Notes to the Consolidated Financial
Statements
(Unaudited)
Recently
Issued Accounting Pronouncements
Lease
Accounting
In
February 2016, the FASB issued ASU 2016-02, “Leases”, which will require lessees to recognize a right-of-use asset
and a lease liability for all leases that are not short-term in nature. For a lessor, the accounting applied is also largely unchanged
from previous guidance. The new rules will be effective for the Company in the first quarter of 2019. The Company is currently
in the process of evaluating the impact of adoption of the new rules on the Company’s financial condition, results of operations
and cash flows. Although the evaluation is ongoing, the Company expects that the adoption will impact the Company’s financial
statements as the standard requires the recognition on the balance sheet of a right of use asset and corresponding lease liability.
The Company is currently analyzing its contracts to determine whether they contain a lease under the revised guidance and has
not quantified the amount of the asset and liability that will be recognized on the Company’s balance sheet.
Revenue
from Contracts with Customers
In
May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”, which supersedes current
revenue recognition requirements and industry-specific guidance. The codification was amended through additional ASUs and, as
amended, requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects
the consideration the entity expects to be entitled to in exchange for those goods or services. The Company is required to adopt
the new standard in 2018 and may adopt either retrospectively to each prior reporting period presented or as a cumulative-effect
adjustment as of the date of adoption using one of two retrospective application methods. The Company has developed an approach
for the implementation of the guidance including a review of all revenue streams to identify any differences in timing, measurement
or presentation of revenue recognition. While the Company is still in the process of completing its evaluation of the standard,
it currently believes the most significant impact will be related to accounting for its software license, maintenance and support
revenue, and the timing in which those revenues are recognized.
Clarifying
the Definition of a Business
In
January 2017, the FASB issued ASU 2017-01, “Clarifying the Definition of a Business,” which provides guidance on evaluating
whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The ASU amends ASC 805 to
provide a more robust framework to use in determining when a set of assets and activities is a business. In addition, the amendments
provide more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more
operable.
The new guidance will be effective
for the Company in the first quarter of 2018.
The Company is currently evaluating the provisions
of this new guidance and
has not determined the impact this standard may have on its financial condition, results of operations,
cash flows and related disclosures.
Simplifying
the Test for Goodwill Impairment
In
April 2017, the FASB has issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which removes step 2
from the goodwill impairment test. As a result, under the ASU, “an entity should perform its annual, or interim, goodwill
impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge
for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should
not exceed the total amount of goodwill allocated to that reporting unit.”
The
Company is required to adopt the new standard in 2020.
The Company is currently evaluating the
provisions of this new guidance and
has not determined the impact this standard may have on its financial condition, results
of operations, cash flows and related disclosures.
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
Note
2 – Business Acquisitions
SureHarvest
Acquisition
On
December 28, 2016,
we entered into an Asset Purchase
Agreement (the “SureHarvest Purchase Agreement”), by and among the Company, SureHarvest Services LLC (the “Buyer”
or “SureHarvest”); and SureHarvest, Inc., a California corporation (the “Seller” or “SureHarvest,
Inc.”). We acquired substantially all the assets of the Seller. SureHarvest develops software and provides services related
to sustainability measurement and benchmarking, traceability, verification and certification to the food and agriculture industries.
Pursuant
to the SureHarvest Purchase Agreement, WFCF purchased the business assets of the Seller for total consideration of approximately
$2.8 million, comprised of approximately $1,122,000 in cash and 850,852 shares of common stock of WFCF valued at approximately
$1,710,000 based on the closing price of our stock on December 28, 2016, of $2.01 per share. Additionally, we issued the Seller
a 40% membership interest in SureHarvest, with the Company holding a 60% interest.
Following
the thirty-six-month anniversary of the effective date of the SureHarvest Purchase Agreement, the Company shall have the option,
but not the obligation, to purchase all the units (the 40% interest) of SureHarvest held by the Seller, and the Seller shall have
the option, but not the obligation, to require the Company to purchase all the units of SureHarvest held by the Seller. The purchase
price for the units shall be equal to the amount the selling holders of the units would be entitled to receive upon a liquidation
of the SureHarvest assuming all of the assets of SureHarvest are sold for a purchase price equal to the product of eight and half
times trailing twelve-month earnings before income taxes, depreciation and amortization, as defined, subject to an $8 million
ceiling.
Because
SureHarvest, Inc. at its option, can require the Company to purchase its 40% interest in SureHarvest, the SureHarvest non-controlling
interest meets the definition of a contingently redeemable non-controlling interest. Redeemable non-controlling interests are
presented at the greater of their carrying amount or redemption value at the end of each reporting period and are shown as a separate
caption between liabilities and equity (mezzanine section) in the accompanying consolidated balance sheet.
