Earnings Call Transcript - VRME Q3 2024

Operator, Operator

Hello, and welcome to the VerifyMe Third Quarter 2024 Financial Results Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. As a reminder, this conference is being recorded. I would now like to hand the call over to Nancy Meyers. Please go ahead.

Nancy Meyers, Chairperson

Good morning everyone and thank you for joining us today for our earnings call presentation. On the call today, I'm joined by Adam Stedham, CEO and President, who will give an operations and strategic update. Following our management presentation, we will have a Q&A session. I would like to bring your attention to the note on forward-looking statements on Slide 3. Today's presentation and the answers to questions include forward-looking statements. It should be understood that actual results could differ materially from those projected due to a number of factors, including those described under the forward-looking statements caption and on the risk factors of the company's annual report on Form 10-K and quarterly reports on Form 10-Q. I will now turn the call over to Adam Stedham for some opening remarks.

Adam Stedham, CEO and President

Thank you, Nancy. I'm pleased with our gross margin, gross profit, and adjusted EBITDA improvement in 2024 compared to 2023. These gains are the result of the leadership team's diligent efforts, and I commend their results. Specifically, in our Precision Logistics segment, we've seen revenue growth in the third quarter from our proactive services, which has nearly offset the loss of a previously disclosed premium customer. Our total year-to-date net cash is slightly down at the end of Q3, but we expect to be net cash flow neutral for 2024. Looking ahead, we believe our 2024 revenue will be slightly below that of 2023. I am disappointed by the lack of revenue growth; a significant contributing factor was FedEx insourcing services from one of PeriShip's premium customers. While we're seeing the results of our expanded sales effort, the loss of that contract will impact our full-year results. A more considerable hindrance to expected revenue growth this year is from our Authentication segment, which, despite positive expectations at the beginning of the year, has not grown in 2024. This situation has prompted a thorough analysis of our competitive position in this area. VerifyMe has focused on anti-counterfeit initiatives for many years, relying heavily on technology partner strategies which, while offering exciting opportunities, ultimately generated limited shareholder value. The partnerships that have created value for shareholders primarily relate to our distribution partnerships that support our ink capability. In 2023, to reduce our reliance on third-party technology providers in the code business, we acquired Trust Codes, completing the transaction with minimal cash. Throughout 2023, we integrated Trust Codes' technology into our operations and worked on developing potential sales and distribution partnerships stemming from that acquisition. As we approached 2024, we anticipated significant growth in our Authentication segment by leveraging these partnerships and completing our service provider agreement with Amazon Transparency. Unfortunately, organic growth for this segment has not occurred in 2024. We have realized that traceability through serialized codes and supporting cloud technology presents a complex sale to U.S. customers. Moreover, our Authentication segment lacks the necessary size and scope to compete effectively in the enterprise market. Additionally, due to varying market dynamics and our company's positioning, we do not believe the Amazon Transparency arrangement will provide the anticipated support for the Authentication segment. As we assess the current situation, we recognize that pursuing this vertically integrated code strategy will require about $1 million annually in cash investments starting in 2024 and continuing into 2026. To put that investment into perspective, $1 million equates to approximately 8% of our entire market cap, while our code services account for about 1% of our annual revenues. Consequently, we are working with multiple advisers to critically evaluate our options. We've concluded that refocusing on our ink product, which represents about 23% of our Authentication revenue, or pursuing other strategic opportunities in areas aligned with our company or board expertise, will likely yield better returns for our shareholders compared to continuing investment in the vertically integrated code strategy. Therefore, we will likely exit that part of the Authentication segment, which would lead to ending our current relationship with Amazon Transparency before the end of 2024 by discontinuing or divesting that business. When I spoke with you just over a year ago, I mentioned that we view our PeriShip business as a strong cash flow generator and believe we could create value through both organic and strategic initiatives. We maintain this belief. While the decision to shift our strategy regarding the Authentication business may come as a surprise, I want to emphasize that we have not taken this decision lightly. At the core of our strategy and efforts is the goal of creating shareholder value. We now firmly believe we can achieve this value best by investing outside the codes portion of our Authentication segment. We have consulted with bankers and advisers in exploring alternatives, and we are currently optimistic about the opportunities ahead. Now, let me shift the discussion to Precision Logistics. We have increased our number of proactive services customers in this segment by 6% year-to-date compared to 2023. Additionally, we have seen continued increases in proposal activity since expanding our sales team. Despite a 4% decrease year-to-date in total shipments for existing customers and proactive services, we are encouraged by the shifting trajectory of these volumes. We expect Q4 to face headwinds, but believe our execution and differentiation will allow us to navigate the circumstances effectively. Furthermore, we believe we are well-positioned to capitalize on wins once the overall perishable shipments market shifts.

