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WFCF > SEC Filings for WFCF > Form 10-Q on 14-Nov-2013All Recent SEC Filings

Show all filings for WHERE FOOD COMES FROM, INC.

Form 10-Q for WHERE FOOD COMES FROM, INC.


14-Nov-2013

Quarterly Report


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

General

This information should be read in conjunction with the condensed 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, 2012. The following discussion and analysis includes historical and certain forward-looking information that should be read together with the accompanying condensed 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. is a leading provider of verification and communication solutions for the agriculture, livestock and food industry. We provide our owned and operated online products and services which specialize in identification and traceability, process/production-practice/supply verification, document control for United States Department of Agriculture ("USDA") and other verification programs and third party auditing services. Our services ensure compliance with governmental and private standards by providing transparency and value in food products for both producers and consumers world-wide.

In late 2012, we changed our corporate name from Integrated Management Information, Inc. ("IMI") to Where Food Comes From, Inc. to better reflect our brand strategy and to raise awareness in the investor community. We are listed on the over-the-counter electronic bulletin board ("OTC:BB") under the stock ticker symbol "WFCF."

Management's Strategy

For several years, management focused its efforts on building a strong foundation, to enhance profitability for the long term. Initially our efforts focused on our age and source verification services. Throughout 2009, we introduced a more robust offering of verification services. We also internally developed automated processes which improved our efficiency and reduced our employee headcount. As a direct result, total verification sales and hardware sales improved. We were able to provide more verification certifications (a multiple service offering) in a single audit, but while this type of service results in an increase in revenue; it also has a lower profit margin as compared to our single service offerings. Interestingly enough, because our customers were seeing more profit per head from multiple verifications at a minimal increase in cost per verification service, they increased the number of cattle within each group audited. We benefitted from increased hardware sales which has higher profit margins due to our process automation.

In early 2009, we understood that all this work was necessary to build a solid foundation but we also recognized a "potential market saturation and decreasing profits dilemma" early on and began working toward a solution. Through our research and development, we learned that we needed to be on the cutting edge of this industry and that the most significant person to influence the food industry was the consumer. We were concerned about various food claims that the industry made without any third party verification. In response, we identified opportunities for horizontal and vertical integration. In addition to our current business structure, we knew we needed to develop a self-sustaining revenue stream with minimal management and labor costs, while simultaneously addressing food concerns near to our heart. We had built a company with strong credibility in the industry, and we had the technical expertise to make our processes operate very efficiently. The opportunities that we identified in early 2009 are built upon the verification services we provide and the solid reputation we have built.

In early 2010, we began to see some of the fruits of our labor. We were able to connect food processors and packers to those suppliers that provided product verified for the specific credence attributes demanded, thereby generating a new revenue stream based upon coordination within the food supply chain. We also introduced the WhereFoodComesFrom® brand. Revenue generated from this program is based upon a similar supply chain sales model. Many long hours of research went into this project and currently we are working hard to market this program to the consumer. Research indicates that transparency in food production is becoming more and more important to consumers. We believe that the future growth of verification services will be achieved only through consumer awareness and demand. The WhereFoodComesFrom® brand is a labeling program that reconnects the consumer to the farmers and ranchers that produce the food. For the consumer, it is a seal of approval on a package or an individual product that provides assurance that the source of origin is known, authentic and verified by an accredited, unbiased third party. Our two most significant customers for our WhereFoodComesFrom® brand are Heinen's Fine Foods and Delmonico's representing industry leaders focused on providing superior quality and value-added services.

In 2010, management, along with the assistance of industry consulting experts, intentionally made the decision to invest heavily in marketing our services and our WhereFoodComesFrom® labeling program to build consumer awareness. We still continue to invest heavily in marketing our verification services and our WhereFoodComesFrom® brand to build consumer awareness and demand through the use of videos, television exposure, word-of-mouth and the internet.

Today, consumers are becoming more educated about food choices. Factors such as the carbon footprint that a particular food represents are playing an increasing role in consumers' decision making. Food safety also plays a significant role in consumer preferences. In recent years, demand increased for livestock identification due to concerns regarding bovine spongiform encephalopathy (mad cow disease). With all of the food recalls, fraudulent food labeling and other food scares (spinach, jalapenos, tomatoes, hamburger, peanuts, horsemeat), consumers are spending their dollars more diligently. Our company strives to identify opportunities to develop verification programs in advance of market demand and we continue to offer competitively-priced, bundled solutions to our growing customer base. Frequently, those bundled solutions include our newest programs in order to address the most recent concerns in the food supply. At times, we may sacrifice short-term profits in order grow a bigger, stronger company for the long-term; and we believe, to help increase transparency in our food production.

