Notes to Condensed Consolidated Financial Statements

September 30, 2019

(Unaudited)

1. Summary of Business, Basis of Presentation

Marrone Bio Innovations, Inc. (the “Company”), formerly Marrone Organic Innovations, Inc., was incorporated under the laws of the State of Delaware on June 15, 2006, and is located in Davis, California. In July 2012, the Company formed a wholly-owned subsidiary, Marrone Michigan Manufacturing LLC (“MMM LLC”), which holds the assets of a manufacturing plant the Company purchased in July 2012. In September 2019 the Company closed its acquisition of Pro Farm Technologies OY, a Finnish limited company, which consisted of Pro Farm Technology OY and its five subsidiaries Pro Farm International Oy (Finland), Pro Farm OU (Estonia), Pro Farm Technologies Comercio de Insumos Agricolas do Brasil ltda. (Brazil – 99% controlling interest), Pro Farm Inc. (Delaware), and Glinatur SA (Uruguay) (collectively “Pro Farm”). As a result of the acquisition, Pro Farm became a wholly-owned subsidiary of the Company. The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The Company makes bio-based pest management and plant health and nutrition products. The Company targets the major markets that use conventional chemical pesticides, including certain agricultural and water markets where its bio-based products are used as alternatives for, or mixed with, conventional chemical pesticides. The Company also targets new markets for which (i) there are no available conventional chemical pesticides or (ii) the use of conventional chemical pesticides may not be desirable or permissible either because of health and environmental concerns (including for organically certified crops) or because the development of pest resistance has reduced the efficacy of conventional chemical pesticides. The Company delivers EPA-approved and registered biopesticide products and other bio-based products that address the global demand for effective, safe and environmentally responsible products.

Going Concern, Liquidity, and Management Plans

The accompanying condensed consolidated financial statements have been prepared under the assumption that the Company will continue to operate as a going concern, for the 12 months upon the issuance of these condensed consolidated financial statements, which contemplates the realization of assets and the settlement of liabilities in the normal course of business. The condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts of liabilities that may result from any inability of the Company to continue as a going concern.

As of September 30, 2019, the Company had an accumulated deficit of $310,508,000, has incurred significant losses since inception and expects to continue to incur losses for the foreseeable future. The Company had funded operations primarily with net proceeds from public sales and private placements of equity and debt securities and from term loans, as well as with the proceeds from the sale of its products and payments under strategic collaboration and distribution agreements and government grants. The Company will need to generate significant revenue growth to achieve and maintain profitability. As of September 30, 2019, the Company had working capital of $1,200,000, including cash and cash equivalents of $7,899,000. In addition, as of September 30, 2019, the Company had debt and debt due to related parties of $18,309,000 and $7,300,000, respectively, for which the underlying debt agreements contain various financial and non-financial covenants, as well as certain material adverse change clauses. As of September 30, 2019, the Company had a total of $1,560,000 of restricted cash relating to these debt agreements (see Note 7).

The Company’s operating results, including historical prior periods of negative working capital, indicate that substantial doubt exists related to the Company’s ability to continue as a going concern for the next 12 months from the date of issuance of these condensed consolidated financial statements. However, the Company believes that its existing cash and cash equivalents of $3,701,000 at November 15, 2019 together with expected revenues, expected future debt or equity financings, including its ability to call outstanding warrants, and cost management as well as cost reductions will be sufficient to fund operations as currently planned through one year from the date of the issuance of these condensed consolidated financial statements.

In August 2019, the Company entered into a warrant amendment and plan of reorganization agreement (the Warrant Reorganization Agreement) with certain holders of the February 2018 Warrants. Pursuant to the Warrant Reorganization Agreement, the Company has agreed to extend the expiration date under the February 2018 Warrants held by such holders from December 2020 to December 2021, and the holders have agreed, at any time the Company’s stock trades above $1.00 and upon request by the Company, to exercise up to 36,600,000 of their respective February 2018 Warrants, in consideration for the delivery of (x) the shares subject to the February 2018 Warrants so exercised and (y) the delivery of new warrants (“August 2019 Warrants”) to purchase such additional number of shares of common stock equal to the amount of shares so exercised and delivered under February 2018 Warrants. As of the date of these condensed consolidated financial statements, the Company has called the exercise of 10,000,000 shares under the February 2018 Warrants (See Note 3).

