RealNetworks, Inc.

Greetings. Welcome to Real Network, the third quarter 2021 earnings 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. Please note this conference is being recorded. I will now turn the conference over to Brian Pandova, Investor Relations. Thank you. You may begin.

Thank you, and welcome to Rio Network's third 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 Rio 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 condition. Other forward-looking statements include the company's plans to implement its strategy and 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 Senior Inc., including its future growth and profitability and financing activities. Effective as of the third quarter of 2020, NAPSTER has been 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 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 Rio Network's expectation as of today, November 3, 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 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 the corporate website at investor.realnetworks.com under the Financials tab. With me today are Rob Glazer, 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 third 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, we will open the call to questions. With that, I will hand the call over to Rob.

Thanks, Brian, and welcome aboard. Good afternoon, everyone, and thanks for joining us. Our remarks today will first center on three topics, then I'll cover high-level financial results. First, I'll provide an update on our overall strategy. Second, I'll highlight our progress in real strategic transformation to an AI-centered company. And third, I'll discuss our games business and the new leadership that we've brought in to address that situation. First, the update on our overall strategy. Earlier this year, we told the public that it was our plan to pivot real to become an AI-centered company. We also described our growth plans and expectations for 2022 and 2023, which included our belief that our games business would again be a significant contributor to growth beginning in 2022. The core of the strategy hasn't changed. Our AI businesses, safer in context, are continuing to grow and believe that they will drive significant growth in the future. That said, issues with our games business, which I'll discuss shortly, now lead us to believe that games will likely not be a significant growth contributor in 2022 as we retool it for future success. As a result, while we're still putting our 2022 plan together, I think it's fair to say that while we believe we will have significant growth in 2022, you should view our expectations of double-digit growth as now excluding games from the calculations. Now, onto our AI businesses. We have two main AI products and services, Safer, which is our computer vision platform, and Context, which is our natural language processing platform. In Q3, we more than doubled Safer revenue compared to Q3 of 2022. Safer continues to be the biggest driver of growth in our AI businesses, with quarterly revenue increasing 124% year over year compared to 2020. Context, compared to its continued steady progress, increasing 12% year-over-year. Safer in context, Together and I represent 31% of our total mobile services segment revenue, compared to 37% in Q2 2021 and 19% in Q3 2020. While our AI businesses in aggregate were sequentially down from Q2 2021, we expect short-term fluctuations as we're building out our AI businesses, especially Safer. We remain bullish about the progress we're making. In April, we raised $20.1 million through a public offering, and are intent to use the proceeds to make targeted investments in our AI-based growth businesses. We believe the steps we're taking with Real's AI businesses will position Real for success and long-term growth. In a few minutes, Mike Hensing will go into greater detail regarding our progress with Safer in Context. Next, an update on our games business. After a promising start in free-to-play games, we've been disappointed by the stalled progress in recent quarters. We came to feel that we needed to make a leadership change, and undertook a rigorous assessment and search process. As a result of this process, we brought in an outstanding new leader, Simonetta Luli Gomez, as GameHouse's new CEO. We announced this change to the team a few weeks ago, and yesterday made the change public. Simonetta has a deep background and track record of success in the games industry and is passionate about GameHouse's mission of creating great games and experiences for female casual gamers. This demographic makes up over 60% of the total players from the top 100 games on the App Store. We believe there's a lot of opportunity and a lot of growth available to Rural Networks from continuing to own this business. Sumaneta is the right leader at the right time to reinvigorate the business and to lead it to significant growth and profit. We recognize that leadership changes involve a ramping up period, hence my earlier comments about our expectations for 2022. Finally, I'll turn briefly to our overall financials. Total revenue for the third quarter was $14.3 million, which was down 2% compared to the prior quarter, and 13% down compared to the prior year. While our AI businesses grew, our gains business declined both sequential and year-over-year, prompting the changes that I just discussed. On the bottom line, we had good results when you look through non-operating items. Our GAAP EPS was a loss of 16% per share compared to 3 cents per share loss in the previous quarter and 8 cents per share loss in the prior year period. Our adjusted EBITDA loss was negative $2.7 million. This compares to a loss of $4.7 million Q2 2021, and a loss of $1.9 million in Q3 of 2020. Christine will provide a bridge between the GAAP and EBITDA numbers in a few minutes. We continue to have a strong balance sheet with $29 million of cash available to us, which we will use judiciously to set us up for future growth. And with that, I'll now turn the call over to Mike Ensign to discuss our AI businesses in further detail. Mike?

