RealNetworks, Inc.
Q4 2017 Earnings Call Transcript

Published: 8 Feb 2018

[Operator:]

Greetings and welcome to the RealNetworks’ Fourth Quarter and Full-Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Laura Bainbridge, Investor Relations. Thank you. You may begin.

[Laura Bainbridge:]

Thank you. Welcome to the RealNetworks’ fourth quarter and 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, gross profit, adjusted EBITDA, and operating expenses and trends affecting its businesses and prospects for future growth and profitability. Other forward-looking statements include the Company’s plans to implement its strategy and invest in its products and initiatives, as well as the expected growth, profitability and other benefits from these activities. Statements that express our belief and expectations, and all statements other than statements of historical facts, 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, including in the risk factors set forth in our most recent report on Form 10-K and in other reports. A copy of those filings can be obtained from the SEC or from the Investor Relations section of our corporate website. Forward-looking statements made today reflect RealNetworks’ expectations as of today, February 7, 2018. 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. In addition, we will present certain financial measures on this call that will be considered non-GAAP under the SEC’s Regulation G. For reconciliation of each non-GAAP financial measures to the most directly comparable GAAP financial measures, 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, 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 fourth quarter and full-year of 2017 and the outlook for the first quarter of 2018. After today's prepared remarks, Rob and Cary we will be pleased to answer questions. With that, I will hand the call over to Rob.

[Rob Glaser:]

Thanks, Laura, and good afternoon everyone. 2017 was a transformative year for RealNetworks. While we didn't achieve all of our objectives in 2017, we achieved almost important ones. Specifically, we've changed the profile of Real's businesses and we believe we set up Real for meaningful revenue growth in 2018 and a return to adjusted EBITDA profitability during 2018. In my commentary today, as I typically to a year-end, I’ll step back and look at 2017 as a whole. Then, I look forward and discuss our outlook for 2018 as a whole as well. Entering 2017, it was a stable, but flat top line business with gross margins in the mid-40s and some promising new products in development. However, all of our major growth drivers were still under development and none has shifted or signed up major customers. In 2017, we moved the ball forward significantly by achieving the following major milestones One, we announced and began initial markets of four new major products our RMHD Video Compression Technology, our Kontxt Matching Filtering Platform, our RealCV Computer Vision Platform and our GameHouse Original Stories mobile subscription service. Two, for two of these, RMHD and Kontxt, we announced launch partners. In China this past August, we announced the partnership with CIBN, one of China’s three biggest OTT broadcast platforms to deploy our RMHD in 2018. Also in August, we announced Syniverse will be deploying context as its anti-spam messaging platform. Three, in November, we began a market test of our GameHouse Original Stories mobile subscription service in Canada and in Netherlands, and we added the UK last month. And fourth and finally, in December, we exited the almost zero margin legacy music on demand business in Korea. As a result, our company gross margins have gone up to over 70% with minimal impacts on our contribution margin. The result of these transformations is that we set will never except to grow meaningfully in 2018, as we rollout these new high margin products, and combined with our high gross margins for the company as a whole, we see opportunities for significant amount of this growth to drop to the bottom line, resulting us returning to adjusted EBITDA profitability during 2018. Now, that I've described what we have accomplished at a high level, let me go to depth on each of our four main performing growth initiatives regarding both where we stand out in 2017 and what we hope to achieve in 2018. I'll start with our RealMedia video technology -- RealMedia HD video technology, RMHD for short. 2017 was a critical year to the global advancement and deployment of RMHD. Based on our strong market position in China in video technology, we decided to pursue China strategy for RMHD. In the third quarter, we announced the partnership with CIBN one of the seven networks license in China to distribute media over the internet. In the coming months, we expect CIBM to encode and deliver 1000s of titles on streaming hours into our RMHD format, which we expect will drive demand for RMHD in China among other content providers, carriers and OEMs. In January, we've made an important follow on announcement of the expansion of our partnership with Amlogic a global leader in fabulous system order chips or SoC technologies. Through digital license agreement, Amlogic plans to support RMHD directly onto its SoC technologies, making our RMHD accessible to smart TV and set top box manufacturers in China first and