Zedge, Inc. Q2 FY2020 Earnings Call

Good afternoon, and welcome to Zedge's Second Quarter 2020 Earnings Conference Call. In today's presentation, Elliot Gibber, Zedge's Interim Chief Executive Officer, and Jonathan Reich, Zedge's Chief Financial Officer and Chief Operating Officer, will discuss Zedge's financial and operational results for the three-month period that ended on January 31, 2020. Any forward-looking statements made during this conference call, whether in prepared remarks or during the question-and-answer session, are subject to risks and uncertainties that may lead to actual results differing significantly from the company's expectations. These risks and uncertainties include, but are not limited to, those disclosed in the reports that Zedge files regularly with the U.S. Securities and Exchange Commission. Zedge does not assume any obligation to update any forward-looking statements made or to update the factors that may cause actual results to vary from those forecasted. Please note that the Zedge earnings release is available on the Investor Relations page of Zedge's website and has also been filed on our Form 8-K with the SEC. I would now like to turn the conference over to Mr. Elliot Gibber.

Thank you, operator, and thank you all for joining us today. I'm Elliot Gibber, Interim CEO of Zedge. Welcome to Zedge's Second Quarter Fiscal 2020 Earnings Conference Call recapping the three months ending January 31, 2020. Joining me today is Jonathan Reich, our Chief Financial and Chief Operating Officer, who will provide additional insight into the numbers that we reported earlier this afternoon. I know there are some people on today's call who are new to Zedge. I'd like to take a minute to tell you a little about the company. Our legacy is being one of the leading providers of mobile personalization content, focused on offering consumers a rich array of high-quality wallpapers, video wallpapers, ringtones, and notification sounds. To date, our legacy app, ZEDGE Wallpapers & Ringtones have surpassed 420 million organic installs and have close to 35 million monthly active users. We generate revenue from this app from advertising, recently added paid subscriptions, and through Zedge Premium, a marketplace that enables license holders to sell their digital content to our customers. Our user base consists mostly of Android users, and approximately 23% of our users are located in well-developed economies. In December 2019, we completed the rollout of a new standalone entertainment-focused app, Schwartz, chat stories by Zedge, which will help us in extending our presence beyond the world of mobile phone personalization. Today, Schwartz provides serialized short-form fiction stories rendered in a text messaging-like format. Q2 was an exciting quarter for us. Our team focused on growing revenue and lowering expenses to continue driving towards our goal of becoming cash flow positive and introducing new products, mainly Schwartz. We accomplished all of this with a smaller workforce. It's great to see our labors bear fruit, and it's exciting to be in a position to offer new products that extend our offerings beyond phone personalization. Since our last conference call, we rolled out Schwartz on iOS. This is momentous because we have an offering that is equally viable across both Android and iOS, a first for Zedge. If the product evolves well, we will be able to capitalize on the conventional belief that iOS users monetize better than their Android counterparts. We stand to benefit from this untapped upside. Our vision for Schwartz calls for building a rich ecosystem centered on short-form content. Although we launched with the chat stories, we believe the opportunity goes far beyond. Indeed, we think of Schwartz as a platform that offers bite-sized, snackable content. Our goal is to provide ubiquity and make content available to users, not only as text but also as audio and possible video as well. We want to offer users the ability to consume content across a multitude of media. In our mind, users should have the option to read, listen, or watch stories based on what most appeals to them. We envision a world where content is deeply coupled, enabling seamless continuity if a user's consumption medium changes. For example, a user may start reading a story and then shift to listening to the story from the same point when they head outside. Our current focus is ensuring that we can meet the conversion average revenue per user and churn targets we established for Schwartz beta. Conversions are usually that install the app and then sign up for a subscription. So far, we are on track. In addition, we expect to start testing audio this fiscal year. Our view is to publish the stories as Schwartz podcasts, what we call MicroCast, and make them accessible, both with the app and major podcasting platforms. Let me provide you with some background about our interest in podcasting. As you likely know, 2019 was a similar year for the podcasting industry in the U.S. Approximately 22% of Americans listen to podcasts on a weekly basis in 2019. Listeners consume over 6 hours a week and are consuming more content every year. The explosion in wireless audio devices, headsets, and smart speakers has resulted in ubiquity and accessibility. There have also been some impressive acquisitions over the past year, with Spotify alone purchasing three podcasting companies for an estimated total of $400 million. Yet podcasting is still in its infancy, and its ultimate success is tied to content. To that end, when viewing the podcasting space through today's content prism, short-form podcasting is predominantly focused on news, sports, and weather. Short-form storytelling hasn't yet emerged as a significant content vertical in the world of podcasting. This is unlike video, think Snap, TikTok, or super-large Quibi, which has experienced explosive growth. Our thesis is that short-form podcasting will become a powerful medium, and we want to claim a leadership position in this evolving format. We believe that Schwartz gives us an opportunity to start establishing ourselves in this space, opening the doors to a whole set of users that may not discover us if we limit Schwartz strictly to readers. As I said, this is an area we believe can be a credit accretive and beneficial in developing the Schwartz ecosystem. We look forward to sharing our success with you. Now I'm going to turn the call over to Jonathan Reich, who will provide an overview of the quarter's financial results. Thank you.

