TEUCRIUM TRADING, LLC—INDEX TO ANNUAL FINANCIAL STATEMENTS

 

Report of Independent Registered Public Accounting Firm		2
Consolidated Statements of Financial Condition		3
Consolidated Statements of Operations		4
Consolidated Statement of Changes in Members’ Equity		5
Consolidated Statements of Cash Flows		6
Notes to Consolidated Financial Statements		7

 

 

 

 Report of Independent Registered Public Accounting Firm

 

 

To the Members of

Teucrium Trading, LLC

 

We have audited the accompanying consolidated statements of financial condition of Teucrium Trading, LLC and Subsidiary (collectively, the “Company”) as of December 31, 2011 and 2010, and the related statements of operations, changes in members’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Teucrium Trading, LLC and Subsidiary as of December 31, 2011 and 2010, and the results of their operations, changes in their members’ equity and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

 

/s/ Rothstein Kass

 

Walnut Creek, California

April 16, 2012

 

  

Teucrium Trading, LLC and Subsidiary

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

		December 31, 2011				December 31, 2010
ASSETS
Cash and cash equivalents		$	81,244,543			$	39,480,493
Commodity futures contracts			2,125,714				5,178,219
Collateral, due from broker			8,747,339				—
Interest receivable			2,609				5,246
Other assets			531,953				12,526
Total assets		$	92,652,158			$	44,676,484
LIABILITIES AND MEMBERS' EQUITY
Liabilities
Accrued expenses		$	987,848			$	1,149,870
Payable for shares redeemed			4,147,011				—
Short-term debt			—				800,000
Collateral, due to broker			—				1,496,045
Commodity futures contracts			3,758,460				—
Other liabilities			—				82,217
Total liabilities			8,893,319				3,528,132
Members’ equity subject to conversion or redemption rights			3,000,000				—
Members' equity
Teucrium Trading, LLC members' deficit			(3,064,029	)			(1,815,487	)
Noncontrolling interest			83,822,868				42,963,839
Total members' equity			80,758,839				41,148,352
Total liabilities and members' equity		$	92,652,158			$	44,676,484

 

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

 

  

Teucrium Trading, LLC and Subsidiary

CONSOLIDATED STATEMENTS OF OPERATIONS

 

		For the year ended December 31, 2011				For the year ended December 31, 2010
Income
Realized and unrealized gain on trading of commodity futures contracts:
Realized gain on commodity futures contracts		$	6,883,031			$	3,693,752
Net change in unrealized appreciation or depreciation on commodity futures contracts			(6,810,965	)			5,178,219
Interest income			64,887				22,049
Total income			136,953				8,894,020
Expenses
Professional fees			1,536,069				1,882,302
Salaries, wages and benefits			748,018				429,286
Business permits and licenses			257,895				276,196
General and administrative			139,266				162,435
Distribution and marketing			1,216,388				106,877
Unit-based compensation			—				86,000
Custodian's fees and expenses			344,965				72,916
Interest expense			6,140				37,443
Brokerage commissions			74,438				14,763
Other expenses			274,214				31,699
Total expenses			4,597,393				3,099,917
Net (loss) income			(4,460,440	)			5,794,103
Net (loss) income attributable to noncontrolling interest			(3,141,898	)			8,435,983
Net loss attributable to Teucrium Trading, LLC		$	(1,318,542	)		$	(2,641,880	)

 

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

 

  

TEUCRIUM TRADING, LLC and Subsidiary

CONSOLIDATED STATEMENT OF CHANGES IN MEMBERS' EQUITY

For the period January 1, 2010 through December 31, 2011

 

 

		Class A				Class B-1				Class B-2																Members'
		Equity				Equity				Equity				Subscription								Noncontrolling				Equity
		Total				Total				Total				Receivable				Subtotal				Interest				Equity Total
Balances, January 1, 2010		$	618			$	739,775			$	—			$	(50,000	)		$	690,393			$	—			$	690,393
Equity Contributed for Member Interest:
Class B-2 Units - issued February 11, 2010			—				—				86,000				—				86,000				—				86,000
Purchase of  CORN Units by Noncontrolling Interest			—				—				—				—				—				39,891,098				39,891,098
Redemption of CORN Units by Noncontrolling Interest			—				—				—				—				—				(5,363,242	)			(5,363,242	)
Receipt of Subscription Receivable			—				—				—				50,000				50,000				—				50,000
Net (loss) income – January 1, 2010 through December 31, 2010			(1,271,459	)			(1,157,337	)			(213,084	)			—				(2,641,880	)			8,435,983				5,794,103
Balances, December 31, 2010			(1,270,841	)			(417,562	)			(127,084	)			—				(1,815,487	)			42,963,839				41,148,352
Equity Contributed for Member Interest February 4, 2011			—				2,070,000				—				—				2,070,000				—				2,070,000
Proceeds from Equity Contributed subject to conversion right			—				(400,000	)			—				—				(400,000	)			—				(400,000	)
Equity Contributed for Member Interest – June 21, 2011			—				1,000,000				—				—				1,000,000				—				1,000,000
Proceeds from Equity Contributed subject to redemption rights			—				(2,600,000	)			—				—				(2,600,000	)			—				(2,600,000	)
Purchase of Fund Units by Noncontrolling Interest																			—				111,123,103				111,123,103
Redemption of Fund Units by Noncontrolling Interest			—				—				—				—				—				(67,122,176	)			(67,122,176	)
Net loss - January 1, 2011 through December 31, 2011			—				(1,318,542	)			—				—				(1,318,542	)			(3,141,898	)			(4,460,440	)
Balances, December 31, 2011		$	(1,270,841	)		$	(1,666,104	)		$	(127,084	)		$	—			$	(3,064,029	)		$	83,822,868			$	80,758,839

