $45.7 million in the first quarter of 2014. While revenue from our legacy products is declining, we are investing in our future and executing on our strategic transition to build a stronger foundation for future growth and profitability. Our total adjusted EBITDA for the first quarter of 2015 was a loss of $14.2 million compared to a loss of $13.9 million for the first quarter of 2014. For the first quarter of 2015, our adjusted EBITDA loss was better than we guided, due in part to a favorable mix of legacy business. In addition, our loss in the first quarter was partially mitigated by compensation from Rhapsody of about $1 million for past services provided by RealNetworks employees in the form of a warrant and our decision to pay a portion of our senior employee compensation in stock instead of cash to better align individual incentives with company goals, which had a favorable impact on EBITDA of approximately $1 million. In order to lay a foundation for growth, we are allocating our resources and capital toward our most promising new products, and as Rob said, during both 2014 and Q1 2015, we reduced our operating expenses and legacy businesses significantly. Now let’s look at our quarterly results by business unit, starting with the RealPlayer Group. For the first quarter, RealPlayer Group revenue was $8 million, down 10% sequentially from the prior quarter. This decline in revenue was primarily due to the expected decline in our legacy business. Although RealPlayer Cloud product has not yet had a material impact on our revenue, we are encouraged by the continued growth in the RealPlayer Cloud’s user base. That growth did slow somewhat in the first quarter when compared to the rapid growth of prior quarters, but note we did not release a new product update in Q1 and we made the decision to shut down certain distribution channels that proved to be unprofitable. Adjusted EBITDA for the RealPlayer Group in the first quarter was a loss of $7.9 million, due to our investments to further develop RealPlayer Cloud. Our mobile entertainment revenue was $14.5 million, down 18% sequentially from the prior quarter, caused by a temporary decline in our Korean music on demand revenue based on a change in attribution of royalties. This is a relatively low margin revenue stream, so it had little impact on EBITDA. We expect this revenue to return to near-historic levels in the coming periods. Our mobile entertainment revenue also had a negative foreign exchange impact of $300,000 in the first quarter of 2015 compared to the prior quarter. Adjusted EBITDA in the first quarter for the mobile entertainment business was $200,000. Games revenue was $8.1 million, down 10% sequentially from the prior quarter. The decrease in games revenue reflects the ongoing industry transition from PC games to social and mobile games, resulting in lower subscriptions and unit sales of our traditional products. While the Emily’s and Slingo franchises are growing, they’ve not yet offset the decline in the other parts of the games business. Our games revenue also had a negative foreign exchange impact of $300,000 in the first quarter of 2015, compared to the prior quarter. The adjusted EBITDA for our games business in the first quarter was a loss of $2.8 million. At the end of the first quarter, we had $134.4 million in unrestricted cash, cash equivalents, and short-term investments. During the first quarter, we had two special situations that impacted our cash. First, we provided a $5 million loan to Rhapsody in connection with a strategic opportunity that Rhapsody is pursuing. Second, our cash was also impacted by approximately $3 million in cash outlays associated with our Korean music on demand business, and we expect one additional cash outlay of approximately $4 million in Q2 for this business and none after that. We also had payments of severance and other restructuring expenses relating to our cost reduction initiatives. While we’re making the necessary investments to return the company to growth and profitability, we’re keeping a careful eye on cash burn and cost management. Beyond our operating results, our GAAP net loss was impacted by $6.2 million in the first quarter, relating to our investment in Rhapsody. This charge is based on Rhapsody’s GAAP results and certain accounting adjustments at RealNetworks. This accounting is more fully described in our Form 10-Q, which we expect to file with the SEC tomorrow. Note that Rhapsody’s adjusted EBITDA was a loss of $3.1 million, which was in line with expectations. Look forward, we expect total revenue of $30 million to $33 million in the second quarter of 2015. While investing for the future, we are focused on being disciplined with our operating expenses. Taking all these factors into consideration, we expect our total adjusted EBITDA for the second quarter to be a loss of $18 million to $21 million. In the second half of the year, we expect to see our losses and cash burn decline as we anticipate growth and improving margins. While we have not yet completed our strategic transition and return to growth and profitability, we made progress during the first quarter of 2015 on executing our plan to revitalize RealNetworks. We have over 11.5 million users of RealPlayer Cloud. We’re managing our noncore legacy products for efficiency while investing in the future, and our financial investment in Rhapsody continues to look promising. With the growth and improving margins that we anticipate in the second half, our cash position is solid and allows us to invest in our business and take advantage of strategic opportunities as they arise. Now, Rob and I would be pleased to answer your questions. Operator?

[Operator:]

[Operator instructions.] Our first question comes from the line of Mr. Eric Wold with B. Riley.