The
following unaudited pro forma information presents the results of operations for the three and six months ended June 30, 2016,
as if the acquisition of SureHarvest had occurred on January 1, 2016. This pro forma information does not reflect any integration
activities or cost savings from operating efficiencies, synergies, asset dispositions or other restructurings that could result
from the acquisition, nor does it purport to represent what the Company’s actual results would have been if the acquisition
had occurred as of the date indicated or what such results would be for any future periods.
|
|
Three months
|
|
|
Year to date
|
|
|
|
ended
|
|
|
ended
|
|
|
|
June 30, 2016
|
|
|
June 30, 2016
|
|
Total revenue
|
|
$
|
3,069,425
|
|
|
$
|
5,890,219
|
|
Net income attributable to Where Food Comes From, Inc.
|
|
$
|
98,295
|
|
|
$
|
167,810
|
|
Basic and diluted earnings per share
|
|
$
|
*
|
|
|
$
|
0.01
|
|
* less than $0.01 per share
|
|
|
|
|
|
|
|
|
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
A
Bee Organic Acquisition
On
May 30, 2017, we acquired A Bee Organic for $150,000 in cash and 45,684 shares of common stock of WFCF valued at approximately
$98,000 based on the closing price of our stock on May 30, 2017, of $2.15 per share. The acquisition primarily consisted of the
existing customer relationships and represents further expansion of our verification and certification solutions into hydroponics/aquaponics
and apiary spaces. We believe the total consideration paid approximates the fair value of the assets acquired. We have allocated
the total consideration to our identifiable intangible assets to be amortized over an estimated useful life of 8 years.
Note
3 – Basic and Diluted Net Income per Share
Basic
net income per share was computed by dividing income available to common shareholders by the weighted average number of common
shares outstanding during the period. Diluted net income per share is based on the assumption that all dilutive convertible shares
and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method,
options and restricted stock awards are assumed to be exercised at the beginning of the period (or at the time of issuance, if
later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.
The
following is a reconciliation of the share data used in the basic and diluted income per share computations:
|
|
Three months ended
June 30,
|
|
|
Year to date ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
24,664,882
|
|
|
|
23,854,451
|
|
|
|
24,656,398
|
|
|
|
23,803,657
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
24,664,882
|
|
|
|
23,854,451
|
|
|
|
24,656,398
|
|
|
|
23,803,657
|
|
Weighted average effects of dilutive securities
|
|
|
157,681
|
|
|
|
151,815
|
|
|
|
146,166
|
|
|
|
149,278
|
|
Total
|
|
|
24,822,563
|
|
|
|
24,006,266
|
|
|
|
24,802,564
|
|
|
|
23,952,935
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Antidilutive securities:
|
|
|
94,000
|
|
|
|
668
|
|
|
|
94,000
|
|
|
|
24,418
|
|
The
effect of the inclusion of the antidilutive shares would have resulted in an increase in earnings per share. Accordingly, the
weighted average shares outstanding have not been adjusted for antidilutive shares.
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
Note
4 – Intangible and Other Assets
The
following table summarizes our intangible and other assets:
|
|
June 30,
|
|
|
December 31,
|
|
|
Estimated
|
|
|
2017
|
|
|
2016
|
|
|
Useful life
|
Intangible assets subject to amortization:
|
|
|
|
|
|
|
|
|
|
|
Tradenames and Trademarks
|
|
$
|
282,307
|
|
|
$
|
282,307
|
|
|
2.5 - 8.0 years
|
Accreditations
|
|
|
88,663
|
|
|
|
88,663
|
|
|
5.0 years
|
Customer Relationships
|
|
|
3,084,551
|
|
|
|
2,836,330
|
|
|
8.0 - 15.0 years
|
Beneficial Lease Arrangement
|
|
|
120,200
|
|
|
|
120,200
|
|
|
11.0 years
|
Patents
|
|
|
970,100
|
|
|
|
970,100
|
|
|
4.0 years
|
|
|
|
4,545,821
|
|
|
|
4,297,600
|
|
|
|
Less accumulated amortization
|
|
|
810,305
|
|
|
|
547,917
|
|
|
|
|
|
|
3,735,516
|
|
|
|
3,749,683
|
|
|
|
Tradenames/trademarks (not subject to amortization)
|
|
|
465,000
|
|
|
|
465,000
|
|
|
|
|
|
|
4,200,516
|
|
|
|
4,214,683
|
|
|
|
Deposit
|
|
|
13,545
|
|
|
|
13,545
|
|
|
|
|
|
$
|
4,214,061
|
|
|
$
|
4,228,228
|
|
|
|
Note
5 – Stock-Based Compensation
In
addition to cash compensation, the Company may compensate certain service providers, including employees, directors, consultants,
and other advisors, with equity based compensation in the form of stock options and restricted stock awards. The Company recognizes
all equity-based compensation as stock-based compensation expense based on the fair value of the compensation measured at the
grant date. For stock options, fair value is calculated using the Black-Scholes-Merton option pricing model. For restricted stock
awards, fair value is the closing stock price for the Company’s common stock on the grant date. The expense is recognized over
the vesting period of the grant. For the periods presented, all stock-based compensation expense was classified as a component
within selling, general and administrative expense in the Company’s statements of income.