Acquisition of Validus Verification Services LLC

As part of our business strategy, we regularly evaluate acquisition opportunities as a means of accelerating our growth and achieving our long-term strategic objectives.

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

Pursuant to the Purchase Agreement, WFCF caused Validus to be organized to purchase and acquire certain audit, assessment and verification business assets of the Seller. The Company acquired a 60% interest in Validus in exchange for aggregate consideration of approximately $1.5 million, which included $565,000 in cash and 708,681 shares (the "Shares") of common stock of WFCF valued at approximately $940,000 based upon the closing price of our stock on September 16, 2013, of $1.32 per share. The Company has the first right of refusal on the remaining 40% of the outstanding stock.

We believe that Validus is the leading dairy, pork and poultry certifiers in the United States and represents an opportunity to extend the range of our existing programs and establish our capabilities in other major food groups. As a result of this acquisition, we believe we are now positioned to offer our customers new solutions across the verification and certification spectrum. We also believe it provides diversification for our company, enables us to better serve our customers, and provides another avenue for our WFCF program.

Current Marketplace Opportunities

We believe the following marketplace opportunities will drive our business forward, effectively increasing consumer demand for third party verification services:

• U.S. beef has been largely absent from the EU for the past 20+ years due to an EU ban on hormone-treated meat and meat products. In late 2009, the EU announced an annual duty-free quota of 20,000 metric tons for high-quality beef from cattle not treated with growth hormones ("NHTC"). In March 2012, the EU expanded the annual duty-free quota from 20,000 metric tons to 48,200 metric tons. NHTC requires third party verification, but with duty-free access lowering the cost of doing business in Europe, we believe that it offers significantly more potential for third party NHTC verification services and our product line, High Quality Beef verification services. In October 2013, the U.S. signed a two-year extension to the existing trade agreement with the European Union regarding zero-tariffs for beef from non-hormone treated cattle, which means that demand for NHTC will continue.

• One-fourth of the world's beef and nearly one-fifth of the world's grain, milk and eggs are produced in the United States. With increased consumer consciousness, Americans are demanding to know where their food comes from and how they can support development of local and regional food systems. We believe that as consumers become better educated they will have more confidence in their food purchase decisions. To date, we have a major retailer, a very well-known restaurant, two major beef packers, a food service distributor and a major pork packer utilizing the Where Food Comes From® label. Consumer demand should accelerate the growth of our "Where Food Comes From®" labeling program.

• The worldwide market for certified organic products was estimated at $59.4 billion in 2010. The U.S. market was estimated at $28.5 billion in 2010 and is expected to reach $42.5 billion by 2015. Increasing consumer demand for healthy, better-for-you products produced with sustainable agricultural practices is driving growth in the organic market. Additionally, specialty food-store chains, conventional grocery store chains and big box retailers are allocating more shelf space to organic products in order to meet the growing demand. Our acquisition of a 60% ownership investment in ICS created a strategic transaction offering major participants in the food and agriculture industries a comprehensive range of verification services for the major food groups through a single platform.

• In January 2011, the Food Safety Modernization Act ("FSMA") was signed into law by President Obama. FSMA represents the most sweeping reform of our food safety laws in more than 70 years. It aims to ensure the U.S. food supply is safe by shifting the focus from responding to contamination to preventing it. On January 4, 2013, two major proposed FSMA rules regarding preventive controls in human food and produce safety were issued. The proposed rules build on existing voluntary industry guidelines for food safety, which many producers, growers and others currently follow. The US Food and Drug Administration ("FDA") expects to soon issue its proposed rule on importer foreign supplier verification; future proposed rules will address preventive controls for animal food, and accreditation of third-party auditors.

• Effective March 11, 2013, the USDA mandated the Animal Disease Traceability Rule primarily covering cattle 18 months of age or older. This ruling solidifies the need for beef producers to participate in a national animal identification program. This presents a significant opportunity for our business. As a result, we have been participating in an industry-led coalition to offer private industry solutions for this ruling.

Current Business Impact for Source and Age Verified Product

On January 28, 2013, the Japanese government announced a change to its import requirements on US beef. Cattle must be 30 months of age or less at time of harvest, which is an increase from 21 months previously. This change allowed for age to be determined using a method called dentition, which can be done in the processing facility and doesn't require actual records for the age to be verified.

Speculation surrounding this change negatively impacted our source and age verification business beginning in the latter half of 2012, first quarter 2013, and we expect it to continue throughout 2013. The change enabled a significant increase in the amount of product qualifying for export to Japan and accordingly, has negatively impacted the premiums typically seen in the marketplace for source and age verified cattle.

