Zedge, Inc.

Good afternoon and welcome to ZEDGE's second fiscal quarter 2022 earnings conference call. During management's prepared remarks, all participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation by ZEDGE's management, there will be an opportunity to ask questions. To ask a question, please press star then one on your touchtone phone. To withdraw your question, please press star 2. In today's presentation, Jonathan Reich, ZEDGE's Chief Executive Officer, and E. Tsai, ZEDGE's Chief Financial Officer, will discuss ZEDGE's financial and operational results for the second fiscal quarter that ended on January 31, 2022. Any forward-looking statements made during this conference call, either in the prepared remarks or in the question and answer session, whether general or specific in nature, are subject to risks and uncertainties that may cause actual results 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.

Thank you, Operator, and thank you all for joining us today. Good afternoon. Welcome to Zedge's earnings conference call for the second quarter fiscal year 2022, ended January 31st, 2022. I'm Jonathan Reich, CEO of Zedge, and with me is our Chief Financial Officer, Yit Tsai, who will provide additional insight into our financial performance. We will then be happy to take your questions. For those of you who are new to the Zedge story or haven't followed us in a while, we own a portfolio of leading digital consumer brands that served 44 million users globally in January of 2022. Our portfolio consists of Zedge ringtones and wallpapers, otherwise referred to as the Zedge app, which is the leading mobile app used for mobile phone personalization, social content, and fandom art. and includes Zedge Premium, a marketplace for artists, celebrities, and emerging creators to market their digital content and NFTs to Zedge's users, Emojipedia, the leading website dedicated to all things emoji, and a set of experimental apps and services that our innovation team are working on, all at various stages of development. It's important to underscore that these are experimental, and may not evolve into full blown commercial offerings. We possess deep expertise in monetizing our digital real estate, whether through advertising, subscriptions, or content sales. Our products appeal to a wide range of user segments globally. We have a strong customer base in North America, Europe, and emerging markets, particularly India. Importantly, At the current time, we do not have material exposure in Russia or Belarus. Today, Android users account for roughly 96% of the Zedge app's monthly active user base and 91% of its revenue. Our second quarter was another record quarter for revenue, growing 30% over last year. Operating margins remained strong at 45%, Net income came in at $2.3 million, and EBITDA was a record $3.4 million. At quarter end, we held more than $30 million in cash with almost no debt. In addition, we continued optimizing our Zedge Apps advertising stack, driving exceptional CPMs, that is, the price that we received for every 1,000 advertising impressions sold in our app. MAO for our Zedge app increased 3 percent to 36 million, with emerging markets up 7 percent, driven mainly by continued demand in India. However, developed markets remain the challenge, with MAO declining in the low double digits. We are working on enhancing our offerings and services to reverse the trend of declining MAO in this segment specifically, and accelerating growth more generally. including introducing social and community features. Despite the latter, ARP now, or average revenue per monthly active user, increased a healthy 22% versus last year. Subscription revenue and active subscriptions increased 18% and 7%, respectively, versus last year. Before I update you on the strategic priorities I have outlined on our last two earnings calls, I want to take the time to address several important items that I believe are relevant to investors. First, concerning advertising. As many of you know, mobile apps that generate programmatic advertising revenue need technology, otherwise known as ad mediation, to manage the sale of their ad inventory. In late 2021, Twitter sold its ad mediation business, MoPub, to Applovin. Soon after the sale, AppLovin announced that it would deprecate MoPub's platform on March 31st. As such, we started assessing various alternatives, including AppLovin's Max platform, and reallocated resources to commence testing and migration by the end of March. Unfortunately, this needed resource investment temporarily delayed the rollout of some of our social and community features. Despite the challenges, we expect to complete our migration by the cutoff date. Although the migration was a compulsory distraction, it was necessary, and we are doing our best to ensure that the long-term outcome will benefit our customers and our business. Next, I want to talk about our innovation team. This group is tasked with identifying potential new products and is targeting to release up to three proofs of concept per quarter. Even though many of these will not progress to full blown products, we will benefit from the learning associated with them. We have fine tuned this development process over the past few years to the point where we can efficiently and cost effectively introduce new ideas, concepts, and apps without material adverse impact to our bottom line. The idea here is to identify new opportunities that can hopefully scale into a sustainable long-term business. As these unfold, we look forward to sharing more details. The shorts beta was the first foray of the innovation team, and we are currently contemplating the future direction for this project. Over the next couple of weeks, we expect to render a decision about future investment, and we'll update you about our plans next quarter. Even if we decide to reduce investment, I assure you, our efforts were not for naught. We gained meaningful insights into scaling the innovation process, rapid tech development, marketing, and product customer fit, which we will benefit from in the future. Next, I want to address a misconception that some investors are using to justify the decline in our stock price. We have over 540 million cumulative installs, representing 12% growth from the end of last year's second quarter. We also have close to 10 million user ratings in Google Play, with an average rating of 4.6. It appears that, due to the lack of public KPIs, certain investors or followers are attributing our strong revenue growth to oversaturating the app with advertisements at the expense of user experience. We do not believe this argument is justified. We regularly analyze customer experience, their satisfaction and usage, and if the information reveals a fundamental issue, we take corrective measures accordingly. Furthermore, if users prefer an ad-free experience, they have the option of signing up for a very affordable subscription. Although some users leave us one- and two-star ratings, we try our best to optimize the holistic experience as evidenced by the enhancements and features we have released and we will continue to release in the future. This provides a good transition to discussing our key strategic priorities. At the top of the list is growing mail and improving engagement, particularly in well-developed markets. During the fiscal first quarter, we began rolling out social and community features, starting with giving our users the ability to follow artists they find interesting. Now that the ad mediation platform migration is almost behind us, we will introduce more of these features and expect the notification pane to be available in the next several months. This will inform users when new content that aligns with their tastes is uploaded to the platform. In addition to core product development, we are also scaling up paid user acquisition and recently expanded our team to help scale profitably. Next up, we continue to invest in the parts of the business that offer optionality. VegPremium is a big part of this opportunity. We rolled out our potentially disruptive NFTs Made Easy platform in December, and even with limited functionality, have experienced early success. To date, we have sold close to 600 video wallpaper NFTs. Our ease of use approach to NFTs allows non-crypto experts to sell NFTs simply by toggling the publish as an NFT option and allows users to purchase these NFTs by buying Zedge tokens, our existing virtual currency, which are available in the Zedge app through in-app purchases and spending them accordingly. Thus far, we have only opened the platform to select artists and limited the offering to video wallpapers. Soon, we will begin to make the platform available to more artists, diversify the content that can be minted, offer numbered editions, drop dates, auctions, and trading. Stay tuned for further announcements in 2022. While there are no material operational updates about Zedge Plus subscriptions, we remain committed to enhancing this offering and will keep you apprised when there is news to share about their progress. Moving to Emojipedia, we are about to roll out multi-language support. Next up is a site redesign centered around improving functionality and increasing engagement and monetization. Finally, we are looking to the second half of the calendar year to experiment with what a native Emojipedia app experience would be like. And finally, there's M&A, where we remain active in evaluating potential opportunities to broaden our offerings and enhance our portfolio. In closing, we had an outstanding second fiscal quarter of 2022 and believe we are still in the early innings of reaching our growth potential. Given the impending transition to the new ad mediation platform and the temporary delay in releasing social and community features, we have chosen to remain conservative with our guidance by leaving it unchanged at this time. We still expect top line growth of 25 to 30% with continued net income growth, 40% plus operating margins, strong cash flow, and EBITDA growth exceeding revenue growth. Before I wrap up the call, I want to especially call out our team in Lithuania, which has remained focused and productive while offering support and assistance, where possible, to their neighbors in Ukraine who are battling unjustified aggression. In fact, in solidarity, we have changed our logo to the colors of the Ukrainian flag to support the Ukrainian people. While we know this may be controversial to some, we believe it is the right thing to do and we have contingencies in place should the aggressor's ambitions move beyond Ukraine. Before handling the call over to E to go through our financial results, I want to thank our investors for your support. I know the market has not been kind to Zedje's stock over the past several months. Still, our fundamentals growth prospects, and profits remain strong, our valuation is inexpensive, our opportunity is large, and we have built a track record of execution. Yi?

