Earnings Call Transcript - VRME Q2 2024

Operator, Operator

Good day, and welcome to the VerifyMe Second 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. Please note today's event is being recorded. I'd now like to turn the conference over to Nancy Meyers, Chief Financial Officer. Please go ahead.

Nancy Meyers, Chief Financial Officer

Good morning, everyone, and thank you for joining us today for our earnings call presentation. On the call today, I am 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

Thank you, Nancy. Welcome, everyone. I'm pleased to report that although Q2 2024 revenue is effectively flat with 2023, we had significant improvement in gross margin, gross profit, and adjusted EBITDA on a gross margin percentage that is noteworthy. This is now the fourth consecutive quarter of positive adjusted EBITDA. Given the previously announced change to a large single contract that was subcontracted to us from FedEx, we anticipate the adjusted EBITDA for Q3 may be slightly negative, but we anticipate H2 and full year positive adjusted EBITDA. We previously announced that we anticipate mid-single-digit revenue growth in 2024 over 2023. As we further evaluate the progress within the authentication segment and the fluctuations in existing customer shipments for Precision Logistics, we now believe 2024 revenue will be roughly in line with 2023, much like H1 2024. With that said, we anticipate our gross profit gross margin percentage and adjusted EBITDA will exceed 2023. I'll address the revenue drivers a bit more in a minute. However, I would like to point out that we continue to have confidence in 2025 because we do not believe the types of unexpected items that have impacted our revenue growth in 2024 are likely to repeat or impact results to the same extent in 2025. Our current cash net of debt is slightly better than this point last year. We anticipate that we will be roughly flat to slightly positive for cash net of debt for 2024, and we continue to have sufficient cash flow to execute all of our organic current growth plans. We continue to have our announced buyback in place, and we're evaluating 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 Precision Logistics segment Q2 2024 revenue is above Q2 2023, just as in Q1 2024. However, the revenue is not experiencing the growth we had previously expected. One contributor to this is the previously announced change to the one FedEx contract. The second factor is that partial shipping volumes in the marketplace are down in 2024 versus 2023. For H1 2024, our shipments with existing customers are down 9% versus H1 2023. However, we've increased our customers within our proactive service line by 7% in H1 2024 versus 2023. So we're pleased with the contribution of our new sales efforts in the interim, but the incremental contribution has been offset thus far by year-over-year reductions in volume with existing customers. In time, we anticipate these volumes will increase and add to the growth contributed to our new sales efforts. For now, we're in a market in which our strongest opportunity to grow our revenues is by expanding our existing customer base. We continue to focus our efforts on adding new customers in the region between Maine and Pennsylvania. That's our plan for the remainder of 2024 and then expanded into 2025. We did add two additional sales representatives as we announced, and we expected to hire on our last call. We continue to believe our plans for 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 our plans for geographic expansion in 2025. Now, let me shift to the authentication segment for a bit. We've made significant progress on a very involved effort to formalize our relationship with Amazon. I realize that the effort has taken longer than we anticipated, but we believe the time and energy we're dedicating to this initiative is critical and is a crucial element of our plan to deliver meaningful shareholder value. We anticipated this process and the subsequent revenue generation would occur sooner, but the length of the process does not in any way undermine the long-term opportunity associated with the relationship. We continue to believe our relationship with Amazon creates significant opportunity to create value for Amazon, our mutual customers and consumers of our customers' brands, and most importantly, for you, VerifyMe shareholders. In addition to the Amazon relationship, we continue to see positive trends for our APAC business, our other strategic relationships, regulatory controls, and ink sales. We anticipate that our H2 and full-year 2024 revenues for authentication will exceed our revenues for the same period in 2023, and I look forward to updating you on these important events as time goes on in the near future. At this point, I'd like to turn the call back over to Nancy Meyers, our CFO, to provide a more detailed financial report.

