Where Food Comes From, Inc. - Annual Report: 2017 (Form 10-K)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission File No. 333-133624

202 6^th Street, Suite 400
Castle Rock, CO 80104
(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code:
(303) 895-3002

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒      No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒       No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and emerging growth company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒

The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2017, the last business day of our most recently completed second fiscal quarter, was $27,805,763, based on the closing stock price on that date of $2.31.

The number of shares of the registrant’s common stock, $0.001 par value per share, outstanding as of March 30, 2018, was 24,657,895.

DOCUMENTS INCORPORATED BY REFERENCE: Part III is incorporated by reference from the registrant’s Definitive Proxy Statement for its 2018 Annual Meeting of Shareholders to be filed, pursuant to Regulation 14A, within 120 days after the close of the registrant’s 2017 fiscal year.

TABLE OF CONTENTS

PART I

ITEM 1.          BUSINESS

GENERAL

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 production practices in North America. The Company supports more than 15,000 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, Validus Verification Services, Sterling Solutions, SureHarvest Services 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, crops and other food products are accurate. In addition, we develop software and provide services related to sustainability measurement and benchmarking, traceability, verification and certification to the food and agriculture industries. 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 food 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 that 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.

BUSINESS OVERVIEW

What We Do

The Company is one of the nation’s largest independent, third-party providers of food production audits and uses rigorous verification processes to ensure that claims made by food producers and processors are accurate.

The Where Food Comes From® labeling program offers food retailers and restaurants a means of connecting consumers to information on where and how the food they purchase has been grown or raised.

With the acquisition of SureHarvest on December 28, 2016, the Company 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.

The Company’s business benefits from growing demand by consumers, retailers and government for increased transparency into food production practices.

Consumers: Due to concerns about food safety, animal welfare and an overall increase in health consciousness, consumers are demanding more information about the food they purchase.

Retailers: Responding to consumer demands for increased transparency as well as to the negative impact food scandals have on their bottom lines, retailers are requiring their suppliers to adhere to more stringent traceability and verification of product claims.

Government Regulation: The U.S. Department of Agriculture’s Animal Disease Traceability program, being phased in over the next few years, gluten-free testing requirements, and ingredient labeling regulations are all impacting product verification.

Growth Strategy

Due to organic growth in our portfolio of auditing standards, consumer demand and acquisitions, our sales have grown rapidly from $1.1 million in 2006 to $15.4 million in 2017, an 11-year compounded annual growth rate of approximately 27%.

Acquisition of Validus Verification Services, LLC

On September 16, 2013, we entered into an Asset Purchase and Contribution Agreement (the “Validus Purchase Agreement”), by and among the Company, Validus Verification Services LLC (“Validus”), and Praedium Ventures, LLC (“Praedium”), formerly known as Validus Ventures LLC.

Pursuant to the Validus Purchase Agreement, WFCF caused Validus to be organized to purchase and acquire certain audit, assessment and verification business assets of Praedium. The Company acquired a 60% interest in Validus in exchange for aggregate consideration of approximately $1.5 million, which included $565,000 in cash and 708,681 shares of common stock of WFCF valued at approximately $940,000 based upon the closing price of our stock on September 16, 2013, of $1.32 per share. On March 16, 2016, the Company exercised its call option to purchase the remaining 40% of the outstanding membership interests of Validus in exchange for aggregate consideration of approximately $363,000, which included $163,000 in cash and 93,057 shares of common stock of WFCF valued at approximately $200,000 based upon the closing price of our stock on February 29, 2016, of $2.15 per share.

Acquisition of SureHarvest Services, LLC

On December 28, 2016, we entered into an Asset Purchase Agreement (the “SureHarvest Purchase Agreement”), by and among Where Food Comes From, Inc., SureHarvest Services LLC (“SureHarvest”), a California limited liability company and wholly-owned subsidiary of WFCF, SureHarvest, Inc., a California corporation (“SureHarvest, Inc.”), and Jeff Dlott, the President, key manager and shareholder of SureHarvest, Inc.

Pursuant to the SureHarvest Purchase Agreement, WFCF purchased the business assets of SureHarvest, Inc. in exchange for total consideration of approximately $2.8 million, comprised of $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. The Company has the right of first refusal on the remaining 40% of the outstanding membership interests of SureHarvest, which owns the business assets of SureHarvest, Inc. As of December 31, 2017, the Company has not exercised its call option.

SureHarvest develops software and provides services related to sustainability measurement and benchmarking, traceability, verification and certification to the food and agriculture industries. Its patented sustainability software solutions support more than 2,200 agri-food operations, including growers, packers, shippers, processors, wineries and trade associations. We believe that SureHarvest provides us with complementary solutions and services, a unique customer base and a valuable patent portfolio. It expands and diversifies our commodity reach with high value specialty crops, including wine grapes, almonds, hazelnuts, mushrooms, cut flowers, leafy greens and other fresh produce. Additionally, the SaaS model bundles annual software subscriptions with professional services to provide predictable, recurring revenue.

Acquisition of A Bee Organic LLC

On May 30, 2017, we acquired the business assets of A Bee Organic LLC (“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.

INDUSTRY BACKGROUND

The value-added food industry has been growing rapidly for the past several years in response to increased consumer interest about food production. Per the Food & Farm Facts book (2017 edition) produced by the American Farm Bureau Foundation, farm and ranch families comprise approximately 2 percent of the U.S. population; thus, there is a growing interest from consumers regarding how their food is produced. We are also in an increasingly global food market with food products traveling around the world, and brands differentiating themselves in the market. These key drivers are increasing the number of food labeling claims made on food products. Natural and/or organic are examples of food labels that indicate that the food or other agricultural product has been produced in a certain way.

Natural and organic sales are only part of the story of how consumers look for the verification of practices tied to food labeling claims. Other factors are also becoming increasingly more important to consumers, evidenced on menus and product labels. While not an exhaustive list, some of the issues that farms, ranches, producers, processors, restaurants and retailers are addressing include how animals are cared for and handled, how a product’s production impacts the environment and societies, and what inputs were used in the production of food items (like antibiotics).

As consumers want more assurance about the trustworthiness of labeling claims, there is a growing trend for verification of raising practices. Additionally, as the agriculture, livestock and food industry continues to mature and expand internationally, there is an increasing need to record, manage, report and verify information regarding the source, age, genetic background, animal treatment, nutrition, and other credence attributes. We believe verification of labeling claims by an independent third-party can meet consumer demands and expectations. Third-party verification also benefits producers, processors, distributors, restaurants, and retailers by addressing marketplace differentiation and global competitiveness.

Current Marketplace Opportunities

Because of growing demand for increased transparency into food production practices, we believe there are three main market drivers to promote forward momentum for our business:

Market Driver #1 - Consumer awareness and expectations

Market Driver #2 - Global competitiveness among retailers

Market Driver #3 - Government regulation

REVENUES

We offer a wide array of services, including verification, certification, consulting and SaaS, to help food producers, brands and consumers differentiate certain attributes and production methods in the marketplace. We sell our services directly to customers at various levels in the agriculture, food and livestock supply chain. Most of our service offerings can be bundled to provide a “one-stop shop” for customers that have multiple levels of verification and certification needs, such as source verification and food safety certification. Our customers include some of the largest U.S. beef and pork packers, organic producers and processors, and specialty retail chains. No single customer generated more than 10% of total net revenue in 2017 or 2016.

With each acquisition, we assess the need to disclose discrete information related to our operating segments. Because of the similarities of certain of our acquisitions that provide certification and verification services, we aggregate operations into one verification and certification services reportable segment. The factors considered in determining this aggregated reporting segment include the economic similarity of the businesses, the nature of services provided, production processes, types of customers and distribution methods. The Company’s chief operating decision maker (the Company’s CEO) allocates resources and assesses the performance of its certification and verification services activities as one segment, which includes product sales.

With the acquisition of SureHarvest, the Company determined that it also has a software sales and related consulting services segment. This segment includes software license, maintenance, support and software-related consulting service revenues.

Management makes decisions, measures performance, and manages the business utilizing internal reporting operating segment information. Performance of operating segments are based on net sales, gross profit, selling, general and administrative expenses and most importantly, operating income.

Verification and Certification Segment

Our 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 include fees earned from our WFCF labeling program and consulting/program development services in our verification and certification revenues due to the immateriality of the revenue stream and because it represents a value-added extension of our source verification. We are recognized and utilized by numerous standard setting bodies as an accredited verification or certification service provider. We enable food producers and brands to make certain claims on live animals or packaged food products by verifying that they are meeting the standards or guidelines associated with the claim(s) they are making. For the years ended December 31, 2017 and 2016, our third-party verification programs provided 79.8% and 89.8% of our total revenue, respectively.

Our product sales are an ancillary part of our verification and certification services and represent sales of cattle identification ear tags. While our product sales have lower profit margins than do our proprietary offerings, the products allow us to offer our customers a comprehensive solution. Approximately 11.1% and 10.2% of our total revenue was generated by the sale of hardware during the years ended December 31, 2017 and 2016, respectively.

Software Sales and Related Consulting Segment

Software license, maintenance and support services represents a new revenue stream specific to our acquisition of SureHarvest, as further described above. SureHarvest employs a 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.

Software-related consulting service revenue 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 above.

MARKETING

Our marketing strategy includes direct marketing, advertising, event sponsorship, and trade show participation. From a public relations perspective, members of our staff are frequently quoted in industry trade journals and requested as speakers at various industry events as subject matter experts on the topics of animal identification, traceability, branding, third-party verification and certification, and the USDA verification programs.

In order to reach additional customers, we continually develop strategic marketing partnerships with leading companies in the industry with complementary abilities and products. We do not currently rely on any third-party contracts with distributors, licenses or manufacturers in conducting our business.

We also use social media sites such as Facebook and Twitter to help promote our business, market our product offerings, and connect consumers with current topics in the agriculture, livestock and food industry.

