Zedge, Inc.

Good afternoon and welcome to Zedge's earning conference call for the second fiscal 2023 quarterly results. During management's prepared remarks, all participants will be in a 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, press star, then one on your touchtone phone. To withdraw your question, please press star two. I will now turn the call over to Brian Siegel.

Thank you, Operator. In today's presentation, Jonathan Wright, ZEG's Chief Executive Officer and ESI, ZEG's Chief Financial Officer, will discuss ZEG's financial and operational results for its second quarter 2023, ended on January 31st, 2023. Any forward-looking statements made during this conference call during 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 in the future to differ materially from those discussed on today's call. These risks and uncertainties include, but are not limited to, specific risks and uncertainties disclosed in the reports that ZEDGE periodically files with the SEC. Zedge assumes no obligation to update any forward-looking statements or to update the factors that may cause actual results to differ materially from those that they forecast. Please note that our earnings release is available on the Zedge Investor Relations page. The earnings release has also been filed on Form 8K with the SEC. I would now like to turn the conference over to Jonathan.

Good afternoon. Thank you, Brian, and thank you all for joining us today. I'm going to start by briefly reviewing our second quarter results, which were generally in line with our expectations. Q2 revenue increased 1% from last year. The combination of geopolitical, economic, and industry-specific challenges resulted in lighter advertising spend compared to past years and lower discretionary spend by consumers. Additionally, Guru Shots, like most iOS apps, whose growth depends on paid user acquisition, has suffered because of Apple's App Transparency Tracking Framework, or ATT for short, making paid iOS user acquisition less efficient and more expensive. While Apple's release of its SCAF Network 4.0 in late 2022 is meant to alleviate some of this turmoil, it is taking time for various ecosystem providers to integrate this successfully into their tech stacks. Adding to the turbulent market is the decline in mobile phone sales in 2022 to the lowest levels in nearly a decade. Mobile phone sales are a growth factor for the Zedge marketplace. Nevertheless, I am encouraged that the holiday season, which encompassed the first two months of the quarter, was better than we expected heading into the quarter. and now actually increased sequentially for the first quarter to over 32 million. Given this overall backdrop, we are focusing on the areas that are within our control and have taken or are taking steps to ensure we don't lose money over the near term while positioning the company for sustainable and profitable growth when the environment improves. To accomplish this, we have implemented a cost reduction plan and are totaling annualized savings of more than $2.5 million. Additionally, we have narrowed our product focus as follows. For the Zedge Marketplace, our top priorities are iterating with Paint, our generative AI wallpaper maker to improve take rates and engagement, overhauling customer onboarding, and upgrading our subscription offering, Zedge Plus, with value adds while also introducing a subscription offering for iOS users. We will also continue scaling paid user acquisition on Android as the ROI justifies the investment. Expanding on our plans for Paint. The world is experiencing an explosion in AI-generated art, and Zedge wants to be a part of this. Our goal is to transform our consumers into creators. Paint enables us to tap into what we call the creator effect, a dynamic that benefits from the pride of ownership that creators have when they make art. In addition, this effect carries with it a desire to share with others, which can contribute to bringing new users to Zedge. To achieve this, we are improving the onboarding experience to get more users into the creation funnel early on in their engagement. process while also iterating with the business model to minimize friction and encourage growth. Turning to GuruShots, we continue advancing the product with the launch of the Battles feature. Battles provides a casual gaming experience that enables newbies to start competing in short-duration photo competitions that are limited in size and built on a coin-based economy. We expect this new feature will open the top of the funnel, making the game accessible and relevant to a broader audience who hopefully will become hooked and transform into long-term players. We released a beta version of Battles into the market last week and will iterate and fine tune as needed. As you know, the Guru Shots photo games growth strategy heavily depends on paid user acquisition. Unfortunately, acquiring profitable iOS users has become markedly more difficult due to Apple's ATT framework, which severely limits the information an advertiser can secure about prospective purchasers. In my opinion, this has had a monumental impact on the contraction of the gaming sector over the last year. That said, We are doing our best to diversify by testing alternative acquisition channels in order to help drive new ROI positive players to the game. In addition, through our experience developing the battles feature and the explosive growth in the AI generative art sector, we saw an opportunity to develop a standalone casual game, which had a recent soft launch. This game is expected to harness the fast paced growth in generative AI art and we will test and iterate on it in the coming months. Turning to Emojipedia, we are now seeing the fruits of the changes we made during calendar 2022, which are yielding the high margin growth we expected when we acquired the company. We plan to release more new features in the coming months. We are very excited about the success of the changes we've made over the past year and believe They can drive high double-digit, low triple-digit growth rates with attractive gross margins in fiscal 2023. I want to thank our investors, board members, partners, and employees for your continued support. In summary, we are and will continue doing our best to build long-term sustainable value and effectively address the challenges that we are facing over the near term. Now, I would like to turn the call to E, who will review our financial results. Yi?

