Zedge, Inc. (ZDGE) Q3 2021 Earnings Call Transcript

Good afternoon, and welcome to Zedge’s Third Quarter 2021 Earnings Conference Call. During management’s prepared remarks, all participants will be in a listen-only mode. After today’s presentation by Zedge’s management, there will be an opportunity to ask questions. In today’s presentation, Jonathan Reich, Zedge’s Chief Executive Officer; and Yi Tsai, Zedge’s Chief Financial Officer, will discuss Zedge’s financial and operational results for the three months period that ended on April 30, 2021. Any forward-looking statements made during this conference call, either in the prepared remarks or the question-and-answer session, whether general or specific in nature, are subject to risks and uncertainties that may cause actual results to differ materially from those which the Company anticipates. These risks and uncertainties include, but are not limited to, specific risks and uncertainties disclosed in the reports that Zedge files periodically with the U.S. Securities and Exchange Commission. Zedge assumes no obligation either to update any forward-looking statements that they have made or may make or to update the factors that may cause actual results to differ materially from those that they forecast. Please note that the Zedge earnings release is available on the Investor Relations page of the Zedge website. The earnings release has also been filed on a Form 8-K with the SEC. I would now like to turn the conference over to Mr. Jonathan Reich.

Thank you, operator, and thank you to all for joining us today. Good afternoon. Welcome to Zedge’s third quarter fiscal year 2021 earnings conference call. I’m Jonathan Reich, CEO of Zedge, and with me is our Chief Financial Officer, Yi Tsai, who will provide additional insights into our financial performance. Q3 was an excellent quarter for Zedge. We reported revenue of $5.3 million, our second highest quarter in the history of the Company. We also delivered our fourth consecutive quarter of net income, sixth consecutive quarter of positive EBITDA, and seventh consecutive quarter of positive cash flow from operations. We’re very proud of these achievements, especially in light of the seasonal nature of our business, with Q3 being historically weak, mostly from a drop in post year-end holiday ad budgets. For those of you that are newer to the story, Zedge is a leading app developer focusing on mobile phone personalization and entertainment. Our heritage is rooted in 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 notifications apps. Our flagship app Zedge Wallpapers and Ringtones is all about personal identity. It acts as a popular hub for self-expression for millions seeking mobile phone personalization, social content, and fandom art. The app is rapidly approaching 500 million organic installs across Android and iOS, an outstanding achievement for any app. The app generates revenue from a combination of advertising, paid subscriptions, and our Zedge Premium Marketplace, which enables content creators ranging from world-class celebrities to emerging artists to display and market their digital content and sell it to our users. Zedge’s strong third quarter performance is a testament to the ongoing investments we are making in ad operations, paid subscriptions, and MAU growth, the latter of which was up nearly 20% year-over-year. Specific to last point, we also started seeing a material slowdown in the rate of MAU decline in well-developed markets, which dropped by only 1% in Q3. Delving into paid subscriptions, although we benefited from what we consider healthy renewal rates of approximately 45% in year two and approximately 65% in year three, year-over-year increases remain strong. We did not match the level of our prior sequential quarterly increases. This was a function of customer churn rate remaining constant on a higher total subscriber number, combined with lower MAU in well-developed countries where our subscription offering tends to have better traction. It is unclear at this time whether the subscription part of our business was actually impacted by seasonality or if it was something else. Either way, we are being proactive in our efforts to reverse this trend, particularly in well-developed markets. Until recently, we had two product managers overseeing our entire product portfolio: Zedge Wallpapers and Ringtones, Zedge Premium, Zedge Plus, and Shortz. We recognized that to better scale, we needed to invest in expanding our product management team. We waited to pull the trigger on this until early calendar 2021 with the completion of the content management system migration, and now have three dedicated product managers working on our personalization initiatives: one focusing on the premium offering, another focusing on Zedge Plus, our paid subscription offering, and the third focusing on Zedge Premium. In addition, we have a product manager assigned to new initiatives, including Shortz. We believe that the additional resources will allow us to scale and execute on the various growth initiatives that we have identified with greater efficiency. Although early, we’re starting to see results from these hires, most recently with the completion of the overhaul of user accounts, a prerequisite for social and community features that will be incrementally introduced later this summer. The ability to follow artists and other users, create and share collections, notify users about new followers and new content, and offering an easy-to-remember handle, like zedge.me/jonathanreich, are expected to unlock fundamental user growth. Furthermore, we are going to enhance Zedge Plus by bundling in value adds to make it more attractive to a broader cross-section of prospective customers and ultimately drive incremental growth. Finally, the newly hired Zedge Premium product manager is working on a set of initiatives to expand our premium creator community, increase average revenue per artist, optimize and localize pricing, make premium content more accessible to consumers, and introduce new functionality, including NFTs or non-fungible tokens, ensuring that they are easy to use, operationally affordable, environmentally sustainable, and an improvement to our creator publishing platform. Apart from this, we now have the marketing infrastructure in place from attribution to analytics and all the associated connections to start testing paid acquisition growth strategies. This will be an iterative process allowing us to scale based on ROAS or return on ad spend. I would be remiss if I didn’t spend some time updating you about Shortz. Earlier this year, we hired a product manager who has been spending the bulk of his time doing foundational work needed to understand the user base, how they interact with the app, what content they like, and how they consume it. Under his watch, we introduced an escorted version of Shortzcasts, high-value podcasts of the content. We believe that short-form fictional content is optimal for smartphone users and that this phase is still in the early stages of maturation. We are also beginning to test various paid user acquisition strategies to complement existing organic channels, introduce new features, and expand our audio catalog. We are even more encouraged that there is a large opportunity here for Zedge in light of Naver’s recent acquisition of Wattpad for $600 million, and Kakao's acquisition of Radish for $430 million. Last quarter, we introduced disciplined M&A as part of our growth strategy. While we don’t have anything to announce at this juncture, we have been active in looking at potential targets. As a reminder, our acquisition strategy is to seek out opportunities where we can leverage our large user base, expertise in monetization, know-how in managing complex platforms, outstanding engineering talent, and a healthy balance sheet. In closing, our first three quarters of the fiscal year have been outstanding, and we expect to report continued strong year-over-year growth in Q4, despite a tougher comparison as our business turned the corner in Q4 of fiscal 2020. Based on our strong fiscal year-to-date performance, we are raising our full year fiscal 2021 expectations for revenue growth of 95% to 100%, while maintaining our track record of strong profitability and cash flow from operations. Before handing the call over to Yi, I would like to thank you, our investors, for your support. I also want to remind everyone that our success is a direct outcome of the outstanding team of talented and dedicated professionals who work at Zedge and who go above and beyond to execute our vision. Thank you. Now, I’m going to turn the call over to Yi, who will provide details about our financial performance.

