RealNetworks, Inc.

Greetings and welcome to Real Networks Incorporated first quarter 2021 earnings call. At this time, all participants are on 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 the conference over to today's host, Kim Orlando with Addo Investor Relations. Please proceed.

Thank you, and welcome to Real Network's first quarter 2021 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 future revenue, operating expenses, and adjusted EBITDA, as well as trends affecting its businesses and prospects for future growth and profitability, liquidity, and financial conditions. 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 December 2020 sale of Rhapsody International, Inc., which does business as Napster, to Melody VR Group, PLC. Effective as of the third quarter of 2020, NAFSA 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 beliefs 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 filings including in the risk factors set forth in our most recent report 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 section of our corporate website. Forward-looking statements made today reflect Real Network's expectations as of today, May 12, 2021. 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 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 are found on our corporate website at investor.realnetworks.com under the Financials tab. With me today are Rod Glazier, Chairman and CEO, Mike Ensign, President and COO, and Christine Chambers, Senior Vice President, CFO, and Treasurer. Rob will discuss the company's strategy and the progress the company made during the first quarter of 2021. Mike will then provide a more detailed update on Real's AI initiatives, Safer in Context. And Christine will conclude with a more detailed review of our financial results. After today's prepared remarks, Rob, Mike, and Christine 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. The data plan to cover three topics. First, I'll discuss the status of real strategic transformation from a digital media technology company to an AI-based company. Next, I'll summarize our first quarter results in the context of the transition. And third, I'll discuss our recent successful fundraising initiative and other activities related to aligning our capital structure with our strategy. Q1 2021 was an important quarter in real strategic transformation to an ad-centric company. This transformation is centered around our QAI-based products and services, Safer, which is our computer vision platform, and Context, which is our natural language processing or NLP platform. Our traditional or foundation businesses will continue to be important to us in two ways. First, they will provide financial balance that will help us fund our AI initiatives, and second, they will contribute data that will help us improve and differentiate our AI products. During the first quarter, we achieved significant growth in Safer and Context. Revenue for Safer increased approximately 160% year-over-year, and Context increased 10% year-over-year. Safer and Context together grew to represent 29% of our mobile services segment revenue Q1, up from 23% in 2020. Mike will provide additional depth on our progress with Safer and Context in a few minutes. Second, let me summarize our financial results. Our first quarter revenue was $15.9 million, which was down 10% compared to the prior quarter, and down 6% compared to the prior year period. This decline was primarily due to the end of a few carrier contracts related to our ringback tone business. As I mentioned earlier, our year-over-year AI revenue growth in Q1 was strong. On the bottom line, our adjusted EBITDA loss was $3 million compared to a loss of $4.4 million in Q1 2020, excluding CNIR, which were in the process of spinning out, adjusted EBITDA was a loss of $2.4 million. And I'll discuss CNIR further in a few minutes. These results reflect continued discipline in how we manage costs in our foundation businesses to enable us to invest in our AI growth opportunities. A word about our games business. After excellent growth in free-to-play games in 2020, we were disappointed with games Q1 results for free-to-play games, which declined slightly compared to the prior quarter. The team is making some changes in order to reinvigorate growth in our two biggest free-to-play titles. We believe that the team will get back onto a growth trajectory, but that it will likely take a few quarters. Finally, before passing the mic to Mike, I'd like to talk about our recent progress and our balance sheet and capital structure. As you know, at the end of 2020, we sold Napster to Melody VR for a total of approximately $70.6 million, which included about $15 million of cash, $11.6 million of Melody VR stock, and the assumption of approximately $44 million by them of Napster's balance sheet liabilities. Last month, we closed out the final piece related to this transaction $4.8 million in consideration for their stake, which we bought in 2019. This disbursement consisted of $2.5 million of cash and the transfer of $2.3 million of Melody stock, as valued as of December 2020, NAFTA's sale closing date. Then, in April, we went out to the public market for the first time in an organized fashion to tell the story of our transition to an asset-centered company. As a result, we raised approximately $20.3 million in net proceeds which we will use to fuel our growth in 2022 and beyond. Indeed, in the context of that program, we told investors that, with those investments, we expect to achieve double-digit revenue growth in both 2022 and 2023. Our next step in simplifying and aligning our balance sheet for the growth opportunities in front of us is the completion of the spin-out of Senior. As you likely recall, Senior is a virtual movie theater service which allows consumers to watch shows virtually with their friends on about a dozen video services, including Netflix, Disney Plus, and HBO Max. Recently, I stepped down as chairman of CENAR, and we brought in an esteemed tech and entertainment industry executive and entrepreneur, Richard Wolpert, to be CENAR's executive chairman. Daniel Stickman remains CENAR's CEO. Richard, Daniel, and the rest of the CENAR team are doing an incredible job scaling up CENAR. CENAR has grown its audience by over 100 times, not 100%, 10,000% over the past year. Consumers are now using CENAR to watch over 100 million minutes of video each month. Given its rapid growth, Senior is in the process of raising additional expansion capital. I'll continue to serve on Senior's board, as will Mike Ensign. I believe Real has a great opportunity as a shareholder to participate in Senior's success. As I said earlier, I'm very pleased with and proud of the progress Real has made in setting our company up for success and in growing our AI business operationally. And with that, I may now pass the baton to Mike to discuss the progress in more detail.