Thank you, Jonathan. I want to remind those on the call that our fiscal year ends July 31st, and our second quarter ended on January 31st. Moving to our second quarter results, MAO defined as the number of unique users that open our ZADS app during the last 30 days of the period. Increased 2.5% to 36.3 million during January versus 35.4 million last January. Immersive market MAO expanded by 7.3%. while well-developed market now contracted by 10.5%. Total revenue in the second quarter increased 30% to $6.9 million from last year. This year, we benefited from our ongoing work to improve our ad operation. In addition, subscription revenue was up 18% from last year. Zed's premium growth transaction volume, or GTD, that is the total sales volume transacted through our marketplace, more than doubled to $434,000. But Jonathan indicated this is a crucial focus for us as we believe the marketplace potential is still substantially untapped. and will benefit significantly from our new NFT platform. Active subscription will top 7% versus last year and will flag sequentially. The slowdown in net subscription growth was basically due to the number of new subscriptions added being offset by our churn rate. which has remained a constant percentage, even as we grew to a higher base number of subscriptions. This is a common problem for consumer subscriptions, as the subscriber base gets larger, and as Jonathan mentioned, we are taking steps to re-accelerate sequential growth in this number. Overall, app miles were 6 cents. An increase of 22% year-over-year, driven by the combination of better advertising performance and higher paid subscription number versus last year. Operating margin decreased to 45% versus 47% last year. While still a very strong number, several items, which when taken as a whole, caused this number to decline. including legal expenses related to the evolving privacy landscape and associated compliance, higher compensation expense due to new hires and stock award, as well as an increase in pay UA. A couple of non-operating items negatively impact net income and EPS in the second quarter. First, as we mentioned on previous call, we are in the transition year for becoming a taxpayer in the U.S. as we use up our U.S. NOL in fiscal 2021, which led to an income tax rate this quarter of 23.4% versus 12.3% last year, which added $392,000 to income tax expense. This tax rate increase restrained our net income growth rate to 2% at $2.3 million. The diluted EPS was down a penny due to the tax increase, combined with an 11.5% increase in share count. When you strip away these non-operating items, EBITDA was a record $3.4 million. versus $2.9 million last year. From a liquidity standpoint, we remain in a strong net cash position with almost no debt and over $30 million in cash and cash equivalent. A $5 million increase for the six-month end of January 31, 2022, and up $2.7 million sequentially. Moving to guidance, despite year-to-date revenue growth of 43%, we remain very conservative, as Jonathan said, due to the impending transition to the Ed Loven Max platform and are therefore not changing our 25% to 30% revenue growth target for the whole year. For operating expenses, We forecasted higher operating expenses mainly due to hiring, pay user acquisition, and other items, and say we expected our operating margin to be at least 40%. We will leave this unchanged as we are at 44% year-to-date. For modeling purposes, we say our expected tax rate would be around 21%, and we are at 22% year-to-date. I also suggested using 15 to 15.4 million shares for calculating diluted EPS, and we are right at 15 million year-to-date. We also said that we expected our net income and EPS growth rate to lag due to this item. Given the increases in the last two items, most significantly the tax rate, we say that we expected a drag on EPS growth in fiscal 2022. Still, we anticipated continued net income growth with robust cash flow and EBITDA growth. For EBITDA, we say we were targeting a growth rate that is slightly higher in our 25% to 30% revenue guidance. And here today, EBITDA growth is 47%, with an EBITDA margin of 49%. Thank you for listening to our second quarter earning call, and I look forward to speaking with you again on the next call. offer them back to you for Q&A.