Thank you, Elliot. My remarks today will focus on our key operational and financial results for the second quarter of our fiscal year 2020. For a comprehensive and detailed discussion of our results, please read our earnings release issued earlier today and our Form 10-Q, which we expect to file with the SEC next week. Following my comments, we will open the call to any questions that you may have. Throughout my remarks, the second quarter refers to November 2019 through January 2020, and comparisons are to the corresponding period in 2018 through 2019 or our first quarter, which was August through October 2019. Monthly Active Users or MAU, that is the number of unique users that opened our app during the last 30 days of the quarter decreased by 6.5% to 34.3 million during January 2020 from 36.7 million in the corresponding period a year ago. As you recall, in late September 2019, Google suspended our app from the Google Play Store for 3 days as a result of buggy code and a standard technology integration with one of our third-party advertising partners. When we were made aware of the issue, we removed the offending code, and the suspension was quickly lifted. However, during the suspension, Google sent a notification to all users that had the problematic version of the app on their phone, recommending that they uninstall it. This accelerated the drop of 20.9% in MAU in well-developed markets from Q2 of fiscal 2019. Despite the action by Google, MAU in emerging markets increased by 2.6% in the same comparative periods. Furthermore, on a sequential quarter basis, MAU grew by 15.5% globally, including 12.4% growth in well-developed markets and 17% in emerging markets. The sequential increase in MAU was likely positively impacted by seasonal growth, marketing initiatives, and users that reinstalled the app following being readmitted into Google Play following the suspension. Total revenue in the second quarter increased 2.8% and 30.1% to $2.6 million compared to the year-ago quarter and the previous sequential quarter, respectively. The sequential increase was a result of several factors, including MAU growth across all regions, growth in paid subscriptions, continued promotion of Zedge Premium, further optimizations in our ad stack, and the benefit of strong ad spending during the holiday season. I would be remiss if I didn't commend the team for doing an excellent job in delivering these results, especially in light of the adverse impact of the Google Play suspension, which hit us at the beginning of the quarter. Your efforts aren't going unnoticed; kudos to you. Zedge Premium's gross transaction volume or GTV, that is the total sales volume transacted through the platform was $198,000 in Q2 compared to $118,000 a year ago, and $192,000 last quarter. Although GTV grew by 68% on a year-over-year basis, it was basically flat quarter-over-quarter. We are likely going to see a short- to mid-term decline in GTV and associated Zedge Premium revenue due to the recent redesign of our app's homepage, which prioritizes Schwartz promotion ahead of Zedge Premium. The redesign mostly made up for the GTV impact by enabling better optimization of our advertising inventory and associated revenue. After we complete the redesign of our homepage later this year, we expect to invest in growing Zedge Premium. Paid subscriptions also grew materially, surpassing 300,000 subscribers at the end of the quarter, an increase of 51% on a sequential quarter basis. Paid subscriptions have generated cumulative gross revenue of $1.35 million since their introduction in January 2019. As you recall, when a premium user converts into a paid subscriber, Google takes a 30% cut, which shows up in SG&A. However, if a subscriber renews their subscription from and after the 13th month, Google lowers its fee to 15%. Overall, average revenue per monthly active user generated from our apps, or ARPMAU, increased by 21% to $0.0262 year-over-year and by 24.8% sequentially. The improvement is attributable to the actions we've taken to further optimize our ad stack, better monetize users in emerging markets, and the growth in paid subscriptions. Direct cost of revenue in Q2 was $308,000 or 11.6% of revenue, representing a 6.4% decrease from $328,000, which represented 12.8% of revenue in the year-ago quarter and 16.2% of revenue in the previous sequential quarter. We expect absolute direct cost of revenue to decline during the remainder of this year. SG&A in the second quarter was $1.9 million, a 12.4% decrease compared to the year-ago quarter and a 2.6% decrease compared to the prior sequential quarter. The decrease primarily relates to lower compensation costs and discretionary spend, offset by increases in the Google fee on paid subscriptions, severance payments, and Schwartz content acquisition expenses. Net income in the second quarter was $100,000 compared to losses of $240,000 in the year-ago period and $801,000 in the previous sequential quarter. This was the first quarter with positive net income since Q1 of fiscal 2017, reversing 12 consecutive quarterly net losses. Net income per share improved to $0.01 from losses of $0.02 and $0.08 in the year-ago and prior quarters, respectively. At January 31, we reported $2.3 million in cash and cash equivalents compared to $2.7 million a year earlier and $1.7 million at October 31, 2019, a 35% increase. Of the $593,000 of sequential quarter increase, $318,000 is primarily attributable to the increase in revenue and decrease in SG&A, net of investments in software and technology development costs of $204,000. We added another $1.9 million in proceeds from our registered direct offering in early February. Zedge has no outstanding debt. We have access to a revolving credit facility of up to $2.5 million from Western Alliance Bank, if needed. In conclusion, Q2 was a good quarter for Zedge. We continue making progress toward our goal of becoming cash flow positive in fiscal 2020. Major key performance indicators improved, including MAU, revenue, and SG&A. We completed the launch of the Schwartz beta across Android and iOS. We have a formidable set of goals for the remainder of the year, including building out the Schwartz ecosystem described by Elliot, continuing our investment in driving subscriptions in our flagship app, better optimizing our ad stack, further reducing our costs with improved infrastructure, and exploring new product introductions that extend our relevance beyond the world of mobile personalization. On that note, back to you, operator, for Q&A.