 

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

 

 

  

Teucrium Trading, LLC and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		For the year ended December 31, 2011				For the year ended December 31, 2010
Cash flows from operating activities
Net (loss) income		$	(4,460,440	)		$	5,794,103
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Net change in unrealized appreciation or depreciation on commodity futures contracts			6,810,965				(5,178,219	)
Unit-based compensation			—				86,000
Changes in operating assets and liabilities:
Collateral, due from broker			(8,747,339	)			—
Interest receivable			2,637				(5,246	)
Other assets			(519,427	)			(12,526	)
Prepaid expenses			—				6,000
Accrued expenses			(118,444	)			986,830
Collateral, due to broker			(1,496,045	)			1,496,045
Other liabilities			(12,217	)			12,217
Net cash (used in) provided by operating activities			(8,540,310	)			3,185,204
Cash flows from financing activities
Proceeds from short-term debt			—				800,000
Proceeds from other liabilities			—				70,000
Proceeds from subscription receivable			—				50,000
Purchase of units by noncontrolling interest			111,123,103				39,891,098
Redemption of units by noncontrolling interest, net of payable for shares redeemed			(62,975,165	)			(5,363,242	)
Proceeds from sale of member equity and option			2,156,422				—
Net cash provided by financing activities			50,304,360				35,447,856
Net change in cash and cash equivalents			41,764,050				38,633,060
Cash and cash equivalents, beginning of year			39,480,493				847,433
Cash and cash equivalents, end of year		$	81,244,543			$	39,480,493
Non-cash investing and financing activities
Conversion of other liability into members’ equity		$	70,000			$	—
Conversion of interest payable into members’ equity		$	43,578			$	—
Conversion of debt into members’ equity		$	800,000			$	—
Reclassification of permanent equity to temporary equity		$	3,000,000				—
Issuance of Class B-2 Units		$	—			$	86,000

 

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

 

  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 — Organization and Operation

 

Teucrium Trading, LLC, (the “Company”), a Delaware limited liability company, formed on July 28, 2009 and began operations on September 1, 2009.  The principal office is located at 232 Hidden Lake Road, Brattleboro, Vermont 05301.  The Company is registered as a commodity pool operator (“CPO”) with the Commodity Futures Trading Commission (“CFTC”) and became a member of the National Futures Association (“NFA”) on November 10, 2009.

 

The Company is solely responsible for the management and conducts or directs the conduct of the business of the Teucrium Commodity Trust (the “Trust”), a Delaware statutory trust, and any other series of the Trust that may from time to time be established and designated by the Company. The Trust issues common units representing fractional undivided beneficial interests in separate series of the Trust, called “Shares.” Each such series (each such series is referred to herein as a “fund” and collectively as the “Funds”) constitutes a separate commodity pool. As of December 31, 2011, the following constitute the series of the Trust: the Teucrium Corn Fund (“CORN”), the Teucrium WTI Crude Oil Fund (“CRUD”), the Teucrium Natural Gas Fund (“NAGS”), the Teucrium Sugar Fund (“CANE”), the Teucrium Soybean Fund (“SOYB”), the Teucrium Wheat Fund (“WEAT”), and the Teucrium Agricultural Fund (“TAGS”).  The Trust and the Funds operate pursuant to the Trust’s Second Amended and Restated Declaration of Trust and Trust Agreement (the “Trust Agreement”). 

