Where Food Comes From Inc

NASDAQ:WFCF

Earnings Call Analysis

Where Food Comes From Shows Stable Growth Despite Challenges

Where Food Comes From reported a slight revenue increase in Q3, rising to $7.1 million due to a 2% uptick in verification services. However, net income fell 32% to $0.5 million, attributed to rising expenses, particularly a 13% increase in SG&A costs. The company anticipates continued headwinds in its beef verification business but expects regulatory changes, like mandatory electronic RFID tagging for cattle, to open a larger market. They predict an additional 10 million cattle will be tagged within a year, potentially leading to a new growth phase in their beef business.

Revenue Overview: A Steady but Slow Climb

Where Food Comes From reported a slight increase in total revenue for the third quarter of 2024, reaching $7.1 million, an uptick from $7 million in the same quarter last year. This growth was primarily driven by a 2% rise in verification and certification services, which garnered $5.5 million compared to $5.4 million a year earlier. Additionally, product revenues increased by 9%, amounting to $1.3 million, up from $1.2 million. However, professional services saw a decline, dropping from $0.4 million to $0.3 million. Over the first nine months, total revenue rose 4% to $9.1 million, indicating steady, albeit modest, growth.

Profitability Metrics: Challenges Ahead

Gross profit for the third quarter shrank slightly to $2.8 million, down from $2.9 million year-over-year. This decline, alongside a 13% increase in selling, general and administrative (SG&A) expenses, which reached $2.2 million due to higher marketing, personnel, and travel costs, led to a 32% year-over-year drop in net income to $0.5 million, translating to $0.09 per diluted share compared to $0.13 last year. Adjusted EBITDA also took a significant hit, decreasing by 29% to $0.8 million from $1.2 million. Year-to-date, net income fell 16% to $1.2 million or $0.21 per diluted share.

Cash Flow and Balance Sheet: A Healthy Position

Despite the challenges faced in revenue and profit margins, Where Food Comes From generated $2.8 million in cash from operations through the first nine months, reflecting a 6% increase from $2.6 million in the previous period. The company's cash and equivalents grew by 4%, reaching $2.8 million as of the end of September. Importantly, the company boasts a solid balance sheet with no long-term debt, which positions it well for future opportunities.

Shareholder Returns: Continuity in Share Buybacks

Where Food Comes From continued its commitment to returning value to shareholders, repurchasing 66,620 shares at a cost of $734,000 during the third quarter. Over the year, the company has bought back a total of 216,039 shares, indicative of its strategy to enhance shareholder value amid ongoing operational adjustments.

Regulatory Impacts: Opportunities from Compliance Changes

Recent regulatory shifts, particularly from the USDA, present new growth opportunities for Where Food Comes From. The USDA's final rule on Animal Disease Traceability mandates that certain cattle must now use electronic RFID tags instead of traditional methods. This transition is expected to significantly expand the company's addressable market, with estimates suggesting an additional 10 million head of cattle will be RFID tagged in the upcoming year, potentially growing to 90 million over the next decade. The company’s strategy leverages this regulatory change to attract new customers to its value-added services, aligning with its growth objectives in the beef verification sector.

Future Outlook: Navigating Challenges and Opportunities

Despite the current headwinds in the beef verification business, Where Food Comes From remains optimistic about its overall business performance. The management expects these headwinds to persist until market conditions improve. However, the ongoing government initiatives, alongside the robust growth in organic product certification processes, equip the company for potential uplifts in revenue. The new Strengthening Organic Enforcement rule is expected to enhance compliance-related service demands, creating additional revenue streams. Therefore, investors should keep a close watch on how these regulatory changes can positively impact the company’s revenue in the near future as it navigates its current landscape.

Earnings Call Transcript 2024-Q3

[Operator]

Greetings, and welcome to Where Food Comes From third quarter earnings conference call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the call over to your host, Jay Pfeiffer, Investor Relations.

[Jay Pfeiffer, executive]

Thank you. Good morning, and welcome to the Where Food Comes From 2024 Third Quarter Earnings Call. Joining me on the call today are CEO, John Saunders; President Leann Saunders; and Chief Financial Officer, Danette Henning.

During this call, we'll make forward-looking statements based on current expectations, estimates and projections that are subject to risk. Statements about current future financial performance, growth strategy, customers, 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 website for more information.

Today, we'll also discuss adjusted EBITDA, a non-GAAP financial measure provided as a complement to GAAP results. Please refer to today's news release for important disclosures regarding non-GAAP measures.

I'll now turn the call over to John Saunders.

[John Saunders, executive]

Good morning, and thanks for joining the call today. Total revenue in the third quarter increased slightly to $7.1 million from $7 million. That included a 2% increase in verification and certification services to $5.5 million from $5.4 million year-over-year. It also included an increase in product revenue, which rose 9% or about $100,000 to $1.3 million from $1.2 million. Professional services revenue declined to $0.3 million from $0.4 million year-over-year. Gross profit in the third quarter declined slightly to $2.8 million from $2.9 million. SG&A increased 13% year-over-year to $2.2 million from $1.9 million, reflecting higher marketing, personnel and travel costs. As a result of the higher fixed costs and lower operating margins, we reported a 32% decline in net income to $0.5 million or $0.09 per diluted share versus $0.7 million or $0.13 per diluted share last year. Adjusted EBITDA in the third quarter was 29% lower at $0.8 million versus $1.2 million. We continued our share buyback program in the third quarter, repurchasing 66,620 shares of stock at a cost of $734,000.

Turning to the 9-month results. Total revenue through 9 months increased 4% to $9.1 million from [ $18.4 million ] in the same period last year. Revenue mix included verification and certification services up 9% to $15.2 million from $13.9 million. Product revenue down 8% to $2.9 million from $3.1 million and professional services revenue of $1 million compared to $1.3 million. Gross profit through 9 months was $7.8 million, up 3% from $7.5 million a year ago. SG&A expense increased 10% to $6.3 million from $5.7 million due to the aforementioned increases in marketing, personnel and travel costs. Operating income year-to-date declined 18% to $1.5 million from $1.8 million. Net income through 9 months decreased 16% to $1.2 million or $0.21 per diluted share compared to net income of $1.4 million or $0.24 per diluted share in the prior year period. Adjusted EBITDA was $2.1 million versus $2.5 million year-over-year.

We generated $2.8 million in cash from operations through 9 months, which was a 6% increase compared to $2.6 million in the same period last year. Our cash and cash equivalents pounds through 9 months increased 4% to $2.8 million from $2.6 million at 2023 year-end. We have a solid balance sheet with no long-term debt. Through the first 9 months of 2024, we bought back 216,039 shares of stock. That total included 135,838 shares as part of our ongoing buyback program and another 80,201 shares in a single private purchase. Given the persistent headwinds in our beef verification business, we're pleased with our overall business performance. We expect those headwinds to continue until the cyclical hertz downsizing begins to cycle back around and the impact of drought conditions subsides.

As you probably know, our Beef business, which includes multiple verification services as well as hardware sales is our largest revenue generator. So I'll reiterate that we're very fortunate to have a diverse non-lead services mix that right now is more than compensating for the temporary slowdown in our beef related revenue.

On another topic, a question we frequently hear from investors is, how might government regulation play into our growth potential, both with our Beef business and other traceability and verification activities. That's a particularly timely question today due to a couple of recent developments relating to USDA activities. We touched on this in our earnings release this morning, but I'd like to provide some more color because we think it's important that investors understand the potential positive impact of these developments. The first involves the USDA's Animal Disease Traceability or ADT program. We've been talking about this for several years and are now able to report some meaningful forward progress with this initiative. In April of this year, the USDA issued its final rule to strengthen procedures and compliance for our animal disease traceability in order to enhance the regulator's ability to manage an animal disease outbreak. A key component of the new role is a requirement that for certain classes of cattle, ranchers transition to electronic RFID tags from the traditional metal clip tag that must be read manually. Beginning last week on November 5, in order to qualify for the interstate transport, [indiscernible] over 18 months, [ dairy caddle ], bulls and certain other animals destined for interstate transfer are required to have electronic RFID tags. As you know, we have required RFID EID tax for years because they allow the beef supply chain to read tags and verify claims at the speed of commerce. These tags are critical to our ability to accurately trace cattle and to ensure that the claims producers are making about their beef products have been verified by an independent third party.

So what does all this mean for Where Food Comes From? Well, in the short term, we're already seeing a positive impact in terms of new [ tag ] customers coming on board. Although this growth has been slower than we'd hoped due to the USDA's decision to provide tags and subsidies to help soften the financial impact of the new requirement. Whether those subsidies are sustainable is yet to be determined because there are a few complicating factors, chief among them, the continuing availability of federal funding and potential tax implications for ranchers. Another important consideration is that these subsidies limit ranchers to vanilla one dimensional tags as opposed to the more versatile, customizable tags that we provide our customers. We also think that there's a high likelihood that some ranchers now transitioning to electronic [indiscernible] for [ principality ] purposes. We'll determine that they may as well take full advantage of those tags by engaging in one or more of our value-added programs to help them capture higher sales for their beef. Our long-term view on this change is the more cattle with RFID tags translate into a much larger addressable market for us over time. We estimate that up to an additional 10 million head of cattle will be RFID tagged over the next year or so with the potential for another 90 million cattle becoming eligible for our value-added programs over the next 10 years. That gives us a lot of runway considering our current annual tag run rate is roughly 2.5 million.

For those of you doing the math, your next question is what percentage of those additional tag cattle will we be able to convert to customers for our value-added services? That's a great question, but one we're not ready to speculate on at this early stage. What I will say is we believe this transition will inevitably lead to new growth phase in our Beef business.

Our second recent example of how government regulation is impacting our business is the new strengthening organic enforcement or SOE rule implemented by the USDA's National organic program. This rule is designed to increase transparency and reduce fraud and organic certification claims. It is the most significant update to the organic [ growth ] regulations since the organic [indiscernible] Production Act of 1990. Specifically, SOE requires domestic brands and producers as well as importers of organic products to comply with new requirements around record-keeping and reporting, supply chain traceability audits, label review, inspections and other processes. In addition, it mandates that other participants in the supply chain entities once exempt from oversight must now comply with the same requirements as the producers and brands themselves. These include brokers, traders, co-manufacturers and other entities.

Our organic business has been a strength for us in recent years as we've dedicated significant resources to new customer acquisition as well as refinement of our [ so organic ] technology platform that directly addresses key requirements of the SOE program at a time when compliance is becoming more challenging and costly. So organic automates the process of achieving an annually renewing organic certification, replacing cumbersome paper-based processes with easy-to-use software that our customers depend on to lower costs and streamline compliance. The software is flexible, nimble, accepting changes in real time that are immediately available on our end.

So as usual, we've got a lot going on across multiple fronts. I'm proud of the work we're doing and how individuals throughout our organization continue to lead the industry in innovating new solutions that benefit producers and consumers of agricultural products in the United States. We believe we are positioned to remain at the forefront of our industries for years to come. With that, I'll turn the call over to questions.

[Operator]

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] At this point, I'd like to turn the call back over to John Saunders for closing comments.

[John Saunders, executive]

Well, thank you all again for your time, and we look forward to talking to you in three months. Have a great fall.

[Operator]

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.