We will now turn to the first questioner from Edison Group.

First of all, congratulations on the 1% earnings per share. I think that's great. You are doing a great job. My main question is regarding the monthly active users and all the downloads you have had so far. What steps are you taking to improve penetration and convert them into paying subscribers? Because it's still pretty low. Last I calculated, it's almost 1% and it seems to have slowed down.

It's Jonathan. Thanks so much. Yes. So we have a set of initiatives to continue to improve the take rate and have premium users convert into paying users. And we have actually improved that overall rate. But if you take gaming as a comparable, the general rule of thumb is that 97%, 98% of your users are going to be free users with a much smaller percentage either subscribing or making in-app purchases. The user dynamic around the product that we offer is clearly different than gaming. But as we continue to grow that business, there are value adds that we are testing in terms of potentially bundling content, offering coins, and things of that sort. And when we find the triggers that help improve conversion rates, we will productize those and make them available to all prospective subscribers. Having said all of that, there are a set of other activities going around or that we are investing in, in order to optimize the return from these customers. We have various price sensitivity tests that we have undertaken. As I've said in my earlier comments, when users renew their subscription in the 13th month, whether it be for a monthly user or an annual user, we retain a greater portion of that revenue because Google at that point only takes 15% as opposed to the 30%. So we have a whole set of activities that will hopefully ensure that more than the 40% that we're experiencing today will actually renew and remain with us for 13 months and beyond.

I see. Okay. Can I ask another question?

Sure.

I'm really impressed with the publishing platform. It allows artists to create their own content and sell it through your online store. Has there been any further information about its growth? I think it's an incredible feature that you offer.

Thank you very much. As mentioned earlier, we have experienced significant growth year-over-year and quarter-over-quarter. We decided to allocate more of our homepage inventory to promote Schwartz, and at the same time, we are undertaking a major initiative to redesign our entire homepage. Once that project is finished, subject to some contingencies related to back-end technology and migration, we anticipate continued growth in Zedge Premium later this year. This is a short-term investment with the intention of achieving longer-term benefits for the company, and we are in agreement on this. We believe there is a significant, untapped opportunity that we can leverage with ongoing investments in Zedge Premium.