The
amount of stock-based compensation expense is as follows:
|
|
Three months ended June 30,
|
|
|
Year to date ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Stock options
|
|
$
|
14,722
|
|
|
$
|
8,616
|
|
|
$
|
29,413
|
|
|
$
|
20,422
|
|
Restricted stock awards
|
|
|
29,691
|
|
|
|
18,598
|
|
|
|
60,057
|
|
|
|
36,405
|
|
Total
|
|
$
|
44,413
|
|
|
$
|
27,214
|
|
|
$
|
89,470
|
|
|
$
|
56,827
|
|
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
As
of June 30, 2017, the estimated unrecognized compensation cost from unvested awards which will be recognized ratably over the
remaining vesting phase is as follows:
Years ended December 31st:
|
|
|
Unvested stock
options
|
|
|
Unvested
restricted stock
awards
|
|
|
Total
Unrecognized
Compensation
Expense
|
|
2017 (six months remaining)
|
|
|
$
|
29,401
|
|
|
$
|
57,986
|
|
|
$
|
87,387
|
|
2018
|
|
|
|
58,695
|
|
|
|
81,001
|
|
|
|
139,696
|
|
2019
|
|
|
|
53,552
|
|
|
|
25,046
|
|
|
|
78,598
|
|
|
|
|
$
|
141,648
|
|
|
$
|
164,033
|
|
|
$
|
305,681
|
|
Equity
Incentive Plans
Our
2016 Equity Incentive Plan (the “Equity Incentive Plan”) provides for the issuance of stock-based awards to employees,
officers, directors and consultants. The Plan permits the granting of stock awards and stock options. The vesting of stock-based
awards is generally subject to the passage of time and continued employment through the vesting period.
Stock
Option Activity
Stock
option activity under our Equity Incentive Plan is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Avg.
|
|
|
|
|
|
|
|
|
|
|
Weighted Avg.
|
|
|
Weighted Avg.
|
|
|
Remaining
|
|
|
|
|
|
|
|
Number of
|
|
|
Exercise Price
|
|
|
Fair Value
|
|
|
Contractual Life
|
|
|
Aggregate
|
|
|
|
|
Awards
|
|
|
per Share
|
|
|
per Share
|
|
|
(in years)
|
|
|
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, December 31, 2016
|
|
|
|
273,586
|
|
|
$
|
1.22
|
|
|
$
|
1.22
|
|
|
|
7.05
|
|
|
$
|
217,892
|
|
Granted
|
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
|
|
|
|
Exercised
|
|
|
|
(7,001
|
)
|
|
$
|
1.17
|
|
|
$
|
1.24
|
|
|
|
6.01
|
|
|
|
|
|
Expired/Forfeited
|
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
—
|
|
|
|
|
|
Outstanding, June 30, 2017
|
|
|
|
266,585
|
|
|
$
|
1.22
|
|
|
$
|
0.85
|
|
|
|
6.57
|
|
|
$
|
289,228
|
|
Exercisable, June 30, 2017
|
|
|
|
172,585
|
|
|
$
|
0.86
|
|
|
$
|
0.87
|
|
|
|
4.99
|
|
|
$
|
249,748
|
|
Unvested, June 30, 2017
|
|
|
|
94,000
|
|
|
$
|
1.89
|
|
|
$
|
1.87
|
|
|
|
9.46
|
|
|
$
|
39,480
|
|
The
aggregate intrinsic value represents the total pre-tax intrinsic value (the aggregate difference between the closing price of
our common stock on June 30, 2017 and the exercise price for the in-the-money options) that would have been received by the option
holders if all the in-the-money options had been exercised on June 30, 2017.