COMPETITION

The competition for third-party verification services in the food and agriculture industry is growing more intense, especially within the organic market. As of December 31, 2017, we estimate that there are approximately eight key competitors serving the food and agricultural industry, including Quality Assurance International, California Certified Organic Farmers, Oregon Tilth, Organic Crop Improvement Association, Earth Claims, FoodChain ID, NSF International, SGS and SCS Global Services. Differentiation hinges upon understanding all facets of food verification and the complex compliance challenges to make product verifications efficient, cost-effective, and seamless. Our core business and expertise focus on the “on farm” verifications to a variety of standards, guidelines and criteria, including source verification, natural, animal care and well-being, and sustainability verification.

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.

INTELLECTUAL PROPERTY

We create, own and maintain a variety of intellectual property assets that we believe are among our most valuable assets. Our intellectual property assets include patents and patent applications related to our innovations, products and services, trademarks related to our brands, products and services, and other property rights. We also have licensing arrangements when features from our programs are desirable to incorporate into either a new or an existing technology we offer. We seek to protect our intellectual property right assets through patent, copyright, trade secret, trademark and other laws of the United States and other countries, and through contractual provisions. Additional information regarding certain risks related to our intellectual property is included in Part I, Item 1A “Risk Factors” of this Annual Report on Form 10-K.

EMPLOYEES

As of December 31, 2017, we had 63 total employees, of which 54 were full-time employees. Our future success is substantially dependent upon the performance of our key senior management personnel, as well as our ability to attract and retain highly qualified technical personnel. Additional information regarding certain risks related to our employees is included in Part I, Item 1A “Risk Factors” of this Annual Report on Form 10-K.

AVAILABLE INFORMATION

Our corporate website is located at www.wherefoodcomesfrom.com. We make available free of charge on our investor relations website under “SEC Filings” our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (the “SEC”). Further, a copy of this Annual Report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding our filings at http://www.sec.gov.

EXECUTIVE OFFICERS OF THE REGISTRANT

John Saunders, 46, founded the Company in 1998 and has served as the Chief Executive Officer since then. Mr. Saunders is also the Chairman of the Board of Directors of the Company and has served in this position since 1998. Previously, Mr. Saunders was a partner and consultant for Pathfinder Consulting Services, Inc. in Parker, Colorado. An expert in both technology and the livestock industry, Mr. Saunders is a graduate of Yale University.

Leann Saunders, 47, has been the President of the Company since 2008. Mrs. Saunders is also a Director on our Board of Directors and has served in this position since January 2012. Prior to 2003, Mrs. Saunders worked for PM Beef Holdings (“PM”), an integrated beef company, and developed a supply system for PM’s Ranch to Retail product line and managed PM’s USDA Process Verified program. She then served as the company’s Vice President of Marketing and Communications. Prior to joining PM in 1996, Mrs. Saunders worked for McDonald’s Corporation as a Purchasing Specialist, and Hudson Foods Corporation. Mrs. Saunders graduated with a B.S. in Agriculture Business and an M.S. in Beef Industry Leadership from Colorado State University. Mrs. Saunders sits on the Board of Directors for the International Stockmen’s Education Foundation, and was the Chair for the United States Meat Export Federation for the 2015–2016 year.

Dannette Henning, 48, has been the Chief Financial Officer of the Company since January 2008. Prior to her appointment, she was engaged by the Company as a consultant beginning in November 2007. From 2004 to 2007, Mrs. Henning was the Corporate Controller for Einstein Noah Restaurant Group. From 2001 to 2003, she served as the Controller for Vari-L Company. Mrs. Henning’s previous experience includes financial management positions with KPMG Peat Marwick, DF&R Restaurant Company, and CSI/CDC Company. Mrs. Henning is a Certified Public Accountant with more than 25 years of professional experience. She received a B.B.A. degree in Accounting from the University of Texas at Arlington.

Family Relationships

John Saunders, our CEO and Chairman of the Board, is married to Leann Saunders, our President. Both Mr. and Mrs. Saunders serve on our Board of Directors.

ITEM 1A.          RISK FACTORS

In addition to the other information included in this report and our other public filings and releases, the following factors should be considered when evaluating our business, financial condition, results of operations and prospects:

We operate in a competitive industry with a limited market characterized by changing technology, frequent introductions of new service offerings, service enhancements, and evolving industry standards.

We compete with many other vendors of products and services designed for tracking cattle and other livestock and for herd management and crop production practices. Our competitors range from small start-up companies to multi-national firms. Our competitors may have significantly more financial, technical and marketing resources than we do. Competition is likely to intensify as current competitors expand their service offerings and as new companies enter the market. Additionally, competition may intensify as our competitors enter into business combinations or alliances, and established companies in other market segments expand to become competitive with our business. Increasing competition may result in reduced margins and the loss of market share. Our competitors may offer broader service offerings or technologies that are more commercially attractive and gain greater market acceptance than our current or future products. Additionally, new technology may render our products and services obsolete.

The success of our business model depends on the broad acceptance of our technologies into markets that are continuing to develop as a result of the increasing focus on food safety and assurance.

We are currently benefiting from a slow but growing movement among the agriculture, livestock and food industry to source and/or age verify products. This emerging trend is fueled in part by consumers’ focus on food safety and assurance. However, we can offer no assurances that there will be market acceptance of our technologies. Furthermore, some of our primary target segments within the agriculture, livestock and food industry are experiencing unpredictable economic conditions and are expected to continue to struggle with supply, trade and profitability issues in the near term. Although we believe that our products, if adopted on a wide-scale basis, would have a significant impact on improving the safety, quality and confidence in the world’s food supply, our customers for these products historically have been very slow to change and reluctant to adopt new technologies and business practices.

We face risks of rapidly changing regulations which may negatively impact our programs.

Regulations and standards are continually evolving and present a challenging risk. For example, in January 2013, the Japanese government announced a change to its import requirements on U.S. beef. Because the change enabled a significant increase in the amount of product qualifying for export to Japan, it negatively impacted the premiums typically seen in the marketplace for source and age verified cattle. As a result, it negatively impacted our source and age verification business by approximately 68% from 2012 to 2013. Due to the diversification of our product offerings and our strategy of managing to profitability, we were able to quickly minimize the impact of these adverse changes. While we attempt to mitigate these risks by creating innovative programs that mitigate the risk of rapidly changing regulations, we can give no assurance that we will be successful in overcoming the potential negative impact to the results of our operations.

We face risks that highly contagious diseases or viral outbreaks may negatively impact the source of product we are able to verify.

Today, infectious disease and viral outbreaks appear to be emerging more quickly than ever. For example, Porcine Epidemic Diarrhea Virus (PEDv) negatively impacted the pork/sow industry in 2014 and Highly Pathogenic Avian Influenza, more commonly known as Bird Flu, is currently impacting poultry operations. Additionally, contagious disease or viral outbreaks create increased bio-exclusion considerations in our business. While we have created innovative solutions that mitigate the risk of transferring disease, we can give no assurance that we will be successful in overcoming the potential negative impact to the results of our operations.

In the event that market demand for third-party verified products declines, our customers may not be able to generate sufficient revenues to justify the purchase of our verification solutions and consulting services.

Public attitudes towards food production practices may be influenced by claims that these products are unsafe for consumption or pose unknown health risks. For example, decreased demand for beef and other livestock products could have a material adverse effect on the operating results and financial condition of our existing or prospective customers. If operating results of our customers are impaired, the resources that our customers can devote to building information systems for tracking cattle and other livestock and herd management are reduced, which in turn may limit purchases of our verification solutions and consulting services. Therefore, our ability to generate revenue is subject to the risks and uncertainties relating to the financial condition of our customers.

We look for opportunities to expand our presence in international markets in which we may have limited experience, and inherently international operations are subject to increased risks which could harm our business, operating results and financial condition.

We continually seek to expand our product and service offerings in international markets. As we expand into new international markets, we will have only limited experience in marketing and operating our products and services in such markets. In other instances, we may rely on the efforts and abilities of foreign business partners in such markets. Certain international markets may develop more slowly than do domestic markets, and our operations in international markets may not develop at a rate that supports our level of investment.

In addition to uncertainty about our ability to expand into international markets, there are certain risks inherent in doing business internationally, including, but not limited to:

One or more of these factors could harm our future international operations and consequently could harm our brand, business, operating results and financial condition.

Our business could suffer if we are unsuccessful in making, integrating, and maintaining our acquisitions and investments.

We have acquired and invested in a number of companies, and we may acquire or invest in or enter into joint ventures with additional companies. These transactions create risks such as:

As a result of future acquisitions or mergers, we might need to issue additional equity securities, spend our cash, or incur debt, contingent liabilities, or amortization expenses related to intangible assets, any of which could reduce our profitability and harm our business. In addition, valuations supporting our acquisitions and strategic investments could change rapidly given the current global economic climate. We could determine that such valuations have experienced impairments or other-than-temporary declines in fair value which could adversely impact our financial results.

Our future success depends upon our ability to obtain and enforce patents; prevent others from infringing on our patents, trademarks and other intellectual property rights; and operate without infringing upon the patents and proprietary rights of others.

We will be able to protect our intellectual property from unauthorized use by third parties only to the extent that it is covered by valid and enforceable patents and trademarks. Patent protection generally involves complex legal and factual issues and, therefore, the enforceability of patent rights cannot be predicted with certainty. Moreover, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. In the event that patents owned by us do not provide adequate protection, we may not be able to prevent competitors from offering substantially similar products and services.

In the event that third parties claim that our current or future products or services infringe upon their intellectual property, we may face litigation and be prevented from selling the products and services at issue. Infringement or other claims could be asserted or prosecuted against us in the future, and it is possible that past or future assertions or prosecutions could harm our business. Litigation either in defense of our intellectual property rights or in response to infringement claims made by others may be both expensive and time consuming, which in turn would adversely affect our business.

A significant data breach or information technology system disruption could adversely affect our business, financial results, or reputation, and we may be required to increase our spending on data and system security.