Nancy Meyers, Chairperson

Thank you, Adam. The third quarter revenue was $5.4 million versus the prior year of $5.6 million, a decrease of $0.2 million. Revenue in the Authentication segment was down slightly year-over-year. In the Precision Logistics segment, premium revenue was down $0.5 million due to the previously disclosed discontinued contracts with one customer, partially offset by a $0.4 million increase in our proactive services revenue. Gross profit decreased $0.2 million to $1.9 million in Q3 2024 versus $2 million in Q3 2023. As a percentage of revenue, gross margin was 35% in Q3 2024 versus 37% in Q3 2023. While the quarter did result in a decrease in year-over-year gross profit with the loss of one customer in premium services, which have higher margins, which we discussed in our last earnings call, the impact was partially mitigated by other process improvements the company has made. We still anticipate our full year 2024 gross margin to exceed full year 2023 even though we expect Q4 gross margin percentage to be below Q3 due to the seasonality associated with our proactive revenue. During the quarter, as a result of the analysis of our competitive positioning in the Authentication segment and likelihood that we will exit the code portion of our Authentication segment as discussed earlier by Adam, an event requiring a goodwill and long-lived intangible asset impairment analysis to be completed was triggered. As a result of the analysis, we recorded a $2.3 million goodwill and intangible asset impairment within total operating expenses. Operating expenses were $4.8 million in Q3 2024 versus $2.9 million in Q3 2023, but included this one-time non-cash goodwill and intangible asset impairment in the Authentication segment. Excluding these items, total operating expenses improved by $0.4 million. Segment management and technology expenses and sales and marketing expenses were flat year-over-year. General and administrative expenses improved by approximately $0.4 million, primarily due to the severance recorded in 2023 that did not recur in 2024. Our net loss for the quarter was $2.4 million or a loss of $0.23 per diluted share. Excluding the non-cash item of the goodwill and intangible impairment as well as gain on fair value of contingent consideration related to the Trust Codes Global business, our net loss for the quarter was $0.6 million, versus $0.9 million in Q3 2023 or a loss of $0.09 per diluted share. Our adjusted EBITDA remained flat year-over-year at $0.2 million and improved $1.1 million to $0.4 million year-to-date 2024 versus a loss of $0.7 million in 2023. On the last slide is our balance sheet as of September 30th, 2024. Our cash as of September 30th is $2.6 million, a decrease of $0.5 million from $3.1 million on December 31st, 2023. During the first nine months of 2024, our use of cash included $0.5 million in repayment of debt and interest. Due to the seasonality of our Precision Logistics segment, our AR unbilled revenue, and accounts payable are higher at year-end compared to the other three quarters. As of September 30th, 2024, we have $1 million remaining on our loan and $1.1 million on our convertible notes. There are no borrowings under our line of credit, and we have $1 million available to us. With that, I would like to turn the call back to Adam.

Adam Stedham, CEO and President

Thank you, Nancy. As for the decision related to our Authentication segment, I can't overemphasize the amount of evaluation and analysis that's gone into this decision. I'm committed to pursuing organic and strategic initiatives that will create value for VerifyMe shareholders. I continue to believe we can create meaningful value for our shareholders and our best opportunity to create this value is to redirect our investment into areas other than the codes portion of the Authentication segment. Over the last 15 months, we've been focused on creating this value for shareholders by strengthening the operations of our Precision Logistics business and investing in the codes portion of our Authentication. However, more recently, we've begun to increase our investment in sales and marketing within Precision Logistics business, and I feel this focus is starting to yield results. I'm optimistic about the conversations that we're having with advisers and bankers. And so at this point, I'll turn the call over to questions from our analysts.

Operator, Operator

We will now begin the question-and-answer session. Today's first question comes from Michael Petusky with Barrington Research. Please go ahead.

Michael Petusky, Analyst

Good morning.

Adam Stedham, CEO and President

Good morning Michael.

Michael Petusky, Analyst

Good morning. I'm curious about the remaining Authentication business. Is it adjusted EBITDA positive or negative? What will remain of that business?

Adam Stedham, CEO and President

At this point, it would be adjusted EBITDA negative at the beginning of the year depending upon our current backlog of revenue that we're pulling into the year. But as we evaluate that, we're obviously looking to drive to a point of being adjusted EBITDA positive in 2025.

Michael Petusky, Analyst

Okay. Yes, essentially, I want to explore whether it makes sense for that segment to continue existing since it accounts for such a small portion of revenue. I understand it contributes positively to gross margin, but it does not enhance adjusted EBITDA. I just wonder, yes.

Adam Stedham, CEO and President

You raise an excellent question. Regarding how we discuss the company and how it’s perceived, the small percentage of our total revenues may not warrant a separate discussion. However, considering our history in Authentication services and the patents we hold in that field, we believe it is important to keep everyone informed by addressing it separately for now.

Michael Petusky, Analyst

Yes, I was not questioning. I was wondering if it makes sense for VerifyMe going forward, considering its minimal contribution and its negative impact on adjusted EBITDA. However, it seems you are optimistic about its future.

Adam Stedham, CEO and President

We are definitely considering our options, and we are committed to pursuing the path that we believe will create the most value for our shareholders regarding that part of the business.

Michael Petusky, Analyst

Got you. That makes sense. So, Adam, I wanted to ask quickly about the FedEx premium decision since we are a couple of quarters past that. There is still some premium business that you have, and I'm curious about your outlook. At the time of the FedEx announcement, you seemed hopeful that the remaining premium business would persist in the near term, although perhaps not with the same level of confidence for the long term. Is there any update on your perspective regarding this part of your business moving forward? Specifically, should I be anticipating developments in this segment for 2025, 2026, and beyond?

Adam Stedham, CEO and President

That's a great question. As a reminder from our Strategy Day, we classify our premium customers into two types. A premium customer is one where we receive payment for our service separately from shipping costs, whereas proactive customers pay for both shipping and our service. We have direct premium customers who pay us directly for our services and also pay the shipping provider directly. Then there are indirect premium customers, for which we are subcontracted by FedEx to deliver services that they resell. We're experiencing growth among our direct premium customers, and our pipeline activity has increased. We expect this segment of our premium business to grow, maintaining a gross margin profile similar to that of our indirect premium segment. Additionally, the workload subcontracted to FedEx has remained consistent, with no major changes in our customer base. That said, FedEx has significantly invested in an AI product that could potentially handle some of the tasks we are subcontracted to perform. At this moment, we don’t foresee any immediate impact from this development. Our current strategy focuses on expanding direct premium services at a pace that compensates for any reduction in indirect premium services. That's our current position. Does that clarify your question?

Michael Petusky, Analyst

It does. It does bring one question. How much direct premium revenue do you guys currently sort of have exposure to?

Adam Stedham, CEO and President

About 10% of the premium revenue is direct premium currently.

Michael Petusky, Analyst

And that's, what, like a couple of million dollars a total that we're talking about?

Adam Stedham, CEO and President

No, no. Because

Michael Petusky, Analyst

No, I don't mean the 10%, but isn't the premium somewhere around a couple of million dollars?

Adam Stedham, CEO and President

No, it's over 4% to 5%.

Michael Petusky, Analyst

Okay. Okay. Even after the FedEx decision from six months ago?

Adam Stedham, CEO and President

Yes.

Michael Petusky, Analyst

Okay. Got it. Okay. Terrific. That’s all I got. Thank you.

Adam Stedham, CEO and President

All right. Thank you.

Operator, Operator

The next question comes from Jack Vander Aarde with Maxim Group. Please go ahead.

Jack Vander Aarde, Analyst

Okay, great. Hi Adam.

Adam Stedham, CEO and President

Hey Jack, how are you?

Jack Vander Aarde, Analyst

I'm good. Thanks for taking my questions. I'm going to just kind of touch on this as well a little bit. I apologize if I've been redundant or things that just aren't ready yet. But in terms of the Authentication segment going forward, which I understand you're still working through the strategy, obviously. But just a couple of things. So, what pieces of that business are still in play for certain? Is it just the inks component of the business or am I missing something else as well?

Adam Stedham, CEO and President

Right now, the ink component is important, along with the related patents, technology, and equipment that support our ink strategy. Historically, the company has utilized various partnerships to integrate the ink component with other technologies or strategies. We are currently evaluating our partner options, keeping in mind that previous partnerships in the coding area did not generate significant value. However, some distributor partnerships have been beneficial. We have expertise in anti-counterfeiting and authentication, and several opportunities we are exploring fall within the broader scope of authentication services.

Jack Vander Aarde, Analyst

Okay, that's very helpful. In general, do you expect revenue from the Authentication segment in 2025? Is there any anticipated increase in the ink's revenue or anything else that would help establish a baseline?

Adam Stedham, CEO and President

We do expect some revenue in 2025. However, I don't believe it will be significant for the company overall. Looking at our total revenue, this year it could be considered marginal with the codes and the ink. Therefore, I don't expect it to represent a substantial amount of revenue in 2025, but there will indeed be revenue.

