VerifyMe, Inc. (VRME) Q3 2024 Earnings Report, Transcript and Summary

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

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.

Thank you, Nancy. I'm pleased with our gross margin, gross profit, and adjusted EBITDA improvement in 2024 versus 2023. These gains have been the result of diligent efforts by the leadership team, and I'm pleased with their results. In particular, I'm pleased to report in our Precision Logistics segment that we have seen revenue growth during the third quarter in our proactive services that has come very close to offsetting the loss of the premium customer previously disclosed. Our total year-to-date net cash is slightly down at the end of Q3, but we anticipate there will be net cash flow neutral for 2024. Looking at 2024 as a whole, we anticipate our 2024 revenue will be slightly below 2023 revenue. And I'm disappointed by the lack of revenue growth. A meaningful contributing factor is the FedEx insourcing of services provided to one of PeriShip's premium customers. As just mentioned, we're seeing the results of our expanded sales effort, but the loss of that contract will still drag on the full year results. Now. a larger drag on overall expected revenue growth this year comes from our Authentication segment, which, despite robust growth expectations at the start of this year, it hasn't grown in 2024. Now. this has led us to do a thorough analysis of our competitive positioning in this area. Now, VerifyMe has been focused on anti-counterfeit efforts for many years. Historically, these efforts were highly dependent upon technology partner strategies, which have presented many exciting opportunities, but which ultimately generated limited shareholder value. The partnerships that have created some value for shareholders have been in the distribution partnerships supporting our ink capability. In 2023, as a way to reduce our reliance on third-party technology providers in the code business, we acquired Trust Codes. This transaction was completed with minimal cash. And during 2023, we integrated Trust Codes' technology into our business. In addition, throughout 2023 and 2024, we focused on developing potential sales and distribution partners created by the Trust Codes acquisition. Now, coming into 2024, we anticipated significant growth of our Authentication segment due to leveraging our sales and distribution partnerships and completing our services provider agreement with Amazon Transparency. Disappointingly, organic growth has not materialized for this segment in 2024. We we've come to realize that traceability through serialized codes and supporting cloud technology is a very complex sale for customers in the U.S. market. We've also discovered that our Authentication segment lacks the size and scope to compete effectively in the enterprise customer market. And then lastly, due to various marketplace dynamics and our company's size and positioning, we do not believe the Amazon Transparency arrangement presents the tailwinds for the Authentication segment that we had previously believed it would. So, as we evaluate the current situation, I think we also need to consider that pursuing this vertically integrated code strategy requires approximately $1 million per year of cash investment by the company in 2024, again in 2025 and continued cash investments into 2026. So -- and I want to help put that required investment into perspective. $1 million is approximately 8% of the entire market cap of the company and our code services represent about 1% of our annual revenues. So, as a result, we've been working with multiple advisers to critically assess what are our various options. And we've concluded that a renewed focus on our ink product, which currently represents about 23% of our Authentication revenue or the pursuit of other strategic opportunities related to areas of company or board expertise will provide a better return for our shareholders than continuing to invest in the vertically integrated code strategy. So, as a result of this, we'll likely exit that portion of the Authentication segment, which would also end our current relationship with Amazon Transparency prior to the end of 2024 by discontinuing the operation or divesting of the business. Now, when I introduced myself to you just over a year ago, I said we believed that our PeriShip business presents a strong cash flow business, and we believe we could create value through organic and strategic initiatives. We continue to believe this is the case. While the decision to change course on the Authentication business is likely to be a surprise to you, I want you to know that we have not made this decision lightly. At the very core of our strategy and efforts is to drive to create shareholder value. We now strongly believe that we'll be able to best create this value by investing in areas outside of the codes portion of our Authentication segment. We've engaged with bankers and advisers in seeking alternatives. And at this point, we're very optimistic about the opportunities that we see. So, I'd like to shift the conversation a bit to discuss Precision Logistics. We've increased the number of proactive services year-to-date customers in this segment by 6% over 2023. We also have continued to see increases in proposal activity in Precision Logistics since increasing the size of our sales team. Now, despite our total shipments for existing customers and proactive services being down 4% year-to-date, we're pleased by the shifting trajectory of these volumes. We expect that Q4 of this year will continue to face headwinds, but we believe our execution and differentiation positions us to navigate the situation well. In addition, we believe we're well-positioned to benefit from the wins once the overall perishable shipments market shift. So, at this point, I'll turn the call over to Nancy for a detailed review of the third quarter financials.

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 has 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.

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.

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

Good morning.

Good morning Michael.

Good morning. So, I'm curious -- so I'm curious on the remaining Authentication business. Is that adjusted EBITDA positive or is it adjusted EBITDA negative? Sort of what will remain of that business?

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.

Okay. Yes, essentially, the road I want to go down is does it make sense for that segment itself to exist given that it's such a tiny part of revenue? I understand its gross margin accretive, but it's not EBITDA -- adjusted EBITDA accretive. I just wonder -- yes.

Yes. You bring up a very good question. And in terms of -- which is really more of a reporting in how we discuss the company and people view it. Given the low percentage of our total revenues, it may not make sense to discuss it in a discrete manner. But given the history of the company in Authentication services and patents that we have in that area, at this time, we still want to keep people informed by discretely talking about it.

Yes, I wasn't questioning. Talking about, I guess, I was -- the question I had was, does it make sense as part of VerifyMe going forward, given how little it contributes and the fact that it's a drag on adjusted EBITDA, but it sounds like you're hopeful it won't be going forward.

Right. And we're looking at -- we're definitely considering that. And if there was a -- whatever the path is that what we think would create the most value for our shareholders relative to that portion of the business, that's the path that we're committed to follow.

