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S&W Seed Company (NASDAQ:SANW)

F3Q 2013 Earnings Conference Call

May 13, 2013 16:30 ET

Executives

Robert Blum - IR

Mark Grewal - CEO

Matt Szot - CFO

Analysts

Michael Cox - Piper Jaffray

Philip Shen – Roth Capital Partners

Frank Smith - Weirton Fund

Operator

Good afternoon and welcome to the S&W Seed Company Third Quarter of Fiscal Year 2013 Financial Results Conference Call. (Operator Instructions). I would now like to turn the conference over to Mr. Robert Blum of Lytham Partners. Please go ahead sir.

Robert Blum

Thank you, Denise, and thank you us for joining us to review the financial results of S&W Seed Company for the third quarter of fiscal year 2013, which ended March 31, 2013. As the conference call operator indicated, my name is Robert Blum. I am with Lytham Partners. We are the Investor Relations consulting firm for S&W Seed Company.

With us on the call representing the Company today are Mark Grewal, President and Chief Executive Officer and Matt Szot, Chief Financial Officer.

After conclusion of today’s prepared remarks, we will open the call for a question-and-answer session. If anyone participating on today’s call does not have a full text copy of the release, you can retrieve it from the company’s website at www.swseedco.com or numerous financial websites.

Before we begin with prepared remarks, we submit for the record the following statements. Statements made by the management team of S&W Seed Company during the course of this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, and Section 21E of the Securities Exchange Act of 1934, as amended and such forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements describe future expectations, plans, results or strategies and are generally preceded by words such as may, future, plan or planned, will or should, expected, anticipates, draft, eventually or projected. Listeners are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, events or results to differ materially from those projected in the forward-looking statements, including the risks that actual results may differ materially from those projected in the forward-looking statements as a result of various factors and other risks identified in the Company’s 10-K for the fiscal year ended June 30, 2012, and other filings made by the Company with the Securities and Exchange Commission.

With that said, let me turn the call over to Mark Grewal, Chief Executive Officer of S&W Seed Company. Mark?

Mark Grewal

Thank you Robert, and good afternoon to all of you. As always we thank you for taking the time to participate on today’s call and we appreciate your continued interest in S&W.

The third quarter was one of strategic importance for S&W Seed Company and will carry for many, many years. When I took over as CEO and the company went public three years ago we set out to build a world class agricultural company built on the backbone of on an established alfalfa seed company that has some of the world’s leading genetics. What we didn’t have was the production capabilities to expand our seed available for sale thus the ability to drive revenue and profit growth. Over the last year we have made good progress in adding production through acquisitions and leases of farmland; the acquisition of a grower base in Imperial Valley of California as well as the continued expansion of our contracted grower base. However on March 17 we announced our largest and most strategic acquisition yet when we acquired Seed Genetics International or SGI based in Adelaide, Australia.

This acquisition creates the largest non-dormant alfalfa seed company in the world. The geographically diversified and year round production in the San Joaquin Valley of California, the Imperial Valley of California and now Southern Australia. Together I believe we boast the industry’s strongest genetics and a top tier breeding program. Our sales channels are highly complementary, reaching across the globe to the middle-east and Africa, North America, South America as well as Southern Europe and Asia.

But this acquisition of SGI is not simply about adding two companies together for the sake of bringing two companies together. Having been in the industry for over 30 years this acquisition was made due to the tremendous synergistic opportunities that exist to drive enhanced shareholder value for years to come. Notably we have the opportunity to cross-sell our existing varieties into each other’s sales channels, create new enhanced blended products designed specifically to excel on certain soil conditions and climates. Convert production acreage to our leading and most sought after varieties, reduce our overall weighted average inventory cost and be better positioned to address the needs of our customers through year around production capabilities.

We can become the single point of contact for all of our customers’ alfalfa seed needs which will drive increased customer loyalty for years to come. We’re extremely pleased to have reached an agreement with the talented seeds men of SGI including Dennis Jury, S&W’s new Vice President of Operations and Mark Harvey, our new Vice Chairman of the Board of Directors. We’re already hitting the ground running and look forward to executing on all the great benefits that the combining of these two companies brings.

Now let’s turn to the production side of our business. Last quarter we announced that we expect to have between 9 million and 10 million pounds of seed available to sale through various sources from the fall 2013 harvest which is an increase from approximately 2.8 million pounds produced by our organic business last fall. We subsequently announced in March that we expected SGI’s ongoing Australian harvest to be approximately 8 million pounds all of which would be available for sale immediately by S&W bringing the total of the two harvests to approximately 17 million pounds to 18 million pounds. With nearly the entire Australian harvest complete we are pleased to announce that we’re now expecting over 9 million pounds of seed available for sale out of Australia versus our original estimate of 8 million pounds which brings the total of the two harvests to approximately 18 million pounds to 19 million pounds.