 

The Teucrium Corn Fund was the first commodity pool to commence trading, and did so on June 9, 2010 on the New York Stock Exchange (“NYSE”) Arca.  On October 22, 2010, the Forms S-1 for NAGS and CRUD were declared effective by the SEC. On January 31, 2011, four Creation Baskets for NAGS were issued representing 200,000 shares and $5,000,000. NAGS began trading on the NYSE Arca on February 1, 2011. On February 22, 2011, four Creation Baskets for CRUD were issued representing 100,000 shares and $5,000,000.  CRUD began trading on the NYSE Arca on February 23, 2011. On June 17, 2011, the Forms S-1 for CANE, SOYB and WEAT were declared effective by the SEC. On September 16, 2011, two initial Creation Baskets for each Fund, representing 100,000 shares and $2,500,000, for CANE, SOYB, and WEAT were issued.  On September 19, 2011, CANE, SOYB and WEAT started trading on the NYSE Arca. The Teucrium Corn Fund, the Teucrium Natural Gas Fund, the Teucrium WTI Crude Oil Fund, the Teucrium Sugar Fund, the Teucrium Soybean Fund and the Teucrium Wheat Fund are collectively referred to herein as the “Operating Funds” and singularly referred to as an “Operating Fund.”  On April 22, 2011, the initial Form S-1 for TAGS was filed with the SEC, and on December 5, 2011, the first pre-effective amendment for TAGS was filed. As of December 31, 2011, the Form S-1 for TAGS had not yet been declared effective by the SEC; however, the Form S-1 for TAGS was declared effective on February 10, 2012. TAGS commenced operations on March 28, 2012.

 

The Company is required to oversee the purchase and sale of Shares by Authorized Purchasers (one that purchases or redeems Creation Baskets or Redemption Baskets, respectively, from or to the Funds), and to manage the Funds’ investments, including to evaluate the credit risk of futures commission merchants and swap counterparties and to review daily positions and margin/collateral requirements.

 

 The Company has the power to enter into agreements as may be necessary or appropriate for the offer and sale of the Funds’ units and the conduct of the Trust’s activities.

 

Note 2 — Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) as detailed in the Financial Accounting Standards Board’s Accounting Standards Codification.

 

For the year ended December 31, 2010, the Company was considered a development stage entity for financial statement reporting purposes. For the year ended December 31, 2011, the Company is no longer considered a development stage entity as planned principal operations related to the Funds have commenced.

 

Principles of Consolidation

 

The consolidated financial statements include the Company and the Trust. All material inter-company transactions and balances have been eliminated in the consolidation.  The consolidated financial statements of the Company also include the noncontrolling interests of the unit holders in the Funds.

 

 

Noncontrolling Interests

 

The consolidated financial statements of the Company include the noncontrolling interests of the unit holders in the Funds.  Net income and loss is allocated between the Company and the noncontrolling interests based on their respective relative ownership interest in the Funds.

 

Revenue Recognition

 

Commodity futures contracts are recorded on the trade date. All such transactions are recorded on the identified cost basis and marked to market daily. Unrealized appreciation or depreciation on commodity futures contracts are reflected in the statements of operations as the difference between the original contract amount and the fair market value as of the last business day of the year or as of the last date of the financial statements. Changes in the appreciation or depreciation between periods are reflected in the statements of operations. Interest on cash equivalents and deposits with the Futures Commission Merchant are recognized on the accrual basis. The Funds earn interest on its assets denominated in U.S. dollars on deposit with the Futures Commission Merchant at a rate equal to 85% of the overnight of Federal Funds Rate. In addition, the Funds earn interest on funds held at the custodian at prevailing market rates for such investments.

 

Brokerage Commissions

 

Brokerage commissions on all open commodity futures contracts are accrued on a full-turn basis.

 

Creations and Redemptions

 

Authorized Purchasers may purchase Creation Baskets from each Fund. The amount of the proceeds required to purchase a Creation Basket will be equal to the NAV of the shares in the Creation Basket determined as of 4:00 p.m. New York time on the day the order to create the basket is properly received.

 

Authorized Purchasers may redeem shares from each Fund only in blocks of shares called “Redemption Baskets.” The amount of the redemption proceeds for a Redemption Basket will be equal to the NAV of the shares in the Redemption Basket determined as of 4:00 p.m. New York time on the day the order to redeem the basket is properly received.

 

Each Fund receives or pays the proceeds from shares sold or redeemed within three business days after the trade date of the purchase or redemption. The amounts due from Authorized Purchasers are reflected in the statements of assets and liabilities as receivable for shares sold.  Amounts payable to Authorized Purchasers upon redemption are reflected in the statements of assets and liabilities as payable for shares redeemed.

  

Accounting Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Income Taxes

 

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 740-10, “Accounting for Uncertainty in Income Taxes,” the Company is required to determine whether a tax position is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position.  The Company files income tax returns in the U.S. federal jurisdiction, and may file income tax returns in various U.S. states and foreign jurisdictions.  The Company is subject to income tax examinations by major taxing authorities for all tax years since inception. The tax benefit recognized is measured as the largest amount of benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.  De-recognition of a tax benefit previously recognized results in the Funds recording a tax liability that reduces net assets.   Based on their analysis, the Company has determined that they have not incurred any liability for unrecognized tax benefits as of December 31, 2011 and December 31, 2010.  However, the Company’s conclusions regarding this policy may be subject to review and adjustment at a later date based on factors including, but not limited to, on-going analysis of and changes to tax laws, regulations, and interpretations thereof.  