Thank you, Jonathan. I want to start by reminding those on our call that our fiscal year ends July 31st. Additionally, last quarter, we introduced the term active subscription to replace paid subscription as a metric. Due to the change in the calculation used by Google Play, they now include account hold, which is a subscription status that begins when the user’s form of payment fails, and a three-day grace period has ended without payment resolution. The account hold period lasts for up to 30 days, with the aim to reduce cancellation rate. Moving to the third quarter results. Monthly active users, or MAU, defined as the number of unique users that opened our app during the last 30 days of the period, increased 20% to 34.5 million during April 2021 from 28.8 million during April 2020. Emerging market MAU expanded by nearly 30%. Total revenue in the third quarter increased 153% from last year to $5.3 million. While our growth was extremely impressive regardless, keep in mind that Q3 of 2020 is when CPMs bottomed out. So, this year, we saw the benefit of the work we are continually doing to improve our ad operations. Subscription revenue was up 98% from last year, still demonstrating strong growth, despite the slowdown in net additions. It is unclear how much of the slowdown in sequential new subscription growth was seasonal and how much was related to lower MAU in well-developed markets. But with our recent hires and product initiatives, we are working to reaccelerate growth in fiscal 2022. Zedge Premium’s gross transaction value, or GTV, that is the total sales volume transacted through our marketplace, was $250,000, up 68% compared to the year-ago quarter and 19% sequentially. As Jonathan indicated, we are investing in growing this offering. Active subscriptions exceeded 750,000 at the end of the quarter, an 89% increase year-over-year. As you recall, when a new user purchases a subscription or a freemium user converts to a paid subscription, we pay a 30% fee to Google, which shows up in our SG&A as a marketing expense. However, if a subscriber, whether monthly or annual, renews their subscription after 12 months, the Google fees drop to 15%. In Q3, we continued to see annual second renewal rates of approximately 45%, and third-year renewals are coming in at 65%, which is generally considered to be strong performance within the industry. Overall, the average revenue per monthly active user, or ARPMAU, was $0.049, an increase of 121% year-over-year, driven by the combination of better advertising performance and higher pay subscription numbers. Operating margin increased to 38% versus negative 6% last year, reflecting the continued cost control we have implemented while still being able to invest in growth. Net income and diluted earnings per share were $1.9 million and $0.13, respectively, versus a net loss of $300,000 and loss per share of $0.03 in the prior year. Average shares outstanding for the third quarter were about 14.6 million on a fully diluted basis, representing the shares issued as part of our ATM, combined with option exercises as they started to increase significantly in value over the past 12 months. EBITDA was $2.3 million versus breakeven last year. From a liquidity standpoint, we remain in a strong net cash position with almost no debt. A near $25 million in cash and cash equivalents, a $20 million increase from last year and over $11 million sequentially. The increase in cash over Q2 was driven by a combination of positive operating cash flow of $4 million and net proceeds of $7 million from the $10 million ATM program we initiated this quarter, sales of which occurred at a weighted average price of about $15. Moving to guidance for the full fiscal 2021. As Jonathan mentioned, we have increased our top line growth expectation to 95% to 100%. Q4 has traditionally been stronger than Q3. But also keep in mind that our Q4 comparison will be tougher due to the growth trajectory that began in Q4 ’20. Also note that with some key new hires, we expect our operating expenses run rate to increase slightly in Q4. I hope that each of you remains safe. And I look forward to speaking with you again on the next call. Operator, back to you for Q&A.