SGI has done a great job recruiting a strong grower base; we are very pleased with strong results out of Australia.

While the strong harvest out of Australia is certainly a positive for the company also of significance is that hay prices continue to climb. The USDA’s recent report that can be found online has alfalfa hay prices at all-time highs.

I believe these increased prices are being driven by both long term and short term dynamics that are playing out favorably for the alfalfa seed industry. The increasing population growth one which is demanding a westernized diet is placing a strain on the agricultural supply chain. We simply need more acres of hay planted to feed the world. We are off to a very strong start to the 2013-2014 seasons. We have had a strong harvest in Australia and are seeing favorable market dynamics that should keep our price of alfalfa hay at strong levels. There is still lot of work to be done along with the U.S. harvest still to be had; things are shaping up to a very good year for S&W.

Now let me turn the call over to Matt for a review of the financials and I’ll make a few closing comments before we open the call to your questions. Matt?

Matt Szot

Thanks Mark. Let me take a few minutes to review the financial results for the quarter. For the third quarter revenues totaled a record 4.2 million compared to 2.5 million a year ago an increase of 65%. Of the 4.2 million in revenues approximately 3.8 million was derived from the company’s IVS operations which were acquired on October of 2012 and this represents just over 90% of total third quarter revenues.

S&W’s organic business contributed 400,000 as the company focused its sales efforts during the seasonally slow third quarter on limited strategic sales of the vast majority of our existing inventories were ear marked for certain customers and markets. In the prior year third quarter we had 2.5 million in revenue from S&W related varieties which were primarily the result of a large order out of Saudi Arabia that shipped in March 2012. This is purely a timing difference. We continue to expect large orders out of Saudi Arabia however the timing of these first initial seasonal shipments will likely take place in the company’s fourth fiscal quarter.

We continue to make progress in improving our gross margin by product line, while consolidated gross margins excluding stevia were 8.8% compared to 31.4% last year, this is largely a result of the additional IVS related revenues that we generated this quarter compared to last year and they involve lower margin profile.

Specifically to IVS which again represented over 90% of the quarter’s revenue we increased gross margins from 8.5% last quarter to 10% this quarter. We’re pleased with this progress that was made and we’re continuing to place a lot of emphasis in this area. However we are far from content and we have a clear path on how to improve them.

The company made very select strategic sales of S&W varieties during the quarter some of which included certain blends and coating. This impacted our gross margins on our S&W’s related varieties in the third quarter, however this is not indication of what we believe margin should look like for the fourth quarter as we expect to do better than what they were for the cumulative first nine months which was 16.3%. To expand on that further, our ultimate goal is to continue to drive gross margins across the board and to do that by converting contracted production fields to our highest performing varieties.

As we stated this is a process that will gradually occur over the next three years. In the meantime our focus is to improve margins in each area. As we look to Q4 our next fiscal year, we anticipate that gross margins from our core S&W varieties and Australia based SGI varieties will be in the low 20% range. This is a significant improvement from our S&W margins over what I recently mentioned was 16.3% for the first nine months of 2013.

Our gross margins from the IVS related varieties will likely be in the low teens which again should be in proven over the last few quarters. There are clearly a number of factors that can impact these ranges but these are our current best estimates. As we indicated in our press release we incurred a stevia impairment charge of 1.8 million during the third quarter due to (inaudible) site damage suffered on stevia. Mark will have more details on that shortly.

Adjusted non-GAAP net loss for the third quarter of fiscal 2013 excluding the stevia impairment charge and non-recurring tax position related transaction expenses was 640,000 or $0.07 per basic and diluted share compared to a profit of 21,000 or $0.00 for basic and diluted share in the third quarter of fiscal 2012. This is largely attributed to the decrease in higher margin revenues as a result of a large Saudi order last year as well as our increased cost structure as we invest in growth. Including the stevia impairment charge and acquisition related expenses our net loss was 1.9 million or $0.21 per basic and diluted share.

Now the balance sheet remains a huge strength of the company. We ended the quarter with 14.1 million in cash and 23 million in networking capital. In January we paid down the entire 4 million outstanding on our wells line of credit and now therefore have 7.5 million available under our line of credit. The only debt on our balance sheet at the end of March was 3.1 million which pertains to a long term mortgage on the farmland basin Imperial Valley that we acquired in July 2012 and a note to the sellers of IDS.