Thank you, Rob. I'd like to briefly discuss progress made in our two AI-based businesses, Safer and Context. Starting with Safer, we are pleased with the progress that Safer made in the third quarter. Year over year, the business increased revenue 124%. Year over year, revenue increased in both the commercial and federal segments of the business. Revenue decreased sequentially, largely driven by the APAC region. COVID-19 was a factor in APAC as several countries had lockdown and travel restrictions in the quarter, impacting bookings and deployments. Also, it is important to realize that revenue recognition in this business can be lumpy. As discussed on prior calls, SAFER is focused on several use cases, including real-time automated surveillance, touchless access control, digital identity authentication, and embedded solutions. We continue to make progress across these use cases, and I would like to highlight a couple of 2021 projects within the access control and digital identity authentication spaces. Within the access control and federal segment, SAFER's recognition platform has been chosen by Bowler Pons for an initial phase to enhance biometric access control solutions for the Department of Defense. Bowler Pons is a leading systems integrator focused on the federal space with services spanning engineering, cybersecurity, program and project management, and information technology. The SAFER solution is focused on improving access control within the DoD and will enable multi-location management. The SAFER platform includes advanced technologies developed to combat presentation attacks and help keep access control solutions safe from spoofing attempts, both simple and advanced. SAFER's compact solution makes it especially valuable for customers seeking to embed face recognition, liveness spoofing detection, and other face and person-centric analytics directly in devices operating at the edge. Within the authentication space, we recently announced that Safer was selected as an authentication facial recognition technology provider to support the Japanese government's evolution from paper documents to digital My Number ID cards with a face-based authentication infrastructure. My Number cards represent a new digital identification system designed to streamline and expand access to government services for Japan's citizens and residents. The initial rollout of My Number cards provides access to Japan's universal healthcare system by allowing citizens to confirm their identity and medical information with specialized card readers and facial recognition features. As part of the new initiative, residents will no longer require multiple ID cards to access different government services. The solution will be rolled out to thousands of hospitals, clinics, and pharmacies over the next several years. We are pleased with our overall technical solution and benefit to Japan's citizens. However, we note that the deployment has been slowed by factors including COVID-19 in Japan. We view the My Number project as a major proof point for SAFER in the authentication space and will build upon it in the quarters to come. Next, I'll turn to a discussion on context, our natural language processing platform. Our team at Contacts has been intently focused on continuing to develop AI-based products and services to help facilitate improved messaging-based services for our customers. By leveraging more than 1 billion SMS and MMS messages processed 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. Over the last several months, we have significantly enhanced our core context platform by both expanding functionality and capabilities. First, we have developed new 10DLC interconnect support, allowing context to scan 10DLC routes, further preventing spam and fraudulent messages. For background, 10DLC stands for 10-digit long codes and is a sanctioned communication method adopted by major telcos used largely for omni-channel messaging campaigns. We have also released a new image hashing service for MMS. We can now scan and block spam and images sent to end users. In addition, we upgraded our core machine learning method, resulting in greater breadth of spam campaigns caught. Finally, we have developed brand phishing and smishing IP that leverages machine learning to detect whether a brand's content or URL is being used within fraudulent messages. We continue to innovate in this space, further developing our current products and working on the next generation of products to enhance benefits to both current and new customers. In summary, we continue to be pleased with our progress and 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 third quarter 2021 financial results in greater detail. Christine?

