Where Food Comes From, Inc. (WFCF) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to Where Food Comes From Fourth Quarter and Full Year Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Jay Pfeiffer, Investor Relations. Thank you. You may now begin.

Good afternoon and welcome to the Where Food Comes From 2017 fourth quarter and year end earnings call. During the course of this call, we will be making forward-looking statements based on current expectations, estimates and projections that are subject to risk. Statements about future revenue, expenses, profitability, cash, growth strategy, new customer wins, business opportunities, market acceptance of our products and services, and potential acquisitions are forward-looking statements. Listeners should not place undue reliance on these statements as there are many factors that could cause actual results to differ materially from our forward-looking statements. We encourage you to review our publicly filed documents as well as our news releases and website for more information about the company. Today, we will also be discussing EBITDA and adjusted EBITDA, which are non-GAAP financial measures provided as a complement to the results provided in accordance with Generally Accepted Accounting Principles. We use and we believe investors benefit from the presentation of EBITDA and adjusted EBITDA in evaluating our operating performance, because it provides us and investors with additional an tool to compare our operating performance on a consistent basis by removing the impact of certain items that management believes do not directly reflect our core operations. It is the company’s policy not to provide specific guidance with respect to future revenue and earnings expectations or new customer wins. I will now turn the call over to John Saunders, Chairman and Chief Executive Officer. John?