In March 2013, our Class A warrants became callable with exercised warrants generating growth proceeds of 9.8 million, 5.2 million of which was received during the third quarter and the remaining 4.6 million from the Class A warrants was received in April. If you would include this 4.6 million to our March ending cash position we would have ended the quarter with almost 19 million in cash. We continue to be well positioned to be proactive in the pursuit of agriculture companies to expand upon these platforms we’re building.

Our March inventory balances included 600,000 pounds of proprietary alfalfa seed and 240,000 pounds from IVS. As March mentioned earlier we are extremely pleased with the recent developments in Australia and are now expecting our Australian operations to contribute over 9 million pound to our inventories during this fourth fiscal quarter. Additionally we will be harvesting fields in an Imperial Valley and San Joaquin Valley in July which will bring our total seed expected from 2013 harvest to 18 million to 19 million pounds.

Finally the weighted average basic and diluted shares outstanding during the quarter was 9.1 million and after considering the shares during the SGI acquisition as well as the recent (inaudible) activity there are approximately 11.6 million shares outstanding today.

We’re pleased with the progress we made over last quarter and we’re optimistic that we will be able to continue to drive top-line and bottom-line growth in the future and now I will turn the call back over to Mark.

Mark Grewal

Thanks Matt. As Matt discussed and we mentioned in our press release stevia plans on the properties in Chowchilla and Los Banos have not emerged from the ground as we expected they would and we have just very recently concluded the plants have suffered damage from the application of certain herbicides for weeding. Due to this herbicide damage it is likely that the existing plants will produce the desired levels of leaf that will make it economically viable to continue farming portions of these fields. Our efforts will be continued focus on breeding improved varieties of stevia, perfecting our harvesting and milling techniques, and developing our marketing and distribution programs for stevia products. In order to minimize risk going forward, we have decided to delay new commercial replanting until we have optimized our farming methodology and our new stevia varieties under development are ready for production.

Now turning back to our alfalfa operations with the acquisition of SGI and the entry into Australian based production the seasonality of our business is greatly reduced. We expect that the fourth quarter which has historically been one of the weakest two quarters for the company will be strong revenue and profit driver going forward. We currently have orders for nearly 1/3rd of the Australian harvest that are being prepared for shipment by the end of June that coupled with our existing Imperial Valley shipments and San Joaquin shipments to transit into a very strong and record breaking fourth quarter of fiscal 2013 for the company. As we indicated in our press release we currently anticipate that revenues in the fourth quarter will be between $12 million and $13 million.

I’m very pleased with the progress that has been made this year, we continue to stay focused on our initiative per growth which are to continue to successfully integrate and maximize the S&W, IVS and now SGI business to capture the many synergies that exist between us resulting in improved margins. This is not just one plus one equals two this is like a one plus one equals five. Continue to ramp up alfalfa seed production whether it be domestically or internationally to meet the strong demands that are in the marketplace. Dedicate our stevia resources to the areas where we believe we can obtain the greatest return on our investments in the areas of breeding and product development. Continued to invest in research and developments of S&W a leading provider of high quality alfalfa seed varieties for the non-biotech area, the dormant alfalfa market and continue our efforts to bring to market proprietary biotech alfalfa seed varieties.

And finally we will continue to stay focused on pursuing other opportunities in the agricultural market that will fit into our expanded platform. We’re very confident in our abilities to continue executing upon these initiatives with the goal of positioning S&W to be a leader in the agricultural breeding, production and processing today and into the foreseeable future. And as always we appreciate your support and we remain dedicated to continue repaying your support many times over. With that said let’s open up the call for your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions). The first question will come from Michael Cox of Piper Jaffray. Please go ahead.

Michael Cox - Piper Jaffray

My first question is on your revenue guidance for the fourth quarter, in particular the mix of that revenue. I’m assuming SGI plays a big part of that number but maybe if you can give us framework as how you see preliminary the mix between SGI, IVS and the legacy S&W prior to your germplasm in that that 12 million to 13 million guidance range?

Matt Szot

As Mark mentioned we have orders which we expect to ship for SGI specific with for about 1/3rd of the overall harvest so that’s about 3.3 million pounds, that should generate around $10 million of revenue and the remainder of that range is estimated to come from both IVS and S&W varieties.

Michael Cox - Piper Jaffray

That’s very helpful. That 1/3rd that’s orders booked, you’d have a lot of history on SGI how would that compare to last year or say like a three year average for this time of year?

Matt Szot

Well it's certainly going to up from historical periods. We’re going to be filing an 8-K with historical information on SGI over the next three to four weeks Michael and you will have more clarity at that point.