In September 2019, the Company completed its asset acquisition of product lines Jet-Ag® and Jet-Oxide® and its acquisition of Pro Farm. The Company utilized an aggregate of $6,393,000 in cash to satisfy the cash consideration component of each transaction, net of the any cash acquired. Additionally, in connection with the acquisitions, the Company has incurred a total of $3,744,000 in advisory, legal and other professional services costs which have been paid or accrued for as of September 30, 2019.

The Company anticipates securing additional sources of cash through equity and/or debt financings, collaborative or other funding arrangements with partners, or through other sources of financing, consistent with historic results. The Company cannot predict, with certainty, the outcome of its actions to grow revenue, to manage or reduce costs or to secure additional financing from outside sources on terms acceptable to the Company or at all. The Company has based this belief on assumptions and estimates that may prove to be wrong, and the Company could spend its available financial resources less or more rapidly than currently expected. The Company may continue to require additional sources of cash for general corporate purposes, which may include operating expenses, working capital to improve and promote its commercially available products, advance and register product candidates, expand international presence and commercialization, general capital expenditures and satisfaction of debt obligations.

The actions discussed above cannot be considered probable of occurring and mitigating the substantial doubt raised by its operating results and satisfying its estimated liquidity needs for 12 months from the issuance of these condensed consolidated financial statements. If the Company becomes unable to continue as a going concern, it may have to liquidate its assets, and stockholders may lose all or part of their investment in the Company’s common stock.

2. Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial information as of September 30, 2019, and for the three and nine months ended September 30, 2019 and 2018, has been prepared by the Company, without audit, in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations and accounting principles applicable for interim periods. However, the Company believes that the disclosures are adequate to make the information presented not misleading. The information included in this Quarterly Report on Form 10-Q should be read in connection with the consolidated financial statements and accompanying notes included in the Company’s Annual Report filed on Form 10-K for the fiscal year ended December 31, 2018.

In the opinion of management, the condensed consolidated financial statements as of September 30, 2019, and for the three and nine months ended September 30, 2019 and 2018, reflect all adjustments, which are normal recurring adjustments, necessary to present a fair statement of financial position, results of operations and cash flows. The results of operations for the three and nine months ended September 30, 2019 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of 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. The Company used significant estimates in accounting for assumptions and estimates associated with acquisition activities in determining the fair values of acquired assets, liabilities and goodwill, assumptions and estimates associated with revenue recognition, including assumptions and estimates used in determining the timing and amount of revenue to recognize for those transactions with variable considerations, fair value of warrants and financial instruments, right-of-use assets and corresponding lease liability, reserves for inventory obsolescence, fair value of stock-based compensation, and in its going concern analysis.

Restricted Cash

The Company’s restricted cash consists of cash that the Company is contractually obligated to maintain in accordance with the terms of its June 2014 Secured Promissory Note. See Note 7 for further discussion.

Concentrations of Risks

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, accounts receivable and debt. The Company deposits its cash and cash equivalents with high credit quality domestic financial institutions with locations in the U.S. and internationally. Such deposits may exceed federal or national deposit insurance limits. The Company believes the financial risks associated with these financial instruments are minimal.

The Company’s customer base is dispersed across many different geographic areas, and currently most customers are pest management distributors in the U.S. Generally, receivables are due up to 120 days from the invoice date and are considered past due after this date, although the Company may offer extended terms from time to time.

The Company’s principal sources of revenues are its Regalia, Grandevo and Venerate product lines. These three product lines accounted for 85% and 95% of the Company’s total revenues for the three months ended September 30, 2019 and 2018, respectively, and 91% and 93% of the Company’s total revenues for the nine months ended September 30, 2019 and 2018, respectively.

Revenues generated from international customers were 11% for each of the three months ended September 30, 2019 and 2018, respectively, and 8% and 11% for the nine months ended September 30, 2019 and 2018, respectively.

Customers to which 10% or more of the Company’s total revenues are attributable for the three months ended September 30, 2019 and 2018 consist of the following:

Customers to which 10% or more of the Company’s total revenues are attributable for the nine months ended September 30, 2019 and 2018, which may or may not correspond with the customers for the periods above, consist of the following:

Customers to which 10% or more of the Company’s outstanding accounts receivable are attributable as of either September 30, 2019 or December 31, 2018, which may or may not correspond with any of the customers above, consist of the following:

Concentrations of Supplier Dependence

The active ingredient in the Company’s Regalia product line is derived from the giant knotweed plant, which the Company obtains from China. The Company currently relies on one supplier for this plant. Such single supplier acquires raw knotweed from numerous regional sources and performs an extraction process on this plant, creating a dried extract that is shipped to the Company’s manufacturing plant. While the Company does not have a long-term supply contract with this supplier, the Company does have a long-term business relationship with this supplier. The Company endeavors to keep 6 months of knotweed extract on hand at any given time, but an unexpected disruption in supply could have an effect on Regalia supply and revenues. Although the Company has identified additional sources of raw knotweed, there can be no assurance that the Company will continue to be able to obtain dried extract from China at a competitive price.