 

The Company recognizes interest accrued related to unrecognized tax benefits and penalties related to unrecognized tax benefits in income tax fees payable, if assessed.  No interest expense or penalties have been recognized as of and for the years ended December 31, 2011 and December 31, 2010.

 

 

The Company may be subject to potential examination by U.S. federal, U.S. state, or foreign jurisdictional authorities in the area of income taxes. These potential examinations may include questioning the timing and amount of deductions, the nexus of income among various tax jurisdictions, and compliance with U.S. federal, U.S. state and foreign tax laws.  The Company’s management does not expect that the total amount of unrecognized tax benefits will materially change over the next twelve months.

 

Offering Costs

 

The Company expenses all initial offering costs associated with the registration of the Funds. Costs include, but are not limited to, legal fees pertaining to the Funds’ units offered for sale, SEC and state registration fees, initial fees paid to be listed on an exchange, underwriting and other similar costs. The initial offering and organization costs incurred to start the Funds will be borne by the Company and not be charged to the Funds.  Approximately $880,000 and $987,000 of accrued legal expenses related to the Funds’ initial offerings costs have been included in the accrued expenses of the consolidated statements of financial condition as of December 31, 2011 and December 31, 2010, respectively.

 

Cash Equivalents

 

Cash equivalents are highly-liquid investments with original maturity dates of three months or less.  The Company reported its cash equivalents in the consolidated statements of financial condition at market value, or at carrying amounts that approximate fair value, because of their highly-liquid nature and short-term maturities. The Company has a substantial portion of its assets on deposit with banks. Assets deposited with the bank may, at times, exceed federally insured limits of $250,000.  The Company had a balance of $61,244,613, and $39,484,450 in money market funds at December 31, 2011 and December 31, 2010, respectively; these balances are included in cash and cash equivalents on the consolidated statements of financial condition. The Company also had investments in United States Treasury Bills with a maturity of three months or less with a fair value of $19,999,830 on December 31, 2011 and $0 on December 31, 2010.

 

Collateral, Due from/to Broker

 

Margin is the minimum amount of funds that must be deposited by a commodity interest trader with the trader’s broker to initiate and maintain an open position in futures contracts. A margin deposit acts to assure the trader’s performance of the futures contracts purchased or sold. Futures contracts are customarily bought and sold on initial margin that represents a very small percentage (ranging upward from less than 2%) of the aggregate purchase or sales price of the contract. Because of such low margin requirements, price fluctuations occurring in the futures markets may create profits and losses that, in relation to the amount invested, are greater than are customary in other forms of investment or speculation. As discussed below, adverse price changes in the futures contract may result in margin requirements that greatly exceed the initial margin. In addition, the amount of margin required in connection with a particular futures contract is set from time to time by the exchange on which the contract is traded and may be modified from time to time by the exchange during the term of the contract. Brokerage firms, such as the Funds’ clearing brokers, carrying accounts for traders in commodity interest contracts generally require higher amounts of margin as a matter of policy to further protect themselves. Over-the-counter trading generally involves the extension of credit between counterparties, so the counterparties may agree to require the posting of collateral by one or both parties to address credit exposure.

 

When a trader purchases an option, there is no margin requirement; however, the option premium must be paid in full. When a trader sells an option, on the other hand, he or she is required to deposit margin in an amount determined by the margin requirements established for the underlying interest and, in addition, an amount substantially equal to the current premium for the option. The margin requirements imposed on the selling of options, although adjusted to reflect the probability that out-of-the-money options will not be exercised, can in fact be higher than those imposed in dealing in the futures markets directly. Complicated margin requirements apply to spreads and conversions, which are complex trading strategies in which a trader acquires a mixture of options positions and positions in the underlying interest.  

 

Ongoing or “maintenance” margin requirements are computed each day by a trader’s clearing broker. When the market value of a particular open futures contract changes to a point where the margin on deposit does not satisfy maintenance margin requirements, a margin call is made by the broker. If the margin call is not met within a reasonable time, the broker may close out the trader’s position. With respect to the Funds’ trading, the Funds (and not its shareholders personally) are subject to margin calls.

 

Finally, many major U.S. exchanges have passed certain cross margining arrangements involving procedures pursuant to which the futures and options positions held in an account would, in the case of some accounts, be aggregated and margin requirements would be assessed on a portfolio basis, measuring the total risk of the combined positions.

 

Fair Value - Definition and Hierarchy

 

In accordance with GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

 

 

In determining fair value, the Company uses various valuation approaches.  In accordance with GAAP, a fair value hierarchy for inputs is used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are those that market participants would use in pricing the asset or liability based on market data obtained from sources independent of the Company.  Unobservable inputs reflect the Company’s assumptions about the inputs market participants would use in pricing the asset or liability developed based on the best information available in the circumstances.  The fair value hierarchy is categorized into three levels based on the inputs as follows:

 

Level 1 - Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the Trust has the ability to access.  Valuation adjustments and block discounts are not applied to Level 1 securities.  Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant degree of judgment. 