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
Restricted
Stock Activity
Restricted
stock activity under our Equity Incentive Plan is summarized as follows:
|
|
|
|
|
|
Weighted Avg
|
|
|
|
|
Number of
|
|
|
Grant Date
|
|
|
|
|
Options
|
|
|
Fair Value
|
|
Non-vested restricted shares, December 31, 2016
|
|
|
|
136,000
|
|
|
$
|
2.44
|
|
Granted
|
|
|
|
—
|
|
|
$
|
—
|
|
Vested
|
|
|
|
(4,000
|
)
|
|
$
|
2.10
|
|
Forfeited
|
|
|
|
—
|
|
|
$
|
—
|
|
Non-vested restricted shares, June 30, 2017
|
|
|
|
132,000
|
|
|
$
|
2.45
|
|
Note
6 – Income Taxes
Deferred
tax assets and liabilities have been determined based upon the differences between the financial statement amounts and the tax
bases of assets and liabilities as measured by enacted tax rates expected to be in effect when these differences are expected
to reverse. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that
some portion or all of the deferred tax assets will not be realized. Our net operating loss (“NOL”) carry forwards
are the most significant component of our deferred tax assets; however, the ultimate realization of our deferred tax assets is
dependent upon generation of future taxable income. We consider past history, the scheduled reversal of taxable temporary differences,
projected future taxable income, and tax planning strategies in making this assessment. Utilization of our NOL carry forwards
reduces our federal and state income tax liability incurred.
The
Company’s subsidiary, SureHarvest, is a California limited liability company (“LLC”). As an LLC, management
believes SureHarvest is not subject to income taxes, and such taxes are the responsibility of the respective members.
The
provision for income taxes is recorded at the end of each interim period based on the Company’s best estimate of its effective
income tax rate expected to be applicable for the full fiscal year. For the three months ended June 30, 2017, we recorded an income
tax benefit of $52,000 compared to income tax expense of $80,000 for the 2016 period. For the year to date period ended June 30,
2017, we recorded an income tax benefit of $49,000 compared to income tax expense of $129,950 for the 2016 period.
Note
7 – Commitments and Contingencies
Unison
Revolving Line of Credit
The
Company has a revolving line of credit (“LOC”) agreement which matures April 12, 2020. The LOC provides for $75,080
in working capital. The interest rate is at the Wall Street Journal prime rate plus 1.50% and is adjusted daily. Principal and
interest are payable upon demand, but if demand is not made, then annual payments of accrued interest only are due, with the principal
balance due on maturity. As of June 30, 2017, the effective interest rate was 5.5%. The LOC is collateralized by all the business
assets of ICS. As of June 30, 2017, there were no amounts outstanding under this LOC.
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
Operating
Leases & Lease Incentive Obligation
The
Company relocated its headquarters within Castle Rock, Colorado, during the third quarter 2016 and entered into a new lease agreement
for approximately 8,000 square feet of office space. This space is being leased from a company in which our CEO and President,
each a related party to the Company, have a 27% ownership interest. The lease agreement has an initial term of five years plus
two renewal periods, which the Company is more likely than not to renew. The office space lease term commenced August 1, 2016.
Rental payments are approximately $19,000 per month, which includes common area charges, and provides for escalating rental payments
annually over the term of the lease. The Company recognizes rent expense on a straight-line basis over the non-cancelable lease
term and option renewal periods. The resulting deferred rent is included in accrued expenses and other current liabilities on
the consolidated balance sheet. The Company recorded leasehold improvements of approximately $406,400, which included approximately
$163,000 in lease incentives. Leasehold improvements are included in property and equipment on the consolidated balance sheet.
Lease incentives have been included in lease incentive obligation as a long-term liability on the consolidated balance sheet and
will reduce rent expense on a straight-line basis over 15 years. Lease incentives are excluded from minimum lease payments in
the schedule below.
As
of June 30, 2017, future minimum lease payments for all operating leases are as follows:
Years ended December 31st:
|
|
|
Total
|
|
2017 (remaining six months)
|
|
|
$
|
122,540
|
|
2018
|
|
|
|
220,749
|
|
2019
|
|
|
|
227,060
|
|
2020
|
|
|
|
233,871
|
|
2021
|
|
|
|
240,888
|
|
Thereafter
|
|
|
|
2,707,132
|
|
Total lease commitments
|
|
|
$
|
3,752,240
|
|
Legal
proceedings
From
time to time, we may become involved in various legal actions, administrative proceedings and claims in the ordinary course of
business. We generally record losses for claims in excess of the limits of purchased insurance in earnings at the time and to
the extent they are probable and estimable. We are not aware of any legal actions currently pending against us.