Thank you. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star 1 on your phone now. If you wish to leave the queue, you may press star 2. We do ask that if listening via speakerphone, that you please pick up your handset for optimum sound quality. Once again, if you have any questions or comments, please press star 1 on your phone now. Please hold a moment while we poll for questions. And our first question today is coming from Alan Klee at Maxim Group. Your line is live. You may begin.

Yes, hi. I think you guys are being humble given your revenue growth rate, 95% gross margins, over 40% operating margins. Very impressive numbers. So I wanted to start off with the migration to a new ad platform. How has it gone, and is there any indication that it will have an impact on your CPMs, or is it just you're being conservative, or what could you tell us about that?

Hi, Alan. Thank you for the compliments, and really the thanks goes to the entire team. Insofar as migration, we have been evaluating a couple of different vendors, and until we are fully up and operational, I think it would be prudent to not leave the answer to conjecture. Having said that, the analysis of potential vendor solutions centered around a couple of different variables, certainly one of those being ad rates, but also scalability, ease of use reporting data, all of those items. Our target, if you will, is to see to it that there is not degradation insofar as how we've been monetizing, but until we're fully at scale, we're not going to be able to answer that question with absolute clarity. Although, again, to reiterate, it goes without saying that the goal is to see to it that we are monetizing at par, if not better than that, uh, in the, um, world after, uh, you know, we have completed this migration.

Okay. That that's helpful. Um, another bigger picture issue. Um, Google came out, um, a little while ago talking about kind of maybe like a two year transition on, um, how they're going to handle privacy. How, um, how do you think about that and how that could, if at all, have an impact on you guys?