Got you. Makes sense. So, Adam, I also wanted to just ask real quick. I guess the FedEx premium decision, we're now maybe a couple of quarters removed from that decision. And obviously, there's still some premium business that you guys have. And I'm just curious because at the time of the FedEx announcement, I think you were hopeful that in the near-term, the remaining premium business would sort of stick around, but maybe not as high -- you maybe didn't have quite as high a conviction on the longer term. I'm just wondering, is there any update in terms of your sort of outlook on that piece of your business going forward? And I'm particularly asking around, hey, should I be thinking about this part of the business for 2025 and 2026 and going forward?

Right. Great, great question. As a reminder, from -- if we go back to our Strategy Day, we have two types of premium customers. And what a premium customer means is simply we get paid for our service independent of any shipping costs, whereas proactive, we get paid for shipping and our service. So, there are direct premium customers. What that means is the customer pays us directly to provide our service and they pay FedEx or whomever else directly for the shipping. That's direct premium. And then indirect premium is we are subcontracted by FedEx to provide a service that they resell. So, we are actually seeing growth of our direct premium customers, and we had increased activity in our pipeline. And so we think that aspect of our premium business is going to grow and it will grow at the same margin profile -- gross margin profile as our indirect premium. So, that's positive for us. To this point, the work subcontracted to FedEx has remained stable, and we haven't seen a significant shift of customers. With that said, FedEx has made significant investments in an AI product and that AI product, as it evolves, has the ability to do some of what we are subcontracted to do. So, we don't anticipate at this point there is any near future impact from this. And our current strategy is to grow the direct premium at a rate that would offset any decline in the indirect premium. So, that's where we sit now. Does that answer the question? Does that make sense?

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

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

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

No, no. Because--

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

No. It's 4% -- it's north of 4% to 5%.

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

Yes.

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

All right. Thank you.

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

Okay, great. Hi Adam--

Hey Jack, how are you?

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?

Well, it's -- so right now, the ink component is in play and the relative patents and the technology and the equipment that supports the ink strategy. But keep in mind that historically, the company, as I said, has leveraged various partnerships that would allow the ink component to join up with other technologies or other strategies. So, we do have that, that we're analyzing from a partner perspective. We're very cognizant, as I said earlier, that the way those partnerships were created in the past on the code side didn't create a lot of value. But there were some partnerships that created value so -- in terms of distributor partnerships and so on and so forth. So that's really where we're at. With that said, we do have expertise in anti-counterfeit, in Authentication and some of the various opportunities that we're looking at could be within the overall realm of Authentication services.

Okay, that's very helpful. And then just in general, regardless of the specifics, I guess. Is it -- maybe just for sandy check, do you indeed expect revenue from the Authentication segment in 2025? Any sort of ramping up of any of the ink's revenue or anything else that's involved just to get a baseline there?

Right. We do expect revenue in 2025. But if you look at it, I don't think it's going to be material for the company as a whole. If you look at our overall revenue, I don't think it will be -- this year, it's questionably material with the codes and the ink. So, I don't anticipate it will be a material amount of revenue in 2025. But there will be revenue in 2025.

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?

Yes, I mean I would from a dollar -- or from a mix perspective, you're looking at about 20% of the revenue is premium, 80% of the revenue is proactive.

Got you. Okay, that's helpful.

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.

Sure. Okay, that's helpful. And then just your comments around gross margin. Obviously, there's some puts and takes here. It sounds like you're expecting the fourth quarter just given, I guess, the higher volume, maybe also less of the Trust Codes business as well. But just in general, gross margin sounds like they will be -- they'll tick down a bit. But nonetheless, you still expect positive adjusted EBITDA for the year. I guess looking forward -- and then I just want to get your comments if you could just tie together the fourth quarter there. And then just kind of give us a sense of how do we expect gross margin to kind of play out from where you see things today next year? Are we going to expect kind of gradual uplift just due to volume and overhead being absorbed? Or is this kind of -- gives a steady state, if you could? Thanks.

I don't think that we'll see a year-over-year gross margin uplift next year versus 2024 for two reasons. One is, keep in mind, our premium business is a much higher gross margin profile than our proactive. And so with the in-sourcing of the one customer that happened halfway through this year, that creates a comparison where we had a much higher gross margin effect in the first half of the year due to that premium customer. On top of that, we expect to see our growth happening in the proactive business. So, as the proactive business grows, the percentage of our total revenue of the -- that is of the lower gross margin type versus the higher will increase, which would have a downward effect on gross margin. With that said, we expect that through our investments in technology and automation, we are going to see some cost rationalization, which would offset that. So, overall, I think we're looking at having a flattening of the gross margin profile going into next year with the exception of the comparison impact of the previously announced premium customer from the first half of the year.

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

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

Thanks. I missed this last question.

No, you're good Michael, no problem.

Thank you. So, Adam, you alluded to -- but if you guys gave specifics, I apologize, I missed it. I know that you guys had hired a couple of salespeople for Precision Logistics in Q2. Have you added to that in Q3?

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

Okay. And do you have any plans as you sort of look out over the next six to 12 months to bolster that? Or is that going to cover you for the near--

We don't have definitive plans. We're evaluating that. It -- I mean, one of the things we're -- as we're redirecting investment dollars that have not resulted in revenue growth this year and have not resulted in the results we wanted, that part of that money could be deployed into sales strategies for the PeriShip business. I mean it's a significant expense that is going away, which one of the very logical things to do with that would be looking at deploying a portion of that towards organic growth in Precision Logistics. But we don't have a final plan as of yet.

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?

We absolutely -- my expectation is that our Q4 Shareholder Day will -- our Q4 earnings call will likely be extended so that we have adequate time to not only share the year-end earnings, but we also are able to provide far more insight to the strategy for 2025.

All right. Awesome. Thank you.

Thank you.

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

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.

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