Note
8 – Contingently Redeemable Non-Controlling Interest
Contingently
redeemable non-controlling interest on our consolidated balance sheet represents the non-controlling interest related to the SureHarvest
acquisition, in which the non-controlling interest holder, at its election, can require the Company to purchase its 40% investment
in SureHarvest. Below is a table reflecting the activity of the contingently redeemable non-controlling interest at June 30, 2017.
|
|
|
|
Balance, December 31, 2016
|
|
$
|
1,888,135
|
|
Net loss attributable to non-controlling interest in SureHarvest for the six months ended June 30, 2017
|
|
|
(248,792
|
)
|
Balance, June 30, 2017
|
|
$
|
1,639,343
|
|
The
contingently redeemable non-controlling interest was adjusted to the greater of the carrying value or redemption value as of each
period end.
Where Food Comes From, Inc.
Notes to the Consolidated Financial
Statements
(Unaudited)
Note
9 – Supplemental Cash Flow Information
|
|
Year to date ended
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Cash paid for:
|
|
|
|
|
|
|
|
|
Interest expense
|
|
$
|
316
|
|
|
$
|
697
|
|
Income taxes
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
Common stock issued for remaining interest in Validus Verification Services LLC
|
|
$
|
—
|
|
|
$
|
200,072
|
|
Equipment acquired under a capital lease
|
|
$
|
—
|
|
|
$
|
22,439
|
|
Common stock issued in acquisition of A Bee Organic
|
|
$
|
98,221
|
|
|
$
|
—
|
|
Common stock issued for acquisition-related consulting fess
|
|
$
|
25,000
|
|
|
$
|
—
|
|
ITEM
2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
This
information should be read in conjunction with the consolidated financial statements and the notes included in Item 1 of Part
I of this Quarterly Report and the audited consolidated financial statements and notes, and Management’s Discussion and
Analysis of Financial Condition and Results of Operations, contained in the Form 10−K for the fiscal year ended December
31, 2016. The following discussion and analysis includes historical and certain forward−looking information that should
be read together with the accompanying consolidated financial statements, related footnotes and the discussion below of certain
risks and uncertainties that could cause future operating results to differ materially from historical results or from the expected
results indicated by forward−looking statements.
Business
Overview
Where
Food Comes From, Inc. and its subsidiaries (“WFCF”, “the Company”, “our”, “we”,
or “us”) is a leading trusted resource for third-party verification of food and agricultural production practices
in North America. The Company supports more than 12,000 farmers, ranchers, vineyards, wineries, processors, retailers, distributors,
trade associations and restaurants with a wide variety of value-added services provided through its family of verifiers, including
IMI Global, International Certification Services (“ICS”), Validus Verification Services (“Validus”), Sterling
Solutions, SureHarvest Services (“SureHarvest”), and our newest acquisition, A Bee Organic. In order to have credibility,
product claims such as gluten-free, non-GMO, non-hormone treated, humane handling, and others require verification by an independent
third-party such as WFCF. The Company’s principal business is conducting both on-site and desk audits to verify that claims
being made about livestock, food, other high-value specialty crops and agricultural products are accurate. In addition, the Company’s
Where Food Comes From Source Verified® retail and restaurant labeling program utilizes the verification of product attributes
to connect consumers directly to the source of the product they purchase through product labeling and web-based information sharing
and education. With the use of Quick Response Code (“QR”) technology, consumers can instantly access information about
the producers behind their food.
WFCF
was founded in 1996 and incorporated in the state of Colorado as a subchapter C corporation in 2005. The Company’s shares
of common stock trade on the OTCQB marketplace under the stock ticker symbol, “WFCF”.
The
Company’s original name – Integrated Management Information, Inc. (d.b.a. IMI Global, Inc.) – was changed to
Where Food Comes From, Inc. in 2012 to better reflect the Company’s mission. Early growth was attributable to source and
age verification services for beef producers who wanted access to markets overseas following the discovery of “mad cow”
disease in the U.S. Over the years, WFCF has expanded its portfolio to include verification and software services for most food
groups and 30 standards. This growth has been achieved both organically and through the acquisition of other companies.
Current
Marketplace Opportunities
Because
of growing demand for increased transparency into food and agricultural production practices, we believe there are three main
market drivers to promote forward momentum for our business:
Market
Driver #1 - Consumer awareness and expectations
|
●
|
A
recent survey conducted by Acosta, a leading full-service sales and marketing agency in the consumer packaged goods industry,
which was released in 2015, indicates consumers are actually changing their shopping habits in the grocery store. Increasingly
more Americans are shopping the perimeter of the grocery store rather than stocking their pantries, and choosing to cook healthy
meals at home, even if it comes at a higher cost.