I see. So the focus is going to be mostly on Schwartz in the near future rather than the publishing platform, the online store thing?

We are prioritizing the use of our marketing inventory for Schwartz at this point. And in parallel with that, we have a comprehensive redesign of our homepage. Just to give you some more detail around that: Currently, our homepage separates our Premium content from the rest of the content in the app. When we're done with this redesign, we are going to ensure that users go into the app and they're availed of all content from the homepage directly, as opposed to having to peel off and enter a particular portion of the app, which either houses the Premium content or the other content accordingly. We think that, that's a more logical way of presenting the content, and it also allows for us to do some pretty interesting things when it comes to serving up content and availing users of the content that is relevant to them independent of whether that content is Premium content or non-premium content.

Got it. And my last question I wanted to ask, I hope I'm not taking the mic too much, is a little bit kind of what's going on in the market with corona and everything? Is there a specific play in regards to Zedge for what's going on? Maybe people might be using their phones more? I don't know. I just wanted to see if you guys have given any thought?

Sure, absolutely. We've given it a lot of thought. So let me start by saying our priority is to ensure that our workforce is protected. We are instituting a work-from-home policy that takes place starting this Friday. We want to make sure that we can afford our employees the ability to remain healthy to the best of our ability. Having said that, from a commercial perspective, it's too early to tell what the outcome and impact to Zedge will be. On the upside, just by taking as a proxy, times when there were hurricanes or other natural disasters, we would typically see an uptick in traffic as people were confined to their homes and didn't have the opportunity of going out as much. And that translates into a higher number of monthly active users, which is critical for our business. On the flip side, it's unclear as to what happens in the advertising portion of the business. Clearly, any businesses that are linked to travel are not advertising. However, performance advertisers like mobile gaming companies, it is reasonable to believe that they are actually going to spend more money at this point because people have, so to speak, more free time on their hands. And that actually may be a very, very good outcome for us as these game advertisers or performance advertisers overall, cover our inventory and our customer base. I think that over the course of the next couple of weeks, we'll have more details, and we'll be able to talk about this when we announce our Q3 results accordingly.

We'll move next to investor Darrell Evans.

Congratulations on returning to profitability. I have a question. Actually, a couple of questions regarding Schwartz. First, I'd like to know about the conversion rate from beta, if you can give me a percent, that would be great. If you could just give me a little feel on how satisfied are you with that rate, that would be good too?

Okay, sure. So we're not yet at the point where we're going to be sharing those conversion rates. But suffice it to say that we had several targets around conversion rates, around average revenue per user and the like. And directionally, we have either beat those numbers or are on a course to meet those numbers accordingly. And if you are engaging with the app regularly, you'll see that we're making a lot of changes on an incremental basis. And each of those changes we are measuring in terms of its impact overall; things are headed in the right direction. I also want to highlight a critical item, which is, Schwartz is equally viable across both Android and iOS. As stated earlier, this is really like the first time where we've had an app, which is equally viable across both ecosystems. And we are excited by where this business can go based upon accessibility to both ecosystems.

Okay. Is there a Google fee associated with this product too?

Yes. So any user that subscribes, Google also will take a 30% cut. And that's not unique to Google; that is the operational model for both the Google Play Store and the Apple App Store. So typically, for digital purchases, they take a 30% cut of whatever the gross amount is that users pay.

I want to discuss the SG&A issue because you seem to have managed it well. I'm curious about how much more efficiency can be achieved. I'm particularly interested in how Google plays into this, as it appears to be an area you have better control over compared to other factors. Could you provide some insights on this?

Sure. Regarding SG&A, I would divide the savings into a few categories. First is headcount; we've undergone a restructuring, and we're currently seeing benefits from those changes. The second category involves infrastructure and technology, where we are implementing changes that will benefit us. We have developed some technology that reduces our reliance on third-party services. Over the past several quarters, we have transitioned to a cloud infrastructure platform and are continuously seeking ways to enhance efficiency and reduce costs. The third category pertains to Google Play and the Apple iTunes Store or App Store, where the standard cut is 30%. When users reach their 13th month of engagement as paying subscribers, that percentage decreases to 15%. We're in the early stages of this with our subscription service launched in January 2019. So far, our renewal rates have been over 40%, allowing us to gain an additional 15% from those users, which is very important for us. We cannot negotiate that rate with Google or Apple as it is standard, but we are dedicated to ensuring that users renew in their 13th month.