Jack Vander Aarde, Analyst

Okay, that's helpful color. And then just switching gears to Precision Logistics. I did see you guys called out the proactive services piece was up 9% year-over-year. And just for a sandy check there, too, so I have it correct, what actually is the mix of the proactive services revenue or what's the dollar amount? If you could just give us a sense there?

Adam Stedham, CEO and President

From a revenue perspective, approximately 20% comes from premium services and 80% from proactive services.

Jack Vander Aarde, Analyst

Got you. Okay, that's helpful.

Adam Stedham, CEO and President

Keep in mind, as Nancy said, there's a strong seasonality component to proactive in Q4, so that mix changes in Q4 because the proactive goes up substantially and the premium doesn't move in the same way in Q4. In addition to that, just like everyone else, we're somewhat assuming what the seasonality will be this year, what Christmas shopping patterns, holiday shopping patterns, all of those things will be this year, we're making some assumptions on that. But no one really knows until after the season is over.

Jack Vander Aarde, Analyst

Sure, that's helpful. Regarding gross margin, it seems there are various factors to consider. You're anticipating that in the fourth quarter, due to higher volume and possibly less activity in the Trust Codes business, gross margins may decrease slightly. However, you still expect to achieve positive adjusted EBITDA for the year. Looking ahead, could you elaborate on how you foresee gross margin evolving next year? Should we expect a gradual increase due to volume and better absorption of overhead, or is the outlook more stable? Thank you.

Adam Stedham, CEO and President

I don't anticipate a year-over-year increase in gross margin next year compared to 2024 for a couple of reasons. First, our premium business generates a significantly higher gross margin than our proactive business. With the insourcing of one customer that occurred halfway through this year, we are facing a comparison where the first half of the year showed a much stronger gross margin due to that premium customer. Additionally, we expect growth to come primarily from the proactive segment, meaning that as this lower gross margin business expands, it will make up a larger share of our total revenue, which could negatively impact overall gross margin. However, through our investments in technology and automation, we anticipate some cost efficiencies that should help mitigate this effect. Therefore, we expect the gross margin profile to remain relatively stable going into next year, aside from the comparison impact of the premium customer from the first half of the year.

Jack Vander Aarde, Analyst

Okay, understood. I think that’s it from me. I appreciate it. I'll hop back in queue.

Operator, Operator

Thank you. The next question is a follow-up from Michael Petusky with Barrington Research. Please go ahead.

Michael Petusky, Analyst

Thanks. I missed this last question.

Adam Stedham, CEO and President

No, you're good Michael, no problem.

Michael Petusky, Analyst

Thank you. Adam, you mentioned something earlier, but if you provided specific details, I apologize for missing them. I know you hired a couple of salespeople for Precision Logistics in Q2. Have you added more in Q3?

Adam Stedham, CEO and President

Yes, we added another sales and marketing person in Q3.

Michael Petusky, Analyst

Do you have any plans to enhance that as you look ahead to the next six to twelve months, or will that be sufficient for the near future?

Adam Stedham, CEO and President

We don't have definitive plans. We're evaluating that. As we redirect investment funds that haven't generated revenue growth this year and haven't achieved the desired results, some of that money could be used for sales strategies in the PeriShip business. It's a significant expense that is being eliminated, and a logical way to use that would be to allocate a portion towards organic growth in Precision Logistics. However, we do not have a final plan at this time.

Michael Petusky, Analyst

Okay. And then just last question. Do you guys have any plans or have you discussed the idea of sort of doing some kind of reset Investor Day where essentially say, hey, a few things have changed in the past year, we want to sort of talk about our go-forward outlook?

Adam Stedham, CEO and President

I expect that our Q4 earnings call will likely be extended so we can adequately share the year-end earnings and provide more insight into our strategy for 2025.

Michael Petusky, Analyst

All right. Awesome. Thank you.

Adam Stedham, CEO and President

Thank you.

Operator, Operator

This concludes our question-and-answer session. I would now like to turn the call back to management for any closing remarks.

Adam Stedham, CEO and President

Well, thank you very much. And as we said, some of the decisions that have been made are probably surprising to people. But with that said, hopefully, you understand and you realize how much thought went into it. And that at the end of the day, we're making decisions that are just very, very laser-focused on growing the company, building shareholder value, and providing returns to our shareholders. So, thank you everybody for attending today.

Operator, Operator

The conference has now concluded. Thank you for your participation. You may now disconnect your lines.