eventually globally. This chipset partnership specifically allows Amlogic to embed RMHD and then SoC hardware of smart TV and set top boxes enabling a next global ultrahigh definition video viewing experience to consumers while also minimizing CPU utilization. We will then generate license revenues from these device manufacturers for all RMHD enabled devices. While our primary commercial focus for RMHD in 2018 is China, we continue to see the market for RMHD globally primarily through our PC [indiscernible] product. Our RealPlayer users have encoded over 8.7 million files into the RMHD format saving an average of about 30% of rate HD 264x720k and about 40% of HD 264 at 1080p. The next growth initiative owner discussed is the messaging space. This past November, we introduced context our next generation mobile messaging platform. Kontxt gives carriers to messaging aggregators the ability to classify, identify and put policy around messaging going across the network. As more and more enterprise rely on text messages to notify consumers about everything from airline flight changes to restaurant reservations, commercial messaging called ATP has becoming a major hyper-commerce as well as person to person communication. The prevalence of ATP is only expected to increase with [indiscernible] research suggesting annual ATP messages volume will double to 3 trillion messages by 2020. As ATP message volume increases, so does the use the [indiscernible] routing, so called gray routes, whereby the sender users non-approved routes to send unapproved messages and avoid tariffs and fees. With context mobile carrier, messenger aggregators and internet commanders can effectively manage this traffic, classify messages appropriately and systematically enforce delivery policy. Context also provides the ability to allow do block spam and other unwanted messages. Glass financing is approximately and systematically enforce in delivery policies. Context also provides the ability rely overall network capacity lows and consumer experience. We are delighted about the go-to-market prospects for context. Context builds on our deep experience of messaging. Our met cap into carrier messaging platform is deployed in nearly 400 carriers worldwide and processes almost 2 billion messages every day. Context will be in market in 2018 initially through a non approved relationship with our long term messaging partner Syniverse. We expect to announce and while our other customers and partners in the months ahead. Our growth initiative is our computer vision platform RealCV. RealCV is a world-class computer vision platform. Our initial application is face recognition of both images and video streams, required recognition to top notch. exceeding 99.5% accuracy against standard industry benchmarks. Our fourth growth initiative RealCV is the one that is most nascent. We see many promising applications for our technology and expect to enterprise with commercial partners in the first half of 2018. Finally, I want to talk about our fourth growth initiative, our GameHouse Original Stories subscription offering. In 2017, we've introduced 10 new GameHouse Original Stories, putting our catalogue to over 30 titles. Due to this catalogue mobile game revenue in 2017 grew 20%. Our most significant growth initiatives in game in 2018 will be a subscription offering based on our growing library GameHouse Original Stories. We began testing the product on the Android platform in Canada and in Netherlands last year, and last month we brought the UK online. We expect to all the product out in the more countries and in both iOS and Android platforms. While it's still early, we think this growth initiative is quite promising. Now that I've described their growth initiatives in detail, I would like to touch on costs. In 2017, we advanced our four growth initiatives while also managing our cost tightly on our legacy businesses. In 2017, we also reduced our operating expenses by 18% over the prior year. As a result, we improved our adjusted EBITDA losses by 48% or $11.2 million in 2017 and reduced our cash burn significantly. Indeed, in Q4 of 2017, we generated GAAP net income, including discontinued operations of $800,000 and increased our cash position by $900,000. Note that some of these results of one-time items, but also its progress we made in managing costs while also investing in our future growth. Finally, let me close with a quick note on last year. Over the course of the last several months, we have evaluated number of strategic alternatives to the business. While doing this, we’ve completed successful financing, reduced expenses and position the business for improved performance and profitability. Spirit in that effort for the past several months has been Bill Patrizio. Today, I am pleased to announce the Napster board has appointed Bill, President and Chief Executive Officer of Napster. Congratulations, Bill. As part of this organizational change, we're promoting Max Pellegrini, our current President of Mobile Services to President of RealNetworks. In this capacity, Max will be taking over most of Bill’s former responsibility at Real. Both Max and Bill are outstanding executives and I'm delighted to congratulate both of them on their new roles and responsibilities. And with that, I'll turn the call over to Cary.