Okay. Final question. I know you're looking to be cash flow positive for the year. Should I be expecting some lumpiness in here? Is there some seasonality I should be focusing on and just by numbers?

Sure. There is seasonality. So our revenue base is still weighted towards advertising. And typically, that means that our Q2 is the strongest quarter of the year, since it overlaps with the end-of-year holiday spend. And that Q3 being comparable to the first quarter of the calendar year, more or less, is one where without advertising or with lesser advertising spend, there is a seasonal impact to us. Having said all of that, we have undertaken several initiatives in order to try to minimize that seasonal impact, such as the ongoing developments in and investment in our subscription-based business. The seasonality there is, from what we see to date, more muted. And also unlocking ways to better monetize certain customer groups that enable us to generate more revenue, such as customers in the emerging markets. Finally, we have also invested a considerable amount of time over the course of the last six months in optimizing our ad stack and ultimately generating higher-margin revenue from the investment that we've made in that, and that continues to hold up. We believe that as the year unfolds, this will continue to be clear through the numbers. Of course, I can't tell you what happens with clarity because of coronavirus. But we're doing everything in that capacity as well to ensure that we still achieve our goal of being cash flow positive in fiscal year 2020. And just let me be clear: the goal of being cash flow positive is that we are on a path that we enter into recurring quarters, months, and years of being cash flow positive. I can't tell you that we will necessarily be cash flow positive on an annual basis, but the goal is that we are in territory where we continue to be cash flow positive as we complete the fiscal year.

We'll move next to Joe Boskovich at Old West.

Yes. So I see that the subscribers grew from 225,000 to 300,000 from the first to last quarter. Is that 300,000 subscribers, is that only Zedge Premium subscribers and Schwartz is not included in that?

It's subscription subscribers, and that does not include Schwartz in it. That's correct. So these are the Zedge Wallpaper & Ringtones, paying subscribers.

Right, right. So going forward, and it sounds like you're not ready to disclose the number yet, but at some point, you will reveal monthly subscribers, and you'll break that out between Zedge Premium subscribers and Schwartz subscribers. Is that correct?

I think that's the direction we're heading. To provide some context, we have Schwartz currently in beta. We are dedicating significant time and resources to ensure the product is well-optimized, allowing us to justify further investments and gain the Board's support for its growth. So far, the performance metrics are either on track or exceeding our initial projections. Simultaneously, we are exploring various ways to expand the ecosystem that Elliot has outlined, as the focus of the business differs greatly from that of our flagship personalization app. I believe we will eventually share information and insights specific to Schwartz, but at this moment, while it remains in beta, we feel that the data may not be particularly useful for shareholders since we haven’t yet reached a confidence level that indicates it is ready for commercialization.

Okay. And then, I guess, this question is kind of twofold. On the Schwartz app, when you go to the Google Play Store or the iTunes stores, you could see that there's been quite a few downloads already. And when you read user feedback, it seems kind of unanimous that the users love the content, and the only pushback is the pricing. I believe at first, you just had one annual subscription pricing, and I think you mentioned that you'd be testing weekly pricing, monthly pricing, and pricing to finish a specific story. Can you comment more on that?

When we launched the beta, we initially established our pricing and the types of SKUs we would provide. From the start, we offered weekly, monthly, and annual subscriptions. We are currently focused on determining the optimal business model, which may include not just subscriptions but also in-app purchases, allowing users to buy a series instead of committing to a subscription. Additionally, we are exploring the possibility of a freemium model to increase our user base, aiming to convert more users into paying customers. We are also conducting extensive elasticity testing to identify the best pricing model and which SKUs to prioritize. It is possible that we may not offer all three SKUs based on our testing results. Therefore, we are still in the early stages and do not have complete clarity yet. Our marketing and product teams are dedicated to finding the right business model to maximize our return on investment.

