Zedge, Inc. (ZDGE) Q2 2023 Earnings Call Transcript

Good afternoon and welcome to Zedge's Earnings Conference Call for the Second Fiscal 2023 Quarterly Results. 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. I will now turn the call over to Brian Siegel.

Thank you, operator. 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 its second quarter 2023 ended on January 31st, 2023. Any forward-looking statements made during this conference call during the prepared remarks or in the question-and-answer session, whether general or specific in nature, are subject to risks and uncertainties that may cause actual results in the future to differ materially from those discussed on today's call. These risks and uncertainties include, but are not limited to, specific risks and uncertainties disclosed in the reports that Zedge periodically files with the SEC. Zedge assumes no obligation to update any forward-looking statements or to update the factors that may cause actual results to differ materially from those that they forecast. Please note that our earnings release is available on the Investor Relations page of the Zedge website. The earnings release has also been filed on Form 8-K with the SEC. I would now like to turn the conference over to Jonathan.

Good afternoon. Thank you, Brian and thank you all for joining us today. I'm going to start by briefly reviewing our second quarter results, which were generally in line with our expectations. Q2 revenue increased 1% from last year. The combination of geopolitical, economic, and industry-specific challenges resulted in lighter advertising spend compared to past years and lower discretionary spend by consumers. Additionally, GuruShots, like most iOS apps, whose growth depends on paid user acquisition has suffered because of Apple's App Transparency Tracking Framework or ATT for short, making paid iOS user acquisition less efficient and more expensive. While Apple's release of its SCAD Network 4.0 in late 2022 is meant to alleviate some of this turmoil, it is taking time for various ecosystem providers to integrate this successfully into their tech stacks. Adding to the turbulent market is the decline in mobile phone sales in 2022 to the lowest levels in nearly a decade. Mobile phone sales are a growth factor for the Zedge marketplace. Nevertheless, I am encouraged that the holiday season, which encompassed the first two months of the quarter, was better than we expected heading into the quarter and MAU actually increased sequentially for the first quarter to over $32 million. Given this overall backdrop, we are focusing on the areas that are within our control, and have taken or are taking steps to ensure we don't lose money over the near term while positioning the company for sustainable and profitable growth when the environment improves. To accomplish this, we have implemented a cost reduction plan that totals annualized savings of more than $2.5 million. Additionally, we have narrowed our product focus as follows: for the Zedge marketplace, our top priorities are iterating with pAInt, our generative AI wallpaper maker, to improve take rates and engagement; overhauling customer onboarding; and upgrading our subscription offering Zedge Plus with value adds, while also introducing a subscription offering for iOS users. We will also continue scaling paid user acquisition on Android as the ROI justifies the investment. Expanding on our plans for pAInt, the world is experiencing an explosion in AI-generated art and Zedge wants to be part of this. Our goal is to transform our consumers into creators. pAInt enables us to tap into what we call the creator effect, a dynamic that benefits from the pride of ownership that creators have when they make art. In addition, this effect carries with it a desire to share with others, which can contribute to bringing new users to Zedge. To achieve this, we are improving the onboarding experience to get more users into the creation funnel early on in their engagement process, while also iterating with the business model to minimize friction and encourage growth. Turning to GuruShots, we continue advancing the product with the launch of the Battles feature. Battles provides a casual gaming experience that enables newbies to start competing in short-duration photo competitions that are limited in size and built on a coin-based economy. We expect this new feature will open the top of the funnel, making the game accessible and relevant to a broader audience who hopefully will become hooked and transform into long-term players. We released the beta version of Battles into the market last week and will iterate and fine-tune as needed. As you know, the GuruShots Photo Games growth strategy heavily depends on paid user acquisition. Unfortunately, acquiring profitable iOS users has become markedly more difficult due to Apple's ATT framework, which severely limits the information an advertiser can secure about prospective purchasers. In my opinion, this has had a monumental impact on the contraction of the gaming sector over the last year. That said, we are doing our best to diversify by testing alternative acquisition channels in order to help drive new ROI-positive players to the game. In addition, through our experience developing the Battles feature and the explosive growth in the AI generative arts sector, we saw an opportunity to develop a standalone casual game, which had a recent soft launch. This game is expected to harness the fast-paced growth in generative AI art and we will test and iterate on it in the coming months. Turning to Emojipedia, we are now seeing the fruits of the changes we made during calendar 2022, which are yielding the high-margin growth we expected when we acquired the company. We plan to release more new features in the coming months. We are very excited about the success of the changes we've made over the past year and believe they can drive high double-digit, low triple-digit growth rates with attractive gross margins in fiscal 2023. I want to thank our investors, Board members, partners, and employees for your continued support. In summary, we are and will continue doing our best to build long-term sustainable value and effectively address the challenges that we are facing over the near term. Now, I would like to turn the call to Yi who will review our financial results. Yi?

