VerticalScope Holdings Inc. (FORA) Earnings Call Transcript

Hello, everyone, and thank you for joining the VerticalScope Holdings Inc. Q3 2026 Earnings Call. My name is Lucy, and I'll be coordinating your call today. [Operator Instructions]. It is now my pleasure to hand over to Diane Yu, Chief Legal Officer, to begin. Please go ahead when you're ready.

Thank you, operator. Good morning, everyone, and welcome to VerticalScope Holdings Third Quarter 2026 Earnings Call. I'm joined by Chris Goodridge, our Chief Executive Officer; and Vince Bellissimo, our Chief Financial Officer. We'll begin with commentary on the quarter before opening the floor to questions. Before we begin, I'd like to remind everyone that today's presentation contains forward-looking information that involves known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations. These statements should not be read as assurances of future performance or results. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from those implied by such statements. A more complete discussion of the risks and uncertainties facing the company appears in the company's management discussion and analysis for the 3- and 9-month period ended September 30, 2026, which is available under the company's profile on SEDAR + as well as on the company's website. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this presentation. The company disclaims any intention or obligation, except to the extent required by law, to update and revise any forward-looking statements as a result of new information, future events or for any other reason. Our discussion today will include references to adjusted financial measures, included adjusted EBITDA, free cash flow, free cash flow conversion and MAU, which are non-IFRS measures. All references to currency in this presentation shall refer to USD unless otherwise specified. Now I will turn the call over to Chris Goodridge, CEO of VerticalScope. Chris?