The Company continues to rely on third parties to formulate Grandevo and Zequanox into spray-dried powders, for all of its production of Venerate, Majestene/Zelto, Stargus and Haven, and from time to time, third-party manufacturers for supplemental production capacity to meet excess seasonal demand and for packaging. The Company’s products have been produced in quantities, and on timelines, sufficient to meet commercial demand and for the Company to satisfy its delivery schedules. However, the Company’s dependence upon others for the production of a portion of its products, or for a portion of the manufacturing process, particularly for drying and for all of its production of Venerate, may adversely affect its ability to satisfy demand and meet delivery obligations, as well as to develop and commercialize new products, on a timely and competitive basis. The Company has not entered into any long-term manufacturing or supply agreements for any of its products, and it may need to enter into additional agreements for the commercial development, manufacturing and sale of its products. There can be no assurance that it can do so on favorable terms, if at all.

The Company’s subsidiary Pro Farm currently sources all of its products from one manufacturing plant in Russia, which it owns a 12% interests. While the Company does not have a long-term supply contract with this supplier, the Company does have a long-term business relationship with this supplier. Pro Farm plans for enough inventory on hand to fill its revenue forecasts for 12 months at any given time, but an unexpected disruption in supply could have an adverse effect on the Pro Farm subsidiary’s supply and revenues. Although the Company has identified additional manufacturers who are capable to produce its products, there can be no assurance that the Company will continue to be able to obtain products at a competitive price.

Deferred Revenue

When the Company receives consideration, or such consideration is unconditionally due, from a customer prior to transferring control of goods or services to the customer under the terms of a sales contract, the Company records deferred revenue, which represents a contract liability. The Company recognizes deferred revenue as net sales after the Company has transferred control of the goods or services to the customer and all revenue recognition criteria are met. The Company’s deferred revenue is broken out as follows (in thousands):

Revenue Recognition

Product Sales. The Company recognizes revenue for product sales at a point in time following the transfer of control of such products to the customers, which typically occurs upon shipment or delivery depending on the terms of the underlying contracts. The Company may enter into contracts in which the standalone selling prices (“SSP”) is different from the amount the Company is entitled to bill the customer. As of September 30, 2019, the Company had deferred product revenue in the amount of $348,000 associated primarily with billings in excess of SSP and will be recognized in future periods in conjunction with the transfer of control of such products to the customers.

Licenses Revenues. The Company recognizes license revenues pursuant to strategic collaboration and distribution agreements under which the Company receives payments for the achievement of certain testing validation, regulatory progress and commercialization events. As these activities and payments are associated with exclusive rights that the Company provides in connection with strategic collaboration and distribution agreements over the term of the agreements, revenues related to the payments received are deferred and recognized over the term of the exclusive distribution period of the respective agreement.

Financing Component Revenues. The Company recognizes a financing component, if material, when the Company receives consideration from the customer, and when the Company expects control of the product or service to be transferred to the customer in a period of greater than one year from the date of receipt of the consideration. For the three and nine months ended September 30, 2019 and 2018, the Company recognized an aggregate of $60,000 and $47,000, respectively, and $187,000 and $149,000, respectively of financing component revenues in the aggregate within product and license revenues in the condensed consolidated financial statements.

Revenue recognition requires the Company to make a number of estimates that include variable consideration. For example, customers may receive sales or volume-based pricing incentives or receive incentives for providing the Company with marketing-related information. The Company makes estimates surrounding variable consideration and the net impact to revenues. In making such estimates, significant judgment is required to evaluate assumptions related to the amount of net contract revenues, including the impact of any performance incentives and the likelihood that customers will achieve them. In the event estimates related to variable consideration change, the cumulative effect of these changes is recognized as if the revised estimates had been used since inception of revenue recognition under the contract. Such revisions could occur in any reporting period, and the effects may be material.

