Earnings Call Transcript - VRME Q1 2024

Nancy Meyers, CFO

Thank you. 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 answer 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 report on Form 10-Q. I will now turn the call over to Adam Stedham for some opening remarks.

Adam Stedham, CEO

Thank you, Nancy, and welcome, everyone. I'm pleased to report that in Q1 2024 we realized an increase in year-over-year revenue and a significant improvement in gross profit, gross margin percentage and adjusted EBITDA. It's noteworthy this is now the third consecutive quarter of positive adjusted EBITDA and even more meaningful, we're experiencing an increase in our sales pipeline. We previously announced that we anticipate our H2 2024 growth rate will exceed our H1 growth rate. We continue to believe this is the trend and the increases in the sales pipeline are a key enabler of that growth. Q1 2024 adjusted EBITDA did not convert efficiently into cash flow from operations in Q1 and that's primarily due to the timing of working capital items. We continue to anticipate that we'll have positive cash flow for 2024, as the timing of these items balance out, and we continue to experience year-over-year growth. As a company with no net debt, that is generating cash with meaningful growth prospects, I think our current valuation represents a significant opportunity for our shareholders. At the end of Q1 2024 we had $2.8 million of cash and only $2.4 million in debt, and this includes the convertible note which we anticipate will likely get converted into stock rather than being repaid in cash. At this point, I'll touch on our capital strategy. We continue to have our announced buyback program in place and we continue to evaluate our strategy around repurchasing shares. Thus far in 2024, the company has repurchased minimal shares. We continue to monitor all available options to utilize our capital to maximize shareholder value. So let's shift the conversation to our two operating segments: The Q1 2024 improvement up and down the income statement is the result of our focus on creating the foundation for the company throughout 2023. We focus on operational efficiency and our go-to-market strategy for our PeriShip business within the Precision Logistics segment. We vertically integrated the Trust Codes technology stack with all of our existing customers in our Authentication segment, as well as redefining our go-to-market strategy for both our traceability products as well as our ink products. Now, looking at Precision Logistics, this segment generated $5.6 million in revenue in Q1 of 2024 versus $5.4 million in revenue in Q1 2023. As we look across the marketplace, partial shipping volumes with the major shippers are down in 2024 versus 2023. We're pleased that due to multiple factors related to our differentiated offering, we continue to experience revenue growth in this environment. We believe this environment provides a good opportunity to add new customers as well as increase our share of wallet with existing customers. So as we look at the business, we had almost 3% more customers ship packages in Q1 2024 versus Q1 2023. With that said, our same customer shipping volumes were down about 2% in Q1 2024 versus Q1 2023. So therefore, we're in a market in which our strongest opportunity to grow our revenues is by expanding our customer base. So we're focusing our efforts to add new customers in the region between Maine and Pennsylvania. We added a new additional sales representative in May, and we're expected to add two additional sales resources in June. We believe our plans of expanding our sales force with a targeted geographic approach will create the most value for the company. Our successes and lessons learned from this year will guide plans related to geographic expansion in 2025. So we're pleased with the efficiencies and improved gross margin percentages we've achieved in the Precision Logistics segment. But we still believe that we have the capacity to further increase our revenues without an associated increase in operating costs. This leverage should enable us to grow revenues and maintain our margin profile, even if softer overall partial shipping volumes create pricing pressure in the industry this year. So now, let me shift over to our Authentication segment. After spending much of last year on internally focused initiatives, I'm pleased with the pipeline expansion in this segment. The Authentication segment generated $150,000 in revenue in Q1 2024 versus $250,000 in Q1 2023. We anticipate the quarterly revenue growth for this segment to increase meaningfully each quarter of this year. We have multiple sales opportunities in the pipeline related to our new integration with Amazon Transparency. We're refining our sales model and developing a better understanding of the sales cycle associated with this specific service. So we continue to believe our relationship with Amazon creates a significant opportunity to create value for Amazon; our mutual customers; consumers of our customers' brands; and most importantly, VerifyMe shareholders. In addition to the Amazon relationship, we continue to see positive trends for our APAC business, strategic relationships and in ink sales. We generated 5% revenue growth in APAC in Q1, and we anticipate continued growth throughout 2024. We're currently working with our strategic partners to define marketing plans to highlight how our technology adds value to their equipment. And then as for ink, in Q1, we attended the Dscoop Conference in Indianapolis. Dscoop is the community of 16,000 Hewlett-Packard industrial print and large-format customers and partners. Participation in this conference is a part of the new go-to-market strategy for our ink products that we discussed with you at the Analyst Day. We believe this conference was a good success for us. I look forward to our future earnings calls and sharing details associated with converting our current pipeline into sales. We continue to also believe the Authentication segment has growth opportunities related to food and agriculture traceability. This traceability aligns to the GS1 standards. So in June, the company is participating in the GS1 conference in Orlando. We believe this conference will create sales opportunities just as the Dscoop Conference created ink sales opportunities. So at this point, I'll turn the call back over to Nancy Myers, our CFO, and she'll provide more detailed financial information.

