Zedge, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended July 31, 2016, compared with fiscal 2015. This is an annual report, not a standalone fourth-quarter filing. Zedge became an independent public company following its June 1, 2016 spin-off from IDT Corporation.
Business context
Zedge operates a single-segment mobile personalization and content distribution platform. Its app offers free ringtones, wallpapers, icons and related content. At year-end it reported 31.1 million monthly active users, 216.4 million cumulative installs and 92.3 million active installs. More than 90% of revenue came from advertising; advertising represented 94% of revenue in both fiscal 2016 and 2015.
Financial performance and liquidity
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $11.113 million | $9.052 million | +22.8% |
| Direct costs | $1.299 million | $1.082 million | +20.1% |
| Selling, general and administrative expense | $7.755 million | $5.723 million | +35.5% |
| Operating income | $1.173 million | $1.623 million | -27.7% |
| Net income | $0.983 million | $1.587 million | -38.1% |
| Operating cash flow | $1.842 million | $2.171 million | Down $0.329 million |
| Cash and cash equivalents at year-end | $5.978 million | $2.170 million | Up $3.808 million |
| Working capital at year-end | $6.1 million | Not clearly stated | — |
Operating margin declined to approximately 10.6% from 17.9%; net margin declined to approximately 8.8% from 17.5%. Higher SG&A, including payroll and costs related to the spin-off and public-company readiness, and a $281,000 write-off of abandoned software projects contributed to lower operating income. The company reported diluted earnings per share of $0.11, versus $0.18.
Investing activities used $1.006 million, mainly for software development and equipment. Financing provided $3.009 million, including $3 million from an equity sale before the spin-off. Total liabilities were $1.837 million at year-end; the balance sheet reported no borrowing outstanding. In September 2016, the company entered a secured revolving credit facility of up to $2.5 million, subject to borrowing-base limits, with maturity in September 2018. The filing does not state that any amount had been drawn.
Material changes and management commentary
- Monthly active users rose 10.3%, to 31.1 million from 28.2 million. Revenue growth also reflected greater advertising demand and pricing, localization, marketing automation and app improvements.
- Average revenue per monthly active user fell 2.2%, to $0.0269 from $0.0275. Management cited the temporary removal of the iOS app from iTunes in January 2016 and reduced investment in its Game Channel; the app returned in March with wallpapers only.
- MoPub accounted for 45% of FY2016 revenue, Google for 20% and Facebook for 13%. One customer represented 62% of year-end receivables. The filing describes the significant customers as advertising exchanges, with receivables representing amounts owed by many advertisers.
- Management expected cash on hand and operating cash flow to cover anticipated FY2017 cash requirements. It also anticipated $750,000–$900,000 of additional annual costs associated with being a public company. No revenue or earnings guidance was provided.
- The company said it would not anticipate dividends until it achieved sustainable profitability and retained minimum cash reserves. The credit facility also restricts dividends while in effect.
Risks, contingencies and unusual items
- Advertising dependence, short-term or cancellable advertiser arrangements, customer concentration and competitive pressure expose revenue to changes in ad spending and platform demand.
- The business depends heavily on Android: approximately 85% of monthly active users were on Android. Distribution-platform changes also pose risk; iTunes temporarily removed the app in early 2016.
- Blue Spike patent claims were dismissed with prejudice in July 2016. A separate Saregama India copyright case seeks approximately $1.596 million in damages and an injunction; management said material liability was remote. Zedge also disclosed that access to its service had been blocked in parts of India since 2013.
- Norwegian authorities notified Zedge Europe AS in September 2016 that they would audit its 2013 and 2014 tax returns. The filing warns assessments could exceed accrued amounts; the amount, if any, is not clear.
- The company identified three material weaknesses in financial reporting, account reconciliations and segregation of duties in connection with the FY2015 audit. It said remediation measures were implemented by July 31, 2016, but their effectiveness had not yet been tested. Disclosure controls were deemed effective at year-end; the auditor did not attest to internal-control effectiveness.
- Foreign-exchange movements produced a $49,000 net loss in FY2016, including $142,000 of losses on hedging activities. The company also faces privacy, data-security, intellectual-property, international regulatory and app-distribution risks.
- Historical financial statements include IDT-allocated costs and may not reflect the costs of operating independently. A Norwegian tax audit and the transition away from IDT services are relevant post-spin-off uncertainties.
Important facts for investors to verify
- Whether user growth, retention and monetization improve, and whether the iOS app regains full functionality and contribution.
- Revenue and receivables concentration by advertising exchange, and the effect of any changes in major counterparties or ad-market pricing.
- Actual post-spin-off costs compared with management’s $750,000–$900,000 annual estimate, and whether operating margins recover.
- Cash generation, any use of the $2.5 million secured revolving facility, and compliance with its financial covenants.
- Outcome and potential financial exposure from the Norwegian tax audit and Saregama litigation.
- Evidence that remediated control processes operate effectively, including the FY2017 internal-control assessment.