RealNetworks, Inc.
Q4 2005 Earnings Call Transcript

Published: 16 Feb 2006

[Operator:]

Ladies and gentleman thank you for standing by, and welcome to the RealNetworks Fourth Quarter 2005 Results Conference Call. During the presentation all participants will be on a listen-only mode. After the presentation you will be invited to participate in a Question and Answer session. If you have a question, please press "*" "1" on your touchtone phone, at anytime. You may remove yourself from the queue at anytime by pressing "*" "2". If you are using a speakerphone, please pick up your handset before pressing the number. If you should require assistance during the call please press "*" "0". As a reminder this conference is being recorded today, Tuesday February 14th 2006. The speaker today will be Ms. Caroline Hughes, Vice President of Investor Relations, Mr. Roy Goodman, Outgoing Chief Financial Officer. Mr. Michael Eggers, Incoming Chief Financial Officer and Mr. Robert Glaser, Chairman and CEO. I would now like to turn the conference over to Ms. Hughes. Please go ahead Ms. Hughes.

[Caroline Hughes:]

Thank you. As a reminder during the course of this call, we’ll make Forward projections and Forward-looking statements regarding future events and the future financial performance of the company. Including our future revenues, expenses, margins, taxes and net income. The future of the competitive landscape in our markets and our ability to grow our business and successfully compete in our market. For future opportunities from and successful of our agreements with Microsoft. The future success of our mobile games initiatives, the future benefits of our merged platform, the benefits of next generation consoles for our casual games business, our ability to maintain our subscription services leadership and meet the competitive challenges in the music business, the opportunities for music growth in the event the technology for portable subscription services improves, the implementation of our distribution agreements with HP and COX and the future results of our relationship with mobile operators. Actual results may differ materially from any projections and forward-looking statements given by management. Our Form-10k for the year ended December 31st 2004, and other Forms on file with the SEC identify important risk factors that you should consider when making an investment decision regarding RealNetworks. And that may affect whether our forward-looking statements proved to be correct. In this call we will make reference to certain Non-GAAP Financial measure including EBITDA and EBITDA less antitrust Litigation expenses. The reconciliation of these Non-GAAP measures to the most directly comparable GAAP measure net income can be found in our earnings release for our first quarter which was filed on EDGAR and Form-8k and it also posted to our website at www.realnetworks.com/company/press. Here with me today to discuss our fourth quarter and full year result for 2005 are Robert Glaser, Chairman and CEO. Roy B. Goodman, our Outgoing Chief Financial Officer and Michael Eggers our new Incoming Chief Financial Officer as we announced earlier today. Robert give you the summery of the quarter and then turn it over to Roy for the financial details and outlook, to get this start call started, I will turn things over to Rob.

[Robert Glaser:]