Thank you, Jonathan. Moving to our second quarter results, now defined as the number of unique users that opened our Zedge app during the last 30 days of the period, decreased 11% from a year ago to 32 million. Now, in well-developed markets, it was down 13% and the emerging markets were down nearly 11%. Europe, which contributed to both metrics continued to suffer from the Russian invasion of Ukraine, inflation, and the energy crisis, which continue to play a significant role in this quarter's MAU decline. Total revenue in the second quarter was $7 million, a 1% increase from last year. Digital goods and services revenue came in at $1.2 million. Similar to Q1, GuruShots' revenue was negatively impacted by conditions in Europe and app limitations on user data. Subscription revenue was down 8%, driven by a 14% decrease in active subscribers. Zedge Premium GTV increased 1% to $440,000, reflecting revenue from AI pAInt, which offset declines in NFP sales. Again, while we are impacted by the winter conditions, we believe our strategy provides us with a differentiated offering that will result in more significant growth over time. ARPMAU was 0.052, a decrease of 13% year-over-year. Operating expenses increased significantly related to both the investment in GuruShots, higher investment in paid user acquisition on Android for the Zedge Marketplace, and higher depreciation and amortization from acquisition but were partially offset by a $1.8 million contract expense related to a reduction in the fair value of contingent consideration related to the GuruShots acquisition. Net income was $1.6 million, and reported diluted earnings per share was $0.11. Diluted share count was 14.3 million. Adjusted EBITDA was $1.4 million versus $3.9 million in the prior year period. From a liquidity standpoint, we remain in a strong net cash position with over $17 million in cash and cash equivalents. Note that we don't have any direct exposure to SVB, Republic National, or Signature Bank. Moving to our stock repurchase program, we repurchased 318,000 Class B shares during the second quarter at an average price of approximately $2.14 per share. We have repurchased 442,000 Class B shares since the inception of the buyback in September 2022. Thank you for listening to our second quarter earnings call, and I look forward to speaking with you again on the next call. Operator, back to you for Q&A.

Thank you. We will now begin the question-and-answer session. First question comes from Allen Klee with Maxim Group. Please go ahead.

Yes, good afternoon. You talked about GuruShots. When you originally did the acquisition, you had some potential commitments of how much you were going to spend on user acquisition spend, I think $5.3 million in year one, subject to getting good returns on that. Are you changing the plan of how much you'll be spending?

So Allen, this is Jonathan. We have until the end of March to spend $5 million, although we are not spending that amount of money. And we have found that when trying to ramp up user acquisition spend, the return on ad spend has declined. As I mentioned during my comments, in large part, that is due to a combination of the App Transparency Tracking System, a framework that Apple had released and is causing major, major issues throughout the industry, as well as the macroeconomic and geopolitical risks that we are all experiencing on a global basis.

Okay. That makes sense. Could you clarify if you disclosed how much GuruShots contributed during the quarter? I also heard you mention that you believe Apple is planning to roll out something else in the future that could enhance your marketing efforts. Could you explain what that is? Thank you.

Sure. I'll start with the second question, and then I'll let Yi provide the numbers. Apple began rolling out their SCAD 4.0 ad network in November 2022. Before this rollout, advertisers were limited to a one-day window to gather data on users who downloaded and installed their apps. SCAD 4.0 extends this window to three, and possibly seven, days, though with slightly reduced accuracy. While Apple released SCAD 4.0 back in November, the entire ecosystem still needs time to adapt and integrate with this technology, which is gradually happening but is not yet complete. We hope that having access to more information over a longer time frame will enhance advertising efficiency, enabling publishers to better acquire customers who match their optimization goals. Yi, would you like to discuss the financial breakdown between GuruShots and other revenue sources?

Yes, sure. Hi, Allen. So, GuruShots contributed $1.25 million on the top line. On the income loss from operation, it shows that they have been a $5,000 loss from operation, mainly because we had about $1.8 million in contract expenses that helped reduce the loss from operations.

Does that answer your question, Allen?

Yes. Thank you. I heard you guys mention that you developed a casual game that you're doing a soft launch on for that's a generative AI art, could you just expand on that a little bit?

The idea is to hold competitions that center around creating generative AI art. Specifically, with GuruShots and its Battles, rather than limiting the audience to amateur photographers, we aim to broaden participation to anyone who can input text related to a specific competition. We envision a range of in-game resources and anticipate that this will facilitate monetization through a mix of advertising and in-app purchases for specific resources. It's still very early, as this is currently in soft launch, and we are making many adjustments. In gaming, it’s common to have a soft launch last for a year, so we are collecting data and continually refining the gameplay. We believe this aligns with our goal when we acquired GuruShots, which was to gamify other visual arts verticals. We look forward to seeing how this develops, especially given the significant interest in AI generative art, and we think the gameplay could appeal to fans of casual games.

Thank you for the information. I understand you mentioned that smartphone sales affected you, but those sales are starting to rebound. Does this suggest that while you aren't providing guidance, monthly active users might stabilize sequentially and see some improvement? Regarding your current rates, is it fair to assume that this quarter's level represents a peak rate, or are there factors that could lead to upward or downward pressure? Thank you.

Generally, there is a strong correlation between handset sales and the monthly active user base for Zedge, Ringtone, and Wallpaper. It makes sense that when a new Android user purchases a phone, they often want to personalize it, leading them to download the Zedge app. Typically, when new handset sales decline, there is also a decline in monthly active users. Regarding CPMs and the overall industry situation, we are facing significant pressures that are difficult to assess. Factors like the ongoing war in Ukraine and potential disruptions to grain shipments could negatively impact the economy. As living costs rise, individuals may prioritize necessities over engaging with mobile apps, affecting ad revenues. While I can't predict if we've reached the lowest point, we are focusing on optimizing our ad inventory to maximize value. So far in Q3, we have observed some improvements in CPMs, but the situation can change quickly. Just a week ago, no one anticipated issues with Silicon Valley Bank, which has now been taken over by the FDIC.

Got it. Okay. You mentioned a cost-cutting initiative of $2.5 million to $3 million. How do you view the time required to implement that?

Sure. So I think that we started to undertake this initiative towards the tail end of Q2. And I think that for Q3, that will be more apparent in the financials. And we're really moving quickly in order to see to it that potential is met sooner rather than later. It's not that this is back-loaded, but rather this is something where boom, there are areas that we have cut back on cost, we've become more efficient and so on and so forth and that immediately benefits the entire business.

Got it. And just to clarify one more big-picture question, and I'd like to get into your groups, but when you say you're not expecting a return to growth in the near term, do I understand that that would mean that likely for your next fiscal quarter, your revenue growth will be down year-over-year?

Yes, I really prefer not to share projections at this point. I think that it's fair to say that we are doing everything within our power to see to it that we do not have a continued downturn in the business and we're doing whatever we can in order to preserve our cash and doing our best to try to operate the company at a very minimum without losing money on an aggregated basis, on a comprehensive basis, that is.

Okay. In terms of your Premium Marketplace, what are your top priorities for the next quarter or two?

Yes. Top priorities are, we continue to evolve in the marketplace and offer content that our users or prospective purchasers would be interested in purchasing that continues to be the case. We have been very clear from the outset, especially during the hype of what had happened with NFTs, that our view of NFTs has been around a technology benefit for creators and purchasers, namely providence and the ability to ensure that you've bought that one or that one of a set of that particular digital item, we did not play the speculative game in terms of being the next people and we believed then and I think it's been proven since then that we have been right in terms of taking that perspective. So we continue to operate within that regard, offering, whether it be NFTs through our NFTs Made Easy product, or non-NFT, non-tokenized content and availing that to our users at various points in their journey for a price.

Okay. Great. Well, I mean, you guys have been very disciplined and quite good performance in a tough market. So I admire what you guys are doing. Thank you so much for answering my questions.

Thank you.

This concludes our question-and-answer session and conference call. Thank you for attending today's presentation. You may now disconnect.