Thank you, Jonathan. Moving to our second quarter result, now defined as the number of unique users that opened our Zedge app in the last 30 days of the period. Decreased 11% from a year ago to 32 million. Now in the well-developed market, was down 13%. and emerging markets were down nearly 11%. Europe, which contributed to both metrics, continued to suffer from the Russian invasion of Ukraine, inflation, and the energy crisis, which continued to play a significant role in this quarter's mild decline. Total revenue in the second quarter was $7 million, a 1% increase from last year. Digital goods and services revenue came in at $1.2 million. Similar to Q1, GuruShot's revenue was negatively impacted by conditions in Europe and Apple's limitation on user data. Subjection revenue was down 8%, driven by a 14% decrease in active subscribers. Zed's premium in GTV increased 1%, to $440,000, reflecting revenue from AI pain, which offset decline in NFT sales. Again, while we are impacted by the crippled winter, we believe our strategy provides us with a differentiated offering that will result in more significant growth over time. amount was 5.2 cents, a decrease of 13% year over year. Operating expenses increased significantly related to both the investment in GuruShop, higher investment in pay user acquisition on Android for the Zed marketplace, and higher DNA from the acquisition, but were partially offset by a $1.8 million contract expense related to a reduction in the fair value of contingent consideration related to guru shot acquisition. Net income was $1.6 million and reported diluted earnings per share was $0.11. Diluted share count was $14.3 million. Adjusted EBITDA was $1.4 million versus $3.9 million in the prior year period. From a liquidity standpoint, we remain in a strong net cash position with over $17 billion in cash and cash equivalents. Note that we don't have any direct exposure to SVB, Republic National, or signature banks. Moving to our stock repurchase program, we repurchased 318,000 Class B shares during the second quarter at an average price of approximately $2.14 per share. We have repurchased 442,000 Class B shares since inception of the buyback in September 2022. Thank you for listening to our second quarter earning call. And I look forward to speaking with you again on the next call. Operator, back to you for Q&A.

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, 2. At this time, we will pause momentarily to assemble our roster. Thank you. The first question comes from Alan Klee with Maxim Group. Please go ahead.

Yes, good afternoon. You talked about Guru Shots. When you originally did the acquisition, you had some potential commitments of how much you were going to spend on user acquisition spend. I think $5.3 million in year one, subject to getting good returns on that. Are you changing the plan of how much you'll be spending?

So, Alan, this is Jonathan. We have until the end of March to spend $5 million, although we are not spending that amount of money. And we have found that when trying to ramp up user acquisition spend, the return on ad spend has declined. As I mentioned during my comments, in large part, that is due to a combination of the app transparency tracking system or framework that Apple had released and is causing major, major issues throughout the industry. as well as the macroeconomic and geopolitical risks that we are all experiencing on a global basis.

Okay, that makes sense. I may have missed it. Did you disclose how much Guru Shots contributed during the quarter? And I also heard you say that you thought that Apple was going to be rolling out something else in the future which might help in terms of your ability to market. Could you review what that is? Thank you.

Sure, I'll address the second question first, and for the numbers, I'll hand over to E. Apple has, I think it was in November 2022, started to roll out their SCAD 4.0 ad network, if you will. And essentially, prior to that rollout, the window in which an advertiser was able to collect information about a user that has downloaded and installed their app was limited to one day in time. And SCAD4 opens up that window to three and potentially seven days with a little bit less accuracy. Although Apple had released SCAD4 back in November, there's a lot of work that the entire ecosystem needs to undertake in order to comply with and integrate into that technology stack. And that is slowly but surely unfolding in the industry, although it is not complete. Our hope and expectation is that with access to more information over a slightly wider period of time that advertising efficiency will kick in allowing for publishers to better acquire customers that align with the particulars of what they're optimizing against. E, do you want to handle the financial breakout between Guru Shots and other revenue sources?

Yes, sure. Hi, Alan. So Guru Shah contributed about $1.25 million on the top line. On the income loss from operation, it showed just a $105,000 loss from operation, mainly because we had that $1.8 million contract expenses that helped reduce the loss from operation. Does that answer your question, Alan?

Yes, thank you. I heard you guys mention that you developed a casual game that you're doing a soft launch on that's a generative AI art. Could you just expand on that a little bit?

Sure. The notion around this is to have competitions around creating generative AI art. And if you will if you were to take guru shots specifically the addition of guru shots battles and as opposed to focusing on amateur photographers which is a more limited audience but open up that funnel to really anyone that can prompt anyone that can type a character string in around a particular competition. That is what we envision. There will be a set of in-game resources that is more, we will have more in-game resources and we imagine that from a monetization perspective that this will open the door for monetization through a combination of advertising as well as in-app purchases of particular game resources. Obviously, very, very early, as you've mentioned, this is in soft launch. We are doing a lot of iteration. And in the world of gaming, it's not atypical that you can have a game in soft launch for, oh, easily a year. we're gathering information or fine tuning and tuning overall gameplay, uh, and, uh, doing this on a regular and consistent basis. Um, however, uh, we believe that this is very much in keeping with a theme that we had made, uh, at the point of time when we acquired guru shots, which essentially was our ability to, um, gamify other, um, that are focused around visual arts, if you will. So we're looking forward to seeing how this unfolds. Clearly, there's been a tremendous amount of interest in AI generative art, and we think that we have gameplay here that could be really attractive to folks that are avid players of casual games, if you will.