Nancy Meyers, Chief Financial Officer

Thank you, Adam. The second quarter revenue was $5.4 million versus the prior year of $5.3 million. Revenue effectively remained flat in both our Precision Logistics and Authentication segments. Gross profit increased by $0.5 million, or 32%, to $2.1 million in Q2 2024 versus $1.6 million in Q2 2023. As a percentage of revenue, gross margin increased to 39% in 2024 versus 30% in 2023. The year-over-year increase in gross profit continues to reflect the shift in customer mix and service offerings in our Precision Logistics segment, as well as process improvements the company has made. As a result of the previously announced change to one significant subcontract from FedEx, we anticipate H2 gross margins to be below H1 2024. We anticipate our full-year 2024 gross margin to exceed full-year 2023, and Q4 gross margin percentage will be below Q3 due to seasonality associated with our proactive revenue. Overall, our operating expenses were effectively flat year-over-year at $2.6 million. Our net loss for the quarter improved by $0.6 million to a loss of $0.3 million or a loss of $0.03 per diluted share versus a loss of $9 million in Q2 2023 or a loss of $0.09 per diluted share. Our adjusted EBITDA increased by $0.6 million to a positive $0.2 million for the second quarter of 2024. On the last slide is our balance sheet as of June 30, 2024. Our cash as of June 30 is $2.9 million, a decrease of $0.2 million from $3.1 million on December 31, 2023. During the first six months of 2024, our use of cash included $0.3 million in repayment of debt and interest. Due to the seasonality of our Precision Logistics segment, our accounts receivable, unbilled revenue, and accounts payable are higher at year-end compared to the other three quarters. As of June 30, 2024, we have $1.1 million remaining on our loan 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. I've now been with the company for about a year, and I continue to be focused on pivoting from transformation to growth. The marketplace adoption of authentication and traceability services continues to be slower than we desire. Additionally, we faced some headwinds from partial shipping volumes. With that said, we've not shied away from the hard work of moving the company forward. We have a healthy balance sheet, a sales strategy that is taking firm hold, and key relationships that are being formalized. Our positioning in the marketplace is growing stronger than it's ever been. At this point, let's turn the call over, and I'm happy to answer any questions.

Operator, Operator

Thank you. We will now start the question-and-answer session. The first question today comes from Jack Vander Aarde with Maxim Group. Please go ahead.

Jack Vander Aarde, Analyst

Okay. Great. Thank you. Good morning, Adam and Nancy.

Adam Stedham, CEO

Hey, how are you doing?

Jack Vander Aarde, Analyst

I’m doing well. Congrats, I know the guidance you had to lower it a little bit, but it's good to see a fourth consecutive positive adjusted EBITDA quarter since you've taken over. I am aware of your comments. It sounds like the third quarter EBITDA loss could be a slight loss. So I understand that, but good to see that it's supposed to be positive for the year. I'd really like to get your comments and just your perspective on your experience and expectations following the GS1 conference. Any takeaways you had? Thanks.

Adam Stedham, CEO

That’s a great question. It was certainly interesting. One major takeaway is that we have been affected this year similarly to others. The regulations, particularly the Food Safety Modernization Act, have resulted in a much slower transition from barcodes to more advanced coding systems than anticipated. Many discussions at conferences focused on this slow progress. It seems that many companies are adopting a cautious stance due to the election year uncertainties. They have until the start of 2026 for full adoption, with 2027 as a deadline for some. Consequently, many firms are opting to wait and see, which has delayed the adoption and, in turn, has affected revenue growth for suppliers in the market. This is an important point. However, looking at the bigger picture, there is currently no sign that the deadlines will be postponed, which gives us hope for 2025. Many customers are actively planning and budgeting for 2025, preparing for the requirements set to begin in January 2026. I found this to be an intriguing and insightful overview of the industry dynamics.

Jack Vander Aarde, Analyst

Okay, thank you for that information. I appreciate your optimism about 2025, even though growth might be flat in 2024. I want to revisit the 5-year target plan you presented at your Investor Day. How do you feel about those targets now? I believe the plan aims for a 17% compound annual growth rate over five years and adjusted EBITDA margins of over 15%. Are you still on track as you approach 2025? Thanks.

Adam Stedham, CEO

So I do feel good about that, assuming that the regulatory environment doesn't experience significant changes and the marketplace and society continue to move forward in terms of food safety and modernization in the shift from barcodes. We've recognized that some subcontracted work from FedEx was not going to continue to grow. We indicated they were working on an AI solution internally, and they wouldn't continue to be long-term dependent upon us. It hit us faster this year than we anticipated, but we didn't expect that growth to continue throughout the 5-year period. We anticipated our growth coming from our proactive business. The salespeople we've hired are excited about the pipeline and have shown growth. This year, it's offset by reductions from our existing customer base, but over a 5-year period, we believe that as those incremental sales continue to come in, we will see growth as the existing customer base goes through the normal economic cycles, and we can expect to see those shipments return. We feel very confident on that side. So with Precision Logistics, we feel very strong there on the authentication side as long as there are no significant changes to the regulatory drivers that we believe are going to drive this business. We continue to have confidence as well.

Jack Vander Aarde, Analyst

Okay. Great. Very much appreciate the color there. And just one more point, just kind of to clarify just because I may have missed it. Did I hear correctly? Parcel shipments from existing customers in H1 2024 are down 9% year-over-year, but shipments from new customers were up 7% year-over-year. Is that correct?

