Zedge, Inc (ZDGE) Q3 2021 Earnings Call Transcript

Zedge, Inc.  (NYSE: ZDGE) Q3 2021 earnings call dated June 10, 2021

Corporate Participants:

Jonathan Reich — Chief Executive Officer

Yi Tsai — Chief Financial Officer and Treasurer

Analysts:

Allen Klee — Maxim Group — Analyst

Presentation:

Operator

Good afternoon, and welcome to Zedge’s Third Quarter 2021 Earnings Conference Call. [Operator Instructions]

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.

Jonathan Reich — Chief Executive Officer

Thank you, operator, and thank you all for joining us today. Good afternoon. Welcome to Zedge’s third quarter of 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 insight 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 notification sounds. 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 the 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 considered healthy renewal rates of approximately 45% in year two and approximately 65% in year three and the year-over-year increase remained 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 recognize 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 app, 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 and these [Phonetic].

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-ads 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 localized pricing, make premium content more accessible to consumers, introduce new functionality, including an NFTs, or non-fungible tokens, ensuring that they are easier 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 ad-supported version of Shortz casts, high-value podcasts of the content. We believe that short-form fictional content is optimal for smartphone users and that this space 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 were 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 comp, as our business turned the corner in Q4 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.

Yi Tsai — Chief Financial Officer and Treasurer

Thank you, Jonathan.

I want to start by reminding those on the 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 a change in the calculation used by Google Play that now includes accounts hold, which is a subscription status that begins when a user’s form of payment fail and the three-days 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 bottoms out. So this year we saw the benefit of the work we are continually doing to improve our ad operation. 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 [Phonetic] new subscription growth was seasonal and how much was related to lower MAU in well-developed market. But with our recent hires and product initiative, we are working to reach a solid rate 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 subscription exceeded 750,000 at the end of the quarter, an 89% increase year-over-year. As you recall, when a new user purchase 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, renew their subscription after 12 months, the Google fee drops to 15%. In Q3, we continued to see annual second renewal rate of approximately 45%, and third year renewal 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 paid 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 share with an [Phonetic] issue as part of our ATM, combined with option exercises, as the stock that increased 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 equivalent, 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 weighted average price 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 had been stronger than Q3, but also keep in mind that our Q4 comps 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 remain safe, and I look forward to speaking with you again on our next call. Operator, back to you for Q&A.

Questions and Answers:

Operator

[Operator Instructions] Your first question is coming from Allen Klee with Maxim Group. Your line is live.

Allen Klee — Maxim Group — Analyst

Good afternoon. Congratulations on continued excellent execution. One thing that — lots of things were positives 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 to the strength that you saw in your monthly average users and the revenue that you were getting for them, per user?

Jonathan Reich — Chief Executive Officer

Hi, Allen. It’s Jonathan. Thank you for the compliment, and really credit goes to the team.

And 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, very significant part of the work that they continue to — or the time that they continue to invest and generating more from the inventory, and then valve [Phonetic] everything from optimizing the inventory, optimizing the user experience, focusing on tools like header bidding, decreasing latency and so on so forth. I’ll also add that I think that industry wide, CPMs have been holding up. As the economy begins to open up, no question of a doubt that we are benefiting from that as well. Hope that helps?

Allen Klee — Maxim Group — Analyst

That does. And then, digging into what you said that you’re well developed monthly — the MAUs was down only 1%, could you go into what do you think was behind that? Or maybe like how you’ve been doing with some of the initiatives with Apple?

Jonathan Reich — Chief Executive Officer

Yeah. So, as you know, we are dominant on Android. And ongoing improvements that we are making in terms of the overall experience or user experience in the app is 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 one growth or the well-developed market growth specific to social and community features, personalized fees, improving — improved search and recommendations, and things like marketing automation where we will send push notifications, and so on and so forth, to our users. And those will be rolled out incrementally. And as we see success, we will continue to go down the path of investing in the enhancements that are yielding that success. And the ones that are not translating into improved engagement will be turned off accordingly.

Allen Klee — Maxim Group — Analyst

Got it. If I move on to your subscription ad free business, it looked to me like that’s continuing to grow sequentially. I’m not — could you explain a little — your comments of what you said that it was a little less than the prior quarter?

Jonathan Reich — Chief Executive Officer

Right. So, let’s bifurcate between subscribers and revenue, you are correct that revenue continue to improve, and that is a function of new subscribers and then 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, now that we’ve got a couple of months of third year renewals under our belt, we’re seeing that approximately 65% of the users that had renewed for a second year are indeed renewing for third year. As such, the overall revenue pod increased even though we did not have a net gain in terms of additions of 100,000 users, which had been the standard in the previous quarters.

Yi, do you want to add anything to that?

