RealNetworks, Inc.

Greetings and welcome to Real Investor Incorporated second quarter 2021 earnings conference 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 your host today, Kim Orlando, Addo Investor Relations. Please proceed.

Thank you, and welcome to Real Network's second 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, and certain forward-looking statements that relate to CENAR, Inc., including its future growth and profitability and financing activities. 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 beliefs 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 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 section of our corporate website. Forward-looking statements made today reflect Real Network's expectations as of today, August 4th, 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 can be found on our corporate website at investor.realnetworks.com under the Financials tab. With me today are Rob Glazer, Chairman and CEO, Mike Ensing, 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 second quarter of 2021. Mike will then provide a more detailed update on Real's AI businesses, 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. My remarks today will center on three main topics. First, I'll highlight our progress and growth as an AI-centered company. Second, I'll discuss how our strength and balance sheet and continued streamlining of our operations position real for future growth. And third, I'll provide further context on our Q2 results. In Q2, we continued our progress towards becoming a company and business centered on machine learning-based AI products and services. In Q2, we more than doubled our AI revenue compared to Q2 of 2020. As a reminder, this transformation is centered on two AI-based products and services, Safer, our computer vision platform, and Context, our natural language processing platform. Safer continued to be our AI pace car, with revenue increasing 282% year-over-year. Context continued its steady progress, increasing 15% year-over-year. This results in a blended average of 101% growth. Safer and context together now represent 37% of our total mobile services segment revenue in Q2, up from 29% in Q1 2021, and from 18% in 2020 Q2. In a few minutes, Mike Ensign will go into greater depth regarding our progress with both Safer and context. Next, I'd like to discuss steps we've taken in Q2 to focus real and resource real ZI businesses, and therefore real as a whole, for growth. As you likely recall, in April we raised $20.1 million in net proceeds through a public offering. We're primarily using these proceeds to make targeted investments in our AI-based growth initiatives. A second step we've taken is to support Senor's progression as an independent company. In Q2, consumers watched over 100 million minutes a month of video using Senor. Moreover, Senor has raised a meaningful amount of money independently of Real and is now self-sufficient financially. As a result, As of June 30th, CENR has moved to its next phase of independence and is no longer part of our consolidated results or operations. Factoring in upcoming investments into CENR, we expect that going forward, Rio will own approximately 40% of CENR. This importance that better aligns our balance sheet with the growth opportunities ahead of us while also providing CENR with the capital it needs to grow and thrive. I look forward to continuing to serve on CENR's board, along with Mike Ensign. We believe Real shareholders have a great opportunity over time to benefit from senior success as an independent company. And now finally, let's go through Real's overall Q2 results and put them in context. Total revenue for the second quarter was $14.6 million, which was down 8% compared to the prior quarter and down 15% compared to the prior year. While our AI businesses grew, as I mentioned above, our game business in Q2 declined both sequentially and year over year as the team is retooling our free-to-play games for future success. While I'm disappointed that our games business has hit an air pocket, we expected this going into the quarter. We in the games team are working hard to address these issues to set games up for resumed growth driven by free-to-play games. On the bottom line, we had mixed results in the aggregate. Our GAAP EPS was a loss of $0.03 per diluted share compared to a loss of $0.27 per share in the previous quarter and a loss of $0.08 per share in the prior year period. are adjusted EBITDA loss when excluding senior operating cost of approximately $600,000, which is negative $3.7 million. This compares to a loss of negative $1.1 million, including senior in Q2 2020, and a loss of negative $1.4 million in Q2 2020. These results reflect judicious increases in investments in our ag growth businesses, which we believe will pay off in the form of continued growth in the quarters ahead. As a result, we continue to expect that we will achieve not only continued growth in our AI businesses, but also double-digit consolidated revenue growth in 2022 and 2023. And with that, I will now turn the call over to Mike to discuss our AI businesses in further detail. Mike?

