Where Food Comes From, Inc. - Quarter Report: 2018 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549

FORM 10-Q

For the Quarterly period ended March 31, 2018

For the transition period from ____________ to _____________  

Commission File No. 333-133624

WHERE FOOD COMES FROM, INC. 

(exact name of registrant as specified in its charter) 

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a small reporting company.  See definitions of “large accelerated filer” and “accelerated filer” and “smaller reporting entity” 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 number of shares of the registrant’s common stock, $0.001 par value per share, outstanding as of May 4, 2018, was 24,637,215.

Where Food Comes From, Inc. 

Table of Contents

March 31, 2018

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

(Unaudited)

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

Where Food Comes From, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

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

Where Food Comes From, Inc.

Consolidated Statement of Equity

Year to date ended March 31, 2018

(Unaudited)

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

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

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 are an independent, third-party food verification company conducting both on-site and desk audits to verify that claims being made about livestock, food, other high-value specialty crops and agricultural products are accurate. We care about food and other agricultural products, how it is grown and raised, the quality of what we eat, what farmers and ranchers do, and authentically telling that story to the consumer. Our team visits farms and ranches and looks at their plants, animals, and records, and compares the information we collect to specific standards or claims that farms and ranches want to make about how they are producing food. We strive to ensure that everyone involved in the food business - from growers and farmers to retailers and shoppers – can count on WFCF to provide authentic and transparent information about the food we eat and how, where, and by whom it is produced.

We also provide sustainability programs, compliance management and farming information management solutions to drive sustainable value creation. We employ 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. Finally, 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.

Most of our customers are located throughout the United States.

Basis of Presentation

Our unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the results of operations, financial position and cash flows of Where Food Comes From, Inc. and its subsidiaries, International Certification Services, Inc. (“ICS”), Validus Verifications Services, LLC (“Validus”), Sterling Solutions (“Sterling”), SureHarvest Services, Inc. (“SureHarvest”), and A Bee Organic (collectively referred to as “we,” “us,” and “our” throughout this Form 10-Q). 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. 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. Actual results could differ from the estimates.

The consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and should be read in conjunction with our audited financial statements and footnotes thereto for the year ended December 31, 2017, included in our Form 10-K filed on April 2, 2018. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. However, we believe that the disclosures are adequate to make the information presented not misleading. The financial statements reflect all adjustments (consisting primarily of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of our financial position and results of operations. The consolidated operating results for the period ended March 31, 2018 are not necessarily indicative of the results to be expected for any other interim period of any future year.

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

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.

Seasonality

Our business is subject to seasonal fluctuations. Significant portions of our verification and certification service revenue are 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.

Recently Issued Accounting Standards

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 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.

Other

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.

Note 2 – Business Acquisitions

SureHarvest Acquisition

On December 28, 2016, we entered into an Asset Purchase Agreement (the “SureHarvest Purchase Agreement”), by and among the Company, SureHarvest Services LLC (the “Buyer” or “SureHarvest”); and SureHarvest, Inc., a California corporation (the “Seller” or “SureHarvest, Inc.”). We acquired substantially all the assets of the Seller. SureHarvest develops software and provides services related to sustainability measurement and benchmarking, traceability, verification and certification to the food and agriculture industries.

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

Pursuant to the SureHarvest Purchase Agreement, WFCF purchased the business assets of the Seller for total consideration of approximately $2.8 million, comprised of approximately $1,122,000 in cash and 850,852 shares of common stock of WFCF valued at approximately $1,710,000 based on the closing price of our stock on December 28, 2016, of $2.01 per share. Additionally, we issued the Seller a 40% membership interest in SureHarvest, with the Company holding a 60% interest.

Following the thirty-six-month anniversary of the effective date of the SureHarvest Purchase Agreement, the Company shall have the option, but not the obligation, to purchase all the units (the 40% interest) of SureHarvest held by the Seller, and the Seller shall have the option, but not the obligation, to require the Company to purchase all the units of SureHarvest held by the Seller. The purchase price for the units shall be equal to the amount the selling holders of the units would be entitled to receive upon a liquidation of SureHarvest assuming all of the assets of SureHarvest are sold for a purchase price equal to the product of eight and half times trailing twelve-month earnings before income taxes, depreciation and amortization, as defined, subject to an $8 million ceiling.

Because SureHarvest, Inc. at its option, can require the Company to purchase its 40% interest in SureHarvest, the SureHarvest non-controlling interest meets the definition of a contingently redeemable non-controlling interest. Redeemable non-controlling interests are presented at the greater of their carrying amount or redemption value at the end of each reporting period and are shown as a separate caption between liabilities and equity (mezzanine section) in the accompanying consolidated balance sheet.