Nancy Meyers, CFO

Thank you, Adam. First-quarter revenue increased by 2% to $5.8 million versus prior year of $5.7 million. The Precision Logistics revenue increased by 4% from $5.4 million to $5.6 million. Authentication revenues decreased from $0.2 million to $0.1 million as a large order from Q1 2023 has slipped into Q2 and Q3 for 2024. As Adam mentioned, our pipeline is growing in this segment, and we anticipate growth in Q2 and through the remainder of 2024. Gross profit increased by $0.7 million or 49% to $2.3 million in Q1 2024 versus $1.5 million in Q1 2023. As a percentage of revenue, gross profit increased to 39% in 2024 versus 27% in 2023. The year-over-year increase in gross profit is mainly due to the shift in customer mix and service offerings in our Precision Logistics segment as well as process improvements the company has made. The gross profit from prior year has been adjusted and has been decreased by 4% from $1.8 million to $1.5 million. This was to better align our variable direct operating costs related to our service centers in Precision Logistics as they are directly related to providing the service to the customer that generates revenue. We have internally reorganized and are able to clearly identify these costs. While we believe there are economies of scale as we continue to grow, we understand these costs could fluctuate. For Q2 and Q3 of 2024, we anticipate our gross margin to remain relatively consistent. When you review our operating cost component of the statement of operations, you will see we have added a new line item for segment management and technology. We have reclassified our operating costs to provide visibility of those costs that are directly related to our two segments in line with new accounting standards. These costs are further broken out between the two segments in a footnote of our 10-Q. This is in line with how the segments are being reviewed for performance and allocation of resources are managed. General and administrative expenses now include those costs that are shared across both segments as well as public company costs. Segment management and technology expenses increased by $0.2 million to $1.3 million in Q1 2024 versus $1.1 million in Q1 2023, primarily as a result of Trust Codes being included for the full quarter in 2024. General and administrative expenses decreased by $0.3 million to $1.1 million in Q1 2024 versus $1.4 million in Q1 2023. The decrease primarily relates to severance expense and one-time professional fees for the Trust Codes' acquisition in Q1 2023 that did not recur. Sales and marketing expenses decreased by $0.1 million to $0.4 million in Q1 2024 versus $0.5 million in Q1 2023. The decrease is primarily related to a reduction in employees and consultants in the Authentication segment. Our net loss for the quarter improved by $1 million to a loss of $0.6 million or $0.05 per diluted share versus $1.6 million in Q1 2023 and a loss of $0.17 per diluted share. Our adjusted EBITDA increased by $0.6 million to a positive $0.1 million for the first quarter of 2024. On the last slide is our balance sheet as of March 31, 2024. Our cash as of March 31, 2024, is $2.8 million, a decrease of $0.3 million from $3.1 million on December 31, 2023. During the first quarter of 2024, our use of cash included $0.2 million in repayment of debt and interest. Due to the seasonality of our Precision Logistics segment our AR, unbilled and accounts payable are much higher at year-end compared to the other three quarters. As of March 31, 2024, we have $1.3 million remaining on our loans and $1.1 million on our convertible note. 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

Thank you, Nancy. Q1 was my third quarter with the company, and I'm pleased to be at the pivot point from transformation to growth. Most construction projects, they start by digging a hole and it's always satisfying to see the structure rise from the ground. It's also exciting that the process begins to speed up at that point. I am pleased that due to the hard work of the team, VerifyMe has generated positive adjusted EBITDA each quarter that I've been with the company. I look forward to the next quarterly call and continuing to share our success and share more about the upcoming revenue growth. But for now, let's turn the call over for questions.