Thanks a lot, Diane, and good morning, everyone, and thanks for joining us today. Before we begin, I'd like to acknowledge that today is Remembrance Day in Canada and Veterans Day in the United States, and we honor all those who have served and those who gave their lives in service. Thank you. Now turning to the quarter. In Q3, we made some important decisions about where to focus the business. We began realigning our organization to lower our cost base as AI changes how we work. We pulled back from Audience Engine and used the working capital at freed up to pay down debt. In October, we signed our first direct data agreements with Frontier AI Labs. Our core business remains stable as we navigate the shift to AI. Revenue was lower in the quarter, and I'll walk through the drivers. But we reported net income generated $6.1 million in operating cash flow and continued to reduce our debt. Our strategy is still anchored in the same 4 areas: Growing direct connections with our users and our advertisers, diversifying our revenue sources, driving AI-powered product growth and using our cash flow to make disciplined investments that accelerate growth. Let me start with Audience Engine. On our last call, I said we weren't looking to push a headline MAU number and that our audience initiatives need to drive profitable growth and real value for our users. That's the lens we applied as Q3 progressed. Audience Engine gave us a new way to bring users to our platform, and it showed we can acquire traffic at scale profitably, but it monetized at a much lower rate than our core audience. It also required a meaningful amount of working capital. We paid traffic acquisition costs upfront and collect from our partners later. And by the end of Q2, our receivables had grown to $20 million. On balance, we decided that capital was better used, accelerating our AI work and reducing debt than adding marginal users. So we pulled back in the quarter and redeployed that capital to pay down debt. As we pulled back, reported MAU averaged $77 million in Q3. And with Audience Engine not operating in Q4, we expect MAU to come in lower than that. We're comfortable with that trade-off. That brings me to where we're putting our focus, growing the value we create for enthusiasts and attracting more of them. Last quarter, I talked about how AI can change the way people get basic information, but it can't replace the experience of someone who's actually owned the vehicle or solved the problem. That continues to hold. At the same time, what counts as a user is changing. AI companies, AI search engines, AI agents are now reading our communities on behalf of people. Over the last 30 days, by our measures, they made 115 million attempts to access our communities. That's a lot of demand for our content, but it doesn't contribute traffic in the traditional sense, and it doesn't show up in MAU. Our job is to surface value for it, and I'll come back to that shortly. Our product strategy is focused on serving our members better and growing participation from the owners and enthusiasts at the heart of our communities. A big part of that is giving members more ways to share what they own. When a member chooses to share what they own, we can give them a more relevant experience. AI can repeat the specs, but it can't tell you what it's like to own something for 10 years. That's when our members record and share. It's why we're making ownership a key part of the member experience. We're also going to build on the early successes of our commerce features by making it easy for vendors to bring their product catalogs directly into our communities so members can shop alongside the advice of people who own what they're buying. Ownership, commerce and community, all reinforce each other, and we're excited about what that means for our members and for our business. Turning quickly to our results. Revenue was $13.1 million, down 11% year-over-year and 5% from Q2, driven by continued softness in programmatic and lower direct custom content campaigns. E-commerce overall was flat, but our new AI-powered commerce recommendations are showing real promise, growing affiliate commerce revenue on [indiscernible] by 29% and offsetting weaker results from ritual. Even as we work through our AI transition, our core operating model remains very profitable with 37% adjusted EBITDA margins and 77% free cash flow conversion, which reflects $1 million of CapEx, mainly for Applied AI work. Vince will walk through all those details. Turning to our operations and how we're transforming the business. As AI becomes a greater part of how we work across VerticalScope, the roles we need and the way we're organized are changing with it. In early November, we realigned the organization to reflect that, reducing annualized costs by an estimated $4.4 million. The changes give us a leaner structure with fewer layers and as our teams continue to adopt AI we expect to keep finding ways to run the business more efficiently. That helped us maintain strong free cash flow while we invest in growth and improve our balance sheet. We're also continuing to change how we build for our communities using AI to accelerate how quickly we can design, test and ship new experiences for our members. One example of this is Pulse, our new CRM community platform. Pulse gives us a single view of our relationship with every member across our communities, combining their activity, their messages to us and their history on our sites. It uses AI to tell our team where to act, whether that's a longtime contributor who stopped posting or a community where members are running into problems. Agentic workflows allowed our team to build and scale pulse in a matter of weeks, which not long ago would have taken us several months. Pulse has allowed us to reach out personally to tens of thousands of long-time contributors and meaningfully increase their engagement. By the end of the year, we'll also replace the third-party software we've been paying for and will also inform our engineering and product teams using AI, what products and features our users really want. It helps us communicate better with our members, keep them engaged and it's a good example of what we can now build and how quickly we can build it. Moving to our AltaML initiative. This work has proven to be an important catalyst across our business. It's solving problems in its own right, but it has also led to a greater focus and sense of urgency around AI transformation across our teams. When we started this initiative back in April, our approach was to focus on areas where we could find efficiencies with improved AI workflows. Several of these workflows are now in production across community management, content and sales and we've extended the arrangement into January to build on those successes and expand the work into some new areas of our business. We're still early in our transformation, but we see a lot of opportunity, much more than challenges ahead. Turning to AI data agreements. In August, I said we were close to a deal that would compensate us for our content's contribution to AI-generated answers and that we'd have more to share on this call. We've now signed 2 agreements with Frontier AI labs and we expect they'll start delivering revenue in Q4. We can't name the companies or share amounts. That's confidential under the agreements. The first is a nonexclusive training license, covering data from a selection of our communities. We completed delivery in early November and are going through post-delivery procedures to calculate contributed token volume and the resulting license fees. We expect to have that settled by the end of the year. The agreement also has options for future data refreshes with a similar pricing model. The second is a variable usage-based agreement that pays us when our content contributes to AI-generated responses. It has started with a subset of our communities and has the potential to expand over time. We continue to have productive discussions with other potential partners. We believe demand for our data from AI companies continues to grow and the number of companies seeking data is increasing as more and more AI agents are being deployed. These agents need access to timely information. We continue to block companies that access our communities without an agreement with us, and we see them as potential partners. Our approach hasn't changed. Where we can reach fair commercial terms, we will. And where we can't, we'll protect our content, including through our claim against open AI, which is still before the courts. Before I pass it to Vince, I'll offer a quick word on capital allocation. Financial discipline remains central to how we run VerticalScope. Even as we transform the business, it continues to generate strong cash flow, and we're deliberate about how we use it. We have 2 priorities: Investing in the AI capabilities and products that will deliver our next phase of growth and continuing to reduce our debt. Every quarter, we're building more financial flexibility, which gives us room to invest when the right opportunities come along and puts the business on a stronger footing over time. To wrap up, the Open Web is changing quickly, and this quarter reflects that. we focused our investment, lowered our cost base and kept strengthening the balance sheet, and we've signed our first agreement with Frontier AI Labs. Our communities are built on firsthand knowledge from real people, and we believe that will only become more valuable. With that, I'll turn it over to Vince.