Thank you, Rob. I will be discussing both safer and context. Before I provide updates on these businesses, I'd like to briefly outline why we are in these businesses strategically. Each of these businesses are part of large, growing markets where we have unique competitive advantages. In the case of safer, our competitive advantages are extremely compact, very fast, highly accurate, and low-bias algorithm that was developed using proprietary data. In the case of context, The source of our competitive advantage is the approximately 1 billion SMS, MMS messages we process daily to base our algorithms upon. This results in highly trained and robust filtering tools. Each one of these products also utilizes leading computer vision and natural language AI talent residing at Real. Now, let me turn to update on each one of these businesses. For SAFER, we delivered yet another strong order driven by successes in both the U.S. federal and global commercial businesses. In addition, we made significant progress with our SAFER product with our latest release and were rated highly by NIST in their most recent ongoing facial recognition vendor test. In the U.S. federal business, we continued to execute on two direct-to-phase-to small business innovation research, or SIBR, contracts, with the United States Air Force. In addition, we were recently awarded a third CIVR with the U.S. Air Force to support perimeter protection and domestic search and rescue missions. Work on this will likely start in Q2 with the bulk of the work being done for the remainder of the calendar year. I'll now turn to a discussion of SAFER's global commercial business and partnerships. As a reminder, the SAFER commercial business focuses on a variety of use cases, including secure access authentication, surveillance watch list, and embedded applications with our Safer Inside initiative. During the quarter, we made several advancements with key partners. We recently announced a partnership with Goiterbrook, an international provider of proprietary high-performance video security software and hardware. Safer has been integrated as an AI layer on top of Goiterbrook's video management system to provide advanced video analytics for surveillance operations. saving both time and increasing efficiencies. During the quarter, we furthered our Safer Inside initiative and expanded our scope with ACCESS. In addition to being available on the ACCESS Q1615 Mark III box camera, the Safer Inside technology can be embedded directly on the ACCESS P3255 dome camera. Safer Inside enables network cameras like the ACCESS P3255 to reduce video processing server overhead and lowers total cost of ownership. In addition, we also recently signed a partnership agreement with Convergint. Convergint Technologies is a U.S.-based $1 billion global industry-leading systems integrator. Convergint will add the Safer Computer Vision platform to their portfolio of integrated security solutions and allow the two trusted companies to bring computer vision analytics solutions to market. Also, Saver recently signed a collaboration agreement with Atos in Europe. Atos is a worldwide provider of information technology consulting, products and services, and a leader in edge computing and digital security. The collaboration agreement focuses on joint go-to-market and project teaming for solutions primarily in the access control and authentication spaces. On the product side, we recently released version 3.4 of SAFER, which introduces new passive liveness detection and anti-spoofing features to enhance security for face biometric authentication solutions. Within 0.3 seconds, SAFER's AI-powered live NIST detection can verify that a real live person is in front of any standard RTSP or USB camera versus a photo or video clip with over 95% accuracy. We are also excited about the latest NIST results, which reinforce our competitive differentiators in the industry. Of the top 50 most accurate algorithms for faces in the wild, RealNetworks was the fastest and the most lightweight. Achieving high accuracy quickly with less data is a key capability when dealing with live video as a source for face recognition. RealNetworks consistently ranks among the least biased of all algorithms tested by NIST. We continue to be very excited about our prospects for future growth for the safer business. Next, I'll turn to a discussion of Context. Based on its messaging expertise, Weal built its next-generation Context platform over the last several years. Context is focused on creating AI-based products and services that help our customers deliver better messaging-based services and experiences. For our Context for Messaging product, we are focused on increasing scope with current customers and expanding our customer footprint by leveraging our telecom relationships developed through our long history of service in the industry. Building on our AI capabilities, we announced a new context product during the first quarter, Context for Voice. Context for Voice is an AI-backed service that actively blocks fraudulent calls and is deployable for carrier operators. In summary, we are excited about both the progress we are making and the growth trajectories of our AI-based businesses safer in context. With that, I will now turn the call over to Christine to talk about our first quarter 2021 financial results in greater detail. Christine.