[Eric Wold:]

Marge, on the guidance for Q2 of $30 million to $33 million, it’s comparable to the original guidance you gave for the first quarter. Can you talk about the underlying puts and takes between the three segments? Are they relatively flat all three of them, quarter to quarter?

[Marjorie Thomas:]

We typically do not provide guidance on our segments. So I’m really not prepared to answer that question.

[Eric Wold:]

Understandable. And then on the RealPlayer Cloud, great growth in terms of users. Can you give any color in terms of the number of paid subscribers you have now, and when do you expect to see meaningful improvements in paid subscriber conversion at that service?

[Robert Glaser:]

As I mentioned, we are obviously very focused on this business. It’s the cornerstone of our future. We mentioned that there are three major areas we’re focusing on to drive the growth of the business. One is new product initiatives that we’re very excited about. Two are some distribution partnerships that we’re also very enthusiastic about. And third is significant ramping up of marketing. In the first quarter, we did what I would call some cleanup work, which is typically of what you do in advance of getting ready to really roll the tanks, so to speak. And so we looked at our current marketing channels, culled the ones that fell below the line in terms of their performance, and got ready to roll the scale up, activities associated with all three of those areas. As I said in the call, the timing of this call is not optimal for being able to explain where we’re going. And I think in the fullness of time, hopefully people will be able to connect what I’m saying today with what we say in the future.

[Eric Wold:]

And then a couple more questions on the financials. With relatively flattish sequential revenues, obviously a big tick down in guidance in terms of the adjusted EBITDA, which likely correlates to the spend around RealPlayer Cloud. Help us connect the pieces towards your thoughts around getting to stronger levels and less cash burn in the back half of the year. I know you talked about expecting a revenue ramp, but would it have also an opex reduction as well? Or is this kind of the ongoing level of opex that we’re seeing in Q2?

[Marjorie Thomas:]

When you look at our business, we certainly have the legacy business and then we have the product initiatives that we’ve really been focused on, of which RealPlayer Cloud is definitely the biggest. And what you’re going to see is a mix shift. We continue to run our legacy businesses for efficiency and profitability, so you’ll see the expenses of that part of the business decline. But as we ramp the newer parts of our business, we anticipate that things like marketing will continue to improve. That being said, we’re constantly looking at overall G&A and other areas of the business where we can reduce our spending and just get more efficient.

[Eric Wold:]

The $5 million advance to Rhapsody, can you give us any color on the terms of that? Is that convertible into equity, or is that just a pure loan? And then separately, if necessary or if you wanted to, what is your ability to monetize some or all of your stake in Rhapsody in your own transaction, away from what Rhapsody may decide to do? Or do you have to kind of wait for them to make a move on that?

[Robert Glaser:]

I was going to answer your previous question before answering Rhapsody. All I was just saying is that obviously I mentioned the fact that we’re planning to scale up marketing in the core product area. And our focus there is clearly going to be on two things. One, to really make sure that we have the right share of mind and share of voice with the product. And second, to make sure that we’re spending money on marketing where it performs. Those are two different kinds of marketing. Obviously, in your dream case, you hit both objectives, but I think it’s fair to say that we’re going to be pursuing both kinds of marketing, some of which will be highly performance based and some of which will be about creating air cover for the rest of the program. And we think that’s an appropriate thing to do and we’re being very disciplined about that. Our forecast about cash burn includes our plans to do that. So this is not like we’re not factoring that in. Now, switching to the Rhapsody question, we obviously are circumspect about what we talk about in terms of the governance of Rhapsody. But we do believe that Rhapsody is a valuable company and is making progress. Columbus Nova are really good partners. They have been for two-plus years, and their arrival on the scene has been an ingredient to the success of scaling up the business. We would have the ability, subject to a complex set of rights that I won’t go through here and that aren’t all fully public, to monetize our stake independently of Columbus Nova, were we to so choose, but we also are in a partnership with them, so we would work with them to figure out what was optimal, were we to decide to go in a different direction than the direction we’re in now, which is running the business, scaling it up, and then being thoughtful about when the time is to leverage the asset. And that’s like anybody who holds significant stakes in assets where you [unintelligible] stake to have a seat at the table. In this case, we’ve got three board seats, but it’s not a controlled entity. So once we decided to go below 50%, we took the view that ultimately this would be monetized by fully passing the baton to some other entity. This public company is a form of that, but we have not made any decision, and the nature of these calls is we won’t telegraph our intentions. You’ll hear about any decision we make after it’s implemented. With regard to the loan, it’s a Rhapsody confidential situation, so we’re not prepared to say more than that, other than that at the time, we and our fellow shareholders in Rhapsody thought that it was a worthy thing to make that investment in. So this was not something that RealNetworks did unilaterally. It was done jointly with our partners in Rhapsody as well as the company as a whole.

[Operator:]

Our next question comes from the line of Mr. Chip Saye of AWH Capital.