Good afternoon and thanks for joining us. This morning, we were pleased to report another year of solid growth for Where Food Comes From. Revenue increased 33% year-over-year to $15.4 million from $11.6 million a year ago. Core verification and certification revenue grew 18% and product sales grew 45% based on continued strength in IMI Global, Sterling Solutions, Validus and ICS business units and to an initial contribution from our newly acquired A Bee Organic business. SureHarvest, acquired at the end of 2016, contributed $1.4 million in revenue for the year or about 9% of our total. As a reminder, SureHarvest revenue is broken out on our income statement in two segments: software license, maintenance and support, and consulting services. Net income for the full year declined to approximately $142,000 from $433,000 last year. I think it’s important to note that the $142,000 profit included the impact of $854,000 in non-cash depreciation and amortization versus just $268,000 in 2016. I will also point out that the hard costs of complying with the new revenue recognition standard ASC 606 was $80,000 for the year, which took another bite out of net income. And as it turned out, after all the settle down with ASC 606 review process, no changes were required on our part. We have been doing it correctly all along. It is disappointed to have to expend that amount and money not to mention many, many hours of senior staff on such an onerous project that we believe puts an undue burden on all public small public companies. The good news is adjusted EBITDA grew by 14% to $1.6 million from $1.4 million a year ago. Again, due to the sharp increase in depreciation and amortization following the SureHarvest acquisition, we tend to focus on adjusted EBITDA versus net income, because we think it provides a more meaningful way of our – a view of our profit picture and the overall health of our business. 2017 was a very eventful year for Where Food Comes From, because of the diversity of our services mixes, the evolving global trends in food verification and our active M&A programs, we have a lot going on across all our operating units as well as at the corporate level. Remember prior to joining Where Food Comes From, each of our operating units focused exclusively on their niche businesses. Now they are asked to work collaboratively with other business units in cross-selling the bundling services and in strategic planning exercises to ensure the success of our integration efforts, incorporate growth objectives. Key to this effort is the investment we have made over the last several years in our sales force trustable relationship management tool which has transformed the way we do business and facilitated a collaborative work environment for all of our operating units. I am very proud of the way everyone has come together to meet this challenge. I want to take this opportunity to commend and thank the entire team for what we have all worked together. We are consistently growing at a double digit rate and are the knowledge leader in our field and we are building a very special company. In recapping our 2017 and setting the stage for continuing growth in 2018 and beyond, I thought it would be appropriate to focus on our individual business units for a minute to give you a feel for what they are working on. IMI Global and Sterling Solutions were already having a good year when China reopened its market to U.S. beef imports in the second quarter of 2017 after they have been closed for 15 years due to B&C outbreak. Things got really busy in the second half of the year as producers began contacting us to conduct source and age verification and traceability audits, necessary to qualify their beef for export to China. The timing of the China reopen was interesting and then it occurred well after the spring cavern season, so many producers missed the opportunity and were forced to wait until the spring to begin the verifications. Because remember source and age audits requires to be involved at the very beginning of the process. For that reason we expect source and age activity to accelerate and to even be stronger this year. In addition, producers have had almost a year to evaluate and confirm the premiums available for America beef producers that is still in demand with the massive Chinese consumer base, the world’s second largest but fastest growing beef consumer. We have recently got some additional good news on the beef side from Cargill, a long-term customer of ours in the U.S. named Where Food Comes From, Canada as the second auditing for its Canadian beef sustainability acceleration pilot program. You recall that we were the exclusive auditor for a similar pilot project conducted by McDonald’s in Canada back in 2016. When Cargill launched their program the following year, they initially had a Canadian based auditing firm as the sole manager of the sustainability verifications. So, we were gratified when Cargill decided to get producers a second option by adding us as an improved auditor and we believe our ability to offer more than one type of verification played a role in their decision. With that in mind, we are exploring opportunities to bundle additional audits to provide more value to Canadian producers. The big picture view on this is that when the blue-chip industry thought leaders like Cargill and McDonald’s are spearheading sustainability programs in response to growing consumer demand then there is a good chance that this trend is here to stay and that bodes very well for us. Our Validus subsidiary is also going strong in the specialty areas of pork, poultry and dairy. They continued to add new customers and strengthened and expand relationships with large legacy customers. Likewise, our ICS subsidiary is also running at capacity and is seeing solid growth, ongoing demand for organic non-GMO and animal welfare bundled audits. Recent projects in the dairy field jointly undertaken by Validus and ICS are a great example of the cooperative effort I mentioned earlier in my remarks. The dairy industry is increasingly emphasizing organic, animal welfare, sustainability biosecurity and worker welfare around the products they sourced. Validus and ICS are collaborating to provide Costco and been on the way with bundled audits in these areas. Next time, we visit our Costco look for the [indiscernible] milk or general lines of organic products. We are also pleased with the performance of our SureHarvest unit which generated $1.4 million in revenue in its first full year on the transaction, roughly in line with our expectations. The integration has been completed and the company is working on a number of exciting initiatives designed to increase revenue for sustainability solutions, for high valued specialty products growers concentrated on the West Coast. For example, SureHarvest is working closely with the Almond Board of California and its initiative to manage greenhouse gases and the carbon footprint involved in almond production. The Board believes almond production can potentially be carbon neutral or even carbon negative. The implications from this work on other specialty products such as wine grapes and avocados are compelling. And finally our A Bee Organic subsidiary that we have brought in 2017 continues to surprise us with interesting initiatives. It is the small business right now with around 150 customers, mostly for organic certifications on products ranging from honey and stone fruit to hydroponic, aquaponic, in-ground and wild crops. A Bee is pursuing projects that I don’t think any of our competitors have even heard of, I know I haven’t, Siberian chaga mushrooms Serbian truffles ruded by dogs as opposed to pigs. These are high-priced premium products in demand by gourmet chefs around the world. Granted, they are relatively small niche opportunities by white truffles, they are worth their weight in gold in terms of helping us raise our profile as the industry’s most diverse and complete solutions provider. Our board portfolio of services is truly a differentiating strength for Where Food Comes From. It is an unparalleled and probably undervalued asset of our business. In closing, I want to spend a minute on a subject that many of you are asking about and that’s block chain. Given the hype around this project, my preference would be not to talk about it at all until we have determined exactly what role the technology meant in our business. Let the questions persist process and the likelihood I will be asked about on this is very high, so I have decided to discuss it in my prepared remarks. Obviously, any company engaged in traceability would seem to be an ideal candidate to benefit from block chain technology. We have been looking at it throughout 2017 in several months they would retain an expert to work with senior management on exploratory project to evaluate block chain’s potential incorporation into our business. Because of our business model, we are also getting a lot of inquiries from some interesting players in the block chain space. For decades, Where Food Comes From has pioneered all types of technology relevant to our industry. We are structured and intentional in this process. It is important to clearly understand the benefits for our partners to ensure that what we do stays in line with our mission and purpose. We do believe block chain has the potential to elevate what we are doing and to drive more value in the marketplace for our producer partners and a deeper connection between producers and consumers, but keep in mind, at the end of the day verifying product plans is a boots on the ground to activity that requires customer relationships based on trust and a deep understanding of the verification process. So, a block chain ends up being playing a part of our business, we expect it to just be that apart. And with that, I am happy to take questions. Operator?

[Operator Instructions] Our first question comes from the line of Terry Thompson, a Private Investor. Please proceed with your question.

Hello. Yes, hi John. My question concerns the recent and active tariffs against China, do you anticipate that having any effect on the Chinese reciprocating against American beef imports or anticipated having any effect at all on your business?

