RealNetworks, Inc.

Greetings and welcome to Real Networks, Inc. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Ms. Kim Orlando, with ADO Investor Relations. Please begin.

Thank you, and welcome to Real Network's third quarter 2020 financial results conference call. Before we begin, I'd like to remind you that some matters discussed today are forward-looking, including statements regarding Real Network's operating expenses on a consolidated basis and trends affecting its businesses and prospects for future growth and profitability, liquidity, and financial condition. Other forward-looking statements include the company's plans to implement its strategy, invest in its products and initiatives, and restructuring efforts, as well as the expected growth, profitability, and other benefits from these activities. In addition, today's call contains certain forward-looking statements that relate to the pending sale of 84% owned Rhapsody International Inc., which does business as Napster, to Melody VR Group, PLC. Effective as of the third quarter of 2020, Napster is presented as a discontinued operation for accounting and disclosure purposes, and comparable historical periods have been recast to conform to this presentation. Statements that express our belief and expectations in 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 filing, including in the risk factors set forth in our most recent reports on Form 10-K and Form 10-Q and in other reports. A copy of those filings can be obtained from the SEC or from the investor relations portion of our corporate website. Forward-looking statements made today reflect Real Network's expectations as of today, November 3rd, 2020. 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 reasons. In addition, we'll present certain financial measures on this call that will be considered non-GAAP under the SEC's Regulation G. For reconciliations 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 8K dated and submitted to the SEC today, both of which can be found on our corporate website at investor.realnetworks.com under the Financials tab. With me today are Rob Glaser, Chairman and CEO, and Judd Lee, Senior Vice President and CFO. Rob will discuss the company's strategy and the progress the company made during the third quarter of 2020. Judd will then provide a more detailed financial review of the third quarter of 2020. After today's prepared remarks, Rob and Judd will be pleased to answer questions. With that, I will hand the call over to Rob.

