UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2011
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 001-34719
S&W SEED COMPANY
(Exact name of Registrant as Specified in its Charter)
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25552 South Butte Avenue
Five Points, CA 93624
(Address of Principal Executive Offices, including Zip Code)
(559) 884-2535
(Registrant's Telephone Number, including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. x YES ¨ NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES
x NO ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer ¨ |
Accelerated filer ¨ |
Non-accelerated filer ¨
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Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES ¨
NO x
As of February 8, 2012, 5,800,000 shares of the registrant's common stock were outstanding.
PDF, as a courtesy
S&W SEED COMPANY 2
Part I -- FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
S&W SEED COMPANY
See notes to consolidated financial statements. - 3 -
S&W SEED COMPANY
See notes to consolidated financial statements. - 4 -
S&W SEED COMPANY
See notes to consolidated financial statements. 5
S&W SEED COMPANY
See notes to consolidated financial statements. 6
S&W SEED COMPANY NOTE 1 — BACKGROUND AND ORGANIZATION Organization Seed Holding, LLC ("Seed Holding") was formed as a Nevada limited liability company on
June 27, 2008 for the purpose of acquiring a majority ownership interest in S&W Seed Company, a
California general partnership ("S&W"), which was engaged in the business of breeding, growing, processing and
selling agricultural commodities, such as alfalfa seed, and to a lesser extent, wheat and small grains. On June 27, 2008, the general partners of S&W entered into an agreement for sale of their
partnership interests to Seed Holding. Under the terms of the agreement, Seed Holding agreed to purchase 90% of
S&W for $3,600,000 in three separate closing transactions. By amendment to that agreement, in December 2009,
Seed Holding agreed to purchase the entire partnership. At December 31, 2009, Seed Holding legally owned an 85%
general partnership interest and had issued $730,000 in promissory notes to the four general partners. These notes
were due on June 30, 2010 but accelerated upon the closing of the Company's initial public offering. Seed
Holding agreed to purchase the remaining 15% general partnership interest on the earlier of June 30, 2010 or
the closing of the Company's initial public offering. The corporate entity, S&W Seed Company (the "Company"), was incorporated in Delaware on
October 2, 2009. In January 2010, the members of Seed Holding exchanged their membership units for
3,000,000 shares of the Company's common stock, the Delaware corporation became the sole member of Seed
Holding, and the corporation assumed the obligation to purchase the remaining 15% general partnership interest.
Following the receipt of the net proceeds from the initial public offering in May 2010, the Company repaid the promissory
notes in full and purchased the final partnership interests, resulting in Seed Holding owning 100% of the former
partnership. The accounting rules applicable to the agreement mandate that Seed Holding account for the acquisition of 90% of
the partnership as of June 30, 2009 and 100% of the partnership as of December 31, 2009 and subsequent
periods. These financial statements reflect this accounting treatment. Prior period consolidated financial statements
have been re-classified to conform to the equity presentation of the Company as a C-corporation. On December 13, 2011, S&W Seed Company ("S&W Delaware"), consummated a merger (the
"Reincorporation") with and into its wholly-owned subsidiary, S&W Seed Company, a Nevada corporation
("S&W Nevada"), pursuant to the terms and conditions of an Agreement and Plan of Merger entered into by
S&W Nevada and S&W Delaware on December 10, 2011 (the "Merger Agreement"). As a result of the
Reincorporation, the Company is now a Nevada corporation. 7
Business Overview Since its establishment, the Company, including its predecessor entities, has been principally engaged
in breeding, growing, processing and selling agricultural commodities, including alfalfa seed, and to a lesser extent,
wheat and small grains. The Company owns a 40-acre seed cleaning and processing facility located in Five Points,
California that it has operated since its inception. The Company's products are primarily grown under contract by
farmers in the San Joaquin and Imperial Valleys of California, as well as a small direct farming operation. Though the
Company's proprietary alfalfa seed varieties have been a mainstay of the business for decades, S&W has in the
past derived material revenue from the processing of wheat and other small grains. The Company began its stevia
initiative in fiscal 2010 and moved from a pilot program to commercial production in fiscal 2011. The Company recorded
its first stevia revenue in the second quarter of fiscal 2012 under a commercial supply agreement with a major stevia
processor. NOTE 2 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation The Company maintains its accounting records on an accrual basis in accordance with generally
accepted accounting principles in the United States of America ("U.S. GAAP"). The consolidated financial statements include the accounts of Seed Holding, LLC and its other wholly-owned
subsidiary, Stevia California, LLC. All significant intercompany balances and transactions have been eliminated.
Unaudited Interim Financial Information The accompanying consolidated balance sheet as of December 31, 2011, consolidated statements of
operations for the three and six months ended December 31, 2011 and 2010, consolidated statement of owners' equity
for the six months ended December 31, 2011 and consolidated statements of cash flows for the six months ended
December 31, 2011 and 2010 are unaudited. These unaudited interim consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In the
opinion of the Company's management, the unaudited interim consolidated financial statements have been prepared on
the same basis as the audited consolidated financial statements and include all adjustments necessary for the fair
presentation of the Company's statement of financial position at December 31, 2011 and its results of operations for the
three and six months ended December 31, 2011 and its cash flows for the six months ended December 31, 2011 and
2010. The results for the three and six months ended December 31, 2011 are not necessarily indicative of the results to
be expected for the fiscal year ending June 30, 2012. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the
United States requires management to make certain estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Estimates are adjusted to reflect actual experience when necessary.
Significant estimates and assumptions affect many items in the financial statements. These include allowance for
doubtful trade receivables, sales returns and allowances, inventory obsolescence, asset impairments, provisions for
income taxes, grower accruals (an estimate of amounts payable to farmers who grow seed for the Company),
contingencies and litigation. Significant estimates and assumptions are also used to establish the fair value and useful lives of depreciable tangible
8
and certain intangible assets as well as valuing stock-based compensation. Actual results
may differ from those estimates and assumptions, and such results may affect income, financial position or cash flows.
Reclassifications Certain amounts in the 2011 fiscal year consolidated financial statements have been reclassified to
conform to the 2012 fiscal year presentation. Certain Risks and Concentrations The Company's revenue is principally derived from the sale of alfalfa
seed, the market for which is highly competitive. The Company depends on a core group of significant customers. Three
customers accounted for 64% and 84% of its net revenue for the three and six months ended December 31, 2011,
respectively. A different combination of three customers accounted for 36% and 52% of its net revenue for the three and
six months ended December 31, 2010, respectively. Three customers comprised 82% of the Company's accounts receivable at December 31, 2011. A
different combination of three customers comprised 85% of the Company's accounts receivable at June 30, 2010. Sales direct to international customers represented 57% and 0% of revenue during the three months
ended December 31, 2011 and 2010, respectively. Sales direct to international customers represented 70% and 0% of
revenue during the six months ended December 31, 2011 and 2010, respectively. The Company is also dependent upon a small network of growers of alfalfa seed that together provide the majority
of the seed the Company sells to its customers. Three growers accounted for 59% and 55% of the Company's seed
requirements for six months ended December 31, 2011 and 2010, respectively. Revenue Recognition The Company derives its revenue primarily from sales of seed and milling services. Revenue from
seed sales is recognized when risk and title to the product is transferred to the customer, which usually occurs at the
time shipment is made from the Company's facilities. When the right of return exists in the Company's seed business, sales revenue is reduced at the time of sale to
reflect expected returns. In order to estimate the expected returns, management analyzes historical returns, economic
trends, market conditions and changes in customer demand. At December 31, 2011, no customers had the right of
return. The Company recognizes revenue from milling services according to the terms of the sales agreements and
when delivery has occurred, performance is complete, no right of return exists and pricing is fixed or determinable at the
time of sale. Additional conditions for recognition of revenue for all sales include the requirements that the collection of sales
proceeds must be reasonably assured based on historical experience and current market conditions, the sales price is
fixed and determinable and that there must be no further performance obligations under the sale. 9
Shipping and Handling Costs The Company records purchasing and receiving costs, inspection costs and warehousing costs in cost of
goods sold. In some instances, products are shipped F.O.B. shipping point and, as a result, the Company is not
obligated to pay for shipping or any costs associated with delivering its products to its customers. In these instances,
costs associated with the shipment of products are not included in the Company's consolidated financial statements.
When the Company is required to pay for outward freight and/or the costs incurred to deliver products to its customers,
the costs are included in cost of goods sold. Sales Commissions
Sales commission expenses are accrued for when the applicable sale is
completed and all such expenses are classified within selling, general and administrative expenses on the consolidated
statements of operations. Commissions paid to Mr. Penner pursuant to his consulting contract were accounted for
consistent with the aforementioned treatment. Cash and Cash Equivalents For financial statement presentation purposes, the Company considers time deposits, certificates of
deposit and all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.
The Company maintains cash and cash equivalent balances at financial institutions that are insured by the
Federal Deposit Insurance Corporation up to $250,000. Deposits with these banks may exceed the amount of insurance
provided on such deposits; however, these deposits typically may be redeemed upon demand and, therefore, bear
minimal risk. The Company provides an allowance for doubtful trade receivables equal to the estimated uncollectible
amounts. That estimate is based on historical collection experience, current economic and market conditions and a
review of the current status of each customer's trade accounts receivable. The allowance for doubtful trade receivables
was $0 and $3,587 at December 31, 2011 and June 30, 2011, respectively. Inventories Alfalfa Seed Inventory Inventories consist of alfalfa seed purchased from the Company's growers under year-to-year production
contracts as well as packaging materials. Alfalfa inventories are accounted for on a specific lot-by-lot identification basis.