Thanks, Mike, and good afternoon, everyone. I'm thrilled to rejoin RIL to lead the finance organization during this exciting period of growth and opportunity. In my remarks today, I will first review our consolidated first quarter results, followed by a more detailed discussion of our segment business performance. Please note that sequential and year-over-year comparisons are not always apples to apples, as certain of our businesses can fluctuate quarter to quarter. In addition, NAPSDA has been deconsolidated as of December 30th, 2020, and is being treated as a discontinued operation for accounting and disclosure purposes. Therefore, our results presented today relate to the continuing operations of rail networks which exclude Napster. Now turning to our results. Total revenue for the first quarter was $15.9 million compared to $17.6 million in the prior quarter and $16.8 million in the prior year period. A strong growth in our AI businesses were more than offset by declines in some of our foundation businesses. primarily due to a few ringback tone contracts that did not renew in 2021. Looking at these results in greater detail, revenue within the consumer media segment was down 100,000 sequentially and down 200,000 year over year. The sequential decrease was primarily due to declines in our PC products when compared to the successful RealPlayer 20 upgrade campaign in Q2 2020. which were partially upset by the timing of renewals and shipments of our IP codec business. Year-over-year, the decrease was primarily due to the timing of our IP contracts and the result of revenue from multi-year deals booked in the prior year period. Mobile services revenue was down $1.4 million on a sequential basis and down $700,000 on a year-over-year basis. The sequential decline was primarily due to lower ringback tones and safer federal revenue compared to the fourth quarter of 2020. Year-over-year, the decrease was primarily due to declines in our ringback tone product, partially offset by higher sales in safer and context. Games revenue for the first quarter was down 300,000 sequentially and was essentially flat year-over-year. On a sequential basis, the decrease was due to a slight decline in both our free-to-play and legacy games. Compared to the prior year period, growth in our free-to-play was offset by lower revenue in our legacy games. Consolidated gross profit for the first quarter was $12.2 million, down $1.4 million compared to the prior quarter, and down $500,000 compared to the prior year period. As a percentage of revenue, gross margin was 77%, which was flat compared to the prior quarter and up from 76% in the prior year period. Total operating expenses for the first quarter were $18.4 million, an increase of $10.3 million from the prior quarter and $900,000 from the prior year period. These numbers can fluctuate because they include several non-core items. When normalizing for non-core items, including restructuring costs and gains resulting from the fair value adjustments on the contingent consideration liability for the Napster transaction. First quarter operating results were up 1.2 million or 8% compared to the prior quarter and were down 1.5 million or 8% compared to the prior year period. Net loss attributed to real networks was 10.4 million or minus 27 cents per diluted share compared to net income of $6.1 million, or $0.16 per diluted share in the prior quarter, and a net loss of $4.6 million, or $0.12 per diluted share in the prior year period. Please also note that in addition to the non-core items discussed earlier, net loss in the first quarter of 2021 included a pre-tax loss of $4.3 million related to the fair value assessment of our interest in Melody VR stock, which is now trading with Napster Group PLC. Adjusted EBITDA for the first quarter was a loss of $3 million compared to a loss of $900,000 in the prior quarter and a loss of $4.4 million in the prior year period. As Rod mentioned, adjusted EBITDA for the first quarter, including $600,000 of cost related to SINA, was $2.4 million. Turning to our first quarter segment results in more detail, consumer media segment contribution was 600,000 compared to 700,000 in the prior quarter and 400,000 in the prior year. On a sequential basis, the decrease is due to lower revenues. On a year-over-year basis, the improvement reflects decreased operating expenses as a result of our ongoing expense management. Mobile services segment contribution was a loss of $1.6 million compared to a loss of $200,000 in the prior quarter and a loss of $2.5 million in the prior year period. The sequential decrease was primarily due to lower revenue in our rimback tones business and safer federal contracts, and slightly higher operating expenses primarily related to our investment and safer in context. Year over year, the contribution margin improvement was primarily driven by lower operating expenses, as a result of our ongoing expense management focused on our foundation businesses, partially offset by high marketing expenses related to Safer. Gain segment contribution margin was a loss of $100,000 compared to a gain of $300,000 in the prior quarter and a gain of $100,000 in the prior year period. On a sequential and year-over-year basis, the decrease was due to lower revenue, along with our investments in mobile gains. At the corporate level, unallocated corporate expenses of $5 million increased by $9.8 million compared to the prior quarter and increased by $2.4 million compared to the prior period. Again, these numbers can fluctuate because they include several non-core items. When normalizing for non-core items, including restructuring costs, and gains resulting from the fair value adjustments on the contingent consideration liability from the NAPSDA transaction, first quarter unallocated corporate expenses were up $700,000 compared to the prior quarter and were flat compared to the prior year period. Further information on our non-core items and other items can be found in the 10Q. Now turning to our balance sheet. At March 31st, 2021, we had $17 million in unrestricted cash and cash equivalents compared to $23.9 million at December 31st, 2020. The decrease was primarily due to cash flows used in operating activity and seasonal working capital timing. At March 31st, 2021, our total debt was $2.9 million, and we had no borrowings outstanding on our revolving credit facility. As Rob highlighted, on April 29th, we strengthened our balance sheet with the closing of an underwritten public offering that resulted in net proceeds to the company of approximately $20.3 million. Now turning to our outlook. We are pleased to be in a position to reinstate financial guidance for our continuing operations today, given our confidence in the long-term plan. For the second quarter ending June 30th, 2021, We currently expect total revenue to be in the range of 14 million to 15.5 million, which reflects softness in our games business and a sequential decline in the IP licensing part of the foundation business due to timing, partially offset by growth in our AI businesses. Further, we expect adjusted EBITDA loss to be in the range of 6 million to 4.5 million, including SINA expenses of up to $750,000, and an adjusted EBITDA loss in the range of $5.25 million to $3.75 million, excluding SINA. This includes approximately $1 million of new investment in light of our capital raise in April. We believe the second quarter will reflect the trough for the year for both revenue and adjusted EBITDA. For the full year ending December 31st, 2021, we currently expect total revenue to be relatively flat with 2020. 2021 will be an investment year with a focus on reigniting overall top line growth in 2022 and beyond. As such, we fully expect our full year 2021 adjusted EBITDA loss to be greater than it was in 2020. We look forward to seeing the benefits of our investments begin to bear fruit in 2022 and 2023, when we expect to see meaningful double-digit revenue growth driven by our AI-focused products, Safer and Context, as well as free-to-play games. With that, we'll now open the call for questions.

Thank you.

Operator?

Thank you. At this time, we will conduct a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star 1 to ask a question at this time. One moment while we pull for our first question. Our first question comes from Mark Aginto with Lake Street Capital. Please proceed.

Hey, Rob, Mike, and Christine. Just a couple of questions. Wanted to dig into the AI business a little bit more. Looks like the Safer business is growing really nicely, up triple digits. Can you talk a little bit about the wins that you're having in that business? You highlighted the access camera deal. Maybe talk about some of the opportunities you're targeting, these systems integration deals where there's big RFPs out there. Maybe talk a little bit about the pipeline and how you see that business building in the coming quarters.

Mike, do you want to take that one?

Yeah, I'll take that. So first of all, from a sort of use case perspective, and this is talking – Two segments were focused on the federal segment and then the commercial segment. On the federal segment, I talked a little bit on the call about the most recent CBER that we've won that we'll begin executing work on. And then there are some other significant opportunities in that pipeline. On the commercial side, we're seeing opportunities across several different use cases. So one is access control. Second is authentication. And third is surveillance watch list. And then, you know, as I mentioned, we're expanding the relationship with Access and now available on one of their most popular dome cameras. And we're pretty excited about the prospects that that will provide. We're also excited about just different types of partnerships. The Atos relationship could bring significant traction in Europe. Similarly, the Convergent relationship. So, you know, our strategy right now is, you know, going significantly after these use cases. And one of the advantages that we have is our global sales force. And that actually helps create diversification of sort of opportunities. and then also going after this very significant partner relationships, as I described.

Great. And how big is the sales force currently selling the Safer product?

It's approximately – well, we probably shouldn't really know right now.

Yeah, we don't break out information on size of sales teams, but it's definitely a leverage model. In other words, our goal is to have partners that bring us opportunities and have our sales team be organized to take advantage of those opportunities primarily through partners. So we're not, it's not our plan, the business plan in the general case to build out sales forces that are calling on every end customer, but rather to put together a network of partners and to leverage those partners in a scale way and then have some of the bigger opportunities where the ones where it's the first of a category, first of a kind, engage more directly in order to build up a repeatable book of business in that vertical or in that region. So it's sort of a combo strategy of prime the pump and leverage the partners.

So you're using a combination of systems integrators and distributors slash bars as the go-to-market versus the direct sales force?

Yes. And I would say the federal business is a little bit different because in the first phase of the federal business, The CBER process is one that has been involved, direct engagement, because you have to actually directly engage the government on those. But similarly, in the federal engagements, we expect over time to be working with partners primarily.

Got it. And then just shifting over to context. That business didn't grow quite as robustly as Safer did. Is that more of a kind of a stair step? I mean, you're signing. I'm assuming you've got to sign large carriers, so when you get one, it's going to step up big. Or maybe just kind of educate me a little bit on how that business could potentially roll out.

Rob, do you want to take that or do you want me to?

Sure. Yeah, well, I would split context in a couple different categories. We announced a partnership with Cineverse early on as our first partner when we asked for contacts, and we've rolled out some additional partnerships as well. And in the case of Cineverse, they have some large carriers that they set up. And as you say, in some cases, once you get a carrier going, You sort of, you kind of, you know, fill that bucket and then you go on to the next one. So we don't necessarily have to sign up more partners, but our partners have to sign up more customers. So it's sort of, you can kind of win either way. And in some of the additional context lines, like for instance, we talked about, you know, the context for voice, there's a similar opportunity of signing up additional partners for those. So it's, we tend to get paid by volume. But sometimes the volumes will have tiers associated with them. So in the general case, the greater volume we do, the more money we make, but it's not necessarily one-to-one. So if somebody is using our product in a given band, we won't necessarily get more money until somebody else comes online or that customer kind of graduates to a different band is generally how it works.

Got it. All right. And then just a quick kind of balance sheet slash expense question. So it sounded like the prepared remarks you think you're going to spend about an incremental million dollars in terms of investment into AI, I think you said Q2. Is that kind of a good pace moving forward in terms of that incremental spend and kind of juxtaposing that against kind of the EBITDA losses you think you suggested they'd be up? you know, year over year. So kind of a million, million and a half bucks a quarter. So maybe the incremental spends, you know, four or five million, six million bucks this year. Maybe you could throw out a little bit of thought there.

Yeah, well, we're not breaking down any numbers beyond Q2 in terms of, you know, giving a Q3 number or a Q4 number or a very detailed Q4 number. We have said that the EBITDA loss in 2021 is expected to be larger than the 2020 loss. but we haven't subdivided there. I would say in terms of the EBITDA loss, we did also say that we expect Q2 to be a trough quarter, both in terms of revenue and in terms of EBITDA loss. And so the question will be, if you look at the Q3 and Q4, what the net effect is of growing revenue, for instance, the AI revenue versus and the margin associated with that versus the incremental investment. We basically said that when you net those out, we don't expect EBITDA losses in Q3 to be larger than the Q2 EBITDA loss. That's why we call it a trough quarter. But in terms of dimensionalizing how much of that is because of the revenue growing and how much of that is because the investment is staying about constant, we didn't break that down.

Yeah, I guess the reason for the question is I'm just trying to understand kind of where you think you are in terms of the evolution of getting the AI business to scale. Does it need another $20 million worth of investment, another $5 million worth of investment? That's why I asked the question, but that's fine. Maybe we could just talk a little bit about... you know, when you're talking about trough and Q2 on the revenue line as well, is that, you know, how much visibility do you have in the business and as much as obviously you can see, you know, if you had some contracts coming off in terms of the ringtones business, but then also can see a ramp up in the other parts of the business. Do you have pretty good visibility quarter in and quarter out in terms of the revenues of the business?

I'll let Mike speak to that. Mike?

Yeah, so, you know, we do from a foundation perspective, we do have long-term contracts and very, very good visibility. And then from even an AI component, strong visibility to a large portion of the revenues. Yeah, so there's pretty good visibility.

Yeah. And in addition, obviously, you have a pipeline, you have a methodology for business that hasn't closed yet where your visibility on what the closing expectation is for future revenue. And then, you know, I would say, in my view, and we haven't broken this out this time, and we may or may not in the future, is sometimes the final form a deal takes has a different impact in terms of booking versus gap revenue. And there was nothing in this quarter that caused us to flip to talking about that. But at some point in the future, you know, we might consider talking about bookings. where you would say, well, we achieved this much in bookings and this much in terms of, you know, gap income and then revenue and then EBITDA that's falling off of that. But in this quarter, we didn't break that out. It just really depends on the nature of those deals. And sometimes when they're in the pipeline, you know what the size of the opportunity is, but you don't necessarily know how it's going to fall in terms of what the final deal structure is going to be.

Understood. Great. Appreciate the initial caller. Thanks.

Thanks, Mark. So, operator, I know we're running a little bit over time. Should we wrap for today? And then I know we're only scheduled to go to and we're running a little bit late for that. Is that okay? Shall we wrap the close down for today and then take the other follow-up offline?

That's correct, sir. That's fine.

Great. All right. Well, I want to thank everybody for joining us today. It's an exciting time for real networks. We I very much appreciate everyone's support and want to thank all of our stakeholders, our investors, of course, our customers, and our employees and staff. The pandemic has been an extraordinary time for us all, and we feel very good about where we are. As certain parts of the world, including the U.S., come out of the pandemic, we feel empathy for our colleagues in parts of the world, such as India, that are really right in the middle of it, in the teeth of it right now, and are wishing the best and trying to be as supportive as we can be for our customers as well as our staff and team in places like India. Hopefully, the world will continue to conquer this pandemic, and we will move to a more normal world and more and more of the world in the months ahead. And we look forward to talking to everybody in three months, if not sooner.

Thank you. This does conclude today's teleconference. You may disconnect your lights at this time, and thank you for your participation.