Where Food Comes From, Inc. (WFCF) Q2 2019 Earnings Report, Transcript and Summary

Greetings and welcome to Where Food Comes From 2019 Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded. I'd now like to turn the conference over to your host, Mr. Jay Pfeiffer, Investor Relations. Thank you. You may begin.

Good morning and welcome to the Where Food Comes From 2019 second quarter earnings call. Joining me today are John Saunders, CEO; Leann Saunders, President; and Dannette Henning, CFO. During the course of the call, we'll be making forward-looking statements based on current expectations, estimates and projections that are subject to risk. Statements about future revenue, expenses, profitability, cash, growth strategy, new customer wins, business opportunities, market acceptance of our products and services, and potential acquisitions are forward-looking statements. Listeners should not place undue reliance on these statements as there are many factors that could cause actual results to differ materially from our forward-looking statements. We encourage you to review our publicly filed documents as well as our news releases and Web site for more information about the company. Today, we'll also be discussing EBITDA and adjusted EBITDA, which are non-GAAP financial measures provided as a complement to the results provided in accordance with Generally Accepted Accounting Principles. We use and believe investors benefit from the presentation of EBITDA and adjusted EBITDA in evaluating our operating performance because it provides an additional tool to compare our operating performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our core operations. I will now turn the call over to John Saunders, Chairman and Chief Executive.

