RealNetworks, Inc.

Drew Markham Tim M. Wan - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer Robert Glaser - Founder, Chairman and Interim Chief Executive Officer

Barbara Coffey - S&P Capital IQ Equity Research

Thank you, Kelly, and welcome to the RealNetworks third quarter 2013 conference call. Before we begin, I remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks future revenue, adjusted EBITDA, operating expenses, trends affecting its businesses, and its prospects for future growth, cost reductions and profitability.

Other forward-looking statements include the company's plans to reduce expenses, implement its strategy and simplify its businesses as well as the new products, value creation and other benefits from those activities. All statements other than statements of historical fact 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 described these and other risks in our SEC filings. A copy of those filings can be obtained from the SEC or from the Investor Relations section of our corporate website.

Forward-looking statements reflect RealNetworks expectations as of today, October 30, 2013. 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.

We will present certain financial measures on this call that will be considered non-GAAP under SEC regulation G. For a reconciliation 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 8-K, dated and submitted to this SEC on October 30, 2013, both of which can be found on our corporate website at investor.realnetworks.com under the tab Financial Information.

Here with me today are Rob Glaser, Chairman and Interim CEO; and Tim Wan, Chief Financial Officer. Tim will provide a financial review of the third quarter, and the outlook for the fourth quarter.

And Rob will discuss company strategy and the progress the company has made in recent months. After their prepared remarks, they will take a few questions.

To get things started, I turn to Tim.

Thanks, Drew. Earlier today, we released financial results for the third quarter of 2013.

We will file our 10-Q for the quarter soon and I encourage you to review it and other SEC filings for a more thorough discussion and disclosure of our results. Today, I will review our third quarter financial result in detail and give some guidance for the fourth quarter of 2013.

Rob will discuss the progress to-date, which will include our recent announcement regarding the RealPlayer Cloud and acquisition of Muzicall. Total third quarter revenue was $49 million, reflecting a sequential decrease of 2% and year-over-year decrease of 17%.

Our adjusted EBITDA loss in Q3 was $8.4 million versus a loss of $5.8 million in the prior quarter, and a loss of $6 million in the year-ago quarter. The increase in EBITDA loss for the quarter was primarily due to the reduction in revenue and increased expenses, associated with new products being launched partially offset by continued efforts in reducing cost, both in COGS and in OpEx.

Overall gross margins improved 4 percentage points over the year-ago quarter as a result of our ongoing expense alignment efforts. Even including the cost of our new product development effort, our quarterly operating expenses were about $3.6 million lower in the quarter than 1 year ago, adjusting for operating expenses from recent acquisitions of Slingo and Muzicall, one-time litigation settlement and restructuring charges.

In Q3, we completed the relocation to our new headquarters. And we will begin to realize the savings starting in Q4 of this year.

We expect annualized cash savings of approximately $7 million. We are working very hard on developing new products and services to turn the corner on revenue growth.

I'm encouraged with the progress and Rob will talk further about the recently announced RealPlayer Cloud. Until our new products and services take hold in the market and scale up, we expect that our short-term results will continue to be negatively affected by the trends that we have talked about before, specifically rising smartphone use and industry pricing trends affecting our legacy Mobile Entertainment business, increased saturation of download partner software in the market and the decline of PC-based casual games.

Now, for more detail on business results of the quarter, let's start with RealPlayer Group. For the third quarter, revenue declined 4% sequentially and 18% year-over-year to $17.6 million.

The sequential decline was due to selective marketing efforts by our download partner and the continuing expected decline in SuperPass revenue. But these were offset positive seasonality in the mobile IP business sequentially.

The year-over-year decline was mainly due to the decrease in SuperPass revenue. Adjusted EBITDA rose slightly sequentially, but declined year-over-year due to lower revenue and investments in new products.

We launched RealPlayer Cloud in September, the service is free up to a certain level of storage capacity, and then has a tiered subscription fee. We do not expect that the RealPlayer Cloud will have a significant impact on our revenue in 2013.

Rob will discuss the RealPlayer Cloud more in depth and the opportunity that it represents. For the third quarter, Mobile Entertainment revenue rose 7% sequentially, but fell 13% year-over-year to $19.9 million.

The increase from the second quarter relates to an increase in SaaS revenue related to our Music On-Demand business in Asia and the acquisition of Muzicall. The year-over-year decline was due to contract terminations, lower transaction volumes and the transfer of certain contracts to LiveWire in Q3 of 2012.

Third quarter adjusted EBITDA for Mobile Entertainment fell slightly sequentially due to increased operating expenses from our recent acquisition of Muzicall, but improved year-over-year as a result of our cost saving efforts. In the third quarter, we acquired Muzicall, a leading hybrid carrier and direct-to-consumer service provider in Europe, known primarily for its ringback tone service.

We expect this acquisition to complement our growth initiative in the Mobile Entertainment segment, which is slated to launch in Q4. Games revenue for the third quarter declined 12% sequentially and 24% year-over-year to $11.4 million.