From time to time, the Company offers certain product rebates to its distributors and growers, which are estimated and recorded as reductions to product revenues, and an accrued liability is recorded at the later of when the revenues are recorded, or the rebate, is being offered.

Contract Assets. The Company does not have contract assets since revenue is recognized as control of goods are transferred or as services are performed or such contract assets are incurred or expensed within one year of the recognition of the revenue.

Contract Liabilities. The contract liabilities consist of deferred revenue. The Company classifies deferred revenue as current or noncurrent based on the timing of when the Company expects to recognize revenue. Generally all contract liabilities, excluding deferred revenue, are expected to be recognized within one year and are included in accounts payable or accrued liabilities in the Company’s condensed consolidated balance sheet.

Research, Development and Patent Expenses

Research and development expenses include payroll-related expenses, field trial costs, toxicology costs, regulatory costs, consulting costs and lab costs. Patent expenses include legal costs relating to the patents and patent filing costs. These costs are expensed to operations as incurred. For the three months ended September 30, 2019 and 2018, research and development expenses totaled $3,473,000 and $2,381,000, respectively, and patent expenses totaled $287,000 and $277,000, respectively. For the nine months ended September 30, 2019 and 2018, research and development expenses totaled $9,490,000 and $6,898,000, respectively, and patent expenses totaled $846,000 and $787,000, respectively.

Shipping and Handling Costs

Amounts billed for shipping and handling are included as a component of product revenues. Related costs for shipping and handling have been included as a component of cost of product revenues. Shipping and handling costs for the three and nine months ended September 30, 2019 and 2018 were $281,000 and $249,000, respectively, and $998,000 and $705,000, respectively.

Advertising

The Company expenses advertising costs as incurred. Advertising costs for the three and nine months ended September 30, 2019 and 2018 were $173,000 and $192,000, respectively, and $548,000 and $794,000, respectively.

Depreciation and Amortization

The Company depreciates and amortizes its capitalized property, plant, and equipment and intangible assets over the useful life of each asset utilizing a straight-line method of expensing. All depreciation and amortization expenses are included in the “Selling, general, and administrative” caption in the statement of operations.

As of the three and nine months ended September 30, 2019 and 2018 the total amount of depreciation expense were $359,000 and $444,000, respectively, and $1,262,000 and $1,427,000, respectively.

As of the three and nine months ended September 30, 2019 the total amount of amortization expense was $165,000. No similar expense was incurred for the three and nine months ended September 30, 2018.

Foreign currency

Assets and liabilities have been translated to the U.S. dollar reporting currency using the exchange rates in effect on the condensed consolidated balance sheet dates. Equity accounts are translated at historical rates, except for the change in retained earnings during the year which is the result of the income statement translation process. Revenue and expense accounts are translated using the weighted average exchange rate during the period. The cumulative translation adjustments associated with the net assets of foreign subsidiaries are recorded  in “Other income (expense)” in the accompanying condensed statement of operations.

Segment Information

The Company is organized as a single operating segment, whereby its chief operating decision maker assesses the performance of and allocates resources to the business as a whole.

Net Loss Per Share

Net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding for the period. The calculation of basic and diluted net loss per share is the same for all periods presented as the effect of certain potential common stock equivalents, which consist of stock options and warrants to purchase common stock and restricted stock units, and contingent shares to be issued in the future are anti-dilutive due to the Company’s net loss position. Anti-dilutive common stock equivalents are excluded from diluted net loss per share. The following table sets forth the potential shares of common stock as of the end of each period presented that are not included in the calculation of diluted net loss per share because to do so would be anti-dilutive (in thousands):

Recently Adopted Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-02, Leases (Topic 842) Leases: Amendments to the FASB Accounting Standards Codifications (“ASU 2016-02”), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.

The Company adopted ASU 2016-02 in the first quarter of 2019 using the modified-retrospective method. This adoption primarily affected the Company’s condensed consolidated balance sheet based on the recording of Right-of-use assets and Lease liability, current and non-current for its operating leases. The adoption of ASU 2016-02, did not change the Company’s historical classification of these leases or the straight-line recognition of related expenses.

See Note 5 for the effects of the adoption of ASU 2016-02 on the Company’s condensed consolidated financial statements as of January 1, 2019 and for the three and nine months ended September 30, 2019. The adoption of this standard had a material impact on the Company’s condensed consolidated financial statements and is expected to continue to have a material impact for the foreseeable future.

