INMG.. $0.50.. Management’s Strategy
For several years, management has been focusing 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 this type of service has marginal increases in revenue with declining profit margins 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 “Where Food Comes From” (WFCF) brand. Revenue to be generated from WFCF 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. WFCF 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 those marketing claims are authentic and have been verified by an accredited, unbiased third party.
During 2010, management, along with the assistance of industry consulting experts, intentionally made the decision to invest heavily in marketing our services and our WFCF labeling program to build consumer awareness. In February 2010, we announced our alliance with cowboy poet Baxter Black to promote our verification, identification and traceability solutions on RFD-TV’s “Cattlemen to Cattlemen” television program. In July 2010, Leann Saunders, our president, was a featured guest in an episode of Lifetime Television’s “The Balancing Act” to discuss our latest effort to connect consumers with the farmers that raise their food.
During 2010 and 2011, we generated a small but consistently growing revenue stream from our WFCF program. We will continue to invest heavily in marketing our verification services and our WFCF brand to build consumer awareness and demand through the use of videos, television exposure, word-of-mouth and the internet. We believe we are positioning ourselves to benefit significantly in 2012 and beyond, but, of course, no assurance can be given that this investment will generate future revenue nor can we determine for how long, if at all.
Acquisition of 60% of outstanding shares of ICS
On February 29, 2012, we entered into a Purchase and Exchange Agreement (the “Purchase Agreement”), dated February 29, 2012 but effective as of the close of business on December 31, 2011 by and among IMI and International Certification Services, Inc. (ICS), and other shareholders as individually named in the Agreement (collectively the “Sellers”).
Pursuant to the Purchase Agreement, on February 29, 2012 (the “Closing”) the Company acquired 60% of the issued and outstanding stock of ICS (the “Acquisition”) in exchange for aggregate consideration of $420,000, which includes $350,000 in cash and 172,840 shares (the “Shares”) of common stock of IMI valued at approximately $77,800 based upon the closing price of our stock on February 29, 2012 of $0.45. The Purchase Agreement provides for 50% of the Shares to be held in escrow for a period of eighteen months to support any indemnification claims by us for breach of ICS representations, warranties and covenants under the Purchase Agreement. The Purchase Agreement also includes non-dilution provisions, and we have right of first refusal on the remaining 40% of the outstanding stock.
ICS is a premier provider of organic accreditation services and has a strong reputation in the organic market segment. They have a large and growing customer base that includes food retailers as well as producers and processors of fruits, vegetables, dairy, livestock and honey. Their flagship certification program is Farm Verified Organic® – an ISO Guide 65 and IFOAM accredited program that meets the requirements of the USDA National Organic Program – that is designed for organic producers selling to U.S. and international markets. ICS also offers USDA National Organic Program, Canadian Organic Regime (COR) and Food Alliance sustainability certification as well as facilitation and compliancy of European Union, Japan and Bio Suisse standards. It is estimated that the total organic market segment in the U.S. and E.U. is more than $50 billion annually.
We believe this acquisition has tremendous synergies for both IMI and ICS. As industry leaders in our respective product and service offerings, 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 in the produce, grain and dairy industries. It should enable us to better serve our customers, as well as accelerate our revenue growth, be accretive to earnings and provide another avenue for our WFCF program.
RESULTS OF OPERATIONS
Year Ended December 31, 2011 Compared to Year Ended December 31, 2010
Years ended December 31, 2011 2011 - 2010
Selected Financial Data 2011 2010 Improvement % Change
Revenues:
Service revenues $ 3,329,615 $ 2,592,172 $ 737,443 28.4 %
Product sales 843,098 648,027 195,071 30.1 %
Other revenue 60,036 34,367 25,669 74.7 %
Total revenues 4,232,749 3,274,566 958,183 29.3 %
Costs of revenues:
Labor and other costs of services 1,282,342 1,026,137 256,205 25.0 %
Costs of products 602,049 448,744 153,305 34.2 %
Total costs of revenues 1,884,391 1,474,881 (409,510 ) -27.8 %
Gross profit 2,348,358 1,799,685 548,673 30.5 %
Gross margin 55.5 % 55.0 % 0.5 % *
Selling, general and administrative expenses 1,671,835 1,440,229 (231,606 ) -16.1 %
Other expense, net 36,421 31,699 (4,722 ) -14.9 %
Income tax benefit (224,350 ) - 224,350 *
Net income $ 864,452 $ 327,757 536,695 163.7 %
* calculation not meaningful for discussion purposes
Revenues
Total revenues for the year ended December 31, 2011 increased 29.3% over the year ended December 31, 2010. We still continue to experience double-digit sales growth from year over year, and we believe this is significant performance in light of the current economic conditions severely impacting the food industry.