[Chip Saye:]

Marjorie, if you don’t mind, could you give a little more detail on Eric’s question, when he asked about the reduced cash burn in the second half? I understand you’re going to have lower costs associated with your legacy business, but is it going to be more of a situation where we get an increase in revenues in the existing businesses, including RPC, or is it going to be further cost reduction? Can you just talk about that a little more?

[Marjorie Thomas:]

What we anticipate is that our revenue will grow by the end of 2015. So that would obviously be a component of our cash burn mitigating. And as I mentioned before, a combination of expense reductions and then as Rob alluded to, very targeted increase in marketing for new products. There will be a bit of shift as far as our expenses are concerned.

[Chip Saye:]

So you’re thinking that may offset each other, the expense reductions and the marketing?

[Marjorie Thomas:]

Well, we’re not really prepared to talk about the second half. We’re not giving guidance on that today.

[Robert Glaser:]

But clearly, you have three countervailing things. One, efficient management of our legacy businesses and being very careful and measured about cost, and I mentioned the 25% year over year overall reduction in operating expenses, which is certainly very significant. Second is clearly the investment from both a product side and a marketing standpoint respectively in our main growth initiative, RealPlayer Cloud. And then third, there’s revenue coming out of that initiative. And so you’ve got the first one lowers costs, the second one raises costs, and the third one raises revenue in a way that would cause, all other things being equal, operating results to improve. So what we’re saying is our belief is when you add up the combination of those three, the bottom line significantly improves in the second half of the year.

[Chip Saye:]

And the cost reduction, is it across the board? Is it in certain segments of your business? Can you talk further on that?

[Robert Glaser:]

We are always looking at managing cost and the fact is, as I said, we have a track record of managing our cost carefully. I think it speaks to the fact that we’re constantly looking at ways to get more efficient within our company as a whole, and especially our legacy businesses.

[Chip Saye:]

A couple more if you don’t mind. You spoke to the unfortunate date of the earnings release coming today and maybe right before you have an opportunity to reveal some big news. Will we get the big news between now and the second quarter earnings call?

[Robert Glaser:]

It would have been silly for me to say this today, if that weren’t the case. But I’m not going to say anything more specific than that.

[Chip Saye:]

Okay. Well, I appreciate it. I understand this is an important asset to you, and you’re watching the cash like a hawk, but the cash burn continues to concern us.

[Robert Glaser:]

Okay. We hear your feedback.

[Operator:]

Our next question comes from the line of Mr. William Meyers from Miller Asset Management.

[William Meyers:]

I was hoping you could tell me this deal with Rhapsody and Twitter, is that possibly a revenue generating deal? Or is that basically something where you’re effectively getting free advertising?

[Robert Glaser:]

The nature of the deal is, effectively, you should look at the tweets that people can do that have full traction as an exchange of value focused for value, where consumers put those tweets out there and they end up driving people to sign up for Rhapsody. We’ve been operating it at sort of an experimental scale in the first couple of months, but you can envision a scenario, given the massive scale of Twitter, that if it’s something that you really like the performance of, you could put some serious promotion behind it and drive scale. So our approach for it was as a customer acquisition vehicle for either immediate paid subscribers or people that would get the tweets and go into trials, and [unintelligible] to convert to paid. So the monetization is not directly through Twitter. The monetization is through the promotional vehicle of Twitter. We are not paying Twitter for the tweets. They are tweets that are done by whoever wants to do them. It’s a platform capability that we are among the first to exploit with major label content.

[William Meyers:]

Sounds smart. Then in your games division, at this point, there’s been a bit of a decline in revenue. Are you seeing good growth in use of the newer things like Slingo? Or is it more a question of monetizing the Slingo?

[Robert Glaser:]

I’d break it down to a few areas, because the games business has two parts. It has the legacy business that you could think of as the casual business, and then it has the social casino business. In the casual business, we are in the process of moving it from a PC-centric business, which is what it was when I came back. And we brought in some excellent guys who ran the company Zylon that we acquired, and they ran our European business afterwards. So they were former RealNetworks executives as well, as entrepreneurs. And they’re now running the global casual games business and moving it to a multiscreen model. And they’re making solid progress on that. We feel very good about their leadership and their efforts there. But that’s certainly something that is a multiquarter transition process, because of building that capability to go from PC-dominant games to a mix of PC, phone, tablet, and all of the formats and create services that span those. So we’re seeing significant growth in the non-PC part of that, but it’s early in the monetization of that non-PC piece, because it’s got to get to reasonable scale for the monetization to move the meter. In the social casino space, Slingo Adventure has now been out on all platforms, I guess Q1 was the first full quarter of being out in general release on all platforms. So we’re seeing continued growth there, but the puts and takes when you look at that product versus some of our legacy social casino products and more generally our legacy products results in the bottom line that you saw, as described. So Slingo continues to be the flagship of the social casino business, and we’re going to focus on continuing to scale it up.

[William Meyers:]

And there was one more thing, which is the Korean cash. I wasn’t actually clear. I know you went through it, but if you could just go through again the Korean cash payments in Q1 and Q2, what those are for.

[Marjorie Thomas:]

So, part of our Korean business, we basically help operate a digital music service over there, and part of our duties are basically to collect the royalties from digital music providers and pass them to the agents, who then send that to artists. And the Korean music industry is going through a change in their royalty tracking process right now. And they had a few getting started situations where they weren’t able to attribute all the royalties to the right agents. So that’s why we saw kind of this temporary decline in our revenue in Q1. So they have been able to fix all those issues and now it’s just a matter of the parties verifying everything, so we’re highly confident that that revenue is going to come back in Q2. And as I mentioned, it’s a fairly low margin business, as you can imagine. So it doesn’t have a substantial impact on our EBITDA.

[William Meyers:]

I guess what I don’t understand, then, were the figures you gave a reduction in revenue, or were they actually cash payments going out?

[Marjorie Thomas:]

So there’s a little bit of both. There was a reduction in revenue, and of course accrual based accounting there. But then the other piece of this process, as they move to the new process, in the past, we would get the cash from the digital music providers and then sometimes it would take up to two months for us to just ensure that the cash passed to the right agent. Now, with the new process, it’s going to be virtually on demand, a much more seamless process. So part of what’s happening is whereas we had kind of a timing buffer before of when our cash came in and our cash went out, now that buffer is going to decrease over the next two quarters.

[Operator:]

Our next question comes from the line of Mr. Aron Pinson of LPS Financial.

[Aron Pinson:]

A quick bookkeeping question for Marge. The equity loss in Rhapsody, the $6.2 million, which line in the balance sheet did that come off?

[Marjorie Thomas:]

We have an investment in Rhapsody in our long term assets, and it would have come off of there. Now, what you’ll also see is the $5 million loan has also been put on that same loan, so it says “Rhapsody investments and advances.” So that’s probably why you’re not really seeing it.

[Aron Pinson:]

Right, I see an increase from $10 million to $10.7 million. So you’re saying the $5 million was added, the $6.2 million came out? It would be $11.2 otherwise, right?

[Marjorie Thomas:]

Right, yeah. You know, you are getting into very technical equity method accounting right now, and there were some additional basis adjustments that were in a memo account that, because of a preference that we actually have with Rhapsody, were not taken to our balance sheet until this quarter. So that’s why you are seeing an adjustment, and you can’t really make a straight additive and subtractive compare.

[Robert Glaser:]

The reason why we disclosed the adjusted EBITDA for Rhapsody was for you guys to have that as a basis. Tomorrow, whenever the Q comes out, you’ll see the numbers we normally provide on Rhapsody quarter numbers. It turns out that because of certain transactions that Rhapsody engaged in, that are not cash related, you’ll see sort of a different number. So the number $6.2 million is not 43% or whatever percent of the loss of Rhapsody’s quarterly number, and the EBITDA number that we put out today is the better proxy for sort of “how Rhapsody’s doing” in our view, in my view, certainly. And when we disclose the rest tomorrow, as we normally do in the Q, you hopefully will connect the dots. After that, you can talk to Marge and she can help you walk through them. But having studied this carefully, because the numbers are significant enough for me to need to do so, I can affirm that I am no GAAP accounting expert. But we have excellent GAAP accounting experts onboard, whose explanations are consistent, and once you understand the GAAP rules, completely sensible.

[Aron Pinson:]

But the equity in Rhapsody, obviously the business can be doing great, but on the balance sheet, bottom line is it went from $10 million to closer to $6 million on the balance sheet. Just to reconcile up back to $10.7 million or $11 million, it was because that $5 million loan was added to the investment?

[Marjorie Thomas:]

That’s right.

[Aron Pinson:]

Okay. And you guys said about the adjusted EBITDA, $3.1 million, I think that’s what you guys said. You never reported this in prior quarters. Are you going to provide us with, let’s say, some historical numbers to see what that can be referenced to, even on a quarterly basis over the last couple of years? Because in the past you only provided gross profit and net loss.

[Robert Glaser:]

We decided to do this this one quarter, because otherwise, the numbers would be a little hard to wrap your mind around. But this was an unusual quarter because of the loan, because of a few other things. So I would say if we have future unusual quarters, where the adjusted EBITDA number is a helpful compass, we will do it again, but we are not intending to certainly go back historically and give our whole base of comparables. The only historical numbers you would have would be the GAAP EPS numbers that we put out every quarter.

[Operator:]

At this time, speakers, there are no questions on queue.

[Robert Glaser:]

With that, operator, thank you all very much for joining us this afternoon. I look forward to talking to you again soon, and hope everybody has a great afternoon and an excellent spring.