Thanks, Mike, 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 business performance. As a reminder, we completed the deconsolidation of CENA as of June 30th, 2021, And as such, costs related to SENA are no longer included in our financial results. Now turning to our results. Total revenue for the third quarter was $14.3 million compared to $14.6 million in the prior quarter and $16.6 million in the prior year period. Similar to the trends of this year, 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 decreased approximately 600,000, both sequentially and year over year. Year over year, safer revenue more than doubled. However, on a sequential basis, safer revenue decreased. This is primarily due to decline in international commercial sales. We do want to remind you that sales on a quarter to quarter basis can be lumpy due to the timing of contract finalization and revenue recognition. Revenue in the consumer media segment increased 700,000 sequentially and 200,000 year-over-year. The sequential and year-over-year increases are primarily due to the timing of contract renewals. Games revenue for the third quarter was down 300,000 sequentially and down 1.8 million year-over-year. On a sequential and year-over-year basis, the decreases were due to sales decline in both our legacy and free-to-play mobile games. As Rob discussed earlier in the call, we're excited about new leadership in the game segment and the direction they can take the business while recognizing that progress from a revenue growth perspective may still take a few quarters. Consolidated gross profit for the third quarter was $11.2 million, a sequential increase of $200,000 but down $1.3 million compared to the prior year period. As a percentage of revenue, gross margin was 78% compared to 75% in the prior quarter and prior year period. Total operating expenses for the third quarter was $17.7 million, an increase of $1 million from the prior quarter and $2.3 million from the prior year period. The increase was primarily due to a $2 million one-time award modification in stock compensation and, to a lesser extent, higher restructuring charges both related to the recent leadership changes and gains. Net loss from continuing operations was $7.7 million or $0.16 per diluted share compared to a net loss of $1.3 million or $0.03 per diluted share in the prior quarter and a net loss of $3.2 million or $0.08 per diluted share in the prior year period. Included in net loss in the third quarter of 2021 was a $1.2 million non-cash loss primarily related to our investment in Napster stock, a $2 million one-time stock award modification, and $700,000 related to restructuring charges associated with the recent leadership changes and gains. All are excluded from adjusted EBITDA, which for the third quarter was a loss of $2.7 million. and was compared to a loss of 4.3 million in the prior quarter and a loss of 1.9 million in the prior year period. Now turning to our third quarter segment results in more detail. Mobile services segment contribution margin was a loss of 1.3 million compared to losses of 1.4 million in the prior quarter and 600,000 in the prior year period. The year-over-year change was driven by lower ringback tones revenue and higher operating expenses from Safer in Context. Consumer media segment contribution margin was a gain of $900,000 compared to a loss of $800,000 in the prior quarter and $100,000 in the prior year period. On a sequential basis and year-over-year basis, the increase was primarily due to increased revenue from software licenses and lower expenses due to the deconsolidation of CNOs. Games contribution margin was a loss of $400,000 compared to a loss of $200,000 in the prior quarter and a gain of $600,000 in the prior year period. Revenue declines were the primary driver of the year-over-year decline in games contribution margin. Now turning to our balance sheet. At September 30, 2021, we had $29 million in unrestricted cash and cash equivalents. compared to $29.9 million at June 30, 2021, and $23.9 million at December 31, 2020. The cash from April's equity offering provides us with the flexibility to make prudent investments in our AI businesses. At September 30, 2021, we had no debt and no borrowings outstanding on our revolving credit facility. Our balance sheet remains strong, and we have ample flexibility to invest in the areas of growth we are most excited about. Now turning to our outlook. For the fourth quarter ending December 31st, 2021, we currently expect total revenue to be in the range of $12.5 million to $15 million, and adjusted EBITDA loss to be in the range of $5.5 million to $3.5 million. The low end of the ranges reflect supply chain issues and chipset shortages that may impact our IP codec business in China. This also means that for the full year, we now expect total revenue will be down from 2020 levels. Per Rob's comments earlier, the decline year over year is in large part due to a decline in games revenue. 2021 continues to be an investment year with a focus on reigniting overall top-line growth in 2022 and beyond. We look forward to seeing the benefits of our investments in our AI-focused products begin to manifest in 2022 when we expect to see meaningful double-digit revenue growth, excluding gains from the calculations. With that, we'll now open the call for questions. Operator?

Thank you. 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. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Mark Argento with Lake Street Advisors. Please proceed.

Hi. Good afternoon. It's on a decent quarter. Just wanted to drill down a little bit on some of the different things going on with the Safer business, in particular the deal with the My Number ID over in Japan. Just a couple questions there. Was that a deal that you guys sourced through NTT Docomo, or how did you end up in the mix, and how competitive of a situation was that?

Yeah, it was a pretty competitive situation. We actually sourced the deal through another partner of ours called NetWare that we've had a longstanding relationship with.

And in terms of the competitive aspect of it, yes, it was competitive. The Japanese government, as I understand it, has split the implementation among four different system integrated technology partners. So we won the business with one of the four partners. And it's my understanding that we are the only international computer vision technology platform, facial recognition platform used in the mix. So the others were all domestic Japanese providers. So we were very excited about that. We don't know, obviously, what the broader competitive dynamics were, both within the one we won in terms of the selection process and also within the other ones. But we were delighted to get a significant piece of such a large strategic piece of business. And as far as I know, it was the only international provider.

There was one other international provider. Oh, there was one other. I can't correct you.

Sorry about that. But not with our integrator, with a different integrator. Correct.

And the solution, are you guys providing the safer AI algorithm, or what are you actually doing for the system integrator for the part of the system that you guys are providing? Yeah, so we're providing the...

Yeah, good question. So we're providing the algorithm that actually gets embedded on these reader devices.

Got it. And then is there a, I mean, obviously I'm guessing there's a licensing component to it, and then is there any kind of maintenance that goes along with that as you continue to fine-tune the algo, or how does something like this at a high level look from the structure?