Thanks, Kim. Good afternoon, everyone, and thanks for joining us today. I want to talk about three topics. First, I'll summarize our financial results. Second, I'll discuss our progress and momentum in our primary growth initiatives, which are free-to-play casual mobile games, and safer. Third, I'll cover our success regarding the interrelated goals of, A, simplifying real, B, monetizing non-strategic assets, and C, bringing capital in to drive these initiatives forward. First, our Q3 results. The following numbers pertain to our continuing operations. which includes our games, consumer media, and mobile services business. Napster also had a very solid quarter, but since Napster is in the process of being sold to Melody VR, Napster's results are now being presented as discontinued operations. I will discuss this pending Napster transaction in more detail shortly, and Judd will go through Napster's financial results a little later. In Q3, our revenue from opinion operations was $16.6 million. The gross margin profile of opinion operations was 75%, which was in line with the prior quarter and is significantly higher than when the numbers included NAFSA. Our commitment to improving business performance led to our fifth consecutive quarter of year-over-year improvement in our adjusted EBITDA loss from new operations, this time to negative $1.9 million. These numbers include CENR, which accounted for roughly $400,000 of our EBITDA loss in both the current quarter and in the prior year period. In 2021, we will likely pro forma out CENR, but for consistency, we've included seniors' expenses in our 2020 numbers. We'll go through our finances in more detail in a few minutes. Next, an update on our two primary growth initiatives, free-to-play games and our safer computer vision platform. Game house revenue increased 2% over the prior quarter and 6% over the year-ago period. This understates our progress in free-to-play games, which increased by 60% compared to the third quarter of 2019, and now represents about half of our game revenue. Gamehouse's growth continues to be driven by the success of our two main free-to-play games, Delicious World and Delicious Bed and Breakfast. We remain confident that free-to-play games will continue to be our primary growth engine for our games business. Next, I'll turn to Safer, our computer vision platform. While certain parts of the commercial sector have clearly been affected by the pandemic, we're starting to see new opportunities for Safer mode. For instance, the T1 International Airport's cross-border express, or CBX, recently chose Safer to track mass compliance and gather critical operations data within the terminal to optimize operations and improve passenger flow. In addition, we're very pleased with the progress we've been making with SACRE in the federal sector. We continue to execute on two Directive Phase II Small Business Innovation Research, or CIBR, contracts that we were awarded in Q2 with the U.S. Air Force. Q3 is the first quarter in which we've generated revenue from these contracts, and we look forward to continuing to deliver on these contracts in the quarters to come. Just last week, we launched SACRE version 3.0, which features enhanced COVID-19 response features and a new default high-sensitivity face detector. This improved face detector enables better face detection and recognition accuracy for both masked and unmasked faces. Safer's accuracy improvements under this release will enable customers to deploy face-based contactless secure access without requiring removal of masks. Safer 3.0 also includes a new mask detection dashboard that enables customers to anonymously track mass usage rates. I'm very pleased with our team's ability to move quickly to address important new customer needs that have emerged during the pandemic. I'm also very pleased with our efforts to continue to strengthen our Safer team, most notably with the recent addition of Brad Donaldson as Vice President of Computer Vision. Brad will be primarily responsible for leading the strategic and product and business development for Safer. We're already benefiting from Brad's expertise and insights, given his extensive experience in the industry. Third, I'd like to talk about our progress in simplifying real, monetizing assets that are not core to our future, and adding resources via outside capital that will enable these spun-out businesses to thrive and scale going forward. We made notable strides in this regard in Q3 with both Napster and Senior. On August 25th, we announced that Napster, of which we own 84%, will be acquired by the Melody VR Group, a leading creator of live virtual reality music. The total deal value is $70 million. This comprises about $44 million in assumed liabilities and fresh consideration of $26.3 million. So a combination of cash and Melody VR stock. The final value from the transaction to our networks is subject to several fractures, including deal costs, Napster repaying $3.9 million in debt, an escrow of $3 million, the mix of cash versus Melody stock and the market value of that stock, and payment to Columbus Nova that's tied to our January 2019 acquisition of CN Stake and Net. We expect the transaction to close during the fourth quarter, at which point we will discuss further details. We're proud of our stewardship of the iconic Napster brand and the Rhapsody business over the past 17 years. We're confident that Anthony Matchett and the team at Melody VR will do a great job of carrying the company forward. The second transaction is for our Senior Watch Party service and platform. Senior is a nascent business we incubated for two years and are now in the process of spinning out. Senior raised a total of $2.1 million in funding from external investors, led by a Seattle real estate investment firm called SeaChage, and also with significant participation from Blanche and its affiliated investors. I also participated as an individual investor. Eventually, we expect that Siena will become an independent operation, but in the short term, Siena will remain consolidated in real estate interest. As of September 30, 2020, we owned approximately 82% of Siena's outstanding equity because the new proceeds were structured as a note that will convert into equity at a later date. Before I conclude, I'd like to briefly touch on the pandemic, which has continued to stress and challenge all of us. The health, safety, and well-being of our employees, their families, our customers, and our communities remains a paramount priority. The vast majority of our staff continue to work virtually for the foreseeable future, through 2020 and into the first part of 2021. I'm extremely pleased that our productivity has remained strong throughout this challenging period, and would like to extend my sincere thanks to all of our team members and business partners who have successfully adapted to this new normal. In closing, I remain optimistic on Real's future prospects, led by our two primary growth initiatives, free-to-play games and Safer. I'm also very pleased with the progress that we've made in monetizing and spending on other assets. Going forward, we will continue to manage cost effectively and keep focusing on our biggest growth opportunities. I will now turn the call over to Judd to go through the numbers in detail.