In January 2017, the FASB issued Accounting Standards Updated No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business which adds guidance to assist registrants in the determination of whether an acquisition (or disposal) represents assets or a business – inputs, processes, and outputs. The update provides a screen to determine when an asset is not a business. If substantially all of the fair value of the assets acquired (or disposed) is concentrated in a single asset or a group of similar identifiable assets, the acquired assets do not represent a business. If this test is not met, the update provides further guidance to evaluate if the acquisition represents a business.

The Company prospectively adopted the guidance in the third quarter of fiscal 2019. The adoption primarily impacted the Company’s condensed consolidated balance sheet based on the accounting treatment for the Jet-Ag Acquisition which could have otherwise been treated as a business combination had the acquired asset not met the screen test outlined in the ASU. The Company did not perform further analysis related to the treatment of the Jet-Ag Acquisition upon the results of the screen test. See Note 3 for the effects of the adoption of ASU 2017-01 on the Company’s condense consolidated financial statements as of July 1, 2019 and for the three and nine months ended September 30, 2019. The adoption of this standard has a material impact on the Company’s condensed consolidated financial statements and is expected to continue to have a material impact for the foreseeable future.

3. Acquisitions

The Company contemplates business combinations and acquisition opportunities that align with the Company’s overall strategy. Acquisitions are accounted for under Accounting Standards Codification (“ASC”) 805 Business Combinations based on the facts and circumstances of the transaction.

Jet-Ag

On September 10, 2019, the Company completed the purchase of substantially all rights and assets related to the Jet-Ag® and Jet-Oxide® product lines from Austin Grant, Inc., a Florida corporation d/b/a Jet Harvest Solutions, for approximately $2,534,000 in cash, of which $544,200 was paid upon closing and the remainder is to be paid in four installments over an 16-month window (the “Jet-Ag Acquisition”). The Jet-Ag Acquisition is accounted for as an asset acquisition consistent with ASC 2017-01, which requires that substantially all of the fair value of the gross assets acquired is concentrated in a single asset or a group of similar assets. The asset purchase agreement also contains a provision providing five yearly earn out payments from 2020 through 2024 based on the Company’s total future sales of Jet-Ag purchased through a specified supplier. The fair value of the contingent consideration was estimated at $190,000 at the close date of the transaction which the Company has included in its total cost to be allocated to the acquired assets. The Company intends to assess its contingent consideration estimate periodically upon the settlement of the revenue contingency at each interim reporting period. Acquisition costs of $117,000 were also included in the total consideration for the Jet-Ag Acquisition to be allocated among the acquired assets. The allocation of the total consideration was based on each of the acquired asset’s relative fair values as follows (in thousands):

The fair value of the acquired customer list, trade name and non-compete assets were estimated using either a relief-from-royalty or multiperiod excess earning method to calculate the fair value of the assets acquired, based on management’s forecasted cash inflows and outflows. Each of the intangible assets are being amortized within the expense reflected in “Selling, general and administrative” expenses in the condensed consolidated statement of operations. The preliminary amortization periods for the customer list, trade name and non-compete are 15 years, 15 years and 6 years, respectively.

Pro Farm Technologies OY

On September 13, 2019, the Company completed its acquisition of 100% of the outstanding shares of Pro Farm Technologies OY, a Finnish limited company (“Pro Farm”) for consideration valued at approximately $28,076,000 (the “Pro Farm Acquisition”). Total consideration consisted of cash payments of $2,843,000 to beneficial owners and $3,178,000 in debt repayments made on behalf of Pro Farm, issuance of a total of 12,666,000 of the Company’s common stock, at the closing market price of $1.59, for an aggregate fair value of $20,299,000, inclusive of 100,000 restricted stock units at a fair value of $159,000 awarded to a key employee and the fair value of up to $7,500,000 of contingent consideration subject to the achievement of certain distributor, revenue, earnings before interest, taxes, depreciation and amortization, and debt and equity milestones from the date of the closing through December 31, 2024, fair valued at $1,755,000. The Pro Farm acquisition meets the definition of a business in accordance with ASC 805 “Business Combinations”, which requires, among other things, that assets acquired and liabilities assumed be recognized at fair value as of the acquisition date and that the results of operations of the acquired business be included in the condensed consolidated statements of operations from the respective date of the acquisition based on the significance of the transaction to the Company’s own condensed consolidated financial statements. The goodwill recorded as a result of the acquisition represents the strategic benefits of growing the Company’s future revenues and product portfolio and the expected revenue growth from increased market penetration. The goodwill is not deductible for income tax purposes.