A Bee Organic Acquisition

On May 30, 2017, we acquired A Bee Organic for $150,000 in cash and 45,684 shares of common stock of WFCF valued at approximately $98,000 based on the closing price of our stock on May 30, 2017, of $2.15 per share. The acquisition primarily consisted of the existing customer relationships and represents further expansion of our verification and certification solutions into hydroponics/aquaponics and apiary spaces. We believe the total consideration paid approximates the fair value of the assets acquired. We have allocated the total consideration to our identifiable intangible assets to be amortized over an estimated useful life of 8 years.

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

Note 3 – Basic and Diluted Net Income per Share

Basic net income per share was computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and restricted stock awards are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

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

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.

Note 4 – Intangible and Other Assets

The following table summarizes our intangible and other assets: 

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 was fully amortized in January 2018.

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

Note 5 – Accrued Expenses and Other Current Liabilities

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

Note 6 – Notes Payable

Notes Payable consist of the following:

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 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 on maturity. As of March 31, 2018, and December 31, 2017, the effective interest rate was 5.5%. The LOC is collateralized by all the business assets of ICS. As of March 31, 2018, and December 31, 2017, there were no amounts outstanding under this LOC.

Note 7 – 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
(Unaudited)

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

As of March 31, 2018, the estimated unrecognized compensation cost from unvested awards which will be recognized ratably over the remaining vesting phase is as follows:

Equity Incentive Plans

Our 2016 Equity Incentive Plan (the “Equity Incentive Plan”) provides for the issuance of stock-based awards to employees, officers, directors and consultants. The Plan permits the granting of stock awards and stock options. The vesting of stock-based awards is generally subject to the passage of time and continued employment through the vesting period.

Stock Option Activity

Stock option activity under our Equity Incentive Plan is summarized as follows:

The aggregate intrinsic value represents the total pre-tax intrinsic value (the aggregate difference between the closing price of our common stock on March 31, 2018 and the exercise price for the in-the-money options) that would have been received by the option holders if all the in-the-money options had been exercised on March 31, 2018.

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

Restricted Stock Activity

Restricted stock activity under our Equity Incentive Plan is summarized as follows:

Note 8 – Income Taxes

Deferred tax assets and liabilities have been determined based upon the differences between the financial statement amounts and the tax bases of assets and liabilities as measured by enacted tax rates expected to be in effect when these differences are expected to reverse. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Our equity-based compensation is the most significant component of our deferred tax assets; however, the ultimate realization of our deferred tax assets is dependent upon generation of future taxable income. We consider past history, the scheduled reversal of taxable temporary differences, projected future taxable income, and tax planning strategies in making this assessment.

The Company’s subsidiary, SureHarvest, is a California limited liability company (“LLC”). As an LLC, management believes SureHarvest is not subject to income taxes, and such taxes are the responsibility of the respective members.

The provision or benefit for income taxes is recorded at the end of each interim period based on the Company's best estimate of its effective income tax rate expected to be applicable for the full fiscal year. For the three months ended March 31, 2018 and 2017, we recorded income tax expense of $8,000 and $3,000 respectively.

Note 9 – 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. 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 from $18,000 to approximately $35,100 per month. The rental payments include common area charges, and are subject to annual increases over the term of the lease. The Company recognizes rent expense on a straight-line basis over the non-cancelable lease term and option renewal periods. The resulting deferred rent is included in accrued expenses and other current liabilities on the consolidated balance sheet.

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

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 connection with the August 2017 amended lease agreement with The Move, LLC, the Company will receive an additional $230,000 in lease incentives to build-out the new additional square footage.

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. Until January 12, 2018, the Company leased space in this building under a five-year lease with an expiration date of March 1, 2018. 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. On January 12, 2018, the Company purchased the 2,300-square foot building and terminated the lease. The purchase price of approximately $135,600 was funded by cash on hand.

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.

As of March 31, 2018, future minimum lease payments for all operating leases 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. We are not aware of any legal actions currently pending against us.

Contingently redeemable non-controlling interest

Contingently redeemable non-controlling interest on our consolidated balance sheet represents the non-controlling interest related to the SureHarvest acquisition, in which the non-controlling interest holder, at its election, can require the Company to purchase its 40% investment in SureHarvest.

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

The table below reflects the activity of the contingently redeemable non-controlling interest at March 31, 2018:

The contingently redeemable non-controlling interest has been adjusted to the greater of the carrying value or redemption value as of each period end.

Note 10 - 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.

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.

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

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

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

Note 11 – Supplemental Cash Flow Information

Note 12 – Revenue from Contracts with Customers

Impact of ASC 606 Adoption

On January 1, 2018, the Company adopted Accounting Standards Update, Topic 606, “Revenue from Contracts with Customers” (ASC 606) using the modified retrospective method of transition. Under this method of transition, we applied ASU 606 to all new contracts entered into on or after January 1, 2018 and all existing contracts for which all (or substantially all) of the revenue attributable to a contract had not been recognized under legacy revenue guidance as of January 1, 2018.

ASU 606 supersedes nearly all existing revenue recognition guidance under U.S. GAAP and includes a five-step process to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services.

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

The impact of adoption on our current period results is as follows:

Changes to verification and certification service revenue and costs of verification and certification services are due to the conclusion that fees collected on behalf of the Non-GMO Project related to the Company’s Non-GMO verification services should be excluded from the transaction price (and, thus, revenue), as these amounts are collected on behalf of a third party. This represents a change from our accounting practice under legacy revenue guidance of presenting these amounts on a gross basis in verification and certification service revenue, with an offsetting amount presented as an expense in costs of verification and certification services.

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.

A more detailed summary of our verification and certification services is included in the subsections below.

Animal Verification and Certification Services

Our animal verification and certification services contracts are generally structured in one of the following ways: (i) we commit to perform the required number of animal audits to verify a customer’s compliance with a standard or claim, or (ii) we commit to perform animal audit services at a fixed price by site or location type as requested by our customer during an annual period. These contract structures are discussed in more detail in the subsections below.

Contract to Provide Required Number of Animal Audit Services

For certain of our animal verification and certification services, we commit to perform the required number of location or site audits within our customer’s supply chain to verify customer’s compliance with a contractually-specified standard or claim. Each location or site audit is typically very short-term in nature, with a typical duration of one to two weeks. Upon completion of an audit, we provide the customer with an audit verification report for the specific site or location that was audited. Payment is made by customer upon completion of each site or location audit.

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

Our customers generally have the right to terminate the contract without prejudice with thirty days’ written notice. We have determined that, as a result of the termination provisions present in these contracts, the accounting contract term is a thirty-day period, with each thirty-day time increment representing a separate accounting contract under ASC 606. We subsequently concluded that it is appropriate to combine each accounting contract for a thirty-day period such that the annual period during which audits are provided to a customer represents a single, combined contract in accordance with the contract combination guidance under ASC 606. This conclusion was reached because: (i) each renewal decision via non-termination is made by customer within thirty days of the previous renewal decision, and (ii) the accounting contracts for each thirty-day period within the annual period were negotiated with a single commercial objective, as evidenced by a single legal contract for the provision of the required number of audits in customer’s supply chain.

Furthermore, we have concluded that there is a single performance obligation that is a series comprised of each distinct location or site audit performed the annual contract term. Our customers are charged a standard daily rate for the provision of an audit based on scale of site operations and geographical location. Consideration attributable to each audit within the series is variable, as the number of days required to complete each audit is not known until performance of that audit occurs. We have concluded that it is appropriate to allocate variable consideration (that is, the number of days required to complete an audit) to each audit within the series. This is because the consideration that we earn for each audit relates specifically to our efforts to transfer to our customer that discrete audit, and the resulting audit opinion or verification report, for that specified site or location, and this allocation is consistent with the allocation objective as defined in ASC 606. As a result, instances in which the Company evaluates and applies the constraint on variable consideration are immaterial.

We further concluded that over-time recognition is appropriate because: (i) our performance of audits does not create an asset with an alternative use, as the audit and related verification report relates to facts and circumstances that are specific to each customer site or location (that is, there is a practical limitation on our ability to readily direct the asset to another customer) and (ii) we have an enforceable right to payment, inclusive of a reasonable profit, for performance completed to date. We utilize an input method to measure over-time progress of each audit within the series based on the number of audit days performed.

We do, however, note that there are instances in which we only have an enforceable right to payment upon completion of an audit, and thus, over-time recognition is not permitted. For these contracts, revenue is recognized at the point in time at which an audit is completed. This does not result in a significant difference in the timing of revenue recognition (as compared to those audits that are recognized over time) due to the very short-term duration of an audit.

Our customer may also have the option to purchase incremental review services (for example, an investigative audit or video review services) that are unrelated to the audit services to verify compliance with a specified standard or claim. The incremental review services are also typically very short-term in nature (that is, one to two weeks). We have concluded that these optional purchases do not reflect a material right under ASC 606 because the incremental review services are performed at standard pricing that would be charged to other similarly situated customers. Upon customer request for an incremental review service, we believe that our customer has made a discrete purchasing decision that should be treated as a separate accounting contract under ASC 606.

