RealNetworks, Inc.
Q2 2017 Earnings Call Transcript

Published: 5 Aug 2017

[Operator:]

Welcome to the RealNetworks’ Second Quarter 2017 Earnings Call. Your lines have been placed on listen-only until the question-and-answer session. [Operator Instructions] This conference is being recorded. If you have any objections, please disconnect at this time. I would like to introduce your first speaker, Ms. Laura Bainbridge at Investor Relations. Please begin.

[Laura Bainbridge:]

Thank you. Welcome to the RealNetworks’ Second Quarter 2017 Financial Results Conference Call. Before we begin, I remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks’ future revenue, adjusted EBITDA, operating expenses and trends affecting it’s 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 these activities. All statements other than statements of historical fact are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. We described 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, August 3, 2017. 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 Cary Baker, our CFO. Rob will discuss the company’s strategy and the progress the company has made in recent months. Then Cary will provide a financial review of the second quarter of 2017 and the outlook for the third quarter of 2017. After our prepared remarks, we will be pleased to answer questions. With that, I will hand the call over to Rob.

[Rob Glaser:]

Thanks, Laura, and welcome to the team. Good afternoon, everyone, and thanks for joining us today. As you know, Cary Baker joined us 3 months ago as our new CFO. I’m delighted to have Cary on board. He’s really hit the ground running. Cary’s comments will follow mine in a few minutes to be able to hear for yourselves. In today’s call, I want to focus on 3 topics; our performance in Q2, our progress with some of our key growth initiatives and a continuing efforts to run RealNetworks ever more efficiently and to manage our cost carefully. Our second quarter results were strong. Revenue for the quarter were $33.1 million, an increase of 8% sequentially and an 11% increase over the prior year quarter. While we’re pleased with these results, I want to add a bit of perspective to them. Certain of our businesses, especially the IP licensing part of our Consumer Media and our mobile casual games can fluctuate quarter-to-quarter. In the case of our IP business, the fluctuation typically relates to the accounting treatment of some of our license deals. In the case of games, the fluctuation is typical related to the waste cycle of our games. In Q2, both of these fluctuations redounded to our benefit. Cary will go through the details of our segment results in a few minutes. Let me focus on a few highlights for each business. In our Consumer Media business, we continue to make progress rolling out our next-generation RMHD codec, especially in China, and now also in the rest of the world. One notable highlight is our partnership in China with Huawei, 1 of the top 3 smartphone vendors in the world with nearly 10% global market share. We’re encouragement by the strong consumer demand for Huawei’s Mate 9 and P10, both of which come with build-in RMHD decoding. We think this will help build the RMHD format ecosystem and drive longer-term adoption of our RMHD codec in China. Our most significant progress outside of China is the integration of the RMHD encode and decode capabilities in our RealPlayer. In just 6 months, consumers have used RealPlayer to convert over 3 million files into the RMHD format. The adoption cycle for new codec is long, and it’s still early days, but we’re pleased with the progress we’re making. Moving on to Games. In Q2, we launched 3 new game has original titles, including our third installation of the very popular Heart’s Medicine franchise. Heart’s Medicine - Hospital Heat. Launched in April, Hospital Heat is the franchise’s more successful launch yet and our most successful title launch to date. Heart’s Medicine - Hospital Heat embodies the original content and storytelling quality of GameHouse original titles with this particular narrative and application resonating very strongly with users. In total, mobile games revenue was up about 60% over the prior year quarter, more than offsetting the slow decline on our legacy PC subscription business. Mobile Services has also had a solid quarter as we begin to realize the benefits of investment made in the last couple of years in both our RealTimes and our Ringback Tone platform. Now let me turn to our growth initiatives where we’ve made good progress this quarter. While unlikely to impact 2017 revenue, these initiatives are designed to drive meaningful revenue contributions in 2018 and beyond. The first one hitting the market is on our next-generation messaging product, which is part of our Mobile Services business. We recently signed our first channel partner for our new products, and it’s our long-term messaging partner Syniverse. We and Syniverse will have more to say about this new products and partnership in the next few months. We plan to formally announce the product later this year and be in market by year-end. One aspect of relationship that I want to note is that unlike our long-standing deal with Syniverse run person-to-person messaging, this new deal is not broadly exclusive. We intend to sell our next-generation messaging products to a number of customers and partners in the months ahead. While we don’t expect meaningful revenue from the product this year, we do expect it’ll contribute to our financial results beginning in 2018. As my final topic, I’ll address our progress in making RealNetworks even more efficient. During the second quarter, we reduced operating expenses by 15% year-over-year and undertook restructuring efforts to improve margins and profitability. Adjusted EBITDA improved to a loss of $800,000 in Q2, reflecting the initial impact of these actions as well as few other performance factors previously discussed. We will continue to identify opportunities to enhance the efficiency and improve profitability. In general, we intend to reinvest operating expense savings into our promising growth initiatives. At this stage of our development, we prioritize accelerating group-wide profit – group-wide growth over short-term profitability with our growth. A quick note before I turn the call over to Cary. The strategic process for Rhapsody is ongoing, and we are unable to provide further updates beyond that at this time. We appreciate your understanding on this matter. In closing, I want to thank our shareholders for their continued support of RealNetworks. We’re pleased with our performance this quarter and the early signs of traction in key growth initiatives. We’re committed to a financial and operational discipline, which is providing us with the flexibility to invest in future growth and innovation of RealNetworks. And with that, turn the call over to Cary.