Michael Petusky, Analyst

I may have missed this. What was the percentage sort of growth or negative comp in each of the segments, please?

Nancy Meyers, CFO

I'm sorry, say that again?

Michael Petusky, Analyst

The percentage revenue growth or negative comp in each of the segments for the quarter?

Nancy Meyers, CFO

Okay. Yes. So Precision Logistics increased by 4%, and Authentication was down. It went from $0.2 million to $0.1 million.

Michael Petusky, Analyst

What's the percentage by any chance?

Nancy Meyers, CFO

I don't, off the top of my head.

Michael Petusky, Analyst

Okay. Let me ask about Precision Logistics. Adam, are you seeing specific industries that are performing better in terms of shipping compared to others that are facing more challenges? I know you’re navigating a tough macro environment, but I'm interested in whether some areas of your business are doing better or growing compared to those that are more affected.

Adam Stedham, CEO

We had a strong focus on life sciences as well as higher-end products. The consumers of these products tend to be more affluent. Consequently, these areas and markets are somewhat more resilient and less affected by economic downturns. This is what we believe is contributing to the strength we are experiencing right now. We have other products targeted at the broader market, and that is where we are noticing a slowdown, particularly in baked goods and some of our lower-priced items.

Michael Petusky, Analyst

All right. I know that with the investor event and confirmed during the Fourth Quarter Conference Call, you have been aiming for double-digit growth in both segments.

Adam Stedham, CEO

Correct.

Michael Petusky, Analyst

This quarter has been challenging. While we performed well in terms of margins, the top line growth hasn't met expectations. Are you viewing your goals as more of a target at this point, or do you still feel confident about them? It seems to me you might be trailing a bit, but I'm not entirely sure. I understand the second half is expected to improve compared to the first half, but it does feel like the current performance might be lagging a bit. Please clarify.

Adam Stedham, CEO

No. So actually, we do feel comfortable with it. One of the things that we've pointed out is that we're adding two additional salespeople. And so those two additional salespeople were not initially part of the plan at that time. So we believe that we will hit the revenue growth target. The way we'll hit the revenue growth target is by making additional investments in sales resources, and we've freed up the room in the income statement to make those investments in the sales resources. So we continue to believe that we will hit the double-digit revenue growth in each segment as well as the company overall. And it will be weighted towards H2 versus H1. Keep in mind, a very large percentage of our revenue is generated in the fourth quarter for Precision Logistics. So naturally, the business cycle for us gives us that opportunity to see a much higher growth rate in H2 than H1.

Michael Petusky, Analyst

Can I just ask? Your internal assumptions around the market, does it assume that the macro sort of improves in the second half?

Adam Stedham, CEO

No. I think it assumes that the macro does not significantly erode in the second half. Status quo is the assumption. And if there's an improvement, that's positive. If there's an erosion, that's negative.

Jack Vander Aarde, Analyst

Adam, I'm doing well. It's impressive to see your strong track record with positive adjusted EBITDA as CEO. I have a few questions. It's encouraging to witness the growth in the Precision Logistics business. Regarding Authentication, you mentioned that the pipeline is strengthening and you're anticipating revenue growth moving forward. Could you provide some insight into the recent revenue mix and the expected near-term revenue growth for Authentication? Specifically, how do your expectations for the Trust Codes business compare to the ink business? Additionally, what do you hope to achieve from the two conferences you mentioned? Will participating in these conferences help you secure orders that will drive growth in the second half?

Adam Stedham, CEO

Absolutely. Great question. So we expect to see growth both in the ink segment as well as in the codes, or the ink portion of our Authentication segment as well as the codes. And when we look at it, what we're finding is that sales cycles are longer than we've expected. So you have kind of a queue in your pipeline. So our pipeline is building and building. I would have previously expected that some of that pipeline would have converted already. But what we're experiencing is a longer sales cycle on that pipeline. Now importantly, we're not experiencing a lower conversion rate than we expected. So it's not as if we're losing more deals than we expected to lose. The sales cycles are just longer. And when we look at the expansion into the Amazon environment, that's a more complicated sale with a little longer sales cycle that involves more players on the other side as well as within our go-to-market strategy for ink. If you look at where we're targeting the ink sales now, those have a tendency to be longer sales cycles. So I think that's been the biggest realization for me from an Authentication business perspective is the fact that the sales cycles do take a little longer than I had previously anticipated they would.

