RealNetworks Banking On Facebook And iPhone For Growth

Seattle-based RealNetworks, Inc., (NASDAQ:RNWK) provides digital media services and software, including the popular media player RealPlayer, online radio, the music service Rhapsody and RealArcade. The company also offers the Helix Server technologies to mobile service providers and communication companies, software and services that include applications for the iPhone and Facebook, videos and music on-demand, ring tones, and so forth.

RealNetworks announced its results for the third quarter ended September 30, 2009, on October 29, 2009. In Q309, revenue was $140.3 million, a decrease of 8% compared to $152.0 million recorded in Q308. Gross margin was 62% in Q309 compared to 59% in Q308. Adjusted EBITDA in Q309 was $16.1 million, up 41% from $11.4 million in Q308 and nearly four times Q209 adjusted EBITDA of $4.1 million. Net income in Q309 was $1.5 million or less than $0.01 per share, compared to a net loss of $4.5 million or $0.03 per share in Q308.

By segment, compared to the year-ago quarter, there was a slight increase in Media Software and Services revenue to $24.6 million, which was offset by a 7% decrease in Music revenue to $38.8 million; an 8% decrease in Technology Products and Solutions revenue to $47.4 million; and a 14% decrease in Games revenue to $29.5 million.

Consumer spending came under pressure in Q309, and the company saw the impact of this on its consumer pay businesses, including games and music. Though the situation has stabilized, RealNetworks does not see any signs of a substantial recovery in consumers’ willingness or ability to spend on its products.

As of September 30, 2009, RealNetworks had approximately $373.2 million in cash and cash equivalents and $35.5 million in restricted cash and equity investments.

In the third quarter, the company achieved two key financial objectives: it returned to sequential revenue growth and reduced operating costs. The cost management efforts are paying off as RealNetworks has lowered its break-even points so as to generate significantly higher adjusted EBITDA, even with a decrease in top-line revenue.

During the quarter, RealNetworks made significant progress in delivering new products and services that support two major fundamental platforms, Facebook and the iPhone/iPod Touch. The company is banking on these two platforms to drive growth. RealNetworks has introduced four new major products this year that align it with Facebook, the iPhone and iPod touch, and trends that the popularity of these products represent. We’ll look at each in turn.

The first, RealPlayer SP, which was announced and shipped in June, has been used to download over 80 million videos from the Internet. Less than five months after RealPlayer SP’s release, over 30 million copies have been installed. RealPlayer SP makes it easy for consumers to move Web video from the Internet to their iPhone or  iPod or other similar mobile devices such as the BlackBerry. The player also makes it easy to share links through video on Web sites such as Facebook and Twitter.

The second new application that RealNetworks introduced was casual games onto its Facebook platform. The company’s total games audience on Facebook is now 3.5 million unique users. RealNetworks has had as many as half a million players using its games in a single day across Facebook, and its digital version of the popular card game Uno has now topped the 3 million mark for monthly average users. Equally important, from a commercial standpoint, RealNetworks introduced premium items into its games that allow players to give tokens to their friends as gifts, either by tokens earned from game play or by micro payments. The company introduced this feature into Collapse and Uno in September 2009.

RealNetworks’s third initiative is to dramatically scale up its games effort on the iPhone and the iPod Touch. In 2009, the company launched 13 titles for the iPhone, two free and 11 paid. Nearly 70% of these have become hits, reaching the top 100 games list. In total, RealNetworks has sold more than 1.3 million games on iPhones in the past 12 months. The company estimates that the iPhone accounted for about 15% of its mobile revenue and 30% of its mobile game unit sales in 2009.

The final initiative is the introduction of Rhapsody for the iPhone and the iPod Touch. In the first six weeks of the product’s release, there were 500,000 iPhone and iPod Touch customers who downloaded this version of Rhapsody. It has become one of the top music apps on the iPhone. In its initial phase, the main benefits of RealNetworks’s business have accrued to its core Rhapsody business.

The arbitration ruling in the RealNetworks–VeriSign case over a mobile messaging partnership between the two companies dating back to 2001 was in favor of RealNetworks. Earlier, the arbitrator had ruled in favor of VeriSign, but on December 4, 2009, the arbitrator concluded that RealNetworks is not responsible for any damages to VeriSign. The current ruling saves RealNetworks from having to make any payments to VeriSign, and the arbitrator disposed of all claims.

For the fourth quarter of 2009, RealNetworks expects total revenue to increase sequentially but to decline year-over-year. Sequentially, the company expects revenue to increase in Games and Technology Products and Solutions, to be flat in Music, and to decline in Media Software and Services. Compared to last year, the company expects fourth-quarter Media Software and Services and Technology Products and Solutions revenue to be flat, and revenue in Music and Games to decline.

RealNetworks seems to have settled on a plan of action. The company is banking on the growth of RealPlayer SP, social and mobile games, and Rhapsody for the iPhone. While these initiatives are positive and are on the right track, they have just been launched and will take time to gain momentum. Also, monetization on Facebook and the iPhone is a very different approach from what RealNetworks is used to. I believe that it will take time for the company to scale up and make decent revenues from the social and mobile gaming space, but, nonetheless, it a worthwhile move.

And finally, the Rob Glaser, the company’s founder and CEO, just resigned, signaling further change to come.