That’s a great question. I anticipated that one. We are taking it as though it is a significant risk and looking at the potential for any type of response, beef being one of those and one of the most recent ones. So, yes, we are considering it and we have done an analysis of the impact of what that would look like and we are moving ahead and we will be ready if and when something does occur.

Okay. Do you feel that might be something low on their list since it is food, do you think it will be less likely that retaliate against beef as opposed to other American imports?

I will let Leann add a little bit more color to that.

Hi, Terry.

Hi, Leann.

How are you?

I am good.

I think it’s yet – we are yet to know the implications, Terry. I mean, beef and pork exports for us obviously are positive for the U.S. So it is a potential target. However because we got the market open, I think it was a win for both governments to kind of find a success story, we are hopeful of that, we maintain access the way that we have it today I don’t know that we will get expanded access, but with the requirements that are already in place which we are verifying today we are hopeful that they stand it’s really hard to know right now.

Of course, I know nobody knew but you are much better informed on it than I, I mean I appreciate your time, look forward to seeing everybody here in about six weeks or so I guess.

Thanks Ken.

Our next question comes from the line of Paul Johnson, a Private Investor. Please proceed with your question.

Yes. Good afternoon, I have a few questions, first of all, particular order you filed – we made a filing in early January where you decided to terminate your prearranged stock trading plan to sell 0.5 million shares which is great, are you able to offer us any kind of color information on that?

Sure. I think it’s just what – I think you are implying there and that is that we personally felt that the value of the stock and our future was too great. And we have had the plan is place for about 3 years and I think we have sold about 12,000 shares. So, it was kind of a no-brainer for us, but based on the positive things that we are seeing in the business that we were going to hold on to as much stock as we could.

Okay, great. The second question is I know a part of the whole game plan or the strategy has been to make acquisitions and to be fair you have done a great job with them and it certainly made the company stronger and more interesting, is there an argument however on the other side that we have done a lot and maybe we need to sort of digest the ones that we have taken on in a lot of different areas and given that the management team is that huge and maybe focus on profitability I mean I feel like what I have discussed with other investors and what I have read is the feeling is like okay, the sales are growing here we go with another acquisition, why can’t we get more profitable first, before we do anymore?

Yes. That’s a fair question. I think the way we have looked at it thus far is that these opportunities present themselves when they present themselves. And as we have evaluated, I don’t know if you have been on any of the earlier calls, but we did an analysis about 5 years ago. And the results of that amounts was potential M&A targets was three dozen companies, so today we have only done less than a third of that. So as we go through that process, we will continue to look at it – those acquisition opportunities as they become available. Hopefully they won’t impact profitability, but I believe that’s something that’s going to come down the road. We are really focused on building the best company we possibly can with the most – but the most difficult hurdles to compete with us and that is at this point to continue to expand the commodities that we address and the standards that we are able to audit against.

Are you saying I just want to understand that a little bit better, are you saying that not having more breadth to your product offering if you will is stopping you from getting more sales in your existing businesses?

Yes, completely. Every customer, the majority of larger customers that we work with we continue to see opportunities to bundle audits for them. So, when we identify a target, it’s most likely because they are conducting audits for one of our large customers in a different area. So, as we continue to look at customers, two of them that I mentioned Costco and DanoneWave there is a wide range of audits that are being done on their suppliers and they are not just a specific commodity, they are multiple levels. So everyday we are continuing to look at what entities are conducting those audits, do they represent a market for us or a potential acquisition.

Who are the – you mentioned Costco, who is the other one?

Danone, it’s called DanoneWave, now they acquired WhiteWave.

Got it, okay. Thank you. That’s helpful. That seems reasonable if the bundling is important, then see if that can help all the various product lines?

Yes. And it’s also that if we – if you take specifically just organic, even though we continue to grow we are relatively small player in the organic verification market. So, as we look at acquisitions, a lot of times it’s a way for us to continue to consolidate that momentum and then to get to a point of critical mass. That’s really what we are trying to get to this critical math that we basically are covering the premier of the grocery store and we are covering the entirety of the plate if you work for the meal and then we will be able to come back and really extenuate and supervise the platform to extend the brand beyond just the services that we are providing now.

Okay, fair enough. So the last question I have is just about the block chain, because it’s not something I understand very well, can you explain in sort of layman’s terms what the opportunity would be in your industry for block chain?