Thanks, Chris, and good morning, everyone. I appreciate you joining the call today. Since our last call, we focused on building the flexibility to keep strengthening our balance sheet while investing in our core priorities of expanding Applied AI across the business and driving long-term organic growth. We pulled on levers within our control. We stopped funding Audience Engine and cash. The cash release more than covered the $6 million draw in July for the AltaML investment. We aligned our organization into smaller, more agile teams designed to move faster, and we continue to invest in our Applied AI program with $1.2 million deployed year-to-date, and we're on track, the $2 million plan we laid out in May. Those choices show up in our results. So let me take you through the quarter. Revenue was $13.1 million, down 11% year-over-year, driven by digital advertising. Programmatic revenue was down 13% to $6.1 million, including a partial quarter contribution from Audience Engine. The main drivers were lower search impressions and softer CPMs in the summer months. Direct advertising was down 14% to $4 million, driven by smaller custom content programs as some clients allocated their budgets differently this year. Display, which makes up the majority of the direct channel was flat for the quarter and is up slightly year-to-date, reflecting the ongoing value of our premium audience to the brands and agencies we have direct relationships with. Turning to e-commerce. Revenue was $3 million, in line with last year, and excluding ritual, the channel grew 10%. E-commerce was 23% of overall revenue in the quarter, and as Chris described, growing that share is central to our organic growth strategy on the platform. Turning to our operating performance. Operating expenses were down $1.8 million year-over-year, driven mainly by $1.1 million in lower depreciation and amortization of acquired intangible assets and approximately $500,000 in wages and consulting savings from lower average headcount. The quarter also included approximately $700,000 in Canadian tax incentives compared to $600,000 in the prior year. These incentives vary year-to-year and are not necessarily expected to recur. With those savings and lower net interest costs, we reported $100,000 net income for the period compared to $400,000 net loss in the prior year. Adjusted EBITDA was $4.8 million at 37% margins. and compared to $62 million at 42% margins in the prior year, which is a decline driven by lower revenue. Year-to-date, our adjusted EBITDA margin is 30%, and we continue to expect 30% or better margins on a full year basis. Turning to cash flow. Operating cash flow was $6.1 million in the quarter compared to $4.7 million last year, driven by the release of working capital from Audience Engine. Free cash flow was $3.7 million, a 77% conversion from adjusted EBITDA after approximately $1 million of capital expenditures, mostly related to our apply ad work with AltaML. Year-to-date, free cash flow was $9.3 million at an 80% conversion. Including our investments in Applied AI, we are targeting a free cash flow conversion of 80% or better for the full year. Over the last 12 months, the business generated approximately $16 million in free cash flow, and we reduced our revolver by a net $11 million after repaying $17 million and drawing $6 million for our AltaML investment. Subsequent to the quarter, we repaid a further $2 million, bringing the balance to $31 million and with $69 million available to draw on the facility. Turning to the balance sheet. We ended the quarter with approximately $26 million in net debt and net leverage of 1.4x as defined by our credit agreement, and we expect leverage to keep trending towards 1x in the coming quarters as we continue to pay down debt. A few things to keep in mind as you look ahead to Q4. First, MAU and ARPU. With Audience Engine behind us, Q4 will be our first quarter without paid traffic. So reported MAU will be lower. The impact on overall revenue will be small because revenue generated from that traffic was recognized net of the cost to acquire it. Mechanically, ARPU will improve, and we started to see that in Q3, where ARPU rose to $0.057 and from $0.045 in Q2. Second, on the data agreements, we expect to recognize most of the revenue from the training data agreement in Q4 once the content is accepted. Third, the realignment. It's expected to reduce annualized costs by approximately $4.4 million, will capture approximately 2 months savings in Q4 and record approximately $1.6 million in onetime termination costs, which fall outside our adjusted results. To wrap it up, our core organic audience is what drives our operating and financial results. The business continues to generate strong free cash flow, and that gives us the flexibility we talked about earlier. We can keep paying down our debt while investing in strategic priorities, including Applied AI and the growth of our communities. Doing both puts the business on a stronger footing with less debt, deeper direct relationships and a more diversified revenue base, creating long-term value for both our shareholders and employees. With that, I'll pass it back to Chris.

Thanks, Vince. Yes, and we're ready to open up to questions now.

[Operator Instructions] The first question today comes from Aravinda Galappatthige of Canaccord Genuity.

I'll start with a couple on data on the data agreements. Chris, I know you can't disclose the identity, but is there anything you can tell us about the profile? Are they sort of larger operators or maybe on the small to midsized aspect of something about the size and history of the players to assess sustainability there. And then would you be disclosing that in a separate line item on a go-forward basis? Or would you just be fitting it into digital advertising. I'll start there.

Thanks a lot, Aravinda. Yes, these are real players in the space. That's all I'll say because obviously, there is confidentiality provisions in the agreement that kind of protect that information. But there are real players in the space who are really pushing things. So we're excited about it. We think it's great validation for what we've been saying a long time about the value of the data, and we think it's going to open up new opportunities for us as well. So I'll let Vince comment on the actual reporting.