Service revenues include sales of our USVerified solutions and related consulting, program development and web-based development services. Service revenues for the year ended December 31, 2011 increased 28.4% compared to the year ended December 31, 2010. The improvement is due in large part to demand from retailers in our US Verified product line. Concerns about animal welfare continue to drive retailers to make program decisions based on animal handling, care, well-being and welfare programs. In late 2010, we introduced a new revenue stream specific to conducting animal welfare audits on pork, beef and chicken farmers and ranchers that supply specialty retailers. This program is having a significant impact on our service revenues and we believe this trend will continue to grow. We also continue to see increased demand in our NHTC verification program.
Product sales are primarily sales of cattle identification ear tags. Product sales for the year ended December 31, 2011 increased 30.1% compared to the year ended December 31, 2010. The overall increase over the prior year was due to special promotions that we offered to our customers based on their volume.
Other revenue primarily represents the fees earned from our WFCF labeling program. Other revenue for the year ended December 31, 2011 increased 74.7% compared to the year ended December 31, 2010. This revenue source is still in its infancy, and we anticipate exponential growth in the future as more and more food producers continue to show interest in this product offering.
Cost of Sales and Gross Margin
Cost of sales for the year ended December 31, 2011 were $1,884,391 compared to $1,474,881 for the year ended December 31, 2010. Gross margin for 2011 slightly improved to 55.5% of revenues compared to 55.0% for 2010.
Our gross profit for 2011 was positively impacted by increased volume of verification audits. Our gross margins for 2011 are slightly improving due to the absorption of certain costs which are generally fixed in nature over a greater volume of sales coupled with shifts in our sales mix as compared to 2010. For a more detailed discussion regarding profitability, read “Management’s Strategy” above.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the year ended December 31, 2011 increased $231,606, or 16.1% over the year ended December 31, 2010. The increase was partially attributed to spending in consulting, marketing and advertising. During the second quarter 2010, management, along with the assistance of industry consulting experts, intentionally made the decision to invest heavily in marketing our “Where Food Comes From®” labeling program to build consumer awareness. We believe that the future growth of verification services will be achieved only through consumer awareness and demand. We recognize that we are allocating significant funds to this effort but we are confident that we are heading in the right direction. This marketing decision and the decision to invest these funds in our future were made at a time when we recognized that our operations consistently generated sufficient cash flow. While we continue to generate a small but consistently growing revenue stream from our WFCF program, we cannot guarantee that our marketing investment will generate future revenue nor can we determine for how long, if at all. Therefore, this investment must be expensed in accordance with accounting principles generally accepted in the United States. For a more detailed discussion regarding our “Where Food Comes From®” labeling program, read “Management’s Strategy” above.
Income Tax Benefit
For tax purposes, utilization of our fully reserved net operating loss (“NOL”) carryforwards offset any taxes due and reduced our effective tax rate for 2011 and 2010. In 2011, we recorded a deferred tax benefit of $224,350 by reversing a portion of our valuation allowance after concluding the likelihood for a partial realization of the benefits of our deferred tax assets is more likely than not.
Net Income and Per Share Information
As a result of the foregoing, net income for the year ended December 31, 2011 was $864,452 or $0.04 per basic and diluted common share, compared to net income of $327,757 or $0.02 per basic and diluted common share for the year ended December 31, 2010. The benefit from income taxes that we incurred related to the reversal of a portion of our valuation allowance on our deferred tax assets had an impact of less than a penny per share on a dilutive basis in 2011.
Liquidity and Capital Resources
At December 31, 2011, we had cash and cash equivalents of $969,020 compared to $513,076 of cash and cash equivalents at December 31, 2010. Our working capital at December 31, 2011 was $1,523,429 compared to $555,074 at December 31, 2010.
Net cash provided by operating activities during 2011 was $720,685 compared to net cash provided of $430,535 during the same period in 2010. Cash provided by operating activities is driven by our net income and adjusted by non-cash items. Non-cash adjustments primarily include depreciation, amortization of intangible assets and stock based compensation expense. The improvement was primarily driven by better operating performance. Additionally, the timing of cash receipts and cash disbursements affects our operating assets and cash balances.
Net cash used in investing activities during 2011 was $310,780 compared to $76,344 during 2010. Net cash used during 2011 was primarily attributable to net purchases of marketable equitable securities of $298,609 in 2011, offset by capital expenditures of $12,171 compared to capital expenditures of $76,344 in 2010. Our capital expenditures are primarily related to purchases and internal development of information technology assets to support our product and service offerings.
Net cash provided by financing activities of $51,231 during 2011 was due to a cash inflow of $200,000 from our new SBA loan agreement offset by repayments of $88,972 towards notes payable and $61,597 in repurchases under our Stock Buyback program. Net cash used in financing activities of $55,794 during 2010 was due to repayments of $28,521 towards notes payable and $22,273 in repurchases under our Stock Buyback program.