Thanks and thanks everyone for joining us, good afternoon . Today RealNetworks announced the fourth quarter and full year results for 2005. As I typically do at this of the year I am going to step back a bit to look at our progress over the past year and where we are going as a company. I believe that 2005 was a watershed year for RealNetworks for four reasons. First, we achieved record revenues of $325.1 million an increase of 22% from the $266.7 million we reported for fiscal 2004. Second, we will turn to profitability. Our GAAP profit for the year was $312.3 million and while our profit was substantially larger for Microsoft unit trust settlement, our core business also contributed to that profit. Third, we dramatically increased our financials throw away. As you know we settled their antitrust suit with Microsoft, entered into a set of legal and commercial agreement with Microsoft worth $761 million . And because there were set a tax of related assets, we estimate that our all in net tax payments associated with this income would under $45 million. As a result we have over $800 million in unrestricted cash, cash equivalent and equity investments on our balance sheet today and estimated that we would receive upto an additional $283 million from Microsoft between now and early 2007. These resources represent both the tremendous opportunity for the company to drive growth as well as an important responsibility. Fourth, 2005 was a breakout year for our games business. Games revenue grew 63% over 2004 to $56.3 million and as we exited 2005, games business was approaching nearly 20% of our revenue. We certainly considered games to be one of our most important core businesses going forward. Along side others such as music. And as you have just seen with our just announced Zylom acquisition and our Gorrilaz and Hasbro agreements which I will discuss further in few minutes. We intend to keep driving business forward very hard. I believe with these watershed events setup RealNetworks for a very bright future. While time does not permit to discuss all the opportunities in front of us, Let me now turn to more detail look at two of our key businesses, games and music. Our strategy in market position in games and different than in other segments. And games we are vertically integrated developer, publisher and distributor of our PC mobile casual games. This mix allows us to participate in economics cross the food chain. Sometimes you make money by selling our intellectual property through other channels, sometimes we make money by selling others intellectual property through our channels. Our ability to operate with flexibility across the value chain is one of our core competitive advantages in casual games. Last year we grew our business across the value chain. In 2005 we have been honored several awards for our internally developed mobile games, including "mobile game of the year" for the title "Playman Summer Games 2", and runner up "Puzzle game for pileup (phonetic). In total we developed and shipped over 20 new mobile games titles in 2005. Also RealNetworks was just selected as the exclusively publisher and developer of the new bubble phone game featuring the hot band Gorillaz which won a grammy just last week. The new game will be on later this spring. On the PC game side our game house development studio released 25 new downloadable games in 2005. And now we are releasing a profile of our publishing activities to a relationship that has Hasbro. Just yesterday, we announced the partnership with Hasbro's property group to be the exclusive providers of downloadable of PC versions of the beloved classic titles "monopoly", "scrabble", "Yahtzee", "clue" and the "Game of Life". We look forward to working with Hasbro for the next several years to create very successful set of digital games. On the PC game distribution side, we quietly built up an impressive portfolio with over 350 downloadable PC games titles, including both our own and third party games. Hasbro library has enabled us to significantly strengthening our distribution. In 2005 we put together new relationship with Microsoft AOL Netscape and Reader Digest among others for our PC games as well as new relationships with Cingular and Sprint for our mobile games. Our new relationships in combination with the existing partnership such as Comcast, Time Warner Cable, Verizon and Lifetime TV, gives us the broadest distribution reach we ever had in games. Last but certainly not the least in games is acquisitions. Last week we announced the acquisition with Zylom our European distributor developer and publisher of casual PC games based in Netherlands. They have the largest library of localized high quality games in Europe. Zylom was recently recognized in internet user poles as the best fun and games website in UK, Germany and Netherlands. The combination of our Real Arcade PC games business, our mobile business and addition of Zylom makes us the leading PC casual games company in all of Europe. Additionally as I would like to remember towards the middle of last year we acquired Helsinki based Mr. Goodliving, a developer and publisher mobile games which expanded our ability to develop and distribute original content on mobile platforms. In particular we believe that the merged platform created by Mr. Goodliving which now supports over 300 mobile handsets including Brew, Java and iMod handsets can be a significant source of cost efficiency and longterm competitive advantage for us in mobile games. The final games topic I want to touch on is platform strategy. On the PC side we continue to be category we are in the US and now in Europe and we see a lot of growth of opportunities ahead. Regarding mobile games it’s still early both for the category and for us. We believe that in the long term, the mobile business will be both a complementary extension of our core pc games business and the good business in its own right. Finally, as part of our Microsoft agreement we agree to create a series of casual games for the Xbox Live Arcade. We think the next generation console platform, they will become very instinct casual games platforms and if that happens we intend to be well positioned to take advantage. Now on to music. Music continues to be extremely important business for us. We continue to believe the premium music subscription business, they had many competitor with more than 1.4 million pages subscribers to Rhapsody and premium radio services, which is double subscribers counts year ago. Music revenues approached to 100 million 2005, growing 50% of 2004 and our accounts approximately 30% of our total revenue. Additionally, 2005 the subscribers listened to an estimated 1.2 billion on demand tracks up from 715 million 2004, and the number