Adam Stedham, CEO

Not exactly. Our shipment volumes are down 9% year-over-year. Our total new users are up 7%. So we've added a significant number of customers. On one hand, I'm comparing volumes with existing customers year-over-year, and on the other hand, I'm comparing the total number of customers year-over-year.

Jack Vander Aarde, Analyst

Got it. Very much appreciate the clarity there. Makes sense. Well, I appreciate the update and glad to hear you have sufficient cash to continue organic growth objectives. Thanks, Adam.

Adam Stedham, CEO

Thank you.

Operator, Operator

Thank you. And our next question today comes from Michael John Petusky with Barrington Research. Please go ahead.

Michael Petusky, Analyst

Good morning. I'm curious if there was any impact from the FedEx Premium business this quarter, or if that business operated normally through June, or if it influenced the quarter in any way.

Adam Stedham, CEO

It did. It did come into the quarter. It transitioned between midway and two-thirds through the quarter is when it transitioned.

Michael Petusky, Analyst

Okay. Is there any quantification of that impact by any chance?

Adam Stedham, CEO

I don't think we've put any quantification out publicly on that.

Michael Petusky, Analyst

Okay. All right. And then your comments on '25, I'm just curious, there's additional premium business at FedEx, I don't believe did transition, but remains. I'm curious if your '25 comments suggest that you've been given any sense that the remaining premium business will continue for the foreseeable future?

Adam Stedham, CEO

I can't provide a direct answer, but I can give you an indirect response. We are very pleased with our relationship with FedEx, and they are open with us about their strategies. We stay informed about the renewal timelines of existing contracts with our shared customers and consider those timelines alongside the strategies FedEx has communicated to us. This understanding contributes to our confidence regarding 2025.

Michael Petusky, Analyst

I think we're only talking about maybe a couple of contracts, right, that remain there that make up a couple of million dollars of premium?

Adam Stedham, CEO

Right. There's a small number, yeah. It's only just few contracts.

Michael Petusky, Analyst

Okay. So can I ask just for longer-term modeling? I mean, do those contracts start to come up in '26? Is that essentially how we should sort of read your comment?

Adam Stedham, CEO

Yeah, that's how I would think about it from a modeling perspective.

Michael Petusky, Analyst

Okay. Intuitively then, I would assume that it may be prudent to assume kind of a couple of million dollar drag in '26 if one was modeling out multiple years here. Is that fair?

Adam Stedham, CEO

From a modeling perspective, I think that's a reasonable approach. It's challenging to predict six months ahead, let alone a year and a half from now. Additionally, there's something to consider: during our Strategy Day, we discussed three types of revenues. First is proactive revenue, where we're actively selling to customers and effectively subcontracting FedEx. Then there's traditional premium revenue, where FedEx subcontracts us, which yields higher gross margins due to its structure. Lastly, we have the direct premium segment of our business, which was small at the time of our Strategy Day. This segment is currently being sold by our new sales force and is showing the most significant percentage growth for us, even though it's still relatively small. Direct premium means we receive payments from customers and operate at a much higher gross margin since we don’t incur additional costs related to servicing it. FedEx has a shipping contract with them, so those shipping costs do not come through us. They engage us directly for all the value-added services beyond shipping. While direct premium is growing, I believe that over time, the model should indicate a decrease as FedEx continues to subcontract us. I hope to provide more guidance on the growth of the premium segment in the upcoming quarter, as it is expanding meaningfully. It's still too early, and we lack sufficient data to offer guidance for 2025 and 2026, but we aim to have that information ready for our next call.

Michael Petusky, Analyst

Adam, can I just ask a quick question on that? How much of the remaining premium business is direct premium? What percentage, like 10% a quarter? I mean what percentage is direct premium?

Adam Stedham, CEO

I don't have an exact number, and I don't want to provide something inaccurate during this call because I know you'll use it in your modeling. We'll share that number with you so you can include it in your model. Is that helpful?

Michael Petusky, Analyst

Absolutely. I mean it's fair to say, no, it's not the majority.

Adam Stedham, CEO

Correct. Right, right. Absolutely. It's on the smaller percentage side of it. But we'll get it and we'll get it to both of the analysts, right? Just so you both have it for modeling.

Michael Petusky, Analyst

Adam, for my last question, I want to follow up on the previous analyst's inquiry about the long-term targets. I wouldn't interpret your comments as a confirmation of the targets shared during Investor Day. Is it reasonable to say that those targets are now more aspirational, and that you might not be entirely comfortable asserting that you've confirmed the 5-year targets? Is that a fair assessment?