Yes. Aravinda, on the presentation, we will likely see this itemized separately on the P&L as a separate line given its quite different from both e-commerce and digital advertising.

And then just on the traffic, the investments in Audience Engine. Is your plan to sort of perhaps use it sort of more sparingly or tactically in the future? Or would you -- are you sort of -- based on your experience and sort of the working capital drag decided that that's not something that you kind of revert back to at all.

So the way I would characterize it. So the priority is for us to really deliver more and more value for our core enthusiast audience. We think that, that is the best driver of organic growth, like not only to serve that audience more, but to grow it organically. That isn't to say that we wouldn't, in the right circumstances, right opportunity with the right economics look for those types of opportunities to grow. Aravinda, so you never say never, but the focus of our teams and the focus of where we're putting our investment dollars is in AI and building with AI and delivering value for that user base.

And last question. Obviously, it's sort of -- the MAU levels are going to find sort of a kind of discern what that level is going to be. Is your expectation as you kind of think about the medium term, perhaps declines similar to Q3 or maybe kind of a step down in Q4 and then a moderation. I mean, what sort of -- how should we think about that trajectory given that you're sort of going back to organic? Is this potentially a kind of a base at which things stabilize, but obviously, it's unclear what that is at this point.

Yes. So because it has -- it is partway through Q3, you'll just see Audience Engine roll off into Q4. So, as I mentioned, that will impact that number. the core base of audience is very stable, right? So our expectation is that you'll see that stability kind of start to work its way through as we work into 2027. And as the initiatives we're working on with respect to organic growth start to bleed through as well, we think that there's a base there that we can grow from.

The next question is from Vince Valentini of TD Cowen.

Just on Aravinda's line of question there. I just want to make sure I'm clear. So you're saying the MAU will decline in Q4 versus the Q3 number, not just on a year-over-year basis?

Yes, that's right, Vince. And the effect -- the driver is the roll-off of Audience Engine.

Yes. No, I get that part. Thanks, Chris. The AI revenue, so 2 different contracts. One of them that you finalized in November, you're saying that will show up in Q4, but it will be a onetime lumpy contribution of revenue and then there will be no recurring revenue from that until that day comes when that counterparty renews or dips in again to get your updated content? Is that how it works as opposed to some sort of recurring revenue stream over the next few quarters?

Yes. One is more recurring in nature. The other has -- because it's mainly -- most of the economics are focused around pre-training against a select segment of our community data. So that will be a lumpier amount that comes in and then the future amounts that we received from them, that's correct as well, Vince, that those will come in when they come in, it won't be kind of a monthly kind of recurring amount.

Okay. And I assume that revenue that comes in, in the fourth quarter has very little direct costs associated with the data you already have and they spend the money...

Yes. Sorry, Vince. It flows through almost entirely to the bottom line.

Got you. I know you can't quantify, but it sounds like this could be meaningful. I mean, and we're going to see it. This is not like the NDA can hide the fact that you're going to -- we're going to see this revenue, especially if you put it on a separate line item in Q4. So you're just remaining the inevitable. Is it -- I mean, should we be thinking that your peak revenue of $80 million from a few years ago, like is something that could be insight again with the combination of these 2 deals, like if we did an annual figure that included the onetime coming in Q4? Or is it that kind of big...

I would think it more it will be a meaningful or it could be a meaningful part of the quarterly results.

The next question comes from Sarah McCuen of RBC.

This is Sarah on for Drew. Just two quick questions for me. First, last quarter, I believe you called out some strength in July in direct advertising. And just wondering if you could provide how bookings are pacing for Q4 and into 2027? And additionally, second, any commentary on the decline in content and kind of how you're thinking about that for 2027 as well.

Sure, Sarah. Thank you. Yes. And bookings in July, were looking quite solid. We had a handful of custom content campaigns from really just a handful of customers that didn't repeat in August and some of that bled into September. And so that impacted that direct number overall. Bookings remain relatively solid, probably not quite as strong as they were back in July to finish the year. So we think direct will be a little bit better that we reported in Q4, but still not showing a big growth number. And then as we look ahead to 2027, the conversations with a lot of our customers are very positive. We're seeing the renewals that we would expect to see. And so we think we'll set up reasonably well for 2027, but it's obviously early to tell and a lot can change between now and then.

The next question coming from Todd Coupland of CIBC [indiscernible].

Great. Are you able to size what the sort of adjusted MAU run rate is ex Audience?

We won't disclose that, but we can say that the quarter-over-quarter drop in MAU was all driven by Audience Engine.