Zedge, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter 2018, the three months ended October 31, 2017; comparative period is the three months ended October 31, 2016. Balance-sheet comparisons are with July 31, 2017. Amounts are in U.S. dollars unless noted.
Business context
Zedge operates a global mobile-content platform offering free personalization content, including ringtones and wallpapers. The company reported 33.4 million monthly active users (MAUs) at quarter-end, up 5.7% year over year, and 288.8 million cumulative app installs. More than 90% of revenue comes from advertising. Zedge also provides advertising operations services for a third-party app publisher.
Financial performance and liquidity
| Metric | Q1 FY2018 | Q1 FY2017 |
|---|---|---|
| Revenue | $2.659 million | $2.383 million |
| Direct costs | $372,000 | $367,000 |
| Gross profit and margin | $2.287 million; 86.0% | $2.016 million; 84.6% |
| SG&A | $2.972 million | $1.756 million |
| Operating income (loss) | ($842,000) | $113,000 |
| Net income (loss) | ($820,000) | $163,000 |
| Basic and diluted EPS | ($0.08) | $0.02 |
| Operating cash flow | $106,000 | $215,000 |
| Investing cash flow | ($488,000) | ($349,000) |
Revenue grew 11.6%, while higher SG&A drove the company from operating and net income to losses. Direct costs were 14.0% of revenue, down from 15.4%; operating and net margins were approximately (31.7%) and (30.8%), respectively. Cash declined $417,000 during the quarter to $4.163 million. At October 31, current assets were $6.633 million and current liabilities were $2.391 million, yielding working capital of approximately $4.242 million. Total liabilities were $2.391 million; no long-term debt was reported. The company had no borrowings on its $2.5 million revolving credit facility and was in covenant compliance.
Changes and management commentary
- Revenue growth reflected improved app experience and content recommendations, increased user engagement and retention, and new Android ad placements. App-derived revenue per MAU rose 9.9% to $0.0256, its fourth consecutive quarterly improvement.
- Advertising eCPMs fell 6.0%, which management attributed to prioritizing viewed impressions per user and a greater share of users in lower-eCPM emerging markets.
- SG&A increased 69.2%. The quarter included $465,000 of Freeform-related liabilities charged to expense and $191,000 of estimated severance costs following a workforce reduction of approximately 10%. Zedge also reported $652,000 spent developing its marketplace, launched as an iOS beta in December 2017.
- The Freeform arrangement involved $834,000 of aggregate consideration: $223,000 cash and 319,632 Class B shares valued at $611,000. The company treated the transaction as an acquihire, not a business combination; $369,000 of employee restricted-share compensation is to be expensed over four years.
- Cash used in investing primarily reflected capitalized software and technology development costs and equipment. Stock-based compensation was $73,000, versus $27,000 a year earlier.
Outlook, risks and contingencies
No numerical earnings or revenue guidance was provided. Management expected cash on hand and operating cash flow to meet anticipated cash requirements for the next 12 months. Its stated growth priorities include product, technology and marketing investment, improved monetization, and selective strategic investments and acquisitions. A limited rewarded-video test showed incremental revenue without an observed negative retention effect; Zedge said it was adding this ad format.
- Zedge’s iOS app was removed from the iTunes store in February 2016. Although iOS revenue increased 29% year over year in the quarter, it remained 68% below the comparable quarter two years earlier; the filing warns that prior user penetration may not be regained.
- Revenue and receivables are concentrated among advertising-exchange customers. Four customers generated 33%, 19%, 12% and 11% of quarterly revenue; three customers represented 44%, 17% and 11% of accounts receivable at quarter-end.
- A copyright lawsuit filed by Saregama India seeks approximately $1.6 million in damages and an injunction. Zedge considered the likelihood of material liability remote.
- A Norwegian tax audit covering Zedge Europe AS returns for 2012–2016 was ongoing; no significant issues had been identified, but assessments could exceed accrued amounts and adversely affect results, cash flow or financial condition.
- The company had no outstanding foreign-exchange contracts at quarter-end. Currency movements remain a risk; the quarter included a $1,000 foreign-exchange loss, compared with a $50,000 gain a year earlier.
- Management reported effective disclosure controls. It also brought certain finance and accounting services in-house from IDT and assumed responsibility for quarterly internal-control evaluations.
Important facts for investors to verify
- Whether MAU growth, engagement and new ad placements can sustain revenue and ARPMAU gains despite lower eCPMs.
- The recurring cost base after the Freeform-related expenses, severance and workforce changes, and progress in monetizing the marketplace.
- Cash flow relative to software development investment and the company’s stated 12-month liquidity expectations.
- Customer concentration and the status or potential financial impact of the Saregama litigation and Norwegian tax audit.
- The extent of continuing iOS recovery and the effects of share-based compensation and outstanding equity awards on dilution.