Where Food Comes From, Inc. - Quarter Report: 2013 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

221 Wilcox, Suite A

Castle Rock, CO 80104

(Address of principal executive offices, including zip code)

Issuer's telephone number, including area code:

(303) 895-3002

Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 S 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 S    No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” 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 S

The number of shares of the registrant’s common stock, $.001 par value per share, outstanding as of November 4, 2013, was 22,686,786.

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

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

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

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

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

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

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

Note 1 - The Company and Basis of Presentation

Business Overview

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

In December 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.

On February 29, 2012, we completed an acquisition of a 60% ownership investment in a North Dakota company, International Certification Services, Inc. (“ICS”) (Note 2). This acquisition has been accounted for using the acquisition method of accounting and, accordingly, its results are included in the Company’s consolidated financial statements from the date of acquisition.

On September 16, 2013, we acquired the auditing business of Praedium Ventures, LLC, previously known as Validus Ventures, LLC (“Validus”) (Note 2). This acquisition has been accounted for using the acquisition method of accounting and, accordingly, its results are included in the Company’s consolidated financial statements from the date of acquisition.

With the acquisition of ICS, we began aggregating operations into one reportable segment: Certification and Verification Services. The Validus business acquired is also within this one 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. The Company also has an operating licensing segment, which does not currently meet the quantitative threshold to be considered a reporting segment.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the results of operations, financial position and cash flows of Where Food Comes From, Inc. and its majority-owned subsidiaries, ICS and Validus (collectively referred to as “we,” “us,” and “our” throughout this Form 10-Q). All intercompany balances have been eliminated.

The condensed 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, 2012, included in our Form 10-K filed on March 6, 2013. 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 third quarter ended September 30, 2013 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 Condensed Consolidated Financial Statements

Note 1 - The Company and Basis of Presentation (continued)

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.

Recent Accounting Pronouncements

We have considered all 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

Validus Acquisition

On September 16, 2013, we entered into an Asset Purchase and Contribution Agreement (the “Purchase Agreement”), by and among the Company, Validus Verification Services LLC (the “Buyer” or “Validus”), and Praedium 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. Such assets acquired included, but were not limited to, verification tools used in the acquired business, including the processes, procedures, systems and documents, intellectual property, a database, contracts and licenses and accounts receivable. Validus acquired such assets 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 common stock on September 16, 2013, of $1.32 per share. In connection with this transaction, the Seller was also issued a 40% interest in Validus, with the Company holding a 60% interest. The Company has the first right of refusal on the remaining 40% of the outstanding stock. The cash consideration component is subject to adjustment based upon a net working capital calculation, as defined, whereby if net working capital exceeds $150,000, the cash consideration shall not be adjusted and Seller will keep and collect on all accounts receivable over $150,000. If the net working capital is less than $150,000, the cash consideration shall be decreased by the amount by which the net working capital is less than $150,000.

At any time following the thirty-month anniversary of the effective date of the Purchase Agreement, the Company shall have the option, but not the obligation, to purchase all the units (the 40% interest) of Validus held by Praedium, and Praedium shall have the option, but not the obligation, to require the Company to purchase all the units of Validus held by Praedium. The purchase price for the units shall be equal to the amount the selling holders of the units would be entitled to receive upon a liquidation of the Validus assuming all of the assets of Validus 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.

Because Praedium, at its option, can require the Company to purchase its 40% interest in Validus, the Validus noncontrolling interest meets the definition of a contingently redeemable noncontrolling interest.

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

Note 2 – Business Acquisitions (continued)

Redeemable noncontrolling 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 balance sheet.

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.

The purchase price allocation is preliminary and subject to change, as an analysis has not been completed as of the date of this report as we are still reviewing all of the underlying assumptions and calculations used in the allocation. However, the table below summarizes the provisional estimated fair values assigned to the assets and liabilities acquired in addition to the excess of the purchase price over the net assets acquired:

On the acquisition date, the provisional fair value of the non-controlling interest was estimated to be $1,000,306. This amount was based upon the gross consideration that would have been paid assuming 100% of the outstanding stock had been acquired. Excess attributable to intangible assets reflects the excess over the identifiable assets acquired to intangible assets based on the preliminary provisional allocation of the purchase price. The provisional amounts of the components of intangible assets have been estimated as follows:

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

Estimated provisional amortization expense related to such intangible assets was not considered material for the period from the acquisition date through September 30, 2013. The useful lives for intangible assets are expected to be between 5 and 15 years.