Great question. Uh, and suffice it to say that, um, Google's primary revenue source or a largest revenue sources, uh, ad dollars, uh, our fundamental belief is that as Google, um, works on their solution that they are going to be mindful of both customer privacy as well as maintaining if not enhancing their revenue stream. Google has been talking about this migration for a while. They had a prototype available give or take last summer that they ultimately had scratched and we will continue to monitor how this evolves over time with the fundamental understanding that we are very sensitive to maintaining customer privacy and with the understanding that we don't believe that Google will want to put itself in a position where it, you know, metaphorically bites its nose despite its space, considering how sensitive their business is to advertising revenue.

That makes sense. And then one other big picture question. I read recently that it's possible that Apple might have some supply constraints related to some of the lockdowns in China, but I'm not sure if that also applies to Android phone production. Have you heard anything that may make us think that new users might get impacted by supply chain issues?

Great question. I, in all candor, have not been following that as closely as I should have. will follow up after the call.

Okay, great. Then I'll move to company specific. So NFT sounded like that started off well. Maybe I can just not even get that. Just a question of, you have a bunch of opportunities you're working on. If If you had to say your new opportunities, which one you would have to guess would, you know, two years from now be the biggest contributor, what would you speculate today?

Sure. So let's bifurcate between the existing ringtone wallpaper business versus the reference that I made to the innovation team. The innovation team is really focused on new products that do not exist in our portfolio today. And as I referenced, our goal is, give or take, to try to get around three proof of concepts out into the market per quarter. And many of those will fail quickly. we will be able to gather information, collect data, analyze, and sort of say, hey, this makes sense to take the next gate, or let's cut it off here. When taking a look at the flagship app, as I've indicated in the past, we believe that the convergence of, generally speaking, the creator economy on a more global basis the evolution of the tokenized world with NFTs, Web3, and the like, coupled with our core value proposition of NFTs made easy, opening up the door to a tokenized world for artists that do not have deep crypto experience or technical experience, is something that we think bodes well for Zedge as a business as we continue to evolve. And as you know, our premium marketplace today, when taking a look at the overall revenue mix of the company, give or take it's around 5% to 10% of the overall revenue mix. We believe that we can see to it that with the proper feature set development and marketing that we can grow that piece of the pie over time.

That makes sense. And I don't know if people realize, but tell me if this is right. If an artist sells an NFT... on average, they're selling that significantly higher price than just their typical art, which is better for the artist and better for you. Is that correct?

That is correct. There's also another derivative of that, and that is if a consumer buys that NFT and then at a later point in time chooses to sell it, there is incremental revenue that the artist will generate and that Zedge will generate from that sale.

Got it. Right. That's very interesting. Okay. And then for subscription, you kind of hinted to some things that might come that some additional features that could maybe enhance that offering? Did I catch that?

So, on the subscription side, I would qualify by saying that there are two areas that we are focusing on. One is around marketing, and then the other is feature set development, and that Those two play hand-in-hand. I think that we've been more heavily focused for the last couple of months on the marketing piece. And as calendar 2022 continues to unfold, we will begin to look at a feature development of value adds, if you will, that can make the subscription offering or that may make the subscription offering more attractive accordingly.

Thank you. How do you think about the potential of Emojipedia kind of where it is now and maybe where it could be in two years?

We imagine that there's going to be growth there. Recall that Emojipedia is today only a web-based offering available in English. And we are, as I discussed, in the process of localizing Emojipedia so that there will be multi-language support opening up the possibility for incremental growth for non-English speakers. And in parallel, we are in the midst of an overall site redesign that should provide additional functionality in use cases, make content more discoverable and available. And as part of that site redesign as well,

That includes monetization and specifically What ad units are placed where and how do we benefit from that?

After we're done completing that and sort of in the second half of the calendar year, we're going to be looking at potential ways to take the Emojipedia from the world of web into the world of native mobile apps. And that will presumably be another growth driver for us.

Thank you.

In terms of on the last quarter's call, you talked about how you were going to be experimenting with paid acquisition, paying to try to get customers and see how that would go. Do you have anything to report back on learning anything there?

Sure. So we have started to scale up paid user acquisition. We're pursuing this with a very clear mindset of making sure that everything that we can do to bring on profitable customers is taken into account and that we don't get too far ahead of ourselves in terms of saying, well, you know, we spend a lot of money and then the more money that you spend, presumably your return on ad spend begins to decline because you find less relevant customers and so on and so forth. So this is really, really being done with that mindset of bringing on customers that will ultimately generate a return for us. We've added to that team and we've had learnings around without getting into the specifics of the platform, certain platforms have proven to be valuable to us that we thought would be out of our price range. Other platforms or other forms of acquiring customers have not always worked out as we would anticipate. But again, when making or when starting with a new platform or a new way of attracting a paid user, we start with a very modest budget and then start to scale from there. And when we see that we've reached the ceiling, then we choose not to overspend in order to protect profitability.