Due to the diversification of our product offerings and our strategy of managing to profitability, we were able to quickly minimize the impact of these adverse changes. We also believe our acquisition of the Validus auditing business further enhances our diversification by expanding our services to dairy and poultry products.

Many Japanese retail and food service companies have expressed their desire to maintain a verified-only product line to ensure a known source and a high quality eating experience. This alone will continue to drive added value for source and age-verified product.

We continue to see growth in our NHTC and Verified Natural Beef ("VNB") programs as domestic customers shift from source and age verification to NHTC and VNB. Additionally, we are seeing an increase in the number of "source verifications" requested in international markets. Although we cannot forecast the long-term impact of the change in "age verifications," we also cannot assume that Japan will change its requirement for source verification from US beef producers, especially considering that Japan has domestic traceability laws.

In summary, we know the inherent value of source and age verifications and the resulting peace of mind that is provided at the consumer level. We believe that the demand for verification, whether at the base level (source and age verification) or at a level that incorporates multiple credence factors (source and age with NHTC and VNB), will continue to grow as more consumers demand to know where their food comes from.

Seasonality

Our business is subject to seasonal fluctuations. Significant portions of our revenues are typically realized during the second and third quarters of the fiscal year 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 September 30, 2013, we had cash and cash equivalents of $1,037,584 compared to $1,403,489 of cash and cash equivalents at December 31, 2012. Our working capital at September 30, 2013 was $1,514,604 compared to $1,715,074 at December 31, 2012.

Net cash provided by operating activities for the year to date period ended September 30, 2013 was approximately $174,994 compared to net cash provided of approximately $317,877 during the same period in 2012. 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. The decrease in cash provided by operations is due to costs, such as legal and consulting fees, incurred directly related to the acquisition of Validus of approximately $219,000, which were expensed as incurred as required by current accounting literature. Other fluctuations are a result of timing of cash receipts and cash disbursements offset by operating performance.

Net cash used in investing activities for the year to date period ended September 30, 2013 was approximately $593,900 compared to net cash provided of approximately $31,800 in the 2012 period. Net cash used in the third quarter of 2013 was primarily attributable to the acquisition of Validus acquisition (see Note 2 in the accompanying condensed consolidated financial statements) in which we paid $565,000 in cash. Net cash provided in the 2012 period was directly related to proceeds on the sale of marketable securities.

Net cash provided by financing activities for the year to date period ended September 30, 2013 was approximately $53,000 compared to $31,100 in the 2012 period. Net cash provided in the third quarter of 2013 was due to proceeds of $105,300 from stock option exercises offset by stock repurchases of $29,555 and repayments towards notes payable and capital lease obligations of approximately $22,700.

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 toward net income has brought opportunities to us including: increased investor confidence and renewed interest in our company, third-party interest in our expertise to develop and enhance websites, 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 means to entry as imposed on international market imports/exports is via a quality verification program.

Debt Facility

On April 22, 2011, we entered into a U.S. Small Business Administration Note with Great Western Bank. The Note which matures on May 1, 2021 provides for $200,000 in additional working capital. The interest rate on the Note is at prime plus 2.5% and is adjusted quarterly. Principal and interest are payable monthly. The note can be prepaid without penalties and contains certain customary affirmative and negative covenants.

The loan agreement is secured by the accounts receivable, property and equipment, and intangible assets of the Company. The Note is further guaranteed by John and Leann Saunders, founders of the Company, with a security interest in 3,000,000 shares of the Company's common stock, which are personally owned by the Saunders.

In September 2013, the Company issued 175,972 shares of the Company's common stock in full settlement of the Lapaseotes note payable (as further discussed in Note 8 to the financial statements). Approximately $14,700 in non-cash interest expense was recognized and is reported in the Company's net loss for the nine months and year to date period ended September 30, 2013.

ICS has a revolving line of credit ("LOC") agreement which matures on April 4, 2014, and provides for $70,050 in working capital. The interest rate is at the bank index rate less 0.5% and is adjusted daily. Interest is calculated using a 360 day year. Principal and interest are payable upon demand, but if demand is not made, then annual payments of accrued interest only is due, with the principal balance due on maturity. The LOC is collateralized by all the business assets of ICS.

Off Balance Sheet Arrangements

As of September 30, 2013, we had no off-balance sheet arrangements of any type.

RESULTS OF OPERATIONS

Both the ICS and Validus acquisitions (as further described in Note 2 to the financial statements) have been accounted for using the acquisition method of accounting and accordingly, results are included in the following discussion from the date of acquisition.

Third Quarter and Year to Date Period ended September 30, 2013 compared to the Same Period in Fiscal Year 2012

Revenues

Total revenues for the third quarter and year to date period ended September 30, 2013 decreased 4.5% and 5.9%, respectively, compared to the same periods in 2012.

Service revenues include sales of our USVerified solutions and related consulting, program development and web-based development services. Service revenues of approximately $1,181,800 and $3,099,000 for the third quarter and year to date period ended September 30, 2013 decreased approximately $55,400, or 4.5%, and $156,300, or 4.8%, respectively, compared to the same period in 2012. Overall, the decrease is due to the changes in Japanese government imposed age restrictions on US beef imports, which has negatively impacted our source and age verification business, offset by Validus revenues of approximately $93,400 for the two week period from acquisition date to September 30, 2013. The Company continues to strategically negate the adverse effect Japan's change in regulations has had on our service revenues by expanding our portfolio of offerings to our existing customer base, as well as increasing our competitive edge with potential new customers.

Product sales represent sales of cattle identification ear tags. Product sales of approximately $263,300 and $544,200 for the third quarter and year to date period ended September 30, 2013 decreased approximately $5,400, or 2.0%, and $81,800 or 13.1%, respectively, compared to the same periods in 2012. The decrease was due to decreased volume in the quantity of tags sold in connection with our Source and Age verification programs.

Other revenue primarily represents the fees earned from our WFCF labeling program. Other revenue of approximately $25,000 for the third quarter ended September 30, 2013, decreased $14,200 or 36.1% compared to the same period in 2012. Other revenue for the year to date period ended September 30, 2013 of approximately $93,200 slightly increased $2,900 or 3.2% compared to same period in 2012. This revenue source is still in its infancy and we anticipate growth in the future as more and more food producers continue to show interest in this product offering.

Cost of Revenues and Gross Margin

Cost of revenues for the third quarter ended September 30, 2013 was approximately $755,500 compared to approximately $742,200 during the third quarter 2012. Gross margin for the third quarter 2013 decreased to 48.6% of revenues compared to 52.0% for the third quarter 2012.

Cost of sales for the year to date period ended September 30, 2013, were approximately $1,828,000 compared to $1,841,800 during 2012. Gross margin for the year to date period ended September 30, 2013 decreased to 51.1% of revenues compared to 53.6% for the year to date period ended September 30, 2012.

Our margins are impacted by various costs such as cost of products, salaries and benefits, insurance, and taxes. Because certain elements of our cost of revenues are fixed in nature, incremental sales positively impact our margins. Conversely, our gross margins for third quarter 2013 slightly declined compared to 2012, predominately due to the absorption of increases in our fixed costs (salaries, payroll taxes and medical insurance) over a slightly smaller revenue base.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the third quarter 2013 were approximately $715,700, an increase of $29,100, or 4.2% over the third quarter 2012.

Selling, general and administrative expenses for the year to date period ended September 30, 2013 were $1,905,900, an increase of $150,100, or 8.5% over 2012.

There are several factors contributing to these overall increases. First, and primarily, the Validus acquisition, which was completed September 16, 2013, resulted in legal and advisory fees of approximately $219,000, which was significantly higher than acquisition costs related to ICS during the same periods last year. In addition, included in our 2013 selling, general and administrative expenses is approximately $25,500 attributable to Validus. These increases were partially offset by our aggressive approach to minimize expenses in response to the impact of Japanese government imposed age restrictions on US beef imports to our operations.

Income Tax Benefit/Expense

For the third quarter ended September 30, 2013 and 2012, we recorded an income tax benefit of $11,000 and income tax expense of approximately $46,500, respectively. For the year to date period ended September 30, 2013 and 2012, we recorded income tax benefit of $12,200 and $363,000, respectively. The income tax benefit for the 2012 period included the effect of reversing $409,500 of our valuation allowance that existed as of December 31, 2011 after concluding the likelihood for a full realization of the benefits of our deferred tax assets was more likely than not.

Net Income (Loss) and Per Share Information

As a result of the foregoing, net loss attributable to WFCF shareholders for the third quarter ended September 30, 2013 was approximately $18,800, or less than a penny per basic and diluted common share, compared to net income of $63,600, or less than a penny per basic and diluted common share for the third quarter ended September 30, 2012.

Net loss attributable to WFCF shareholders for the year to date period ended September 30, 2013 was $22,200 or less than a penny per basic and diluted common share, compared to net income of $730,200 or $0.04 per basic and $0.03 per diluted common share for the year to date period ended September 30, 2012. The benefit from income taxes that we recorded related to the reversal of our valuation allowance on our deferred tax assets had an impact of approximately $0.02 per share on a dilutive basis for the year to date period ended September 30, 2012.

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