Net product sales to consumers in the Home and Garden Market in the United States totaled $74,403 and $112,305 in the three months ended June 30, 2007 and 2006, respectively, and $209,058 and $343,486 in the six months ended June 30, 2007 and 2006, respectively. We believe this decrease in sales volume is due to higher levels of product inventory in the distribution channel, lower spending on personnel, marketing and advertising and poor weather conditions in the first half of 2007. Based on the decline in sales in the first half of 2007 compared to the same period in 2006, we expect sales to consumers in this market in the second half of 2007 to be significantly lower than to sales in the second half of 2006 which totaled $49,516. Our only two employees in home and garden sales and marketing resigned effective on July 20, 2007 and August 14, 2007. Although we intend to continue to operate our home and garden business with our remaining two employees, we do not currently intend to fill these positions at this time and do not intend to significantly increase our investment toward the development of this business. We expect this to negatively impact our sales in the second half of 2007.
In February 2004, we received approval to sell Messenger in Spain. We initiated marketing activities in March 2004, but the approval was not received in time to meet initial sales activity. In order to ensure that an adequate supply of Messenger STS was quickly disbursed in the new distribution channel and to limit the amount of working capital required by our new distributors at this early stage of introduction, we granted flexible and/or extended payment terms to distributors in this new market. Because of this combination of factors, revenues from product deliveries to certain distributors were deferred and are recognized as payment is received. We recognized net revenue of $8,724 in the second quarter of 2007 and $19,832 in the first six months of 2007. Gross revenues of approximately $47,000 and cost of goods sold of approximately $26,000 are deferred at June 30, 2007 and will be recognized when payment is received.
Due to the growing seasons in the United States, we expect usage of our Home and Garden Products to be highly seasonal. Based on the recommended application timing, we expect the second quarter to be the most significant period of use. Our Home and Garden Product sales to distributors are also expected to be seasonal. However, actual timing of orders received from distributors will depend on many factors, including the amounts of our products in distributors’ inventories.
Product sales revenue is reported net of applicable sales allowances, as follows:
Sales allowances represent allowances granted to independent distributors for sales and marketing support and are estimated based on the terms of the distribution arrangements. Sales allowances are estimated and accrued when the related product sales revenue is recognized or when services are provided and are paid in accordance with the terms of the then-current distributor program arrangements. Distributor program arrangements expire annually, generally on December 31.
Sales allowances during the quarter and six months ended June 30, 2007 were zero compared to $160,754 (9% of gross product sales) in the second quarter of 2006 and $507,932 (13% of gross product sales) in the first half of 2006. The decrease was due to the sale of Harpin Protein Technology to PHC on February 28, 2007. As a result of the sale of the Harpin Protein Technology to PHC, we expect sales allowances to be less than 1% of sales in 2007. Net revenue for second quarter of 2006 included the reduction by $91,676 of sales allowance recognized in prior quarters that were not paid because actual amounts earned by distributors were less than amounts previously estimated. For the six months ended June 30, 2007 and 2006, these sales allowance reductions totaled $664 and $133,705, respectively.
Cost of goods sold includes the cost of products sold to distributors, idle capacity charges, royalty expense, shipping and handling and other costs necessary to deliver product to distributors, and the cost of products used for promotional purposes. Cost of goods sold was $15,093 in the second quarter of 2007, compared to $839,572 in the
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second quarter of 2006 and totaled $138,335 in the first half of 2007, compared to $1,855,052 in the first half of 2006. The decrease in cost of goods sold was primarily due to lower sales volumes in our Home and Garden Business and lower sales volumes, idle capacity charges, royalty expense, shipping and handling costs and products used for promotional purposes as a result of the sale of Harpin Protein Technology to PHC.
As a result of the sale of the Harpin Technology to PHC, cost of goods sold is expected to be significantly less in 2007 compared to 2006. Royalty expenses and idle capacity charges ceased as of February 28, 2007 and we currently expect that the cost of products used for promotional purposes will be less than $5,000 in 2007.