We will now begin the question-and-answer session. Your first question is coming from Allen Klee with Maxim Group. Your line is live.

Good afternoon. Congratulations on continued excellent execution. One thing that lots of things were positive in the quarter, but the first thing I wanted to highlight to dig into was the strength in your users and your advertising rates. This was supposed to be a seasonally weaker quarter, so what do you attribute the strength that you saw in your monthly average users and the revenue that you were getting for them per user?

Hi, Allen, it’s Jonathan. Thank you for the compliment, and really credit goes to the team. Specific to your question, it is the hard work of our ad ops team that is really focused on optimizing the CPMs associated with our inventory. We think that that is a very significant part of the work that they continue to invest in generating more from the inventory and that involves everything from optimizing the inventory, optimizing the user experience, focusing on tools like header bidding, decreasing latency, and so on. I’ll also add that I think industry-wide CPMs have been holding up as the economy begins to open up. No question that we are benefiting from that as well. I hope that helps?

That does. Given that your monthly active users were down only 1%, could you elaborate on what you believe contributed to that? Additionally, what initiatives have you been implementing in relation to Apple?

Yes. So, as you know, we are dominant on Android. Ongoing improvements that we are making in terms of the overall experience or user experience in the app are something that we are benefiting from. As I indicated in my comments, going into the summer, we have a lot of initiatives focused on what we expect will result in Tier 1 growth or the well-developed market growth specific to social and community features, personalized feeds, improved search and recommendations, and marketing automation, where we will send push notifications to our users. Those will be rolled out incrementally, and as we see success, we will continue to invest in the enhancements yielding that success. The ones that are not translating into improved engagement will be turned off accordingly.

Got it. If I move on to your subscription ad-free business, it seems that it's continuing to grow sequentially. Could you explain your comments regarding it being a little less than the prior quarter?

Right. So, let’s bifurcate between subscribers and revenue. You are correct that revenue continues to improve. That is a function of new subscribers and renewals from existing subscribers. Going into year two renewals, we’re seeing that approximately 45% of annual subscribers will renew for a second year, and then going into third year renewals, we have been tracking that now for a couple of months, and we’re seeing approximately 65% of the users that had renewed for a second year are indeed renewing for a third year. As such, the overall revenue increased, even though we did not have a net gain in terms of additions of 100,000 users, which had been the standard in previous quarters. Yi, do you want to add anything to that?

Yes. Allen, this quarter, we only added 42,000 net additions to our pool of subscribers. And as Jonathan mentioned, as our pool gets bigger and bigger, you need to get new subscribers to offset the churn. So, as your base grows larger, it’s harder to find new subscriptions to offset the canceled subscriptions. That’s why the net addition has slowed down a bit when compared to last quarter.

And I just would like to add one more piece, which I touched upon in my comments. When looking at calendar year 2021 to date, we have really made a significant commitment towards growing our product management team and seeing to it that we have dedicated product managers focusing on our various products. So, we’ve got a dedicated product manager focusing on the premium portion of the Wallpaper and Ringtone app. We’ve got a brand-new dedicated product manager focusing on Zedge Premium or marketplace. We have another brand-new dedicated product manager focusing on subscriptions and what we can do to grow that business over time with value adds and things of that sort. And then, we have a product manager that we’ve replaced focusing on new initiatives. At this point, that is primarily around Shortz, although we have other things going on under the hood in terms of new potential product opportunities that are also being looked into by that particular product manager.