We rely heavily on information technology networks and systems, including the Internet, to manage or support a wide variety of important business processes and activities throughout our operations.

Our information technology systems may be susceptible to damage, disruptions or shutdowns due to failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, computer viruses, cyber-attacks, ransomware attacks, malware attacks, malicious employees or other insiders, telecommunications failures, human errors or catastrophic events. Hackers, foreign governments, cyber-terrorists and cyber-criminals, acting individually or in coordinated groups, may launch distributed denial of service attacks or other coordinated attacks that may cause service outages, gain inappropriate or block legitimate access to systems or information, or result in other interruptions in our business. In addition, breaches in security could expose us and our customers, or the individuals affected, to a risk of loss or misuse of proprietary information and sensitive or confidential data, including personal information of customers, employees and others. The techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently, may be difficult to detect for a long time and often are not recognized until launched against a target. As a result, we may be unable to anticipate these techniques or to implement adequate preventive measures.

We also depend on and interact with the information technology networks and systems of third parties for many aspects of our business operations, including our customers and service providers such as cloud service providers and third-party delivery services. These third parties may have access to information we maintain about our company, operations, customers, employees and vendors, or operating systems that are critical to or can significantly impact our business operations. Like us, these third parties are subject to risks imposed by data breaches and cyber-attacks and other events or actions that could damage, disrupt or close down their networks or systems. Security processes, protocols and standards that we have implemented and contractual provisions requiring security measures that we may have sought to impose on such third parties may not be sufficient or effective at preventing such events, which could result in unauthorized access to, or disruptions or denials of access to, or misuse of, information or systems that are important to our business, including proprietary information, sensitive or confidential data, and other information about our operations, customers, employees and suppliers, including personal information.

Any of these events that impact our information technology networks or systems, or those of acquired businesses, customers, service providers or other third parties, could result in disruptions in our operations, the loss of existing or potential customers, damage to our brand and reputation, regulatory scrutiny, and litigation and potential liability for the Company. Among other consequences, our customers’ confidence in our ability to protect data and systems and to provide services consistent with their expectations could be impacted, further disrupting our operations. Similarly, an actual or alleged failure to comply with applicable U.S. or foreign data protection regulations or other data protection standards may expose us to litigation, fines, sanctions or other penalties.

We have invested and continue to invest in technology security initiatives, information technology risk management and disaster recovery plans. The cost and operational consequences of implementing, maintaining and enhancing further data or system protection measures could increase significantly to overcome increasingly intense, complex and sophisticated global cyber threats. Despite our best efforts, we are not fully insulated from data breaches and system disruptions. There is no assurance that such impacts will not be material in the future, and our efforts to deter, identify, mitigate and/or eliminate future breaches may require significant additional effort and expense and may not be successful.

Our future success depends to a significant degree upon the continued service of key senior management personnel, in particular, John and Leann Saunders.

Both John and Leann Saunders’ reputation and prominence in the field provide us with a strong competitive advantage. While they are currently bound by employment agreements, we can offer no assurance that John and/or Leann Saunders will be able to continue to work for us in the event of an unforeseen accident, severe injury or major disease, or on a long-term basis. The loss of key personnel could have a material adverse effect on our business and operating results.

Directors, executive officers, principal stockholders and affiliated entities beneficially own or control a significant amount of our outstanding common stock and together meaningfully influence our activities.

As of March 23, 2018, John Saunders, our Chairman and CEO, and Leann Saunders, our President, beneficially owned in the aggregate approximately 29% of our common stock. These officers, if they determine to vote in the same manner, would have a significant impact on the outcome of any matter requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions or terms of any liquidation. This concentration of ownership may have the effect of delaying or preventing a change in control of our company that may be favored by other shareholders. This could prevent transactions in which shareholders might otherwise recover a premium for their shares over current market prices.

Because we are not presently subject to the same corporate governance standards as companies listed on registered stock exchanges or NASDAQ, our officers and directors may have interests adverse to those of the shareholders.

Registered stock exchanges and NASDAQ have enhanced corporate governance requirements that apply to issuers that list their securities on those exchanges. For example, we are not required to have any independent directors or to adopt a code of ethics. In certain circumstances, management may not have the same interests as the shareholders’ and conflicts of interest may arise. Notwithstanding the exercise of their fiduciary duties as directors and executive officers and any other duties that they may have to us or our shareholders in general, these persons may have interests different than yours which could adversely affect your investment.

We do not currently intend to pay cash dividends.

We have not declared or paid any cash dividends on our common stock since our incorporation and do not anticipate that we will do so in the foreseeable future. Our present policy is to retain all available funds for use in our business development, operations and expansion. Payment of future cash dividends, if any, will be at the discretion of the Board of Directors and will depend on our financial condition, results of operations, contractual restrictions, business prospects and other factors that the Board of Directors considers relevant. In the absence of dividends, investors will only see a return on their investment if the value of our common stock appreciates.

Future sales of our securities in the public or private markets could adversely affect the trading price of our common stock and our ability to continue to raise funds in new stock offerings.

It is likely that we will sell common stock or securities exercisable or convertible into common stock in order to finance our future growth plans. Future sales of substantial amounts of our securities in the public or private markets would dilute our existing shareholders and potentially adversely affect the trading prices of our common stock and could impair our ability to raise capital through future offerings of securities. Alternatively, we may rely on debt financing and assume debt obligations that require us to make substantial interest and principal payments that could adversely affect our business and future growth potential.

Price volatility of our publicly traded securities could adversely affect investors’ portfolios.

In recent months and years, the securities markets in the United States have experienced high levels of price and volume volatility, and the market prices of securities of many companies have experienced wide fluctuations that have not necessarily been related to the operating performance or prospects of such companies. It is likely that continual fluctuations in market and share prices will occur. Our shares of common stock trade on the OTCQB marketplace, which may not provide as much liquidity for our common stock as would a registered stock exchange. The price of our common stock has been subject to price and volume volatility in the past and will likely continue to be subject to such volatility in the future. In addition, unlike the registered stock exchanges, there are few corporate governance requirements imposed on OTCQB quoted companies.

Because our common stock is deemed a “penny stock,” an investment in our common stock should be considered high risk and subject to marketability restrictions.

Since our common stock is a penny stock, as defined in Rule 3a51-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), it will be more difficult for investors to liquidate their investment even if and when a market develops for our common stock. Until the trading price of our common stock rises above $5.00 per share, if ever, trading in our common stock is subject to the penny stock rules of the Exchange Act specified in Rules 15g-1 through 15g-10. Those rules require broker-dealers, before effecting transactions in any penny stock, to:

Consequently, the penny stock rules may restrict the ability or willingness of broker-dealers to sell our common stock and may affect the ability of holders to sell their common stock in the secondary market and the price at which such holders can sell any such securities. These additional procedures could also limit our ability to raise additional capital in the future.

As a public company, we are subject to complex legal and accounting requirements that require us to incur substantial expenses, and our financial controls and procedures may not be sufficient to ensure timely and reliable reporting of financial information, which, as a public company, could materially harm our stock price and listing on the OTCQB marketplace.

As a public company, we are subject to numerous legal and accounting requirements that do not apply to private companies. The cost of compliance with many of these requirements is substantial, not only in absolute terms but, more importantly, in relation to the overall scope of the operations of a small company. Failure to comply with these requirements can have numerous adverse consequences, including, but not limited to, our inability to file required periodic reports on a timely basis, loss of market confidence, delisting of our securities and/or governmental or private actions against us. We cannot assure you that we will be able to comply with all of these requirements or that the cost of such compliance will not prove to be a substantial competitive disadvantage as compared with privately held and larger public competitors.

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) requires, among other things, that we maintain effective internal controls over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of Sarbanes-Oxley (“Section 404”). Our compliance with Section 404 of Sarbanes-Oxley requires that we incur substantial accounting expenses and expend significant management efforts. The effectiveness of our controls and procedures may in the future be limited by a variety of factors, including:

If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, we may be subject to delisting, investigations by the SEC and civil or criminal sanctions.

ITEM 1B.          UNRESOLVED STAFF COMMENTS

None.

ITEM 2.          PROPERTIES

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. In August 2017, the Company amended its lease agreement to provide for an additional 7,700 square feet of office space to commencing on December 1, 2017. Total rental payments beginning on December 1, 2017 increased from approximately $18,000 to approximately $35,100 per month, which includes common area charges, and are subject to annual increases over the term of the lease. The lease agreement has an initial term of five years plus two renewal periods, which the Company is likely to renew. 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.

In September 2017, the Company entered into a new lease agreement for our Urbandale, Iowa office space. The lease is for a period of two years and expires on August 31, 2019. Rental payments are approximately $2,900 per month, which includes common area charges, are subject to annual increases over the term of the lease.

The Company also owns approximately ¾ acre on which a 2,300-square foot building is located in Medina, North Dakota. Until January 12, 2018, the Company leased space in this building under a five-year lease with an expiration date of March 1, 2018. On January 12, 2018, the Company purchased the 2,300-square foot building and terminated the lease. See Note 16 to the consolidated financial statements for additional information. Under the lease, the Company was charged a monthly rental rate of approximately $150 plus all insurance, taxes and other costs based on actual expenses to maintain the building.

In connection with our acquisition of SureHarvest, we added two locations in California: Soquel and Modesto. Our office lease in Soquel expires on November 30, 2018 and requires rental payments of approximately $2,700 per month. In addition to primary rent, this lease requires additional payments for operating costs and other common area maintenance costs. The monthly rental payments for our leased space in Modesto is approximately $600 and the lease agreement is month-to-month.

ITEM 3.         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.

There are currently no pending proceedings against the Company.

ITEM 4.         MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5.      MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information for Common Stock

Since the inception of the public trading of our securities in November 2006 until June 2012, our common stock traded over-the-counter under the symbol “INMG.” In June 2012, we changed our stock ticker symbol to “WFCF” to better reflect our brand strategy and to raise awareness in the investor community. The following table sets forth the range of high and low bid prices over the past two years. The quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not represent actual transactions.