that will believe you will believe that by far a number one in the industry. Our primary focus in music is to create great end to end consumer experiences on a variety devices that allows us to aggregate packaging distribute music created and published by others. We have the three kinds of music services, radio, on demand subscriptions, our Rhapsody service and individual title purchases. Because radio is based on statutory licensing it is the best unit of economics in gross margins while track selling is basically retail business and on demand subscriptions are in the middle. In 2005, we transitioned from a fairly simple core music product line primarily subscriptions services for the dollar card to a more diverse product line inside the marketing channels, which we believe will enable us to successfully meet both consumer needs and competitive challenges. Rhapsody-25 which we announced in April 2005, it really consumers and continues to be a productive business both as an ramp (phonetic) for new premium subscribers and as a way for our music business to directly precipitate in the burgeoning internet advertising opportunity. We further enhanced our free music products last quarter, by launching Rhapsody.com a web-based product, that offers consumers a free and legal way to find, play and share all 1.5 million songs in our Rhapsody library. Rhapsody.com is also a significant milestone, because it makes Rhapsody available to Mac and Windows users for the first time. Our consumer marketing efforts in music continue to include sales through our own web traffic and direct you to internet marketing. Additionally in 2005, we broadened our channels by using direct marketing television advertising, as well as adding a number of distribution partners who pick consumer footprints. We talked about few of these including HP and Microsoft, Comcast, Cox and Sandisk. Regarding Microsoft, we just stated integrating Rhapsody into MSN, and we will be broadening activities in the first half of 2006, to encompass MSN music, Messengers and Search. Our goal is to make it, as easy as possible for consumer to join the Rhapsody community and integrate music into a wide verity of internet experiences. At the consumer electronic show last month, we announced an important agreement with Hewlett-Packard to promote the Rhapsody online music service on a range of HP consumer desktop and notebook PC’s, sold in the US including HP Pavilion, Compact Presario, and HP Pavilion Mediacenter TV, PC product lines. Importantly Rhapsody will also become the default player on these machines for all major music formats including MP3, RealAudio, Windows Media Audio and AIC, and in this regard replacing iTunes. At CES we also announced important new relationship with Cox. Cox, the nation's third largest cable operator has over trillion broadband subscribers, and will offer a premium Rhapsody music service as well as provide those customers with integrated billing. In May 2005, we begin working close with SanDisk, the two providers of MP3-players at retail in the US. We have bundled in the box with several of SanDisk popular MP3 players and we have recently reached an agreement with SanDisk to be the preferred service partner for your exciting new E200 player. We are really excited about the prospects in this relationship. Regarding important new subscriptions, our assessment with 2005 was large a good year for earlier adapters with the marker now ready for the mass consumer market. This turned out to be true, we believe this was start to change in 2006, especially in the second half of the year, as the technology and quality user experience continues to improve. When this happens, we think we will see a significant opportunity to take our music business to a greater level of scale and success. To summarize, I would state what I said last quarter, we were expected a digital music service will be a competitive space and we expect this trend to continue. We have attained a strong competitive position as both leading music descriptions and one of the very few companies, with all of competitive piece in digital music to innovative across every part of the end to end consumer experience, while we don’t expect market dynamics to change overnight. We expect to continue to grow our business in short-term in a disciplined way and establish a strong position for long-term success. Before I pass things on to way Michael, two more quick topics. First, the number you have asked what are we going to do with our tremendous balance sheet. While I don’t want to tip that to competitors, here are few thoughts. We are going to invest in our key businesses, to set the stage for strong long-term growth in the way it is both aggressive and disciplined. This means investing a little bit more on R&D in 2006, on a few projects that we will have excellent returns in 2007 and beyond. Our 2006 guidance, which Michael will discuss in a few minutes reflects this approach. We also expect to use our balance sheet in disciplined way for acquisitions; our Zylom acquisition is a perfect example of this. In addition to Zylom being a great strategic fit, we have also aligned with SanDisk for future success. The $21 million priced acquisition includes a base payment of $10 million and an earned item of upto a $11 million over the next three years. More generally, we are going to be thoughtful about shareholder value. We contnue to consider internal investments, M&A opportunities and other ways to add shareholder values. Our recent announce share buyback program is an example of this. Second, I want to make a few comments about the change in regard to finance that we just announced today. Last summer, Roy decided to move his family back to Virginia for personal release. Otherwise, he continues to service well as our CFO, he and I recently came to agree that a commute from Virginia was simply not sustainable over the long-term. As part of our regular succession planning activity, we look to both internal and external CFO candidates. An exceptional internal candidate Michael Eggers emerged as a superior choice to any of the external candidates. I am delighted to join with rest of the board to promote Michael to CFO. Michael has been with our company for over eight years and most recently his service as VP at finance, response for corporate accounting, tax and worldwide financial planning. Since, Michael and Roy worked together over the past several years, we expect a smooth transition. We are also planning to carve out a new role for Roy, so he can continue to add value with finance organization, even from a distance. So, with that said, let me thank Roy for his high quality and rigorous work. Welcome Michael to his new roll and past the microphone on to Roy.