 

Level 2 - Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. 

 

Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. 

  

The availability of valuation techniques and observable inputs can vary from security to security and is affected by a wide variety of factors including, the type of security, whether the security is new and not yet established in the marketplace, and other characteristics particular to the transaction.  To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.  Those estimated values do not necessarily represent the amounts that may be ultimately realized due to the occurrence of future circumstances that cannot be reasonably determined.  Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the securities existed.  Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for securities categorized in Level 3.  In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  In such cases, for disclosure purposes, the level in the fair value hierarchy within which the fair value measurement in its entirety falls, is determined based on the lowest level input that is significant to the fair value measurement.

 

Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure.  Therefore, even when market assumptions are not readily available, the Trust’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.  The Trust uses prices and inputs that are current as of the measurement date, including periods of market dislocation.  In periods of market dislocation, the observability of prices and inputs may be reduced for many securities.  This condition could cause a security to be reclassified to a lower level within the fair value hierarchy. For instance, when Corn Futures Contracts on the Chicago Board of Trade (“CBOT”) are not actively trading due to a “limit-up” or ‘limit-down” condition, meaning that the change in the Corn Futures Contracts has exceeded the limits established, the Trust and the Fund will revert to alternative verifiable sources of valuation of its assets.  When such a situation exists on a quarter close, the Sponsor will calculate the Net Asset Value (“NAV”) on a particular day using the Level 1 valuation, but will later recalculate the NAV for the impacted Fund based upon the valuation inputs from these alternative verifiable sources (Level 2 or Level 3) and will report such NAV in its applicable financial statements and reports.

 

The Funds and the Trust record their derivative activities at fair value. Gains and losses from derivative contracts are included in the consolidated statements of operations.  Derivative contracts include futures contracts related to commodity prices. Futures, which are listed on a national securities exchange, such as the CBOT or the New York Mercantile Exchange (“NYMEX”), or reported on another national market, are generally categorized in Level 1 of the fair value hierarchy.  OTC derivatives contracts (such as forward and swap contracts) which may be valued using models, depending on whether significant inputs are observable or unobservable, are categorized in Levels 2 or 3 of the fair value hierarchy.

 

On December 31, 2010 and 2011, in the opinion of the Company, the reported value at the close of the market for each commodity contract fairly reflected the value of the futures and no alternative valuations were required.

 

New Accounting Pronouncements

 

In May 2011, the Financial Accounting Standards Board (“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 IFRS.” ASU No. 2011-04 clarifies existing requirements for measuring fair value and for disclosure about fair value measurements in converged guidance of the FASB and the International Accounting Standards Board. The amendments are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The implementation of ASU No. 2011-04 is not expected to have a material impact on financial statement disclosures for the Company.

 

  

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Amendments of the FASB Accounting Standards Codification and Disclosures about Offsetting Assets and Liabilities in U.S. GAAP and IFRS.” ASU No. 2011-11 clarifies existing requirements for balance sheet offsetting and for disclosures about the offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position in converged guidance of the FASB and the International Accounting Standards Board. The amendments are to be applied retrospectively for all comparative periods presented. For public entities, the amendments are effective for annual reporting periods beginning on or after January 1, 2013. The implementation of ASU No. 2011-11 will not be adopted prior to January 1, 2013, and we are evaluating the material impacts on the financial statement disclosures for the Company.

 

Note 3 – Fair Value Measurements

 

The Company’s assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy as described in the Company’s significant accounting policies in Note 2. The following table presents information about the Company’s assets and liabilities measured at fair value as of December 31, 2011 and assets as of December 31, 2010:

 

December 31, 2011

  

														Balance
														as of
														December 31,
Assets:		Level 1				Level 2				Level 3					2011
Cash equivalents		$	81,244,443			$	—			$	—			$	81,244,443
Commodity futures contracts							—				—
Corn futures contracts			1,928,408				—				—				1,928,408
WTI crude oil futures contracts			116,142				—				—				116,142
Soybean futures contracts			9,994				—				—				9,994
Wheat futures contracts			71,170				—				—				71,170
Total		$	83,370,157			$	—			$	—			$	83,370,157

  

															Balance
															as of
															December 31,
Liabilities:		Level 1				Level 2				Level 3					2011
Commodity futures contracts
Corn futures contracts		$	2,711,523			$	—			$	—			$	2,711,523
Natural gas futures contracts			602,440				—				—				602,440
WTI crude oil futures contracts			168				—				—				168
Soybean futures contracts			164,663				—				—				164,663
Sugar futures contracts			138,198				—				—				138,198
Wheat futures contracts			141,468				—				—				141,468
Total commodity futures contracts		$	3,758,460			$	—			$	—			$	3,758,460

  

December 31, 2010

 

														Balance
														as of
														December 31,
Assets:		Level 1				Level 2				Level 3					2010
Cash equivalents		$	39,479,993			$	—			$	—			$	39,479,993
Corn futures contracts			5,178,219				—				—				5,178,219
Total		$	44,658,212			$	—			$	—			$	44,658,212