Thank you, Rob. The focus of my remarks today will be to elaborate on the progress we have made during the quarter in our two AI-based businesses, Safer and Context. As Rob highlighted, we once again delivered a strong quarter in Safer, driven by success in both the global commercial and the U.S. federal markets, along with several product advancements. On the global commercial front, we grew revenue significantly year over year. In addition to this revenue growth, we signed a reseller agreement with NTT DoCoMo, Japan's leading mobile operator. While NTT DoCoMo already leverages SAFER's facial recognition platform to enhance safety and security in Japan, NTT DoCoMo will further utilize SAFER to expand its nationwide 5G network to include artificial intelligence. We are thrilled that NTT DoCoMo chose SAFER over several competitors as a key partner to implement its strategy. NTT DoCoMo expects to dedicate significant sales and engineering resources to drive the safer technology within its 5G network. We look forward to both companies benefiting from the partnership. Similar to the commercial business, our U.S. federal revenues also grew significantly year over year. During the quarter, we executed against two previously announced SIBRs and built a significant pipeline focused on additional SIBRs beyond our current customer base, larger R&D opportunities, and full deployments. On the product side, we made several key advancements during the quarter. In April, we released version 3.4 of SAFR, which introduced new passive liveness detection and anti-spoofing features to enhance security for access control applications. In addition, we released a new post-event searching feature, which enables users to conduct forensic analysis within our software to enhance our investigative capabilities. Further, we will be enabling the full porting of the SAFER embedded solution to two popular SOCs. This advancement will take the SAFER algorithms to the edge and run our advanced computer vision platform on smart devices. Testing has shown that our edge solution can attain the same accuracy as our existing server-based solution. This allows SAFER to run on the edge as a smart IoT device further driving down the cost of hardware and the total cost of ownership for our customers. Next, I'll turn to a discussion of Context, our natural language processing platform. Our team at Context has been intently focused on continuing to deliver AI-based products and services to help facilitate improved messaging-based services for our customers. By leveraging the 1 billion plus SMS and MMS messages we process daily, Along with our long-term telecom industry relationships, we've been able to develop robust AI-based filtering tools to deliver enhanced experience for our customers. We continue to innovate in this space, working on the next generation of products like Context for Voice, as outlined on the last earnings call. We look forward to the further development of the Context platform to enhance benefits to both current and new customers. In summary, we are pleased with the development of the safer business across both the commercial and federal markets and remain optimistic on the future growth prospects for both safer and context. It's evident that our transformation to an AI-centric company is largely underway, and we look forward to communicating continued execution against our strategy in the quarters to come. With that, I will now turn the call over to Christine to discuss our second quarter 2021 financial results in greater detail. Christine?