We generally don't comment on individual deal structures. I would say that our goal where we can do it is to get business relationships that are scalable, which is to say where the more of our product is used, the more customers pay us. That can be manifested based on, you know, for example, device-based camera deals based on the number of cameras that we're deployed on for identity-based solutions. We like deals where we can get paid based on the number of identities associated with the platform, and that's obviously, sometimes we can get that, sometimes it's aspirational, but we sort of take the long view, which is if we can get deeply integrated into large-scale operations, there's plenty of opportunities to scale up. So we love attached with something that has scalability with usage associated with it. And that's more of a statement about safer. In the case of context, because it's SAS-based, it tends to be monthly services revenue associated with volumes. But on the safer side, it's a more diverse set of ways of doing business, at least today.

Yeah, in the integration work you're doing, it sounds like you're working with one of the integration partners, the systems integrator. integrating the technology into the hardware, you know, is that like a name brand hardware provider or is there any kind of scalability or any kind of leverage that you get potentially from, you know, that relationship like you have with like access on the camera side where they can take you in other areas trying to figure out any kind of leverage points to the relationship?

So NextWare is a very, it's a, pretty scalable system integrator, and I think working with them will allow us to drive scale.

Great. And then pivoting over, you had mentioned that you're working with, I think it was Bowler Ponds, which is a system integrator to a lot of DOD on the access control side there. you know, maybe talk a little bit about your expectations on how that rolls out. Is it kind of in beta testing, or, you know, is there specific RFPs or the government equivalent of RFPs that you guys have been responding to with them? You know, I'm trying to gauge kind of how that could roll out or scale up.

Yeah, so this is a a 12-month POC that we expect that will go very, very well, and then there would be significant rollout potential beyond that.

I would say in general, again, I appreciate you want to ask about specific deals, and we have talked about a few of them, and my number card being two of them. Generally, what we see is that customers start with deployments that is a subset of their intended scale deployment, in part because of the newness of the technology, in part because of the number of pieces being integrated with, and there's sort of a prove-out period. Sometimes they are formally recalled POCs, sometimes they're phased rollouts, and then in success, there's opportunity to scale up further. Sometimes the scale-up opportunities are very much larger, 10x what the initial deployment would be, not always that ratio, but it depends on what they're trying to do. So we think what we're doing is we're planting seed corn, if you will, and hoping that a high percentage of it fertilizes and grows and scales. But that's the nature of these businesses in the early days.

Great. That's helpful. And this last one on the context business, you know, it's been kind of, you know, plugging along, you know, kind of low double-digit growth. I think it was a 12% if my memory serves me. What's the opportunity to start to see maybe that business growth rate there accelerate? Do you have to sign more carriers? Do you need to go deeper into existing carriers? What's the dynamic there that maybe could unlock some growth?

Well, it's hard to talk about that without going into deals that are in process, products that are under development. Let me just say that I very much share the goal of describing that of accelerating the growth of that business. You know, it's always a tradeoff between servicing your current customers well and growing with them and developing derivative products that go into new market segments that might have, you know, additional customers or a broader portfolio of customers. And I'd say the big difference today between SAFR and context is SAFR is an opportunity that technology gets deployed or can be deployed in multiple use cases in many different scenarios. In what we're doing with context today, it's focusing on the messaging business, SMS and MMS today. What Mike talked about with the image hashing is actually a significant broadening of the appeal of the product and the utility of the product because there's a lot of image spam that wasn't getting caught because the the spam content was being embedded in an image. And so being able to do a set of tricks to actually extract that spam from the image and do it in a scalable way, because the volumes are pretty high, and figure out how to efficiently do that and add that to our mix, I think has increased the viability and value of our product and has created new opportunities for us to associate with it. And we just, you know, we'll keep We'll continue to grow the business with the current portfolio of customers we have, with the current portfolio of markets we serve, and then we're going to look at additional markets where our really, really great natural language processing technology is applicable, and we still see significant growth opportunities in that business, and we would love it to grow faster.

Great. Appreciate the call. Thanks, everybody. Great. Thank you, Mark.

We have reached the end of our question and answer session. I would like to turn the conference back over to Rob for closing comments.

Thanks, everybody. I guess the last thing I'll say is Mike and Christine made a few references to some of the things we're seeing around supply chain disruptions and some of the impacts we're seeing on some of the pandemic. We still know we're not in a full back to normal world. The world's made a lot of progress and hope everyone on this call is healthy and that your friends and family are and colleagues are as well. As we continue to go through this post-vaccination but not post-pandemic phase we're in, I hope everyone stays safe. We're going to keep driving the business forward, continuing to make investments that we think are going to scale us to success and profit in the future, and look forward to continuing to engage with you in the weeks, months, and quarters ahead.

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