Stockholders

As of March 23, 2018, we estimate that there were approximately 120 record holders of our common stock. A significant number of the outstanding shares of common stock which are beneficially owned by individuals and entities are registered in the name of Cede & Co. A nominee of The Depository Trust Company, Cede & Co. is a securities depository for banks and brokerage firms.

Dividends

We have not declared or paid any cash dividends on our common stock. We presently do not have plans to pay any cash dividends in the foreseeable future.

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

On January 7, 2008, we announced our intention to buy back up to one million shares of our common stock from the open market. Activity under the Stock Buyback Plan is as follows:

Our Stock Buyback Plan has been and will be used to return capital to shareholders and to minimize the dilutive impact of stock options and other share-based awards. In the future, we may consider additional share repurchases under our plan based on several factors, including our cash position, share price, operational liquidity, and planned investment and financing needs.

ITEM 6.      SELECTED FINANCIAL DATA

Not applicable.

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 

Cautionary Note Regarding Forward-Looking Statements

This Annual Report on Form 10-K and other publicly available documents, including the documents incorporated herein and therein by reference, contain, and our officers and representatives may from time to time make “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipate,” “intend,” “plan,” “goal,” “seek,” “believe,” “project,” “estimate,” “expect,” “strategy,” “future,” “likely,” “may,” “should,” “will” and similar references to future periods. Examples of forward-looking statements include, among others, statements we make regarding:

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

Any forward-looking statement made by us in this Annual Report on Form 10-K is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.

RESULTS OF OPERATIONS

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

The following table shows information for reportable operating segments:

Verification and Certification Segment

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. Fees earned from our WFCF labeling program are also included in our verification and certification revenues as it represents a value-added extension of our source verification. Verification and certification service revenue for the year ended December 31, 2017 increased approximately $1.90 million, or 18.2% compared to 2016. Overall, the increase is due to 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 in Item 1. “Business - Industry Background - Current Marketplace Opportunities.”

Our product sales are an ancillary part of our verification and certification services and represent sales of cattle identification ear tags. Product sales for the year ended December 31, 2017 increased approximately $528,500, or 44.8% compared to 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 for cattle.

Costs of revenues for our verification and certification segment for the year ended December 31, 2017 were approximately $6.81 million compared to approximately $5.52 million in 2016. Gross margin for the year ended December 31, 2017 decreased slightly to 44.2% compared to 46.6% in 2016. 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 for the year ended December 31, 2017 were approximately $5.32 million compared to $4.78 million in 2016. Overall, the increase in our selling, general and administrative expenses is due in part to slightly higher head count and 2017 bonuses paid, increased sales and marketing costs, and increasing public company compliance costs and implementing new accounting standards. The year ended December 31, 2017 also included $118,000 in acquisition-related (legal, accounting and consulting) expenses of SureHarvest and A Bee Organic.

Software Sales and Related Consulting Segment

Software license, maintenance and support services revenue for the year ended December 31, 2017 of approximately $769,600 represents a new revenue stream specific to our acquisition of SureHarvest, as further described in Note 2 to the consolidated financial statements. SureHarvest employs a 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.

Software-related consulting service revenue for the year ended December 31, 2017 of approximately $634,300 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.

Selling, general and administrative expenses for the year ended December 31, 2017 was approximately $1.41 million. Approximately $566,100 is due to amortization and depreciation expense related to assets acquired in the SureHarvest acquisition, and approximately $848,400 is due to salaries, professional services and other general and administrative costs.

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 acquired businesses, removing excess capacity, creating market access for products, acquiring skills and technologies more quickly or at a 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 can take two to three years after an acquisition to fully understand the complexities of a larger acquisition, at which time, we have seen solid improvements in revenues and/or costs.

Income Tax Expense

For the year ended December 31, 2017, we recorded income tax expense of approximately $266,225 compared to $235,600 for 2016. The effective tax rate for the year ended December 31, 2017 increased significantly due to two items. The first was the loss incurred by SureHarvest. For consolidation purposes, SureHarvest’s entire loss is included in the Company’s consolidated net income. However, for tax purposes, 40% of the loss will be allocated to the holder of the minority interest. As a result, approximately $116,000 of the tax expense relates to this adjustment in the financials. The second item relates to the true up of prior year net operating losses for federal and state tax purposes, resulting in an additional tax expense of approximately $62,600.

Net Income and Per Share Information

As a result of the foregoing, net income attributable to WFCF shareholders for the year ended December 31, 2017 was approximately $140,700 or $0.01 per basic and diluted common share, compared to approximately $433,200 or $0.02 per basic and diluted common share in 2016.

Liquidity and Capital Resources

At December 31, 2017, we had cash, cash equivalents and short-term investments of approximately $3,449,000 compared to approximately $3,223,100 at December 31, 2016. Our working capital at December 31, 2017 was approximately $3,779,200 compared to approximately $3,429,200 at December 31, 2016.

Net cash provided by operating activities during 2017 was approximately $657,200 compared to net cash provided by operating activities of $986,100 during the same period in 2016. Net cash provided by operating activities is driven by our net income and adjusted by non-cash items. Non-cash adjustments primarily include depreciation, amortization of intangible assets, stock-based compensation expense, and deferred taxes. Fluctuations are primarily due to the timing of cash receipts and cash disbursements offset by operating performance.

Net cash used in investing activities during 2017 was approximately $242,800 compared to net cash used in investing activities of approximately $1.72 million during 2016. 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 a 60% interest in SureHarvest for $1,122,000 in cash, and the acquisition of the remaining 40% interest in Validus for which we paid $162,700 in cash. Additionally, we spent approximately $445,900 towards property and equipment in 2016, primarily due to relocating our corporate headquarters.

Net cash used in financing activities during 2017 was approximately $198,600 compared to net cash used of $307,200 in the 2016 period. Net cash used in the 2017 period was primarily due to the repurchase of common shares under the Stock Buyback Plan of approximately $199,600. Net cash used in the 2016 period was primarily due to the repurchase of common shares under the Stock Buyback Plan of approximately $347,000 offset by proceeds from stock option exercises of approximately $65,000.

Historically, our growth has been funded through a combination of 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 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 has brought significant opportunities to us, including increased investor confidence and renewed interest in our company, 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 primarily based upon acquisitions, as well as intensifying our focus on international markets. We believe that there are significant growth opportunities available to us because often the only way to overcome import or export restrictions 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 upon maturity. As of December 31, 2017, the effective interest rate was 5.5%. The LOC is collateralized by all the business assets of International Certification Services, Inc. (“ICS”). As of December 31, 2017, there were no amounts outstanding under this LOC.

Off Balance Sheet Arrangements

As of December 31, 2017, we had no off-balance sheet arrangements of any type.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are discussed in Note 2 to our consolidated financial statements set forth in Item 8 of this Annual Report on Form 10-K.

Revenue Recognition

Verification and Certification Segment

We offer a range of products and services to maintain identification, traceability, and verification systems. We conduct 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. We generate revenue primarily from the sale of our verification solutions, consulting services and hardware sales. We sell our products and services directly to customers at various levels in the livestock and agricultural supply chains.

Verification and certification service revenue primarily consists of fees charged for verification audits and other verification services that the Company performs for customers. Revenue from verification audits is recognized upon completion of the audits. Contracts for these services are cancelable only for non-performance.

Deferred revenue represents payments received in advance from our customers for annual customer support services not yet performed as of December 31st, and revenue is recognized as services are performed, generally over the one-year contract term.

Product sales are primarily generated from the sale of cattle identification ear tags. Revenue is recognized when goods are shipped and after title has transferred to the customer.

Software Sales and Related Consulting Segment

We also derive revenue from software licenses, maintenance and services. Our license arrangements generally contain multiple-elements, including software maintenance services and consulting services. We do not recognize revenue until the following four basic criteria are met: (i) persuasive evidence of an arrangement exists, (ii) our product has been shipped or, if delivered electronically, the customer has the right to access the software, (iii) the fee is fixed or determinable, and (iv) collection of the fee is probable.

We predominately offer products via a SaaS model, which is a subscription based model. Subscription revenue derived from these agreements is generally recognized on a straight-line basis over the subscription term.

We generally sell our software licenses with maintenance services and, in some cases, also with consulting services. For these multiple-element arrangements, we allocate revenue to the delivered elements of the arrangement using the residual method, whereby revenue is allocated to the undelivered elements based on vendor specific objective evidence (or “VSOE”) of fair value of the undelivered elements with the remaining arrangement fee allocated to the delivered elements and recognized as revenue assuming all other revenue recognition criteria are met. For the undelivered elements, we determine VSOE of fair value to be the price charged when the undelivered element is sold separately. We determine VSOE for maintenance sold in connection with a software license based on the amount that will be separately charged for the maintenance renewal period. We determine VSOE for consulting services by reference to the amount charged for similar engagements when a software license sale is not involved. We review services sold separately on a periodic basis and update, when appropriate, our VSOE of fair value for such maintenance and services to ensure that it reflects our recent pricing experience. If payment of the software license fees is dependent upon the performance of consulting services or the consulting services are essential to the functionality of the licensed software, then we recognize both the software license and consulting fees using the completed contract method.

Revenue from maintenance is recognized ratably over the service period. Maintenance revenue is deferred until the associated license is delivered to the customer and all other criteria for revenue recognition have been met. Revenue from consulting services is generally recognized as the services are delivered to the customer.

Other

Sales taxes collected from customers and remitted to government authorities are excluded from revenue.

Generally, we do not provide right of return or warranty on product sales or services performed.

In connection with certain arrangements, reimbursable expenses are incurred and billed to customers and such amounts are recognized as both revenue and cost of revenue.

Stock-Based Compensation

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.