[Roy Goodman:]

Thank you, Bob for your nice comments and I would like to add my welcome to everybody. In a moment I will review financial results for the fourth quarter and 2005 fiscal years. As always we encourage investors to review our SEC filings for more comprehensive understanding of our results. But, first on a personal note today I am announcing my decision to resign, as CFO of RealNetworks. This resignation is strictly due to family reasons, I have enjoyed working with Rob, management and the board and especially the many team successes we have experienced over the past two and half years. Unfortunately, after the sudden loss of a close relative, our family decided to return to the east cost be closer to our relatives. I expect to continue working with the Company, however in a different capacity, involving treasury, investor relations and other corporate activities and principally located in Virginia. I sincerely appreciate the flexibility the Company is providing to accommodate my family situation. I also like to congratulate Michael on his promotion. Michael is a long-term respected executive of the Company, who brings strong leadership skills and deep institutional knowledge. I look forward to working with him and continue to strive for future corporate successes. Moving now to our financial review, as Rob mentioned 2005 marked an historic year, in many respects for the Company, and indeed it's reflected in our financial result and metrics. We achieved the highest annual and quarterly revenue in the Company’s history. We exceeded both the top-line and bottom-line guidance, we provided at the beginning of the year. We turned to profitability and in fact we are profitable in each of the fiscal quarters of the year. Additionally we sold our position in Musicnet for a gain in access of $7.6 million, while also eliminating an approximately $1 million per quarter drag on the P&L. I will now briefly discuss full year and Q4 financial results and then Michael will review forward guidance. Starting with highlights of fiscal 2005, revenues were record $325.1 million an increase of 22% from fiscal 2004, and represents the second consecutive year of over 20% annual revenue growth. Net-income for the year was record $312.3 million were $1.70 pre diluted share, compared to a net-loss of $23 million or negative $0.14 per share reported for fiscal 2004. these results include the impact of Microsoft payments, which I will discuss in more detail in just a moment. EBITDA for 2005, was $431.4 million compared to a negative $11.6 million in 2004. moving to a brief review of the fourth quarter, we saw 15% year-over-year revenue growth, achieving $83.6 million, which represents the highest quarterly revenue on the Company's history. For the quarter, the consumer product and services segment grew 19% to $73.4 million driven principally with strong growth in the games and music product lines. Games revenue grew 52% to $15.7 million, and with strong across subscription sales allocate game sales as well as third party provision. Music revenue grew 29% to $26.1 million and its primarily attributable to growth in Rhapsody, with allocate sales also increasing with a slower rate than the overall music revenue growth. Video consumer software and other revenue, declined 10% to $22.6 million, compared to the same period in 2004, principally due to the discontinuation of several low-margin standalone video products. Media properties revenue grew 55% to $9 million, from $5.8 million in the fourth quarter of 2004. Increase reflects with higher revenues from the distribution of third party software, such as Google toolbar, as well significant increases in banner type advertising across the web properties. Finally, business products and services contributive revenue of $10.2 million, compared to $11 million in the prior year fourth quarter. The decline was primarily related to the previously disclosed legacy system license agreement that expired earlier in the year. For the fourth quarter gross margins increased to 71% from 67% in the prior year quarter. The improvement was driven by mix shift within our consumer segment including increase revenues in the games and advertising categories as well as a reduction in content cost associated with certain products. Specifically video margins improved to the discontinuation of several bellow margins standalone video products, are a real concern here. Operating expenses for the quarter are unusual, as we have a credit of $342.8 million compared to a cost of $50.7 million for the fourth quarter of 2004. This quarter results include a benefit of $434.4 million in operating expenses related to the Microsoft agreements. In addition operating in expenses include approximately $22 million of expenses primarily related to income from the Microsoft agreements. Including $14.8 million donation to the RealNetworks foundation, representing 5% of our net-income as well as non-income related taxes and also bonuses related to the settlements. The quarter's operating expenses also include an 8.5 million loss on the cancellation of our purchase commitment related to an element of ongoing R&D project. Recently we made this decision, as because we found more economically efficient and beneficial way to achieve the projects goals. Finally, marketing expenses increased approximately $4.5 million of achieved three levels in $6 million over the fourth quarter 2004 levels, primarily related to online direct marketing of our music and games products. Other income was approximately $6.7 million in the fourth quarter, compared to $1.3 million in the prior years fourth quarter, reflecting both the higher average cash balance, as well as higher interest rates. Also, last year results included approximately $1 million loss associated with our investment in music net. For the quarter, our tax rate was approximately 28%, resulting in a tax provision just over $113 million. Our tax rate was lower than we guided, as we are able to complete our prior assessment of our substantial tax assets. You will note that a big portion of the benefit flow directly into the balance sheet, is aid to accrued an increase of approximately $170 million, all note the cash taxes are quiet different. We currently expect owe the higher as less than $10 million related to 2005 income. In the fourth quarter of 2005, we again achieved our goal of GAAP profitability, with GAAP net-income for the quarter $295.6 million or $1.61 per diluted share. Additionally for the fourth quarter, EBITDA was $406.4 million, which compares to $1.4 million in the fourth quarter of 2004. Regarding the balance sheet, unrestricted cash equivalents increased to $781.3 million, from approximately $363.6 million in the prior year. This includes proceeds of $100 million from our convertible data offering. We also hold shares of publicly traded companies, valued approximately $43.4 million with quarter end. Also during the quarter, we announced that the board has increased the share repurchase authorization, planed for many a new $100 million stock repurchase program. The Company repurchases approximately 3.2 million shares in the fourth quarter worth a total of $25 million. For the fiscal year, the Company repurchases the total of 8.6 million shares at a cost of just over $54 million. 75 million remains authorized and available for future purchases under this program. And with that, I would like to pass the bit on to Michael and ask him to go thorough our forward guidance.

[Michael Eggers:]

Thanks Roy. I am very existed about this roll and out coming way head of us. I look forward to meeting with our shareholders and analysts in the months ahead. I will review focus on guidance. I like to reiterate, that the following forward-looking statements reflect RealNetworks expectations as of today February 14th, 2006. The Company currently does not intend to update these forward-looking statements until next quarterly results announcement. Also before I walk thorough guidance, a quick note on Microsoft agreements, all these agreements create a new and predictable income stream they also result in real incur in certain expenses that have not been part of our historical run-rate. We have included these expenses in our guidance in expect in future recorders to itemize the impact of these expenses in order to improve the clarity of our operation results. For the first quarter of 2006, we expect revenue in the range of $82 million to $86 million and earnings of $0.11 to $0.13 per diluted share. Operating expenses are expected to include the benefit of $14 million or approximately $0.22 per diluted share, in income from our agreements with Microsoft. Projected earnings also include $0.8 to $0.10 per diluted share. Other expenses primarily related to the income from the Microsoft agreements and include the following; approximately $0.01 per diluted share for non-income related taxes and employee bonuses, $0.01 per diluted share of tradable contributions represent 5% of net-income. And $0.06 to $0.08 per diluted share of income tax expenses, which represents a tax rate of approximately 37%. In addition we expect to incur $0.02 to $0.03 per diluted share of non-cash stock compensation expense. For full year 2006, we expect to report revenue in the range of $365 million to $380 million, in earnings of $0.75 to $0.80 per diluted share. Operating expenses for the year are expected to include the benefit of $222 million or approximately $1.22 per diluted share, in income from our agreements with Microsoft. Projected earnings also include, $0.51 to $0.55 per diluted share, other expenses primarily related to the income from the Microsoft agreements and those include the following; approximately $0.03 to $0.04 per diluted share for non-income related taxes and employee bonuses. $0.04 per diluted share of tradable contributions representing 5% of net-income. And $0.44 to $0.47 per diluted share of income tax expense, which represents tax rate of approximately 37%. However, actual a federal income tax is owe to expected view less than $10 million, due to the utilization of differed tax assets. In addition for the full year, we expect incur $0.08 to $0.10 per diluted share of non-cash stock compensation expense. With that I now like to turn the call back over to Bob.

[Robert Glaser:]

Thanks Michael. To summarize my earlier comments, 2005 was a watershed year for us. and we enter 2006, we enter with greater opportunities in movie sources, we ever had to drive our business forward. I would like to thank everyone at Real, and all their partners in making 2005, such a successful year. With your help we look forward to even greater success in 2006. And with that I would like to turn the call over the operator to start the Q&A section. Operator.

[Operator:]

Thank you, ladies and gentlemen we will now begin the questions and answer session. Please limit your question to one. If you wish to ask a question please press "*" "1" at any time on your touch tone phone. Our first question is with Anthony Noto with Goldman Sachs.

[Anthony Noto:]

Thank you very much, I was wondering if you could comment on the trend on the average revenue per user. You know that the mix shift has changed quite dramatically over the last couple of years, especially with the relationships you have added, and they have been reliable with Comcast etc., but ARPU was down about 37% year-over-year falling 33 in the third quarter and 24 in the second quarter, where do you see that bottoming out, as the mix shift kind of bubbles off. And then one clarification question, it is how helpful to get the bridge between your guidance and some of the non normalized factors from Microsoft on a EPS basis, I was wondering if you gave us the same type of bridge on EBITDA, what would EBITDA guidance will be for full year 2006, excluding all Microsoft impact and that we are going see how to deal with the tax issue.

[Robert Glaser:]

Good to talk to you Anthony, I will take the first one and pass - pass things on to Michael to take the second one. We are not guiding specific in ARPU but I would say the following, when you look at wholesale relationship that we have I guess, Comcast customers, probably the similar is visible example of that, we look at them in terms of the profitability and the reach we get from them, so it looks from you standpoint when you are ARPU calculation that the more successful that is, the lower the ARPU is. But it is really, it is two different models, in one model we have wholesale, we have customer acquisition marketing cost. We have billing cost, we are getting revenue off of retail base, but we have all the content cost. Where as in these wholesale arrangements, generally speaking we are off-shifting lot of those costs as well, and we are also in many cases doing volume deals there, much much higher volume, because if you get committed on it, on a tier of service for instance the way Comcast does with Rhapsody Radio. If not everybody who has Comcast High Speed Internet takes it, but is available to everybody who has Comcast High Speed Internet. So it is really an apples to oranges things, and if you look at from time to time, putting information out that would allow that to be broken down but so far we haven't done that mostly because of competitive reasons frankly. But I certainly understand that if you are trying to model for marginalized normalized ARPU, it would make it more complicated but for us the tradeoff is how much information you want to get competitors about the forensics of our individual business dealings and it is inside thus far or just do what we are aggregated on the sect the game sect or the music sect, etc., The second question on EBITDA versus EPS, I am going to pass this to Michael.

[Michael Eggers:]

In terms of our guidance I noticed that we moved to growing to a GAAP EPS guidance which with all of the impact of the Microsoft agreement we felt that was more transparent way of providing guidance in giving the component parts of how the Microsoft relationship is impacting our different financial results. At the time we aren't giving an adjusted EBITDA guidance, we felt that would be little bit too complex with the just add an bunch of items and then having Microsoft items factory in as well but at this point we are giving our GAAP guidance but certainly start talking and shareholders and the analyst welcome feedback in how you provide our results.

[Robert Glaser:]

Next question operator.

[Operator:]

Thank you, our next question comes from Aaron Kessler with Piper Jaffray.

[Aaron Kessler:]

Hi guys, couple of questions on the marketing front from Q3 to Q4 looks like you have increased marketing bios to $6 million but on the revenues from I guess gaming and music tag increased about 2 to 3 million, when should we expect to see some increased traction from some of the advertising initiatives that you have undertaken as well as some of the Microsoft partnership deal you have began here in January? Thanks.

[Robert Glaser:]

Well, I will break it into pieces, on terms of the advertising, the things were good Q4, it was actually, our belief that we would use our, this is marketing activity that would be long term profitable but generally speaking, whenever we step up the marketing, the revenue in quarter, is less than the life time revenue, and ofcourse life time margin, you can use that for content cost, we think it could be more extreme. But in the case of the Q4 activities when we stepped up marketing and games and in music we definitely saw increases in sort of the takeaway was, generally can translate into future opportunities for subscribers and the like. But most of that revenue has a long tail associated with it. With regard to the Microsoft pieces I think when we said when we did the Microsoft accounts, which we reconfirmed today, that we thought that it was something that would be kind of a snowball rolling down hill and we would start with some very low hanging fruit like the integration we have done, with MSN and MSN Music which is likely then we have the technically advanced integration like the MSN Search, and the MSN Messenger, is scheduled to take place in the first half of the year, I believe in the second quarter, and then as those system propagate out there in terms of broader distribution I think they have a greater impact and I think the obviously we didn't break out the financial effect of any of our individual marketing messages. But the numbers as a whole, I think reflect that kind of curve.

[Robert Glaser:]

Next question operator.

[Operator:]

Your next question comes from Heath Perry with Credit Suisse.

[Heath Perry:]

I was wondering if you could talk a little bit about the maybe walk us through the time line for rolling out the Microsoft integration, within search, messenger, and then the directory on the site. When should we start to see those rolled out, what is the integration kind a look like or when should we expect the integration to look like the demos that you have been showing.

[Robert Glaser:]

Heath, I can talk to you, I think I answered that, just highlighted that question in this second half of the previous question which is, first half of the year, and I believe second quarter for the search and the messenger integration which were the two things we demoed, that we have done, we already have a lightweight level of integration with MSN Music and we are moving from there. I would like to add at this instance, since this the second question on the topic that, the Microsoft commercial pieces is just one of the number of partners we have for our music and games businesses and I don't mean to stress that it is unimportant relationship but I think when you look at our growth of our partners, I think you have got to look at COGS, Comcast and the High Speed Internet space, Cingular has a big service that they are trying to roll out in the video area that we announced at the end of the last year, we have a partnership around, range of partnerships in the games area, but I understand this is all music area, HP is one of the music area so, it is, obviously because of our pivoting from an end, sort of antagonist mode principally with Microsoft we have collaborative mode, it gets more headlines, but I think it is important to put in context that, that is just one of the number of distribution relationships and with that be most productive one or one of the ten most productive ones but not the most productive one I think plays out over time. Next question operator.

[Operator:]

Your next question comes from Sasa Zorovic from Oppenheimer & Co.

[Sasa Zorovic:]

Yes. So my question would be, sort of looking at your year had a very strong growth, domestically, and somewhat less of a growth internationally. Sort of one of the, all of this is basically, you know that the success that you have here, would be then, hopefully easily replicable internationally, I would just say so far atleast we haven't done that.

[Robert Glaser:]

I think it is an excellent question. I break it into pieces, first you will note that the last two acquisitions that we did, the Mr. Goodliving acquisition and the Zylom acquisition, both international acquisitions specifically European acquisition so I think we have recognized that there are aggregation and consolidation opportunities that are international in nature, and particularly both those cases in the games business, the game business blends itself very well to that kind of international scale, when something is a hit casual game, we find that if the hit casual game in the US, it is hit casual game in Germany, hit casual game in Japan, and so the sort of the global rollout of that business is a natural one and those two cases we found teams that focused specifically on the European market. And the reason probably while they with combination with them and organic effort was better than pure organic is in order to hit the European market you have to have an intense focus of sort of local, local language, local culture, in a very efficient way. So both Zylom and Mr.Goodliving had very efficient methodologies and processes for translating games into many different languages at once. And I think, in the case of Zylom there are like 70 games in 7 different languages, in the case of Mr. Goodliving you mentioned merged technology that supports a couple on the different handsets and when you look at all of the handset language profiles, you get up like 10,000 different binary sku's that you need which is why you had an automated system in that business. So, we have identified international growth as a big opportunity and the fact that our last two acquisition were international Europeans specifically speaks to that. In terms of our other businesses, specifically the music business, we see international growth opportunities which we just came out within Europe, a product we call Real Music which is a different kind of platform, that case, because in music, most reputed online games were hit games, a hit game anywhere. In most countries, now a days, 60% to 70% of the hit music is local language, local culture repertoire and even though they are multinational companies that control that, it tends to be more country by country. So, one of the reasons why for instance continental Europe digital music sales across categories, indexed per capita will be much lower than US and UK, has been, in my opinion, because of the complexity of actually rolling out all those local language repertoire. So, it’s kind of a light built in, so net, net we see great opportunities, our focus is just on Europe, we see equally large opportunities in Asia and infact, on Sunday, I am going to Asia for a week, for a lot of activities over there both in our USB Japan operation which is large and China operations we are building up. So, we big believer in international growth and don't see any reasons why we can't have very substantial growth internationally in the months and years ahead.

[Operator:]

Next question comes from Steven Frankel with Canaccord Capital.

[Steven Frankel:]

Rob, I wonder if you might some color on Mr.Goodliving's progress in porting some of your Real Games in the US to a mobile platform.

