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S&W SEED COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

S&W Seed Company, a Nevada corporation (the "Company"), began as S&W Seed Company, a general partnership, in 1980 and was originally in the business of breeding, growing, processing and selling alfalfa seed. We then incorporated a corporation with the same name in Delaware in October 2009, which is the successor entity to Seed Holding, LLC, having purchased a majority interest in the general partnership between June 2008 and December 2009. Following the Company's initial public offering in May 2010, the Company purchased the remaining general partnership interests and became the sole owner of the general partnership's original business. Seed Holding, LLC remains a consolidated subsidiary of the Company.

In December 2011, the Company reincorporated in Nevada as a result of a statutory short-form merger of the Delaware corporation into its wholly-owned subsidiary, S&W Seed Company, a Nevada corporation.

On April 1, 2013, the Company, together with its wholly-owned subsidiary, S&W Holdings Australia Pty Ltd, an Australia corporation (f/k/a S&W Seed Australia Pty Ltd "S&W Holdings"), consummated an acquisition of all of the issued and outstanding shares of Seed Genetics International Pty Ltd, an Australia corporation ("SGI"), from SGI's shareholders. In April 2018, SGI changed its name to S&W Seed Company Australia Pty Ltd ("S&W Australia").

Since its establishment, the Company, including its predecessor entities, has been principally engaged in breeding, growing, processing and selling agricultural seeds. The Company owns seed cleaning and processing facilities, which are located in Five Points, California, Nampa, Idaho and Keith, South Australia. The Company's seed products are primarily grown under contract by farmers. The Company began its stevia initiative in fiscal year 2010 and is currently focused on breeding improved varieties of stevia and developing marketing and distribution programs for its stevia products.

The Company has also been actively engaged in expansion initiatives through a combination of organic growth and strategic acquisitions, including in December 31, 2014, when the Company purchased certain alfalfa research and production facilities and conventional (non-GMO) alfalfa germplasm assets and assumed certain related liabilities ("the Pioneer Acquisition") of Pioneer Hi-Bred International, Inc. ("DuPont Pioneer").

The Company has a long-term distribution agreement with DuPont Pioneer regarding conventional (non-GMO) varieties, the term of which extends into 2024. The Company's production agreement with DuPont Pioneer (relating to GMO-traited varieties) terminates on May 31, 2019. Although the production agreement will terminate on May 31, 2019, the Company expects that the DuPont Pioneer distribution agreement will continue to be a significant source of the Company's annual revenue through December 2024.

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In May 2016, the Company acquired the assets and business of SV Genetics, a private Australian company specializing in the breeding and licensing of proprietary hybrid sorghum and sunflower seed germplasm, which represented the Company's initial effort to diversify its product portfolio beyond alfalfa seed and stevia.

In October 2018, the Company acquired substantially all of the assets of Chromatin, Inc., a U.S.-based sorghum genetics and seed company, as part of the Company's efforts to expand its penetration into the hybrid sorghum market.

The Company's operations span the world's alfalfa seed production regions with operations in the San Joaquin and Imperial Valleys of California, five other U.S. states, Australia, and three provinces in Canada, and the Company sells its seed products in more than 30 countries around the globe.

The Company maintains its accounting records on an accrual basis in accordance with accounting principles generally accepted in the United States of America ("GAAP").

The consolidated financial statements include the accounts of Seed Holding, LLC and its other wholly-owned subsidiaries, S&W Holdings, which owns 100% of S&W Australia, and Stevia California, LLC. All significant intercompany balances and transactions have been eliminated.

The Company has prepared the accompanying consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") for interim financial reporting. These consolidated financial statements are unaudited and, in the Company's opinion, include all adjustments, consisting of normal recurring adjustments and accruals, necessary for a fair presentation of the Company's consolidated balance sheets, statements of operations, comprehensive income (loss), cash flows and stockholders' equity for the periods presented. Operating results for the periods presented are not necessarily indicative of the results to be expected for the full year ending June 30, 2019. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted in accordance with the rules and regulations of the SEC. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended June 30, 2018, as filed with the SEC.

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Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are adjusted to reflect actual experience when necessary. Significant estimates and assumptions affect many items in the financial statements. These include allowance for doubtful trade receivables, inventory valuation, revenue recognition, asset impairments, provisions for income taxes, grower accruals (an estimate of amounts payable to farmers who grow seed for the Company), contingent consideration obligations, derivative liabilities, contingencies and litigation. Significant estimates and assumptions are also used to establish the fair value and useful lives of depreciable tangible and certain intangible assets, goodwill as well as valuing stock-based compensation. Actual results may differ from those estimates and assumptions, and such results may affect income, financial position or cash flows.