In terms of your marketplace, there are many initiatives set to launch this summer. Two things you mentioned caught my attention as new. One was the introduction of NFTs; could you explain how that would work? Would users be able to bid for them on your site, or would they be created there? Additionally, you mentioned the possibility of starting paid acquisition marketing. If that happens, how do you envision targeting those efforts? Thank you.

Sure. With respect to NFTs, non-fungible tokens, we view NFTs as being a valuable utility that will be attractive to artists that exist in our marketplace. Our requirements for that, if you will, are we want to make sure that they’re affordable. So far as getting the NFT out there, the artist is not going to be in a position where they have to pay so much money to mint these NFTs that it is not valuable for them. Number two is that they are sustainable from an environmental perspective. Third, we want to do everything possible to provide for ease of use. In today’s world, minting an NFT is complicated for most people. It requires having a crypto wallet and a lot of know-how regarding the NFT side. We’re really trying to lower that bar to make this utility, one which is accessible to a wide array of artists, many of whom do not have the technical know-how needed to create NFTs. Whether or not we will avail those on third-party sites remains to be seen, but we certainly want to make sure that they are embedded in our creator platform. Turning to your second question of our paid user acquisition, we are looking at this very analytically. We want to know that if we market to a particular segment, however, you define that segment by demographic, geography, content taste, gender, etc., we can measure the return on ad spend and understand if that user base, that segment generates a positive ROI when taking into account their LTV or lifetime value. So, we have invested in building the infrastructure so that we have all of those connections available to understand, starting from attribution, all the way through to the customer signing up and then interacting with our product. Whether or not that’s a segment we can afford to bring on over a positive ROI will take time. This process is one where we will proceed cautiously; however, when we find and hopefully unearth segments that make a lot of sense, we’ll begin to spend more money on acquiring those segments accordingly. Until such time as we cross the threshold or determine we cannot spend beyond a certain amount for that particular segment. Does that answer your question?

Yes, that sounds great. I have a few housekeeping items to cover, and then I'll be finished. First, you've made some hires that should contribute positively to future growth. I'm wondering if the costs for these hires were fully reflected in this current quarter or if this quarter serves as a good baseline for future expenses, or if we can expect costs to increase. Can you provide any clarification on that? Yes.

Well, some of these hires were brand new and were not part of our team this quarter. So I think that you will see some change; but on the flip side, there have been some people that have exited the Company. So, it’s really a balancing game. Yi, do you want to provide a little bit of color there?

Yes. Allen, so for the nine months until April 30th, we brought on about 13 developers, engineers, and product managers, with 6 of the 13 onboarding during Q3. In terms of run rate, we are not done with the hiring yet. In Q4, we’re probably bringing on another two product managers. So, if you’re looking for a run rate, you probably need to factor in more hires.

That's great. Going back to seasonality, can you remind us about the July quarter? I know you mentioned it a bit, but you indicated that the upcoming quarter is usually higher in absolute terms compared to the previous one. However, I also heard you say that the comparisons are becoming more challenging. Is there a specific reason why you think that is, or how should we consider the seasonality when comparing the fourth quarter to the third, or just in general?

Yes. It’s probably too early in the quarter for us to provide an educated answer there. But turning back to Q2 versus Q3, as you know, our Q2 is November, December, January. So, typically, we benefit from end-of-year ad spend, and then there’s a seasonal decline in the February, March, and April timeframe, where ad budgets are cut back. We then expect that Q4 for us will be slightly above Q3. But, I think that is historical. With all the changes that we have going on in the app right now, it’s something that we’re not in a position to provide accurate guidance other than overall the business is holding up nicely.

Great, thank you. My last question is about the balance sheet. It looks like you raised around $7.4 million in equity during the quarter, likely from your $10 million ATM. Can you provide an update on where that stands today and the current share count, assuming it was included in your quarterly report? I'm not sure if your quarterly report has been released yet. Thank you.

Yi, do you want to address that?

Yes. So, we raised about $7.4 million, and we still have about $2.6 million or $2.7 left. We expect to complete the $10 million offering within the timeframe. Our current share count is somewhere around 14.2 million shares.

Excellent. Okay. Congratulations. Thank you so much.

Thank you, Allen.

We have no questions from the lines. This concludes our question-and-answer session and conference call. Thank you for attending today’s presentation. You may now disconnect.