Certain estimated fair values are not yet finalized and are subject to change, which could be significant. The Company expects to finalize its purchase accounting by the end of the second quarter of fiscal year 2020 when it has completed its assessment of certain consideration adjustments and completed the assessment of deferred taxes and uncertain tax positions. Amounts for acquired current assets and liabilities, deferred tax liabilities, intangibles and goodwill also remain subject to change. The preliminary estimated fair values of the assets acquired, and liabilities assumed are as follows (in thousands):

Tangible assets and liabilities acquired were recorded at their preliminary fair values on the date of close based on management's preliminary assessment. The purchase price allocated to developed technology, in process technology and trade name were estimated using either a relief-from-royalty or multiperiod excess earning method to calculate the fair value of the assets purchased, based on management’s forecasted cash inflows and outflows. All intangible assets are being amortized with the expense reflected in “Selling, general and administrative” expenses in the condensed consolidated statement of operations. The preliminary amortization period for intangible assets acquired has been estimated between 10 and 11 years. The net deferred income tax liability represents the net amount of the estimated future impact of adjustments for any costs to be recognized as intangible asset amortization, which is not deductible for income tax purposes and transfer pricing exposure offset by the deferred tax asset for the preliminary calculation of NOLs.

Acquisition costs are recorded in “Selling, general and administrative” expenses as incurred. As of September 30, 2019 the Company has incurred expenses of $2,724,000 in connection with the Pro Farm Acquisition. The Pro Farm Acquisition was financed through the Company’s exercise of 10,000,000 warrants in connection with the Company’s warrant call option under the Warrant Reorganization Agreement (see Note 8).

The condensed consolidated statement of operation include $119,000 of product revenues and $276,000 of operating expenses from Pro Farm for the period from September 14, 2019 through September 30, 2019. The following unaudited pro forma results of operations assume the Pro Farm acquisition had occurred on January 1, 2019 (in thousands):

Significant pro forma adjustments incorporated into the pro forma results above include elimination of nonrecurring acquisition-related costs incurred prior to the close of the Pro Farm Acquisition, amortization of acquired intangible assets. These pro forma results are based on estimates and assumptions, which the Company believes are reasonable. They are prepared for comparative purposes only and do not necessarily reflect the results that would have been realized had the Pro Farm Acquisition occurred at the beginning of the period ended September 30, 2019 and are not necessarily indicative of the Company’s consolidated results of operations in future periods.

4. Inventories

Inventories, net consist of the following (in thousands):

As of September 30, 2019 and December 31, 2018, the Company had $268,000 and $579,000, respectively, in reserves against its inventories.

5. Right-Of-Use of Assets and Lease Liability

On January 1, 2019, the Company adopted ASU No. 2016-02, “Leases (Topic 842)” (ASU 2016-02) using the modified retrospective transition method allowing it to apply the new standard at the adoption date and to recognize a cumulative-effect adjustment to the opening balance of retained earnings on the date of adoption. Under this transition method, the prior comparative period continues to be reported under the accounting standards in effect for that period.

The Company elected to use the package of practical expedients permitted which allows (i) an entity not to reassess whether any expired or existing contracts are or contain leases; (ii) an entity need not reassess the lease classification for any expired or existing leases; and (iii) an entity need not reassess any initial direct costs for any existing leases. The Company made an accounting policy election to adopt the short-term lease exception which allows the Company to not recognize on the balance sheet those leases with terms of 12 months or less resulting in short-term lease payments being recognized in the condensed consolidated statements of income on a straight-line basis over the lease term. All of the Company’s leases were previously classified as operating and are similarly classified as operating lease under the new standard.

Adoption of the new standard resulted in recognition of both right-of-use assets and lease liabilities of approximately $5,324,000 and $5,510,000 as of January 1, 2019, respectively. As the right-of-use assets and lease liabilities were substantially the same at adoption, the Company did not record a cumulative effect adjustment to the opening balance of retained earnings.