The Company's revenue is principally derived from the sale of alfalfa seed, the market for which is highly competitive. One customer accounted for 75% of its revenue for the three months ended September 30, 2018. In comparison, two customers accounted for 37% of its revenue for the three months ended September 30, 2017.

Two customers accounted for 49% and 45% of the Company's accounts receivable at September 30, 2018 and 2017, respectively. One customer accounted for 35% of the Company's accounts receivable at June 30, 2018.

In addition, the Company sells a substantial portion of its products to international customers. Sales to international markets represented 16% and 65% of revenue during the three months ended September 30, 2018 and 2017, respectively. The net book value of fixed assets located outside the United States was 20% of total assets at September 30, 2018 and June 30, 2018. Cash balances located outside of the United States may not be insured and totaled $379,615 and $369,803 at September 30, 2018 and June 30, 2018, respectively.

The following table shows revenue from external sources by destination country:

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International Operations

The Company translates its foreign operations' assets and liabilities denominated in foreign currencies into U.S. dollars at the current rates of exchange as of the balance sheet date and income and expense items at the average exchange rate for the reporting period. Translation adjustments resulting from exchange rate fluctuations are recorded in the cumulative translation account, a component of accumulated other comprehensive income. Gains or losses from foreign currency transactions are included in the consolidated statement of operations.

The Company adopted the provisions of ASC Topic 606, Revenue from Contracts with Customers ("Topic 606") as of July 1, 2018.  See Note 3 for further discussion.

The Company records purchasing and receiving costs, inspection costs and warehousing costs in cost of revenue. When the Company is required to pay for outward freight and/or the costs incurred to deliver products to its customers, the costs are included in cost of revenue.

For financial statement presentation purposes, the Company considers time deposits, certificates of deposit and all highly liquid investments with original maturities of three months or less to be cash and cash equivalents. At times, cash and cash equivalents balances exceed amounts insured by the Federal Deposit Insurance Corporation.

The Company provides an allowance for doubtful trade receivables equal to the estimated uncollectible amounts. That estimate is based on historical collection experience, current economic and market conditions and a review of the current status of each customer's trade accounts receivable. The allowance for doubtful trade receivables was $431,211 and $584,202 at September 30, 2018 and June 30, 2018, respectively.

Inventories consist of seed and packaging materials.

Inventories are stated at the lower of cost or net realizable value, and an inventory reserve permanently reduces the cost basis of inventory. Inventories are valued as follows: Actual cost is used to value raw materials such as packaging materials, as well as goods in process. Costs for substantially all finished goods, which include the cost of carryover crops from the previous year, are valued at actual cost. Actual cost for finished goods includes plant conditioning and packaging costs, direct labor and raw materials and manufacturing overhead costs based on normal capacity. The Company records abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) as current period charges and allocates fixed production overhead to the costs of finished goods based on the normal capacity of the production facilities.

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The Company's subsidiary, S&W Australia, does not fix the final price for seed payable to its growers until the completion of a given year's sales cycle pursuant to its standard contract production agreement. S&W Australia records an estimated unit price; accordingly, inventory, cost of revenue and gross profits are based upon management's best estimate of the final purchase price to growers.

Inventory is periodically reviewed to determine if it is marketable, obsolete or impaired. Inventory that is determined to be obsolete or impaired is written off to expense at the time the impairment is identified. Because the germination rate, and therefore the quality, of alfalfa seed improves over the first year of proper storage, inventory obsolescence for alfalfa seed is not a material concern. The Company sells its inventory to distributors, dealers and directly to growers.

Components of inventory are:

Property, plant and equipment is depreciated using the straight-line method over the estimated useful life of the asset - periods of 5-28 years for buildings, 3-20 years for machinery and equipment, and 3-5 years for vehicles. 

Intangible assets acquired in business acquisitions are reported at their initial fair value less accumulated amortization. Intangible assets are amortized using the straight-line method over the estimated useful life of the asset. Periods of 10-30 years for technology/IP/germplasm, 10-20 years for customer relationships and trade names and 3-20 for other intangible assets. The weighted average estimated useful lives are 26 years for technology/IP/germplasm, 17 years for customer relationships and 20 years for trade names and other intangible assets.