Got it. Thank you.

I'm sorry, I should mention one other thing. I think this is critical. We've done all of this with our existing employee base. We've been very, very clever around the code base and being able to take advantage of a lot of the tech stack that we have and expanding into this without having to increase the size of our employee base. So that will likely continue to be the case. Of course, as the game evolves, assuming that the game begins to see great success, we may need to bring on some additional staff to scale with the game, but we don't see that as being an imminent short-term need.

That's great. Very helpful. Thank you. And then I heard you talk about you were impacted by the sales of smartphones, but that started to pick up. So does that imply, I know you're not guiding on this, but just that MAUs might sequentially have at least have a bottom and might pick up a little. And then on the rates that you get, is it reasonable to think that the level of this quarter is kind of a rated, as good as you can tell it'll be at, or that are the reasons that you might see pressure downwards or upwards? Thank you.

Okay. Generally speaking, and per your comments, this is not guidance, but generally speaking, there is a strong correlation between handset sales and Zedge, Ringtone, and Wallpaper monthly active user base. And intuitively, it makes a lot of sense. As a new Android user... buys an Android phone or as someone buys a new Android phone, and as you know, we're highly weighted towards Android users. One of the early things that that user wants to do is they want to personalize their phone. So it's obvious that they would download the Zedge app and accomplish that goal. And when there's been a contraction in new phone, new handset sales, typically that has resulted in, um, you know, a contraction in, uh, monthly active users. Uh, so, uh, moving on to, uh, your second question in terms of, uh, let's call it CPMs and what we're seeing in the industry overall, um, the, uh, the, uh, pressures are really quite hard for us to, uh, account for. Um, obviously if, uh, you know, the economic situation, um, declines because of the war continuing in the Ukraine or the Russians potentially, uh, blockading, um, the black sea. So the grain shipments can't take place and so on and so forth. We think that that will, uh, generally speaking have spillover effect, uh, to, um, the economy and as food prices or energy prices or just general cost of living increases, many people have to make that decision. Are they going to buy their next loaf of bread or are they going to engage with a mobile app where either they may need to buy something or an advertiser is there advertising something which there's not demand for? So I don't pretend to be a prognosticator and sort of say, hey, we've hit the bottom. We haven't hit the bottom. What I can tell you is that we continue to invest resources in really optimizing the ad inventory that we have to squeeze out the most value from that and You know, insofar as being almost halfway through Q3, we have seen some improvement in CPMs. But, you know, between now and the end of the quarter, as we all know, the world can change dramatically. Just rewind a week ago and Silicon Valley Bank was not on people's minds. And nonetheless, you know, that bank has been taken over by the FDIC.

Got it. Okay. And then you talked about a cost-cutting initiative of $2.5 to $3 million. How do you think about the time that it takes to implement that?

Sure. So I think that we started to undertake this initiative towards the tail end of Q2. And I think that for Q3, that will be more apparent in the financials. And we're really moving quickly in order to see to it that that potential is, you know, met sooner rather than later. It's not that this is backloaded, but rather this is something where, boom, there are areas that we have cut back on costs, we've become more efficient, and so on and so forth. And that immediately, you know, benefits the entire business.

Got it. And just to clarify, one more big-picture question, and then I'd like to get into your groups. But when you say you're not expecting a return to growth in the near term, do I understand that that would mean that likely for your next fiscal quarter, your revenue growth will be down year over year?

Yeah, I really prefer not to, you know... share projections at this point. Uh, I think that, uh, it's fair to say that we are doing everything within our power to, uh, see to it that we do not have, uh, you know, continued, uh, downturn in the business and we're doing, um, whatever we can in order to, um, preserve, uh, uh, you know, our cash and, and, and, uh, doing our best to try to operate the company at very minimum without losing money on an aggregated basis, on a comprehensive basis, that is.

Okay. In terms of your premium marketplace, what are your top priorities for the next quarter or two?

Yeah, top priorities are we continue to evolve the marketplace and offer content that our users or prospective purchasers would be interested in, you know, purchasing. That, you know, continues to be the case. We have been very clear from the outset, especially during the hype of, you know, what had happened with NFTs, that our view of NFTs has been around a technology benefit for creators and purchasers, mainly provenance, and the ability to ensure that you've bought that one or that one of a set of, you know, that digital, you know, particular, that particular digital item. We did not play the speculative game in terms of, you know, being the next people. And, uh, we believed then, and I think, uh, you know, it's been proven since then that we have been in the, uh, in the right in terms of taking that perspective. So we continue to operate within that regard offering, whether it be NFTs through our NFT made easy pro product or, uh, non NFT, non tokenized content, uh, and availing that to our users. at various points in their journey for a price.

Okay, great. Well, I mean, you guys have been very disciplined and it's quite good performance in a tough market. So I admire what you guys are doing. Thank you so much for answering my questions.

Thank you.

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