Calculating stock-based compensation expense using the Black-Scholes-Merton option-pricing model requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility, and the pre-vesting option forfeiture rate. Under this pricing model, which incorporates ranges of assumptions for inputs, our assumptions are as follows:

The assumptions used in calculating the fair value of stock options represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment.

There is a risk that our estimates of the fair values may differ from the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. It is possible that employee stock options may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. Although the fair value of our stock options is determined in accordance with GAAP and the SEC’s Staff Accounting Bulletin No. 107 using the Black-Scholes-Merton option-pricing model, the value calculated may not be indicative of the fair value observed in a willing buyer / willing seller market transaction.

Estimates of share-based compensation expense are highly subjective as to value and have an impact on our financial statements, but these expenses will never result in the payment of cash by us. For this reason, and because we do not view share-based compensation as being related to our operational performance, we exclude estimated share-based compensation expense when internally evaluating our performance.

Income Taxes

We record income taxes under the asset and liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the enacted tax rates expected to be in effect when we realize the underlying items of income and expense. We consider all relevant factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income and the carryforward periods available to us for tax reporting purposes, as well as assessing available tax planning strategies. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.

The accounting standard related to income taxes applies to all tax positions and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. The accounting standard requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are to be recognized. Differences between financial and tax reporting which do not meet this threshold are required to be recorded as unrecognized tax benefits. This standard also provides guidance on the presentation of tax matters and the recognition of potential Internal Revenue Service interest and penalties. As of December 31, 2017 and 2016, the Company did not have an unrecognized tax liability.

Business Combinations

A component of our growth strategy has been to acquire businesses that complement our existing operations. We account for business combinations in accordance with the guidance for business combinations and related literature. Accordingly, we allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed based upon their estimated fair values at the date of purchase. The excess of the purchase price over the fair value of the net assets acquired is recorded as goodwill.

In determining the fair values of assets acquired and liabilities assumed in a business combination, we use various recognized valuation methods, including present value modeling and referenced market values (where available). Further, we make assumptions within certain valuation techniques, including discount rates and the timing of future cash flows. Valuations are performed by management or independent valuation specialists under management’s supervision, where appropriate. We believe that the estimated fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions that marketplace participants would use. However, such assumptions are inherently uncertain and actual results could differ from those estimates.

As part of our accounting for business combinations, we are required to determine the useful lives of identifiable intangible assets recognized separately from goodwill. The useful life of an intangible asset is the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the acquired business. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized.

Additionally, when acquiring a company that has recorded deferred revenue in its historical, pre-acquisition financial statements, we are required as part of purchase accounting to re-measure the deferred revenue as of the acquisition date. Deferred revenue is re-measured to represent solely the cost that relates to the associated legal performance obligation which we assumed as part of the acquisition, plus a normal profit margin representing the level of effort or assumption of risk assumed. Legal performance obligations that simply relate to the passage of time would not result in recognized deferred revenue as there is little to no associated cost.

Definite Lived Intangible Assets

Our definite lived intangible assets consist of customer relationships, accreditations, a beneficial lease arrangement, tradenames/trademarks and patents related to our acquisitions, recorded at estimated fair value. It also consists of our trademark rights and the related costs incurred to obtain the trademark rights recorded at cost. These definite lived assets are subject to amortization using the straight-line method over the estimated useful lives of the respective assets, which range from two to fifteen years. See Note 5 to our consolidated financial statements set forth in Item 8-K of this Annual Report on Form 10-K.

Assumptions and estimates about future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by a variety of factors, including external factors such as consumer spending habits and general economic trends, and internal factors such as changes in our business strategy and our internal forecasts. We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. If our qualitative analysis indicates that there could be an impairment, we then determine whether an impairment loss occurred which requires a comparison of the carrying amount to the sum of the undiscounted cash flows expected to be generated by the asset, or the expected proceeds, net of costs to sell, upon sale of the asset. If an impairment exists, the amount of impairment is measured as the excess of the carrying amount of the asset over its fair value. During 2016 and 2017, we completed a qualitative analysis, and based upon the work performed, we concluded that no impairment existed.

Goodwill and Other Non-Amortizable Intangible Assets

Goodwill relates to our acquisitions of ICS, Validus and SureHarvest. All other non-amortizable intangible assets relate to the trademarks/tradenames acquired in the Validus acquisition and have an indefinite life. Pursuant to Accounting Standards Codification (“ASC”) Topic 350, if an intangible asset is determined to have an indefinite useful life, it shall not be amortized until its useful life is determined to no longer be indefinite. Accordingly, we evaluate the remaining useful life of an intangible asset that is not being amortized each reporting period to determine whether events or circumstances continue to support an indefinite useful life. As of December 31, 2017, there have been no changes to the indefinite life determination pertaining to these intangible assets.

In addition, an intangible asset that is not subject to amortization shall be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an indefinite-lived intangible asset exceeds its estimated fair value, an impairment loss equal to the excess is recorded. However, entities testing an indefinite-lived intangible asset for impairment have the option of performing a qualitative assessment before calculating the fair value of the asset. If entities determine, on the basis of qualitative factors, that the likelihood of the indefinite-lived intangible asset being impaired is below a “more-likely-than-not” threshold (i.e., a likelihood of more than 50 percent), the entity would not need to calculate the fair value of the asset.

During the fourth quarter of 2017, we assessed the carrying value of goodwill and other intangible assets of each of ICS, Validus and SureHarvest, our three reporting units. At December 31, 2017, goodwill assigned to ICS, Validus and SureHarvest was approximately $533,000, $746,800, and $1,372,500 respectively.

We performed a qualitative assessment on our ICS and Validus reporting units for our 2017 annual test and concluded that it was more-likely-than-not that the fair value of the reporting unit exceeded its carrying value and, therefore, a two-step impairment test was not necessary. The qualitative assessment compares current performance, expectations and other indicators against what was expected as part of the most recent Step 1 valuation. Consequently, the key estimates and assumptions related to the most recent Step 1 valuation pertaining to this reporting unit had not changed since our previous annual report.

We estimate the SureHarvest reporting unit’s fair value using a 13-year projection of discounted cash flows which incorporates planned growth rates, market-based discount rates and estimates of residual value. Additionally, we used a market-based, weighted-average cost of capital of 16.3% to discount the projected cash flows of those operations. Estimating the fair value of an individual reporting unit requires us to make assumptions and estimates regarding our future plans, industry and economic conditions and our actual results and conditions may differ over time. If the carrying value of a reporting unit’s net assets exceeds its fair value, the second step is applied to measure the difference between the carrying value and implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, the goodwill is considered impaired and reduced to its implied fair value. In connection with our testing, we noted the SureHarvest reporting unit was more sensitive to near-term changes in discounted cash flow assumptions. As of December 31, 2017, the fair value exceeded the carrying value of net assets by approximately 3%. While the reporting unit passed the first step of the impairment test, if operating income or another valuation assumption were to deteriorate significantly in the future, it could adversely affect the estimated fair value. If we are unsuccessful in our plans to increase the profitability of the SureHarvest reporting unit, the estimated fair value could decline and lead to a potential goodwill impairment in the future.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2 to our consolidated financial statements set forth in Item 8 of this Annual Report on Form 10-K for a detailed description of recent accounting pronouncements.

Not applicable.

ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
Where Food Comes From, Inc.
Castle Rock, Colorado

OPINION ON THE FINANCIAL STATEMENTS

We have audited the accompanying consolidated balance sheets of Where Food Comes From, Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of income, equity, and cash flows, for each year in the two-year period ended December 31, 2017, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each year in the two-year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.

BASIS FOR OPINION

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ EKS&H LLLP

April 2, 2018
Denver, Colorado

We have served as the Company’s auditors since 2016.

Where Food Comes From, Inc.
Consolidated Balance Sheets

The accompanying notes are an integral part of these consolidated financial statements.

Where Food Comes From, Inc.
Consolidated Statements of Income

The accompanying notes are an integral part of these consolidated financial statements.

Where Food Comes From, Inc.
Consolidated Statements of Cash Flows

The accompanying notes are an integral part of these consolidated financial statements.

Where Food Comes From, Inc.
Consolidated Statement of Equity
Years ended December 31, 2017 and 2016

The accompanying notes are an integral part of these consolidated financial statements.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Note 1 - The Company and Basis of Presentation

Business Overview  

Where Food Comes From, Inc. is a Colorado corporation based in Castle Rock, Colorado (“WFCF,” the “Company,” “our,” “we,” or “us”). We provide verification and certification solutions for the agriculture, livestock and food industry. Most of our customers are located throughout the United States.

On September 16, 2013, we acquired a 60% interest in Validus Verification Services LLC (“Validus”) which consisted of the auditing business of Praedium Ventures, LLC (“Praedium”), previously known as Validus Ventures LLC. On February 29, 2016, the Company exercised its call option to acquire the remaining 40% interest in Validus (Note 3).

On December 28, 2016, we acquired a 60% interest in SureHarvest Services, LLC (“SureHarvest”) which consisted of all the business assets of SureHarvest, Inc. (Note 3).

On May 30, 2017, we acquired 100% of the business assets of A Bee Organic, LLC.

Basis of Presentation

Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues, costs and expenses during the reporting period. Actual results could differ from the estimates.

Our consolidated financial statements include the accounts of all majority-owned or controlled subsidiaries, and all significant intercompany transactions and amounts have been eliminated. The results of businesses acquired are included in the consolidated financial statements from the date of the acquisition.

Note 2 - Summary of Significant Accounting Policies

Cash and Cash Equivalents

We place our cash with high quality financial institutions. At times, cash balances may exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limit; however, we have not experienced any losses related to balances that exceed such FDIC insurance limits, and we believe our credit risk is minimal. At times, we may also invest in short-term investments with original maturities of three months or less, which we consider to be cash and cash equivalents, since they are readily convertible to cash.

Short-Term Investments

Certificates of deposit with original maturities greater than three months and remaining maturities less than one year are classified as “Short-term investments.”