Research and Development Expenses
Research and development expenses consist primarily of personnel, field trial, laboratory, regulatory, patent and facility expenses. Research and development expenses were zero in the second quarter of 2007 compared to $372,937 in the second quarter of 2006 and totaled $136,442 and $689,475 the first half of 2007 and 2006, respectively. This decrease was primarily a result of the sale of Harpin Protein Technology to PHC and lower personnel, facility, depreciation and field trial costs. Stock compensation expense included in research and development was zero in 2007 and $6,708 and $13,416 in the second quarter and first half of 2006, respectively. As a result of the sale of our Harpin Protein Technology to PHC, we do not expect to incur any additional research and development expenses for the remainder of 2007.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of payroll and related expenses for sales and marketing, executive and administrative personnel; advertising, marketing and professional fees; and other corporate expenses. Selling, general and administrative expenses decreased $1,145,784 from $1,379,502 in the second quarter of 2006 to $233,718 in the same quarter of 2007. For the first six months of 2007, selling, general and administrative expenses decreased $2,304,788 from $2,938,288 in 2006 to $633,500 in 2007. The decrease resulted primarily from reductions in personnel, advertising and marketing expenses, facility costs and the sale of Harpin Protein Technology to PHC. Stock compensation expense included in selling, general and administrative expenses was $5,398 and $72,122 in the second quarter of 2007 and 2006, respectively, and $10,901 and $190,543 in the first half of 2007 and 2006, respectively.
Our business strategy moving forward is to use any revenues generated by our Home and Garden Business to support our operations while we explore whether there may be opportunities to realize potential value from our remaining business assets, primarily our tax loss carryforwards. As described below, we engaged legal professionals to validate the underlying assumptions related to our tax loss carryforwards and analyze and provide advice on the options that may be available to preserve and maximize the potential use of our deferred tax assets, as well as on potential limitations and risks of such utilization strategy. We expect this to be an expensive and time consuming process, and we may not generate revenue from our Home and Garden Business or otherwise attract capital to support the process for its duration.
Loss on impairment of equipment and leasehold improvements
We periodically review the carrying values of our property and equipment to determine whether such assets have been impaired. An impairment loss must be recorded pursuant to SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, when the undiscounted net cash flows expected to be realized from the use of such assets are less than their carrying value. The determination of expected undiscounted net cash flows requires us to make many estimates, projections and assumptions, including the lives of the assets, future sales and expense levels, additional capital investments or expenditures necessary to maintain the assets, industry market trends and general and industry economic conditions. Our property and equipment consisted primarily of assets used to manufacture and sell our products and assets used in our research and administration. For the purpose of assessing asset impairment, we have grouped all of these assets together in one asset group because our administration and research support our manufacturing and sales activities and do not have a separate identifiable cash flow.
In the first half of 2006, we continued to incur losses from operations and actual sales and growth rates for the first half of 2006 were significantly lower than expected. In reviewing our assets for impairment in connection with the preparation of the Company’s financial statements for the quarter ended June 30, 2006, we compared the carrying value of such assets to updated undiscounted cash flows expected from the use of this asset group. As a result of continuing operating losses and lower sales and growth rates in the first half of 2006 compared to forecasts,
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the carrying value of the group of assets exceeded undiscounted cash flows expected from the use of this asset group. Consequently, the Company concluded on July 31, 2006 that a charge for impairment to its equipment and leasehold improvements was required and a $4,880,516 impairment loss was recognized at June 30, 2006. We estimated the fair value of equipment using an orderly liquidation method and no fair value was attributed to leasehold improvements. The impairment charge will not result in future cash expenditures.
Gain on sale of investment
In the first quarter of 2006, we sold a minority stock investment for $100,000 that resulted in a gain of $99,884.
Interest Income
Interest income consists primarily of earnings on our cash and cash equivalents. Interest income increased $28,545 from $55,558 in the second quarter of 2006 to $84,103 in the same quarter of 2007. Interest income increased $31,392 from $116,672 in the first half of 2006 to $148,064 in the same period of this year. The change was due to a higher average cash balance available for investment in the six months ended June 30, 2007 compared to the same period in 2006.
Income Taxes
We have generated a net loss from operations for each period since we began doing business. As of December 31, 2006, we had accumulated approximately $115,800,000 of net operating loss carryforwards for U.S. Federal income tax purposes, which expire between 2009 and 2026, and net operating loss carryforwards in 19 U.S. states that range from approximately $12,500,000 to approximately $2,000 per state and expire between 2007 and 2026. Our total U.S. general business credit carryforwards were approximately $1,400,000 and expire between 2013 and 2026. We have also accumulated approximately $1,400,000 of net operating loss carryforwards in Mexico that expire between 2011 and 2016 and approximately $7,000,000 million in France, of which approximately $4,200,000 expires in 2007 and 2008 and approximately $2,800,000 does not expire. We have provided a valuation allowance against our net deferred tax assets because of the significant uncertainty surrounding our ability to realize value on such assets.