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

We charge a fixed fee for the incremental review service, and thus, upon customer request, we are entitled to fixed consideration for that service under ASC 606. We concluded that over-time revenue recognition is appropriate for incremental review services because: (i) our performance of incremental review services does not create an asset with an alternative use because that review service, and the associated customer deliverable, relates to facts and circumstances that are specific to each customer site or location (that is, there is a practical limitation on our ability to readily direct the asset to another customer) and (ii) we have an enforceable right to payment, inclusive of a reasonable profit, for performance completed to date on incremental review services. We utilize a time-based input method to measure progress toward complete satisfaction of an incremental review service, which is based on the number of hours performed on the incremental review service relative to the total number of hours required to complete that review service. As previously mentioned, our incremental review services are typically completed within one to two weeks of a customer request.

Contract to Provide Animal Audit Services at Customer Request

Other animal verification and certification services contracts are structured such that we commit to perform audit services at a fixed price by site or location type as requested by our customer during an annual period. Performance of an audit typically occurs within a one to two-week period. We invoice our customer upon completion of an audit, and payment is due from customer within thirty days or less of receipt of invoice.

Under this contract structure, the customer is, in effect, provided a pricing list for animal audit services, and pricing is effective over a one-year period. We have concluded that enforceable rights and obligations do not arise until a customer actually engages us to perform an audit service documented in the pricing list; therefore, each customer request represents a purchasing decision that is a separate accounting contract under ASC 606.

We note that the termination provisions specified in our pricing lists vary. In certain instances, a customer may only have the right to terminate in the event of non-performance. Alternatively, in other contracts, a customer may have the right to terminate without prejudice at any time or with thirty days’ written notice. However, regardless of the termination provision specified, we have concluded that the accounting contract term is equal to the duration of the requested audit service (that is, the termination provisions generally do not affect the accounting contract term for each requested audit service).

Upon a customer’s request for an audit service, consideration is fixed, as we charge the customer a fixed fee by audit type over the annual period per the pricing list.

We concluded that over-time revenue recognition is appropriate for a requested audit service because: (i) our performance of the requested audit service does not create an asset with an alternative use as that audit, and the associated audit report, relate to facts and circumstances that are specific to each customer site or location (that is, there is a practical limitation on our ability to readily direct the asset to another customer) and (ii) we have an enforceable right to payment, inclusive of a reasonable profit, for performance completed to date on a requested audit. A time-based input method is utilized to measure progress toward complete satisfaction of an audit based on the number of hours performed on that audit relative to the total number of hours expected to be required to complete the audit. As previously mentioned, our audit services are typically completed within one to two weeks of a customer request.

Other Considerations for Animal Certification and Verification Services

In connection with the provision of on-site audits related to animal certification and verification services, reimbursable expenses are incurred and billed to customers, and such amounts are recognized on a gross basis as both revenue and cost of revenue.

Any amounts collected on behalf of a third party and remitted in full to that third party are excluded from the transaction price and, thus, revenue.

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

Crop and Other Processed Product Verification and Certification Services

Third party crop and other processed product audits are generally structured such that we commit to perform an independent audit to verify that food producers and/or farmers comply with certain standards. We generally provide verification services related to organic, Non-GMO and gluten free standards. Depending on the crop or product type, verification audit activities may take three months to one year to complete. During this assessment period, various integrated audit activities and/or input reviews are performed in accordance with the regulations specified by the relevant standard.

The fee structure is such that customers pay an annual assessment fee for a crop or other processed product to verify compliance with the specified standard. This fee is payable upfront on a nonrefundable basis. Our customers can typically terminate a crop or other processed product audit at any time without prejudice. However, given the nonrefundable upfront payment structure for the annual assessment service, we have concluded that the contract term is one year. There are certain limited circumstances in which our customer may pay for the annual assessment service in installments. In this scenario, we have also concluded that the contract term is one year. This is because the initial upfront installment payment is the only consideration in the contract that meets the contract existence criterion. As a result, the customer does not have a separate purchasing decision that is substantive (that is, by not terminating the contract) because it has prepaid for a substantial portion of the annual assessment service on a nonrefundable basis. We record the upfront payment made by customer for the annual assessment service as deferred revenue.

The audit activities and input reviews required in the provision of an annual assessment are not distinct under ASC 606, and consequently, we account for an annual assessment as a single integrated performance obligation.

For certain of our third-party crop and other processed product audits, the annual assessment fee is fixed for the annual period. In other scenarios, the annual assessment fee may be variable due to increased review activities required for incremental inputs to a crop or processed product identified through the assessment process. At the time that an incremental input is identified, which generally occurs in the early stages of an annual assessment, the incremental consideration for the provision of review services related to that incremental input also becomes known.

We allocate the transaction price derived from the annual assessment fee to the single integrated performance obligation for that annual assessment. Revenue related to the annual assessment is recognized over time in accordance with ASC 606. This is because the annual assessment service does not create an asset with an alternative use, as it relates to facts and circumstances that are specific to a customer’s crop or processed product. Further, we have an enforceable right to payment for performance completed to date on the annual assessment due to the nonrefundable upfront payment made by customer. We utilize an input method to measure progress toward satisfaction of the annual assessment based on the percentage of activities/phases or input reviews completed under the annual assessment.

As it relates to the upfront payment for the annual assessment, we have utilized the practical expedient that exempts us from adjusting consideration for the effects of a significant financing component when we expect that the period between customer payment and the provision of the related service is one year or less.

In certain contracts, an independent third-party inspection may be required for a site or location in our customer’s supply chain in accordance with the regulations for a specified standard. An inspection is performed by an independent third-party inspector, and the customer is charged an hourly rate for these inspection services.

Under this scenario, a separate accounting contract arises upon initiation and performance of an inspection, and we typically invoice our customer for the inspection upon completion of the inspection service. Given that customer has the ability to terminate at any time without prejudice, we have concluded that the contract term for each inspection ends as control of an inspection service transfers. Inspections are generally short-term in nature with a term ranging from a few days to two weeks.

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

We have further determined that inspections are distinct from an annual assessment. Consideration attributable to an inspection is variable, as the inspector is only able to provide a high-level estimate of the cost of the inspection based on the inspector’s hourly rate until the inspector is at the relevant producer/supplier site to determine the time and level of effort required to complete the inspection. Given the very short-term nature of an inspection, variability related to an inspection generally resolves itself within a reporting period. However, we are typically required by certain regulations to provide an inspection cost estimate to our customer, and, if required, we utilize that estimate as our estimate of variable consideration. The cost estimate is generally derived from the cost to perform the prior-year inspection for that specific customer site or location or, when required, the historical cost to provide an inspection for a comparable site or location. In our experience, the historical cost of inspections has been predictive of the future cost of an inspection.

Other Considerations for Crop and Other Processed Product Verification Services

Reimbursable expenses incurred in the provision of an annual assessment or required inspection are billed to our customers, and such amounts are recognized on a gross basis as both revenue and cost of revenue.

In addition, any amounts collected on behalf of a third party and remitted in full to that third party are excluded from the transaction price and, thus, revenue.

Product Sales

Product sales are primarily generated from the sale of cattle identification ear tags. Each customer purchase request represents a purchasing decision made by customer. As such, enforceable rights and obligations (and, thus, a separate accounting contract under ASC 606) arise at the time a customer submits its purchase request to us. At the time of request, we are entitled to fixed consideration, as the sales quantity and related price of the product is known. All of our customers are charged the same fixed price per tag.

Revenue for product sales is recognized upon delivery of the goods to customer, at which point title, custody and risk of loss transfer to the customer. We typically deliver product to the customer within a few days of customer’s sales request. At the time of delivery, we invoice our customer for the related product sales and record invoiced amounts to accounts receivable. Payment is typically due by customer upon receipt of invoice.  

In relation to our product sales, the sales taxes collected from customers and remitted to government authorities are excluded from revenue.

Additionally, we do not typically provide right of return or warranty on product sales.

Software Sales and Related Consulting Segment

We predominately offer software products via a SaaS model, which is an annual subscription based model. Support services are generally included in the subscription. We also provide web hosting services on an annual basis to all of our customers in conjunction with their software subscription. Customers have the ability to terminate without prejudice upon thirty days’ written notice; however, the subscription fee, inclusive of maintenance and support services, and the web hosting fee are paid upfront by the customer on a nonrefundable basis. Consequently, we have concluded that the contract term for the annual software subscription and web hosting services is one year.

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

We have determined that a software license subscription and the related hosting service should be accounted for as a service transaction, as we provide the functionality of our software through the hosting arrangement. The SaaS arrangement provides customers with unlimited access to our software and, thus, is accounted for as a series of distinct daily service periods that provide substantially the same service (that is, continuous access to the hosted software) each day during the annual contract term. Further, the provision of basic technical support services also represents a stand ready obligation that is a series of distinct daily service periods that provide substantially the same service (that is, access to our technical support infrastructure) during the annual contract term. Because the basic technical support services and SaaS each represent performance obligations that are a series of distinct daily service periods, we have elected to combine these performance obligations.

We are entitled to fixed consideration for the software license subscription, inclusive of support services, and the related hosting service. The software license subscription and hosting fees in our contracts represent the standalone selling price for that related service. This is because the fees charged for the software license subscription and hosting service represent the software license subscription and hosting service fees that are charged to other customers with a similar level of data loaded into the software (regardless of whether that customer contracts for professional services). Accordingly, the software license subscription and hosting fees are allocated to the combined SaaS performance obligation.

We recognize revenue related to the SaaS arrangement over time because a customer simultaneously receives and consumes the benefit from the provision of access to the hosted software over the annual subscription period. Accordingly, we utilize a time-based output measure of progress that results in a straight-line attribution of revenue. That is, revenue related to the combined SaaS obligation should be recognized daily on a straight-line basis over the one-year subscription term, as this reflects the direct measurement of value to a customer of the provision of access to the software via hosting each day.

As it relates to the upfront payment for the software subscription and hosting service, we have utilized the practical expedient that exempts us from adjusting consideration for the effects of a significant financing component when we expect that the period between customer payment and the provision of the related service is one year or less.

In addition, we record the upfront payment made by customer for the annual assessment service as deferred revenue.

In some of our SaaS contracts, we also provide software-related consulting services to our customers during an annual software subscription period. Consulting services fees are derived from a standard rate card by employee level, and we invoice for consulting services monthly on a time incurred basis. Due to the termination provisions present in our SaaS contracts, our customers have an in-substance renewal decision each month for further consulting services (that is, via their decision not to terminate the contract each month). Accordingly, the contract term for consulting services is on a month-to-month basis within the annual subscription period.

We have concluded that consulting services are distinct from the SaaS arrangement. To the extent that consulting services result in a software enhancement or new functionality, we have determined that those consulting services are still distinct because added features typically provide new, discrete capabilities with independent value to a customer and a customer accesses the SaaS in a single-tenant architecture. Further, additional features and functionality are often made available to a customer substantially after the “go-live” date of the software (via the hosting service). As a result, our software-related consulting services represent distinct performance obligations.

We recognize revenue over time in accordance with ASC 606. This is because our performance does not create an asset with an alternative use, as consulting services, and, if applicable, any related software enhancements, are highly tailored to the farming industry specific to the given customer, and we have an enforceable right to payment, inclusive of profit, for performance completed to date. As a result, for our consulting services, we have elected to utilize the practical expedient that allows us to recognize revenue in the amount to which we have a right to invoice, as we believe that we have a right to consideration from a customer in an amount that corresponds directly with the value to the customer of our performance completed to date for the provision of consulting services.

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

Other Significant Judgments

Principal versus Agent Considerations

Under certain of our verification and certification service contracts, a third-party inspector may be required to perform an independent inspection of a site or location within our customer’s supply chain in accordance with regulations of a certain standard or claim. In this scenario, we have concluded that we are the principal in the provision of inspection services to our customer, as we control the inspection service, and the related inspection report, before it is transferred to our customer. In accordance with this conclusion, we present revenue related to inspections on a gross basis, with customer payment for an inspection presented as revenue and the inspection cost paid to the third-party inspector presented as an expense.

In addition, we utilize a third party to provide web hosting services in the provision of our SaaS arrangements. In this scenario, we are primarily responsible for fulfilling the promise to provide web hosting services to the customer, and we establish the fee that the customer is charged for the web hosting services. Consequently, we have also concluded that we are the principal in the provision of web hosting services under our SaaS arrangements. As such, we present revenue on a gross basis, with consideration received from our customer for the web hosting service recorded as revenue and the cost paid to the third party to provide those web hosting services recorded as an expense.

Disaggregation of Revenue

We have identified four material revenue categories in our business: (i) verification and certification service revenue, (ii) product sales, (iii) software license, maintenance and support services revenue and (iv) software-related consulting service revenue.

Revenue attributable to each of our identified revenue categories is disaggregated in the table below.

Transaction Price Allocated to Remaining Performance Obligations

We generally enter into revenue contracts with a one-year term. In certain instances, we have concluded that our contract term is less than one year because: (i) the termination provisions present in the contract impact the contract term under ASC 606 or (ii) a contract under ASC 606 arises at the time our customer requests the provision of a good or service that is delivered within or over a few days to a couple of weeks. As a result of our short-term contract structures, we have utilized the practical expedient in ASC 606-10-50-14 that exempts us from disclosure of the transaction price allocated to remaining performance obligations if the performance obligation is part of a contract that has an original expected duration of one year or less.

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

Contract Balances

Under our animal verification and certification services contracts, we invoice customers once the performance obligation for the provision of a site or location audit has been satisfied, at which point payment is unconditional. In addition, any product sales are invoiced upon delivery to the customer, at which point payment is also unconditional. Accordingly, our animal verification and certification services contracts do not give rise to a contract asset under ASC 606; rather, invoiced amounts reflect accounts receivable.

Under our crop and other processed product verification and certification services, a nonrefundable payment for an annual assessment of compliance with a standard is typically made by our customers upfront upon contract execution. That is, payment is made in advance of the provision of annual assessment services. Accordingly, we recognize deferred revenue upon receipt of the upfront payment from our customers for crop and other processed product audit assessment services. Revenue is subsequently recognized, and the related deferred revenue is reduced, over the one-year period during which assessment services are provided to the customer using the over-time measure of progress selected in accordance with ASC 606. To the extent that an inspection is required during the annual assessment period, we invoice customers once the performance obligation for the inspection has been satisfied, at which point payment is unconditional. As such, inspection services give rise to accounts receivable.

Our software subscriptions, web hosting, and support services are paid by our customers upfront on a nonrefundable basis. That is, payment is made in advance of the provision of these services to our customers. As a result, we recognize deferred revenue upon receipt of the upfront payment from our customers for software subscriptions, web hosting and maintenance and support services. Revenue is subsequently recognized, and the related deferred revenue is reduced, on a straight-line basis during the annual contract term that these stand ready services are provided to customer.

Software-related consulting services are invoiced monthly on a time incurred basis, at which point we have an enforceable right to payment for those services. Because payment is unconditional upon invoicing, our software-related consulting services are reflected as accounts receivable.

As of March 31, 2018, and January 1, 2018, accounts receivable from contracts with customers, net of allowance for doubtful accounts, were approximately $1,523,300 and $1,898,700, respectively.

As of March 31, 2018, and January 1, 2018, deposits and deferred revenue from contracts with customers were approximately $1,468,500 and $851,200, respectively. Revenue recognized in the three months ended March 31, 2018 that was included in the deferred revenue balance at January 1, 2018 was approximately $785,400.

Prior-period performance obligations

For the three months ended March 31, 2018, revenue recognized in the reporting period related to performance obligations satisfied or partially satisfied in prior reporting periods was not material.

Costs to fulfill a contract

We incur a fixed cost, payable to a third-party provider, to perform set-up activities for new (or first-year) customers that contract for our software subscription and hosting services. We have concluded that those set-up activities do not transfer a good or service as defined in ASC 606 to our customers.

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

We capitalize fixed set-up costs as an asset on the following basis: (i) the fixed set-up costs incurred relate specifically to a customer contract for our software subscription and hosting service, (ii) the fixed set-up costs incurred are expected to be recovered via provision of the software subscription and hosting service to that customer and (iii) the set-up costs generate or enhance resources of the Company by permitting us to provide software subscription and hosting services to our customer, which, in turn, generates revenues.

Capitalized costs related to those set-up activities are amortized on a straight-line basis over the one-year license subscription and hosting period.

The ending balance at March 31, 2018 of capitalized assets attributable to the set-up costs incurred to fulfill software subscription and hosting contracts was not material. No set-up costs related to our software subscription and hosting services were incurred for the three months ended March 31, 2018.

In addition, amortization of capitalized set-up costs for the three months ended March 31, 2018 was not material, and no impairment loss was incurred related to capitalized set-up costs for the three months ended March 31, 2018.

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

This information should be read in conjunction with the consolidated financial statements and the notes included in Item 1 of Part I of this Quarterly Report and the audited consolidated financial statements and notes, and Management’s Discussion and Analysis of Financial Condition and Results of Operations, contained in the Form 10−K for the fiscal year ended December 31, 2017. The following discussion and analysis includes historical and certain forward−looking information that should be read together with the accompanying consolidated financial statements, related footnotes and the discussion below of certain risks and uncertainties that could cause future operating results to differ materially from historical results or from the expected results indicated by forward−looking statements.

Business Overview

Where Food Comes From, Inc. and its subsidiaries (“WFCF,” the “Company,” “our,” “we,” or “us”) is a leading trusted resource for third-party verification of food 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 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. We verify claims to over 40 independent standards. This growth has been achieved both organically and through the acquisition of other companies.

Current Marketplace Opportunities

Because of growing demand for increased transparency into food 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

Seasonality

Our business is subject to seasonal fluctuations. Significant portions of our verification and certification service revenue are typically realized during late May through early October when the calf marketings and the growing seasons are at their peak. Because of the seasonality of the business and our industry, results for any quarter are not necessarily indicative of the results that may be achieved for any other quarter or for the full fiscal year.

Liquidity and Capital Resources

At March 31, 2018, we had cash, cash equivalents and short-term investments of approximately $4,567,400 compared to approximately $3,449,000 at December 31, 2017. Our working capital at March 31, 2018 was approximately $3,796,200 compared to $3,712,200 at December 31, 2017.

Net cash provided by operating activities for the three months ended March 31, 2018 was approximately $1,314,700 compared to net cash provided of $795,400 during the same period in 2017. Net cash provided by operating activities is driven by our net income (loss) and adjusted by non-cash items. Non-cash adjustments primarily include depreciation, amortization of intangible assets, stock based compensation expense, and deferred taxes.