|
|
●
|
According
to the US Grocery Shopper Trends 2014 Report, more than 25% of consumers surveyed are seeking products that are minimally processed,
locally grown or produced, with recognizable and a short list of ingredients. Jenny Zegler, Global Food and Drink Analyst at Mintel,
said “These trends explore how consumers’ evolving priorities, opportunities from advancements in functional formulation
and the almost inescapable reach of technology will affect food and drink in the coming year. Consumers are not only the influencers,
as shifting economics, natural phenomena and social media are shaping what, how, where and with whom consumers are choosing to
eat and drink…”
|
|
●
|
Based
on a survey in the March 13, 2014 Cone Communication Food Issues Trend Tracker, food safety and nutritional value rose to the
top as the most important factors when hitting the grocery aisles. Additionally, at least two-thirds of Americans prioritized
the following as significant factors when deciding what makes it into the shopping cart: locally produced, sustainable packaging,
animal welfare, non-GMO, protection and renewal of natural resources.
|
|
●
|
Three
in five Americans are on the lookout for non GMO-labeled foods when shopping. Per the March 13, 2014 Cone Communication Food Issues
Trend Tracker, 39% believe that non-GMO foods are healthier, 32% are concerned about the effects on the environment, and 24% question
the ethics behind the use of GMOs.
|
|
●
|
According
to the United States Department of Agriculture (“USDA”) website, the U.S. market for certified organic products was
estimated at more than $39 billion as of October 2015 while USDA-approved organic operations have grown more than 250% since 2002.
Increasing consumer demand for healthy, better-for-you products produced with sustainable agricultural practices is driving growth
in the organic market.
|
Market
Driver #2 - Global competitiveness among retailers
|
●
|
Restaurant
chains and retailers with dominant market shares and large buying power, like McDonald’s and Wal-Mart, are leading the way
in prioritizing sustainable food supply initiatives in answer to consumer demands. With information literally at our fingertips,
Google searches and smart phone apps are making it easier to expose where sustainable food supply chains are, and where they are
not.
|
|
●
|
Producers,
packers, distributors and retailers understand that verification, identification and traceability are key competitive differentiators.
Oftentimes, it is necessary for export into international markets, including Korea, Russia and the European Union.
|
Market
Driver #3 - Government regulation
|
●
|
In
January 2013, the Food Safety Modernization Act (“FSMA”) issued two major proposed rules regarding preventive controls
in human/animal food and produce safety. Compliance dates for some businesses began September 2016. Under the new rules, the food
safety plan defined by the regulation differs from traditional hazard analysis and critical control points (“HACCP”)
plans. It must include a hazard analysis, preventive controls, monitoring procedures, corrective action procedures, verification
procedures, a supply chain program, and a recall program. We continue to see significant movement in companies requesting our
consulting expertise to developing programs designed to assist them in maintaining compliance with the new rules.
|
|
●
|
The
Animal Disease Traceability Rule primarily covers beef cattle 18 months of age or older. Under the final rule, unless specifically
exempted, livestock moved interstate must be officially identified and accompanied by an interstate certificate of veterinary
inspection or other documentation, such as owner-shipper statements or brand certificates.
|
|
●
|
The Saudi Arabia
market closed to U.S. beef in 2012. Since that time, the beef industry has been working with the U.S. government to re-open
that market, which officially happened in early August 2016. In order to be approved to meet the export requirements, a
company must have or must be approved by a USDA process verified plan (“PVP”) and meet the Saudi Arabia export
verification requirements.
U.S. exports to Saudi Arabia in 2010 and 2011 were valued at approximately $30 million. We believe the Saudi Arabia market
focuses on the highest quality middle meats, making it a valuable market for the U.S. to re-gain access.
|
|
●
|
On
June 12, 2017, officials announced the technical requirements for beef exports to the People’s Republic of China. Export
verification (“EV”) requirements include source and age verification with the use of a program compliant tag. In addition,
China bans the use of synthetic growth promotants, including ractopamine. So, although there is not a formal non-hormone component
to the EV requirements for the supply chain, due to China’s residue testing, packers will be seeking non-hormone treated
cattle (“NHTC”) and/or Verified Natural cattle to ensure continued market access. China is the world’s second largest
buyer of beef, but beef imports from the US to China have been banned since the 2003 Bovine Spongiform Encephalopathy (“BSE”)
outbreak, also known as “Mad Cow Disease.”
|
Current
Concerns in Our Industry
U.S.
beef exports to the European Union (“EU”) must be third-party verified as High Quality Beef (a USDA
feeding claim) and NHTC. With duty-free access to the EU lowering the cost of doing business in Europe, we believe that it
offers significantly more potential for third-party NHTC verification services and High Quality Beef verification services.
However, due to the current strength of the US dollar and increased competition globally, we are seeing downward pressure on NHTC
cattle prices causing the momentum of these programs to slow.