Investee companies that are not consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee company's board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, an investee company's accounts are not reflected within the Company's consolidated balance sheets and statements of operations; however, the Company's share of the earnings or losses of the investee company is reflected in the caption "Loss on equity method investment" in the consolidated statements of operations. The Company's carrying value in an equity method investee company is included in the Company's consolidated balance sheets. When the Company's carrying value in an equity method investee company is reduced to zero, no further losses are recorded in the Company's consolidated financial statements unless the Company guaranteed obligations of the investee company or has committed additional funding. When the investee company subsequently reports income, the Company will not record its share of such income until it equals the amount of its share of losses not previously recognized.

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Cost Method Investments

Investee companies not accounted for under the consolidation or the equity method of accounting are accounted for under the cost method of accounting. Under this method, the Company's share of the earnings or losses of such investee companies is not included in the consolidated balance sheet or statement of operations. However, impairment charges are recognized in the consolidated statement of operations. If circumstances suggest that the value of the investee company has subsequently recovered, such recovery is not recorded.

The Company is engaged in ongoing research and development ("R&D") of proprietary seed and stevia varieties. All R&D costs must be charged to expense as incurred. Accordingly, internal R&D costs are expensed as incurred. Third-party R&D costs are expensed when the contracted work has been performed or as milestone results have been achieved. The costs associated with equipment or facilities acquired or constructed for R&D activities that have alternative future uses are capitalized and depreciated on a straight-line basis over the estimated useful life of the asset.

Deferred tax assets and liabilities are determined based on differences between the financial statement and tax basis of assets and liabilities, as well as a consideration of net operating loss and credit carry forwards, using enacted tax rates in effect for the period in which the differences are expected to impact taxable income. A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized. The Company's effective tax rate for the three months ended September 30, 2018 and 2017 has been affected by the valuation allowance on the Company's deferred tax assets.

Basic net income (loss) per common share ("EPS"), is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. 

Diluted EPS is calculated by adjusting both the numerator (net income (loss)) and the denominator (weighted-average number of shares outstanding) for the dilutive effects of potentially dilutive securities, including options, restricted stock awards, and common stock warrants. 

The treasury stock method is used for common stock warrants, stock options, and restricted stock awards. Under this method, consideration that would be received upon exercise (as well as remaining compensation cost to be recognized for awards not yet vested) is assumed to be used to repurchase shares of stock in the market, with net number of shares assumed to be issued added to the denominator.

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The calculation of Basic and Diluted EPS is shown in the table below. Classes of securities identified in the table with no adjustments in the calculation of Diluted EPS were determined to be antidilutive for the applicable periods. 

The Company evaluates its long-lived assets for impairment annually or more often if events and circumstances warrant. Events relating to recoverability may include significant unfavorable changes in business conditions, recurring losses or a forecasted inability to achieve break-even operating results over an extended period. The Company evaluates the recoverability of long-lived assets based upon forecasted undiscounted cash flows. Should impairment in value be indicated, the carrying value of long-lived assets will be adjusted, based on estimates of future discounted cash flows resulting from the use and ultimate disposition of the asset.

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Derivative Financial Instruments

The Company's subsidiary, S&W Australia, is exposed to foreign currency exchange rate fluctuations in the normal course of its business, which the Company at times manages through the use of foreign currency forward contracts.

The Company has entered into certain derivative financial instruments (specifically foreign currency forward contracts), and accounts for these instruments in accordance with ASC Topic 815, "Derivatives and Hedging", which establishes accounting and reporting standards requiring that derivative instruments be recorded on the balance sheet as either an asset or liability measured at fair value. The Company's foreign currency contracts are not designated as hedging instruments under ASC 815; accordingly, changes in the fair value are recorded in current period earnings.

The Company reviews the terms of the common stock, warrants and convertible debt it issues to determine whether there are embedded derivative instruments, including embedded conversion options and redemption options, which are required to be bifurcated and accounted for separately as derivative financial instruments.

The Company discloses assets and liabilities that are recognized and measured at fair value, presented in a three-tier fair value hierarchy, as follows:

• Level 1. Observable inputs such as quoted prices in active markets;
• Level 2. Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
• Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

No assets or liabilities were valued at fair value on a non-recurring basis as of September 30, 2018 or June 30, 2018.

The carrying value of cash and cash equivalents, accounts payable, short-term and all long-term borrowings, as reflected in the consolidated balance sheets, approximate fair value because of the short-term maturity of these instruments or interest rates commensurate with market rates. There have been no changes in operations and/or credit characteristics since the date of issuance that could impact the relationship between interest rate and market rates.

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Assets and liabilities that are recognized and measured at fair value on a recurring basis are categorized as follows:

The Company adopted Accounting Standards Update No. 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04") effective July 1, 2018. This standard eliminates Step 2 from the goodwill impairment test. Instead, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The adoption did not have a material impact on the consolidated financial statements.

The Company adopted Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, ("Topic 606") as of July 1, 2018.  This ASC topic outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most previously existing revenue recognition guidance under U.S. GAAP. The core principle of Topic 606 is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.

The Company adopted Topic 606 using the modified retrospective approach, in which the cumulative effect of applying the new standards to open contracts as of July 1, 2018 was to be recognized as a cumulative effect adjustment.  The adoption did not result in a cumulative effect adjustment as of July 1, 2018.

The adoption of Topic 606 had a significant effect on the Company's accounting for its distribution and production agreements with Pioneer for the period ended September 30, 2018. There were no other changes in the Company's accounting as a result of the adoption of Topic 606.

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The change in the accounting for the distribution and production agreements with Pioneer arises from the provisions of Topic 606 regarding the determination of whether a performance obligation is satisfied at a point in time or over time. Under those provisions, a performance obligation is considered to be satisfied over time if the company's performance creates an asset that the customer controls as the asset is created or enhanced; or the work to satisfy the performance obligation does not create an asset with alternative future use to the vendor and the customer has an obligation to pay for work completed. Under the agreements, Pioneer submits a demand plan to the Company in advance of the growing season specifying the amount of seed that it intends to order for the upcoming sales year. Once the demand plan is submitted, Pioneer cannot cancel or reduce the amount of seed that it is obligated to purchase under the agreements. In addition, the Company is not permitted to sell products produced for Pioneer under the agreements to other customers. Therefore, under Topic 606, the performance obligation is satisfied, and revenue is recognized, over time, as the Company takes delivery of, processes, and packages the seed.

The Company has concluded that cost is the best measure of progress under the Pioneer contracts because no other measure adequately reflects the value added to the product by each of the Company's major tasks - having the crop grown, processing, and packaging. As the Company contracts out the growing of seed to third parties, the vast majority of the Company's costs under these agreements are incurred, and therefore the vast majority of the revenue from such agreements is recognized, when the raw seed is purchased from the third-party contract growers. The rest of the costs are incurred, and therefore the rest of the revenue is recognized, as the Company processes and packages the product. Because revenue is recognized as costs are incurred, no inventory costs related to performance under the Pioneer contract are capitalized as inventory - instead, they are recognized as expenses as they are incurred.

Prior to the adoption of Topic 606, revenue related to the Pioneer agreement was recognized when seed was delivered to Pioneer. Costs incurred to purchase and process seed were capitalized as inventory until the product was delivered. As the Company adopted Topic 606 using the modified retrospective approach, figures for fiscal 2018 have not been adjusted and continue to reflect the prior accounting policies.

The change in accounting for the Pioneer contract did not result in a cumulative effect adjustment, because all seed produced for Pioneer in previous growing seasons had been delivered, and revenue recognized, prior to July 1, 2018, and no seed had been received prior to July 1, 2018 related to the current growing season. However, the change materially affected the amount of revenue and costs recognized during the three months ended September 30, 2018. The effects of the new accounting for the Pioneer contracts on the Company's financial statements are shown below:

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Topic 606 also requires enhanced disclosures about the nature, amount, timing, and uncertainty of revenues and cash flows arising from contracts with customers. Those disclosures can also be found in Note 3.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02: Leases ("ASU 2016-02"). This standard amends various aspects of existing accounting guidance for leases, including the recognition of a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. This standard also introduces new disclosure requirements for leasing arrangements. For public business entities, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The new standard must be adopted using a modified retrospective approach, and provides for certain practical expedients. The Company is evaluating the impact of the adoption of ASU 2016-02 on its consolidated financial statements and related disclosures.

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NOTE 3 - REVENUE RECOGNITION

The Company adopted the provisions of Topic 606 as of July 1, 2018. As the Company adopted Topic 606 using the modified retrospective approach, comparative figures have not been revised and are still reported under prior accounting standards.

The Company derives its revenue from 1) the sale of seed, 2) milling services and 3) research and development services.

The following table disaggregates the Company's revenue by type of contract¹:

Under the production and distribution agreements with Pioneer, the Company grows, processes, and delivers alfalfa seed for and to Pioneer. The Company has concluded that none of the individual activities performed under these contracts are distinct, as the customer is contracting for processed and packaged product.

Pioneer submits a demand plan to the Company in advance of the growing season specifying the amount of seed that it intends to order for the upcoming sales year. The Company is required to use commercially reasonable efforts to arrange for the requisite amount of seed to be grown and to process and package the product as provided for in the contract. Once the demand plan is submitted, Pioneer cannot cancel or reduce the amount of seed that it is obligated to purchase under the agreements. In addition, the Company is not permitted to sell products produced for Pioneer under the agreements to other customers. Therefore, as provided in Topic 606, the Company recognizes revenue from these agreements over time, as it incurs costs to fulfill its obligations.

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To the extent the Company produces more product than Pioneer has specified in its demand plan, the Company must first offer such product to Pioneer. If Pioneer does not purchase such excess product, the Company may sell such product to other customers subject to certain limitations. Revenue from such excess product is recognized as other product revenue, as discussed below.

The agreements specify prices per finished unit which are adjusted each year, up or down, based on current market conditions, by a maximum of 4% per year. The prices for a given crop year are determined one year in advance of the beginning of the sales season.

The Company believes that cost is the best measure of progress under these contracts because no other measure adequately reflects the value added to the product by each of the Company's major tasks - having the crop grown, processing, and packaging. As the Company typically contracts out the growing of seed to third parties, the vast majority of the Company's costs under these agreements are incurred, and therefore the vast majority of the revenue from such agreements is recognized, when the raw seed is purchased from the third-party contract growers. The rest of the costs are incurred, and therefore the rest of the revenue is recognized, as the Company processes and packages the product. Prior to the adoption of Topic 606, revenue from these agreements was recognized when risk and title to the product was transferred, which generally occurs upon shipment.

Revenue from other product sales is recognized at the point in time at which control of the product is transferred to the customer. Generally, this occurs upon shipment of the product. Pricing for such transactions is negotiated and determined at the time the contracts are signed. We have elected the practical expedient that allows us to account for shipping and handling activities as a fulfillment cost, and we accrue those costs when the related revenue is recognized.

The Company does not provide warranties or rights of return to its customer.

Revenue from milling services, which are performed on the customer's product, is recognized as services are completed and the milled product is delivered to the customer.

Revenue from research and development services is recognized over time as the services are performed. R&D services are generally paid for in advance. In fiscal 2019, R&D revenue relates to a single contract in which the customer may decide annually whether to continue the arrangement. Revenue is recognized straight-line over time, as services are expected to be provided roughly evenly throughout the year.

Accounts receivable represent amounts that are payable to the Company by its customers subject only to the passage of time. Payment terms on invoices are generally 30 to 120 days. As the period between the transfer of goods and/or services to the customer and receipt of payment is less than on year, the Company does not separately account for a financing component in its contracts with customers.

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Unbilled receivables represent contract assets that arise when the Company has partially performed under a contract, but is not yet able to invoice the customer until the Company has made additional progress. Unbilled receivables arise from the distribution and production agreements with Pioneer for which the Company recognizes revenue over time, as the Company bills for these arrangements upon product delivery, while revenue is recognized, as described above, as costs are incurred. Unbilled receivables may arise as much as three months before billing is expected to occur. Unbilled receivables are generally expected to be generated in the first and second fiscal quarters, and to be billed in the second, third and fourth fiscal quarters

Losses on accounts receivable and unbilled receivables are recognized if and when it becomes probable that amounts will not be paid. These losses are reversed in subsequent periods if these amounts are paid. During the three months ended September 30, 2018, the Company recognized a gain of $211,200 from collection of a previously impaired accounts receivable.

Total estimated revenue remaining on uncompleted contracts is $94.6 million. This is comprised of $9.7 million remaining on the Pioneer distribution and production agreements which is expected to be recognized in fiscal 2019, an estimated $84.9 million related to fiscal years 2020 - 2023 based on the minimum purchase requirements in the Pioneer distribution agreement and $0.1 million remaining on a research and development services agreement expected to be recognized in fiscal 2019.

The following table summarizes the activity of goodwill for the three months ended September 30, 2018 and the year ended June 30, 2018, respectively.

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Intangible assets consist of the following:

Amortization expense totaled $506,618 and $572,921 for the three months ended September 30, 2018 and 2017, respectively. Estimated aggregate remaining amortization is as follows:

Components of property, plant and equipment were as follows:

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Depreciation expense totaled $348,490 and $315,331 for the three months ended September 30, 2018 and 2017, respectively.

Total debt outstanding is presented on the consolidated balance sheet as follows: