RealNetworks, Inc.
Q1 2016 Earnings Call Transcript

Published: 8 May 2016

[Operator:]

Welcome to the RealNetworks First Quarter 2016 Earnings Call. At this time all participants are in listen-only mode. After the discussion we will have a question-and-answer session [Operator Instructions]. Today’s conference is being recorded. If you have any objections you may disconnect at this time. I would now like to turn the call over to our first speaker, Drew Markham. Thank you, you may begin.

[Drew Markham:]

Thank you, Vince, and welcome to the RealNetworks’ first-quarter 2016 conference call. Before we begin I remind you that some matters discussed 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 pursue its initiatives as well as the expected 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 website. These forward-looking statements reflect RealNetworks’ expectations as of today, May 5, 2016. 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 the company’s strategy and the progress the company has made in recent months, and then Marge will provide a financial review of the first quarter of 2016 and the outlook for the second quarter. After their prepared remarks they will be pleased to answer questions. Now I will turn the call over to Rob.

[Rob Glaser:]

Thanks, Drew. Good afternoon, everyone, and thanks for joining us. Today I will review and discuss our results for the first quarter of 2016. In today’s call I want to focus on three macro topics. One, our continued progress in stabilizing RealNetworks’ business, managing costs and setting us up for a return to growth and profitability in 2016. Two, how and why we have realigned our business unit to set us up for this next chapter. And three, our progress in strengthening the leadership team going forward. First our progress in stabilizing our business. Our revenue in Q1 was $28.2 million, very close to the $28.8 million in revenue we achieved in Q1 of 2015 excluding the Slingo and Social Casino games business which we sold last August. While we still have some legacy businesses that are declining, we are starting to see new products kick in across our business sectors, games, mobile services and consumer media, that we believe set us up to return to growth by the end of 2016. Of particular note in Q1 is the new design win we announced with Vodafone in Europe for our RealTimes mobile product. Vodafone joins Verizon in the U.S. and KDDI in Japan as Tier 1 carriers who are integrating RealTimes into their own suite of cloud-based services. We have also continued to focus on getting more efficient. We have reduced operating costs by 16% compared to the first quarter of 2015. These cuts allow us to move closer to breakeven while also enabling us to continue to invest in new products and services. Second, I want to talk about how we have realigned our main business segments to set us up for future success. The first step in doing so came last summer when we decided to focus our games business on casual games and sold our Social Casino games business to Gaming Realms for $18 million. Last month we announced a reorganization of our other two businesses which we now call Mobile Services and Consumer Media. Our Mobile Services division combined the businesses that were in our Mobile Entertainment group with our RealTimes Mobile product. As a result we now have one integrated business unit that is focused on delivering mobile products and services to consumers primarily through partnerships with mobile operators. The main reason for this realignment was that our best business successes and biggest opportunities for RealTimes were with mobile carriers and that bringing an innovative product such as RealTimes to the carrier channel was having a positive effect at revitalizing the channel for Real in general. The new Mobile Services group is headed by longtime RealNetworks executive Max Pellegrini who previously ran our Worldwide Products group. Our other division, Consumer Media, combines our RealPlayer product and business with what we call our IP business which includes video and audio compression and media playback software for consumer devices that we primarily license directly to consumer electronics companies. As part of our recent organization I’ve become the acting head of our Consumer Media division. The latest product to come out of our IP group is our next generation video codec which we call RealMedia HD, or RMHD for short. As we previously discussed, RealMedia HD delivers substantial quality improvements over the current industry-standard H.264 while requiring substantially less computing power than the proposed next-generation standard H.265. RMHD allows our partners to meet the demands of consumers’ increasing mobile video consumption on a wide range of devices while using less device resources and battery life. In the initial phase of the launch we focused RMHD on the Chinese market where a very strong market position in media formats. In fact, we are happy to announce that Huawei, one of China’s largest mobile handset manufacturers, is our first customer to license RMHD. Last week I was in China and expect to continue to work very closely with both our teams in China and our team in Seattle as we figure out the best way to lever the combination of the RealPlayer franchise and our exciting new HRMAT technology. In some ways we see the opportunity similar to the one with leveraged 21 years ago when we first launched RealAudio or 19 years ago when we first launched RealVideo. Of course the digital media marketplace is much more crowded than it was 20 years ago, but we nonetheless think there is a great opportunity to open up new markets based on great new technology. My third topic is our progress in significantly strengthening Real’s management team to enable us to take the greatest advantage of the opportunities in front of us. In particular we brought in two outstanding senior executives in the past month. The first is Reza Rassool who joined us about a month ago as our new Chief Technology Officer. Reza has a great track record of driving innovation and new product development in a number of areas that are highly adjacent to our current businesses. Reza is the first companywide CTO we have hired since I came back to Real 3.5 years ago. This was because in the first phase of our turnaround we were focused on driving independent innovation in each of our businesses. Now that we have started to see those efforts bear fruit, such as RMHD and RealTimes, we believe the time is right to bring together and leverage these innovations across our businesses. The second great senior addition to our group is Mike Davis, our new Rhapsody CEO. Prior to joining us Mike served as CEO of Alliance Entertainment where Mike unlock tremendous value for Alliance and its major shareholders including Gores and Platinum. Prior to Alliance Mike spent 13 years at Universal, the largest recorded music company in the world. At Universal Mike played a senior role in the company’s distribution division and then served as Executive Vice President and General Manager of Universal Music Enterprises. Bringing Mike into Rhapsody was a joint effort of the full Rhapsody Board, including our main Rhapsody partner, Columbus Nova. Mike is off to a fast start; I think he will do a great job leading Rhapsody into the future. While the market is highly competitive we continue to see significant opportunities for Rhapsody as the entire music industry moves to make streaming the primary model for music distribution and consumption around the world. In summary, I believe we are well-positioned to return to growth in the three main business segments in which we will operate and to see continued growth in our Rhapsody affiliate. With that let me turn the call over to Marge to review the financials.

[Marjorie Thomas:]

Thanks, Rob. Let’s go through the results for the first quarter of 2016. For the first quarter revenue was $28.2 million compared to $29.9 million in the previous quarter and $28.8 million in the first quarter of 2015, excluding the revenue from the Slingo and Social Casino games business which was sold during the third quarter of 2015. While revenue from some of our legacy products is still declining, and you can expect quarter-to-quarter fluctuations, we are pleased to see our revenue levels stabilizing. And we believe our efforts to rebalance resources, reduce costs and optimize our investments are paying off. Our total adjusted EBITDA for the first quarter of 2016 was a loss of $8.1 million, compared to a loss of $4.2 million for the previous quarter and a loss of $10.8 million for the first quarter of 2015, again excluding the results of the Slingo and Social Casino games business. We have taken steps to reduce costs in recent quarters, which is reflective of the year-over-year improvement in EBITDA. We reduced our OpEx by 16% in Q1 2016 compared to Q1 2015, excluding stock compensation, restructuring charges, the Slingo and Social Casino games business, and the impact of a non-cash warrant from Rhapsody that benefited our operating expenses in Q1 of 2015. Our operating expenses for the first quarter of 2016 were higher than the fourth quarter. This increase reflects the over $3 million of one-time fourth-quarter benefit that I talked about in our last earnings call, some increased investment in casual games and stock compensation granted in Q1 for the 2015 employee incentive bonus plan. And there were also some seasonal increases in expenses that are typically higher in the first quarter of a year. Following the realignment that Rob just described, we now manage our business and report revenue and operating results in the following three segments

[Operator:]

Thank you, ma’am. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mr. Eric Wold with B. Riley. Your line is now open.

[Eric Wold:]

Thank you and good afternoon. A couple questions. I guess, one, first off on the Q1 results, Marge, I assume we will see more when the Q comes out, but any reason why there was no recognition of any income or loss from Rhapsody in the quarter?

[Marjorie Thomas:]

So, as you know, Eric, we account for Rhapsody as an equity method investment. And due to the fact that from a book value perspective where we are at a zero book value there is nothing that comes on and off our income statement now.

[Eric Wold:]

Okay, so that will be the case going forward for the remaining quarters?

[Marjorie Thomas:]

That is right.

[Eric Wold:]

Okay. And then just want to clarify Rob’s comments at the beginning – or I guess both of yours, getting back to growth and profitability in 2016. So, I am assuming getting back to growth means sometime before the end of the year we’ll have year-over-year growth in the segment, assumedly toward the end of the year. And sort of clarify the profitability comment. Does that mean you expect to get to profitability on a quarterly basis by the end of the year? And if that is the case kind of maybe help us get there from the current loss level to more of a breakeven profitable level, what are the major drivers there?

[Rob Glaser:]

Well, what I believe we said in the past – and in today’s comments my intention and our intention is to reaffirm them, not to modify them – is that we think 2016 will be a growth year for the company versus 2015 certainly when you exclude the discontinued business, the sold business, the social casino games business. So that means that our revenue for 2016 will be bigger than 2015. For profitability what we have said and what my statements are intended to reaffirm is that during 2016 we return to profitability, but we made no statement about the aggregate profitability for the year. So our statement is that there is four quarters in a year and that presumably if it is in 2016 it is in the fourth quarter if not sooner we will return to profitability as a company. So in terms of how you get there you can raise the bridge or you can lower the river, is the blunt answer to the question. As Marge said, Q1 had a certain set of things in it that are sort of structurally frontloaded, if you will, from a cost standpoint. Some of those are going to taxes and kind of normal stuff. We had a few things in our business that are specific to our business. Marge can take you through whatever she said publicly about those to – not to open new ground up but to clarify anything she said. But we believe and we still obviously have work to do to get there, it is not shooting fish in a barrel. But we see a path to driving our growth rates up – our growth quantities up and combined with continued careful management of costs to get into the black during 2016 by the end of the year in a way that sets us up for doing that on a continuing basis.

[Eric Wold:]

That is helpful, Rob. I guess just one final question. I don’t know how much you can say individually about each of the partnerships, but you kind of think about Verizon, KDDI, Vodafone. Maybe help us understand when each of those have started kind of being offered to their subscriber bases and, for the ones that haven’t, when that plan is in place?

[Rob Glaser:]

So, both KDDI and Verizon started to roll their products out that include integration with our products at the end of last year. So, we are just starting to see it. And they have multiple channels and multiple touch points. So once they start to roll something out it phases up from there. Vodafone, we announced the relationship at the end of March – in February, beginning of March in Mobile World Congress with the intent to roll service out to end users and consumers later this year. Vodafone has what they call OPCOs or operating companies in several different parts of Europe. So what happens is you get a design win from Vodafone global, but a corporate sort of overseeing group. And then you work country by country for the rollout plan. So you would typically see Vodafone rollouts happening one country then a second country then a third country and so on. So they are phased in a different way than Japan where KDDI has won national network or Verizon where they have a couple different brands but they basically – each brand is a national brand.

[Eric Wold:]

Perfect, thank you both.

[Operator:]

Thank you. Our next question comes from Mr. William Meyers with Miller Asset Management. Your line is open.

[William Meyers:]

Hi, thanks for taking the question. I would be interested in knowing more about RealMedia HD. And I think you said something about there being a different codec that was the planned future standard. Could you explain how that works and what advantage or disadvantage there might be for a Company adopting the nonstandard codec?

[Rob Glaser:]

Great, happy to speak to that. So in the world of the Internet in particular there has always been a mix of codecs, you could say media formats because format involved more than codec, but sometimes people use those words interchangeably. We historically have done a mix of both where we will support industry standards. And when we see innovation opportunities we’ll create innovation. We started with an audio codec, RealAudio, then we created various flavors of both RealAudio and then starting in 1997 RealVideo. And that had been a good business for us as a means of basically creating innovation and differentiation of our products compared to products that only supported industry standards. We – basically when H.264 came into the market and sort of became a standard for many, many parts of the Internet we stepped back and we looked at where there were opportunities to do things beyond standards and – because we’re 264 in basically all of our relevant products. And we reached a conclusion that there were opportunities starting with the Chinese market. In the Chinese market the real format, which is commonly called RMVB, continues to be very vibrant. You can measure it different ways but there are certain segments where we have upwards of 30% share of the content that is available in those formats or in those segments of the market in China. So we put together a team based in Beijing to build the next-generation codec with the initial design goal to look at opportunities to do something that was meaningfully better than RMVB, our current best proprietary codec, meaningfully better than H.264, the current standard codec, and then with an eye towards being competitive with and hopefully superior to the next generation of standard codec. What we ended up creating with RMHD sort of achieved and in some ways over achieved those objectives. Substantially better in terms of quality and compression in both RMVB and H.264. Probably between 30% and 40% better than H.264 depending on the content type, which is to say that a file of equal quality in H.264 we could make 30% to 40% smaller in RMHD. So that is a competitive advantage that is significant. When we compare it to the next generation proposed standard codec, which is called H.265 or some people call it HEVC, it’s the same thing, you’ll hear it referred to by both names. We are very competitive in file size. Typically HEVC is a little bit smaller, but it depends on the content. But we are very, very competitive with regard to computational complexity because HEVC is really a bear from a computing power standpoint required to have encode and decode. As a result of its computing complexity it has actually been one of the major reasons why people have been slower to embrace it. So we see a significant opportunity in sort of being better in 264 in quality, and being better than 265 in computing complexity. The first form of that that we are rolling out is in the Chinese market which is a natural place for us to start given the strong format position that we have. We are also looking to see whether there are opportunities outside of China and we haven’t made any announcements and we haven’t made any pronouncements. But we are looking into that and we are starting to organize for that. The opportunity to have those crossover collaborations was one of the major drivers of that aspect of a reorganization which is basically create a consumer media group looking at the intersection of the RealPlayer on the one hand and the IP business including the RMHD format on the other. I could go on about this at length, but in the interest of brevity, or what passes for brevity for me today anyway, I will stop now.

[William Meyers:]

Yes, thanks, that was very informative. And I understand the advantage of – the advantages you were talking about. And I hope to see it is adopted more broadly and does bring in some revenue. Thanks so much.

[Rob Glaser:]

Great. So, operator, do you have any last questions? Or if not, we are ready to close out the call. Should we do a last call?

[Operator:]

No questions on queue at this time, sir. [Operator Instructions]

[Rob Glaser:]

With that being the case I want to thank everybody for joining us today. Marge, do you want to add any closing comments?

[Marjorie Thomas:]

No, we are just excited about the second half and…

[Rob Glaser:]

Starting with the second quarter.

[Marjorie Thomas:]

Yes.

[Rob Glaser:]

Great. Look forward to seeing everybody, assume we’ll see you in a quarter if not sooner. Thanks, everybody.

[Operator:]

Thank you. So, that concludes today’s conference call. Thank you all for participating. You may now disconnect.