[Cary Baker:]

Thanks, Rob, and good afternoon, everyone. We are pleased with our second quarter financial results as well as the profits made on our growth initiatives, which are not yet reflected in our P&L. In my remarks today, I will first review our consolidated results followed by a more detailed discussion of our segment business performance. I will then review our expectations for the third quarter of 2017. For the quarter, consolidated revenue of $33.1 million was up 8% from $30.6 million in the prior quarter and up 11% from $29.7 million in the prior year period. Of the year-over-year and sequential increase, Mobile Services revenue grew by $1.9 million year-over-year and by $100,000 sequentially, largely reflecting increases in our low-margin Korean Music On Demand business. Games revenue grew by $900,000 year-over-year and by $1.1 million sequentially. In both comparisons, revenue growth in mobile games more than offset the decline in our legacy PC subscription business. And finally, Consumer Media revenue grew by $600,000 year-over-year and by $1.3 million sequentially. In the second quarter of 2017, we recognized higher licensed revenue related to the shipment of devices enabled with our codec technologies in China. On both a year-over-year and sequential basis, this increase was partially offset by continued decline in our legacy PC-based products. Operating expenses in the quarter were $18.5 million, down 14% from the prior quarter and down 15% from the second quarter of 2016. In the second quarter, we undertook restructuring efforts that benefited segment margins and profitability. We believe our cost structure is more in line with our scale, and we will maintain our focus on reallocating and realigning our resources towards our growth initiatives. RealNetworks’ bottom line saw significant improvement on both sequential and year-over-year basis. Adjusted EBITDA for the second quarter was negative $800,000 compared to a loss of $4.4 million in the first quarter and a loss of $4.8 million in the second quarter of 2016. Please keep in mind, however, that adjusted EBITDA in the quarter benefited from the variable nature of our Consumer Media and Games revenue. I’ll review those details momentarily. Now let’s look at our second quarter 2017 results by segment. Mobile Services revenue was $19.2 million, up 1% sequentially and up 11% from the second quarter of 2016. The sequential increase reflects growth in our low-margins Korea Music on Demand business and increased revenue from our carrier partners, partially offset by a decline in our Ringback Tone’s business. Year-over-year performance was largely driven by growth within our low-margin Korean Music on Demand business. Segment contribution was a loss of $500,000 in the quarter compared to a loss of $2.6 million in the prior quarter and a loss of $3.1 million in the same period of 2016. The year-over-year and sequential improvement was largely driven by restructuring measures taken during the quarter. In our Consumer Media segment, which combines the RealPlayer product and the IP codec, including our new RMHD codec technology, revenue was $7 million in the quarter, a sequential increase of 23% and a year-over-year increase of 9%. As mentioned previously, contribution from our IP licensing business was partially offset by decline in our legacy PC-based products. By its nature, IP revenue in the Consumer Media segment can be heavily influenced by the timing of customer contracts, contract renewals and customer shipments. Our second quarter performance benefited from these factors. Contribution margin in the segment was $2.2 million, up $900,000 in the same period of 2016 and up from $400,000 in the prior quarter. Contribution margin for the quarter benefited from the increased in IP license venues which carry higher gross margins. In our Games segment, revenue was $6.9 million, up 19% from the prior quarter and up 15% from the second quarter of 2016 as growth in mobile Games more than offset continued decline in our legacy PC subscription business. Mobile Games grew about 60% over the prior year quarter, led by the release of 3 new games compared to the release of 2 new games in the prior year quarter. As Rob mentioned, during the second quarter, we released the third installment of our very popular Heart’s Medicine franchise, which drove strong growth and adoption among our user base. Second quarter contribution margin was a loss of $700,000 compared to a loss of $300,000 in the same period in 2016 and a loss of $900,000 in the prior quarter. On a year-over-year basis, a slight decline reflects our continued investment in our mobile games business, which should allow us to increase the future production of original GameHouse titles. Sequentially, contribution margin benefited from the growth of mobile games. Turning back to the corporate level. Unallocated corporate expense of $3 million decreased by 24% from the second quarter of 2016 and by 31% from the prior quarter. The sequential improvement was driven by a reduction in restructuring expenses. The year-over-year improvement was driven by a reduction in facilities expense and reduced headcount. We had $62.5 million in unrestricted cash, cash equivalents and short-term investments at the end of the second quarter. During the quarter, our cash consumption was impacted by our EBITDA loss of approximately $800,000. I’ll now turn to our outlook for the third quarter. As noted, year-over-year and sequential comparisons are not only as apples-to-apples due to the periodic variability in our revenues. As an example, our IP business received revenue in the second quarter that we had previously expected to receive in the third and fourth quarters. Nevertheless, we are pleased with our direction and positioning of the company. We believe our strategic initiatives to drive top line growth are progressing while the reduction in our operating expense is clearly evident in our result. With that as a backdrop for the third quarter, we currently expect total revenue in the range of $29 million to $31 million and adjusted EBITDA loss in the range of $2 million to $4 million. With that, we will now open the call for questions. Ash, can you please instruct the listeners on how to queue up for questions?