[Robert Glaser:]

Well, in terms of specific announcements, I don't know, what the – what will be in our pipeline and I want to be careful not to pre-announce. We are going two different ways in that. One is by taking some of the titles that Mr. Goodliving develops in Europe and bringing them over to mobile carriers in the US. And the second, by taking the casual games that we have been already been in the process of developing and publishing in the US and bringing them to Europe. And we started to using the emerged platform, it’s is in a, it’s a very unique set of tools but the – they take it from where it's started where you had a team in Helsinki that knew it and knew how to use it. And now training our team here at Seattle, actually a couple of different teams in Seattle, who start using that program. It's playing out pretty much as we hoped, which is, we are starting to see real efficiency come off that. Probably the most visible example in the mobile games space is this, here we are just with the music band Gorillaz for those of you that aren't in that, in that demographic. Gorillaz is an animated rock band, that is the brainchild of the, one of the greatest hands behind the British band Blur. But all the characters are cartoon characters. They first, I think he was called Clint Eastwood, their new album was actually won a Grammy, the performed it, opening at the Grammy and you all saw it performing with Madonna, who is not a cartoon character. And so they are very visible and very successful and it’s a unique kind of prop to create a game with and that's a mobile game that we intend to bring out in US and Europe. So, it’s an earlier stage business for us and I think, we are trying to do two things which is express our long term optimism and we recognize that in terms of the sort of the spinning that business up, there is lag time associated with the first porting of the games and getting them into the carrier channels. And Michael do you have anything about that, in terms of the economics, I don't think, we have done any breakouts of that part of games business.

[Michael Eggers:]

No, we haven't I think, you have carried it quite well.

[Operator:]

Next question comes from Michael Schuster with Ventura Partners.

[Michael Schuster:]

It’s a little of house keeping, what are your number shares outstanding at the end of the year?

[Michael Eggers:]

Well, I will go and cover that. The - I think, the relevant answer to that is the number of shares outstanding that we were using from in an EPS standpoint and for the quarter we used to fully diluted share account of 184 million and I am sorry, for the year, we used to share account of 184 million and for the quarter, use 183 million.

[Operator:]

Our next question from Lee Westerfield with Harris Nesbitt

[Lee Westerfield:]

Thanks, this might be helpful for all of us to get a breakdown of the fourth quarter of $434 million from Microsoft, how much that was onetime, what tax rate was on that we continue to see if in the quarter, that number was ultimately ongoing trend in that number?

[Robert Glaser:]

It was a gross payment of $478 million and so the, contingent legal fees and other little litigation costs are just the difference between 478 and 434.4. So, I will let you do the math there, the other item which may be, Michael can comment more fully on but there's ongoing expenses related to the Microsoft agreements or probably more specifically associated with income, associated with Microsoft agreements. We have a long standing corporate policy of donating 5% to charity, we have incorporated that into our guidance. We also have certain non-income related taxes that will be ongoing as the money is actually received. There is also employee bonuses associated with the successful settlement of the agreement and so, all those are incorporated into the forward guidance and we tried in that scenario to break that those out for you as well. So, you will have some transparency moving forward, what are actual operating results 'X' Microsoft impact for?

[Michael Eggers:]

And that's correct, that's why I mentioned the $434 million has one time payments associated with the contingent legal fee settlement and then in the forward guidance, we break out the expected payments from Microsoft and related income and then, as well as itemizing the expected expenses that are primarily attributable to that income.

[Robert Glaser:]

And perhaps, one more new answer to explain here, is that the, direct litigation related expenses ie. contingent legal fees are netted against the Microsoft income in that line item. The other expenses, we have spoken are actually are operating expenses and are largely flow through the G&A line item. So, why are we trying to be explicit in isolating and commenting on those, as do fall on different places throughout the P&L. Next question operator.

[Operator:]

Our next question comes from the line of PJ McNealy with American Technology Research.

[PJ McNealy:]

Hi Good Afternoon , thank you very much. As a follow up on the 8.5 million number of write off, for the R&D project , that's somewhat like 10% to 15% for the fiscal year and I am just wondering, put some color on, I believe that is an MP3 player project quite often, just some more color on what went wrong given how much of the size of write up was? Thanks.

[Robert Glaser:]

Well, I will say the following. What we said, what I said in the script is the truth and is the amount we are listing publicly. We have a lot of R&D projects along the way and we have a very success rate in bringing those to market. Every once in a while, as you are doing in R&D project, you come up with a better way to implement it and the better way is algorithm, you just implement that algorithm. And it's you know, it might mean, you only takes twp months longer but you have a much faster streaming algorithm, you have much higher codec or something. In this case, it turned out that the better method of bringing this project to market, indent involved the nature of the business partnerships we have, which is why, there is a document, there is disclosed item in that, but because we don't have a desire to share information with our competitors, we won't go into that. But this isn't a case of things going wrong, it’s actually a case of things goings well and we are very excited about it but in total products associated with efforts shift, it would be a jumping the gun for us to talk about it and since we don't like to jumping the gun and sharing unnecessary competitors, we will leave it at that. Next question operator.

[Operator:]

Our next question comes from the line of Kit Spring with Stifel Nicolaus

[Kit Spring:]

Okay, first question for Rob, can you talk a little bit about what's happening on the video side, it’s looks like, there is a decline in the video subs. And what do you think the outlook is for the need for the Realplayer with many video over the internet, just being on the dot com site until and it’s better than downloading software. And then question for Rob or Michael, is the EBITDA growing on an organic basis in '06 excluding Microsoft and one time items, what's the growth rate and on the revenue guidance of 12% to 17%, how much of that is organic versus acquisition growth, thanks.

[Robert Glaser:]

Well, I will take the first two and have Michael take the third. Clearly, our Realplayer continues to be a vital and important central part of both our business strategies and the network. We download on a worldwide basis of half a million of pieces of software a day, which is the, best published paper (phonetic) that we put out and it continues to be a very strong on a worldwide basis and the substantial majority of that are, is the Realplayer, I don't think, we break it out between Realplayer and games and Rhapsody claim like, but it’s a very vibrant. We've always had inside the player the ability to embed it in a web page. And for instance if you look at Rhapsody.com or Rhapsody.com is an essential takes a version of the RapCity services and raps that inside a web browser as well. So the philosophy is create great client technology and give it to consumers however they want as the web browsing gets richer we ourselves with Rhapsody.com and our Real's website are happy to deliver services in that way and we see very, very bright future ahead for delivery of our technology. We have preinstalled deals like we just did with HP, be it in web downloads or be it in mobile phone and the last counted over 50 million mobile handsets out there that have Real Audio and Video technology or the Real Player built into them. So we feel very bullish about that and we expect to continue to invest on a go forward basis and I think there is a lot of great things to do there. On the video side we were not breaking our subscriptions, people, given that we have said that we overall number two in quarter and music is 1.4 you can certainly adjudge from that and say hey there was a growth in music that’s faster than the overall growth in Subs. Now the thing I'd say that kinds at the docks here a little bit to give you sense of it is. We always for last three years a seasonality effect around BIG BROTHER where we have a very big success in summer with BIG BROTHER and some of those subscribers stay on but some of them rotate off in the, towards the end of the year after the end of that Television show. And this year in 2005, BIG BROTHER was the biggest success ever which is high class prop we have but it means, since when the roll off than. There is great amount of roll off than if it was a less success. So Michael, do you want to take the last question.

[Michael Eggers:]

Sure I guess I'll start with the organic revenue growth. Net revenue growth is current based on our, what we know today and we don’t break out a specific growth from acquisitions we have historically on a quarter that we plan acquisition, it will give some measurement as to how that is done. And so for instance Zylom was approximately $8 million of revenue in 2005 so to give you some color on that. And then I think your other question was in terms of EBITDA guidance how much is growing organically and just to clarify we haven’t provided EBITDA guidance but we are providing on GAAP EPS guidance and as Rob had mentioned we're looking at 2006 as a year of investment and we are looking at it from a standpoint of a prudent investment strategy and so we see that benefiting us into 2006 and 2007.

[Robert Glaser:]

Operator just time for a couple more questions.

[Operator:]

Next question comes from Steve Lidberg with Pacific Crest Securities.

[Steve Lidberg:]

Good afternoon guys. With regards to R&D you talked about you just actually talked about the year of investment. What are you thinking in terms of percent increase 2006 over 2005 especially if you look at 2005 ex, the $8.5 million write off thanks.

[Michael Eggers:]

Hi this is Michael. So again we aren’t giving necessarily guidance specifically on our different expenditures or lines like that and as Rob had mentioned for competitive reasons we don’t come out and announce any projects we have in the pipeline but again we are going to take a very hard look at our investments in those marking channels in our development projects and do that with an eye towards to continue growth in the future.

[Robert Glaser:]

So I guess it’s time for the last question operator.

[Operator:]

Yes we only have time for one question and it’s coming from Christopher Rowen with Suntrust.

[Christopher Rowen:]

Hi Rob what would say are the chances that we would see a meaningful wireless music offering either which Real involves with a major wireless partner this year. And do you expect Rhapsody to be integrated in the Microsoft Media Center this year.

[Robert Glaser:]

Rowen, I think both cases you are asking me to talk about future unannounced products or future unannounced business partnerships so I sure I am going to disappoint you I will say the following which is we think that as mobile phones are getting more capable and as has you have greater storage capacity. Generally speaking through Flash and removable Flash and you have form factors in mobile phones that are good products, there is definitely cross over there. That Apple rocker thing was a total dud and certainly that's not the state of art and what's being promoted to market right now aren’t really state of the art products from some of the other carries. But we think there is a great opportunity to deliver something that is very concurrent to integrate the pieces together. And with regard to the Microsoft integration I don’t think we have said much more than the fact that Hewlett Packard who is one our partners will be integrating Rhapsody into their Media Center PCs and HP obviously you know is that unit volume leader in PCs in North America so that's a great place to start. But in terms of anything beyond that HP announcement I think that's the furthest we will go in that regard. So with that I guess I should thank everybody for joining us, I especially want to take Roy for the great work that he has done, I look forward to welcoming Michael to his new role after eight years as a colleague. It's terrific to see him growing his responsibility and skills over the years and I think he's going to do a terrific job as our Chief Financial Officer. I think you'll come to share that view in the weeks and months ahead. And look forward to see you all face to face or talking to you in our next quarterly call.

[Operator:]

This concludes the RealNetworks fourth quarter 2005 results conference call. You may access the replay of this conference call on the RealNetworks website at www.realnetworks.com/company/investor/earnings.html thank you for your time and we appreciate your interest in RealNetworks.