That’s a great question. And I think it’s one that I have been spending the last year plus trying to figure out exactly what that opportunity is. Block chain at its quarter level has a decentralized database. We, on the other hand, comes from having a very centralized database, so incorporating those two very distinct mechanisms for storing information requires some 4 to 5. I think the other thing that’s important to know is that when we conduct verifications we conduct verifications for hundreds of different brands and thousands of different branches. Almost all of those companies or those brands have different technology. So, we really don’t – we don’t provide any guidance for them on how they store their information or what they are doing it, we purely audit the way that they are doing it. So, if you extrapolate that with block chain, it seems like once everyday, there is a new article about somebody that just started a new block chain, I think what we have really become aware of is the vastness of what block chain represents and the number of parties that are involved. So, I think where there maybe some anticipation that Where Food Comes From would introduce its own block chain, I think it’s a much broader concept than that and I think it’s something that will incorporate all of these different groups at block chains that are developing, because that’s the only true way to again get to critical mass and provide a solution for a company like McDonald’s or others that would be comprehensive.

Thank you. That’s helpful and I appreciate all the information.

You bet.

[Operator Instructions] Our next question comes from the line of Daniel Rogala, a Private Investor. Please proceed with your question.

Hi, thanks for taking my call.

You bet.

Okay, great. So my question was in the press release you talked about a bonus payment that impacted gross margins for the quarter, just wondering if you could share a little more detail on that?

Sure. Yes, we have over the last 2 years especially in 2017 we have had a very, very lean team here and if you can imagine and look at the growth rate that we accomplished in 2017 that was done by a relatively small group of people, so we use this opportunity for us to reward on place, so it was really just a bonus for the hard work that have been the combination of 2 long years of effort.

Okay. So, it’s not like a structural bonus that’s built into specific metrics it was just kind of a management decision?

Well, everything that we do is structured, but yes, it was very much based on the strong results that we have had over the course of 2016 and 2017.

Okay. And then I assume it was a cash bonus, because within the impact of adjusted EBITDA so is there anything that was cash versus stock?

I am sorry, I didn’t quite catch that.

Sure. I said I assume it was a cash bonus, because it looks like it still had a negative impact on adjusted EBITDA and I think you guys back out stock-based compensation. So, I was just curious what was the reasoning for I guess cash versus stock whether there was any consideration to doing any stock bonus?

Well, once again, I think we are just we are modeling the stock and we are very protective on the stock as management and as large shareholders in the company, so everything that we do try to incentivize, we do use stock options to a degree, to incentivize employees, but we saw this as an opportunity to do that at one-time.

Okay. I appreciate that. And then one other bullet point from the press release, so if it’s all operating subsidiaries just like since you contributed to continued profitable growth in 2018 and I just want to make sure I am interpreting that right, does that mean you would expect all operating subsidiaries to be profitable or just to contribute?

Yes, all of our operating units we managed profitability, so yes that is accurate. We are managing those operating units to be profitable, so independently by themselves.

Perfect. And that includes SureHarvest?

Yes.

Okay, great. And then one more and I will jump back into queue, so there has been a handful of headwinds, especially I think from the EU about fraudulent verification for organic and other food claims, I am just curious on what your guys opinion of that is and if you guys have started to look at potentially in international acquisitions?

Good questions. Yes, we are very sensitive to it and we have spent a lot of time engaging with [indiscernible] on those specific issues. And so that everybody is clear, all of the standards that we audit to have the process improvement in place to better the system that is the verification itself. So, whatever issues arise from a fraud perspective, we believe over time that system will cure those problems. The international question is very pertinent. We have looked in other areas, honestly Europe is relatively saturated. So, we have looked at other parts of the world as opportunities. I would rather not talk about where they are right now, but that’s kind of our focus, it’s not on Europe.

Okay, that’s great. If I can just sneak one more in, so the USDA withdrew their role around organic livestock in poultry practices, can you maybe comment a little bit about what you think that does from a business outlook perspective?

So right now, they top that out, it’s currently on hold. I think based on the public comment period and the comments that they received they decided to put some of those changes on hold. So, we are currently kind of in a holding pattern right now to see where that falls out. It incorporated, it’s not animal welfare pieces and some other things that will be easy for us to bundle into our existing programs and with some of our existing programs, but it’s unclear yet whether that would go through or not.

Okay. Thank you guys so much and congratulations on another successful year.

Thank you.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would now like to turn the call over to John for closing remarks.

Once again it looks like we have had a great time for the call, so thank you very much for your participation and the great questions. We are very excited as we moved into 2018. There is more stuff than we can really imagine that continued to be positive, so we appreciate all of your support and we look forward to talking to you again in a couple of months. Thanks everybody.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.