Zedge, Inc.
Q1 2017 Earnings Call Transcript

Published: 9 Dec 2016

[Operator:]

Good day everyone and welcome to Zedge’s first quarter fiscal year 2017 earnings conference call. During management’s prepared remarks, all participants will be in listen-only mode. [Operator Instructions] In today’s presentation, Tom Arnoy, Zedge’s Co-Founder and 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 ended October 31st, 2016. Any forward-looking statements made during this conference call, either in the prepared remarks or in the Q&A 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 SEC. Zedge assumes no obligation either to update any forward-looking statements that they have made, or may make, or to update the factors that can cause these actual results to differ materially from those that they forecast. Please note that Zedge earnings release is available on the Investor Relations page of Zedge’s website and the earnings release has also been filed on Form 8-K with the SEC. I would now like to turn the conference over to Mr. Arnoy. Please go ahead, sir.

[Tom Arnoy:]

Thank you operator. And thank you all for joining us today. I am Tom Arnoy, Co-Founder and CEO of Zedge. Welcome to Zedge’s first quarter of fiscal 2017 earnings conference call, recapping the three months ended October 31, 2016. Joining me today is Jonathan Reich, our Chief Financial and Chief Operating Officer. We’re pleased to share the highlights of the quarter. As you know from our previous calls, Zedge is focused on growing our user base, increasing engagement and ultimately expanding our revenues through that user growth and new methods to monetize our base. We know there is great untapped potential in our platform that we can unlock by investing in these priorities. After a decline last quarter, we made good progress in Q1, most notably with the uptick in monthly active users, or MAU, and we are seeing improving trends in engagement. I want to quickly note that we are no longer reporting active installs, as Google has ceased reporting total device active installs. For Zedge, MAU is a significant performance indicator, because it speaks to both reach and retention. We’re pleased about the recent improvement in MAU, and are optimistic that we can build on that success. During the last 30 days of the first quarter, MAU grew by 2.6% to 31.6 million when compared to the last 30 days of Q1 of fiscal 2016. We also saw modest growth in MAU compared to Q4 of the prior fiscal year. MAU resumed growing this past quarter, which is important considering that Q4 2016 was the first quarter in our history which witnessed a decline in MAU. This growth is a direct result of our investments in improving the user experience, which should provide a sustained user growth and ultimately translate into revenue expansion. That said, in Q1, average revenue per monthly active user declined by 10.7%. We are working hard to reverse this downturn by continuing to grow our user base with users that generate greater revenues, and unlocking the potential with improved engagement and introducing new monetization layers. As stated earlier, user growth, engagement and retention are harbingers of revenue growth. In Q1, we took assertive steps to advance Zedge’s reach and revenue potential. To that end, I want to outline three areas of focus that we have adopted, scaling our team, optimizing the user experience and expanding our product portfolio. I would like to elaborate on the progress we’ve made in each of these areas. First, the team. We have made significant investments in expanding our team, both in Norway and in the US. In fact, compared to the year-ago quarter, our team has grown by eight people. Key hires in Q1 were related directly to driving Zedge’s revenue potential, namely hiring in products, engineering, marketing and commercial partnerships. Our engineering and development team growth contributed directly to an unprecedented level of updates and new product growth. We also expanded our commercial team by bringing on seasoned professionals focusing on the sports and entertainment verticals. They are already hard at work establishing partnerships with major content providers, as Zedge takes action on its stated commitment to open up the homescreen to brands that want to engage with their fans and customers with compelling personalization content. Second is our focus on optimizing the user experience and improving engagement. Our quarterly results show that our efforts are resonating in these areas, as we selectively deployed feature enhancements to accelerate user growth and increase customer engagement. An improved user experience is especially critical as we approach the holiday period, not to mention for overall retention. Examples of feature enhancements made in the first quarter includes, using AI technology to scale images from low resolution to high resolution, thus making more content available, just in time for those turning to Zedge in order to personalize their new high-end phones this holiday season. This effort resulted in a significant increase of wallpapers available to 54% of US users and 40% of global users. For users affected, this has led to 20% more interaction with the content and 4% more wallpapers being set. Through deep learning and enhanced technology, we have improved the user experience by ensuring that our content is easy to discover and fun to navigate. This update has unearthed 10% more unique content. We will continue to leverage this powerful functionality to improve content recommendations and search results. We have enabled the possibility to set lock screen wallpapers directly from within the app for more than 40% of our user base, which, for this group, has increased the number of users setting wallpapers by 6%. In the coming months, we expect to enable this functionality to more and more users. We have significantly reduced the latency for users playing ringtones and notifications, to ensure a much more responsive experience. After these improvements, on average, our users are listening to 15% more ringtones and notifications than before. Finally, we remain committed to expanding our product portfolio with the goal of increasing our reach. We have rolled out an unprecedented number of products over the past several months. We most recently launched Ringtones for iOS as well as expanded the beta of our new app, SNAKK, globally. Even as we expect to continue to optimize these products, we view these launches as significant accomplishments which will help us in growing our user base. Beyond this, our data reveals that overall retention has improved with the Android widgets beta. We’re also focused on finalizing Set My Ringtone in calendar 2017, which we believe will have broad appeal and help expand our user base. In another exciting development, we made steady progress with the introduction of Zedge Stories both in terms of the core product offering and brand partners. To this end, we started promoting content from MMA's World Series of Fighting, our first foray into sports and expect to offer embedded merchandising capabilities in Stories in time for the holidays. The content is related to World Series of Fighting's New Year's Eve mega-event at New York's Madison Square Garden to be broadcast live on the NBC Television Network. We remain committed to growing our user base and designing and deploying products that cement our leadership position in smartphone personalization. We believe that over time this will create a sustainable path to revenue growth. Now, I am going to turn the call over to Jonathan Reich for a discussion of the quarter’s financial results. Thank you.