Michael Cox - Piper Jaffray

Any update on pricing expectations for your proprietary S&W seed for this upcoming selling season, you have given some ranges in the past just wanted to check to see how that’s or give an update on that?

Mark Grewal

Going into the new year I have seen it very strong, so the July and I’m just going to give you some true data. There has been some 17 [loads] [ph] of public varieties that have been purchased directly at the $4 level already. I see the July, August window at the start of the year to be very strong. We’re going to have to see how large a crop that comes off this fall into October to see how that holds but with a number of things that are happening in the world, with the synergies we have with incorporating these companies and our abilities to move into some solid markets into Argentina, expand our Middle-East markets, use the ability to develop branding that’s at a higher level coupled with the water issues in California and the droughts and things like that I see our pricing remain strong. I will tell you if you just yesterday’s (inaudible) report they are talking as much as 26% to 33% reduction in inventory of hay in the United States, mid-west is really big with the downfall coupled that with some other commodity issues and I think it bodes well for alfalfa seed and feed inventory just for cattle.

Michael Cox - Piper Jaffray

Given this margin differential between IVS and your proprietary germplasm can you maybe provide a bit of an update on the time line of converting some of that planted acreage in down in the Imperial Valley towards your proprietary germplasm and the mix lift that would come along with that.

Mark Grewal

Mike, it's a transitional period as we’ve stated in the past, it's a 1 to 3 year transitional operation where we are kind on in the mid-season we are just getting into starting that, you have a company you bought with growers that provide products to that company being IVS that are still under contracts with other seed companies, have other varieties that once they are done with that we will be changed and rotated. Since it's an agricultural deal so you only have one year every year to do a product it's not like making tires every month or some other type of product line. So it is going to be a transitional phase but we believe that within three years we will start to really see some major turnarounds in that margin capability. It will continue to improve.

Michael Cox - Piper Jaffray

Okay and then I guess one last quick one on stevia, sorry to hear about the issues this season. Does that make you rethink how you invest in that space as you look ahead in the next year, do you scale back your project size such that you can control the variables in a different way just any kind of change in thought around the stevia approach.

Mark Grewal

Mike, I mean we have just been dealt this hand, okay. In fact our agronomist they are out in the field right now still analyzing it. We will have updates weeks ahead as far as actual acreage and stuff but we know that we are on the right track; we know that we need to focus on our breeding capabilities. We have the top professor in the United States, Dr. Clinton Shock. He has been working with stevia since 1969.

We have a great crew, we have got a big team, we have a team that’s only focused on stevia and they know what to do and how to do it and so we have to – there are some things that we have to do to improve some of the things that occur but we’re being responsible to our shareholders, we don’t want to pull any things at all. We want to do what’s right and hopefully we’ve taken a conservative approach in this but we’re not leaving the stevia realm, we’re just focusing on bringing in technology. Did I answer that or do you want more?

Operator

Actually he disconnected sir. (Operator Instructions). And the next question will come from Philip Shen of Roth Capital Partners. Please go ahead.

Philip Shen - Roth Capital Partners

My first question is on it's kind of a follow-up and you were talking about conversion of acreage to the proprietary blends for IVS. Can you talk about what the conversion might be if any at all on the acreage in Australia. What’s the strategy there?

Mark Grewal

Okay I will go into a little bit of it Phil. I don’t want to give away everything but the ability to land seed in California and put a California license plate on it has added valued; the ability to make a stronger - they have very high quality seed, as good as in California but California has shown to have a premium over the rest of the world. So our ability to join forces breeds some of our varieties down there, bring some of theirs over here, get our breeders together. It's going to allow us to create newer, higher use varieties that we think will fit the world’s needs and even move into tropical and some other areas on the Asian market front. So we think that this is a very big long term play, we’re very pleased with some of the things our breeders are coming up with. It's going to be very strategic move of germplasm and genetics and how that incorporates in the agronomic geographies around the world.

Philip Shen - Roth Capital Partners

My next one is on; you usually talk about revenue mix for Q4. Can you kind of just talk in general about how you see the revenue mix changing as we get through the year, how do you expect your core alfalfa operations to drive revenues going through ‘14, through ‘13 and into ‘14?

Matt Szot

I will give a further clarity on our production that’s coming on off right now, so it's at 18 million to 19 million pounds that we’re projecting from both the Southern Hemisphere and California harvest, off that 18 million pounds over 50% of that is going to be SGI variety, 25% of that will be S&W proprietary varieties and then the other 25% will most likely be coming from the IDS varieties.

Philip Shen - Roth Capital Partners

And one last one and I will jump back in queue, getting back to stevia I know this is it sounds like it's a relatively fresh event. Have you given any thoughts on how this delays your commercial production and do you have a sense for timing or do you want to reserve that judgment for after you collect more information?

Mark Grewal

Well Phil we didn’t plan anything last year at all. We are solid with what we have, this is going to down size the commercial size just because of the damage that’s occurred, we still will have a commercial operation. We’re still analyzing the actual acres that will be commercialized and so we will still supply some product that fits the needs of peer circle through them and others if it doesn’t meet their quality parameters. So we’re still going to do that. If anything what when you get a lemon and all of a sudden you make lemonade, our breeders are very excited about the prospects of being able to select for herbicide tolerance and also to look at the stuff that continues to emerge.

This is more of an emergence issue that has been delayed by the herbicides and then how far do you go, so we just know that we are doing the right thing it's a slow scale back and we’re happy with while we can make of this with the scientist that we have. So we think we are going to learn a lot from this and we will be better off for it.

Operator

The next question will from Frank Smith of Weirton Fund. Please go ahead.

Frank Smith - Weirton Fund

You guys have been pretty busy here this past quarter, I just want to get a little insight into the area of Asia and diet change there and how much seed demand do you see there and can you just give us a little bit of color on that?

Mark Grewal

Frank when you say seed demand what area of geography are you talking about?

Frank Smith - Weirton Fund

Well Asia you know Philippines that area or South China, areas where the non-dormant can grow.

Mark Grewal

Okay Frank we’re looking at that very hard right now. SGI has done some business in that area, S&W has not currently but what that area is going to be is we are gearing up for dormant type production. So Canadian production, South Dakota we got a couple of growers that are going to be going to South Dakota. So that is China area is going to be more of a dormant. Now the Asian is going to be tropical and so we’re looking at that type of breeding and genetics for that area. I see that Asian market, I don’t know if we ever talked about this but the Israelis went into Vietnam and they built the largest area in the world and they don’t have alfalfa and they don’t have the quality. I know that you have probably read in the press where Chinese people are bringing in powdered milk from Hong Kong and they are bringing it and there is almost, there is severe penalties for doing this. People want to know that their food safe and they want to know where it's from. People want to know that they have really high quality food. This bodes well for S&W, our quality capabilities and the varieties that we can breed.

We have the top breeders in this and genetics, so with the coupling of the Southern Hemisphere, South Australia and what they are working on. We’re going to be very pleased to discuss things in the future. So we think it bodes well, we’re not there yet but it won't take long.

Operator

The next question will come from (inaudible). Please go ahead.

Unidentified Analyst

I just kind of wanted to understand the slowdown in the base business kind on a year-over-year basis, I know you guys have been focusing on the summer season but given kind of the strong pricing fundamentals I just wanted a little more color on that.

Mark Grewal

Well can you I don’t know for sure if I’m understanding you.

Unidentified Analyst

So it looks like yeah I’m just talking about the sales and the base business. It looks like last year they were about 2.5 million and if you apply the fact that this year 90% of the sales were IVS, you’re getting to a number that’s lower than that 2.5 last year.

Mark Grewal

Well last year we shipped an order to Saudi Arabia in March and that’s really just the timing different, that demand is certainly there this year. Anything we’re constrained by our current inventory level the 600,000 pounds of S&W proprietary varieties we have in stock now are year marked for select markets and particular customers that we will be shipping here in the coming months, it's really just a timing difference.

Unidentified Analyst

Okay great so it sounds like for just this quarter this was just – that’s getting pushed forward but if the SGI is about 10 million next year what was the IVS in your fiscal Q4 last year just for modeling purposes say else for IVS in your Q4?

Mark Grewal

We haven't disclosed that quarterly information.

Unidentified Analyst

Because I’m just trying to get a sense if 10 million is SGI and then it looked so would the sales that kind of didn’t happen in your Q3 would those kind of be pushed into Q4 or is that something we would see later?

Mark Grewal

It may be happening for anytime from May through July time period.

Unidentified Analyst

Great. So it sounds like everything is going well there, it's just a question of timing. Okay well thanks guys for the clarity.

Mark Grewal

There are not anymore inventory constraints so we are been very selective in where we are allocating the remaining quantities we have.

Operator

Ladies and gentlemen this will conclude our question and answer session. I would like to turn the call back over to Mark Grewal for any closing remarks.

Mark Grewal

Again I want to thank everyone for participating on today’s call. We look forward to talking to you again at the conclusion of the current quarter and I hope everybody has a good evening. Have a great time. Take care.

Operator

Ladies and gentlemen the conference has now concluded. We thank you for attending today’s presentation. You may now disconnect your line.

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