Yi Tsai — Chief Financial Officer and Treasurer

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

Jonathan Reich — Chief Executive Officer

And…

Allen Klee — Maxim Group — Analyst

Got it. Go ahead.

Jonathan Reich — Chief Executive Officer

I guess would like to — I’d 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 marketplace. We have another brand new dedicated product manager focusing on subscriptions and what we can do in order to grow that business over time with value-ads and things of that sort. And then we have a product manager that we replaced focusing on new initiatives, and at this point in time, that is primarily around Shortz, although we have other things going on under the hood in terms of new potential product opportunities that is also being looked into by that particular product manager.

Allen Klee — Maxim Group — Analyst

Thank you. In terms of your marketplace and — you have a lot of initiatives that are going to launch this summer. Two things that I heard you say stood out to me is kind of new. One was including NFTs, and if could you explain maybe how that would work? Would people actually bid for them on your site or have to go — they’d be created there? And then second, you said that you might be able to start paid acquisition marketing. And if so, how do you think about what that would be targeted for? Thank you.

Jonathan Reich — Chief Executive Officer

Sure. With respect to NFTs, non-tangible tokens, we view NFTs as being a valuable utility that will be attractive to artists that exist in our marketplace. And our requirements for that, if you will, are, we want to make sure that they are affordable, and so far is 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. And then number three, we want to do everything possible to provide for ease of use. And in today’s world, minting an NFT for most people is complicated. It requires having a crypto wallet. It requires a lot of know-how on the NFT side. We’re really trying to lower that bar to make this utility, one which is accessible to a wider array of artists, many of whom do not have the technical know-how needed to mint those NFTs. In terms of 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 about paid user acquisition. We are looking at this very analytically. We want to know that if we market to particular segment, however you define that segment, by demographic, geography, content taste, gender, you name it, that we measure the return on ad spend and understand did that user base, did that segments generate a positive ROI when taking a look at their LTV, their lifetime value. So, we have invested in building the infrastructure so that we have “all of that — those connections” available, such that we will understand from the point of attribution all the way through and including the customer signing up, and then interacting with our product, whether or not that’s a segment that we can afford to bring on with a positive ROI.

And that will take — that process is one where we will proceed cautiously 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 if we cross the threshold where we say, oh, financially, we can’t go beyond this amount or money for this particular segment.

Does that answer your question?

Allen Klee — Maxim Group — Analyst

Yeah, that’s great. I just had a few housekeeping things, and I’m done. One is, so you’ve made some hires that should be positive on future growth. Is the way — I’m guessing that not all of the cost of them was in this current quarter, or is this current quarter a good run rate, or it’s going to jump up from that level? Any color on that?

Jonathan Reich — Chief Executive Officer

So some of these adds 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?

Yi Tsai — Chief Financial Officer and Treasurer

Yeah. Allen, so for the nine months till April 30, we brought onboard [Phonetic] 13 developer, engineer, product manager, and six of the 13 came onboard during Q3. And in terms of run rate, I mean we are not done with hiring yet. In Q4, we’d probably bring on another two product manager. So, we probably going to — if you looking for run rate, you probably need to factor into more head or two more head.

Allen Klee — Maxim Group — Analyst

That’s great. And then just going back to seasonality, remind us, I know you talked about it a little bit, but you did say that the July quarter, which is the next quarter, is typically higher on an absolute basis compared to the quarter you just had. But you then I heard you say, I think, that your comparisons are getting tougher. But is there any reason that makes you think that there’s something about that — or just something about the seasonality of how to think about the fourth quarter versus the third, or just in general?

Jonathan Reich — Chief Executive Officer

Yeah. It’s probably too early in the quarter for us to be able to provide a 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 the year ad spend. And then there is the seasonal decline in the February, March, April timeframe where ad budgets are cut back. And — we then will begin to see that Q4 for us will be slightly above Q3. But I think that is historical with all of 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 to say that, overall, the business is holding up nicely.

Allen Klee — Maxim Group — Analyst

Great. Thank you. My last question just — it’s balance sheet. It looks like you raised around $7.4 million in equity during the quarter. I’m guessing that was from your — from the $10 million ATM. Are you able to provide where that stands today? And maybe where the share count is? It’s probably in your Q. I’m not sure if your Q came out yet. Thank you.

Jonathan Reich — Chief Executive Officer

Yi, do you want to address that?

Yi Tsai — Chief Financial Officer and Treasurer

Yeah. So, we raised about $7.4 million and we still have about $2.6 million, $2.7 million left, and we expect to complete the $10 million offering within the [Technical Issues]. So, our current share count is somewhere around 14.2 million share.

Allen Klee — Maxim Group — Analyst

Excellent. Okay. Congratulations. Thank you so much.

Jonathan Reich — Chief Executive Officer

Thank you, Allen.

Operator

[Operator Instructions] We have no questions from the lines. [Operator Closing Remarks]