[Jonathan Reich:]

Thank you, Tom. My comments today will focus on our key operational and financial results for Q1 of fiscal 2017, the three months ended October 31st, 2016. 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 by December 15th. Following my comments, we will open the call and address any questions you may have. In my remarks and unless I specify otherwise, comparisons are to the year ago quarter, mainly the first quarter of fiscal year 2016. Monthly active users, or MAU, climbed to 31.6 million during the last 30 days of the first quarter from 30.8 million in the comparable period one year ago, and 31.1 million in the sequential quarter. As Tom mentioned, this growth primarily relates to improving the user experience, increasing engagement and re-launching the iOS ringtone app. Revenue in the first quarter was $2.4 million, a decrease of 6.9% compared to the first quarter of fiscal year 2016, while average revenue per monthly active user, or ARPMAU, decreased 10.7% year over year to 2.33 cents. The year-over-year declines in revenue and ARPMAU reflect the impact of Apple’s decision to remove the Zedge app from iTunes in early 2016 and our decision, in April 2016, to de-emphasize the Game Channel which resulted in a decline in game installs. MAU is a leading directional indicator of revenue, and we expect that the investments we are making in our offerings will help expand our reach and drive continued growth in MAU. Taken together with the improvements in user engagement, we believe that these efforts will translate into both expanding revenues and new monetization opportunities that will start to unfold later this year. Direct cost of revenue as a percentage of revenue increased slightly to 15.4% from 15% in Q4 2016 and from 11.5% in Q1 2016 as we experienced higher marketing automation expense related to reaching a larger number of our customers and increases in both hosting and content filtering costs. We will seek to manage these costs and ensure that we have the right partners and infrastructure to support our user growth. SG&A grew by 4.2% or $71,000 to $1.8 million compared to the year ago quarter. The increase primarily reflects growing our headcount to 59 from 51 in the year ago quarter and the added costs of operating as a public company following our spin-off from IDT in June. The impact of these factors was partially offset in the first quarter by several non-routine items including a tax credit in Norway and lower bonus payouts. Looking ahead, we expect that SG&A will continue to increase in 2017 as we further expand the team and increase our investment in new technology and content development. The revenue decline in combination with the increase in SG&A expense lowered income from operations to $113,000 from $419,000 in the year ago quarter. Net income per diluted share decreased to $0.02 compared to $0.04 in the first quarter of fiscal 2016 despite a $51,000 foreign exchange gain compared to a foreign exchange loss of $54,000 a year earlier. Turning to our balance sheet, Zedge remains well capitalized. As of October 31st, we reported $6 million in cash and cash equivalents compared to $2.4 million a year earlier. Trade accounts receivable were $1.9 million, and our historical receivables collection rate is 100%. Zedge continues to carry no debt, although we have access to a $2.5 million credit facility with Bridge Bank. To wrap up my remarks, our efforts to improve MAU, expand reach and improve engagement are starting to pay dividends as evidenced by the reversal in the direction of MAU from last quarter. We believe that these initiatives will result in expanding revenue in 2017 both organically and through the introduction of new monetization schemes. We will continue to invest judiciously in growth opportunities pursuant to the strategy Tom outlined in his remarks and do so while maintaining a healthy balance sheet with ample liquidity. This concludes my remarks. Now, Tom and I will be happy to take your questions. Operator, back to you for Q&A.

[Operator:]

[Operator Instructions] And our first questioner today is John Rolfe [ph] with Oregon Capital. Please go ahead.

[Unidentified Analyst:]

Hey, Guys. So just a little help I guess with the numbers. Can you give us any sort of guidance with respect to, on either a percentage of revenue basis or on an absolute basis how we should be thinking about SG&A for the entire year? And I guess I sort of asked the question in the context of your comment that there were some puts and takes this quarter. So I'm just trying to understand what a certain normalized level for SG&A might be for the year, now that you have certain ongoing run rate with all the public company expenses?

[Jonathan Reich:]

Yes. So this is Jonathan and thanks for asking the question. What we've said in the past really is two things. First of all, the cost of being a public company, we estimated it to be somewhere between $750,000 to $900,000 compared to when we were majority owned by IDT. And the growth in SG&A that we see aside from that really relates to adding more personnel, which as we mentioned, we grew around 8 people from a year ago this quarter. We’re not really at the point where we are providing projections. But suffice it to say that if we're 59 people now, we believe that we will be north of 70 people by the end of the fiscal year, if not more than that. And I should add as well that we have had a pretty consistent policy within the company that we are not going to just load up the ship with contents on the people unless we know that or unless we feel very comfortable that the revenue will be there to ultimately support that investment.

[Unidentified Analyst:]

Okay. That's helpful. Thank you. And let me just ask, I guess, one additional question. I mean looking longer term, can you guys talk at all about sort of what you think a target operating model for the business might be. I mean when you look at a business like yours, what -- once you sort of transition through the growth investments, what sort of operating margins do you think should be achievable for a business like yours?

[Jonathan Reich:]

Yes. So it’s also a little bit early for us to answer that question because as we've described, we have several initiatives in terms of the monetization stack that we need to really scale out in a marketplace. As I think John you know that our revenue today is primarily driven by programmatic advertising and the new monetization schemes that we have been working on we believe will sell at a premium to those, but it's still a little bit too early for us to really be able to sort of say, hey, it will be a 20%, 30%, 40%, whatever that number is. So we ask that you indulge with us while we are sort of getting those products out there and assessing what demand will be like and where those products price out. That being said, when thinking about the add-ons that we've had on the commercial side, focusing on the sports and the entertainment verticals, these are verticals which are investing tons and tons of money in terms of their marketing initiatives and thinking about the fact that Zedge really can bring ownership of the homescreen, whether it be through wallpapers, lock screen wallpapers, widgets, icons and all of the associated audio to these different verticals, we are very excited about what the opportunity is and look forward to executing on that in the upcoming quarters.

[Operator:]

Our next questioner today is Andrew Walker with Rangeley Capital. Please go ahead, sir.

[Andrew Walker:]

Hey, guys. Thanks for taking the question. Yes. So I just wanted to start with, so for the overall revenue declines, obviously ARPU was way down and you guys kind of mentioned games as a driver, but I was wondering if you could draw a little bit further down and kind of switch -- and kind of break it down like how much was games a driver versus I think the other piece has to be either a lot lower prices on advertising or a lot less engagement from users. So can you kind of break those three different pieces down?

[Jonathan Reich:]

Hey, Andrew. How are you? Yeah. It’s Jonathan. So a couple of things. What we've said was really that there were two pieces here, a, not being around an iOS obviously had hurt us and that prevented us from pushing upgrades to the existing customers, so that was basically something that contributed to the downturn. And when comparing the two platforms, iOS does monetize at a higher rate than [indiscernible], number one. Number two is the game channel specifically, we experienced a downturn there because we've not been investing there and that was a, we’ve not broken out the numbers in the past, but it's fair to assume that that was definitely something that was helping us in terms of lifting the average revenue per monthly active user. We, overall, have seen that on Android that we're holding our own in terms of where that has been pricing out. So these ancillary and important, but ancillary removals from iOS and from the game channel, we think are the overall piece that has hurt us there. In terms of engagement, Tom, do you want to address that a little bit?

[Tom Arnoy:]

Yeah, sure. So Mike, we have not seen like a decline on engagement on the retention in general. There are no clear patents on the crease. They’re like, in fact like our focus on engagement and retention, we think over time will have a significant impact on the average revenue per user. And we speak more to both factors as like session time and frequency of use as like how many times a user actually uses Zedge in a month, et cetera that has very big impact on the average revenue per user and that is one of our main focus areas right now and expands everything from focusing on content discovery and like search recommendations and UI and algorithms, a whole lot of things.

[Andrew Walker:]

Okay. That was super helpful. And then I guess, you’ve mentioned the iPhone a couple of times and we didn’t get to talk about it last quarter, but if we just looked at monthly active users on Android versus iPhone, would it be substantially higher than the 2% that you're reporting right now on Android, because I'm guessing iPhones drives it down?

[Jonathan Reich:]

Are you talking about growth on Android versus growth on iOS?

[Andrew Walker:]

Yeah. Monthly active users on Android, instead of like you guys report overall, but if I was looking just at Android, would it be much higher. So iPhone is dragging the overall number down.

[Jonathan Reich:]

Yes. I don't have the numbers in front of me, but let me get back to you on that.

[Andrew Walker:]

Okay. I can follow up with you guys on that. And then just kind of turning to Zedge stories, so I’m just on my iPhone looking at Zedge stories and the top two right now are kind of Bad Santa and the Washington Wizards, are you guys getting paid for these or are these still kind of aimed I guess freebie mode?

[Jonathan Reich:]

Yes. So we're not, as of yet, charging for stories and let me sort of share with you what we envision in terms of progression. We need to iterate until we get the product right. And we also need to have a couple of successes and wins that we can use to market, but we believe that in calendar year 2017, we will begin to monetize those stories directly with content owners there, looking to gain access to our customer base.

[Andrew Walker:]

Perfect. Okay. Well, that was super helpful and I will follow up kind of offline with you guys on everything else.

[Operator:]

[Operator Instructions] Our next questioner is Dylan Adelman from Global Platinum Securities. Please go ahead.

[Dylan Adelman:]

Hi. So I have a question about the alignment of management and shareholder interests. So because Zedge is a smaller fast growing company that's based around the mobile application, it does seem very much like a start-up company and start-ups usually compensate upper management and regular employees as well using options. And this is to align those interests of management with shareholders as well as prevent cash burn. But looking to the proxy, you noticed that both of you, Mr. Reich and Mr. Arnoy, you both received about 99,000, 990,000 in total compensation and none of that was in stock owned options. This is about one-seventh of the total SG&A of the firm and more than the firm's net income for the year. So in recognizing that options are really critical for smaller fast run companies like Zedge, they're critical for aligning that management shareholder interest. Can you talk a little bit more about how you think about this compensation structure and choosing to pay a large salary and bonus in cash rather than focusing mostly on options?

[Jonathan Reich:]

So, first of all, Dylan, I think that there was mention of a new options package being offered to management and the compensation you're looking at is for the previous year. The ownership of the company, it felt that in light of our having grown the company to the point where it was self-sustaining, and would unlock value for shareholders, that it was the right thing to throw some additional cash our way, but certainly we have, we had at the point of the spinout, our equity piece had been fully vested and there is an additional equity grant that is part of compensation now. In terms of our cash compensation, we have a bonus on top of or the potential for a bonus I should say on top of our base compensation. And if we don't meet our numbers in fiscal year 2017, we will not be able to take benefit of that cash bonus accordingly.

[Dylan Adelman:]

Okay. So just like one follow-up question on that, are you looking at shifting your compensation more towards stock or options in the future and the reason why I just press on this so much is because to me Zedge does seem like a great company, but there's always those concerns with smaller companies if management is not, really, if they don't have skin in the game, as I can phrase it that way and for me, that's just one persistent concern that I don't see that same skin in the game that you might hope for in a smaller company. So do you see that compensation shifting at all?

[Jonathan Reich:]

Yeah. That's really not a question that, and I don't want to sound that I'm not sensitive to your question, but ultimately our compensation is determined by the board and by the comp committee. And I would venture to say that we both have skin in the game and that our employees overall have skin in the game in terms of overall option grants and hard equity that is owned by that group. So I'll be glad to follow-up with you if you like, but I don't have that much more to say on this at this point in time.

[Operator:]

[Operator Instructions] It looks like we have no further questions. So this will conclude our question-and-answer session and today's conference call. Thank you all for attending today's presentation. You may now disconnect your lines.