Zedge's (ZDGE) CEO Tom Arnoy on Q3 2016 Results - Earnings Call Transcript

| About: Zedge, Inc. (ZDGE)
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Zedge, Inc. (NYSEMKT:ZDGE) Q3 2016 Results Earnings Conference Call June 9, 2016 5:30 PM ET

Executives

Tom Arnoy - CEO

Jonathan Reich - CFO and COO

Analysts

Gary Ribe - MACRO Consulting

Operator

Good afternoon. And welcome to Zedge’s Third Quarter Fiscal Year 2016 Earnings Conference Call. During management’s prepared remarks, all participants will be in listen-only mode. [Operator Instructions] After today’s presentation by Zedge’s management, there will be an opportunity to ask questions. [Operator Instructions] In today’s presentation, Tom Arnoy, Zedge’s 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 months ended April 30, 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 discussed 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 may cause actual result 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. I am Tom Arnoy, the Co-Founder and the CEO of Zedge, and welcome you to Zedge’s first earnings conference call as an independent public Company, recapping the third quarter of fiscal 2016, the three months ended April 30, 2016. Joining me today is Jonathan Reich, our Chief Financial and Chief Operating Officer.

In my remarks today, I am going to provide a brief overview of our strategy and update you on our operational priorities, particularly in new product development that we expect will drive our long-term growth. But first, I want to make it clear that we consider our shareholders as partners and will strive to be open and honest about the business and forthright in expressing our expectations and challenges.

I’ll begin the discussion of our plans with our pipeline of exciting new features and enhancements that we expect to drive continued user growth and engagements in our flagship app over the long run.

Later this calendar year, we expect to launch the Set My Ringtone, a new feature that will allow users to select their ringtone that they associate with and have anyone in their address book seamlessly set this as their contact ringtone. For example, I like the ringtone Thomas Calling. I can send the message to any of my contacts saying click here to set this ringtone as Tom Arnoy’s contact ringtone. From then on, any time I call them their phone will ring to Thomas Calling. This will open up a new way of engaging an enjoyable communication between people tapping into their social graphs. If we are correct about the broad appeal this serves, there is the potential for viral growth.

Furthermore, Set My Ringtone can act as a wonderful user acquisition vehicle for recipients that do not have Zedge installed on their phone. If they act on a request sent by a Zedger, they will be redirected to the Google Play Store where they can install Zedge. Down the road, it may become an interesting way to promote music or branded audio, opening a new revenue stream for us as well.

Wallpapers and ringtones have traditionally been our two most constant categories. This fall, we will introduce a feature, lockscreen which will enable users to personalize and set wallpaper on the lockscreen of many popular handsets. We like to think on the smartphone homescreen as one of the most valuable pieces of real estate in the world of digital advertising. On average, user interacts with his or her phone, whether if they’re looking at the screen, hearing the phone ring or receiving a notification sound more than 100 times daily. We’re almost giddy when thinking about this and the potential that it holds for creators and brands that use Zedge for distribution.

As one brand representative said to us, you guys are unique when compared to other social outlets, unlike other mediums where we can only interact with a customer and while they’re using a platform with Zedge, we can become only person. [Ph] Our message will be reinforced close to 1,000 times a week. How powerful is that for the brand expansion? To take the advantage of this opportunity, we are making a proprietary homescreen widget that could allow Zedgers to select between various common widgets that can be themed or branded.

Imagine the value of a uniquely designed and fully branded Red Bull clock or a Kung Fu Panda weather widgets on their homescreen. Combined with wallpapers and icons, the homescreen widget will allow us to offer complete homescreen theming. This is another differentiating feature and thus should be very attractive with brands and content creators. In addition, it will enable us to harvest valuable data around customer intents. Think about it. If a user tattoos their phone with a brand’s content, it’s a very strong measure of intent.

Zedge Stories is another enhancement in our product pipeline; its feature will allow us to package various content items; visuals, [ph] audio clips app icons, and even short form video, into story promoting a particular theme. From a user’s prospective, they can read, share, download or even scan their phone with the content. From a creator’s perspective, they can tell an engaging and comprehensive story promoting a specific message or theme in an inspiring and sticky fashion. We have done some initial tests with some Hollywood studios and the engagement results are impressive. We think Zedge stories can become a powerful marketing tool for branding.