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Revenue Recognition

Verification and Certification Segment

We offer a range of products and services to maintain identification, traceability, and verification systems. We conduct 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. We generate revenue primarily from the sale of our verification solutions, consulting services and hardware sales. We sell our products and services directly to customers at various levels in the livestock and agricultural supply chains.

Verification and certification service revenue primarily consists of fees charged for verification audits and other verification services that the Company performs for customers. Revenue from verification audits is recognized upon completion of the audits. Contracts for these services are cancelable only for non-performance.

Deferred revenue represents payments received in advance from our customers for annual customer support services not yet performed as of December 31st, and revenue is recognized as services are performed, generally over the one-year contract term.

Product sales are primarily generated from the sale of cattle identification ear tags. Revenue is recognized when goods are shipped and after title has transferred to the customer.

Software Sales and Related Consulting Segment

We also derive revenue from software licenses, maintenance and services. Our license arrangements generally contain multiple-elements, including software maintenance services and consulting services. We do not recognize revenue until the following four basic criteria are met: (i) persuasive evidence of an arrangement exists, (ii) our product has been shipped or, if delivered electronically, the customer has the right to access the software, (iii) the fee is fixed or determinable, and (iv) collection of the fee is probable.

We predominately offer products via a SaaS model, which is a subscription based model. Subscription revenue derived from these agreements is generally recognized on a straight-line basis over the subscription term.

We generally sell our software licenses with maintenance services and, in some cases, also with consulting services. For these multiple-element arrangements, we allocate revenue to the delivered elements of the arrangement using the residual method, whereby revenue is allocated to the undelivered elements based on vendor specific objective evidence (or “VSOE”) of fair value of the undelivered elements with the remaining arrangement fee allocated to the delivered elements and recognized as revenue assuming all other revenue recognition criteria are met. For the undelivered elements, we determine VSOE of fair value to be the price charged when the undelivered element is sold separately. We determine VSOE for maintenance sold in connection with a software license based on the amount that will be separately charged for the maintenance renewal period. We determine VSOE for consulting services by reference to the amount charged for similar engagements when a software license sale is not involved. We review services sold separately on a periodic basis and update, when appropriate, our VSOE of fair value for such maintenance and services to ensure that it reflects our recent pricing experience. If payment of the software license fees is dependent upon the performance of consulting services or the consulting services are essential to the functionality of the licensed software, then we recognize both the software license and consulting fees using the completed contract method.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Revenue from maintenance is recognized ratably over the service period. Maintenance revenue is deferred until the associated license is delivered to the customer and all other criteria for revenue recognition have been met. Revenue from consulting services is generally recognized as the services are delivered to the customer.

Other

Sales taxes collected from customers and remitted to government authorities are excluded from revenue.

Generally, we do not provide right of return or warranty on product sales or services performed.

In connection with certain arrangements, reimbursable expenses are incurred and billed to customers and such amounts are recognized as both revenue and cost of revenue.

Accounts Receivable and Allowance for Doubtful Accounts

Our receivables are generally due from trade customers. Credit is extended based on our evaluation of the customer’s financial condition, and generally collateral is not required. Accounts receivable are generally due approximately 30 days from the invoice date and are stated at amounts due from customers, net of an allowance for doubtful accounts. Accounts receivable that are outstanding longer than the contractual payment terms are considered past due. We determine our allowance by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss and payment history, the customer’s current ability to pay its obligations to us and the condition of the general economy and the industry as a whole. We write off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. The allowance for doubtful accounts was approximately $47,600 and $17,900, at December 31, 2017 and 2016, respectively.

No single customer accounted for greater than 10% of our accounts receivable balances at December 31, 2017 and 2016.

Cost of Revenues

Salaries and related fringe benefits directly associated with our verification and certification service revenues are allocated to costs of verification and certification services.

Costs of products primarily represents the cost of livestock ear tags generally used in connection with our verification programs. Livestock identification ear tags sold in connection with our verification offerings are purchased primarily from one supplier. However, there are numerous other companies which manufacture and market such ear tags.

Costs of product support, including web hosting fees, salaries and related fringe benefits directly associated with our software license, maintenance and support services, are allocated to costs of software license, maintenance and support services.

Salaries and related fringe benefits directly associated with our software-related consulting revenues are allocated to costs of software-related consulting services.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Fair Value Measurements

ASC Topic 820, Fair Value Measurements and Disclosure, establishes a hierarchy for inputs used in measuring fair value for financial assets and liabilities that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

The financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

The Company’s non-recurring fair value measurements include purchase price allocations for the fair value of assets and liabilities acquired through business combinations. Please refer to Note 3 for further discussion of business combinations.

The acquisition of a group of assets in a business combination transaction requires fair value estimates for assets acquired and liabilities assumed. The fair value of assets and liabilities acquired through business combinations is calculated using a discounted future cash flows method. The discounted cash flows are developed using the income approach in which a value (based on management’s expectations for the future) is determined by converting anticipated benefits. The fair value measurements are based on significant inputs not observable in the market and thus represent fair value measurements which are designated as Level 3 inputs within the fair value hierarchy. Key assumptions and considerations include:

Other Financial Instruments

The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their fair value due to their short maturities. The carrying values shown for short-term investments and notes payable also approximate fair value because current interest rates and terms offered to us for similar instruments are substantially the same (Level 2 inputs).

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Property and Equipment

Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the respective assets. Land is not depreciated. Buildings are depreciated over 20 years. Leasehold improvements are depreciated over the shorter of the lease term, which generally includes reasonably assured option periods, or the estimated useful lives of the assets. All other property and equipment have depreciable lives which range from two to seven years. Upon retirement or disposal of assets, the accounts are relieved of cost and accumulated depreciation and the related gain or loss is reflected in earnings.

Impairment of Long-Lived Assets

We review all of our long-lived assets (including intangible assets) for impairment at least annually or whenever impairment indicators are determined to be present. If an impairment exists, the amount of impairment is measured as the excess of the carrying amount of the asset over its fair value as determined utilizing estimated discounted future cash flows, or some other fair value measure, or the expected proceeds, net of costs to sell, upon sale of the asset.

Significant judgments are required to estimate the fair value of intangible assets, including estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions or the occurrence of one or more confirming events in future periods could cause the actual results or outcomes to materially differ from such estimates and could also affect the determination of fair value and/or impairment at future reporting dates.  No impairment was identified among the Company’s long-lived assets through December 31, 2017 and 2016.

Definite Lived Intangible Assets

Our definite lived intangible assets consist of customer relationships, accreditations, a beneficial lease arrangement, tradenames/trademarks and patents related to our acquisitions, recorded at estimated fair value. Such assets also consist of our trademark rights and the related costs incurred to obtain the trademark rights recorded at cost. These definite lived assets are subject to amortization using the straight-line method over the estimated useful lives of the respective assets, which range from two to fifteen years. (Note 5).

Assumptions and estimates about future values and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by a variety of factors, including external factors such as consumer spending habits and general economic trends, and internal factors such as changes in our business strategy and our internal forecasts. We review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. If our qualitative analysis indicates that there could be an impairment, we then determine whether an impairment loss occurred, which requires a comparison of the carrying amount to the sum of the undiscounted cash flows expected to be generated by the asset, or the expected proceeds, net of costs to sell, upon sale of the asset. If an impairment exists, the amount of impairment is measured as the excess of the carrying amount of the asset over its fair value. During 2017 and 2016, we completed a quantitative and qualitative analysis, and based upon the work performed, we concluded that no indicators of impairment existed.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Goodwill and Other Non-Amortizable Intangible Assets

Goodwill relates to our acquisitions of International Certification Services, Inc. (“ICS”), Validus and SureHarvest. All other non-amortizable intangible assets relate to the trademarks/tradenames acquired in the Validus acquisition and have an indefinite life.  Pursuant to ASC Topic 350, if an intangible asset is determined to have an indefinite useful life, it shall not be amortized until its useful life is determined to no longer be indefinite. Accordingly, we evaluate the remaining useful life of an intangible asset that is not being amortized each reporting period to determine whether events or circumstances continue to support an indefinite useful life. As of December 31, 2017, there have been no changes to the indefinite life determination pertaining to these intangible assets.

In addition, an intangible asset that is not subject to amortization shall be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of an indefinite-lived intangible asset exceeds its estimated fair value, an impairment loss equal to the excess is recorded. However, entities testing an indefinite-lived intangible asset for impairment have the option of performing a qualitative assessment before calculating the fair value of the asset. If entities determine, on the basis of qualitative factors, that the likelihood of the indefinite-lived intangible asset being impaired is below a “more-likely-than-not” threshold (i.e., a likelihood of more than 50 percent), the entity would not need to calculate the fair value of the asset.

During the fourth quarter of 2017, we assessed the carrying value of goodwill and other intangible assets of each of ICS, Validus and SureHarvest, our three reporting units. At December 31, 2017, goodwill assigned to ICS, Validus and SureHarvest was approximately $533,000, $746,800, and $1,372,500 respectively.

We performed a qualitative assessment on our ICS and Validus reporting units for our 2017 annual test and concluded that it was more-likely-than-not that the fair value of the reporting unit exceeded its carrying value and, therefore, a two-step impairment test was not necessary. The qualitative assessment compares current performance, expectations and other indicators against what was expected as part of the most recent Step 1 valuation. Consequently, the key estimates and assumptions related to the most recent Step 1 valuation pertaining to this reporting unit had not changed since our previous annual report.