 

 

Transfers into and out of each level of the fair value hierarchy for the corn futures contracts valued using alternative verifiable sources due to a "limit-down" condition for the period January 1, 2011 through December 31, 2011 were as follows: 

 

Transfers

Transfers

Transfers

Transfers

Transfers

Transfers

into

out of

into

out of

into

out of

Level 1

Level 1

Level 2

Level 2

Level 3

Level 3

Assets (at fair value)

Derivative contracts

Corn future contracts

$

9,140,288

$

9,140,288

$

9,140,288

$

9,140,288

$

—

$

—

 

Transfers

Transfers

Transfers

Transfers

Transfers

Transfers

into

out of

into

out of

into

out of

Level 1

Level 1

Level 2

Level 2

Level 3

Level 3

Liabilities (at fair value)

Derivative contracts

Corn future contracts

$

5,938,713

$

5,938,713

$

5,938,713

$

5,938,713

$

—

$

—

  

 For year ended December 31, 2010, there were no significant transfers.

 

Note 4 -Derivative Instruments and Hedging Activities

 

In the normal course of business, the Funds utilize derivative contracts in connection with its proprietary trading activities.  Investments in derivative contracts are subject to additional risks that can result in a loss of all or part of an investment.  The Funds’ derivative activities and exposure to derivative contracts are classified by the following primary underlying risks: interest rate, credit, commodity price, and equity price risks.  In addition to its primary underlying risks, the Funds are also subject to additional counterparty risk due to inability of  its counterparties to meet the terms of their contracts.  For the year ended December 31, 2011, the Operating Funds invested in commodity futures contracts and Chicago Mercantile Exchange Calendar Swaps. Cleared Corn Swaps have standardized terms similar to, and are priced by reference to, a corresponding Benchmark Component Futures Contract.  Additionally, Other Corn Interests that do not have standardized terms and are not exchange-traded, referred to as “over-the-counter” Corn Interests, can generally be structured as the parties to the Corn Interest contract desire.  Therefore, each Fund might enter into multiple Cleared Swaps and/or over-the-counter Interests intended to exactly replicate the performance of each of the Benchmark Component Futures Contracts for the Fund, or a single over-the-counter Interest designed to replicate the performance of the Benchmark as a whole.  Assuming that there is no default by a counterparty to an over-the-counter Interest, the performance of the Interest will necessarily correlate exactly with the performance of the Benchmark or the applicable Benchmark Component Futures Contract.  As of December 31, 2011 and 2010, the Operating Funds had investments only in commodity futures contracts specifically related to each Fund.

 

Futures Contracts  

          

The Funds are subject to commodity price risk in the normal course of pursuing their investment objectives. A futures contract represents a commitment for the future purchase or sale of an asset at a specified price on a specified date.

 

The purchase and sale of futures contracts requires margin deposits with a Futures Commission Merchant (“FCM”).  Subsequent payments (variation margin) are made or received by each Fund each day, depending on the daily fluctuations in the value of the contract, and are recorded as unrealized gains or losses by each Fund.  Futures contracts may reduce the Funds’ exposure to counterparty risk since futures contracts are exchange-traded; and the exchange’s clearinghouse, as the counterparty to all exchange-traded futures, guarantees the futures against default.

 

The Commodity Exchange Act requires an FCM to segregate all customer transactions and assets from the FCM’s proprietary activities.  A customer’s cash and other equity deposited with an FCM are considered commingled with all other customer funds subject to the FCM’s segregation requirements.  In the event of an FCM’s insolvency, recovery may be limited to each Fund’s pro rata share of segregated customer funds available.  It is possible that the recovery amount could be less than the total of cash and other equity deposited.

 

The following tables identify the fair value amounts of derivative instruments included in the statements of assets and liabilities as derivative contracts, categorized by primary underlying risk, at December 31, 2011 and December 31, 2010.  Balances are presented on a gross basis, prior to the application of the impact of counterparty and collateral netting.  Total derivative assets and liabilities are adjusted on an aggregate basis to take into consideration the effects of master netting arrangements and have been reduced by the application of cash collateral receivables and payables with its counterparties. The following tables also identify the net gain and loss amounts included in the statement of operations as realized and unrealized gains and losses on trading of commodity futures contracts, categorized by primary underlying risk, for the year ended December 31, 2011 and December 31, 2010.