We
continue to monitor the situation but we believe we have diversified our product offerings across multiple species such that it
did not have a significant negative impact on our 2016 operations and we do not believe it will have a significant impact upon
our 2017 operations.
Seasonality
Our
business is subject to seasonal fluctuations. Significant portions of our verification and certification service revenue is typically
realized during late May through early October when the calf marketings and the growing seasons are at their peak. Because of
the seasonality of the business and our industry, results for any quarter are not necessarily indicative of the results that may
be achieved for any other quarter or for the full fiscal year.
Liquidity
and Capital Resources
At
June 30, 2017, we had cash, cash equivalents and short-term investments of $3,828,785 compared to $3,223,089 at December 31, 2016.
Our working capital at June 30, 2017 was $3,614,907 compared to $3,429,185 at December 31, 2016.
Net
cash provided by operating activities for the six months ended June 30, 2017 was $789,547 compared to net cash provided of $765,763
during the same period in 2016. Net cash provided by operating activities is driven by our net income (loss) and adjusted by non-cash
items. Non-cash adjustments primarily include depreciation, amortization of intangible assets, stock based compensation expense,
and deferred taxes.
Net
cash used in investing activities for the six months ended June 30, 2017, was $170,563 compared to $204,663 used in the 2016 period.
Net cash used in the 2017 period was primarily attributable to the acquisition of A Bee Organic, as well as routine purchases
of property and equipment. Net cash used in the 2016 period was primarily attributable to the acquisition of the non-controlling
interest of Validus, as well as routine purchases of property and equipment.
Net
cash used in financing activities for the six months ended June 30, 2017, was $20,572 compared to approximately $54,014 used in
the 2016 period. Net cash used in the 2017 period was due repayments under lease obligations of approximately $2,000 and repurchase
of common shares under the Buyback Plan of approximately $26,700, offset by cash received from stock option exercises of approximately
$8,200. Net cash used in the 2016 period was due to repayments of debt and lease obligations of approximately $5,800 and repurchase
of common shares under the Buyback Plan of approximately $77,600 offset by proceeds from stock option exercises of approximately
$29,400.
Historically,
our growth has been funded through a combination of cash flow from operations, convertible debt from private investors and private
placement offerings. We continually evaluate all funding options including additional offerings of our securities to private,
public and institutional investors and other credit facilities as they become available.
The
primary driver of our operating cash flow is our third-party verification solutions, specifically the gross margin generated from
services provided. Therefore we focus on the elements of those operations including revenue growth and long term projects that
ensure a steady stream of operating profits to enable us to meet our cash obligations. On a weekly basis we review the performance
of each of our revenue streams focusing on third party verification solutions compared with prior periods and our operating plan.
We believe that our various sources of capital, including cash flow from operating activities, overall improvement in our performance,
and our ability to obtain additional financing are adequate to finance current operations as well as our acquisition strategy
and the repayment of current debt obligations. We are not aware of any other event or trend that would negatively affect our liquidity.
In the event such a trend develops, we believe that there are sufficient financing avenues available to us and from our internal
cash generating capabilities to adequately manage our ongoing business.
The
culmination of all our efforts toward net income has brought opportunities to us
including:
increased investor confidence and renewed interest in our company,
third-party interest in our expertise, as well as the
potential to develop business relationships with long term strategic partners. In keeping with our core business, we will continue
to review our business model with a focus on profitability, long term capital solutions and the potential impact of acquisitions
or divestitures, if such an opportunity arises.
Our
plan for continued growth is based upon acquisitions and, continuing to add more accreditations to our products and
services, as well as intensifying our focus on international markets. We believe that there are significant growth
opportunities available to us because often the only means to entry as imposed on international market imports/exports is via
a quality verification program.
Debt
Facility
The
Company has a revolving line of credit (“LOC”) agreement which matures April 12, 2020. The LOC provides for $75,080
in working capital. The interest rate is at the Wall Street Journal prime rate plus 1.50% and is adjusted daily. Principal and
interest are payable upon demand, but if demand is not made, then annual payments of accrued interest only are due, with the principal
balance due on maturity. As of June 30, 2017, the effective interest rate was 5.5%. The LOC is collateralized by all the business
assets of ICS. As of June 30, 2017, there were no amounts outstanding under this LOC.
Off-Balance
Sheet Arrangements
As
of June 30, 2017, we had no off-balance sheet arrangements of any type.
RESULTS
OF OPERATIONS
Second
quarter and year to date ended June 30, 2017 compared to the same periods in fiscal year 2016
Revenues
Total
revenues for the three months and year to date period ended June 30, 2017, increased 25.1% and 25.4%, respectively, compared to
the same periods in 2016.