[Operator:]

Thank you, speakers. We’ll now begin the question-and-answer session on today’s conference. [Operator Instructions] And our first question comes from William Meyers from Miller Asset Management. William, your line is now open.

[William Meyers:]

Hi, congratulations on the strong revenue in the quarter. I think I understand why you got the bump in Consumer Media and wouldn’t expect that in Q3. I’m a little bit less clear on why Games revenue would go down after going up in this quarter? So if you could just clarify that a little bit, I’d appreciate it.

[Rob Glaser:]

Great. Well, this is Rob. So we haven’t guided on particular segments because we don’t do that. We did say that Games had a strong quarter in a way that is – needs to be put a little bit of context. Heart’s Medicine would shift in Q2 as the present time is probably our single best-performing franchise, and we got a significant amount of revenue for it in Q2. And we had 2 other solid titles in Q2. So in a given quarter, the majority of our mobile revenue, although certainly not all of it by any means, comes from title that are in their first few months of shipment. It’s a nature of that business model as it set up today, and which where we put a game out. And if you look at its lifetime revenue, the first 3 months of sales of that game are generally where you get the majority of the revenue of the game even from our perennials titles and our titles that do very well in library. They’re doing well in library. But they’re still above their revenues within those first 3 months or so. So it’s really because we had 3 launches, including 1 very, very strong one that impacted that. But we like our roster for the rest of the year. It’s just a question of whether what actually newly ships in Q3. And of course is the – and the Q2 going forward, what that’s going to generate. But again, we don’t break down revenues by particular segments. We’re clearly on a path to ship more Games this year, more GameHouse original games than we ever shipped before. So our pace is continuing to move ahead. But that’s – those are the reasons why we characterize it is what happened in Q2. It’s not necessarily something that we will see the exact same results in Q3 or Q4.

[William Meyers:]

That’s helpful. If I might ask a second question. So you got fairly close to breakeven at least on EBITDA basis in Q2. How do you see profitability going forward? Or you feel that you’re pretty much on track to get to some kind of profitability sometime in the next few quarters?

[Rob Glaser:]

Well, as I said in my comments, and I’ll say it again. We have some investments in growth initiatives such as the messaging platform that we’ve just announced having a new relationship with Syniverse for that we do not expect to be meaningful revenue generation in 2017. And of course, the nature of those projects, we have 3 or 4 of them not 10 of them, is that they cost money during the development phase, and they generate revenue over time. So if we weren’t doing any of those things, we could be profitable now. But we’ve decided that we think we – it is a good investment of our resources to invest in those and to scale them for accelerated growth in the out years. So what we’re saying today is we’ve got the business close to breakeven. We feel very comfortable about how we have a handle on the business. We obviously love to be profitable, but we are – our assessment is it’s a better return investment and a better way to create value for us to put those – put that money back in, if you will, to some of these growth initiatives. The spend in the growth initiatives is not huge, it’s not crazy, but it could make the difference in a given quarter between a slight EBITDA profit and slight EBITDA loss, it’s in those ranges. And that’s what we’re signaling that we intend to keep working on some of these growth initiatives because they’re promising, and we think they have good prospect of future growth in 2018 and beyond.

[William Meyers:]

Okay. The answer that sounds great to me. Just wanted to get some feedback on that. Thank you.

[Rob Glaser:]

Great.

[Operator:]

Thank you. Speakers, we show knows further questions in queue. [Operator Instructions] And that concludes today’s conference. Thank you for your participation. You may disconnect at this time.