  

  

At December 31, 2011, the fair value of derivative instruments was as follows:

 

Primary underlying risk		Asset derivatives				Liability derivatives				Net derivatives
Commodity price
Corn futures contracts		$	1,928,408			$	(2,711,523	)		$	(783,115	)
Natural gas futures contracts			—				(602,440	)			(602,440	)
WTI crude oil futures contracts			116,142				(168	)			115,974
Soybean futures contracts			9,994				(164,663	)			(154,669	)
Sugar futures contracts			—				(138,198	)			(138,198	)
Wheat futures contracts			71,170				(141,468	)			(70,298	)
Total commodity futures contracts		$	2,125,714			$	(3,758,460	)		$	(1,632,746	)

 

At December 31, 2010, the fair value of derivative instruments was as follows:

 

Primary underlying risk		Asset derivatives				Liability derivatives				Net derivatives
Commodity price
Corn futures contracts		$	5,178,219			$	—			$	5,178,219

  

The following is a summary of realized and unrealized gains and losses of the derivative instruments utilized by the Company:

 

For the year ended December 31, 2011

 

		Realized gain (loss) on				Net change in unrealized gain (loss)
Primary underlying risk		derivative instruments				on derivative instruments
Commodity price
Corn futures contracts		$	7,937,425			$	(5,961,334	)
Natural gas futures contracts			(541,020	)			(602,440	)
WTI crude oil futures contracts			(162,359	)			115,974
Soybean futures contracts			(140,281	)			(154,669	)
Sugar futures contracts			(35,874	)			(138,198	)
Wheat futures contracts			(174,860	)			(70,298	)
Total commodity futures contracts		$	6,883,031			$	(6,810,965	)

  

For the year ended December 31, 2010

  

		Realized gain on				Net change in unrealized gain
Primary underlying risk		derivative instruments				on derivative instruments
Commodity price
Corn futures contracts		$	3,693,752			$	(5,178,219	)

  

Volume of Derivative Activities

 

At December 31, 2011, the notional amounts and number of contracts, categorized by primary underlying risk, were as follows:

 

		Long exposure
		Notional				Number
Primary underlying risk		amounts				of contracts
Commodity price
Corn futures contracts		$	71,289,525				2,260
Natural gas futures contracts			1,383,770				43
Crude oil futures contracts			4,481,380				46
Soybean futures contracts			2,177,038				36
Sugar futures contracts			2,315,802				90
Wheat futures contracts			2,250,188				65
Total commodity futures contracts		$	83,897,703				2,540

   

  

At December 31, 2010, the notional amounts and number of contracts, categorized by primary underlying risk, were as follows:

 

		Long exposure
		Notional				Number
Primary underlying risk		amounts				of contracts
Commodity price
Corn futures contracts		$	42,979,000				1,411

 

Note 5 – Capitalization (including debt)

 

The Company is authorized to issue equity interests in the Company designated as "membership units" which shall constitute "membership interests" and shall initially include Class A units, Class B-1 units and Class B-2 units. Class A Units are granted the right to vote on all matters regarding management and members. The voting rights granted to Class B units are limited to matters requiring a majority vote of Class A units, including but not limited to, dissolution.

 

Ownership or “membership” interests in the Company are owned by persons referred to as “members.”  The Company currently has three voting or “Class A” members – Mr. Sal Gilbertie, Mr. Dale Riker and Mr. Carl N. Miller III – and a small number of non-voting or “Class B” members who have provided working capital to the Company.  Messrs. Gilbertie and Riker each currently own 45% of the Company’s Class A membership interests.

 

The members (acting by a majority vote of the Class A members) are authorized, by resolution or resolutions, to create and to issue, on behalf of the Company, different classes, groups or series of membership units and to fix for each such class, group or series such voting powers (full or limited or no voting powers), and such distinctive designations, preferences and relative participating, optional or other special rights and qualifications, limitations or restrictions as determined by the members (acting by a majority vote of the Class A members) in exchange for contributions of cash or property, the provision of services or such other consideration, as may be determined by the members (acting by a majority vote of the Class A members). Each membership unit of a class of membership units shall be identical in all respects to each other membership unit of such class. All membership units may be issued as fractional units.

 

The Company entered into convertible notes on September 28, 2009 for $225,000, and the note holders had rights to convert for 3% interest in the Company. On October 28, 2009, the note holders converted $225,000, including $50,000 which had not been received by the Company. Due primarily to the short-term nature of the convertible notes, the Company has determined that the bifurcation of the convertible debt would not have had a material impact on the consolidated financial statements.  In August 2010, the Company received the $50,000 that was previously included in subscription receivable.

 

During the period from inception (September 1, 2009) through December 31, 2009, GFI Group LLC (“GFI”) contributed $1,500,000 in cash in connection with its interest in the Company through Class B-1 units and an option agreement. The Company granted GFI the right and option to purchase that number of Class B-1 units of the Company representing the Percentage Interest in the Company at the exercise price shown below (the “Option”):

 

-Percentage Interest subject to Option: Up to 5%. 

-Exercise Price: $2,500,000 per each two and one-half percent (2.5%) (the “Incremental Exercise Percentage”)  Percentage Interest, for an aggregate exercise price of $5,000,000.

-The Option shall become vested and exercisable in full as of the date of grant.

-The Option shall expire and cease to be exercisable upon the five-year anniversary of the date the option was granted, October 28, 2009.