Our business strategy is to use any revenue generated by our Home and Garden Business to support our continued operations while we explore whether there may be opportunities to realize potential value from our remaining business assets, primarily our tax loss carryforwards. The strategy is extremely speculative and subject to a large number of risks and uncertainties including those set forth under the heading “Risk Factors” in our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2007. We have conducted only limited preliminary analysis of our ability to utilize our tax loss carryforwards and have drawn no final conclusions about the viability of this strategy. We have not developed any specific plan as to whether, how or within what time frame we might pursue or implement this strategy. In order to confirm whether there are opportunities to realize potential value from our tax loss carryforwards, we engaged legal professionals to validate the underlying assumptions related to our tax loss carryforwards and analyze and provide advice on the options that may be available to preserve and maximize the potential use of our tax loss carryforwards, as well as on potential limitations and risks of such utilization strategy. This will be an expensive and time consuming process, and we may not generate revenue from our Home and Garden Business or otherwise attract capital to support the process for its duration.
In the event we were to undergo an ownership change as defined in Section 382 of the Code, our net tax loss and general business credit carryforwards generated prior to the ownership change would be subject to annual limitations, which could reduce, eliminate, or defer the utilization of these losses. Based upon an analysis of past changes in our ownership, we believe the Company may have experienced ownership changes (as defined under Section 382) on March 20, 1996 and October 2, 2000 that may result in limitations on our future ability to use tax loss carryforwards generated prior to those dates. We do not believe that the sale to PHC resulted in another ownership change that would further limit our future ability to use tax loss carryforwards generated after October 2, 2000 because it was a sale of assets. However, we cannot assure you that the IRS or some other taxing authority may not disagree with our position and contend that we have already experienced other such ownership changes. In such case, our ability to use our tax loss carryforwards to offset future taxable income would be severely limited. If the sale of assets to PHC were deemed to result in an ownership change as defined in Section 382 of the Code, our tax loss carryforwards available to offset future taxable income could be severely limited and the tax loss carryforwards may expire as a result of the limitation. If an ownership change is not deemed to occur as a result of the sale to PHC,
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there is still the potential for an ownership change to occur under Section 382 as a result of future changes in stock ownership. Net operating loss carryforwards may expire if we do not generate sufficient income to utilize the losses before their normal expiration.
Generally, an ownership change occurs if one or more shareholders, each of whom owns 5% or more in value of a corporation’s stock, increase their aggregate percentage ownership by more than 50% over the lowest percentage of stock owned by such shareholders at any time during the preceding three-year period. For example, if a single shareholder owning 10% of our stock acquired an additional 50.1% of our stock in a three-year period, a change of ownership would occur. Similarly, if ten persons, none of whom owned our stock, each acquired slightly over 5% of our stock within a three-year period (so that such persons own, in the aggregate, more than 50%) an ownership change would occur. Ownership of stock is determined by certain constructive ownership rules which can attribute ownership of stock owned by entities (such as estates, trusts, corporations, and partnerships) to the ultimate indirect owner.
For purposes of this rule, all holders who each own less than 5% of a corporation’s stock are generally treated together as one (or, in certain cases, more than one) 5% shareholder. Transactions in the public markets among shareholders owning less than 5% of the equity securities generally are not included in the calculation. Special rules can result in the treatment of options (including warrants) or other similar interests as having been exercised if such treatment would result in an ownership change.
As we explore whether there may be opportunities to utilize our tax loss carryforwards, due to the importance of avoiding a future ownership change under the tax laws, we will be limited in our ability to issue additional stock in the future to provide capital for our business. We would only be able to issue such additional stock in a manner that would not cause an ownership change, for purposes of these rules, and thus our ability to access the equity markets could be restricted.
Finally, in addition to Section 382, certain other statutory provisions and common law doctrine could limit our opportunities to realize potential value from, or otherwise adversely affect our ability to preserve and utilize, our tax loss carryforwards.
The use of our tax loss carryforwards is subject to uncertainty because it is dependent upon the amount of taxable income we generate. We have no assurance that we will have sufficient taxable income in future years to use the tax loss carryforwards before they expire. We believe that our ability to achieve profitability may depend in substantial part on our ability to identify and acquire suitable acquisitions on favorable terms, so that we can increase our revenues and generate new income. We may seek additional capital from time to time, including through the sale of stock or other securities, which may result in dilution to existing shareholders. In addition, as noted above, the provisions of the Code and certain applicable IRS regulations will limit the number of shares of stock we can sell from time to time without causing a limitation on our ability to use our tax loss carryforwards to reduce our future tax obligations.
Liquidity and Capital Resources
Our operating expenditures have been significant since our inception. We currently anticipate that our operating expenses in 2007, although substantially less than our operating expenses in 2006, will significantly exceed net Home and Garden Product sales and that net losses and working capital requirements will consume a material amount of our cash resources in 2007. Our future capital requirements will depend on the success of our Home and Garden Business and our ability to successfully implement our strategy of realizing potential value from our remaining business assets, primarily our tax loss carryforwards. We have no current intention to make substantial investments to grow our Home and Garden Business. We believe that the balance of our cash and cash equivalents at June 30, 2007 will be sufficient to meet our anticipated cash needs for net losses, working capital and capital expenditures for more than the next 12 months, although there can be no assurance in this regard.
At June 30, 2007, our cash and cash equivalents totaled $6,004,702, an increase of $1,819,477 from the balance of $4,185,225 at December 31, 2006. In the first quarter of 2007, we received $1,396,824 in net proceeds (after transaction costs incurred after January 1, 2007) from the sale of the Harpin Protein Technology to PHC and on June 6, 2007 we collected $506,250 from PHC as a partial payment of the promissory note. We expect to collect the remaining principal and interest of the promissory note on December 28, 2007. Prior to October 2000, we financed our operations primarily through the private sale of our equity securities, resulting in net proceeds of approximately $36,500,000 through September 30, 2000. In October 2000, we received approximately $91,500,000 in net proceeds from the initial public offering of 2,223,333 shares of our common stock. We plan to finance our operations in 2007
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using existing cash and cash equivalents. Our business strategy of exploring whether there may be opportunities to utilize our remaining business assets, including our tax loss carryforwards, will, due to the importance of avoiding a future ownership change under the tax laws, limit us in our ability to issue additional stock to provide capital for our business.
The sale of our Harpin Protein Technology had the following effects on our cash used in operations and cash resources in the first half of 2007:
| • | | Cash and cash equivalents increased by $1,500,000 on February 28, 2007. This increase was offset by the payment of transaction costs totaling $103,176 incurred and recorded in the first three months of 2007 (approximately $320,000 was incurred and recorded in selling, general and administrative expense in 2006). Cash and cash equivalents also increased and other long-term assets decreased by $287,879 for the release of restricted cash and return of deposit by the facility lease landlord. On June 6, 2007, cash and cash equivalents increased and note receivable decreased by $506,250 as a result of collecting a portion of the note receivable from PHC. |
| • | | Current inventory decreased by $1,895,978 for inventory sold to PHC. We also sold $261,820 of finished goods to PHC under our Independent Distribution Agreement with PHC. The remaining inventory consists primarily of raw materials and finished goods used for our Home and Garden Business. |
| • | | Other current assets decreased by $63,750 for equipment classified as held for sale and sold to PHC. |
| • | | Property and equipment decreased by $647,962 for assets sold to PHC. |
| • | | Current accrued liabilities decreased by $59,625 due to PHC’s assumption of these liabilities. |
| • | | Other long-term liabilities decreased to zero at February 28, 2007 due to PHC’s assumption of our office and manufacturing facility lease liabilities recorded for rent expense in excess of rent payments totaling $73,131 and asset retirement obligation of $287,857 and our $100,000 liability to CRF. |
| • | | Product sales, cost of goods sold, research and development and selling, general and administrative expense are expected to decrease significantly in 2007 compared to 2006. |
Additionally, future minimum lease payments under the non-cancelable office and manufacturing facility lease totaling $184,970 in 2007, $229,424 in 2008 and $238,366 in 2009 were assumed by PHC as of February 28, 2007. We currently have no contractual obligations associated with capital and operating lease obligations.
Net cash used in operations decreased by $1,640,987 from $1,706,923 in the first six months of 2006 to $65,936 in the same period of 2007. Net cash used in operations in the first six months of 2007 resulted primarily from a net loss of $374,346 offset by net fluctuations in various asset and liability balances totaling $303,741. We expect that net cash used in operations will continue to be significant.
We conduct our operations in two primary functional currencies: the U.S. dollar and the euro. Historically, neither fluctuations in foreign exchange rates nor changes in foreign economic conditions have had a significant impact on our financial condition or results of operations. We currently do not hedge our foreign currency exposures and are, therefore, subject to the risk of exchange rate fluctuations. We may invoice our international customers in U.S. dollars and euros, as the case may be. We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation. As of February 28, 2007, the cumulative translation adjustment related to our European subsidiary totaling $103,470 was reclassified from accumulated other comprehensive income and reported as part of the gain on sale of Harpin Protein Technology as this subsidiary was substantially liquidated as a result of the sale to PHC. Foreign exchange rate fluctuations did not have a material impact on our financial statements in the six months ended June 30, 2006.
Employment Agreement
On July 25, 2007, we entered into an employment agreement with Bradley S. Powell, our President and Chief Financial Officer. Under the terms of the employment agreement, we agreed to pay Mr. Powell an annual base salary initially set at $205,000, and a lump sum amount payable upon execution of the employment agreement equal to the retroactive application of his annual base salary to December 15, 2006, the date on which he became our President. Mr. Powell may receive, at the Compensation Committee’s sole discretion, a bonus upon completion of an acquisition, merger or consolidation to which the Company is a party. Mr. Powell is also entitled to participate,
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subject to and in accordance with applicable eligibility requirements, in fringe benefit programs provided to our other employees. The employment agreement includes noncompetition and nonsolicitation provisions that apply to Mr. Powell during his employment and for a period of 18 months thereafter, and includes customary nondisclosure and inventions assignment provisions.
The employment agreement extinguished Mr. Powell’s change-in-control agreement, dated August 16, 2000, and severance agreement, dated January 28, 2002, in exchange for supplemental payments totaling $356,145. The supplemental payments are payable in installments as follows: one-half on execution of the employment agreement; one-quarter on September 30, 2007; and one-quarter on January 1, 2008. Any remaining unpaid supplemental payment shall not be made in the event Mr. Powell’s employment is terminated by us for cause, as defined in the agreement, or if Mr. Powell voluntarily terminates his employment for any reason. If Mr. Powell’s employment is terminated by the Company without cause or as a result of his death or total disability, as defined in the agreement, any remaining unpaid supplemental payment shall be accelerated and paid on the date of termination and Mr. Powell’s unvested stock options would accelerate and become fully vested and exercisable.
Critical Accounting Policies, Estimates and Judgments
Our critical accounting policies are more fully described in Note 1 to our consolidated financial statements included in our most recent Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 30, 2007. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on historical experience, terms of existing contracts, commonly accepted industry practices, information provided by our customers and other assumptions that we believe are reasonable under the circumstances. Our estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the condensed consolidated financial statements in the period in which they are determined to be necessary. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates include:
Revenue Recognition
Prior to the sale of our Harpin Protein Technology assets on February 28, 2007, we sold the majority of our products to independent, third-party distributors in the agricultural and horticultural markets. We sell the majority of our Home and Garden Products to independent, third-party distributors and directly to consumers over the internet in the Home and Garden Markets. Our arrangements with those distributors provide no price protection or product-return rights. We recognize revenue from product sales, net of sales allowances, when product is delivered to our distributors and all of our significant obligations have been satisfied, unless acceptance provisions or other contingencies or arrangements exist, including whether collection is reasonably assured. If acceptance provisions or contingencies exist, revenue is recognized after such provisions or contingencies have been satisfied. As part of the analysis of whether all of our significant obligations have been satisfied or situations where acceptance provisions or other contingencies or arrangements exist, we consider the following elements, among others: sales terms and arrangements, including customer payment terms, historical experience and current incentive programs.
Sales allowances represent allowances granted to independent distributors for sales and marketing support and are based on the terms of the distribution agreements or other arrangements. Sales allowances are estimated and accrued when the related product sales are recognized or when services are provided and are paid in accordance with the terms of the then-current distributor program agreements or other arrangements.
We also record, at the time revenue is recognized, a liability for warranty claims based on a percentage of sales. The warranty accrual percentage and warranty liability are reviewed periodically and adjusted as necessary, based on historical experience, the results of product quality testing and future expectations. Changes in our estimate of the warranty liability are recorded in cost of goods sold.
Accounts and Note Receivable and Allowance for Doubtful Accounts
Accounts receivable balances are reported net of customer-specific related sales allowances. In determining the adequacy of the allowance for doubtful accounts, we consider a number of factors, including the age of outstanding invoices, customer payment trends, the financial condition of our customers, historical bad debts and current economic trends. Based upon our analysis of outstanding accounts and note receivable at June 30, 2007, no allowance for doubtful accounts was recorded. Changes in the factors above or other factors could result in a significant charge.
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Inventory Valuation and Classification
Our inventory is valued at the lower of cost or market on an average cost basis. We regularly review inventory balances to determine whether a write-down is necessary. We consider various factors in making this determination, including recent sales history, including bulk sales, and predicted trends, industry market conditions, general economic conditions, the age of our inventory and recent quality control data. Changes in the factors above or other factors could result in significant inventory cost reductions and write-offs.
As of December 31, 2006, we reviewed assets for impairment in connection with the sale of our Harpin Protein Technology to PHC by comparing the carrying value at February 28, 2007 of assets sold to consideration received from PHC and recorded liabilities assumed by PHC. Based on this review, the carrying value of inventory sold to PHC exceeded the consideration received from PHC and recorded liabilities assumed by PHC. Accordingly, we recorded a $452,347 charge for impairment to inventory as of December 31, 2006.
We also review our inventory to determine inventory classification. Inventory expected to be utilized in the next twelve-month period is classified as current and inventory expected to be utilized beyond that period is classified as non-current. In determining the classification of inventory, we consider a number of factors, including historical sales experience and trends, existing distributor inventory, expansion into new markets, introduction of new products and estimates of future sales growth.
Valuation of Property and Equipment
We periodically review the carrying values of our property and equipment to determine whether such assets have been impaired. An impairment loss must be recorded pursuant to SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, when the undiscounted net cash flows expected to be realized from the use of such assets are less than their carrying value. The determination of undiscounted net cash flows expected requires us to make many estimates, projections and assumptions, including the lives of the assets, future sales and expense levels, additional capital investments or expenditures necessary to maintain the assets, industry market trends and general and industry economic conditions. Prior to the sale of our Harpin Protein Technology assets on February 28, 2007, our property and equipment consisted primarily of assets used to manufacture and sell our products and assets used in our research and administration. For the purpose of assessing asset impairment, we grouped all of these assets together in one asset group because our administration and research support our manufacturing and sales activities and do not have a separate identifiable cash flow. Equipment and leasehold improvements are stated at estimated fair value as a result of asset impairment charges recorded at June 30, 2006.
Stock-Based Compensation
We account for stock-based compensation in accordance with the fair value recognition provisions of SFAS 123R. We use the Black-Scholes-Merton option-pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements. Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized in the condensed consolidated statements of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We do not currently hold any derivative instruments, and we do not engage in hedging activities. Also, we do not have any outstanding variable-rate debt and currently do not enter into any material transactions denominated in foreign currency. Because of the relatively short-term average maturity of our investment funds, such investments are sensitive to interest rate movements and we do not expect interest rate fluctuations to significantly affect our results of operations. Our direct exposure to interest rate and foreign exchange rate fluctuation is currently not material to our results of operations. We believe that the market risk arising from the financial instruments we hold is not material.
Item 4. Controls and Procedures
Our President and Chief Financial Officer has carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of
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the fiscal quarter covered by this report. Based on that evaluation, our President and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of the end of such quarter. There have been no changes in our internal control over financial reporting during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1A. Risk Factors
Except as described below, there have not been any material changes during the quarter ended June 30, 2007 to the risk factors set forth in Part I, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2006 filed with the SEC on March 30, 2007.
On July 25, 2007, we entered into an employment agreement with Bradley S. Powell, our President and Chief Financial Officer, that extinguished Mr. Powell’s existing change-in-control agreement and severance agreement in exchange for supplemental payments totaling $356,145. The terms of the employment agreement are described above in this Form 10-Q. As a result of the termination of the change-in-control agreement and the severance agreement, the risk factor in the 10-K titled “Our liquidity and financial condition could be materially impaired if we are required to pay any severance amounts to Mr. Powell under his employment agreement and/or change in control agreement” is no longer applicable.
The following additional risk factor is applicable:
Our rights plan could discourage a change in control and harm the rights of our common shareholders
On June 4, 2007, our Board of Directors adopted a shareholder rights plan and declared a dividend distribution of one preferred share purchase right on each outstanding share of our common stock. Each share of our outstanding common stock is now associated with one right to acquire one one-hundredth (1/100) of a share of our Series R Participating Cumulative Preferred Stock, without par value, at a purchase price of $12.00.
The rights only become exercisable in certain limited circumstances on the distribution date, which is the earlier of: (1) the close of business on the tenth business day after a public announcement that a person has acquired beneficial ownership of 5% or, in the case of any person or group that owned beneficially 5% or more of our outstanding shares of common stock on June 1, 2007, 13% (or 18% in the case of SF Holding Corp., an existing investor that owns in excess of 16% of our outstanding shares) or more of our outstanding shares of common stock (such percentage of our outstanding shares is referred to as the “Requisite Percentage”); and (2) a date that our Board of Directors designates following the commencement of, or first public disclosure of an intent to commence, a tender or exchange offer for outstanding shares of common stock that could result in the offeror becoming the beneficial owner of the Requisite Percentage or more of our outstanding shares of common stock. Prior to the earlier of June 1, 2017, the expiration date of the rights, and a person becoming the beneficial owner of the Requisite Percentage or more of our outstanding shares of common stock, the rights are redeemable by us at a price of $0.0025 per right. If the rights are not redeemed, each right will then entitle the holder to purchase for the purchase price common stock having the value of twice the then-current purchase price. After a person becomes the beneficial owner of the Requisite Percentage or more of our outstanding shares of common stock, but before a person becomes the beneficial owner of more than 50% of these shares, our Board of Directors may elect to exchange each preferred share purchase right, other than those that have become null and void and nontransferable as described above, for shares of common stock, without payment of the purchase price. The exchange rate in this situation would be one-half of the number of shares of common stock that would otherwise be issuable at that time upon the exercise of one preferred share purchase right.
The principal purpose of the preferred share purchase rights is to protect the utilization of our net operating tax loss carryforwards, which could be jeopardized in the event that any investor accumulates a large position in our stock. However, some provisions in the rights plan may have the effect of discouraging a third party from making an acquisition proposal for us and may thereby inhibit a change in control. For example, such provisions may deter tender offers for shares of common stock, which offers may be attractive to shareholders, or deter purchases of large
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blocks of common stock, thereby limiting the opportunity for shareholders to receive a premium for their shares of common stock over the then-prevailing market prices.
Item 4. Submission of Matters to a Vote of Security Holders
The 2007 annual meeting of shareholders of Eden Bioscience Corporation was held on May 24, 2007. At the annual meeting, our shareholders were asked to elect three directors to our Board of Directors. The following directors were elected to serve for terms expiring at the 2010 Annual Meeting, or until the directors’ earlier retirement, resignation or removal:
| | | | Votes For
| | Votes Withheld
|
|---|
Class III Directors:
|
| Rhett R. Atkins | | | | | 7,643,564 | | | | 67,029 | |
| Jon E. M. Jacoby | | | | | 7,656,624 | | | | 53,969 | |
| William T. Weyerhaeuser | | | | | 7,644,952 | | | | 65,641 | |
There were no broker nonvotes in the election of directors since brokers who hold shares for the accounts of their clients have discretionary authority to vote such shares with respect to election of directors.
Item 6. Exhibits
Exhibit 31.1 is being filed as part of this quarterly report on Form 10-Q. Exhibit 32.1 is being furnished with this quarterly report on Form 10-Q.
Exhibit
Number
| | | | Description
|
|---|
| 3.1 | | | | Designation of Rights and Preferences of Series R Participating Cumulative Preferred Stock. |
| 4.1 | | | | Rights Agreement, dated as of June 1, 2007, between Eden Bioscience and Mellon Investor Services LLC, a Rights Agreement which includes as Exhibit B the Form of Rights Certificate and as Exhibit C the Summary of Rights to Purchase Preferred Shares (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A, filed June 4, 2007). |
| 31.1 | | | | Rule 13a-14(a) Certification (President and Chief Financial Officer). |
| 32.1 | | | | Section 1350 Certification (President and Chief Financial Officer). |
SIGNATURE
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.
EDEN BIOSCIENCE CORPORATION
Date: August 10, 2007
| By: | | /s/ Bradley S. Powell
Bradley S. Powell
President, Chief Financial Officer and Secretary
(Principal Executive, Financial and Accounting Officer) |
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