To this end, just yesterday, we announced a distribution deal with IDW, an award winning publisher of comic books, graphic novels and trade paperbacks. IDW is going to use Zedge for brand extension for their publishing and entertainment properties inclusive of Zedge Stories. I want to thank Howard Jonas, our Chairman, who holds significant interest in both Zedge and IDW for helping to facilitate this distribution deal. It looks like a strong win-win for both companies.

In addition to these initiatives, we continue improving on the content freshness, discoverability and quality, leveraging deep learning to provide content that is relevant, interesting to users investing in improved app performance, improving user interface and making user experience more wowing. We’ve seen good evidence in our data that we can gain a lot through relatively small changes and continued optimization. Clearly, our products and enhancement pipeline is robust, centered on most valuable asset the end user. It is my belief that this is the key to strong long-term growth, even as the smartphone market matures.

Keep in mind that all of these developments only make reference to consumer facing enhancements and products. Yes, each of these requires a host of related products and technology investments to make them equally exciting for advertisers. For instance, in order to effectively offer Zedge Stories, we’re developing a new content management system, which will make it easier to upload and manage contents. In addition, we’re building core data analytics tools that will provide valuable insights, based on the user interactions to these creators and brands.

If things go the way we plan, this will be the beginning of a new marketing self service platform. I also want to point out that our growth depends on our ability to recruit talented and highly motivated employees. As you, no doubt, have heard the competition for such people in our industry is global and fierce. I’m pleased to report that although it has been challenging at times, we have been successful in our efforts to identify and hire highly skilled and creative people. That’s partly because we invest in our employer brand and because we have established a good reputation in Norway and the industry. This in turn helps us attract qualified talent across northern Europe. Having our product design and engineering teams in Nordics, it’s a real advantage. The benefit from having a well educated, dedicated and hard working group of professionals who have now consistently -- who are not consistently being approached high profile tech companies. Not to mention that we’re all about design and user experience and the Nordic design ethic is part of our DNA.

Now, I’ll touch on some highlights with the quarter’s results, before Jonathan gets into them in some more detail.

Monthly active users or MAU increased 18%year-over-year, although a reasonably good number, we nonetheless grew at a slower face when compared to previous quarters. This is not unexpected, but we’re actively implementing the steps to get back to more robust growth rates. When looking at the smartphone market globally, there is no question that sales are slowing. Earlier this week, Gartner forecasted that smartphone sales would increase by 7% in 2016 compared to double-digit growth in the years past. This more sluggish growth was not unexpected and our strategy is crafted to address this reality.

We will continue driving user growth and engagement by executing the robust product roadmap that we have planned for including both, introduction of new features and rollout of new products. And by entering us yet untapped international markets, not to mention, leveraging our distribution platform provides omni-presence and brand extensions. We believe that these initiatives will translate into long-term growth and value creation.

Now, I’m going to turn the call over to Jonathan Reich for a discussion of the quarter’s financial results. Jonathan?

Jonathan Reich

Thank you, Tom. Our remarks today will focus on our key operational and financial results for the three months ended April 30, 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 June 14.

Following my remarks, we will open the call and address any questions you may have. Joining us for the Q&A on this call will be Mitch Silberman. As you know, we entered into a transition services agreement with IDT for finance support, and Mitch has done a great job in leading this effort. I want to thank Mitch and his team accordingly. They are truly helping to smooth the transition.

As our business is linked to the seasonality of the advertising cycle, sequential comparisons may not be meaningful. For the purpose of today’s call, I will compare our fiscal year ‘16 Q3 performance, mainly February, March and April 2016 to the year ago quarter’s results.

I’m proud to report that Zedge continued growing its user base, revenue, profitability, and cash flow year-over-year. And I’m very pleased by the advances that we’ve made in introducing new features and releasing new products in a more timely and streamlined fashion.

Active installs that is the number of devices that have the Zedge app installed, have grown nicely to more than 90 million from around 70 million a year ago. As such, we are able to promote and market new products and enhancements to any of these devices, making them an important operational metric for us. Zedge’s revenue in the third quarter increased year-over-year by 17% to $2.6 million closely tracking the growth in our active user base, which increased 18% to 31.6 million. Average revenue per monthly active users declined by 1.6% to $0.0247 from $0.0251, mainly as a result of our absence from the iTunes app store for much of the quarter and the decline in game installs on Android. We re-launched the modified version of our app in the iTune store in late March, after having been removed from the store in late January, when Apple notified us that we were out of compliance with their terms and conditions. Although we disagreed with their assertion, we decided that it was more beneficial to seed to their demands and re-launch our app with wallpapers only rather than to challenge them with no guarantee of success.