Jack Vander Aarde, Analyst

Okay. That makes sense. And then maybe if I just switch gears again, gross margin was another bright spot. It sounds like you expect gross margins to be fairly consistent going forward. But just given what I believe is your expectation for ramping Authentication sales in general, it feels to me like there would be potential upside to that gross margin just given the margins with that revenue stream. Can you just speak to that a bit? Is that a conservative assumption to have gross margins around the current quarter? Or what are your thoughts there?

Adam Stedham, CEO

The gross margin could be influenced by several factors. If we encounter pricing pressure, we plan to respond accordingly to meet our revenue target for the year, which might lead to some erosion in gross margin. However, we believe we have the ability to generate revenue without increasing costs, so even if we need to reduce prices to achieve our sales goals, we expect our bottom line margin percentage to remain stable. While gross margin may decrease slightly as a percentage of revenue, our costs below gross margin would also decline, balancing things out and preserving our bottom line margin profile. If we need to adjust pricing due to overall marketplace pressures, that's how it would unfold. Conversely, if the economy remains stable without any additional pricing pressure, and we can grow our sales team effectively at our current price levels, we could see some improvement in gross margin in the latter half of the year. It's important to note that when modeling, adjustments must account for the different margin mix in Q4 compared to the other three quarters. Additionally, our Authentication business has a significantly higher gross margin than our Precision Logistics business. If Authentication grows as we expect, an increase in its revenue relative to Precision Logistics would also impact the overall gross margin profile. I realize this is more detailed than you might have anticipated, but I wanted to provide you with all the relevant factors for your modeling. Does that make sense?

Jack Vander Aarde, Analyst

No, no. That makes complete sense, and I very much appreciate the thorough response. It's good to see you guys continue to execute and look forward to tracking the story.

Michael Petusky, Analyst

I didn't catch the first part of the previous question about gross margin, and I want to clarify your response. Were you referring to potential gross margin erosion in the Authentication business only, or did it apply to both?

Adam Stedham, CEO

No. If we consider the current situation as stable, our gross margin should remain steady.

Michael Petusky, Analyst

Yes. Got you.

Adam Stedham, CEO

If we start to experience increased pricing pressure in the marketplace, our strategy will be that we will adjust pricing in accordance with the pressure in the marketplace in order to deliver the revenue growth that we want to deliver. If that happens, we would see some gross margin erosion. We do not believe that we would see bottom line profit erosion because of the offsetting pickup below gross margin. On the other hand, if the economy improves or maintains status quo, we don't expect to see gross margin erosion; accounting for the fact that Q4 has a different product mix and you get a different, you get a different gross margin in Q4 than you do the other quarters. So, except for that one factor.

Michael Petusky, Analyst

Is there a side of your business that you're more concerned about the potential of some pricing pressure impacting through the year?

Adam Stedham, CEO

No, not really. However, I believe it's crucial to focus on targeting the broader market for our revenue growth, as this simplifies the sales process. It's easier to locate customers when they refer more customers. We have identified the market segments we find appealing and those that remain largely unaffected by the overall macroeconomic conditions. Therefore, we are concentrating on those targeted segments, even though this approach results in a somewhat less efficient sales process compared to addressing the broader market. While I wouldn't say there are specific areas of concern, I do anticipate that achieving revenue growth may be more challenging than we initially expected.

Michael Petusky, Analyst

Okay. All right. But all aspects, I mean, my sense is you've essentially affirmed all aspects of prior financial guidance, whether it's top line or cash flow, etc.

Adam Stedham, CEO

Correct. Correct.

Nancy Meyers, CFO

And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to Adam Stedham for any closing remarks.

Adam Stedham, CEO

Thank you. Well, so we do look forward to the remainder of the year, and it's been an exciting journey so far. Our next call will mark the one-year point for me with the company. I look forward to that call. I look forward to sharing the results with you for the second quarter. So thank you, everyone.

Operator, Operator

And thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.