Okay, just a couple more questions. In terms of Schwartz and what you're doing, and I know that's short-form content. And I guess, specifically, chat stories, there are others doing that, and it seems that some have had massive success. I'm sure that you're maybe using some of that as a blueprint for what you could accomplish. Can you, I guess, talk more about the success that others have had in this kind of niche space? And I guess, what you envision the upside or where this potentially can go over the next couple of months and years?

Sure. So less about the success that other providers are experiencing in this space. Unfortunately, any of the competition that we know of is privately held, so I can't really speak to details about their numbers. But I can tell you that what we're trying to build is this ecosystem that Elliot had talked about in his comments. Phase 1, as you said, is the text-based stories that have both readable and visual images and are delivered in this chat message-type format. But I think that the way to look at it more generically is we're building an ecosystem around bite-sized, snackable, short-form content. Today, we're availing that as a chat story. It could be that down the road it will not only be chat stories, but it will be just short stories that you would pick up, and we're going to begin to test audio. We expect that we will avail that audio, both in-app as well as syndicated across third-party platforms; as an aside, that may also open up the door for new revenue streams, whether it be from advertising or sponsorship. And we also view that syndication as a user acquisition strategy, such that when new peers begin to listen to those contents, they engage with the content, they like the content, and they will be inclined to go to Schwartz and download the app. When you push this out, I don't know, end of 2020, beginning of 2021, we can envision that we avail this content as short-form video as well. Again, that provides for ubiquity. Certainly, we know in the world of short-form video, whether it be Snapchat or TikTok or potentially even Quibi, that that has been a fast-paced sort of exponential growth market where users really like to have that bite-sized content available to them. That is certainly on the radar screen for us in terms of going out and getting our hands around when is the right time to begin to include that in the mix and what's the right way to do that accordingly.

Okay, great. And then I guess, just last question going back to Zedge Premium. I noticed that on the Premium that the app has promoted a few popular network shows, which makes me wonder, are studios seeing Zedge as an effective allocation of its marketing dollars?

Yes. I think that you've seen in the past, and it's certainly been the case where Hollywood, whether it's big screen or streaming, entities have used the Zedge platform as an immersive way to promote their content and really build a fan base around that particular content. We continue to look for opportunities there. Although, I would say that more generally, we have scaled back on that to some extent because what we found, generally speaking, in the world of Hollywood is that these are not pipeline type of deals, but rather they are individual deals. So on an opportunistic basis, we do pursue them. In the case of Netflix, and in the case of streaming, we're beginning to test the waters to see whether or not they follow the same model as Hollywood on the big screen side or whether or not we can actually build a more integrated distribution platform, where we would have a pipeline of content associated with their releases. And that's a work in progress. I don't have clarity as to where that falls out at this point.

We'll go next to Investor Niel Shanske.

Well, gentlemen, thank you so much for putting together a wonderful quarter, and we look forward to more like it. The subscription growth was really encouraging. Do you have any color on what net growth looks like in subscriptions once we get to starting to see churn?

I'm sorry, once we get to what, Niel?

To starting to churn? So as you know, with January, you started to churn out both subscription, and you talked about a 40% renewal rate, obviously a 60% churn rate. What do you think about net growth in subscriptions once that starts happening in scale?

Sure. So let's bifurcate between new subscribers and renewals. We are still seeing very healthy growth in terms of new subscribers. We think that there are two classes of subscribers to this product. One is more impulsed by very, very effective price points; they can gain the benefits of the subscription model. Then there's, let's call it, more long-term hyper users that feel that now is the time to take the plunge. We treat and market those users differently than what we're trying to do in terms of the renewals, where there's a totally different marketing message and it's focused around the benefits that we're bringing to the table. Then there are things such as credit card declines and what do we do in order to get people to update their credit cards, so we can see more users renewing, things of that sort. At this point, we are not at the point yet where we're providing the sort of projection that you're looking for. From everything that I've seen up until now, we are in a place, and again, I can't speak to coronavirus, but prior to the breakout of the virus, we were still seeing nice, healthy growth with respect to first-time purchasers. As I’ve said, with respect to the renewals, we are pretty pleased that at minimum, we're seeing a 40%-plus renewal rates. Now we’re really in the midst of trying to increase that number based upon a whole set of marketing initiatives.

And with no other questions holding, this will conclude today's question-and-answer session and the conference call. We thank you for attending today's presentation. You may now disconnect.