Good morning, and thanks for joining the call. Today, I will do a quick recap of our financial highlights for the second quarter and six month period, and then cover a few operational highlights before opening the call to questions. Beginning with the second quarter, revenue grew 10% year-over-year to 4.9 million from 4.4 million, I'm pleased to note that all four revenue streams contributed to our growth that included verification revenue and tag sales growth of 7% and 32% respectively. On the SureHarvest side, software license maintenance and support revenue grew 14% and software consulting revenue grew 23%. I'm also pleased to report that all four revenue categories were profitable on a standalone basis. Total gross profit increased 4% year-over-year, but our gross margin declined due primarily to the addition of fixed labor costs related to two 2018 acquisitions. SG&A expense declined 5% or approximately $85,000 year-over-year despite a $56,000 increase in depreciation and amortization. The reduced SG&A was due to lower year-over-year in marketing expense in the period. Remember, we do one-off marketing programs from time-to-time, so our SG&A trends won't always be predictable. Operating income was up 67% year-over-year to 403,000. As a result, net income attributable to Where Food Comes from grew 104% year-over-year to 361,000 from 177,000 last year. Adjusted EBITDA grew 39% year-over-year to 824,000 from 593,000. Turning to the 6-month results, revenue grew 10% year-over-year to 8.8 million from 8.1 million, once again, all four revenue streams showed profitable growth including verification and tag sales up 4% and 50% respectively. Software license revenue was up 8% and software consulting was up 18% year-over-year. Gross profit was flat at 3.7 million and gross margin was down year-over-year due to the competitive year tag pricing into added overhead from two acquisitions, Sow Organic and JVF Consulting that we completed in the second and third quarters last year. SG&A expense was up 5% year-over-year, but you may recall that in the first quarter this year, we incurred some special expense events related to training and marketing programs that pushed costs higher than normal. In addition, depreciation and amortization expense was $44,000 higher in the first half of this year compared to last year. As a result, operating income declined 62% in the 6-month period. Net income increased 3% year-over-year to 218,000 from 212,000. And finally, adjusted EBITDA was down 4% to 906,000 from 948,000, the decline reflects the competitive pricing programs from volume air tag purchasers higher year end audit expenses and special staff training programs. The year ago number benefited from 64,000 in acquisition expenses that were not repeated this year. We generated 1.4 million in net cash from operations in the first half of 2019. That's up from 1.1 million in the same period a year ago. Cash and cash equivalents and investments grew to 2.9 from 2 million at 2018 year-end. And our working capital balance from 9% to 2.9 million from 2.7 million. Our steady revenue growth reflects success in many facets of our diverse business mix. As you're probably aware our large and ever growing solutions portfolio makes us the market leader in terms of food group and verification standard coverage. More than 15,000 customers count on us to provide them with product claims credibility and product differentiation. I've spoken many times about what we've created around our business and barriers to entry and how long it would take even a well-funded competitor to gain entry into the many markets and verification areas that we operate in. We believe our diversity and wide ranging expertise are consistent introduction of innovative new services, our industry reputation and solid customer retention rates and the quality of our people have positioned us for continued success well into the future. Our beef verification business continues to lead the way in terms of revenue growth and profit generation. As you know, the reopening of the Chinese market has accelerated that growth over the last year and this increased China-related source and age verification activity despite ongoing tariff dramas shows no signs of slowing down. On a related note, last week the United States and the EU signed in an agreement regarding U.S. beef access to the EU. Under the agreement, the U.S. will be able to almost triple its annual duty free exports to the European Union. This guarantees American ranchers a much larger share of Europe's beef market. What that means to us is more demand for NHTC audits that are required for export to the EU. In addition to source and age audits for China and NHTC audits for the EU, our domestic beef verification programs are showing continued strength. Animal welfare and natural claims remain front of mind for U.S. meat producers and consumers and our programs are at the forefront in that space. Another recent development in the beef realm is our introduction of a new Black Angus Verified Beef Standard, which is part of our new USDA approved breed verified program. As restaurant and retail claims around Black Angus beef become more prevalent, we see a real need for a program that can reassure cattle buyers and consumers that claims around Black Angus genetics are authentic. We introduced the new program in mid-May and by the end of Q2, we announced the first sale of cattle verified and the Black Angus verified beef standard. As an aside, we also verified that first group of cattle to other standards as part of our bundling of programs. So, while our meat verification segment is both legacy cornerstone and a robust growth driver for us. We're also seeing some highlights in other areas of our business. Our hemp initiative is one example. In the roughly eight months, since we were selected as program administrator, an exclusive provider of certifications to the U.S. Hemp Authority Certified Verification Standard, we have made good progress onboarding new customers comprised of hemp growers and processors. We estimate there are more than 250 growers and processors in North America, a number that will almost certainly grow with in-line with consumer demand for hemp based medicinals and supplements. But, growers and processors are just the tip of the iceberg. There are other players in the supply chain with similar needs and their numbers are much higher. These are the manufacturers of consumer products such as CBD oil, food items, supplements, and personal care products, all of which can benefit from U.S. Hemp Authority Certification. On top of that, there are retailers who are eager to ride this wave, that are rightfully cautious about the quality standards and thus are seeking third-party expertise and guidance. For example, we are presently consulting with mature grocer that wants to make the U.S. Hemp Authority Certification, a requirement for CBD product makers buying for shelf space in their stores. Due to lingering misconceptions about hemp based CBD and the fact that quality control remains a major concern of both consumers and retailers. We think such certification requirements will become the norm among the broader retail community. So, we think the hemp business can evolve over time into a very interesting revenue opportunity for us. I'll remind you that hemp was an $820 million industry in 2017. Following passage of the 2018 farm though, the total market for hemp based products is expected by some analysts to grow to nearly 2 billion by 2022. So, with that, I'll open the call to questions. Operator?

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Raphi Savitz with RYS Advisors. Please proceed with your question.

Hey, John. Just a quick question for you. I was a bit surprised to see your SG&A decrease year-over-year. Can you talk about what the opportunity set is or how you think about investing more money into sales marketing going forward.

Yes. Good question. We've really put a lot of investment over the last three years in to streamlining our business and with that we've created a much more scalable delivery model and ability for our team to handle a much, much higher workload and higher numbers of producers using software and technology as opposed to growing our human resources and our FTEs. On the marketing side, we continued to focus on our relationships at the retail and consumer level and the pull through associated with that. So, we've really focused a lot of effort on obviously China. And then, my comment about the increase in the market for U.S. beef in Europe. Those were both, what I would call very targeted sales opportunities and sales wins for us as we spend a lot of time working with both governments -- both here in the United States and in the EU and China to increase those opportunities. So, we continue to spend the majority of our time really focusing on that pull through for our major beef retail and packer customers.