Inventories are sold to the Company's customers on the same specific lot-by-lot identification basis. Inventories are stated at the lower of cost or market, and the inventory reserve reduces the cost basis of
inventory. Inventories are valued as follows: Actual cost is used to value raw materials such as packaging materials, as
well as goods in process. Costs for substantially all finished goods, which include the cost of carryover crops from the
previous year, are valued at actual cost. Actual cost for finished goods includes plant conditioning and packaging costs,
direct labor and raw materials and manufacturing overhead costs based on normal capacity. The Company records abnormal amounts of idle facility
10
expense, freight, handling costs and wasted material (spoilage) as current period
charges and allocates fixed production overhead to the costs of finished goods based on the normal capacity of the
production facilities. Inventory is periodically reviewed to determine if it is marketable, obsolete or impaired. Inventory that is
determined to not be marketable is written down to market value. Inventory that is determined to be obsolete or impaired
is written off to expense at the time the impairment is identified. Because the germination rate, and therefore the quality,
of alfalfa seed improves over the first year of proper storage, inventory obsolescence is not a material concern. The
Company sells its inventory to distributors, dealers and directly to growers. Growing Crops Expenditures on growing crops are valued at the lower of cost or market and are deferred and charged to cost
of products sold when the related crop is harvested and sold. The deferred growing costs included in inventories in the
consolidated balance sheets consist primarily of labor, lease payments on land, land preparation, cultivation, ongoing
irrigation and fertilization costs. Costs included in growing crops relate to the current crop year. Costs that are to be
realized over the life of the crop are reflected in crop production costs. Components of inventory are: Crop Production
Costs Expenditures on stevia and other crop production costs are valued at the lower of cost or market and are
deferred and charged to cost of products sold when the related crop is harvested and sold. The deferred crop production
costs included in the consolidated balance sheets consist primarily of the cost of plants and the transplanting,
intermediate life irrigation equipment and land amendments and preparation. Crop production costs are estimated to
have useful lives of three to four years depending on the crop and nature of the expenditure. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulated depreciation. The cost of plant and
equipment is depreciated using the straight-line method over the estimated useful life of the asset - periods of
approximately 18-28 years for buildings, 3-7 years for machinery and equipment and 3-5 years
for vehicles. Long-lived assets are reviewed for impairment whenever in management's judgment
conditions indicate a possible loss. Such impairment tests compare estimated undiscounted cash flows to the recorded
value of the asset. If an impairment is indicated, the asset is written down to its fair value or, if fair value is not readily
determinable, to an estimated fair value based on discounted cash flows. Fully depreciated assets are retained in
property, plant and equipment and accumulated depreciation accounts until they are removed from service. In case of
disposals of assets, the assets and related accumulated
11
depreciation are removed from the accounts, and the net amounts after proceeds from disposal are credited or charged to income. Intangible Assets Intangible assets acquired in the business acquisition of the S&W general partnership in 2008 are
reported at their initial fair value less accumulated amortization. Intangible assets acquired in the acquisition of the
customer list in July 2011 are reported at their initial cost less accumulated amortization. See Note 3 for further
discussion. The intangible assets are amortized based on useful lives ranging from 3-20 years. Research and Development Costs The Company is engaged in ongoing research and development ("R&D") of proprietary seed and
stevia varieties. The Company accounts for R&D under standards issued by the Financial Accounting Standards
Board ("FASB"). Under these standards, all R&D costs must be charged to expense as incurred. Accordingly,
internal R&D costs are expensed as incurred. Third-party R&D costs are expensed when the contracted work
has been performed or as milestone results have been achieved. The costs associated with equipment or facilities
acquired or constructed for R&D activities that have alternative future uses are capitalized and depreciated on a
straight-line basis over the estimated useful life of the asset. The amortization and depreciation for such capitalized
assets are charged to R&D expenses. Stock-Based Compensation The Company has in effect a stock incentive plan under which incentive stock options have been granted to
employees and non-qualified stock options have been granted to employees and non-employees, including members of
the Board of Directors. The Company accounts for its stock-based compensation plan by expensing the estimated fair
value of stock-based awards over the requisite service period, which is the vesting period. The measurement of stock-based
compensation expense is based on several criteria including, but not limited to, the valuation model used and
associated input factors such as expected term of the award, stock price volatility, dividend rate, risk-free interest rate,
attrition rate and exercise price. The input factors to use in the valuation model are based on subjective future
expectations combined with management judgment. The Company estimates the fair value of stock options using the
binomial lattice valuation model and the assumptions shown in Note 10. The excess tax benefits recognized in equity
related to equity award exercises are reflected as financing cash inflows. See Note 10 for a detailed discussion of stock-based
compensation. Net Income (Loss) Per Common Share Data Basic net income (loss) per common share, or earnings per share ("EPS"), is calculated by
dividing net income (loss) by the weighted average number of common shares outstanding during the year. Diluted EPS
is calculated by adjusting outstanding shares, assuming any dilutive effects of options and common stock warrants
calculated using the treasury stock method. Under the treasury stock method, an increase in the fair market value of the
Company's common stock results in a greater dilutive effect from outstanding options, restricted stock awards and
common stock warrants. 12
Potentially dilutive securities not included in the calculation of diluted
net income (loss) per share because to do so would be anti-dilutive are as follows: Income Taxes Organized as a limited liability company until January 28, 2010, the Company was not a taxable entity
for income tax purposes until January 28, 2010. Prior to January 28, 2010, items of membership income, deductions and
credits are allocated among the members for inclusion in their respective income tax returns. Effective January 28, 2010, the Company accounts for income taxes in accordance with standards of disclosure
propounded by the FASB and any related interpretations of those standards sanctioned by the FASB. Accordingly,
deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of
assets and liabilities, as well as a consideration of net operating loss and credit carry forwards, using enacted tax rates
in effect for the period in which the differences are expected to impact taxable income. A valuation allowance is
established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized.
Impairment of Long-Lived Assets The Company has adopted Accounting Standards Codification subtopic 360-10, Property, Plant and
Equipment ("ASC 360-10"). ASC 360-10 requires that long-lived assets and certain identifiable intangibles held and
used by the Company be reviewed for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The Company evaluates its long-lived assets for impairment
annually or more often if events and circumstances warrant. Events relating to recoverability may include significant
unfavorable changes in business conditions, recurring losses or a forecasted inability to achieve break-even operating
results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted undiscounted cash
13
flows. Should impairment in value be indicated, the carrying value of long-lived assets will be
adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the
asset. ASC 360-10 also requires assets to be disposed of be reported at the lower of the carrying amount or the fair
value less costs to sell. The Company performed an annual review for impairment and none existed as of
June 30, 2011. Fair Value of Financial Instruments In the first quarter of fiscal year 2009, the Company adopted Accounting Standards Codification subtopic
820-10, Fair Value Measurements and Disclosures ("ASC 820-10"). ASC 820-10 defines fair value, establishes a
framework for measuring fair value and enhances fair value measurement disclosure. ASC 820-10 delays, until the first
quarter of fiscal year 2009, the effective date for ASC 820-10 for all non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at
least annually). The adoption of ASC 820-10 did not have a material impact on the Company's consolidated financial
position or operations, but does require that the Company disclose assets and liabilities that are recognized and
measured at fair value on a non-recurring basis, presented in a three-tier fair value hierarchy, as follows:
Table of Contents
(A NEVADA CORPORATION)
CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31,
June 30,
2011
2011
ASSETS
CURRENT ASSETS
Cash and cash equivalents
$
6,808,285
$
3,738,544
Accounts receivable, net
4,064,315
1,803,909
Inventories
3,919,025
5,664,119
Prepaid expenses and other current assets
58,398
58,451
Deferred tax asset
352,393
352,393
TOTAL CURRENT ASSETS
15,202,416
11,617,416
Property, plant and equipment, net of accumulated depreciation
2,341,875
2,299,306
Other intangibles, net
637,044
502,436
Crop production costs
850,752
220,431
Deferred tax asset - long term
56,996
517,672
Other asset - long term
90,000
-
TOTAL ASSETS
$
19,179,083
$
15,157,261
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable
$
2,651,445
$
207,074
Accounts payable - related party
829,868
218,863
Accrued expenses and other current liabilities
102,374
169,060
TOTAL CURRENT LIABILITIES
3,583,687
594,997
TOTAL LIABILITIES
3,583,687
594,997
STOCKHOLDERS' EQUITY
Preferred stock, $0.001 par value; 5,000,000 shares authorized;
no shares issued and outstanding
-
-
Common stock, $0.001 par value; 50,000,000 shares authorized;
5,800,000 issued and outstanding
at December 31, 2011 and June 30, 2011
5,800
5,800
Additional paid-in capital
14,672,019
14,604,716
Retained earnings (deficit)
917,577
(48,252)
TOTAL STOCKHOLDERS' EQUITY
15,595,396
14,562,264
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
19,179,083
$
15,157,261
(A NEVADA CORPORATION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
Six Months Ended
December 31,
December 31,
2011
2010
2011
2010
Revenue
Seed revenue
$
4,073,865
$
516,613
$
9,959,177
$
1,195,739
Milling and other revenue
654,164
393,043
884,531
647,060
Total revenue
4,728,029
909,656
10,843,708
1,842,799
Cost of revenue
Cost of seed revenue
2,960,857
369,734
7,258,802
893,513
Cost of milling and other revenue
243,379
77,207
309,821
115,248
Total cost of revenue
3,204,236
446,941
7,568,623
1,008,761
Gross profit
1,523,793
462,715
3,275,085
834,038
Operating expenses
Selling, general and administrative expenses
761,765
490,851
1,469,718
1,025,413
Research and development expenses
61,629
127,850
154,505
262,128
Depreciation and amortization
65,516
60,306
136,611
119,697
Total operating expenses
888,910
679,007
1,760,834
1,407,238
Income (loss) from operations
634,883
(216,292)
1,514,251
(573,200)
Other (income) expense
Loss on disposal of fixed assets
26,362
-
26,362
5,706
Interest (income) expense, net
4,260
(3,165)
8,422
(7,143)
Net income (loss) before income tax expense (benefit)
604,261
(213,127)
1,479,467
(571,763)
Income tax expense (benefit)
161,197
(130,930)
513,638
(235,487)
Net income (loss)
$
443,064
$
(82,197)
$
965,829
$
(336,276)
Net income (loss) per common share:
Basic
$
0.08
$
(0.01)
$
0.17
$
(0.06)
Diluted
$
0.08
$
(0.01)
$
0.17
$
(0.06)
Weighted average number of common shares outstanding:
Basic
5,800,000
5,800,000
5,800,000
5,800,000
Diluted
5,804,207
5,800,000
5,817,006
5,800,000
(A NEVADA CORPORATION)
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
Additional
Retained
Total
Common Stock
Paid-In
Earnings
Stockholders'
Shares
Amount
Capital
(Deficit)
Equity
Balance, June 30, 2010
5,800,000
$
5,800
$
14,482,531
$
763,196
$
15,251,527
Stock-based compensation
-
-
122,185
-
122,185
Net loss for the year ended June 30, 2011
-
-
-
(811,448)
(811,448)
Balance, June 30, 2011
5,800,000
$
5,800
$
14,604,716
$
(48,252)
$
14,562,264
Stock-based compensation
-
-
67,303
-
67,303
Net income for the six months ended December 31, 2011
-
-
-
965,829
965,829
Balance, December 31, 2011
5,800,000
$
5,800
$
14,672,019
$
917,577
$
15,595,396
(A NEVADA CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
December 31,
2011
2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)
$
965,829
$
(336,276)
Adjustments to reconcile net income (loss) from operating activities to net
cash provided by (used in) operating activities
Stock-based compensation
67,303
69,141
Change in allowance for doubtful accounts
(3,587)
-
Depreciation and amortization
136,611
119,697
Loss on disposal of fixed assets
26,362
5,706
Changes in:
Accounts receivable
(2,256,819)
445,889
Inventories
1,745,094
(4,114,939)
Prepaid expenses and other current assets
53
(66,378)
Crop production costs
(630,321)
-
Deferred tax asset
460,676
(235,487)
Other asset - long term
(90,000)
Accounts payable
2,444,371
1,274,012
Accounts payable - related party
611,005
842,612
Accrued expenses and other current liabilities
(66,686)
89,878
Net cash provided by (used in) operating activities
3,409,891
(1,906,145)
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property, plant and equipment
(175,150)
(231,982)
Acquisition of customer list
(165,000)
-
Proceeds from disposal of property, plant and equipment
-
4,500
Net cash used in investing activities
(340,150)
(227,482)
NET INCREASE OR (DECREASE) IN CASH
3,069,741
(2,133,627)
CASH AND CASH EQUIVALENTS, beginning of the period
3,738,544
7,830,517
CASH AND CASH EQUIVALENTS, end of period
$
6,808,285
$
5,696,890
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest
$
-
$
-
Income taxes
-
-
(A NEVADA CORPORATION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
December 31,
June 30,
2011
2011
Raw materials and supplies
$
49,829
$
124,402
Work in progress
816,553
100,812
Finished goods
3,052,643
5,438,905
Reserve for obsolescence
-
-
$
3,919,025
$
5,664,119
Three Months Ended
Six Months Ended
December 31,
December 31,
2011
2010
2011
2010
Net income (loss)
$
443,064
$
(82,197)
$
965,829
$
(336,276)
Net income (loss) per common share:
Basic
$
0.08
$
(0.01)
$
0.17
$
(0.06)
Diluted
$
0.08
$
(0.01)
$
0.17
$
(0.06)
Weighted average number of common shares outstanding:
Basic
5,800,000
5,800,000
5,800,000
5,800,000
Diluted
5,804,207
5,800,000
5,817,006
5,800,000
December 31,
2011
2010
Class A warrants
1,400,000
1,400,000
Class B warrants
1,400,000
1,400,000
Under-writer warrants
280,000
280,000
Other warrants
-
50,000
Stock options
-
480,000
Total
3,080,000
3,610,000
No assets were valued at fair value on a recurring or non-recurring basis as of December 31, 2011 or June 30, 2011, respectively.