Judd? Thanks, Rob, and good afternoon, everyone. In my remarks today, I will first review our consolidated third quarter results, followed by a more detailed discussion of our segment's business performance. Please note that year-over-year and sequential comparisons are not always apples to apples due to the periodic variability in our revenues. Certain of our businesses, including the IP licensing part of our consumer media business and mobile games within our games business, can fluctuate quarter to quarter. but we will continue to update you on these timing impacts and their implications. In addition, as Rob highlighted, Napster is being treated as discontinued operations for accounting and disclosure purposes. Therefore, unless otherwise noted, our results presented today relate to the continuing operations of real networks, which exclude Napster. Now, turning to our results from continuing operations. Total revenue for the third quarter was $16.6 million as compared to $17.1 million in the prior quarter and $17.7 million in the prior year period. The decreases over both periods were due to declines in our consumer media and mobile services segments, which were partially offset by growth in our game segment. Looking at these results in greater detail, revenue within the consumer media segment was down $600,000 sequentially and down $1 million year over year. The sequential and year-over-year declines were primarily due to the timing of shipments and payments and continuing declines in our legacy PC products. Mobile services revenue was down slightly on a sequential basis and down $500,000 on a year-over-year basis. The sequential and year-over-year decreases were primarily due to declines in our legacy products. On a year-over-year basis, the decrease was partially offset by higher sales in context. Games revenue. for the third quarter was up 100,000 sequentially and up 400,000 year-over-year. On a sequential and year-over-year basis, the increase was driven by the continued strong performance of free-to-play mobile games, partially offset by fewer premium game launches. Consolidated gross profit for the third quarter was $12.5 million, down $300,000 compared to the prior quarter and down $900,000 compared to the prior year period. The sequential and year-over-year decline is primarily due to lower revenue from legacy products in our consumer media and mobile services segments, partially offset by higher revenue in the game segment. As a percentage of revenue, gross margin was 75% compared to the 75% in the prior quarter and 76% in the prior year period. Total operating expenses for the third quarter were $15.3 million, a decrease from $15.6 million in the prior quarter and $18.5 million in the prior year period. The sequential decrease was primarily related to lower people-related costs. The year-over-year decline was due to lower people-related costs and professional service fees. Adjusted EBITDA for the third quarter was a loss of $1.9 million compared to a loss of $1.4 million in the prior quarter and a loss of $3.2 million in the prior year period. Net loss attributable to real networks from continuing operations was 3.2 million or minus eight cents per diluted share compared to a net loss of 3.1 million or minus eight cents per diluted share in the prior quarter and a net loss of 5.2 million or minus 14 cents per diluted share in the prior year period. Turning to our third quarter segment results in more detail. Consumer media segment contribution margin was a loss of $100,000 compared to a gain of $500,000 in the prior quarter and a gain of $300,000 in the prior year period. The sequential and year-over-year decrease primarily reflects lower revenue. Year-over-year, the decrease was partially offset by decreased operating expenses as a result of our ongoing expense management. Mobile services segment contribution margin was a loss of $600,000 compared to a loss of $900,000 in the prior quarter and a loss of $1.9 million in the prior year period. The sequential and year-over-year contribution margin improvements were primarily related to lower people-related costs, marketing expenses, professional service fees, and facilities expenses. Game segment contribution margin was $600,000 in line with the prior quarter, compared to $200,000 in the prior year period driven by a continued strong performance of free-to-play mobile games. At the corporate level, unallocated corporate expenses of $2.5 million decreased by $200,000 compared to the prior quarter and decreased by $1 million compared to the prior year period. The sequential and year-over-year decreases were primarily due to lower restructuring costs and other charges and stock-based compensation. Our third quarter operating expenses at the corporate level included $300,000 of restructuring costs compared to $700,000 in both the prior quarter and prior year periods. Before I turn to a discussion on our financial condition, I'd like to briefly touch on NAPSR's results, which are being presented as discontinued operations. NAPSR's revenue of $23.6 million was up slightly compared to $23.3 million in the prior quarter and was down compared to $27.3 million in the prior year period. Napster's net loss at approximately $1,000 was essentially break-even. Now, turning to our balance sheet. At September 3, 2020, we had $13.2 million in unrestricted cash and cash equivalents, compared to $8.5 million at December 31, 2019. The increase was primarily related to the cash proceeds we received from our sales of Series B preferred stock to our CEO, Rob Glazer, in the first quarter of 2020, and funding received pursuant to the Paycheck Protection Program in the second quarter of 2020, which was partially offset by cash used to fund our operations. Our cash balance declined slightly compared to $14.4 million at June 30, 2020, primarily due to cash used to fund operations partially offset by $2.1 million in funding from investors for CENR. Our total debt at September 30 was $6.8 million. Looking ahead, Given the uncertainty and lack of visibility resulting from the COVID-19 pandemic, its impact on the economy, and its potential impact on our operations, we will not be providing guidance for the fourth quarter of 2020. In summary, our progress with our key initiatives, combined with our commitment to diligent expense management to help fuel their growth, lays the foundation to make a stronger and better position for future success. thanks to all of our employees for their ongoing commitment to keeping Real Networks a safe, productive, and rewarding place to work. With that, we will now open the call for questions. Operator?

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation symbol indicate your line is in the question queue. You may press star two if you would want to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up a handset before pressing the start key. One moment while we poll for questions. Ladies and gentlemen, I would like to turn this call back over to our CEO. Rob, you may conclude this call.

I want to thank everybody for joining us, either live or on demand, of course, given that today is Election Day. I look forward to being in touch with each and all of you, either during these calls or afterwards as we customarily make ourselves available. And with that, I want to thank everybody in the company for working hard and continuing to focus very effectively during this pandemic. I want to thank all of our partners and stakeholders for the same and look forward to seeing everybody virtually in the short term and physically over the longer term. Thanks.

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time. Thank you for your