From the September 16, 2013 acquisition date through September 30, 2013, Validus revenues and income were approximately $93,400 and $11,700, respectively.

The following unaudited pro forma information presents the results of operations for the nine months ended September 30, 2013 and 2012, as if the acquisition of Validus had occurred on January 1, 2013 and 2012.

As of September 30, 2013, we have incurred a total of approximately $269,000 in advisory and legal fees related to the acquisition of Validus, of which, approximately $219,000 and $50,000 are reported in selling, general and administrative expenses in the accompanying condensed consolidated statement of operations for the year to date period ended September 30, 2013 and 2012, respectively.

ICS Acquisition

On February 29, 2012, we entered into a Purchase and Exchange Agreement (the “Purchase Agreement”), by and among the Company and ICS, and other shareholders as individually named in the Agreement (collectively the “Sellers”).

From the acquisition date through September 30, 2012, ICS revenues and net income were approximately $714,500 and $7,700, respectively. The following unaudited pro forma information presents the results of operations for the nine months ended September 30, 2012, as if the acquisition of ICS had occurred on January 1, 2012.

Note 3 - Basic and Diluted Net Income (Loss) per Share

Basic net income (loss) per share was computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) 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 warrants 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 Condensed Consolidated Financial Statements

The following schedule is a reconciliation of the share data used in the basic and diluted net income (loss) per share computations:

Antidilutive securities in the table above represent securities that could potentially dilute basic earnings in the future that were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period presented.

Note 4 - Stock-Based Compensation

Our stock-based award plans (collectively referred to as the “Plans”) provide for the issuance of stock-based awards to employees, officers, directors and consultants. The Plans permit the granting of stock awards and stock options. The vesting of stock-based awards is generally subject to meeting certain performance-based objectives, the passage of time or a combination of both, and continued employment through the vesting period.

The fair value of stock options is estimated using the Black-Scholes option-pricing model, which incorporates ranges of assumptions for inputs. Our assumptions are as follows:

For the year to date periods ended September 30, 2013 and 2012, options to purchase 82,500 and 100,000 shares of common stock were granted, respectively. Stock-based compensation expense for the year to date periods ended September 30, 2013 and 2012 was $49,260 and $16,117, respectively. Stock-based compensation expense for the quarters ended September 30, 2013 and 2012 was $21,347 and $7,335, respectively. Stock-based compensation expense has been included in general and administrative expenses.

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

Note 5 - Stock Option Plan Activity

Stock option activity under our Plans 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 September 30, 2013 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 September 30, 2013.

Note 6 - Stock Buyback Plan

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

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

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

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

Note 7 – Income Taxes

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

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

As of December 31, 2012, our net operating loss carry forwards for U.S. federal income tax purposes were $1.6 million, and were subject to the following expiration schedule:

Our unused net operating loss carry forwards may be applied against future taxable income.

For the third quarter and year to date period ended September 30, 2013 we recorded an income tax benefit of $11,019 and $12,229, respectively. For the quarter ended and year to date period ended September 30, 2012, we recorded income tax expense of $46,500 and income tax benefit of $362,972, respectively. The income tax benefit for the year to date period ended September 30, 2012 included the effect of reversing $409,500 of the 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.

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

Note 8 - Notes Payable

Notes payable consist of the following:

Equipment Note Payable

In December 2012, we entered into a note payable of $37,407 for the purchase of a vehicle. Interest and principal payments are due in equal monthly installments of $715 over five years beginning January 2013. This note bears an interest rate of 5.5% per annum and is collateralized by the vehicle.

Lapaseotes Note Payable – Related Party

In September 2007, we obtained $300,000 in unsecured debt financing. The notes were held by a major shareholder who is related to Mr. Lapaseotes, a member of our Board of Directors.

