Zedge, Inc.
Q4 2017 Earnings Call Transcript

Published: 19 Oct 2017

[Operator:]

Good afternoon and welcome to Zedge’s Fourth Quarter and Full Year Fiscal 2017 Earnings Conference Call. [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 3 and 12 months period ended July 31, 2017. Any forward-looking statements made during this conference call either in 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 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 & 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. Arnoy.

[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 fourth quarter 2017 earnings conference call, recapping the three months ended July 31, 2017 which is also the end of our fiscal year. Joining me today is Jonathan Reich, our Chief Financial and Chief Operating Officer who will provide insight into the numbers that we reported earlier this afternoon. If I were to select one word to describe our activities this quarter, it would be “realignment”. Let me explain. On the one hand, Q4 saw relatively flat revenues and monthly active users when compared to Q3. We didn’t release any major updates, announce any material partnerships or surpass any significant milestones. Yet, we continued with our targeted focus on initiatives to increase MAU, improve engagement, enhance frequency of use and retention, grow revenue and deliver profitability. I’m happy to report that, so far in Q1, we are seeing these efforts bear fruit validating our focus areas and investments. The “winning by hitting singles” approach has become our operating mantra. By way of example – I’d like to discuss the redesign our backend infrastructure. This is not an item that generates great interest in the investment community and is invisible to our users. However, it opens the door to easier and faster deployments while also lowering our cost structure. The benefits of this project are manifold - having allowed us to roll out our new content publishing platform, which I announced during last quarter’s call; materially increasing content uploads from our users, which is key to our growth; and cutting our hosting costs. This represents a solid base hit for our company. Another example is our app’s core user experience... We’ve invested a lot in improving the user journey, whether it be introducing side swipe, improving content recommendations or other initiatives, ensuring that it’s an immersive experience and that relevant and fresh content is always easily available, constantly inviting the customer to continue engaging with the app. This work has resulted in improving engagement, frequency of use and retention. Although these efforts contribute to improving revenue because of increased session time and engagement, we have also successfully introduced new ad units further contributing to improved monetization. Having a targeted focus on the core user experience doesn’t mean that we have lost sight of the bigger picture, mainly becoming relevant to a much larger audience, growing our user base and expanding our monetization portfolio. As we recently announced, the Freeform acquihire was undertaken in order to fuel an exciting new path to unlock new revenue streams. Before the end of 2017 we expect to introduce the first phase of our marketplace where amateur, semi-professional and professional artists can turn to in order to sell their digital content helping them generate revenue. We plan to offer these artists monetization tools that can be used in the Zedge marketplace to unlock their digital content. The marketplace is well aligned with our focus on growth for a host of reasons. Today, Zedge is a powerful platform for what I like to call “social creators”. That is creators that want to share their art with a community in order to obtain bragging rights like “how many downloads did my ringtone generate”. By contrast, Zedge hasn’t been a popular destination for creators that want to generate revenue from their content. With the introduction of the marketplace we will become relevant to a whole world of artists that are accustomed to generating revenue from their handiwork. In addition, these creators will bring followers who in turn will become Zedge users. Finally, we will generate revenue directly from this offering. Need I say that our narrowed focus has great potential? We are actively looking at other opportunities - organic and external - to accelerate our growth, rationalize our business and deliver profitability. Going back to alignment - I am tasked with doing my best to ensure that we are managing Zedge responsibly. Management and our Board saw a need for rebalancing and have decided to undertake a strategic rightsizing and refocusing of the organization in order to help us both accelerate our path to profitability as well as invest in the resources needed to execute on our marketplace vision. Jonathan will provide more details about this as well as overall cost cutting initiatives in his prepared remarks. In closing, I want to underscore that that we are on the right track and that our targeted focus, coupled with some of the longer term investments that we’ve made over the past quarters, are finally yielding fruit. 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 remarks today will focus on our key operational and financial results for the fourth quarter and full fiscal year of 2017. For a comprehensive and detailed discussion of our results, for Q4 and the entire fiscal year, please read our earnings release issued earlier today and our Form 10-K which we expect to file with the SEC by the end of October. Following my comments, we will open the call to any questions you may have. Monthly active users, or MAU, that is, the number of unique users that opened our app, during the last thirty days of the quarter, increased by 1.9% to 31.7 million during July 2017 from 31.1 million in the corresponding period a year ago but was flat on a sequential basis. The year over year MAU improvement reflects robust growth in emerging markets with a more modest decline in well-developed countries. As Tom mentioned, our targeted focus on engagement, frequency of use, retention and revenue generation is starting to bear fruit. In Q1, quarter-to-date we have witnessed improved metrics across our business. Total revenue in the fourth quarter increased by 3.9% compared to the year ago quarter and was basically flat from the prior quarter at $2.5 million. The year-over-year improvement was primarily related to our Android app where we introduced new ad units that commanded higher advertising rates as well as MAU growth in emerging markets. Revenue in fiscal year 2017 decreased 9.7% to $10 million compared to $11.1 million in fiscal 2016 primarily as a result of the decline in MAU in well-developed markets where we are able to command higher advertising rates; our decision to reduce our investment in the Game Channel in mid-April 2016, which resulted in a decline in game installs for which we are paid on a “cost per install” basis; not fully recovering from our app being temporarily removed from the iTunes Store on February 1, 2016; declining revenue from our desktop and mobile websites which became less relevant with the adoption of our Smartphone apps; and a drop in revenue from managing and optimizing a third-party’s app advertising inventory. However, I want to point out that, although revenue generated from our Android app in Q4 was flat sequentially, it increased by close to 10% when compared to the same period a year earlier. Importantly, it is growing at a nice clip in the current quarter, which ends on October 31st. We are proud of this achievement that validates our focus areas and resource investments. Revenue derived from our Android app constituted over 90% of Zedge’s aggregate revenue in the fourth quarter. In Q4, overall average revenue per monthly active user generated from our apps – or ARPMAU – increased by 4.5% to 2.55 cents when compared to the same period a year earlier and was up 2.4% sequentially. As stated earlier, the majority of this increase was driven by the introduction of new ad units in our Android app that commanded higher advertising rates. Our direct cost of revenue as a percentage of revenue was 15% in the fourth quarter or unchanged when compared to the same period a year ago. On a sequential basis it was down to 15% from 16.1%. The decline reflects the benefit that we are experiencing from the investment we made in rebuilding our entire backend infrastructure and we expect to see similar year over year declines in the upcoming quarters. SG&A in the fourth quarter declined 7.9% to $2.2 million when compared to the year ago quarter and increased 4.5% when compared to the sequential quarter. The sequential increase primarily relates to higher compensation expense with less capitalized labor as a result of summer holiday, offset by decreases in PR, content acquisition costs and more used vacation days. When comparing FY ’17 to FY ’16, SGA increased by $713 thousand, or 9.2%, primarily as a result of incremental spending and investments in marketing campaigns, additional hires in Norway, Finland and Canada, and the costs associated with the relocation to a larger facility in Norway. Public company expenses also contributed to the overall increase in SG&A in FY 2017. Our loss from operations in the fourth quarter was $236 thousand compared to a loss of $771 thousand in the same period a year earlier. On a sequential basis, our loss from operations increased 22.7% from a loss of $193 thousand in Q3. Our loss per share remains unchanged at 2 cents from the sequential quarter. In the year ago quarter, we reported a loss of 8 cents per diluted share, primarily due to non-cash compensation expense related to option extension, executive bonuses paid as well as certain expenses incurred in connection with the spin-off from IDT Corporation as an independent public company on June 1, 2016. Zedge’s balance sheet is solid and liquid. At July 31st, we reported $4.6 million in cash and cash equivalents compared to $6 million a year earlier and $5.1 million in the sequential quarter. Our working capital – or current assets less current liabilities – was $5.1 million compared to $6.1 million at July 31, 2016. Zedge has no debt. I would now like to elaborate on the cost cutting initiatives that Tom mentioned earlier. In aligning for growth, productivity and profitability, we have undergone an extensive process looking at healthy ways by which we can reduce our costs by $1.5-$2.0 million annually – ex Freeform. As Tom mentioned, our new backend infrastructure not only brings efficiency and ease but also cost savings of at least $250,000 annually. In addition and although painful, we are going to trim our workforce – employees and consultants – generating annual savings of approximately $1.25 million. Finally, we expect to generate additional savings through renegotiated vendor relationships, and tighter discretionary spending controls. We expect the layoffs to be complete before the end of the month and will recognize a restructuring charge in Q1 giving us a fresh start in Q2. This isn’t to say that we aren’t going to hire in the upcoming months and quarters. Rather it is to say that we need to match our staffing to our growth plan and financial condition. To this end we are expanding the marketplace team in order to execute on that initiative. We view this as a good investment being that the marketplace is directly coupled with customer growth revenue creation. Let me shift gears and talk a little about the Freeform acquihire. The deal was structured efficiently with a cash component of around $225 thousand to be used by the sellers to wind down the company and deal with creditors. In addition, we issued 126,679 Zedge Class B shares, that Freeform used to satisfy its noteholders, which have a two-year lock up. The employees that came with the acquihire and who will be building the marketplace received an additional 192,953 restricted shares that vest in four equal annual instalments contingent upon their ongoing employment with Zedge. Although this deal resulted in dilution of approximately 3% -- assuming that the employees earn their entire stock award -- we firmly believe that the benefits outweigh the modest dilution. While we are on the topic of acquisitions, we are actively looking for opportunities and we may seek equity or debt financing to consummate a transaction. Our criteria for deals are that they be accretive and/or offer material strategic benefits. We will update you if warranted by developments. To wrap up, Q4 ’17 specifically and the full fiscal year more generally constituted a period of transition for Zedge. We narrowed our focus - investing in projects to grow MAU, improve engagement, enhance frequency of use, increase retention and expand revenue. We redesigned our backend infrastructure providing efficiency and cost savings, introduced a state of the art publishing platform and improved the app’s core user experience. We are encouraged by the positive results and growth that we have been experiencing in the current quarter as a result of these efforts and are confident that these investments will reverse some of the trends we experienced in fiscal year 2017. That concludes my remarks. Now, Tom and I will be happy to take your questions. Operator, back to you for Q&A.

[Operator:]

[Operator Instructions] Our first question comes from Brian Warner of Performance Capital. Please go ahead.

[Brian Warner:]

Hi, guys. Thanks for taking my questions. Just I have a few questions. Did I hear you say that 90% of your revenue in the quarter came from Android and if so I am just wondering what’s going on with you guys on Apple in terms of initiatives anything you are thinking about there? Another question you sort of you talked a little about the premium advertising sort of driving a little bit better revenue trends in the quarter. I am wondering how far along you are in terms of kind of rolling that stuff out. And I don’t know if you can give us any color on maybe what percent of the inventory that you think you have you are monetizing now? And then if you can give just a little bit of color on the sort of a 1,000 foot view of the marketplace initiative. I am sort of curious if I am artist sort of what’s the proposition to me, maybe you can give me a little bit of color on revenue shares and sort of the model and just maybe a timeline around maybe the next 6 months as you implement that?

[Tom Arnoy:]

Hi, this is Tom. I will answer the first question on this and then I think Jonathan can answer the second one. In regards to iOS, we haven’t done many investments on iOS lately. We have the apps we have had the last year and we have seen us like a modest growth there. But what’s important is that like iOS is playing an important role on the marketplace strategy. So, we are certainly going to invest on iOS as part of executing in the marketplace. So, hopefully, we will grow there. So, maybe Jonathan can answer your second question.

[Jonathan Reich:]

Hey, Brian. Thanks for the questions. So, I think when you talk about premium what we actually said in our remarks were that advertising overall has picked up, because we have introduced new ad units and work on improving the user interface of the app. I think that what you maybe referring to more generally is Zedge collections and we have started to monetize on those collections. It is a rather small portion of the overall revenue stream and we continue to iterate there as the sales cycle is lengthy working with major brands or the movie studios has a sales process that we continued to mine. That being said, collections as part of our product is something which provides core value and something which will be a part of the overall marketplace in terms of promoting the artists that participate in the marketplace. In terms of the business model for marketplace, it’s really completely mature for us to get into that level of detail other than to say that the attraction for artists is that they will have a means by which they can monetize their content. Today, these semi pros, amateur and professional artists do not have a way by which they can monetize in Zedge. And this opens up the door for us to attract that community and we will offer them a bunch of different ways by which they can monetize and share in the revenue creation there.

[Brian Warner:]

Okay. And how will you – I mean, do you know how you are going to sort of charge the buyer you artist product?

[Tom Arnoy:]

So, we are going to offer several payment mechanisms here, but I think what I can say is that we are looking at the freemium model right, like we have a lot of free content a day. Obviously, that’s what people are coming for a lot of people and the idea is to try to convert some of those users into paying users, right and there are different ways in paying the freemium play today right, everything from watching videos to actually paying, buttering the efforts etcetera. So, we are going to use several ways of payments, but it’s too early to provide of course exact details.

[Brian Warner:]

Okay, terrific. Maybe I will catch up with you guys offline and we will talk some more, but thank you.

[Tom Arnoy:]

Sure, thanks.

[Operator:]

[Operator Instructions] Our next question comes from Dylan Adelman of Global Platinum Securities. Please go ahead.

[Dylan Adelman:]

Hi. So, I just have a few questions related to the MAU figures and how those sort of relate to total users and then also to revenue growth. So, you mentioned about a year ago in Q3 2016 that you are growing MAU about 18% a year, but now that’s much more flat. So, I am trying to understand what’s driving a lot of that deceleration in MAU growth? And then on top of that, you talked a bit about how ARPMAU and MAU are both up this year. So, if you could explain a bit more how with both of those figures being up, revenue is still down 10%. I am sort of curious what’s driving those lower revenue figures and then what’s also driving that MAU deceleration?

[Tom Arnoy:]

Yes. So, MAU is so far obviously like a function of many variables, but the most important variable here is new user acquisition right. So, we do get like a lot of organic users everyday that have certainly been viewing our growth historically. When you get to a certain level, you need more new users where you need to increase the number of new users coming in, in order to continue that growth. And I think we have – while we are still doing good on new user acquisition, we are flapping out on the mound level right. So, our focus is clearly to keep more of the users to retain more users, but also acquire – also acquire more new users. So, yes, I am not sure if that answered your question, but like that is explaining why it has been threatening out.

[Dylan Adelman:]

So, I guess maybe to tack on to that, your growth rate in total downloads has been pretty consistently strong in the range of 20% to 30% a year, but usually the MAU is also growing with historically, but now we are sort of seeing MAU flat lining right around that $31 million to $32 million. So, I guess what’s driving that change in retention, because by looking at those figures, it looks like retention has deteriorated materially?

[Jonathan Reich:]

That’s exactly what I was explaining right. Like if you get like an equal amount of new users everyday, it will make you grow, but at some point it will flatten out, right, if you have a sale like given a churn rate. So, that is sort of explaining it.

[Dylan Adelman:]

Yes, but I guess I didn’t kick in before. It just seems to have sort of played out in the last year, I mean you had the same total growth in total downloads which if that’s continuing to grow you would expect the monthly active user growth would maintain at least its level as well. So, I guess my point is just total downloads still growing substantially, but total monthly active users is not. And at one point those both grew together and now they are not growing together. So, there is something there.

[Jonathan Reich:]

There is churn right. So, clearly that’s what we are really focusing on and trying to improve our retention as well keeping users longer as well as trying to make – trying to increase the usage and frequency of use, which is important. So, it’s Tom’s last comments we had said earlier that there was a lot of work put into the user interface and other things such as content recommendations, search and so on and so forth. And although not apparent in Q4, we are seeing as we have said earlier as well that there has been an uptick in that. We are seeing the fruits of that labor across the various KPIs that sort of fueled that business. So, overall, MAU has I would say sort of two variables, one is overall bringing in new customers and then once you brought in a new customer seem to it that you are doing the right things in the app and that is really what fueled a lot of this work. We went back to what we will call basics and that comprised everything that we have talked about. In the past conference calls, work around the UI, work around search, work around content. Now with the new publishing platform, bringing in new content for users to take advantage of and that work was very much tied to implementing new infrastructure on the back end. Those pieces have been completed and we are now beginning to see the impact of that in a positive fashion. With respect to how did all this tie into revenue, well, fiscal year 2017 was really a transitional year in many ways. There were certain revenue streams that we made a conscious decision to stop investing in whether it be web and mobile web, where we had historically run advertising, whether it be the game channel, which we would be prioritized, because the store has become much better in terms of discovery and the like. We have the issue with iTunes and we haven’t fully recovered from that. And those taken in aggregate had removed a chunk of revenue from the mix. On the flipside as I said, we have seen a 10% year-over-year increase in terms of Android revenues and now going into Q1 with overall improved metrics. The outcome of a lot of the heavy lifting that we had undertaken in 2017 we are encouraged by what the trends are showing us. And obviously, we will have more information in a detailed fashion when we release Q1 earnings in summer in January – sometimes in January.

[Tom Arnoy:]

I will add as well that the reason or one of the reasons behind the marketplace is that it does open up a new monetization scheme to us as well as increases the content available to us and when thinking about the participants the semi pros and the pros that are going to turn to us for distribution to our 31 million, 32 million monthly active users, they are also going to bring along their customer base. So, that will – the reason why we pursue this is because we think that it has great potential in terms of unlocking growth both in terms of with respect to both customers and revenue potential.

[Dylan Adelman:]

So, maybe on that point of the marketplaces that you are rolling out, because you said you will be bringing in new content producers that it understand it primarily on the – was that on the music side like ringtones. You are going to have to find new content producers correct. So, how are you thinking about the acquisition of those new producers rather than just getting that content from your existing user base?

[Tom Arnoy:]

So, first of all, we are not so limited to music at all. We are looking for all sorts of creators of visual contents. And we are not limiting ours to personalization content either. So, but – we are not so prepared to share more details around that now. There are really interesting verticals. For us like certainly we have the benefit of having a lot of users and users that wants to consume this content and we believe that we know how to do this.

[Dylan Adelman:]

Okay, great. Thanks.

[Operator:]

[Operator Instructions] This concludes our question-and-answer session and conference call. Thank you for attending today’s presentation. You may now disconnect.