Thanks, Mike, and good afternoon, everyone. In my remarks today, I will first review our consolidated second 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 30, 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 NAPSDA. Further, we completed the deconsolidation of SENA as of June 30, 2021, And as such, costs related to SINA are included in our second quarter 2021 financial results, but will not continue going forward. Now turning to our results. Total revenue for the second quarter was $14.6 million compared to $15.9 million in the prior quarter and $17.1 million in the prior year period. Similar to last quarter, strong growth in our AI businesses was more than offset by declines in our games and foundation businesses. Looking at these results in greater detail, mobile services revenue was up 400,000 on a sequential basis and down 100,000 year over year. The sequential increase was primarily driven by higher, safer revenue in both the global commercial and U.S. federal space. This was partially offset by lower revenue from our intercarrier messaging business. Year over year, the decrease was largely due to lower revenues from our ringback tones and inter-carrier messaging businesses, partially offset by higher, safer revenue in both the global commercial and U.S. federal markets. Revenue within the consumer media segment was down $1.2 million sequentially and down $1.1 million year over year. The sequential and year over year decreases were primarily due to timing of contract renewals in our IP codec business as a result of revenue from multi-year deals booked in the prior quarter and prior year period, respectively. Games revenue for the second quarter was down $500,000 sequentially and down $1.3 million year-over-year. On a sequential and year-over-year basis, the decrease was due to sales decline in both our legacy and free-to-play games. games as the team continues to work towards reinvigorating growth in our two biggest free-to-play titles, Delicious Whale and Delicious Bed and Breakfast. Consolidated gross profit for the second quarter was $11 million, down $1.2 million compared to the prior quarter, and down $1.8 million compared to the prior year period. As a percentage of revenue, gross margin was 75% compared to 77% in the prior quarter, and flat compared to the prior year. Total operating expenses for the second quarter was $16.7 million, a decrease of $1.7 million from the prior quarter, and an increase of $1.1 million from the prior year period. These numbers can fluctuate because they include certain non-core items. When normalizing for non-core items, including restructuring costs and fair value adjustments on the contingent consideration liability from the January 2019 purchase of Napster. Second quarter operating expenses were down 300K, or 2%, compared to the prior quarter, and were up 1.2 million, or 8%, compared to the prior year period, driven by focused investments as a result of our capital raise in April to drive growth in our AI businesses. Net loss from continuing operations attributable to real networks was $1.3 million, or minus $0.03 per diluted share, compared to a net loss of $10.4 million, or $0.27 per diluted share in the prior quarter, and a net loss of $3.1 million, or $0.08 per diluted share in the prior year period. Included in net loss attributable to real networks in the second quarter of 2021 was a one-time gain on the forgiveness of debt of $2.9 million from the principal and interest on the Paycheck Protection Program loan that was approved during the quarter, and a one-time gain of $2 million related to the deconsolidation of CINO. Adjusted EBITDA for the second quarter, including $600,000 of operating costs relating to SINA, was a loss of $4.3 million compared to a loss of $3 million in the prior quarter and a loss of $1.4 million in the prior year period. Adjusted EBITDA excluding the $600,000 of operating costs related to SINA was a loss of $3.7 million. Now turning to our second quarter segment results in more detail. Mobile services segment contribution margin was a loss of $1.4 million compared to a loss of $1.6 million in the prior quarter and a loss of $900,000 in the prior year period. The sequential improvement was driven by higher revenue from our safer business lines. partially offset by higher operating expenses, primarily related to our investments in Safer in Context. On a year-over-year basis, the increase was due to investments in our AI growth initiatives, Safer in Context. Consumer media segment contribution margin was a loss of 800,000 compared to a gain of 600,000 in the prior quarter and 500,000 in the prior year period. On a sequential basis and year-over-year basis, the decrease was primarily due to the timing of contract renewals in our IP codec business as a result of revenue from multi-year deals booked in the prior quarter and prior year period, respectively, in addition to expenses related to SINA. GAIM's segment contribution margin was a loss of $200,000 compared to a loss of $100,000 in the prior quarter and a gain of $600,000 in the prior year period. On a sequential and year-over-year basis, the decrease was mostly due to lower revenue in our legacy and free-to-play games. At the corporate level, unallocated corporate expenses of $3.2 million decreased by $1.8 million compared to the prior quarter and increased by $400,000 compared to the prior year period. These numbers can fluctuate because they include certain non-core items. When normalizing for non-core items, including restructuring costs and fair value adjustments on the contingent consideration liability from the January 29 purchase of Napster, second quarter and allocated corporate expenses were down $400,000 compared to the prior quarter and were up $500,000 compared to the prior year period. due to focused investments as a result of our capital raise in April. Further information can be found in the 10-Q. Now turning to our balance sheet. At June 30, 2021, we had $29.9 million in unrestricted cash and cash equivalents, compared to $17 million at March 31, 2021, and $23.9 million at December 31, 2020. The increase from March 31st, 2021 was primarily driven by the closing of an underwritten public offering on April 29th that resulted in net proceeds to the company of approximately 20.1 million. Offset in part by cash used in operating activities. At June 30th, 2021, we had no debt and no borrowings outstanding on our revolving credit facility. During the quarter, we also used $2.5 million of cash and transferred 47.8 million ordinary shares of Napster valued at the December 2020 Napster sale closing date to settle our contingent consideration liability for our January 29 purchase of Napster. In addition, we strengthened our balance sheet through the removal of CENA's associated liabilities which resulted in a non-cash gain of approximately $2 million during the second quarter. Now turning to our outlook. For the third quarter ending September 30th, 2021, we currently expect total revenue to be in the range of $13.5 million to $15.5 million and adjusted EBITDA loss in the range of $5 million to $3.5 million. excluding CENA, which has been deconsolidated as of June 30th, 2021. For the full year ending December 31st, 2021, we now expect total revenue will be relatively flat to slightly down from 2020 levels, due primarily to softness in our games business. 2021 will continue to be an investment year with a focus on reigniting overall topline growth in 2022 and beyond. As such, we expect our full year 2021 adjusted EBIT loss to be greater than it was in 2020. We look forward to seeing the benefits of our investments begin to manifest 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. 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 mind 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 poll for our first question. Our first question comes from Mark Argento with Lake Street Capital. Please proceed.

Hey, good afternoon, guys. Thanks for taking my questions. I've got a few different ones here. I'll start with Safer. I was just wondering if you could kind of walk us through the NTT Docomo deal. It sounds very interesting, you know, how a contract like that will scale up. You know, is Docomo reselling the product into their channel? Are they deploying it? primarily through existing relationships? Maybe you could kind of dig into that and just try to better understand the size and opportunity of a contract like that.

Yeah, so thanks for the question, Mark. So yeah, they will sell both within their existing channel and additional customers. Uh, it is a, uh, approximately two year agreement. Uh, and then, uh, you know, there are, you know, established, um, fees or license fees to us as part of the agreement.

And is that they're, they're, you know, they're effectively the reseller group. So they're selling corporate solutions to, or solutions to corporations. Um, is that their target on market? Yeah.

Yeah. Yeah. It's, uh, it's enterprise focus.

helpful and then in terms of um how quickly you know would they could they get out market and start selling is there a long scale-up period in terms of how to educate the sales force or implementation uh no i think they can scale up pretty quickly here mark right and then um uh just um Just a couple questions on the senior business. So I'm assuming now that you guys are at roughly a 40% ownership or will be shortly, that's what precipitated the deconsolidation of the numbers in the financial statements?

Well, the whole calculation, this is Rob, for how you deconsolidate a business is a multivariate equation, as I have learned and painstakingly appeal from our legal and finance teams. But this is something that has been carefully scrutinized by our finance team and our legal team. CNIR has an independent leadership team. Mike and I are on the board, but we are not a majority of the board. There's a number of different factors. and the context of how the company is developing independently. We kind of set sail to go in this direction, and apparently when the boat gets a certain amount offshore, you get to characterize it this way, and I always try to understand these things so they can generalize, and I've learned some generalizable things, but it's, I think, suffice to say that as of June 30th, the boat is far enough from shore for us to consider it an independent company for consolidation purposes.

Great, and So you guys, is it technology that originally came out of Real Networks, or did you guys invest into the business? Remind us, give us a little history there.

So the history, I was the intrapreneur, now entrepreneur, who created the core platform that became Senior. It was somebody who worked at Real. We'd actually acquired his company some years before. He's sort of a very catalytic thinker, and I and a few other people worked closely with him. as he incubated the idea. Originally, he was working with the real player team, and as the idea developed, it became clear to us that the best opportunity for this idea was as an independent path. It was doing pretty well, and it sort of started independent. It joined an incubator called Launch, which was helpful to the team to kind of learn sort of how to be more independent and entrepreneurial in their not just their technology, but sort of how they run the business. And then the pandemic hit, and it exploded. It blew up in terms of usage. I think at one point it said that usage grew 100x over the previous couple quarters. It was just great product, right place, right time. Everyone was at home, locked down, but still wanting to stay connected to their friends. So Senior, which allowed people to do watch parties on a wide range of services, started with Netflix, and now it supports over a dozen companies. was well positioned to take advantage of that wave. And one of the exciting things about it is it's continued. It hasn't, you know, any thought that one might have had that this was going to be something that would be a temporary phenomenon and people would go back to their old way of doing things. And I think it's like a lot of other things in the pandemic. pandemic has changed patterns and has introduced new methods of communicating. I think, you know, just to, for instance, like think about Zoom calls. You know, yes, face-to-face meetings will come back, but it's not like people are going to stop doing meetings by Zoom and the like. And similarly, you know, people will go over to their friend's house to watch shows or they'll go into movie theaters, but this is a new modality of how people can watch shows with their friends, and the senior team is really well positioned for that fundamental trend. So, We're glad we incubated it. We're glad we spun it out. We like the team very much. We believe in the opportunity. It has an independent capital needs. Basically, this sort of model, if you think of any of these free consumer services, the big ones like the Facebooks of the world or the Twitters of the world, Instagrams, et cetera, you're in investment mode for several years as you're scaling the audience. And then once the audience gets to a certain size, there's a bunch of ways to monetize it. So it has a different investment profile. than the kinds of businesses that we build and run within real. So it made sense to, to spin it out. And I believe it will, it will serve both us and senior well for us to have done that.

Great. Well, it'd be interesting to watch the progress there and hopefully maybe, you know, can become a valuable asset economically for you guys as well. So just getting back to safer and, and, and AI in general, you know, Mike, can you talk a little bit about your go-to-market strategy, maybe a little bit on the sales team there? I think maybe you've made some hires, kind of where you're sitting in terms of the go-to-market team right now.

Yeah, Mark. So we have actually made some contract hires to strengthen leadership in that space. We are still very focused globally leveraging our global sales team. As you see in the results, you know, we talk about strength in APAC in Japan and, you know, very good strength there. And then we're actually continuing to build our sales force and our resources within the federal segment.

Great. All right. I think that does it for me. I appreciate it. Thanks, guys.

Thank you. Thanks, Mark.

Once again, ladies and gentlemen, to ask a question at this time, please press star 1 on your telephone keypad. Once again, that's star 1 on your telephone keypad at this time.

And this is Christine Chambers. I would like to just correct... One statement that we made earlier and just that our adjusted EBITDA loss when excluding CENA operating costs of approximately 600,000 with 3.7 million. And this compares to a loss of 2.4 million excluding CENA in Q1 2021 and a loss of 1.1 million in Q2 2020.

Thank you. At this time, I would like to turn the call back over to Mr. Robert Glazier for closing comments.

Thank you, operator. Well, thank you all for joining us today. I hope everyone's summer is going well and that everyone is staying healthy. One thing we did not comment on in this call, and it sometimes comes in question, is how our business is progressing in the context of the phase we're in in the pandemic. We're all trying to be safe and careful, and we're observing all of the necessary health and safety precautions while still running the business. As you know from earlier in the pandemic, we've been able to move things forward in many parts of our business, even in spite of the uncertainty, and we'll continue to do so. And we didn't feel a need to call out any specific aspects of the business. We'll let you know in future quarters if there are any other glitches or other changes associated with that, but we are moving forward with plans that are predicated on the current complex world continuing to be complex for a while. Hopefully everyone is able to stay safe and healthy during this period, and we all get vaccinated and get our world back on a healthy path. So with that, I want to thank everybody for joining us today. Thank the team at Real for everything the team is doing to move our business forward. Thank our partners and the audience for listening today, and we will be in touch soon.

Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation, and have a great day.