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 intensifying our focus on international markets. We believe that there are significant growth opportunities available to us because often the only way to access various restrictions as imposed on international market imports/exports is via a quality verification program, like our USVerified™.com product line.
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. As of December 31, 2011, the current effective rate is 5.75%. 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 Integrated Management Information, Inc. stock. The 3,000,000 shares are personally owned by the Saunders.
Simultaneous with the closing of the new loan agreement with Great Western Bank, we amended the terms of our existing $300,000 in unsecured debt. The note is held by a major shareholder who is related to Pete Lapaseotes, a director of the Company. Modifications to the terms of the existing agreement include a reduction in the interest rate from 9% to 6% annually, as well as an extension of the maturity date from September 12, 2012 to March 31, 2014. Principal is due in full upon the maturity date; interest is payable quarterly.
Off Balance Sheet Arrangements
As of December 31, 2011, we had no off-balance sheet arrangements of any type.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are discussed in Note 2 to our financial statements as set forth in Item 8 of this Form 10-K.
Stock-Based Compensation Expense
Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility, and the pre-vesting option forfeiture rate. We utilize the Black-Scholes option-pricing model to estimate the fair value of stock options. Under this pricing model, which incorporates ranges of assumptions for inputs, our assumptions are as follows:
? Dividend yield is based on our historical and anticipated policy of not paying cash dividends.
? Expected volatility assumptions were derived from our actual volatilities.
? The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant with maturity dates approximately equal to the expected life at the grant date.
? The expected term of options represents the period of time that options granted are expected to be outstanding giving consideration to vesting schedules, based on historical exercise patterns, which we believe are representative of future behavior.
The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment.
There is a risk that our estimates of the fair values of our share-based compensation awards on the grant dates may differ from the actual values realized upon the exercise, expiration, early termination or forfeiture of those share-based payments in the future. Certain share-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly in excess of the fair values originally estimated on the grant date and reported in our financial statements. Although the fair value of our share-based awards is determined in accordance with GAAP and the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 using an option-pricing model, the value calculated may not be indicative of the fair value observed in a willing buyer / willing seller market transaction.
Estimates of share-based compensation expenses do have an impact on our financial statements, but these expenses are based on the aforementioned option valuation model and will never result in the payment of cash by us. For this reason, and because we do not view share-based compensation as being related to our operational performance, we exclude estimated share-based compensation expense when internally evaluating our performance.
Income Taxes and Realization of Deferred Tax Assets
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the respective tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using current enacted tax rates expected to apply to taxable income in the years in which we expect the temporary differences to reverse. We routinely evaluate the likelihood of realizing the benefit of our deferred tax assets and may record a valuation allowance if, based on all available evidence, we determine that some portion of the tax benefit will not be realized.
In addition, our income tax returns are periodically audited by federal and state tax authorities. These audits include questions regarding our tax filing positions, including the timing and amount of deductions taken and the allocation of income amongst various tax jurisdictions. We evaluate our exposures associated with our various tax filing positions and record a related liability. We adjust our liability for unrecognized tax benefits and income tax provision in the period in which an uncertain tax position is effectively settled, the statute of limitations expires for the relevant taxing authority to examine the tax position or when more information becomes available.
The ultimate realization of deferred income tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Although we achieved $640,102 and $327,757 of pre-tax income for 2011 and 2010, respectively, we reviewed various qualitative and quantitative data in regards to the realization of our deferred tax assets, including:
? The level of historical taxable income and projections for future taxable income over periods in which the deferred tax assets would be deductible, and
? Accumulation of income (loss) before taxes utilizing a look-back period of three years.
? Events within the industry,
? The cyclical nature of our business,
? The health of the economy,
? Our future forecasts of taxable income and
? Historical trending.
The recording of our net deferred income tax assets requires significant management judgment regarding the interpretation of applicable statutes, the status of various income tax audits, and our particular facts and circumstances. After consideration of the aforementioned qualitative and quantitative data, we concluded not to reduce our valuation allowance as of December 31, 2010 because of the current macroeconomic climate and uncertainty around credit markets and consumer behavior. In the fourth quarter of 2011, after again assessing the existing qualitative and quantitative data, including the wide-spread consensus that the economic climate was beginning to improve, we reduced our valuation allowance of $643,370 by $224,350 to $419,020 after consideration the following factors:
• Our continued profitability through December 31, 2011 resulting in eight consecutive quarters of profitability; and
• Our cumulative income before taxes of $967,859 over the past two years through December 31, 2011
On an on-going basis, we will continue to assess the likelihood of realization of the benefits of our deferred tax assets considering the many qualitative and quantitative factors. We believe that our estimates are reasonable; however, actual results could differ from these estimates.
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