The Company’s operating leases have remaining terms ranging from less than one year to five years. The leases are for office space and various office equipment. The Company determines if an arrangement includes a lease at the inception of the agreement and the right-of-use asset and lease liability is determined at the lease commencement date and is based on the present value of estimated lease payments. The Company’s lease agreements contain both fixed and variable lease payments, none of which are based on a rate or an index. Fixed lease payments are included in the determination of the right-of-use asset and lease liability. Variable lease payments that are not based on a rate or index are expensed when incurred. The present value of estimated lease payments is determined utilizing the rate implicit in the lease agreement if that rate can be determined. If the implicit rate cannot be determined, the present value of estimated lease payments is determined utilizing the Company’s incremental borrowing rate. The incremental borrowing rate is determined at the lease commencement date and is estimated utilizing similar or collateralized borrowing instruments adjusted for the terms of leasing arrangement as necessary. Some of the leases include an option to renew that can extend the lease term. For those leases which are reasonably certain to be renewed, the Company included the renewal period in the lease term. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. As of September 30, 2019, the weighted average incremental borrowing rate and the weighted average remaining lease term for the operating leases held by the Company were 7.03% and 5 years, respectively.

The components of lease expense were as follows (in thousands):

Other information (in thousands)

Maturities of lease liabilities for each future calendar year as of September 30, 2019 are as follows (in thousands):

6. Accrued Liabilities

Accrued liabilities consist of the following (in thousands):

The Company warrants the specifications of its products through implied product warranties and has extended product warranties to qualifying customers on a contractual basis. The Company estimates the costs that may be incurred during the warranty period and records a liability in the amount of such costs at the time product is shipped. The Company’s estimate is based on historical experience and estimates of future warranty costs as a result of increasing usage of the Company’s products. During the three months ended September 30, 2019 and 2018, the Company recognized $75,500 and $58,000, respectively in warranty expense associated with product shipments for the period. This expense was reduced by $29,000 for the three months ended September 30, 2019 as a result of warranty claims being lower than previously estimated and during the three months ended September 30, 2019 the Company recognized $29,000 in warranty claims. During the nine months ended September 30, 2019 and 2018, the Company recognized $245,000 and $215,000, respectively in warranty expense associated with product shipments for the period. This expense was reduced by $173,000 for the nine months ended September 30, 2019 as a result of the historical usage of warranty reserves being lower than previously estimated. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amount as necessary. Changes in the Company’s accrued warranty costs during the period are as follows (in thousands):

7. Debt

Debt, including debt due to related parties, consists of the following (in thousands):

As of September 30, 2019, aggregate contractual future principal payments on the Company’s debt, including debt due to related parties for each calendar year, are due as follows (in thousands):

The following is a reconciliation of interest expense for the debt outstanding during the three and nine months ended September 30, 2019 and 2018 (in thousands).

Secured Promissory Notes

On October 2, 2012, the Company borrowed $7,500,000 pursuant to senior notes (the “October 2012 Secured Promissory Notes”) with a group of lenders. On April 10, 2013 (“Conversion Date”), the Company entered into an amendment to increase, by up to $5,000,000, the amount available under the terms of the loan agreement with respect to the October 2012 Secured Promissory Notes. Under this amendment, an additional $4,950,000 was issued in partial consideration for $3,700,000 in cash received and in partial conversion for the cancellation of a $1,250,000 subordinated convertible note (collectively, the “April 2013 Secured Promissory Notes”). The total amount borrowed under the amended loan agreement for the October 2012 Secured Promissory Notes and the April 2013 Secured Promissory Notes increased from $7,500,000 to $12,450,000.

On February 5, 2018, the Company converted, pursuant to an amendment, dated December 15, 2017, to the October 2012 and April 2013 Secured Promissory Notes, $10,000,000 aggregate principal amount of indebtedness outstanding under the October 2012 and April 2013 Secured Promissory Notes to an aggregate of 5,714,285 shares of common stock and warrants to purchase 1,142,856 shares of common stock (such conversion, the “Snyder Debt Conversion”), such that $2,450,000 of principal under the October 2012 and April 2013 Secured Promissory Notes is outstanding as of September 30, 2019. Simultaneously with the Snyder Debt Conversion, the maturity of the October 2012 and April 2013 Secured Promissory Notes was extended to December 31, 2022 (“Maturity Date”), the interest was reduced from 14% to 8% and all interest payments under the October 2012 and April 2013 Secured Promissory Notes were deferred to the Maturity Date.

The October 2012 and April 2013 Secured Promissory Notes contain representations and warranties by the Company and the lender, certain indemnification provisions in favor of the lenders and customary covenants (including limitations on other debt, liens, acquisitions, investments and dividends), and events of default (including payment defaults, breaches of covenants, a material impairment in the lender’s security interest or in the collateral, and events relating to bankruptcy or insolvency). The October 2012 and April 2013 Secured Promissory Notes contain several restrictive covenants. The Company is in compliance with all related covenants, or has received an appropriate waiver of these covenants.