We estimate the SureHarvest reporting unit’s fair value using a 13-year projection of discounted cash flows which incorporates planned growth rates, market-based discount rates and estimates of residual value. Additionally, we used a market-based, weighted-average cost of capital of 16.3% to discount the projected cash flows of those operations. Estimating the fair value of an individual reporting unit requires us to make assumptions and estimates regarding our future plans, industry and economic conditions and our actual results and conditions may differ over time. If the carrying value of a reporting unit’s net assets exceeds its fair value, the second step is applied to measure the difference between the carrying value and implied fair value of goodwill. If the carrying value of goodwill exceeds its implied fair value, the goodwill is considered impaired and reduced to its implied fair value. In connection with our testing, we noted the SureHarvest reporting unit was more sensitive to near-term changes in discounted cash flow assumptions. As of December 31, 2017, the fair value exceeded the carrying value of net assets by approximately 3%. While the reporting unit passed the first step of the impairment test, if operating income or another valuation assumption were to deteriorate significantly in the future, it could adversely affect the estimated fair value. If we are unsuccessful in our plans to increase the profitability of the SureHarvest reporting unit, the estimated fair value could decline and lead to a potential goodwill impairment in the future.

Research and Development and Software Development Costs

Research and development costs are charged to operations as incurred. We did not incur any research and development expense in 2017 and 2016.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Internal use software development costs represent the capitalization of certain external and internal computer software costs incurred during the application development stage. The application development stage is characterized by software design and configuration activities, coding, testing and installation. Training costs and maintenance are expensed as incurred, while upgrades and enhancements are capitalized if it is probable that such expenditures will result in additional functionality.

Website software development costs related to certain planning and training costs incurred in the development of website software are expensed as incurred, while application development stage costs are capitalized.

In 2013, we acquired certain assets of Validus, which included internally-developed software with an estimated fair value of $129,000. During 2017 and 2016, the amortization of capitalized costs totaled approximately $0 and $43,000, respectively, included in depreciation expense (Note 4). Capitalized costs are included in property and equipment.

Software development costs for external sale are capitalized once technological feasibility is achieved. Capitalized costs are amortized over the expected benefit period. We generally expense a significant portion of software development costs because technological feasibility occurs very late in the software development process. In connection with our SureHarvest acquisition on December 28, 2016 (Note 3), software developed for external sale with an estimated fair value of approximately $558,000 has been included in property and equipment. During 2017, the amortization of capitalized costs totaled approximately $186,000, included in depreciation expense (Note 4).

Advertising and Marketing Expenses

Advertising and marketing costs are expensed as incurred. Total advertising and marketing expenses for the years ended December 31, 2017 and 2016, were approximately $290,000 and $220,400, respectively.

Income Taxes

We record income taxes under the asset and liability method. Deferred tax assets and liabilities reflect our estimation of the future tax consequences of temporary differences between the carrying amounts of assets and liabilities for book and tax purposes. We determine deferred income taxes based on the differences in accounting methods and timing between financial statement and income tax reporting. Accordingly, we determine the deferred tax asset or liability for each temporary difference based on the enacted tax rates expected to be in effect when we realize the underlying items of income and expense. We consider all relevant factors when assessing the likelihood of future realization of our deferred tax assets, including our recent earnings experience by jurisdiction, expectations of future taxable income and the carryforward periods available to us for tax reporting purposes, as well as assessing available tax planning strategies. We may establish a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. Due to inherent complexities arising from the nature of our businesses, future changes in income tax law, tax sharing agreements or variances between our actual and anticipated operating results, we make certain judgments and estimates. Therefore, actual income taxes could materially vary from these estimates.

The accounting standard related to income taxes applies to all tax positions and defines the confidence level that a tax position must meet in order to be recognized in the financial statements. The accounting standard requires that the tax effects of a position be recognized only if it is “more-likely-than-not” to be sustained by the taxing authority as of the reporting date. If a tax position is not considered “more-likely-than-not” to be sustained, then no benefits of the position are to be recognized. Differences between financial and tax reporting which do not meet this threshold are required to be recorded as unrecognized tax benefits.  This standard also provides guidance on the presentation of tax matters and the recognition of potential Internal Revenue Service interest and penalties. As of December 31, 2017 and 2016, the Company did not have an unrecognized tax liability.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

The Company classifies penalty and interest expense related to income tax liabilities as an income tax expense. The Company did not incur any interest and penalties for the years ended December 31, 2017 and 2016.

The Company files income tax returns in the U.S. and various state jurisdictions, and there are open statutes of limitation for taxing authorities to audit our tax returns from 2014 through the current period.

The Tax Cuts and Jobs Act (“Tax Act”) was signed into law on December 22, 2017. The Tax Act includes significant changes to the U.S. corporate income tax system, including a federal corporate rate reduction from 35% to 21%, limitations, the deductibility of interest expense and executive compensation, eliminating the corporate alternative minimum tax (“AMT”) and changing how existing AMT credits can be realized, changing the rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017, and, the transition of U.S. international taxation from a worldwide tax system to a territorial tax system.

As a result of the reduction in the federal tax rate, the Company was required to revalue its ending net deferred tax liabilities and/or assets as of December 31, 2017, as well as evaluate whether a valuation allowance was needed for deferred tax assets. For 2017, the primary impact to the Company is the reduction in the federal corporate tax rate from 35% to 21% which reduced the Company’s ending deferred tax assets by approximately $40,000.

Stock-Based Compensation

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 at the date of grant 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. See Note 10 for additional information.

Deferred Rent and Lease Incentives

For leases that contain fixed escalations of the minimum annual lease payment during the original term of the lease, we recognize rental expense on a straight-line basis over the lease term and record the difference between rent expense and the amount currently payable as deferred rent. Deferred lease incentives include construction allowances received from landlords, which are amortized on a straight-line basis over the lease terms.

Recently Issued Accounting Standards

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 changes the revenue recognition for companies that enter into contracts with customers to transfer goods or services. The standard is a comprehensive new revenue recognition model that requires revenue to be recognized in a manner depicting the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. The FASB has also issued a number of updates to this standard. We adopted the standard on January 1, 2018. Companies may use either a full retrospective or a modified retrospective approach to adopt this standard. We adopted the standard using a modified retrospective approach.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

We are in the final stages of assessing the impact of adoption and evaluating the materiality of that impact on our consolidated financial statements. We note that our conclusions are subject to change, and we continue to review our implementation documentation, finalize our impact assessment and perform other implementation activities.

In addition to completing our review of contracts and quantifying the impacts on the consolidated financial statements, we have analyzed our internal control over financial reporting framework and determined that there will be new controls added around contract inception and contract modifications, as well as periodic reviews of material contracts. In addition, we have reviewed the impacts of this standard on our footnote disclosures for periods subsequent to January 1, 2018. We have determined that the adoption of this standard will result in several additional disclosures, including but not limited to additional information around our performance obligations, the timing of revenue recognition, remaining performance obligations at period end, contract assets and liabilities and significant judgments made that impact the amount and timing of revenue from our contracts with customers.

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 has evaluated the provisions of this new guidance and has determined this standard does not currently have an impact on its financial condition, results of operations, cash flows and related disclosures.

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.

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 Accounting Standards Update (“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

We have considered all other recently issued accounting pronouncements and do not believe the adoption of such pronouncements will have a material impact on our consolidated financial statements.

Reclassifications

Certain prior year amounts have been reclassified to conform to current year presentation. Net income and shareholders’ equity were not affected by these reclassifications.

Note 3 – Business Acquisitions

Validus Acquisition

On September 16, 2013, we entered into an Asset Purchase and Contribution Agreement (the “Validus Purchase Agreement”), by and among the Company, Validus, and Praedium. In connection with this transaction, Praedium was issued a 40% interest in Validus, with the Company holding a 60% interest. The Company had the first right of refusal on the remaining 40% of the outstanding membership interests and a call option to acquire the remaining 40% interest.

Effective February 29, 2016, the Company exercised its call option to purchase the remaining 40% interest of Validus in exchange for cash consideration of approximately $162,700, and 93,057 shares of common stock valued at approximately $200,100, pursuant to the Validus Purchase Agreement, dated September 16, 2013. The carrying amount of the contingently redeemable non-controlling interest was adjusted to $0 to reflect the change in the Company’s ownership interest up to 100%. The difference between the fair value of the consideration paid and the carrying value of the non-controlling interest on the date of the transaction, which totaled approximately $542,000, net of taxes of $110,900, was adjusted to equity.

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 (“SureHarvest”) and SureHarvest, Inc., a California corporation (“SureHarvest, Inc.”). 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 SureHarvest, Inc. in exchange for total consideration of approximately $2.8 million, comprised of $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. The Company has the right of first refusal on the remaining 40% of the outstanding membership interests of SureHarvest, which owns the business assets of SureHarvest, Inc.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Following the thirty-six-month anniversary of the effective date of the SureHarvest Purchase Agreement, the Company has the option, but not the obligation, to purchase all the membership interests (the 40% interest) of SureHarvest held by the SureHarvest, Inc., and SureHarvest, Inc. has the option, but not the obligation, to require the Company to purchase all the membership interests of SureHarvest held by the SureHarvest, Inc. The purchase price for the membership interests shall be equal to the amount the selling holders of the membership interests would be entitled to receive upon a liquidation of 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 in the SureHarvest Purchase Agreement, 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 sheets.

The table below summarizes the final allocated fair values assigned to the assets and liabilities acquired in addition to the excess of the purchase price over the net assets acquired:

On the acquisition date, the fair value of the non-controlling interest was estimated to be $1,888,135. This amount was based upon the gross consideration that would have been paid assuming 100% of the outstanding equity had been acquired. Excess attributable to goodwill reflects the excess over the identifiable intangible assets acquired based on the final allocation of the purchase price. Goodwill is primarily attributable to the operational and financial benefits expected to be realized from the acquisition, including cost saving synergies from operating efficiencies, future growth in bundling opportunities across divisions and brands, realized savings from a more sophisticated information technology infrastructure, and strategic advances from expansion of our intellectual property. The final amounts of the components of intangible assets have been recorded as follows:

The useful lives for these identifiable intangible assets are expected to be between three and fifteen years.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

The following unaudited pro forma information presents the results of operations for the year ended December 31, 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.

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 eight years.

The pro forma effects of A Bee Organic on the Company’s consolidated results of operations for 2017 and 2016, as if the acquisition had occurred on January 1, 2016 and 2017 are not material. 