Our absence from the app store during most of the quarter clearly impacted our user and revenue growth during the quarter. Going forward the wallpaper only version of the app will limit our ability to maintain our previous growth rate on Apple’s platform.

As Tom mentioned, we are considering and whether and how to once again offer ringtones on iOS. And as we introduce new products like Snakk, we are committed to making new initiatives equally viable across both Android and iOS.

Revenue less direct cost expressed as a percentage of revenue was 87.3%, well within our historical range of 85% to 90% for this metric. Our direct costs are those expenses incurred to operate our content distribution platform including hosting, marketing automation and content filtering services.

SG&A increased in line with our expectations to $1.9 million, note $1.9 million compared to $1.4 million in the year ago quarter. This was a result of three factors, namely growing our work force to 55 employees from 46 employees; content creation initiatives; and cost associated with the preparations for the spin-off. Looking ahead, we expect that SG&A will continue to increase as we hire additional personnel to accelerate our growth, further invest in content creation and incur the cost of being a publicly listed company. We estimate that the last item will add between $750,000 to $900,000 in G&A expense, annually, beginning in the fourth quarter. The higher levels of SG&A resulted in a decrease in income from operations, which was $243,000 compared to $404,000 in the year ago quarter.

Although our income from operations declined as a result of higher SG&A, our net income increased $326,000 in the quarter compared to $211,000 in the year ago quarter. The year-over-year improvement in net income reflected foreign exchange gains this quarter and a reduction in the provision for income taxed due to higher U.S. earned income offset by historical NOLs utilized this quarter. Because the bulk of our employees reside in Norway, most of our expenses are incurred in the Norwegian kroner. We typically purchase hedges to mitigate the impact of foreign exchange fluctuations. Hedges are mark-to-market and incorporated in our total FX gains or losses.

Zedge’s balance sheet remains strong and liquid. As of April 30th, we reported $4 million in cash and cash equivalents compared to $2.2 million a year earlier. Trade accounts receivable were $1.8 million compared to trade account payable of $59,000. Our historical receivable collection rate is 100% and our days sales outstanding was just 40 days. Zedge has no debt.

Subsequent to the quarter closed but prior to the spin-out, existing stockholders and key management capitalized the Company with an additional $3 million in investments and cash, at an implied pre-investment valuation of $27 million. Including the shares sold in this capitalization, Zedge currently has around 525,000 shares of Class A common stock and 8.8 million shares of Class B common stock outstanding. Cash generated by operating activities during the third quarter was $2.5 million compared to $1.9 million in the year ago quarter and CapEx was basically flat at $680,000.

Looking ahead, we are changing our approach from being fiscally conservative at the expense of growth to being fiscally responsible and investing to accelerate growth based on carefully balancing risks and the anticipated rewards in order to grow a successful, sustainable business and ultimately to maximize shareholder value over the long-term.

That concludes my remarks. Now, Tom, Mitch and I will be happy to take your questions. Operator, back to you for the Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Gary Ribe of MACRO Consulting. Please go ahead.

Gary Ribe

So, I guess my first question just relates to some of the cash. You’ve mentioned you have a fairly -- you have a strong balance sheet, no debt, and you just put capital under the Company. I was wondering just us as shareholders, if you can help us understand the priorities for the use of cash, given that you guys -- your business seems to generate cash already at a pretty descent cliff. So, I just wonder if you can help us understand that a little bit.

Jonathan Reich

Sure. So, this is Jonathan. What we’ve been saying while meeting with investors over the course of last couple of weeks is we have historically really managed the business to throw off free cash. And we want to now take those profits and that cash, and reinvest that in the business. In addition to that, recognize that with the cost associated we’re going public, we have a new set of expenses that we will need to address accordingly. And then, finally, we also have the need to not only accelerate the business in terms of hiring new staff, whether that be staff in Norway where we take care of product developments, we take care of engineering and we take care of product design, but also staff here in the United States and growing our commercial team by bringing on these people, marketing people, and the customers support people accordingly. So, those various investments will require us to deploy cash in growing business accordingly.

Gary Ribe

So, if I am hearing you, then the additional investment would be in things you’re looking at driving organic growth?