Adam Stedham, CEO

I think that's fair. I think, in essence, we're on track for our efficiency gains and margin improvement. We are on track for our strategy. We're not over a 5-year period significantly changed by the FedEx subcontracting model, all of that. With that said, obviously, we're not achieving the revenue that we desired this year. So it does push things back a little bit in the model. So I don't necessarily think that the trajectory of the model is shifting, but the starting point of the model is moving to the right a bit because the revenue gains aren't materializing this year as we had anticipated.

Michael Petusky, Analyst

Can you share your thoughts on the authentication process and your relationship with Amazon? Are you optimistic that you'll be able to formalize that relationship by the end of the year or by the next reporting period?

Adam Stedham, CEO

Yes, definitely by year-end. Quite transparently, we anticipated we would have it by now. It's complicated, but just because it's complicated, it doesn't mean that it's not valuable. It just means that it's taking more time than we expected. Without a doubt, by year-end, I would anticipate that.

Michael Petusky, Analyst

Is this the kind of relationship that you feel like essentially is bigger than the run rate of the business? I mean, is it of that magnitude?

Adam Stedham, CEO

Absolutely. If it comes together as planned, it should have a significant impact. I believe that the relationship will change the way we operate in that business. It's a transformative relationship that will enhance what we can offer and the value we can deliver to specific consumers. It definitely alters the dynamics of that part of the business.

Michael Petusky, Analyst

Okay. Terrific, alright. Thank you so much. Really helpful.

Adam Stedham, CEO

Thanks.

Nancy Meyers, Chief Financial Officer

And Mike, just to give you an update.

Adam Stedham, CEO

Up.

Nancy Meyers, Chief Financial Officer

Sorry, Mike, just to give you the direct premium number, it's running about 10%.

Operator, Operator

Sorry about that ma’am. Our next question today comes from Jeff Porter of Porter Capital Management. Please go ahead.

Unidentified Analyst, Analyst

Hey, Adam.

Adam Stedham, CEO

Hey Jeff, how are you?

Unidentified Analyst, Analyst

Good. I’m wondering if you can elaborate on the Amazon perspective relationship—what gives us a competitive advantage there? And are you seeing others that we're competing with for that business?

Adam Stedham, CEO

If there were others competing for the business, that could happen without our knowledge. I want to be transparent about that. However, we currently believe we are the only ones working on this, based on the facts and conversations we've had so far. We don't expect to be the only ones forever; that would be naive. But as of now, we are the only ones. Our confidence stems from what was previously announced, not necessarily by us, but by one of our customers—we have already demonstrated a proof of concept with one of our customers that is integrated and going live. That gives us a sense of overall confidence.

Unidentified Analyst, Analyst

Great. And could you speak to what the margins on this business prospectively would be?

Adam Stedham, CEO

Not exactly. The margins will be roughly in line with our authentication margins overall. It won't vary tremendously from our existing margins. Much of the margin depends upon the actual go-to-market strategy. If we have a customer that wants just codes, that would command extremely high gross margins. If they want codes that we put on a label and they buy an integrated label with codes, then there would be lower margin because we can't demand the same margin on a label markup that we can on the intellectual property associated with the codes. So it's difficult for us to predict because we don't know the product mix between label and non-label that consumers or brands will go with. Based upon that, if we assume it will follow the traditional pattern of the authentication business, then you could model that the gross margins would stay intact with what authentication generates right now.

Unidentified Analyst, Analyst

Okay, that’s helpful. Thank you.

Adam Stedham, CEO

Thank you.

Operator, Operator

Thank you. And this concludes our question-and-answer session. I'd like to turn the conference back over to the company for any closing remarks.

Adam Stedham, CEO

Thank you very much for that. As I said, it's been about a year. It's been a really educational year for me, and we're sitting here. I do believe that we're on track from a strategy perspective. We're on track from an efficiency perspective and in many of our sales efforts. We're on track from an incremental sales perspective, but those sales have been counterbalanced by some headwinds in part of the business. None of that changes the optimism on the Precision Logistics side to realize the growth that we expect to realize over time. On the Authentication side, we're dealing with a business that continues to be very small, very subscale dependent upon key relationships that will give us tremendous leverage. As there's been delays formalizing those relationships, it has delayed our leverage. Nonetheless, we do believe those relationships are going to materialize, and that will result in the leverage that we need to allow this subscale business to grow in a very meaningful way. I look forward to giving updates on the next call. Ideally, we anticipate there will be updates between now and then as well. Thank you very much.

Operator, Operator

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.