Note 4 - Property and Equipment

The major categories of property and equipment are as follows as of December 31st:

Total depreciation expense for the years ended December 31, 2017 and 2016 was approximately $317,200 and $112,600, respectively. Depreciation expense for assets recorded under capital lease was approximately $5,100 and $3,600 for the years ended December 31, 2017 and 2016, respectively.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Note 5 – Intangible and Other Assets

The following table summarizes our intangible assets as of December 31st:

Amortization expense for the years ended December 31, 2017 and 2016 was approximately $537,000 and $155,100, respectively.

As of December 31, 2017, future scheduled amortization of intangible assets is as follows:

In connection with our acquisition of ICS in 2012, we recorded a beneficial lease arrangement of $120,200 related to a 2,300-square foot building located on approximately ¾ acre in Medina, North Dakota. On January 12, 2018, the Company purchased the 2,300-square foot building and terminated the lease. The net book value of the beneficial lease arrangement at December 31, 2017 was approximately $56,500 and will be was written off in January 2018.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Note 6 – Accrued Expenses and Other Current Liabilities

The following table summarizes our accrued expenses and other current liabilities as of December 31st:

Note 7 - Notes Payable and Capital Lease Obligations

Equipment Note

In September 2017, we entered into a note payable of $54,165 for the purchase of a vehicle. Interest and principal payments are due in equal monthly installments of $1,087 over five years beginning October 2017. This note bears an interest rate of 7.44% per annum and is fully secured by the vehicle.

Unison Revolving Line of Credit

The Company has a revolving line of credit (“LOC”) agreement which matures on April 12, 2020. The LOC provides for $75,050 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 upon maturity. As of December 31, 2017, the effective interest rate was 5.5%. The LOC is collateralized by all the business assets of ICS. As of December 31, 2017 and 2016, there were no amounts outstanding under this LOC.

Capital Lease

The Company has capital leases for certain of its office equipment. Approximately $40,500 in asset cost and $8,000 in accumulated amortization is included in property and equipment. Imputed interest ranges of 1.8% to 3.3% have been used in determining the minimum lease payments.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Future minimum lease payments for capital leases are as follows:

Note 8 - Income Taxes

The provision for income taxes consists of the following:

The reconciliation of income taxes calculated at the statutory rates to our effective tax rate is as follows:

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

The income tax effects of temporary differences that give rise to significant portions of deferred tax assets (liabilities) as of December 31, 2017 and 2016 are as follows:

Our net operating loss carryforwards were fully utilized against taxable income for the year ended December 31, 2016.

Note 9 – Stock Buyback Plan

On January 7, 2008, we announced our intention to buy back up to one million shares of our common stock from the open market at the quoted market price on the date of repurchase. Activity under the Stock Buyback Plan by year is as follows:

The repurchased shares are recorded as part of treasury stock and are accounted for under the cost method.

Our Stock Buyback Plan has been and will be used to return capital to shareholders and to minimize the dilutive impact of stock options and other share-based awards. In the future, we may consider additional share repurchases under our plan based on several factors, including our cash position, share price, operational liquidity, and planned investment and financing needs.

Note 10 – 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 at the date of grant 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 consolidated statements of income.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

The amount of stock-based compensation expense is as follows:

As of December 31, 2017, the estimated unrecognized compensation cost from unvested awards which will be recognized ratably over the remaining vesting phase is as follows:

The Company estimated the fair value of stock options using the Black-Scholes-Merton option-pricing model with the following assumptions:

Equity Incentive Plans

Our 2006 Equity Incentive Plan (the “2006 Plan”) and 2016 Equity Incentive Plan (the “2016 Plan,” and together with the 2006 Plan, the “Plans”) provide for the issuance of stock-based awards to employees, officers, directors and consultants. The Plans permit 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.

Our 2006 Plan provided for the issuance of a maximum of 3,000,000 shares of our common stock. The 2006 Plan terminated in September 2016. As of December 31, 2017, the 2006 Plan had 271,585 awards outstanding.

Our 2016 Plan was ratified by our shareholders in May 2016 and provides for the issuance of a maximum of 5,000,000 shares of our common stock, of which 4,891,750 shares were still available for issuance as of December 31, 2017.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Stock Option Activity

The Company generally grants stock options to directors, eligible employees and officers as a part of its equity incentive plan. Restrictions and vesting periods for the stock option grants are set forth in the award agreements. A stock option grant represents an option to purchase a defined number of shares of the Company’s common stock to be released from restrictions upon completion of the vesting period. The awards typically vest in equal increments over one to three years. Stock option activity during 2017 and 2016 is summarized as follows: 

The aggregate intrinsic value of stock options represents the total pre-tax intrinsic value (the aggregate difference between the closing stock price of our common stock on December 31, 2017 and the exercise price for in-the-money options) that would have been received by the option holders if all in-the-money options had been exercised on December 31, 2017.

During the year ended December 31, 2017, no stock-based awards were forfeited. During the year ended December 31, 2016, a total of 500 options issued under the 2006 Plan were forfeited, all of which were unvested. The options were forfeited upon the employees’ termination from the Company.

Restricted Stock Activity

The Company grants shares of restricted stock to directors, eligible employees and officers as a part of its equity incentive plan. Restrictions and vesting periods for the awards are set forth in the award agreements. Each share of restricted stock represents one share of the Company’s common stock to be released from restrictions upon completion of the vesting period. The awards typically vest in equal increments over one to three years. Shares of restricted stock are valued at the closing price of the Company’s common stock on the grant date and are recognized as selling, general and administrative expense over the vesting period of the award.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

The following table summarizes activity for restricted stock awards for the fiscal years presented:

Note 11 - 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 plus unrecognized stock-based compensation obtained thereby were used by the Company 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:

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

Note 12 - Related Party Transactions

In 2017 and 2016, we recorded total net revenue of approximately $7,900 and $12,000, respectively, from related parties. The related parties consisted of a business owned by the father of Leann Saunders, our President, and businesses owned by members of our Board of Directors.

The Company leases its corporate headquarters from a company in which our CEO and President have a 27% ownership interest (Note 13). Under the related party arrangement, approximately $271,700 and $88,100 in rent expense for our corporate headquarters was included under selling, general and administrative expenses in the consolidated statements of income for the years ended December 31, 2017 and 2016, respectively.

Note 13 – Commitments and Contingencies

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 The Move, LLC 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 on August 1, 2016. Rental payments are approximately $18,000 per month, which includes common area charges, and are subject to annual increase 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 of approximately $71,300 is included in 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 sheets. Lease incentives have been included in other long-term liabilities 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.

In August 2017, the Company amended its lease agreement with The Move, LLC to provide for an additional 7,700 square feet of office space commencing on December 1, 2017. The additional space is currently not approved for occupancy. Total rental payments beginning December 1, 2017 increased to approximately $35,100 per month, which includes common area charges, and are subject to annual increases over the term of the lease. The Company will also receive approximately $230,000 in lease incentives to build-out the new additional square footage. All other terms will remain the same.

In September 2017, the Company entered into a new lease agreement for our Urbandale, Iowa office space. The lease is for a period of two years and expires on August 31, 2019. Rental payments are approximately $2,900 per month, which includes common area charges, and are subject to annual increases over the term of the lease.

The Company also owns approximately ¾ acre on which a 2,300-square foot building is located in Medina, North Dakota. The Company leases space in this building under a five-year lease with an expiration date of March 1, 2018. On January 12, 2018, the Company purchased the 2,300-square foot building and accordingly, the lease terminated. See Note 16 for additional information. Under the lease, the Company was charged a monthly rental rate of approximately $150 plus all insurance, taxes and other costs based on actual expenses to maintain the building.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

In connection with our acquisition of SureHarvest, we added two locations in California: Soquel and Modesto. Our office space in Soquel expires on November 30, 2018 and requires rental payments of approximately $2,700 per month. In addition to primary rent, this lease requires additional payments for operating costs and other common area maintenance costs. The monthly rental payments for our leased space in Modesto is approximately $600 and the lease agreement is month-to-month.

Rent expense for the years ended December 31, 2017 and 2016 was approximately $371,800 and $204,200, respectively. Future minimum lease payments are as follows:

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.

Employee Benefit Plan

The Company has established a 401(k) plan for the benefit of our employees. The plan covers substantially all of our employees who have attained age 21. We may make a discretionary matching contribution in an amount that is determined by our Board of Directors. If a matching contribution is made, the amount cannot exceed the elective deferral contributions. For the years ended December 31, 2017 and 2016, we made aggregate matching contributions of approximately $164,100 and $45,300, respectively.

Contingently Redeemable Non-Controlling Interest

Contingently redeemable non-controlling interest on our consolidated balance sheets represents the non-controlling interest related to the Validus and SureHarvest acquisitions (see Note 3).

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Below reflects the activity of the redeemable non-controlling interest as of and for the years ended December 31, 2017 and 2016.

Note 14 – Supplemental Cash Flow Information

Note 15 - Segments

With each acquisition, we assess the need to disclose discrete information related to our operating segments. Because of the similarities of certain of our acquisitions that provide certification and verification services, we aggregate operations into one verification and certification services reportable segment. The factors considered in determining this aggregated reporting segment include the economic similarity of the businesses, the nature of services provided, production processes, types of customers and distribution methods. The Company’s chief operating decision maker (the Company’s CEO) allocates resources and assesses the performance of its certification and verification services activities as one segment, which includes product sales.

With the acquisition of SureHarvest, the Company determined that it also has a software sales and related consulting services segment. This segment includes software license, maintenance, support and software-related consulting service revenues.

Where Food Comes From, Inc.
Notes to the Consolidated Financial Statements

Management makes decisions, measures performance, and manages the business utilizing internal reporting operating segment information. Performance of operating segments are based on net sales, gross profit, selling, general and administrative expenses and most importantly, operating income.

The Company eliminates intercompany transfers between segments for management reporting purposes. The following table shows information for reportable operating segments: