RealNetworks, Inc.
Q3 2015 Earnings Call Transcript

Published: 10 Nov 2015

[Operator:]

Welcome to the RealNetworks’ Third Quarter 2015 Earnings Call. At this time, all participants are in a listen-only until the question-and-answer session of today's conference. [Operator Instructions] Today’s conference is being recorded. If you have any objections you may disconnect at this time. I would now like to introduce our first speaker, Drew Markham. You may begin.

[Drew Markham:]

Thank you, Iris and welcome to the RealNetworks’ third quarter 2015 conference call. Before we begin, I’ll remind you that some matters today are forward-looking, including statements regarding RealNetworks’ future revenue, adjusted EBITDA, and operating expenses, 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, and invest in its products and initiatives, as well as the expected growth, profitability and other benefits from those 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 Web site. These forward-looking statements reflect RealNetworks’ expectations as of today, November 9, 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 Web site at investor.realnetworks.com, under the tab Financial Information. With me today are Rob Glaser, Chairman and CEO; and Marjorie Thomas, our CFO. Rob will discuss Company’s strategy and the progress the Company has made in recent months. Then Marj will provide a financial review of the third quarter of 2015 and the outlook for the fourth quarter of 2015. After their prepared remarks, they will be pleased to answer questions. Now, I’ll turn the call over to Rob.

[Rob Glaser:]

Thanks Drew. Good afternoon, everyone and thanks for joining us. Today, I’ll give you an update on the progress we made in the third quarter in turning around RealNetworks and putting the Company on a path to achieve sustainable growth in users, user engagement, revenue, and profit. I’ll cover four topics today; first, our new RealTimes strategy we announced last week and a very promising new partnership with Verizon in action currently; second, how we are reorganizing the RealTimes and RealPlayer teams to optimize for this strategy and to get our other operating expenses in line; third, the progress we are making in our Casual Games business; and fourth an update on progress at Rhapsody. First, we’ll update on RealTimes. Two years ago we launched RealPlayer Cloud RPC, a major initiative to reinvent our core Media Player franchise for the cloud and mobile era. Then six months ago we launched RealTimes an innovative product built on top of the RPC platform that enables people to easily turn their personal digital photos and videos into compelling stories. Through our own direct-to-consumer distribution, we've recorded over 14.5 million of registered users to these two products. In the past two years, we've created two great products and learned to lot about inventing compelling video and photo apps for consumers. Now we are applying these learnings to double down on what is working to pivot what is not working and to align our team behind this new strategy. As we announced last Thursday, we're refocusing our strategy to prioritize the following areas. First, we are leveraging partners, especially mobile carriers to drive scale for RealTimes. We've been working hard to put together significant partnerships in U.S. Japan, Europe and Latin America. Second, we're further upgrading up RealTimes to a wide venture partners by developing a RealTimes SDK that enables partners to deeply integrate RealTimes capabilities into their products and services. Third, we're moving to a bring-your-own-cloud model for RealTimes, while we'll continue to offer a complete solution including a limited storage, we think overtime that most consumers will use RealTimes in conjunction with other cloud storage solutions. Fourth and finally, on PCs, we will make the RealPlayer product and brand our primary focus going forward. We believe this strategy allows us to get our products into the hands of more consumers faster and allows the Company to start to monetize the experience more efficiently. In conjunction with our new strategy, last week we announced the new partnership with Verizon to integrate RealTimes directly into one of Verizon’s foundation products Verizon Cloud. This integration allows the 30 plus million users of Verizon Cloud to create real time stories directly from the Verizon Cloud app. The new integrated offering has just started shifting on Android and shifts on iOS later this month. This puts RealTimes capability directly into the hands on tens of millions of Verizon customers dramatically increasing our reach and lowering cost to customer acquisition. And it creates and demonstrates a model for integrating RealTimes into partner products and services that we intend to rollout around the world in the weeks and months ahead. This brings here my second topic, our new organization model. In order to put the right focus on our strategy and right size the team building these products, we are deemphasizing some other initiatives such as the PC RealTimes client and our end-to-end cloud offering. We're also moving off for a legacy e-commerce system and reengineering some related operations that will both reduce cost and provide some more flexibility. As a result of this reorganization about 60 people, representing about 10% of Real's worldwide staff, have left or will be leaving the Company in the weeks ahead. It's never easy to see value colleagues go and I want to thank you staff members for their excellent work. Taking together with our cost reduction efforts in recent periods, we expect to reduce our operating cost in the RealPlayer and RealTimes group by about $5 million through the quarter, while we see most of these savings in Q1. We expect to fully benefit by Q2. These changes demonstrate our commitment to taking balanced approach to focusing our investments in the best opportunities by scaling those investments based on results. Third, I want to talk about our Casual Games business. As you know, last quarter we sold our Social Casino business to Gaming Realms for $18 million. We did this for multiple reasons one of which was to enable us to focus on what we thought was the most promising part of the games business for Real the Casual Games business. I'm pleased to report that our Casual Games business grew by 15% sequentially in the third quarter, driven by the success of the Delicious franchise. Our team that runs this business led by Erik Goossens and Rutger Peters were based in the Netherlands has both stabilized the PC games service side of the business and has grown the mobile and studio side of the business. The latter has been achieved primarily through our first-party studios in Europe to create a successful games franchise called Delicious and have a solid pipeline of additional titles under development. While there will be quarter-to-quarter variations going forward, primarily based on release cycles of new games, we believe that our team has turned the quarter and is going to turn this business to growth. We expect to continue to reinvest profits in Casual Games in coming quarters to drive its growth, but do not expect to deploy new capital for organic needs. Fourth, I want to provide an update on Rhapsody, the online music service company of which we own a significant stake and support it through a role in the Board of Directors including my role as Co-Chairman. During the third quarter, Rhapsody continued to grow and broaden its footprint. We also won a Rhapsody Kids and entered in the Canadian market and do the national brand. As was previously announced, Rhapsody crossed 3 million paying subscribers in Q3 and continues to grow. While the streaming music service market is highly competitive for instance this year has seen the launches of Apple Music and Google's YouTube Red product. We continue to see significant opportunity as the entire music industry moves to make streaming the primary model for music consumption around the world. In summary while it would take longer than I hope when I returned to CEO three years ago, we have made progress. Plus our Casual Games business and Rhapsody are now growth businesses. We've a great new design win, and distribution partner for RealTimes with Verizon and we just streamlined the RealTimes and RealPlayer teams to improve efficiency, while still dedicating a very significant set of resources and talent to these best opportunities. I believe we will end 2015 in the strongest position operationally, since I returned to Real. With that, let me turn the call over to Marj, to review the financials, Marj?

[Marjorie Thomas:]

Thanks, Rob. Let's go through the results for the third quarter of 2015. For the third quarter, our total revenue was $30.8 million, taking out the partial serious results of the Slingo and Social Casino Games business which we sold to Gaming Realms on August 10th. Our revenue for the third quarter was 29.8 million compared to $31.8 million in the previous quarter and $32.7 million in the third quarter of 2014. The sequential decrease in revenue reflects the timing of fluctuations in our Mobile Entertainment business that we discussed last quarter. While revenue from some of our legacy products is declining, we are making significant progress to rebalance resources, reduce costs, and optimize our investments. Our total adjusted EBITDA for the third quarter of 2015 was a loss of $12.2 million, compared to a loss of $15.2 million in the previous quarter and a loss of $14.4 million for the third quarter of 2014. Excluding our Slingo and Social Casino business that we sold in August, we estimate that our loss would have been $10.9 million compared to an estimated loss of $12.5 million for the prior quarter and a loss of $10.9 million for the third quarter of 2014. For third quarter of 2015, our adjusted EBITDA loss was better than we guided, due to a favorable mix of business and our cost reduction efforts. Our total operating expenses, excluding restructuring related charges in Q3 were down by $3.4 million sequentially and $4.3 million year-over-year, due to the sale of Slingo and Social Casino Games and streamlining our ongoing operations. Note that our GAAP operating results for the third quarter of 2015 include $5.2 million restructuring charge of which 3.1 million is related to severance and the rest is related to the abandonment of certain leases as we reduce our office needs. Now let’s look at our quarterly results by business units, starting with the RealPlayer Group. For the third quarter, RealPlayer Group revenue was $6.6 million, down 11% sequentially from the prior quarter and flat versus the third quarter of 2014. The sequential decline in revenue was primarily due to the IP business which had a seasonal decline in Q3 despite its growth of 27% year-to-date compared to 2014. Although our RealTimes and RealPlayer Cloud products have not yet had a material impact on our revenue, we are encouraged by the potential of our new collaboration with Verizon and we’re working to form similar partnerships in coming periods. Adjusted EBITDA for the RealPlayer Group in the third quarter was a loss of $8.2 million, due to our investments in rolling out RealTimes and continued enhancements to our cloud-based products. Our mobile entertainment revenue was $16.4 million, down 11% sequentially from the prior quarter, due primarily to higher than normal revenue recognized in our Korean music-on-demand business in Q2. You will recall that in Q2, we had an increase in revenue, caused by the timing of our Korean music-on-demand attribution of royalties. This temporary fluctuation was associated with a new royalty tracking process stipulated by the Korean government. This is a relatively low margin revenue stream, so it had little impact on EBITDA. Adjusted EBITDA in the third quarter for the Mobile Entertainment business was $500,000. Our Casual Games’ revenue was $6.8 million up 15% sequentially from the prior quarter. We’re very pleased to see the growth and progress in this business. Revenue from our Slingo and Social Casino business that we sold in August contributed approximately $1 million compared to $2.2 million for the prior quarter. The adjusted EBITDA for our Games business in the third quarter was a loss of $700,000 excluding the Slingo and Social Casino business. However, we estimate that our EBITDA would have been a game of about $500,000. At the end of the third quarter, we had $112.2 million in unrestricted cash, cash equivalents and short-term investments. This is an increase of $1.2 million from our position at the end of Q2. During the third quarter, as we anticipated our cash benefited by $10 million from the sale of Slingo and Social Casino Games business. As we discussed previously, the remaining $8 million of the total 18 million sales price will be payable either all in cash or in a mix of cash and Gaming Realms’ stock at RealNetworks’ selection in two installments on the first and second anniversaries of closing. Our cash position also benefitted from the $5.2 million repayment in fall by Rhapsody of its outstanding loan to Teal plus interest. Note that our cash was negatively impacted by about $1.7 million in payments for severance and other restructuring expenses related to our cost reduction initiatives. As we discussed earlier in the call, we’re taking the necessary steps to reduce our cash burn and cost, while still investing judiciously for growth. As Rob underscored, we are streamlining our business and working to stabilize the Company. With the sale of Slingo and Social Casino Games behind us and based on our recent notifications to employees, we expect that we will have reduced headcount by approximately 180 people by the end of the first quarter of 2016 compared to the start of 2015. The actions we've taken over the last couple of quarters are expected to reduce our total cost run rate by about $6 million per quarter by Q2. This takes into account the sale of Slingo and Social Casino Games, the rebalancing of resources in the RealPlayer Group that Rob spoke about to align with our new strategy and our continued investment in the Casual Games business. Taking all these factors into consideration, we expect total revenue of $26 million to $29 million in the fourth quarter of 2015, with an adjusted EBITDA loss in the range of $5 million to $8 million. Please note, we expect a one-time non-cash benefit to operating expenses of approximately $2.5 million in the fourth quarter. While we have not yet completed our strategic transition and return to growth and profitability, we made progress during the third quarter of 2015 on executing our plan to revitalize RealNetworks. We've refocused our strategy for RealPlayer Cloud and RealTimes and formed an exciting new collaboration with Verizon. We sold our Slingo and Social Casino Games business and gotten our Casual Games business on the growth path. We have also significantly reduced our expenses and cash burn. Now, Rob and I would be pleased to answer your questions, operator?

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mr. William Meyers from Miller Asset Management. Sir, your line is now open.

[William Meyers:]

Okay. Could you talk about how the money works with the Verizon deal, do they pay for the Verizon Cloud and then you get some percentage of that or is there some other -- just go through the model, that would be great?

[Rob Glaser:]

Well, I'm sure you are interested in the answer of question. This is Rob. But what we said is that the terms of the agreement with Verizon are confidential and that's the nature of those relationships. So we do not expect to either breakout the revenue specifically or provide metrics specific to the Verizon deal. I will tell you the way the product works, which I think will give you some answer for the question, if you have a Verizon Android phone today you can see the product action where you will be able to assume they've been rolling it out in an install base. I got an update on Friday. So the way it works is, you have to have the latest version of RealPlayer Cloud or should I say RealTimes rather installed on your phone and if you don't you will be prompted to do so. And then when you can upgrade the Verizon Cloud app, it independently will show you stories in the app. It will assemble from the photos and videos that it has backed up in your cloud. When you see one that you are interested in, you push a button and it loads the RealTimes’ photo application and then if you do all the editing and manipulation in the app. So you basically are form of our developer kit is embedded in the Verizon Cloud app and therefore you're using our technology when you're in the Verizon Cloud app and you use it more when you find a story that you would like to work on and then it pulls up our full app. It's a very seamless integration model, but it is one application calling the other. That helps us in a few ways, one whatever the direct compensation is between RealNetworks and Verizon which has been disclosed. Second, it drives engagement with the RealTimes application from users of the Verizon Cloud app. Third, when you have users who have the Verizon Cloud app and Verizon has around 30 something million of its users that have the app and have the service installed and use it to varying degrees. If you don't have the RealTimes app, it will prompt you to download it. So we get distribution that ways while from the phone application. So, we benefit both directly but we're not commenting on in terms of that and we benefit indirectly because it drives distribution of our platform.

[William Meyers:]

Okay. That actually was helpful, but if I can ask one little further extension. So, if you already have or aren’t actually paying for RealTimes on say a regular computer or a tablet, does that then relate in any way to if you also get it on Verizon are those two totally separate things?

[Rob Glaser:]

So, if you are a paying RealTimes subscriber you get all the benefits you used to get nothing has changed with our value proposition. If you are a Verizon Cloud customer, you can store your stories in the Verizon Cloud in fact the stories will get stored automatically for you there, but if you will have the option of also continuing to use your storage separately and you will get either the free amount of storage that we offer all free RealTimes users, or you can upgrade for a premium storage. We also have a special offer for Verizon users where they get a special deal on an upgrade to our premium stories. I think we are currently selling that product for $2 a month and that's coming, it's an introductory price in offering, we'll see what our long-term program is but we're doing that as a encouragement for Verizon users who don't have our premium offering to get the premium features of our product without the storage and that's an offering that we’re making available with the Verizon product.

[William Meyers:]

Okay sounds good I'll be interested in seeing how it ramps.

[Rob Glaser:]

Do we have another question operator?

[Operator:]

Yes, sir. We have Mr. Dan Weston from WestCap Management. Sir, your line is now open.

[Dan Weston:]

I had a couple of them, one of which is on the Verizon deal so most of that got answered there Rob, but if I may I know you are not giving a whole lot of details at this point, but could you give us a little bit of color maybe Marj on maybe what do you think you potentially save on customer acquisition costs if future RealTimes subscribers are generated through your carrier partners?

[Marjorie Thomas:]

Yes. So, hi Dan, yes in Q3 we actually dialed back a bit on our awareness campaigns for RealTimes and RealPlayer and we expect that our marketing will probably come down somewhat from Q3 as well. I am not going to give guidance on the specifics of our marketing, but we do consider that we have to be a more economic way for us to get our app out in the hands of consumers with the Verizon deal and hopefully more of those to follow.

[Dan Weston:]

Okay. I'll wait to some of those. And then Rob maybe I missed it could you talk a little bit about your Codec and IP licensing business was there anything of note during the quarter?

[Rob Glaser:]

Well. I’ll let Marj talk about any of the numbers aspect of it. We introduced the RMHD Codec in China and that's in the rollout process over there in China it was a industry event over the summer that we introduced it out and then in terms of the deal some of the deals we have are a little lumpy where there will be a large amount of revenue licensed revenue recognized one quarter or another and I review that to Marj to explain that but no fundamental change in the business overall so Marj do you want to speak to that?

[Marjorie Thomas:]

Yes. So that's exactly the case and we did have a large deal in Q2 that we recognized right at the end of the quarter and that was part of the lumpiness that we saw in Q3. But yes things are going well with that business and that is actually another place where we anticipate some investment.

[Dan Weston:]

And then just last two quick ones. Maybe I missed it as well, but Rob can you or did you disclose what the total user base now is for RPC and RealTimes?

[Rob Glaser:]

The number we put out is -- we are doing our halfway in increments and we said we’ve now crossed 14.5 million users is the most recent number that we’re putting out on that, so we have to assign number every three months and as Marj mentioned in the run up to some of these partner distribution deals we pulled back a little bit on some of the non-organic or paid customer acquisition things because we were moving to what we thought and think is a more efficient model.

[Dan Weston:]

Very good thanks for clearing that up. And then finally I know it's not your company, but Deezer had some pretty big news during the quarter filing for an IPO and then subsequently cancelling it. Rob just because you are in the industry and you are kind of in the know is there any kind of dialogue you can share with us in terms of why do you think that happened why they were filing and then cancelled this a few weeks later?

[Rob Glaser:]

Of all the things that I know about the French IPO market is not one of them. So I can't give you insight as to what would make somebody think that a company was a good candidate to be in the French IPO market and what would subsequently make people think a company was not a good candidate to be in the French IPO market. I would say that if you look at Rhapsody’s business and obviously we disclosed a fair amount about it because of the fact the RealNetworks describes in our filings we made sure about it, but we don’t describe as much about it as these are files and there are various documents so I now know more about Deezer’s business from a financial profile standpoint that I did before and I know a lot of that Rhapsody’s business from the chair I sit in I think Rhapsody’s business is a far better business. We have a much more diversified set of partners no single partner dominates our business in the way that Orange French Telecom dominated their business so if they've got that great design win there, good for them, but clearly from our standpoint Rhapsody has a much more balanced portfolio of distribution partners our three plus million subscribers come from a variety of sources a significant number of direct to consumer and have the carrier partner based ones it's just -- we are probably depending how you count different countries and different carriers we've got eight or 10 significant partners that are driving six figure distribution each so when you look at our portfolio versus Deezer’s I think our product is a product to I think overall Rhapsody is a superior product since we grew business obviously I was supposed to think that but I think the information that we learned out of their filings reinforced IPO.

[Dan Weston:]

Fair enough. I appreciate the candor there and I will jump back in the queue. Thanks guys.

[Rob Glaser:]

Well I think that may be it for questions. We'll do last call if there are any more questions. Speak now or for three month hold your peace, hearing none, thank you all for joining us this afternoon. Hope people have a good rest of the week and thanks for joining us today.

[Operator:]

That concludes today's conference. Thank you for participating. You may disconnect at this time.