Effective October 1, 2008, the Company adopted Accounting Standards Codification subtopic 820-10, Fair Value Measurements and Disclosures ("ASC 820-10") and Accounting Standards Codification subtopic 825-10, Financial Instruments ("ASC 825-10"), which permits entities to choose to measure many financial instruments and certain other items at fair value. Neither of these statements had an impact on the Company's financial position, results of operations or cash flows. The carrying value of cash and cash equivalents, accounts payable and short-term borrowings, as reflected in the balance sheets, approximate fair value because of the short-term maturity of these instruments.
Recent Accounting Pronouncements
In December 2010, the FASB issued FASB ASU No. 2010-28, "When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts," which is now codified under FASB ASC Topic 350, "Intangibles - Goodwill and Other." This ASU provides amendments to Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not a goodwill impairment exists. When determining whether it is more likely than not an impairment exists, an entity should consider whether there are any adverse qualitative factors, such as a significant deterioration in market conditions, indicating an impairment may exist. FASB ASU No. 2010-28 is effective for fiscal years (and interim periods within those years) beginning after December 15, 2010. Early adoption is not permitted. Upon adoption of the amendments, an entity with reporting units having carrying amounts which are zero or negative is required to assess whether is it more likely than not the reporting units' goodwill is impaired. If the entity determines impairment exists, the entity must perform Step 2 of the goodwill impairment test for that reporting unit or units. Step 2 involves allocating the fair value of the reporting unit to each asset and liability, with the excess being
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implied goodwill. An impairment loss results if the amount of recorded goodwill exceeds the implied goodwill. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. This ASU is not expected to have any material impact to the Company's consolidated financial statements.
In December 2010, the FASB issued FASB ASU No. 2010-29, "Disclosure of Supplementary Pro Forma Information for Business Combinations," which is now codified under FASB ASC Topic 805, "Business Combinations." A public entity is required to disclose pro forma data for business combinations occurring during the current reporting period. This ASU provides amendments to clarify the acquisition date to be used when reporting the pro forma financial information when comparative financial statements are presented and improves the usefulness of the pro forma revenue and earnings disclosures. If a public company presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) which occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The supplemental pro forma disclosures required are also expanded to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. FASB ASU No. 2010-29 is effective on a prospective basis for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, with early adoption permitted. The adoption of this ASU did not have a material effect on the Company's consolidated statement of financial position, results of operations or cash flows.
In May 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-04, "Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs." This update clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This update is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for the Company is January 1, 2012. The adoption of this update is not expected to have a material impact on its consolidated financial statements.
NOTE 3 — ACQUISITION OF CUSTOMER LIST
On July 6, 2011, the Company entered into a Customer List Purchase Agreement (the "Purchase Agreement") by and between Richard Penner ("Mr. Penner"), the former owner of Genetics International, Inc., a California corporation ("Genetics International"), and the Company. For more than two decades, Genetics International was the Company's international distributor in the Middle East region and other international locations and provided the majority of the Company's international distribution. In connection with the sale of Genetics International's vegetable seed business to new owners, Mr. Penner acquired the right to sell Genetics International's alfalfa seed business customer list. Pursuant to the Purchase Agreement, the Company acquired the list of customers and related information (the "Customer List") from Mr. Penner related to Genetics International's customer list.
Pursuant to the Purchase Agreement, the Company paid $165,000 in cash. The Company also entered into a consulting agreement with Mr. Penner's consulting company. The transaction closed on July 7, 2011. The Purchase Agreement includes customary representations, warranties and covenants. The Purchase Agreement also contains a five-year non-competition provision.
The purchase was accounted for as an asset acquisition and the consideration paid of $165,000 was allocated to the intangible assets acquired based on their relative fair values on the acquisition date.
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The following table summarizes the final allocation of the purchase price and the estimated useful lives of the acquired intangibles:
| Useful Lives | ||||||
| Customer list | $ | 121,786 | 17 | |||
| Non-compete | 43,214 | 5 | ||||
| $ | 165,000 |
NOTE 4 — OTHER INTANGIBLE ASSETS
Other intangible assets consist of the following:
| Balance at | Balance at | |||||||||||
| June 30, | December 31, | |||||||||||
| 2011 | Additions | Amortization | 2011 | |||||||||
| Trade name | $ | 210,351 | $ | - | $ | (6,186) | $ | 204,165 | ||||
| Customer relationships | 108,620 | - | (3,198) | 105,422 | ||||||||
| Technology/IP | 183,465 | - | (13,104) | 170,361 | ||||||||
| Customer list | - | 121,786 | (3,582) | 118,204 | ||||||||
| Non-compete | - | 43,214 | (4,322) | 38,892 | ||||||||
| $ | 502,436 | $ | 165,000 | $ | (30,392) | $ | 637,044 |
Amortization expense totaled $15,196 and $11,562 for the three months ended December 31, 2011 and 2010, respectively. Amortization expense totaled $30,392 and $23,124 for the six months ended December 31, 2011 and 2010, respectively. Estimated aggregate amortization expense for each of the five succeeding fiscal years is as follows:
| 2012 | 2013 | 2014 | 2015 | 2016 | |||||||||||
| Amortization expense | $ | 60,779 | $ | 60,779 | $ | 60,779 | $ | 60,779 | $ | 60,779 |
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NOTE 5 — PROPERTY, PLANT AND EQUIPMENT
Components of property, plant and equipment were as follows:
| December 31, | June 30, | ||||||||||
| 2011 | 2011 | ||||||||||
| Land and improvements | $ 139,827 | $ 139,827 | |||||||||
| Buildings and improvements | 2,006,862 | 2,006,862 | |||||||||
| Machinery and equipment | 646,099 | 470,949 | |||||||||
| Vehicles | 123,551 | 183,884 | |||||||||
| Total property, plant and equipment | 2,916,339 | 2,801,522 | |||||||||
| Less: accumulated depreciation | (574,464) | (502,216) | |||||||||
| Property, plant and equipment, net | $ 2,341,875 | $ 2,299,306 | |||||||||
Depreciation expense totaled $50,320 and $48,744 for the three months ended December 31, 2011 and 2010, respectively. Depreciation expense totaled $106,219 and $96,573 for the six months ended December 31, 2011 and 2010, respectively.
NOTE 6 — SHORT TERM DEBT
The Company entered into a Credit Agreement (the "Credit Agreement") with Wells Fargo Bank, National Association (the "Lender") and related loan documents, dated April 1, 2011. The Credit Agreement provides the Company with a revolving credit facility of up to $5,000,000 that can be used for working capital requirements. Amounts outstanding under the revolving credit facility may be repaid and re-borrowed through April 1, 2012, at which time all amounts outstanding become due and payable. There is no borrowing base under the terms of the Credit Agreement. The loans comprising each borrowing bear interest at a rate per annum equal to the daily one month LIBOR rate for the applicable interest period plus two percent. Interest is payable each month in arrears. Under the Credit Agreement, the Company also will pay the Lender certain fees, including, without limitation, a fee of 0.5% of the unused portion of the credit facility, calculated quarterly. During the three and six months ended December 31, 2011, the Company incurred $6,389 and $12,778, respectively, of fees for the unused portion of the credit facility.
The loan is secured by all of the Company's existing and after-acquired goods, tools, machinery, furnishings, furniture and other equipment. The Company has also granted the Lender a continuing security interest in all existing and after-acquired "Rights to Payment" and "Inventory," both as defined in the Continuing Security Agreement - Rights to Payment and Inventory. The Credit Agreement contains customary representations and warranties, and affirmative and negative covenants, including but not limited to, minimum working capital and tangible net worth and quick ratio affirmative covenants and limitations on liens and certain additional indebtedness, guarantees and certain merger, consolidation or transfer of asset transactions, among others. The Company has not yet drawn down on the line of credit.
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NOTE 7 — STOCKHOLDERS' EQUITY
On May 7, 2010, the Company closed its initial public offering ("IPO") of 1,400,000 units, which priced at $11.00 per unit, raising gross proceeds of $15,400,000. Each unit consisted of two shares of common stock, one Class A warrant and one Class B warrant. In connection with the IPO, the Company issued Representative's Warrants to Paulson Investment Company, Inc. and Feltl and Company to purchase up to an aggregate of 140,000 units at $13.20, expiring May 3, 2015. Equity offering costs included $1,424,500 of underwriters' fees and $1,153,444 of other equity offering costs.
Each Class A warrant entitles its holder to purchase one share of the Company's common stock at an exercise price of $7.15. Each Class B warrant entitles its holder to purchase one share of common stock at an exercise price of $11.00. The Class A warrants and Class B warrants are exercisable at any time until their expiration on May 3, 2015. The Class A warrants and Class B warrants are redeemable at the Company's option for $0.25 upon 30 days' prior written notice beginning November 3, 2010, provided certain conditions are met. The Class A warrants are redeemable provided that the Company's common stock has closed at a price at least equal to $8.80 for at least five consecutive trading days. The Class B warrants are redeemable on the same terms, provided the Company's common stock has closed at a price at least equal to $13.75 for five consecutive trading days.
The Company is authorized to issue up to 50,000,000 shares of its $0.001 par value common stock. At December 31, 2011 and June 30, 2011, there were 5,800,000 shares issued and outstanding.
See Note 10 for discussion on equity-based compensation.
NOTE 8 — COMMITMENTS AND CONTINGENCIES
Contingencies
The Company is not currently a party to any pending or threatened legal proceedings. Based on information currently available, management is not aware of any matters that would have a material adverse effect on the Company's financial condition, results of operations or cash flows.
NOTE 9 — RELATED PARTY TRANSACTIONS
Grover T. Wickersham, the Company's Chairman of the Board, also serves as the chairman of the board of Triangle T Partners, LLC ("Triangle T Partners") and, until December 2010 was chairman of the board of directors of Triangle T Ranch, Inc. ("Triangle T Ranch" and, collectively with Triangle T Partners, "Triangle T"). Mr. Wickersham indirectly owned a controlling interest in Triangle T Partners until December 2010 and now owns such interest directly as a member of Triangle T Partners. Michael N. Nordstrom, one of the Company's directors, was also a member of the board of managers of Triangle T Partners until April 2011 and, until December 2010, was a director of Triangle T Ranch. Until October 2010, Mark S. Grewal, the Company's President and Chief Executive Officer, as well as a member of the Company's board, also served as president and chief executive officer and was on the boards of Triangle T Partners and Triangle T Ranch. He no longer holds these positions. Triangle T Ranch was dissolved in December 2010.
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Triangle T is one of the Company's alfalfa seed growers and is also a customer. The Company enters into annual alfalfa seed production contracts with Triangle T on the same commercial terms and conditions as with the other growers with whom the Company contracts for alfalfa seed production. For the six months ended December 31, 2011 and 2010, the Company purchased from Triangle T $1,430,984 and $1,495,023, respectively, of alfalfa seed Triangle T grew and sold to the Company under one-year production agreements. The Company entered into agreements with Triangle T to plant 893 acres of various alfalfa seed varieties as part of its calendar 2011 production for which the Company will pay Triangle T the same price it agreed to pay its other growers. Mr. Wickersham, the sole remaining related party affiliated with both Triangle T and the Company, did not personally receive nor will he receive any portion of these funds.
As one of the Company's customers, Triangle T purchases certified alfalfa seed from the Company to plant alfalfa on its own property for the production of alfalfa hay and to grow alfalfa seed for the Company. The Company sells certified alfalfa seed to Triangle T under the same commercial terms and conditions as other alfalfa seed customers in the San Joaquin Valley. The Company also generates revenue from selling milling services to Triangle T under the same commercial terms and conditions as other milling customers. The Company sold $138,578 and $33,702 of certified alfalfa seed and milling services to Triangle T during the six months ended December 31, 2011 and 2010, respectively. Triangle T also worked with the Company as the initial service provider for the Company's stevia cultivation program, and the Company has planted its stevia plantings on Triangle T property. The Company incurred $57,807 of charges from Triangle T during the six months ended December 31, 2011 for its services and costs in connection with the stevia cultivation program including $3,420 in monthly rent charges for the use of the 114 acre main plot being used for commercial stevia production. The Company incurred $147,286 of charges from Triangle T during the six months ended December 31, 2010 for its services and costs in connection with the stevia cultivation program. Mr. Wickersham personally did not receive any portion of these funds.
There were no amounts due from Triangle T at December 31, 2011 and June 30, 2011, respectively. Amounts due to Triangle T totaled $829,868 and $218,863 at December 31, 2011 and June 30, 2011, respectively.
In July 2011, the Company purchased 20 bee trailers from Triangle T for a total price of $85,000. In December 2011, the Company purchased 38 additional bee trailers from Triangle T for a total price of $76,000. Mr. Wickersham personally did not receive any portion of these funds.
On November 22, 2011, the Company entered into a one-year Agricultural Sub-Sublease Agreement with Triangle T Partners under the terms of which the Company agreed to sublease approximately 1,400 acres of farmland in Madera County for seed alfalfa production and approximately 1,000 acres for the planting of other crops (collectively, the "leased property") owned by John Hancock Life Insurance Company (U.S.A.) ("John Hancock"). John Hancock purchased the property known as Triangle T Ranch from Triangle T Partners in 2009, and the parties entered into an Agricultural Sublease in connection with that purchase transaction. The Company is now subleasing a portion of the subleased farmland.
The sub-sublease provides for a lump sum payment of $352,000 in exchange for the right to farm the leased property through November 15, 2012. Although the sub-sublease is between the Company and Triangle T Partners, payment was made directly to John Hancock, with Triangle T receiving no payment as the lessor. In addition to the annual rent payment, the Company will pay for all farming operations and will be responsible for keeping, maintaining and repairing all parts of the lease property, including buildings, roads, pumping drainage and irrigation systems, equipment, as well as paying the costs of insurance, utilities, assessments and other costs incidental to the farming and maintenance of the
19
subleased property. The Company will be entitled to all income and proceeds from the farming operations on the leased property, including but not limited to income and proceeds from all crops, crop insurance, government payments and subsidies. S&W may use the services of TTP employees and TTP equipment in connection with farming the leased property, as needed. The Company incurred $109,238 of charges from Triangle T Partners for its services and costs in connection with farming operations during the three and six months ended December 31, 2011.
NOTE 10 — EQUITY-BASED COMPENSATION
2009 Equity Incentive Plan
In October 2009 and January 2010, the Company's Board of Directors and stockholders, respectively, approved the 2009 Equity Incentive Plan (the "2009 Plan"). The plan authorized the grant and issuance of options, restricted shares and other equity compensation to the Company's directors, employees, officers and consultants, and those of the Company's subsidiaries and parent, if any. Initially, 750,000 shares of have been reserved for issuance under the 2009 Plan.
The term of incentive stock options granted under the 2009 Plan may not exceed ten years, or five years for incentive stock options granted to an optionee owning more than 10% of the Company's voting stock. The exercise price of options granted under the 2009 Plan must be equal to or greater than the fair market value of the shares of the common stock on the date the option is granted. An incentive stock option granted to an optionee owning more than 10% of voting stock must have an exercise price equal to or greater than 110% of the fair market value of the common stock on the date the option is granted.
On October 24, 2011, the Company granted 259,500 stock options to its directors, officers, employees and certain consultants at an exercise price of $4.20, which was the closing price for the Company's common stock on the date of grant. These options vest in equal quarterly installments over one and two year periods, commencing on January 1, 2012 and expire five years from the date of grant.
As of December 31, 2011, options to purchase 677,000 shares of common stock were outstanding and unexercised, and 73,000 shares remain available under the 2009 Plan for future grants and awards.
The Company has adopted ASC 718, Stock Compensation, ("ASC 718"). ASC 718 requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award.
The Company accounts for equity instruments, including stock options, issued to non-employees in accordance with authoritative guidance for equity based payments to non-employees. Stock options issued to non-employees are accounted for at their estimated fair value. The fair value of options granted to non-employees is re-measured as they vest, and the resulting increase in value, if any, is recognized as expense during the period the related services are rendered.
For stock-based awards granted, the Company amortizes stock-based compensation expense on a straight-line basis over the requisite service period.
20
The fair value of employee option grants are estimated on the date of grant and the fair value of options granted to non-employees are re-measured as they vest. Fair value is calculated using a binomial lattice model. The weighted average assumptions used in the models are outlined in the following table:
| Employee Options | Non-Employee Options | |||||||||||
| December 31, | June 30, | December 31, | June 30, | |||||||||
| 2011 | 2011 | 2011 | 2011 | |||||||||
| Risk-free rate of interest | 1.10% | - | 1.10% | 0.81% | ||||||||
| Dividend yield | 0% | - | 0% | 0% | ||||||||
| Volatility of common stock | 63% | - | 56% | 68% | ||||||||
| Exit / attrition rates | 20% - 30% | - | 20% | 20% | ||||||||
| Target exercise factor | 1.25 - 1.75 | - | 1.25 | 1.25 | ||||||||
A summary of activity related to the Company's stock option incentive plans for six months ended December 31, 2011 and the year ended June 30, 2011 is presented below:
| Weighted- | |||||||||
| Weighted- | Average | ||||||||
| Average | Remaining | ||||||||
| Number | Exercise Price | Contractual | |||||||
| Oustanding | Per Share | Life (Years) | |||||||
| Outstanding at June 30, 2010 | 480,000 | $ | 4.00 | 4.75 | |||||
| Granted | - | - | - | ||||||
| Exercised | - | - | - | ||||||
| Canceled/forfeited/expired | (62,500) | 4.00 | 4.00 | ||||||
| Outstanding at June 30, 2011 | 417,500 | $ | 4.00 | 3.75 | |||||
| Granted | 259,500 | 4.20 | 4.83 | ||||||
| Exercised | - | - | - | ||||||
| Canceled/forfeited/expired | - | - | - | ||||||
| Outstanding at December 31, 2011 | 677,000 | $ | 4.08 | 3.86 | |||||
| Options vested and exercisable at December 31, 2011 | 208,750 | $ | 4.00 | 3.26 |
The weighted average grant date fair value of options granted and outstanding at December 31, 2011 was $0.75. At December 31, 2011, the Company had $320,510 of unrecognized stock compensation expense, net of estimated forfeitures, related to the stock option plan, which will be recognized over the weighted average remaining service period of 1.5 years. Stock-based compensation expense recorded for the three months ended December 31, 2011 and 2010 totaled $42,983 and $22,893, respectively. Stock-based compensation expense recorded for the six months ended December 31, 2011 and 2010 totaled $67,303 and $69,141, respectively. The Company settles employee stock option exercises with newly issued shares of common stock.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
This Quarterly Report on Form 10-Q, including, but not limited to, this "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Report that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins, expenses, tax provisions, earnings, cash flows and other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding our ability to raise capital in the future; any statements concerning expected development, performance or market acceptance relating to our products or services or our ability to expand our grower or customer bases; any statements regarding future economic conditions or performance; any statements of expectation or belief; any statements regarding our ability to retain key employees; and any statements of assumptions underlying any of the foregoing. These forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "will," "plan," "project," "seek," "should," "target," "will," "would," and similar expressions or variations intended to identify forward-looking statements. We have based these forward-looking statements on our current expectations about future events. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Risks, uncertainties and assumptions include the possibility that certain foreign markets into which our seed is sold could be adversely impacted by discounted pricing of non-proprietary seed by competitors, our alfalfa seed growers could choose to grow more profitable crops instead of our alfalfa seed and the dairy industry decline might not recover as quickly as we anticipate. Other risks, uncertainties and assumptions include macro-economic and geopolitical trends and events; the execution and performance of contracts by our company and our customers, suppliers and partners; the challenge of managing asset levels, including inventory; the difficulty of aligning expense levels with revenue changes; the outcome of pending or future legislation or court decisions and pending or future accounting pronouncements; and other risks that are described herein, including but not limited to the items discussed in the Risk Factors set forth in Item 1A of Part I of our Annual Report on Form 10-K, filed with the Commission on September 26, 2011, in Item 1A of Part II of this Quarterly Report on Form 10-Q and that are otherwise described or updated from time to time in our Securities and Exchange Commission reports.
Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. Many factors discussed in this Report, some of which are beyond our control, will be important in determining our future performance. Consequently, actual results may differ materially from those that might be anticipated from the forward-looking statements. In light of these and other uncertainties, you should not regard the inclusion of a forward-looking statement in this Report as a representation by us that our plans and objectives will be achieved, and you should not place undue reliance on such forward-looking statements. Furthermore, such forward-looking statements speak only as of the date of this Report. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
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Executive Overview
Our business includes (i) our core alfalfa seed business, which has been expanded in fiscal 2012 to include our own farming operations; (ii) our more recently initiated stevia breeding and production operations; and (iii) our seed and small grain cleaning and processing operations that leverage the excess capacity in our mill. Until we incorporated in 2009, our business was operated for almost 30 years as a general partnership and was owned by five general partners. We incorporated in October 2009, bought out the former partners between June 2008 and May 2010 and raised capital in our May 2010 initial public offering in order both to grow the existing alfalfa seed business and take the company in a new direction.
Our alfalfa seed business consists of breeding our proprietary alfalfa seed varieties in order to be able to offer seed with the traits sought by our customers such as high salt and heat tolerance and high yields, contracting primarily with San Joaquin Valley farmers for the production of that seed, cleaning, processing and bagging the seed at our facility and marketing and selling it as certified seed to agribusiness firms and farmers throughout the world. We contract annually at fixed prices with growers who have established a history of yields that provide some predictability into anticipated supply volume and cost. Nevertheless, yields are subject to agriculture risk and the farming practices of each seed grower. Our principal business is subject to uncertainty, caused by the following factors, among others: (i) our seed growers may decide to grow different crops when prices for alternative commodities are on the rise, which can create a shortage of our certified seed; (ii) farmers who typically purchase our seed to grow alfalfa hay may plant alternative crops either in reaction to a decline in the dairy industry, which in turn causes shrinking demand for alfalfa hay or because they can make a higher profit planting alternative crops, either way, with the result that smaller quantities of our seed are purchased, or (iii) farmers may choose to convert their hay crops to non-certified common seed, and an overabundance of non-certified seed entering the market can drive down the overall market price for alfalfa seed, including the market for certified alfalfa seed. Consequently our revenue and margins can be difficult to project.
In connection with our alfalfa seed operations since our May 2010 IPO, we have (i) expanded our sales and marketing efforts; (ii) leased acreage in Kern and Madera Counties in California's San Joaquin Valley, on which we are producing a portion of our alfalfa seed supply ourselves; and (iii) purchased the customer list of our principal international distributor from its owner in order to sell our alfalfa seed directly to customers in Saudi Arabia and other Middle Eastern and North African countries such as Sudan, Egypt and Morocco. We began direct international sales in June 2011. Our first crop of internally-produced alfalfa seed was planted in the second fiscal quarter of 2012 and will be harvested, cleaned, bagged and made available for sale to our customers in the first and second quarters of fiscal 2013, along with the seed we purchase from our growers.
While the dairy business on which our alfalfa seed business is largely dependent is subject to significant cycles of over-supply and under-supply, these fluctuations are generally localized. Consequently, although we are subject to the volatility of local markets, the breadth of our market and the quality niche of our certified seed have resulted in relatively stable demand in most years. However, the supply of seed in the marketplace is subject to substantial swings. Fiscal 2011 proved to be a particularly challenging year, but the first half of fiscal 2012 reflects a significant turnaround in seed revenues.
From inception until 2003, almost all our seed sales were to distributors who exported our products to international markets. Modest sales efforts in the western U.S. were initiated around 2003, and in the fiscal year ended June 30, 2010, our seed shipments were allocated approximately 51% to the domestic market and 49% to distributors who sold into international markets. In fiscal 2011, both markets were negatively impacted by events beyond our control: The domestic market continued to be impacted by the dairy industry downturn that began in fiscal 2009 when dairy prices declined due to over-supply. While in normal years, we are typically able to offset this situation with sales to our distributors in our
23
international markets, in fiscal 2011, our Middle East distributor experienced the most challenging year in its history due to an over-supply of uncertified common seed being sold at significantly reduced prices. We and our distributor elected to hold back much of our certified proprietary seed rather than sell into that depressed market in fiscal 2011. As a result of all of these factors, seed sales were down in fiscal 2011 compared to the prior year. However because of our decisions in fiscal 2011, we had strong levels of certified seed inventory available for sale in the first half of fiscal 2012 when most of the common seed that glutted those markets in fiscal 2011 had been sold out. This allowed us to meet expected demand and, to some extent, control pricing as we began our first year selling directly into international markets, after having purchased our distributor's customer list in the first quarter of fiscal 2012 in order to build a direct sales network of customers. We plan to continue to expand our served markets and therefore minimize the risks associated with any specific geographic market.
Our alfalfa seed business is seasonal, with domestic sales concentrated in the first five months of our fiscal year when customers are planting their fields. This coincides with the period during which seed growers harvest and deliver seed to us. We contract with growers based upon our anticipated market demand; we mill, clean and stock the seed during the harvest season and ship from inventory throughout the year. Tests show that seed that has been held in inventory for over one year improves quality of the seed. Therefore, provided that we have sufficient capital to carry additional inventory, we may increase our seed purchases and planned season end inventory if, in our judgment, we can generate increased margins and revenue with the aged seed. This will also reduce the potential for inventory shortages in the event that we have higher than anticipated demand or other factors, such as growers electing to plant alternative, higher priced crops, reducing our available seed supply in a particular year.
Although we believe an opportunity exists to materially expand our alfalfa seed business without substantially overhauling our operations, we could nevertheless encounter unforeseen problems. For example, in fiscal 2011 and 2012, some of our seed growers elected to grow crops, such as cotton, that yielded greater profit than alfalfa seed, and this could reoccur from time to time as commodity prices shift. However, having leased farmland beginning in fiscal 2011, we now have the ability to grow a portion of our alfalfa seed production ourselves, which could partially mitigate this risk in future years. Our growers could also decide to grow stevia for us instead of alfalfa seed, which is another uncertainty facing our primary business, although, to date, we have not contracted with third parties to grow our stevia crop. Beginning in fiscal 2011, we also faced the new risk caused by the availability of Roundup Ready alfalfa ("RRA") in the U.S., which could materially impact sales of our seed. We are still uncertain as to the extent to which RRA will negatively impact our business, if at all, but lack of regulations regarding field isolation could raise concerns about contamination of our non-GMO seed. Moreover, we sell into regions of the world that have a zero tolerance policy regarding GMO seed, so we will have to be able to maintain the integrity of our seed in order to sell in certain parts of the world. Therefore, we acknowledge that our plans to grow our alfalfa seed business are subject to some uncertainties.
Beginning in fiscal 2011, we began our direct farming operations by leasing approximately 800 acres in Kern County in California's San Joaquin Valley, on which we are growing a portion of our alfalfa seed supply ourselves as well as other crops, and leasing approximately 1,400 acres of farmland in Madera County for seed alfalfa production and approximately 1,000 acres for the planting of other crops. Although we have an experienced farming management and operations staff, this new business opportunity poses new challenges. Nevertheless, we believe that by vertically integrating our alfalfa seed business to include our own production, we can leverage our management infrastructure, our experienced agronomics team and milling capacity, while reducing our costs and more directly controlling our inventory.
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We currently are using less than 25% of our mill capacity, leaving room for substantial revenue growth without having to incur significant capital costs. In particular, we clean, process and bag seed and small grains for growers in the Five Points, California. Although only representing a small portion of our business, our milling services operations experienced an increase in revenues in fiscal 2011 and is the highest margin portion of our business.
Since our May 2010 IPO, we have also been developing our stevia business, working with top stevia breeders and the world's largest stevia processor to conduct trials on numerous varieties to order to breed and select the best stevia varieties for the climate, soil and water conditions in the San Joaquin Valley. In July 2010, we entered into a five- year supply agreement with the stevia processor under which the processor has agreed to purchase all of our dried stevia leaf produced from seeds, plants and plant materials sourced from the processor or its agents that meets the contractual specifications, up to 130% of the quantity agreed upon by the parties on an annual basis. In May 2011, we commenced the planting of our first commercial crop of stevia on 114 acres and harvested a portion of that crop in the fall of 2012.
Historical Background
Our business was operated as a partnership beginning in 1980. On June 27, 2008, the general partners entered into an agreement with Seed Holding, LLC for the purchase of a 90% interest in the partnership over a two-year period. Pursuant to that purchase agreement, Seed Holding had initially purchased a 60% interest in the partnership for $2,400,000 in cash, with the obligation to acquire an additional 15% interest on June 30, 2009 for $600,000 in cash and another 15% interest on June 30, 2010 for an additional $600,000 in cash. The original agreement was modified in December 2009 to permit Seed Holding to purchase the entire partnership.
The corporate entity was incorporated in Delaware on October 2, 2009. In January 2010, the members of the Seed Holding exchanged their membership units for 3,000,000 shares of S&W Seed Delaware, the Delaware corporation became the sole member of Seed Holding, and the corporation assumed the obligation to purchase the remaining 15% general partnership interest. Following the receipt of the net proceeds from the initial public offering in May 2010, S&W Seed Delaware repaid the former S&W partners the principal and interest due under the outstanding promissory notes and purchased the remaining 15% of the partnership, resulting in Seed Holding owning 100% of the former partnership.
On December 13, 2011, S&W Seed Company ("S&W Delaware"), consummated a merger (the "Reincorporation") with and into its wholly-owned subsidiary, S&W Seed Company, a Nevada corporation ("S&W Nevada"), pursuant to the terms and conditions of an Agreement and Plan of Merger entered into by S&W Nevada and S&W Delaware on December 10, 2011 (the "Merger Agreement"). As a result of the Reincorporation, the Company is now a Nevada corporation.
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Results of Operations
Three Months Ended December 31, 2011 Compared to the Three Months Ended December 31, 2010
Revenue and Cost of Revenue
Alfalfa Seed and Milling and Other Services
Revenue for the three months ended December 31, 2011 was $4,728,029 compared to $909,656 for the three months ended December 31, 2010. The $3,818,373 or 420% increase in revenue for the current period was due to a $3,557,252 increase in seed revenue coupled with a $261,121increase in milling and other services. The substantial increase in seed revenue is due primarily to the continuation of direct sales to our customers in Saudi Arabia and to a lesser extent other international markets, which reflects the success of our initiatives to sell direct into the international markets, along with strong demand for our proprietary alfalfa seed varieties. As previously communicated, we and our former distributor had intentionally decided to withhold our certified seed from the market in fiscal 2011 due to pricing, rather than sell it at prices we felt were too low. Sales (both direct and through distributors) into international markets accounted for 58% of our current period revenue compared to 0% in the comparable period of the prior year. Domestic revenues accounted for 42% and 100% of our total revenues for the three months ended December 31, 2011 and 2010, respectively.
Throughout fiscal 2011, the prices of commodities, such as cotton, corn and wheat, which compete with alfalfa hay for acreage, increased dramatically and, in some cases, hit all-time record highs. Additionally, the economic recovery of the U.S. dairy industry continues to lag in comparison to the agricultural industry as a whole and is encouraging hay growers (our customers or customers of our distributor customers) to look for alternative crops such as cotton, which experienced dramatic price increases in fiscal 2011. This posed certain sales challenges in the domestic market during the 2011 fiscal year, but also created the opportunity of a developing shortage (and pricing power) for our alfalfa seed products in the 2012 fiscal year. We experienced a 121% increase in domestic revenues over the same period of the prior year.
Revenue for the three months ended December 31, 2011 included approximately $654,164 of milling and other services compared to $393,043 for the three months ended December 31, 2010. The increase is due to the timing of the harvests and the corresponding timing of milling services being performed throughout the year. This has resulted in a higher concentration of revenue in the current quarter versus the prior year.
Cost of revenue of $3,204,236 in the three months ended December 31, 2011 was 68% of revenue, while the cost of revenue of $446,941 in the three months ended December 31, 2010 was 49% of revenue. The dollar increase in cost of revenue for the current period was primarily attributable to an increase in the amount seed sold. Margins on seed revenue totaled 27% in the current period versus 28% in the comparable period in the prior year. The slight decrease in seed margins can be primarily attributed to an increase in revenues of wheat seed and sorghum and shipping charges which carry a much lower margin than our alfalfa seed.
Total gross profit margins for the current period totaled 32.2% versus 50.9% in the comparable period of the prior year. The significant increase in seed revenue in the current period principally contributed to the decrease in the total gross profit margins in the current period because seed sales constituted most of the revenue in the current period, and margins are lower in seed sales than for milling services, which represented only 14% of the revenue in the second quarter of fiscal 2012. By comparison,
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in the second quarter of fiscal 2011, milling and other services contributed over 43% of the total revenue recorded in the period, and therefore, the higher margin line of business impacted the gross profit margins to a greater degree.
We have contracts with our growers for the production of seed for harvest periods that began in late summer and end in the fall. The price per pound in these 2012 grower contracts is approximately 18% more than the 2011 harvest product price.
Stevia Breeding and Production Program
We began our stevia initiative in fiscal 2010. We moved from a pilot program to commercial production in fiscal 2011, planting the first commercial crop in the spring and summer of 2011. We earned our first stevia revenues of $25,382 during the second fiscal quarter of 2012 under a commercial supply agreement with a major stevia processor.
As a result of the foregoing arrangements, we incurred $159,923 in stevia expenditures for the three months ended December 31, 2011 compared to $97,543 in similar expenditures for the three months ended December 31, 2010. The stevia-related expenses in the second quarter of fiscal 2012 have been allocated as follows: $12,171 has been included in work in process inventories, $100,000 has been recorded as crop production costs which is a long-term asset at December 31, 2011 and the balance of the stevia-related costs are included in research and development on the consolidated statements of operations. With respect to the fiscal 2011 period amount, $18,260 has been included as work in process inventory and the remaining costs are included in research and development expense on the consolidated statement of operations.
We harvested the first commercial crop of stevia leaf in the quarter ended September 30, 2011, but did not earn any revenue until the following period, when we earned just modest revenue. In connection with this first commercial crop, our agronomists focused their efforts on ensuring our plantation has a healthy stand for the first winter months, not on maximizing yield. This was essentially a test harvest in which we cut only the top portion of the plants and experimented with harvesting methods and equipment settings. We expect the next stevia harvest of this crop, as well as new acreage we plan to plant in the spring of 2012, will take place in the second half of fiscal 2012 or the first quarter of fiscal 2013. Inasmuch as we are still in the earliest stages of commercial stevia development, it is currently unknown whether these early crops will produce multiple cuttings and whether the cuttings will result in improved yields, although we expect future harvests will provide crop improvements as we perfect best agronomic practices for stevia. We further expect that our costs will be highest in the first year of production and will decline in subsequent years as we continue to harvest crops planted in prior years.
Selling, General and Administrative Expenses
Selling, general and administrative expenses ("SG&A") for the three months ended December 31, 2011 totaled $761,765 compared to $490,851 in the three months ended December 31, 2010. The $270,914 or 55% increase in SG&A expense versus the prior year period was primarily due to a $78,752 increase in sales commissions paid to our international sales consultant, a $37,415 increase in legal expenses, a $20,090 increase in non-cash stock based compensation, a $19,950 increase in franchise taxes, and the remaining increase relates to miscellaneous expenses to support our expansion. Included in SG&A expenses is non-cash stock based compensation, which totaled $42,983 in the current period versus $22,893 in the comparable period in the prior year. As a percentage of revenue, SG&A expenses were 16% in the current quarter compared to 54% in the three months ended December 31, 2010.
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Research and Development Expense
Research and development expenses ("R&D") for the three months ended December 31, 2011 totaled $61,629 compared to $127,850 for the three months ended December 31, 2010. R&D expenses decreased $66,221 in the current period due to a $46,603 decrease in stevia product development expenses. In addition, we decreased our alfalfa seed product development expenses by $19,618 in the second quarter of fiscal 2012 compared to the comparable period in fiscal 2011.
Depreciation and Amortization
Depreciation and amortization expense for the three months ended December 31, 2011 was $65,516 compared to $60,306 for the three months ended December 31, 2010. Included in the amount is amortization expense for intangibles assets, which totaled $15,196 in the current period and $11,562 for the second quarter of the fiscal year ended December 31, 2010. The increase in depreciation expense was attributable primarily to the addition of certain new fixed assets, including additional storage containers, irrigation equipment and bee trailers.
Interest (Income) Expense, Net
Interest expense, net during the three months ended December 31, 2011 totaled $4,260 compared to interest income, net of $3,165 for the three months ended December 31, 2010. Current period interest expense consisted of the fee for the unused credit facility partially offset by interest income derived from cash and cash equivalents.
Income Tax (Benefit)
Income tax expense totaled $161,197 for the three months ended December 31, 2011 compared to an income tax benefit of $130,930 for the three months ended December 31, 2010.
Net Income (Loss)
We had net income of $443,064 for the three months ended December 31, 2011 compared to a net loss of $82,197 for the three months ended December 31, 2010. The increase in profitability was attributable primarily to the increase in shipments into international markets in the second quarter of fiscal 2012, partially offset by an increase in SG&A and income tax expense, all of which are discussed above. The net income per basic and diluted common share for the current period was $0.08, compared to a net loss per basic and diluted common share of $0.01 for the three months ended December 31, 2010.
Six Months Ended December 31, 2011 Compared to the Six Months Ended December 31, 2010
Revenue and Cost of Revenue
Alfalfa Seed and Milling and Other Services
Revenue for the six months ended December 31, 2011 was $10,843,708 compared to $1,842,799 for the six months ended December 31, 2010. The $9,009,909, or 488% increase in revenue for the current period, was due to an $8,763,438 increase in seed revenue coupled with a $237,471increase in milling and other services. The substantial increase in seed revenue is due primarily to the continuation of direct sales to our customers in Saudi Arabia and to a lesser extent other international markets, which reflects the success of our initiatives to sell direct into the international markets, along with strong
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demand for our proprietary alfalfa seed varieties. As previously communicated, we and our former distributor had intentionally decided to withhold our certified seed from the market in fiscal 2011 due to pricing, rather than sell it at prices we felt were too low. Sales (both direct and through distributors) into international markets accounted for 73% of our current period revenue compared to 2% in the comparable period of the prior year. Domestic revenues accounted for 27% and 98% of our total revenues for the six months ended December 31, 2011 and 2010, respectively.
Throughout fiscal 2011, the prices of commodities, such as cotton, corn and wheat, which compete with alfalfa hay for acreage, increased dramatically and, in some cases, hit all-time record highs. Additionally, the economic recovery of the U.S. dairy industry continues to lag in comparison to the agricultural industry as a whole and is encouraging hay growers (our customers or customers of our distributor customers) to look for alternative crops such as cotton, which experienced dramatic price increases in fiscal 2011. This posed certain sales challenges in the domestic market during the 2011 fiscal year, but also created the opportunity of a developing shortage (and pricing power) for our alfalfa seed products in the 2012 fiscal year. We experienced a 75% increase in domestic revenues over the same period of the prior year.
Revenue for the six months ended December 31, 2011 included approximately $884,531 of milling and other services compared to $647,060 for the six months ended December 31, 2010. The increase is due to the timing of the harvests and the corresponding timing of milling services being performed throughout the year. This has resulted in a higher concentration of revenue in the current quarter versus the prior year.
Cost of revenue of $7,568,623 in the six months ended December 31, 2011 was 70% of revenue, while the cost of revenue of $1,008,761 in the six months ended December 31, 2010 was 55% of revenue. The dollar increase in cost of revenue for the current period was primarily attributable to an increase in the amount seed sold. Margins on seed revenue totaled 27% in the current period versus 25% in the comparable period in the prior year. The increase in seed margins can be primarily attributed to an 8% decrease in the average cost of seed sold versus the comparable period in the prior year as prior period sales consisted of higher concentrations of seed from the 2009 harvest, which had higher costs than the subsequent 2010 and 2011 harvests.
Total gross profit margins for the current period totaled 30.2% versus 45.3% in the comparable period of the prior year. The significant increase in seed revenue in the current period principally contributed to the decrease in the total gross profit margins in the current period because seed sales constituted most of the revenue in the current period, and margins are lower in seed sales than for milling services, which represented only 8% of the revenue in the first six months of fiscal 2012. By comparison, in the first six months of fiscal 2011, milling and other services contributed over 35% of the total revenue recorded in the period, and therefore, the higher margin line of business impacted the gross profit margins to a greater degree.
We have contracts with our growers for the production of seed for harvest periods that began in late summer and end in the fall. The price per pound in these 2012 grower contracts is approximately 18% more than the 2011 harvest product price.
Stevia Breeding and Production Program
We began our stevia initiative in fiscal 2010. We moved from a pilot program to commercial production in fiscal 2011, planting the first commercial crop in the spring and summer of 2011. We earned our first stevia revenues of $25,382 during the second fiscal quarter of 2012 under a commercial supply agreement with a major stevia processor.
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As a result of the foregoing arrangements, we incurred $551,171 in stevia expenditures for the six months ended December 31, 2011 compared to $188,097 in similar expenditures for the six months ended December 31, 2010. The stevia-related expenses in the first half of fiscal 2012 have been allocated as follows: $74,717 has been included in work in process inventories, $386,248 has been recorded as crop production costs, which is a long-term asset at December 31, 2011, and the balance of the stevia-related costs are included in research and development on the consolidated statements of operations. With respect to the fiscal 2011 period amount, $30,816 has been included as work in process inventory and the remaining costs are included in research and development expense on the consolidated statement of operations.
We harvested the first commercial crop of stevia leaf in the quarter ended September 30, 2011. We earned modest revenue totaling $25,382 from this harvest during the second quarter when a portion of the leaf was shipped to our customer. Our agronomists focused their efforts on ensuring our plantation has a healthy stand for the first winter months, not on maximizing yield. This was essentially a test harvest in which we cut only the top portion of the plants and experimented with harvesting methods and equipment settings. We expect the next stevia harvest of this crop, as well as new acreage we plan to plant in the spring of 2012, will take place in the second half of fiscal 2012 or the first quarter of fiscal 2013. Inasmuch as we are still in the earliest stages of commercial stevia development, it is currently unknown whether these early crops will produce multiple cuttings and whether the cuttings will result in improved yields, although we expect future harvests will provide crop improvements as we perfect best agronomic practices for stevia. We further expect that our costs will be highest in the first year of production and will decline in subsequent years as we continue to harvest crops planted in earlier years.
Selling, General and Administrative Expenses
Selling, general and administrative expenses ("SG&A") for the six months ended December 31, 2011 totaled $1,469,718 compared to $1,025,413 in the six months ended December 31, 2010. The $444,305 or 43% increase in SG&A expense versus the prior year period was primarily due to a $226,973 increase in sales commissions paid to our international sales consultant, a $43,317 increase in legal expenses, a $50,734 increase in franchise taxes, and the remaining increase relates to various expenses to support our expansion. Franchise taxes in future periods will decrease due to the reincorporation of our company from Delaware to Nevada in December 2011. Included in SG&A expenses is non-cash stock based compensation, which totaled $67,303 in the current period versus $69,141 in the comparable period in the prior year. As a percentage of revenue, SG&A expenses were 14% in the current period compared to 56% in the six months ended December 31, 2010.
Research and Development Expense
Research and development expenses ("R&D") for the six months ended December 31, 2011 totaled $154,505 compared to $262,128 for the six months ended December 31, 2010. R&D expenses decreased $107,623 in the current period due to a $67,075 decrease in stevia product development expenses. In addition, we decreased our alfalfa seed product development expenses by $40,548 in the first six months of fiscal 2012 compared to the comparable period in fiscal 2011.
Depreciation and Amortization
Depreciation and amortization expense for the six months ended December 31, 2011 was $136,611 compared to $119,697 for the six months ended December 31, 2010. Included in the amount is amortization expense for intangibles assets, which totaled $30,392 in the current period and $23,124 for the six months ended December 31, 2010. The increase in depreciation expense was attributable primarily
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to the addition of certain new fixed assets, including additional storage containers, irrigation equipment and bee trailers.
Interest (Income) Expense, Net
Interest expense, net during the six months ended December 31, 2011 totaled $8,422 compared to interest income, net of $7,143 for the six months ended December 31, 2010. Current period interest expense consisted of the fee for the unused credit facility partially offset by interest income derived from cash and cash equivalents.
Income Tax (Benefit)
Income tax expense totaled $513,638 for the six months ended December 31, 2011 compared to an income tax benefit of $235,487 for the six months ended December 31, 2010.
Net Income (Loss)
We had net income of $965,829 for the six months ended December 31, 2011 compared to a net loss of $336,276 for the six months ended December 31, 2010. The increase in profitability was attributable primarily to the increase in shipments into international markets in the first half of fiscal 2012, partially offset by an increase in SG&A and income tax expense, all of which are discussed above. The net income per basic and diluted common share for the current period was $0.17, compared to a net loss per basic and diluted common share of $0.06 for the six months ended December 31, 2010.
Liquidity and Capital Resources
Our working capital and working capital requirements fluctuate from quarter to quarter depending on the phase of the growing and sales cycle that falls during a particular quarter. Our need for cash is highest in the second and third fiscal quarters (October through March) because we typically pay our contracted growers progressively, starting in the second quarter. In certain years, we have deferred our payments until later in the year to coincide with collections from our customers. Because of our long-standing, excellent relationships with most of our growers, we have the ability to negotiate extended payment terms with them to coincide with the timing of our cash collections from customers. In the 2011 Fiscal Year, we paid our growers approximately 50% of the amount owed in October 2010 (the second fiscal quarter) and the remaining 50% in February 2011 (the third fiscal quarter), in accordance with the annual contracts. We expect to pay our growers on a similar schedule in fiscal 2012. Alfalfa seed harvest occurs during our first fiscal quarter (August and September), and we typically process most of our alfalfa seed during September, October and November. Therefore, the value of inventory is the highest in the first and second quarters, as are our labor costs. But we also generate the greatest amount of cash receipts during the planting season in the second fiscal quarter (October through December).
Historically, due to the concentration of sales to certain distributors and key customers, which typically represented a significant percentage of alfalfa seed sales, our month-to-month and quarter-to-quarter sales and associated cash receipts were highly dependent upon the timing of deliveries to and payments from these distributors and customers, which varied significantly from year to year. At the end of fiscal 2011, our largest international distributor left the alfalfa seed sales business, and we purchased its customer list in July 2011. Although we have no history of directly selling into the Middle East and other international markets, we believe that we will be able to successfully transition into our direct sales model into the Middle East. We commenced direct international sales in June 2011. We expect that as direct sellers, we will experience similar timing constraints to that which we were accustomed when we sold into these markets through our former distributor.
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We continuously monitor and evaluate our credit policies with all of our customers based on historical collection experience, current economic and market conditions and a review of the current status of the respective trade accounts receivable balance. Our principal working capital components include cash and cash equivalents, accounts receivable, inventory, prepaid expense and other current assets, and accounts payable.
In the 2011 Fiscal Year, we established a working capital line of credit with Wells Fargo Bank under the terms of which we are able to draw down up to $5,000,000 to fund our seasonal working capital needs. The outstanding principal balance of the line of credit bears interest at the one month LIBOR plus 2%, which equals 2.27% per annum as of February 2, 2012. The line of credit bears a standby fee on one-half percent per annum on the average daily unused amount of the line of credit, for a maximum of $25,000 if the line is not utilized. As of February 8, 2012, we have not drawn down on the line, and during the three months ended December 31, 2011, we incurred $6,389 of fees for the unused portion of the credit facility.
Summary of Cash Flows
The following table shows a summary of our cash flows for the six months ended December 31, 2011 and 2010:
| Six Months Ended | ||||||
| December 31, | ||||||
| 2011 | 2010 | |||||
| Cash flows from operating activities | $ | 3,409,891 | $ | (1,906,145) | ||
| Cash flows from investing activities | (340,150) | (227,482) | ||||
| Cash flows from financing activities | - | - | ||||
| Net increase (decrease) in cash | 3,069,741 | (2,133,627) | ||||
| Cash and cash equivalents, beginning of period | 3,738,544 | 7,830,517 | ||||
| Cash and cash equivalents, end of period | $ | 6,808,285 | $ | 5,696,890 | ||
As of December 31, 2011, we had cash and cash equivalents of approximately $6.8 million. Cash and cash equivalents consist of cash and money market accounts. To date we have experienced no loss or lack of access to our invested cash or cash equivalents; however, we can provide no assurances that access to our invested cash and cash equivalents will not be impacted by adverse conditions in the financial markets.
Amounts deposited with third-party financial institutions exceed the Federal Deposit Insurance Corporation, or FDIC, and Securities Investor Protection Corporation, or SIPC, insurance limits, as applicable. These cash and cash equivalents balances could be impacted if the underlying financial institutions fail or are subjected to other adverse conditions in the financial markets. To date we have experienced no loss or lack of access to our cash and cash equivalents.
Operating Activities
For the six months ended December 31, 2011, operating activities provided $3,409,891 in cash, as a result of net income of $965,829 and an increase in accounts payable of $2,444,371 and a decrease in inventories of $1,745,094, partially offset by an increase in accounts receivable of $2,256,819. For the six months ended December 31, 2010, operating activities used $1,906,145 in cash, as a result of a net loss of $336,276, and an increase in inventories of $4,114,939, partially offset by an increase in accounts payable of $1,274,012. Due to the seasonality of our business, our inventory and accounts payable balances are typically at their highest levels during the second quarter of the fiscal year. Because the germination rate, and therefore the quality, of alfalfa seed improves over the first year of storage, inventory obsolescence is not a material concern. We do not see any recoverability issues with respect to our current inventory
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balances of alfalfa seed on hand. We may choose to carry higher levels of inventory in future periods to meet anticipated demand, although the anticipated timing of such possible increased demand, if any, cannot be ascertained.
Our largest international customer, which is located in Saudi Arabia, owed us approximately $5.4 million at September 30, 2011. The outstanding balance of $5.4 million was paid in full during our second quarter. At December 31, 2011, this particular customer owed us approximately $2.8 million. These outstanding invoices have 90 day payment terms. Our relationship with this customer is strong, and we intend to continue to do a significant amount of business together. In future periods, we may also further extend credit to this customer. We believe that we will fully collect all accounts receivable balances outstanding at December 31, 2011, although the exact timing cannot be predicted with certainty.
Investing Activities
Our investing activities during the six months ended December 31, 2011 totaled $340,150, funded with a portion of the net proceeds of our initial public offering in May 2010. These activities consisted primarily of the purchase of our distributor's customer list for $165,000 and the purchase of bee trailers and irrigation equipment totaling $175,150. Our investing activities during the six months ended December 31, 2010 totaled $227,482 and consisted of the addition of certain new fixed assets, including upgrades to the milling facility, additional storage containers, a vehicle and other equipment. During fiscal 2012, we expect to have ongoing capital expenditure requirements to support our stevia production plans and other infrastructure needs. We expect to fund this investment with a portion of the net proceeds from our initial public offering.
Financing Activities
We did not have any financing activities during the six months ended December 31, 2011 nor the six months ended December 31, 2010.
Inflation Risk
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. However, if our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.
Off Balance Sheet Arrangements
We do not engage in material off-balance sheet transactions.
Capital Resources and Requirements
Our future liquidity and capital requirements will be influenced by numerous factors, including:
- the extent and duration of future operating income;
- the level and timing of future sales and expenditures;
- working capital required to support our growth;
- investment capital for plant and equipment;
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- our sales and marketing programs;
- investment capital for potential acquisitions;
- competition; and
- market developments.
Our more recent focus on sales and marketing efforts is expected to increase sales volume over time, which, in turn, we anticipate will result in increasing revenue. Our available labor force is plentiful and stable, and many of our laborers have worked for us for over a decade. Our networks of distributors in the western United States and growers in California have been generally stable and productive for over 10 years. The price we pay to growers is contracted annually and prior to establishing our sales prices for the season. Therefore, while the market price for alfalfa seed may fluctuate year to year, we are generally able to maintain a profitable margin between our seed costs and selling prices. We have not seen, nor do we expect, technology changes in the methods of processing and milling alfalfa or other small grain products requiring a capital investment to maintain our competitive high quality and low cost position. Consequently, our capital investment needs and our maintenance expenses from year to year are relatively minor, predictable and stable.
Critical Accounting Policies
The accounting policies and the use of accounting estimates are set forth in the footnotes to the audited financial statements.
In preparing our financial statements, we must select and apply various accounting policies. Our most significant policies are described in Note 2 - Significant Accounting Policies set forth in the notes to the financial statements. In order to apply our accounting policies, we often need to make estimates based on judgments about future events. In making such estimates, we rely on historical experience, market and other conditions, and on assumptions that we believe to be reasonable. However, the estimation process is by its nature uncertain given that estimates depend on events over which we may not have control. If market and other conditions change from those that we anticipate, our results of operations, financial condition and changes in financial condition may be materially affected. In addition, if our assumptions change, we may need to revise our estimates, or to take other corrective actions, either of which may also have a material effect on our results of operations, financial condition or changes in financial condition. Members of our senior management have discussed the development and selection of our critical accounting estimates, and our disclosure regarding them, with the audit committee of our board of directors, and do so on a regular basis.
We believe that the following estimates have a higher degree of inherent uncertainty and require our most significant judgments. In addition, had we used estimates different from any of these, our results of operations, financial condition or changes in financial condition for the current period could have been materially different from those presented.
Intangible Assets: All amortizable intangible assets are assessed for impairment whenever events indicate a possible loss. Such an assessment involves estimating undiscounted cash flows over the remaining useful life of the intangible. If the review indicates that undiscounted cash flows are less than the recorded value of the intangible asset, the carrying amount of the intangible is reduced by the estimated cash-flow shortfall on a discounted basis, and a corresponding loss is charged to the consolidated statement of operations. Significant changes in key assumptions about the business, market conditions and prospects for which the intangible asset is currently utilized or expected to be utilized could result in an impairment charge.
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Stock-Based Compensation: We account for stock-based compensation in accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification Topic 718 Stock Compensation, which establishes accounting for equity instruments exchanged for employee services. Under such provisions, stock-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense, under the straight-line method, over the employee's requisite service period (generally the vesting period of the equity grant).
We account for equity instruments, including stock options, issued to non-employees in accordance with authoritative guidance for equity based payments to non-employees. Stock options issued to non-employees are accounted for at their estimated fair value. The fair value of options granted to non-employees is re-measured as they vest, and the resulting increase in value, if any, is recognized as expense during the period the related services are rendered.
We use the binomial lattice valuation model to estimate the fair value of options granted under share-based compensation plans. The binomial lattice valuation model requires us to estimate a variety of factors including, but not limited to, the expected term of the award, stock price volatility, dividend rate, risk-free interest rate, attrition rate, and exercise rate. The input factors to use in the valuation model are based on subjective future expectations combined with management judgment. The expected term used represents the weighted-average period that the stock options are expected to be outstanding. We use the historical volatility of a comparable peer group to derive the expected volatility of our common stock. The peer group historical volatility is used due to the limited trading history of our common stock. We use a risk-free interest rate that is based on the implied yield available on U.S. Treasury issued with an equivalent remaining term at the time of grant. We have not paid dividends in the past and currently do not plan to pay any dividends in the foreseeable future and as such, dividend yield is assumed to be zero for the purposes of valuing the stock options granted. We evaluate the assumptions used to value stock awards on a quarterly basis. If factors change and we employ different assumptions, share-based compensation expense may differ significantly from what we have recorded in the past. When there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned share-based compensation expense. To the extent that we grant additional equity securities to employees, our share-based compensation expense will be increased by the additional unearned compensation resulting from those additional.
Income Taxes: We regularly assess the likelihood that deferred tax assets will be recovered from future taxable income. To the extent management believes that it is more likely than not that a deferred tax asset will not be realized, a valuation allowance is established. When a valuation allowance is established or increased, an income tax charge is included in the consolidated financial statements and net deferred tax assets are adjusted accordingly. Changes in tax laws, statutory tax rates and estimates of the company's future taxable income levels could result in actual realization of the deferred tax assets being materially different from the amounts provided for in the consolidated financial statements. If the actual recovery amount of the deferred tax asset is less than anticipated, we would be required to write-off the remaining deferred tax asset and increase the tax provision, resulting in a reduction of net income and stockholders' equity.
Inventories: All inventories are accounted for on a lower of cost or market basis. Inventories consist of raw materials and finished goods as well as in the ground crop inventories. Depending on market conditions, the actual amount received on sale could differ from our estimated value of inventory. In order to determine the value of inventory at the balance sheet date, we evaluate a number of factors to determine the adequacy of provisions for inventory. The factors include the age of inventory, the amount of inventory held by type, future demand for products and the expected future selling price we expect to realize by selling the inventory. Our estimates are judgmental in nature and are made at a point in time, using available information, expected business plans and expected market conditions. We perform a review of our inventory by product line on a quarterly basis.
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Recently Adopted and Recently Enacted Accounting Pronouncements
In May 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This update clarifies the application of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This update is effective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011, which for the Company is January 1, 2012. The adoption of this update is not expected to have a material impact on its consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are a smaller reporting company and therefore, we are not required to provide information required by this item of Form 10-Q.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2011. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 31, 2011, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There have been no significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) or in other factors that occurred during the period of our evaluation or subsequent to the date we carried out our evaluation which have significantly affected, or are reasonably likely to significantly affect, our internal control over financial reporting. Potential investors should be aware that the design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any system of controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
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Part II
OTHER INFORMATION
We are not a party to any material legal proceedings.
In addition to the other information set forth in this quarterly report on Form 10-Q, you should carefully consider the risk factors discussed under the caption "Risk Factors" in our Form 10-K, filed with the SEC on September 26, 2011. Except as set forth below, there have been no material changes to the risk factors previously disclosed under the caption "Risk Factors" in the Form 10-K.
Adverse weather conditions, natural disasters, crop disease, pests and other natural conditions can impose significant costs and losses on our business.
Alfalfa seed, our primary product, is vulnerable to adverse weather conditions, including windstorms, floods, drought and temperature extremes, which are quite common but difficult to predict. In addition, alfalfa seed is vulnerable to crop disease and to pests, which may vary in severity and effect, depending on the stage of production at the time of infection or infestation, the type of treatment applied and climatic conditions. Unfavorable growing conditions can reduce both crop size and quality. While historically, we have not grown the alfalfa seed we sell, these factors can nevertheless directly impact us by decreasing the quality and yields of our seed, reducing our inventory and supply of seed we sell to our customers. Moreover, beginning in fiscal 2012, we began growing a portion of our alfalfa seed directly as well as farming wheat and alfalfa hay, and therefore, we have a direct vulnerability to the same adverse effects of weather, pests, natural disasters and other natural conditions that concern our third party growers. These factors can increase costs, decrease revenues and lead to additional charges to earnings, which may have a material adverse effect on our business, results of operations and financial condition.
We may not be able to fully recover the costs of our initial stevia operations.
Our stevia operations are subject to the same farming risks that other agricultural operations face, including, weather-related events and natural disasters, which, depending on the growth cycle at the time of such event, could materially negatively impact our yields. Although we have a contract in place with a major stevia processor, our costs could exceed the revenue we are able to earn from a particular stevia harvest. As we plant additional stevia acreage, as we expect to do, this risk could become more material.
The adoption of GOZ zones in our primary alfalfa seed growing region could impact our international operations.
A substantial portion of our alfalfa seed is grown in Fresno County for both domestic and international sales. In January 2012, the National Alfalfa & Forage Alliance held a vote of growers in Fresno County to determine if they should form a Genetically Enhanced ("GE") Grower Opportunity Zone ("GOZ") in part of Fresno County. A GOZ is a seed grower-defined region within which a super-majority of growers (by number of growers or acreage) elects to focus on the production of either Adventitious Presence Sensitive ("APS") or GE alfalfa seed, including Roundup Ready alfalfa. The January 2012 vote to organize the proposed GOZ in Fresno County failed to obtain the required super-majority, and therefore the motion failed. However, there is no assurance that another vote will not be taken and that, at a future meeting, the proposal will not succeed in obtaining the required vote to form a GOZ for GMO alfalfa. If a GOZ were formed in Fresno County or in any other county where we
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currently produce seed or might produce seed in the future, our efforts to grow conventional alfalfa seed for international sale in such county could be threatened because of the isolation and contamination issues about which we remain concerned. In such circumstance, we might be forced to find alternative locations to grow our proprietary alfalfa seed for sale into Saudi Arabia and other locations that prohibit GMO seed, and there is no assurance that we would be able to do so successfully
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(a) Sales of Unregistered Securities
None.
(b) Use of Proceeds
On May 3, 2010, our registration statement on Form S-1 (File No. 333-164588) was declared effective for our initial public offering, pursuant to which we registered the offering and sale of 1,400,000 units, each unit consisting of two shares of our common stock, one Class A warrant and one Class B warrant, at a public offering price of $11.00 per unit.
We raised approximately $12,822,056 in net proceeds after deducting underwriting discounts of $1,424,500 and other estimated offering costs of $1,153,444. There has been no material change in the planned use of proceeds from our IPO as described in our final prospectus filed with the SEC pursuant to Rule 424(b) on May 4, 2010.
From the effective date of the registration statement through December 31, 2011, we used approximately $6 million of the net proceeds primarily to pay off the revolving credit facility, complete the purchase of the partnership interests of S&W Seed Company and fund our operations including working capital investments into inventory and the improvements to our facilities to support the anticipated growth of our business. We have invested the remainder of the funds in registered money market funds and short-term investments with original maturities of less than 90 days.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
None.
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________
(1) The information in Exhibit 99.1 hereto shall not be deemed "filed" for the purposes of or otherwise subject to the liabilities under Section 18 of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on the 8th day of February, 2012.
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S&W SEED COMPANY |
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By: /s/ Matthew K. Szot |
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Matthew K. Szot |
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Senior Vice President Finance and Chief Financial Officer |