[Cary Baker:]

Thanks, Rob, and good afternoon, everyone. In my remarks today, I will first review our consolidated fourth quarter results followed by a more detailed discussion of our segment business performance. I would then review our consolidated full year results and our expectations for the first quarter of 2018. Before we begin and as Rob touched on previously, we exited the contract with our low margin music on demand customer in Korea at the end of 2017. Operations from this contract are now reported as discontinued operations. Revenues attributable to this contract were $12.2 million and $46 million for the fourth quarter and full-year respectively. Over the life of this contract, gross profit has declined significantly to result in minimal gross margin contribution in current periods. For the fourth quarter and full-year, gross profit attributable to this contract was $500,000 and $1.4 million respectively. Now turning to our results. For the fourth quarter, revenue was $18.9 million, down 8% from $20.4 million in the prior year period and up 2% from $18.6 million in the prior quarter. Please note that the year-over-year and sequential comparisons are not always apples-to-apples due to the periodic variability in our revenues. Certain of our businesses, especially the IP licensing part of our Consumer Media business and our Mobile Games can fluctuate quarter-to-quarter. For the fourth quarter, Mobile Services revenue was down $600,000 year-over-year and down $500,000 sequentially, reflecting slight declines in some of our legacy businesses. Consumer Media revenue for the fourth quarter was down $700,000 year-over-year, on a top compare due to timing of our IP contract revenue as well as reflecting declines in our legacy PC business. Revenues were up $1.6 million sequentially, reflecting stabilization in our legacy PC business as well as timing of IP license revenue. Finally, Games revenue for the fourth quarter was down 200,000 year-over-year reflecting a decline in our legacy PC subscription gaming business compared to the prior quarter, revenue was down 700,000 largely the result of timing of game launches within the quarter. Gross profit was 13.9 million in the fourth quarter, up 100,000 over the prior year period and up 700,000 from the prior quarter. Gross margin for the fourth quarter was 74%, up from 68% in the prior year quarter and from 71% in the prior quarter. The year-over-year and sequential increase in gross margin is reflective of ongoing efficiencies in our cost of revenue line items. Compared to the prior quarter, gross margin also benefited from the revenue mix shift towards higher margin IP revenues. Operating expenses in the quarter were $18.7 million, down 9% from prior year period reflecting our focus on maintaining a properly aligned cost structure. On a sequential basis operating expenses were up 6% from the prior quarter, primarily reflecting increased research and development and sales and marketing expenses. Adjusted EBITDA for the fourth quarter was a loss of $3.6 million compared to a loss of $4.5 million in the prior year quarter and a loss of $2.6 in the prior quarter. Net income from continuing operations [Audio Gap] compared to a loss from continuing operations of 10.2 million or minus $0.28 per share in the prior year quarter and a loss from continuing operations of 2.5 million or minus $0.12 in the prior quarter. In the fourth quarter, net income from continuing operations included a one-time 4.5 million gain on the final receipt of cash from the 2015 sale of Slingo and social casino business. Turning to our fourth quarter segment results in more detail. Mobile Services segment contribution margin was a loss of $1.6 million, compared to a loss of $2.4 million in the prior year quarter and a loss of 600,000 in the prior quarter. The year-over-year improvement was largely driven by gross margin efficiencies and reduced operating expenses related to personal and infrastructure. The sequential decrease was mainly driven by revenue. Consumer Media segment contribution margin was a gain of 1.3 million compared to a gain of 600,000 in the prior year quarter and breakeven in the prior quarter. The year-over-year improvement was largely driven by gross margin efficiencies and reduced operating expenses related to personal and infrastructure. Compared to the prior quarter, contribution margin benefited from the increased IP license revenues. Games segment contribution margin was a loss of 1 million compared to a loss of 700,000 in the prior year period and the loss of 400,000 in the prior quarter. The year-over-year and sequential decline was mainly driven by revenue. At the corporate level unallocated corporate expenses of 3.1 million declined by 200,000 compared to the prior year period and increased by 100,000 compared to the prior quarter. These compares reflect our focus on maintaining the right level of operating expenses to support our growth. Now let's look at our full year 2017 results. Revenue for the full year was 78.7 million, down 2.8 million from the prior year. Revenue including discontinued operations was a 124.7 million up 4.3 million from the prior year. Mobile Services revenue was 30.8 million down 500,000 compared to the prior year. Consumer Media revenue was 22.6 million down 2.5 million compared to the prior year. And Games revenue was 25.4 million up 300,000 compared to the prior year. Gross profit was 55.6 million for the full year, up 1.6 million from the prior year. Gross margin for the full year was 71%, up from 66% last year, reflecting continued operating efficiencies in cost of revenue, predominantly in our Consumer Media and Mobile Services business. Operating expenses for the year were $76.2 million, down 18% from the prior year. Throughout the year, we undertook restructuring efforts that benefited segment margins and profitability. We believe our current cost structure is more in line with our scale and we will continue to prioritize aligning our resources towards our key growth initiatives. Adjusted EBITDA for the year was a loss of $12 million compared to loss of $23.2 million in the prior year. Net loss from continuing operations for the year was $17.4 million or minus $0.47 per share, compared to a loss of $37.8 million or minus $1.02 per share in the prior year. Now turning to our balance sheet, we ended the year with $60 million and unrestricted cash, cash equivalents and short-term investments, reflecting a sequential increase of $900,000. During the quarter, our cash position benefited from the final receipt of cash from the 2015 sale of our Slingo and social casino business. I’ll now turn to our outlook for the first quarter. As noted, 2017 was a year of progress for us. We have positioned RealNetworks for profitable growth through stabilizing our financial framework while simultaneously investing in our growth initiatives. We believe our strategic initiatives remain on track to deliver top line growth in 2018, and we expect to return to positive adjusted EBITDA during 2018. Specifically, for the first quarter of 2018, we currently expect total revenue in the range of $20 million to $22 million and an adjusted EBITDA loss in the range of minus 1 million to minus $3 million. With that, we will now open the call for questions. Operator?

[Rob Glaser:]

Well, thank you. Thanks everyone for joining today’s call. We appreciate your continued interest in RealNetworksand. We look forward to keeping you update on our progress in the weeks and months ahead. Thank you.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.