In September 2013, the Board and Mr. Lapaseotes agreed to settle the note and accrued interest with the issuance of the Company’s common stock, at a 6% premium of the outstanding balance based on the stock price of $1.22 on the date of the agreement. As a result, 175,972 shares of the Company’s common stock were issued in settlement of the debt. We recorded a $14,686 non-cash loss on extinguishment, presented within interest expense, related to the premium associated with the settlement of this debt.

Great Western Bank SBA Loan

On April 22, 2011, we entered into a U.S. Small Business Administration (“SBA”) Note with Great Western Bank. This note, which matures on May 1, 2021, provides for $200,000 in additional working capital. The interest rate is at prime plus 2.5% and is adjusted quarterly. Principal and interest are payable monthly. As of September 30, 2013, the effective interest rate is 5.75%. The note can be prepaid without penalties and contains certain customary affirmative and negative covenants.

The loan agreement is collateralized by the accounts receivable, property and equipment, and intangible assets of the Company. The note is further guaranteed by John and Leann Saunders, significant shareholders, officers and members of the Company’s Board of Directors, with a security interest in 3,000,000 shares of the Company’s common stock, which are personally owned by the Saunders.

ICS Revolving Line of Credit

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. As of September 30, 2013, the effective interest rate is 5.75%. The LOC is collateralized by all the business assets of ICS. As of the date of acquisition and through September 30, 2013, ICS had no amounts outstanding under this LOC.

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

Note 9 - Commitments and Contingencies

Operating Leases

In June 2012, we amended the building lease for our headquarters in Castle Rock, Colorado. The lease is for a period of three years with an expiration date of June 15, 2015. In addition to the primary rent, the lease requires additional payments for operating costs and other common area maintenance costs.

We also own approximately ¾ acre on which a 2,300 square foot building leased by our ICS office is located in Medina, North Dakota. The North Dakota office is leased for a period of five years with an expiration date of March 1, 2018. One additional option to renew for a five-year term exists and is deemed to automatically renew unless written notice is provided 60 days before the end of the term. Rent for this location consists of a minimum monthly rental rate of approximately $150 plus all utilities, taxes and other expenses based on actual expenses to maintain the building.

In September 2013, as part of the Validus acquisition (see Note 2), Validus entered into a sub-lease agreement for its office space with Praedium. The lease is for a period of three years, expiring October 31, 2016. There is no renewal feature. In addition to primary rent, the lease requires additional payments for operating costs and other common area maintenance costs.

As of September 30, 2013, future minimum lease payments are as follows:

Sub-lease Agreement

ICS sub-leases approximately 300 square feet of space located within its corporate office to a third party on a month-to-month basis. Monthly rent of $302 includes utilities and other common area maintenance. The sub-lease agreement provides for 30 days’ notice to terminate the agreement.

Capital Leases

During the first quarter ended March 31, 2012, we entered into a capital lease for certain office equipment with a base rent of $405 per month. This 63-month lease expires April 2017. Approximately $22,300 in asset cost has been included in property and equipment and is being amortized over 63 months. Imputed interest of 5.25% was used in determining the minimum lease payments.

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

ICS leases certain office equipment under a capital lease with a base rent of $521 per month. The lease expired in April 2013. Included in property and equipment is $17,000 in asset cost. Imputed interest of 6.25% was used in determining the minimum lease payments.

As of September 30, 2013, future minimum lease payments for capital leases are as follows:

Employment Agreements

In January 2006, we entered into employment agreements with John Saunders, our Chief Executive Officer, and with Leann Saunders, our President. The agreements automatically renew annually unless a 60-day notice of non-renewal is provided by either the Company or the employee.

Effective January 1, 2012, ICS entered into an employment agreement with Christina Dockter as its Chief Executive Officer, for a period of 2 years. The agreement automatically renews annually unless a 60-day notice of non-renewal is provided by either the Company or the employee.