Net cash used in investing activities for the three months ended March 31, 2018, was $154,300 compared to $20,000 used in the 2017 period. Net cash used in the 2018 period was primarily attributable to the acquisition of the 2,300-square foot building located in Medina, North Dakota, which was previously leased.

Net cash used in financing activities for the three months ended March 31, 2018, was $43,800 compared to $18,000 used in the 2017 period. Net cash used in the both the 2018 and 2017 period was primarily due to the repurchase of common shares under the Stock Buyback Plan.

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 March 31, 2018, and 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 March 31, 2018, and December 31, 2017, there were no amounts outstanding under this LOC.

Off-Balance Sheet Arrangements

As of March 31, 2018, we had no off-balance sheet arrangements of any type.   

RESULTS OF OPERATIONS

Three months ended March 31, 2018 compared to the same periods in fiscal year 2017

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 three months ended March 31, 2018 increased approximately $241,600, or 9.5% compared to 2017. 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 above in “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 three months ended March 31, 2018 increased approximately $110,600, or 45.5% compared to 2017. 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 three months ended March 31, 2018 were approximately $1.68 million compared to approximately $1.41 million in 2017. Gross margin for the three months ended March 31, 2018 decreased slightly to 46.8% compared to 49.6% in 2017. The decrease in our margins is predominately due to product mix changes. Additionally, our margins are impacted by various costs such as cost of products, salaries and benefits, insurance, and taxes.

Selling, general and administrative expenses for the three months ended March 31, 2018 were approximately $1.41 million compared to $1.08 million in 2017. Overall, the increase in our selling, general and administrative expenses is due in part to slightly higher head count, an increase in base salaries, the accelerated amortization of the ICS beneficial lease arrangement previously discussed, increased square footage and corresponding rent expense for the corporate headquarters, and increasing public company compliance costs and professional fees due to implementing new accounting standards.

Software Sales and Related Consulting Segment

Software license, maintenance and support services revenue is a revenue stream specific to our acquisition of SureHarvest. 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 license, maintenance and support services revenue for the three months ended March 31, 2018 increased approximately $180,300, or 168.2% compared to 2017. The increase is predominately due to a significant increase in the number of billable hours of staff focused on software enhancements and upgrades.  

Software-related consulting service revenue primarily represents fees earned from professional appearances, customer education and training related services specific to our acquisition of SureHarvest. Software-related consulting service revenue for the three months ended March 31, 2018 increased approximately $14,400, or 8.5% compared to 2017. The increase is predominately due to the timing of customer education and training services.  

Costs of revenues for our software sales and related consulting segment for the three months ended March 31, 2018 were approximately $212,900 compared to approximately $200,100 in 2017. Gross margin for the three months ended March 31, 2018 improved significantly to 54.8% compared to 27.5% in 2017.  Our margins were positively impacted by improvements in overall efficiency and the number of our billable hours, as well as other variable costs of salaries and benefits, insurance, and taxes.

Selling, general and administrative expenses for the three months ended March 31, 2018 decreased approximately $95,100, or 24.4% compared to 2017. The decrease is predominately due to some employee turnover and re-alignment with a shift from non-billable hours to billable hours to reduce fixed 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

The provision or benefit for income taxes is recorded at the end of each interim period based on the Company's best estimate of its effective income tax rate expected to be applicable for the full fiscal year. For the three months ended March 31, 2018 and 2017, we recorded income tax expense of $8,000 and $3,000 respectively.

Net Income and Per Share Information

As a result of the foregoing, net income attributable to WFCF shareholders for the three months ended March 31, 2018 was approximately $35,500, or less than $0.01 per basic and diluted common share, compared to $115,400, or less than $0.01 per basic and diluted common share for the same period in 2017.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rule 13a-15(e) as of the end of the period covered by this report, have concluded that our disclosure controls and procedures are effective based on our evaluation of these controls and procedures as required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.

Internal Control Over Financial Reporting

With the adoption of ASC Topic 606 as further described in Note 11 to the Consolidated Financial Statements in Part I of this Quarterly Report, we have analyzed our internal control over financial reporting framework and determined that new controls were needed around contract inception and contract modifications, as well as periodic reviews of material contracts. There have not been any other changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1.  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.

ITEM 1A. RISK FACTORS

Our business is subject to a number of risks, including those identified in Item 1A. — “Risk Factors” of our 2017 Annual Report on Form 10−K, that could have a material effect on our business, results of operations, financial condition and/or liquidity and that could cause our operating results to vary significantly from period to period. The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 6. EXHIBITS

(a) Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.