Jonathan Reich

That’s correct. If you’re hinting at whether or not we are looking to acquire companies at this point, although in the information statements we did make reference to that as being a possibility, that is not something that immediately we are going to act upon, unless an incredible opportunity crosses our radar screen. We need to make sure that the underlying foundation of our business is accelerated. And while we’re going through that process, if either we see an opportunity to acquire another Company that can be advantageous in terms of growing your organic business, or alternatively in terms of hiring group of people be hirer, then we would certainly pursue that.

Gary Ribe

And I was just kind of curious, one of the things that jumped out of me, reading the filings and everything, the average revenues per user, are there any things like are reasonably obvious leverage you can pull to drive that up without negatively impacting the user experience?

Jonathan Reich

Sure. It’s a great question. So, what we have really prioritized and what we will continue to prioritize right now is making sure that we continue to develop products, and products that our users will embrace. And as Tom had alluded to in his comments, we have a fairly robust product roadmap that we need to execute on. The way that we have historically grown the Company is by making sure that, the product is there. Our belief is that with the great products, we’ll have a long term users. Long term users are ultimately the ones that will help us in terms of climbing up the monetization scheme. But with that in mind, we believe that there are going to be new monetization opportunities, whether it be Zedge Stories that we feel that we can get out and sell to content and create content creators and brands that are premium or exploring new avenues for us, whether it would be merchandizing. Tom has mentioned that a user that chose their phone with content that is strong measure of intent. So, if I’m actually going to download a wallpaper and a ringtone and an app icon around the particular theme, we have a hypothesis that we can extend beyond the handset by selling other merchandise, whether it would be t-shirts with that content, coffee mugs, phone cases and the like. And the beauty there is that we do not need to take on the operational risk associated with fulfilling and producing all that stuff, rather we can work with third parties that have an expertise in that. Tom, do you have anything to add.

Tom Arnoy

Yes. I think like we’re definitely not like focusing on heavily chasing new revenue streams at this point. So, we are sort of like focusing on the line [ph] first and then there is programmatic advertising and making sure we focus on sustainable revenue streams at scale. And we certainly have other revenue streams that we see and that we could return as we get ground if we wanted. But now the most important for us is to invest heavily in the products and user growth. We need to do enough on the revenue side.

Gary Ribe

Okay, that’s great. And I guess just one last one for me and then I’ll leave that if there is anyone else. Just kind of a stuff with iOS, I think you guys mentioned that from your prepared remarks, I don’t know, you can kind of expand on that or is that an area where you guys look to or you could potentially show better penetration in growth and kind of like, it’s really [indiscernible] versus Android platform and I think versus other apps. My understanding is that, if you here develop for the app store, then it is for Google Play, so kind of surprising to see, just kind of help us understand the balance, and is that a potential driver for you in the future and kind of what happens with the ringtones if you comment on it?

Tom Arnoy

So, this is Tom. I want to say a few words. Personalization on iOS has always been complicated, do anything what you can do in that platform. So, -- it’s impossible to create a really good user experience anyway, although there are success on Android, this is also causing a great demand on iOS. We see that on search statistics. So, there is great, great demand for such product on iOS. So, it’s like we are very -- it’s very sad that we can’t really right give the users what they want on iOS. However, we are now making new products and we’re chasing social content or these types of contents, they’re leveraging our strength and still within sphere of self expression or try new products and those products will have equal, let’s call…

Jonathan Reich

Ubiquity.

Tom Arnoy

On iOS as on Android. So, we really hope that we can and that this can change moving forward with new products. When it comes to personalization part, who knows, may be Apple, yes, of course, they should.

Gary Ribe

It should change.

Tom Arnoy

Because people really want this; there is a huge demand for personalization in general. I would be surprised if Apple changes that in the future. But yes, that we need to...

Jonathan Reich

This is Jonathan, and I do want to add two points there. What we’ve said consistently is we’re not managing or running the business or making any assumptions about what Apple may or may not do. Everything that we talk about is based upon what we know today, not in conjecture. That being said, in the events that Apple were to open up the space and make it seem less as it is on Android, our business would double or triple very, very quickly, we feel pretty comfortable in saying that. And finally just to give you an idea of magnitude, when we released the wallpaper only version of the app after having been removed from the store for more or less around two months, we jumped to the top 50 or 60 apps literally within a period of a couple of days, which really speaks to the demand for what we offered and specifically speaks to the strength of our brand, which we will take advantage of as we roll out new products that are ubiquitous across Android and iOS accordingly.

Operator

[Operator Instructions] It seems that we have no further questions at this time. This concludes our question-and-answer session and conference call. Thank you for attending today’s presentation. You may now disconnect.

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