 

On June 7, 2010, the Company entered into a debt agreement (the “Loan Agreement”) with GFI. Under the terms of the Loan Agreement, the Company borrowed $800,000 for a one-year term at an annual interest rate of 8.25%. The payment of principal and interest was due at maturity and was subject to optional prepayment by the Company at any time without premium or penalty.  The Loan Agreement was collateralized by substantially all of the current and future assets of the Company.

 

In connection with the execution of the Loan Agreement, the terms of the Option Agreement were modified to allow GFI to purchase that number of Class B-1 units of the Company representing the Percentage Interest in the Company at the exercise price shown below (the “Modified Option”):

 

-Percentage Interest subject to the Modified Option:  Up to 5%.

 

  

-Exercise Price:  $2,100,000 per each two and one-half percent (2.5%) Incremental Exercise Percentage Interest for an aggregate exercise price of $4,200,000.

 

The Company determined that modification of the Option Agreement did not change the de minimis value of the Option.

 

On February 4, 2011, the Company entered into a subsequent agreement with GFI, in which GFI purchased an additional interest in the Company through Class B-1 units. GFI provided cash of $1,156,422 and converted the principal balance of the Company’s $800,000 borrowing and accrued interest through the date of signing of $43,578 as payment for 217.220 Class B-1 units.  GFI received the right to convert $400,000 of their additional investment into a loan, should specific agreement objectives not be achieved by February 4, 2012.  The issuance of the $400,000 loan upon conversion would not result in a decrease in GFI’s ownership interest and would mature eight months following the election to exercise this right. As a result of this conversion right, the Company has classified $400,000 of this equity contribution outside permanent members’ equity on the December 31, 2011 consolidated statement of financial condition. The Company also received an additional equity contribution of $70,000 in exchange for 5.860 Class B-1 units on the same date as the GFI agreement.

 

On June 21, 2011, the Company entered into an agreement with NMSIC Classic, LLC (“NMSIC”), a Delaware limited liability company, in which NMSIC contributed $1,000,000 in cash in exchange for 91.491 units of Class B-1 shares.

 

In connection with the contribution by NMSIC, the Company entered into side-letter agreements with both GFI and NMSIC.  Under the terms of the side-letter agreements, the Company granted both GFI and NMSIC the right for the next ten calendar years to redeem their Class B-1 units at a pre-determined value which is based on the assets under management of the Trust.  The redemption amount shall be paid in cash and cash equivalents to the extent is the Company has Excess Cash, as defined.  In addition, the Company has a call option to acquire the Class B-1 units of GFI and NMSIC based on a pre-determined calculation for the next ten calendar years.  As a result of the redemption rights granted, the Company has classified the interests of GFI and NMSIC totaling $3,000,000, including GFI’s right to convert $400,000 of their additional investment into a loan, outside of permanent members’ equity on the December 31, 2011 consolidated statement of financial condition.

 

Note 6 — Unit-Based Compensation

 

 In February 2010, the Company issued 100 units of Class B-2 shares to a small number of non-employee individuals representing 7% of the total collective Company membership interests.  The Class B-2 shares were awarded based on services. The Class B-2 shares generally have the same rights as Class B-1 shares; however, in the event of termination, the Class B-2 shares are subordinate to Class B-1 shares regarding any distributions. The Class B-2 shares are redeemable at the sole option of the Company at a predetermined price of $1,000,000 per 1% of collective membership interests represented by the Class B-2 shares.

 

For the year ended December 31, 2010, $86,000 of unit-based compensation expense representing the estimated fair value of the Class B-2 shares issued is included on the statement of operations. In accordance with FASB ASC Topic 505, “Equity,” the Company determined the fair value of the Class B-2 shares issued based on recent similar transactions, the financial condition and book value of the Company at the time of issuance, and the respective rights of the Class B-2 shares versus the other classes of membership interests.

 

Note 7 — Related Party Transactions

 

The Riker Group has invoiced the Company for professional services rendered by Dale Riker $30,000 for the year ended December 31, 2011 and $240,000 for the year ended December 31, 2010. Of these amounts, $0 and $20,000 are included in the accrued expenses balance on the accompanying consolidated statements of financial condition at December 31, 2011 and December 31, 2010, respectively. 

 

The Gilbertie Herb Farm was paid by the Company for rent in the amount of $6,000 each for the years ended December 31, 2010 and 2011. No amounts were payable as of December 31, 2010 or December 31, 2011.

 

Note 8 - Subsequent Events

 

On February 10, 2012, the SEC declared effective the Form S-1 for the Teucrium Agricultural Fund (TAGS). On February 24, 2012, the SEC granted listing authority to the Fund. TAGS commenced operations on March 28, 2012.

 

On February 15, 2012, GFI elected to convert to a loan payable the $400,000 portion of its equity contributed on February 4, 2011 that was subject to the conversion right described in Note 5.