Okay, thank you. You highlighted that you were spending some money on the transition to the new ad platform. Is it possible to call out kind of how much that was? Maybe we could think of that as kind of one time.

Yeah, I think that that is correct in terms of being a one-time item. We have not broken that out. in our earnings release. And as discussed earlier, so there are sort of like one-time cost, if you will, and there was a diversion of resources. So engineers that would otherwise work on feature development got pulled off to undertake the analysis, testing, and so on and so forth. We expect that that process will be pretty much wrapped up, you know, next month, barring any unforeseen surprises.

Okay, great. Anything you want to add on shorts?

So, as I said, we're in the process of analyzing where we go with shorts. We'll have greater clarity in the next quarter. And we're looking at a whole set of different KPIs. And then coming back and sort of saying, well, build a business case in terms of how can it scale. Separate and apart from that, the Shorts foundation is one, the Shorts platform, if you will, is one which lends itself to potentially other innovative products or proof of concepts, and we're considering those as well. We'll be able to get into a lot more detail when we announce Q3, and give or take around three months from now.

Great. Okay. My last question is just on... your efforts to start to grow the developed user base. I know some of that's going to be focused on socialization and personalization. Could you maybe just touch on that one more time? Because that seems like that should be pretty important long term.

Absolutely. So as I mentioned in our fiscal Q1, we started to roll out early stage social capabilities such as follow me because of the ad mediation migration as I had mentioned a couple of minutes ago we had to divert resources for getting the next stage out but next up in the pipeline is the notification panel where users will get notified based upon all sorts of different choices, but the concept is new content that is relevant to the user. There'll be a little sign on the app or some messaging to the user saying, hey, come back and visit more. And we will continue to incrementally add features that we suspect will draw users back in to the app and help us in terms of reversing that Tier 1 monthly active user decline that we have discussed over the course of the last couple of quarters.

That's great. Thank you so much.

Thank you.

Thank you. Once again, ladies and gentlemen, if you have any questions or comments, please press star 1 on your phone at this time. Our next question today is coming from William Vaughn at Regent Atlantic Capital. Your line is live. You may begin.

Hi, guys. Congratulations on the really good quarter. My question surrounds capital allocation. When you look at the market cap of the company, the cash balance keeps going up. Now you're up to $30 million in cash. Backing out the cash, I mean, we're, we're looking at something close to a five times EBITDA to the valuation, closing in on that or five times cash or whatever valuation metric you want to use. Um, so how do you think about allocating the cash in terms of, you know, to new investments or possibly, you know, doing a buyback, you know, what are the thought process on using the 30 billion in cash going forward?

Great question, William. So, uh, you know, our, primary focus, and we've talked about in the past quarters, is how can we continue to grow the company and invest that cash, whether it be through internal development or M&A. And the board will continue to evaluate these options over time in order to prioritize whether we continue down that path or potentially consider using some of that for a buyback.

Thanks. In terms of user growth, we saw another quarter of growth in emerging markets and sort of flat numbers in developed markets. I guess, could you talk a little bit more about the trends in terms of what makes the product or the experience so, I guess, attractive for emerging markets, specifically India, and also thought process around turning around the user trends and developed markets? I know you just touched on that a little bit, but any more color would be helpful on that.

Yeah, really not much more color in terms of the developed markets. Obviously, as I said, social community features, more features in terms of our artist community, NFTs, as you can imagine. So artists begin to embrace that offering as they want to grow their business. They're going to reach out to their followers, and that translates into bringing users into the Zedge ecosystem, as well as user acquisition initiatives, whether it be paid or organic. And so far as what makes the product attractive in the emerging markets, remember that our app consists of or has both premium content and premium content. And in many of these emerging markets, disposable income is a fraction of what it would be in, you know, a well-developed market. So when offering a user an option where they can acquire content that is attractive to them without having to pay for it in hard dollars, that becomes a very, very compelling offering if you will.

Yep. Makes sense. Makes sense. Um, and so that's a Moja P I know you mentioned that, uh, it's mainly in English right now. What's the geographic distribution of users for Mojapedia?

Uh, it is solely in English, uh, right now. Uh, and, We have not, uh, you know, broken out geographic footprint, but, uh, I think it's fair to say that, uh, our footprint in terms of the English speaking markets, including the United States, Canada, Australia, and the UK is, uh, uh, you know, over 50%, if I recall correctly. So it's, it's, it's a big number.

Okay. Those are my questions. Thanks, guys. Great quarter. Thank you.

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