Effective September 16, 2013, Validus entered into an agreement with Earl Dotson, as its Chief Executive Officer, for a period of 30 months, expiring March 16, 2016. The agreement is automatically renewed at expiration for a one-year term unless a 90-day notice of non-renewal is provided by either the Company or the employee.

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.

ICS was involved in a claim in the District Court of Lancaster County, Nebraska. The plaintiff in this claim alleged that ICS conspired with another party (the “Defendants”) to deny the plaintiff organic certification. The plaintiff was seeking damages (an amount up to approximately $7.5 million) from the alleged difference in value of his crops if they had been certified organic versus the value of the crops as conventional grains.

Where Food Comes From, Inc.

Notes to the Condensed Consolidated Financial Statements

In October 2013, a summary judgment was reached in favor of the Defendants and the court awarded ICS fees to cover a portion of attorney and other costs incurred to defend this case. The plaintiff has until October 30, 2013 to file an appeal with the court. If no appeal is filed, the judgment will be executed.

Although it is not possible to predict with certainty the probability or outcome of an appeal filing, we do not believe, based on current knowledge, that this claim, or any legal proceeding or claim, is likely to have a material effect on our financial position, results of operations, or cash flows.

Note 10 – Redeemable Noncontrolling Interest

Redeemable noncontrolling interest on our condensed consolidated balance sheet represents the noncontrolling interest related to the Validus acquisition (see Note 2), in which the Company’s unaffiliated partner, at its election can require the Company to purchase their 40% investment in Validus. Below is a table reflecting the activity of the redeemable noncontrolling interest at September 30, 2013:

Note 11 – Supplemental Cash Flow Information

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:

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.

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) Rules 13a-15(e) or 15d-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

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-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.

On September 16, 2013, we completed the Validus acquisition. We are in the process of integrating Validus into our overall internal control over financial reporting process. See Note 2 to the accompanying condensed consolidated financial statements for additional information on the Validus Acquisition.

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.

ICS was involved in a claim in the District Court of Lancaster County, Nebraska. The plaintiff in this claim alleged that ICS conspired with another party (the “Defendants”) to deny the plaintiff organic certification. The plaintiff was seeking damages (an amount up to approximately $7.5 million) from the alleged difference in value of his crops if they had been certified organic versus the value of the crops as conventional grains.

In October 2013, a summary judgment was reached in favor of the Defendants and the court awarded ICS fees to cover a portion of attorney and other costs incurred to defend this case. The plaintiff has until October 30, 2013 to file an appeal with the court. If no appeal is filed, the judgment will be executed.

Although it is not possible to predict with certainty the probability or outcome of an appeal filing, we do not believe, based on current knowledge, that this claim, or any legal proceeding or claim, is likely to have a material effect on our financial position, results of operations, or cash flows.

ITEM 1A. RISK FACTORS

Our business is subject to a number of risks, including those identified in Item 1A. — “Risk Factors” of our 2012 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. As of September 30, 2013, there have been no material changes to the risks disclosed in our most recent Annual Report on Form 10−K. We may also disclose changes to such factors or disclose additional factors from time to time in our future filings with the SEC.

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

In connection with the Validus acquisition (see Note 2 to the accompanying condensed consolidated financial statements), we issued 708,681 shares of common stock of Where Food Comes From, Inc. valued at approximately $935,500 based upon the closing price of our stock on September 16, 2013, of $1.32 per share.

For services rendered by our advisors in connection with the Validus acquisition (see Note 2 to the accompanying condensed consolidated financial statements), we issued 56,818 shares of common stock of WFCF valued at approximately $75,000 based upon the closing price of our stock on September 16, 2013, of $1.32 per share.

In connection with the settlement of a $200,000 unsecured note with a related party, we issued 175,972 shares of common stock of WFCF valued at approximately $214,700 based upon the market price at the date of the agreement of $1.22 per share.

The aforementioned shares were issued pursuant to the exemption from registration provided by Section 4 (2) of the Securities Act of 1933. The shares bear a legend restricting the sale, transfer or exchange, and may only be sold, transferred or exchanged pursuant to a registration of such shares or a valid exemption therefrom.

ITEM 6. EXHIBITS

(a) Exhibits

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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