The declines were due to overall market shares in consumer game play from traditional PC Games to social and mobile games, resulting in lower subscriptions and unit sales. Adjusted EBITDA in Games also declined sequentially in year-over-year.

As you may recall on the last earnings call, we announced the launch of GameHouse Casino Plus with the Golden Dreams Sweepstakes feature and the acquisition of Slingo. Rob will provide more context and an update.

Corporate costs adjusted for relocation, restructuring and one-time litigation settlement costs increased sequentially primarily due to one-time tax credit in prior quarter, but improved year-over-year due to our cost alignment efforts. During the third quarter, we recognized $11.5 million related to the settlement of our 2 most significant outstanding litigation matters.

We made the $11.5 million payment in October. Based on historical experience, these were unusual cases for us and we do not anticipate this level of litigation expense in the foreseeable future.

We ended the quarter with $218.4 million in cash and short-term investments, down $18.3 million from the second quarter of 2013. Uses of cash for the third quarter included $6.7 million for the acquisition of Muzicall, $1 million related to our headquarters relocation and $8.4 million related to our EBITDA loss and other net working capital changes.

We have not sold any shares of LoEn since the third quarter of last year. In addition to the cash and short-term investments on our balance sheet, we also have $39.5 million in restricted cash and equity securities in publicly traded companies, so we are in a strong liquidity position.

Further, as you may know, we also own approximately 45% of Rhapsody, one of the leading global online music subscription services. Moving on to our Q4 outlook.

I will provide some financial guidance for the fourth quarter. We are making progress on our previously articulated plan to revitalize RealNetworks by introducing new products and services during the second half of 2013.

But until those new products take hold in the market, our revenue outlook will continue to be challenged. For the fourth quarter of 2013, we expect total revenue of $47 million to $50 million with all segments declining year-over-year, but on a sequential basis we expect a slight increase in Mobile Entertainment, flat revenue in Games and a decrease in RealPlayer.

We expect adjusted EBITDA for the quarter to be a loss of $8 million to $11 million. Now, I'd like to turn the call over to Rob.

Rob?

Thanks, Tim. Good afternoon, everyone, and thanks for joining us.

Since Tim just went through the numbers in great detail, I'm going to focus on providing context around our recent product announcements. As I've mentioned in each of the earnings calls I've been on since returning as Interim CEO, our focus is on completing the implementation of 4 objectives: one, ending cash burn; two, putting a growth plan into place and into action; three, making Real a much simpler and more focused company; four, moving quickly and having a strong bias towards action.

In light of the announcements we made over the past 3 months, our plans for achieving the above objectives, especially #2, have now come into public view. To repeat what we said at the beginning of the year, we expect to ship at least 1 major new product or service in each of our 3 divisions during 2013.

As of today, we've now shipped 2 of those products, GameHouse Casino Plus and RealPlayer Cloud, and have taken a major step in support of the third, which will come from our Mobile Entertainment division. In aggregate, we feel very good about the progress we're making.

Since I talked at length in the last quarter's call about GameHouse Casino Plus, let me go into some depth now about our new RealPlayer Cloud product. We introduced RealPlayer Cloud about a month ago, on September 25.

While it built on our very successful RealPlayer product, RealPlayer Cloud is a dramatic step forward in scope and capabilities. RP Cloud enables consumers to take videos from a wide variety of devices, a PC, a Mac, an iPhone, an iPad, an Android phone, an Android tablet, or a Kindle and play that video on just about any other device, even a TV, save that video permanently and share it with friends anywhere in the world.

Our business model for RealPlayer Cloud is a premium model. Everyone gets 2 gigabytes of free storage, about 1 hour of high def video, or about 4 hours of standard def, we then charge for additional storage.

This business model has proven to be very successful at scale for document and file-oriented companies such as box.net (sic) [box.com] and Dropbox. RealPlayer Cloud builds on Real's 15-plus years of experience in Internet digital video to deliver a compelling and unique service, in particular RP Cloud uses an advanced set of technologies, which we call SurePlay, to deliver the right type and formatted video to a very broad range of devices, fast and reliably.

Initial press and customer feedback has been outstanding. RP Cloud has a 4.5 star rating on iOS, and 4.4 on Android and it has gotten great reviews from critics, including notoriously tough ones such as the Wall Street Journal's Walt Mossberg who wrote "I think RealPlayer Cloud is well-designed and makes storing and sharing videos easy across different devices."

While it's very early, we've been very pleased by the initial consumer response to RealPlayer Cloud. We've only released the products in the U.S.

and Canada, and have not yet marketed to our base of 25 million monthly active RealPlayer users or otherwise have not rolled out any significant marketing campaigns. This is because we first want to make sure that RealPlayer Cloud is working well and will continue to perform well at very large scale.

Nonetheless, in just 1 month, and with only earned media and word of mouth, over a 100,000 people have both downloaded RealPlayer Cloud and set up Cloud accounts and they are actively using the product. They've already uploaded 10s of terabytes of content.

While it's early yet, and we have a lot of work to do to fully capitalize on the opportunity, we couldn't be more encouraged by the initial customer and market reaction to RealPlayer Cloud. Let me now give you an update on our 2 other divisions and their core growth initiatives.

First, Mobile Entertainment. On Monday, we announced the acquisition of Muzicall, a UK-based company that has pioneered a hybrid model in Europe that combines partnership with carriers with direct-to-consumer marketing of ringback tones.

We think this model, called carrier enabled over-the-top services, has a lot of promise and we intend to do a lot more with this model in the weeks and months ahead. Stay tuned.

Second, social casino Games. As you know, in August, we introduced GameHouse Casino Plus globally, and the Golden Dreams Sweepstakes in 32 states and territories, to cover about 60% of the U.S.

population. Based on where we are today, I would say we've made some progress.

We have a lot more work to do. We also announced the acquisition of Slingo, and are hard at work on a new social mobile Slingo product line, that we think has a great deal of potential.

In sum, we believe that our recently announced and upcoming product offerings will set up us for a durable return to growth and profitability for each of our 3 businesses and, therefore, for RealNetworks as a whole. In particular, we believe these new initiatives will enable us to return RealNetworks to revenue growth in 2014.

In closing, I want to step back and compare where we are today to where I thought we'd be 16 months in, when I came back to run Real in July 2012. I would say there are 2 main differences: one that's purely positive; and one that's negative in the short term, but that I think will turn to a positive in the long term.

On the positive side, I think our new products, especially RealPlayer Cloud, have entered the market with great promise by delivering real value and meeting important, yet previously unmet, needs. On the other hand, the investment required to get these products to scale will likely exceed what we originally thought, although not by a huge amount of money given Real's scale and resources.

The reason I think this will turn into net positive in the longer term is that the opportunities in front of us are even bigger than we thought, and we're making these incremental investment decisions in the context of having great products in hand. Therefore, we think the ROI on these additional investments should be very favorable.

In sum, I'm very confident that we're on a path to revitalize Real and that the products and services we're bringing and planning to bring to market this year will enable us to do so. While it will take time, and we have much hard work ahead of us, I believe that we're setting ourselves up for growth in 2014, as I said previously, and for future sustainable profitability.

And with that, operator, let's open the call up for questions.

Actually 2 quick questions. Would you go into a bit on the litigation, what was it about, is there anything still out outstanding because I didn't -- that was a bit of a surprise to me.

And then I understand the absence of marketing, but is there a time when that will -- when you expect to ramp that up and could you give us some timetable around that?

I think for a more thorough discussion around the recent litigation settlement, we will be filing our 10-Q very shortly. I think that's where you will get most of that information.

But there are no outstanding issues related to the settlement. Bobby?

This is Rob. I'll take the second half of that.

So we are not specifically announcing the timetable for the ramp up other than to say that we feel very good about the performance of the product in the field right now. So we are tracking our rollout plans.

And I think I would say 2 other things that will helpfully hope (sic) [hopefully help] connect the dots. One is, the nature of these freemium products is you build up a user base, and then you monetize them as they become more and more active users.

So if you look that the historical conversion rates of a Dropbox or Drop.net -- I mean a box.net (sic) [box.com] rather -- who have different offerings, but a conceptually similar model, you see that you got to get the product out there and you kind of grow it from there. And so for us, we have the special opportunity unlike those companies which are starting from scratch to apply a working model to a large base.

So for us, it's much more important in the very sort of short-term, for us to make sure we have it right, so that when we roll the product out to 10s of millions of users, they're going to have a delightful experience. Now one other thing I can say is that, that's going to be a geographically phased roll out.

In this next phase, we'll be scaling it up in the U.S. and Canada.

And then in a subsequent phase, we will be scaling it out internationally because we really want to make sure that the performance of the product is very good, and in particular, that our other Cloud infrastructure that we're using in those other markets is local to those markets and is tuned for the specific network characteristics of those markets. So, we are moving very quickly, very energetically, but we're also trying to be very methodical about how we do this.

We have a lot of experience in services as you know from our Mobile Entertainment business, and we're applying that expertise in phased rollouts to the rollout of RealPlayer Cloud.

As an associated question to that, is there a way that you are reaching out to influential end users to make sure that they are exposed to the product and working with them that way?

That seems like a great idea. It sounds like a terrific idea.

If you have any influence with end users that you particularly are influential with, please send them our way. And more generally -- yes I mentioned someone like Walt Mossberg who obviously is hugely influential and other reviewers who have reviewed and given positive feedbacks on the product and more generally in addition to the major media influencers.

We do definitely think influencers across the board are very important.

Thank you, everyone for joining the call. We look forward to talking to you after this call or hearing from you later this quarter.

Thanks everyone. Bye-bye.