Got it. And I guess on the top-line side, it's certainly nice to see verification growing nicely this quarter. I think was up 7%. Can you talk about what drove the acceleration there and really how you think about the business over the next couple of years. You mentioned it is a legacy business, but it is growing.

Yes. When we talk about our growth opportunities internally Raphi, it's very, very much focused on our opportunity within beef. So, the second quarter is typically a slower quarter for us as it relates to beef. So, two things I'll draw your attention to are the growth in the first quarter and then the six month period for our tag and hardware revenue. And the correlated sales associated with those tags as they become part of our pipeline of cattle and beef that are in the system will continue to drive our verification revenue both through the third and fourth quarter. But, I think really looking into 2020, you'll see beef continue to be a big driver for us and there's a lot of dynamics that are that are driving that. I would say I've talked about China and the EU, but there's also political issues global political issues which are affecting the U.S. beef industry as we speak. So, we're on top of that all the time. So, I would be excited, or I would look forward investors too, what the beef opportunity is going to be for our company over the next several quarters and years. It's been a market that we've worked on now close to 25 years. And I've talked about it quite a bit over that over the years we've consolidated we've acquired three of our major competitors in the beef industry. We really don't have a major beef industry competitor today. And what's all of the dynamics that I'm talking about we're in a very unique position to be the largest beneficiary of that growth in the U.S. beef industry. So, it's a big driver for us. We're really focused on it.

What does that mean for the software and consulting business since you've been helping out?

They go right along with it. As we've -- one of -- as I mentioned our SG&A is down this quarter. Part of that is because of some timing of expenses. But, part of it is because we've come to a real streamline system specifically within beef and there's some components of beef that make it very unique. One is, that it's -- when we talk about hardware revenue and the tags associated with our verification those tags are sold exclusively into the beef and dairy industry and the beef industry that results from the dairy industry. So, we as tag sales grow, it's very lucrative for us because it allows us to create margin on those animals over time. Cattle have a very long lifespan. So the two to three years that it takes for that animal to mature all the while there's interactions there's marketing's of those animals all of which require continued verification and are generating revenue and margins for us on that on that animal. So, when I really talk about how we're streamlining and how we're growing our business, we do probably 60% of our business is beef related specifically. And all of the other commodities that we work in dairy, poultry, pork combine to create that 40%. So, it's a much larger opportunity and it's much bigger and if you can sense my excitement and some confidence that we've really done a good job in the beef industry not just creating a system that works for beef producers, which is what we've done, but more importantly we're creating value for beef producers, all the producers. And it's what has become really the critical part of our relationship with the producers are the additional markets that we're able to help them introduce their cattle to. And almost to a producer they're able to generate higher margins and profit as a result of that.

Perfect. Thank you for your time.

Our next question comes from [Gary Thompson] [ph] a private investor.

Hello, John, Lean, and Dannette. Looks like a pretty good quarter. My question is, has there been any more thought or discussion on that 1 to 4 reverse split. We spoke about and voted on it via stockholders meeting.

Yes. Thanks Gary. As maybe some of you know, or don't know the stockholders at our most recent corporate meeting approved a reverse split with the ratio up to [144] [ph] Excuse me. But, as we made it clear, this is our opportunity, but it's not our obligation. So we really again Terry haven't set a timetable to do it. We see great opportunity in an uplifting and the reverse split was an opportunity for us to prepare for that, which we've done, but we're still weighing a lot of different factors.

Okay. So, still very much on a backburner, just to give you the option at some point, if you need it. Am I understanding that correctly?

That is correct. We talk about it quite a bit, but it is, yes, that's a good description.

Okay. Very good. Well, I don't think a lot of the stockholders are real excited about the idea. But, what's going to happen is going to happen. I appreciate your time and thank you very much for what you're doing.

You bet.

There are no further questions at this time I'd like to turn the call back to John Saunders for closing comments.

Thanks, again, for joining us today. We'll look forward to talking again after the closing our third quarter. Take care.

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