Verification
and certification service revenues
consist of fees charged for verification audits and other verification
and certification related services that the Company performs for customers. We have recently begun including
fees earned
from our WFCF labeling program
in our verification and certification revenues due to the immateriality
of the revenue stream and because
as it represents a value-added extension of our source verification. Verification and
certification service revenues for the three months and year to date period ended June 30, 2017 increased approximately $330,200,
or 12.7%, and $710,100, or 14.9%, respectively, compared to the same periods in 2016. Overall, the increase is due to both an
increase in new verification customers, as well as an increase in product offerings. We are seeing increased demand from cattle
producers in response to the re-opening of the export market to China as discussed above.
Product
sales represent sales of cattle identification ear tags. Product sales for the three months and year to date period ended June
30, 2017 increased approximately $91,100, or 44.6%, and $63,300, or 13.3%, respectively, compared to the same periods in 2016.
Overall, our product sales have increased primarily in response to the re-opening of the China export market and the requirement
for source and age verification using an identification tag at birth.
Software
license, maintenance and support services revenue for the three months and year to date period ended June 30, 2017 of $130,200
and $289,500, respectively, represents a new revenue stream specific to our acquisition of SureHarvest, as further described in
Note 2 to the consolidated financial statements above. SureHarvest employs a software-as-a-service (SaaS) revenue model that bundles
annual software licenses with ongoing software enhancements and upgrades and a wide range of professional services that generate
incremental revenue specific to the food and agricultural industry.
Consulting
service revenue for the three months and year to date period ended June 30, 2017 of $150,900 and $267,700, respectively, primarily
represents fees earned from professional appearances, customer education and training related services. It is a new revenue stream
specific to our acquisition of SureHarvest, as further described in Note 2 to the consolidated financial statements above.
Cost
of Revenues and Gross Margin
Total
costs of revenues for the three months and year to date period ended June 30, 2017 was approximately $1.91 million and $3.52 million,
respectively, compared to approximately $1.48 million and $2.72 million, respectively, for the same periods in 2016. Gross margin
for the three months and year to date period ended June 30, 2017 decreased slightly to 45.4% and 46.4%, respectively, compared
to 47.1% and 48.1%, respectively, for the same periods in 2016. The decrease is partially due to a change in the overall product
mix due to our SureHarvest acquisition in which margins tend to be lower.
Our
margins are impacted by various costs such as cost of products, salaries and benefits, insurance, and taxes. Because certain elements
of our cost of revenues are fixed in nature, incremental sales positively impact our margins.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses for the three months and year to date period ended June 30, 2017 were approximately $1.71
million and $3.18 million, respectively, compared to $1.07 million and $2.17 million, respectively, for the same periods in 2016.
For the year to date period ended June 30, 2017, the dollar increase included $118,000 in acquisition-related (legal, accounting
and consulting) expenses of SureHarvest and A Bee Organic; an additional $286,000 in amortization and depreciation expense specific
to assets acquired with the SureHarvest and A Bee Organic acquisitions; and an additional $636,000 in increased general and administrative
costs specific to SureHarvest.
As
with all of our acquisitions, we continue to identify synergies and implement best practices. We focus our efforts to create value
in various ways such as: improving the performance of our acquisitions, removing excess capacity, creating market access for products,
acquiring skills and technologies more quickly or at lower cost than we can build in-house, exploiting our industry-specific scalability
and bundling opportunities, and picking winners early and helping them develop their businesses. Achieving any, or all of these
strategies take time to implement. We have learned that it takes about 2-3 years after acquisition date to fully understand the
complexities of our larger acquisitions, at which time, we have seen solid improvements in revenues and/or costs.
Income
Tax Expense
The
provision for income taxes is recorded at the end of each interim period based on the Company’s best estimate of its effective
income tax rate expected to be applicable for the full fiscal year. For the three months ended June 30, 2017, we recorded an income
tax benefit of $52,000 compared to income tax expense of $80,000 for the 2016 period. For the year to date period ended June 30,
2017, we recorded an income tax benefit of $49,000 compared to income tax expense of $129,950 for the 2016 period.
Net
Income and Per Share Information
As
a result of the foregoing, net income attributable to WFCF shareholders for the three months ended June 30, 2017 was approximately
$62,400, or less than a penny per basic and diluted common share, compared to approximately $169,600, or $0.01 per basic and diluted
common share for the same period in 2016. Net income attributable to WFCF shareholders for the year to date period ended June
30, 2017 was approximately $177,800 or $0.01 per basic and diluted common share, compared to approximately $256,900 or $0.01 per
basic and diluted common share for the same period in 2016.