In conjunction with the Snyder Debt Conversion, the Company accounted for the partial debt extinguishment under the troubled debt restructuring accounting guidance. The Company recognized a gain of $3,014,000 for the nine months ended September 30, 2018 on partial extinguishment of the October 2012 and April 2013 Secured Promissory Notes, which included the recognition of the debt discount. Because the Company recognized a gain on the partial extinguishment of debt, the Company was required to include all future interest and additional consideration, which included accrued interest, under the terms of this agreement as a reduction of the gain. As a result, the amount of the debt on the Company’s consolidated balance sheet related to the October 2012 and April 2013 Secured Promissory Notes is $3,425,000, as compared to $2,450,000 of contractual principal outstanding thereunder. Going forward, subject to future amendments to debt agreement or costs, the Company will not recognize future interest expense on the October 2012 and April 2013 Secured Promissory Notes.

The accounting for the change due to the Snyder Debt Conversion is as follows (in thousands):

Additionally, in conjunction with the terms of the October 2012 Secured Promissory Notes and the April 2013 Secured Promissory Notes, the Company agreed to pay a fee of 7% of the funded principal amount to the agent that facilitated the 2018 February Financing Transactions between the Company and the collective lenders. As part of the Snyder Debt Conversion, the Company renegotiated the Agent Fee, which resulted in 498,000 shares of the Company’s common stock being issuable to the agent in lieu of a cash payment for services. These shares are issuable at the Maturity Date of the note. The Company has included this liability in other non-current liabilities. The change in the value of the agent fee and the fair value of the common stock granted in lieu of cash was also included in the gain on partial extinguishment of debt as follows (in thousands):

June 2014 Secured Promissory Note

In June 2014, the Company borrowed $10,000,000 pursuant to a business loan agreement and promissory note (“June 2014 Secured Promissory Note”) with Five Star Bank that bears interest at 7.5% as of September 30, 2019. The interest rate is subject to change and is based on the prime rate plus 2.00% per annum. The June 2014 Secured Promissory Note is repayable in monthly payments of $76,286 and adjusted from time-to-time as the interest rate changes, with the final payment due in June 2036. The Company is required to maintain a deposit balance with the Five Star Bank of $1,560,000, which is recorded as restricted cash included in non-current assets.

Under this note the Company is required to maintain a current ratio of not less than 1.25-to-1.0, a debt-to-worth ratio of no greater than 4.0-to-1.0 and a loan-to-value ratio of no greater than 70% as determined by Five Star Bank. The Company is also required to comply with certain affirmative and negative covenants under the loan agreement discussed above. In the event of default on the debt, Five Star Bank may declare the entire unpaid principal and interest immediately due and payable. As of September 30, 2019, the Company was in compliance with the “loan to value ratio” covenant, however was not in compliance with the “current ratio”, nor the “debt to worth ratio” and, potentially, a requirement that no material adverse situation shall have occurred, given the Company’s current going concern assessment and the requirement that there be no unapproved compensation increases for the Company’s executives for calendar year 2019. However, the Company has obtained a waiver from the lender for any non-compliance through November 20, 2020.

The following table reflects the activity under this note (in thousands):

Secured Convertible Promissory Note

On October 12, 2017, the Company and Dwight W. Anderson (“Anderson”) entered into a $1,000,000 convertible promissory note, which was restated in its entirety by a convertible promissory note entered into by the Company and Anderson on October 23, 2017 (the “October 2017 Convertible Note”). The October 2017 Convertible Note was an unsecured promissory note in the aggregate principal amount of up to $6,000,000, was subject to Anderson’s approval and due on October 23, 2020 (the “Anderson Maturity Date”).

On December 15, 2017, the Company entered into the Securities Purchase Agreement with an affiliate of Anderson and certain other accredited investors (collectively, the “Buyers”). In conjunction with the transaction contemplated in the Securities Purchase Agreement, Anderson was entitled to convert any portion of the balance outstanding under the October 2017 Convertible Note and any accrued interest into shares of the Company’s common stock at a rate of one share of common stock per $0.50. Anderson’s ability to affect conversions at the $0.50 rate was subject to, among other things, approval of the Company’s stockholders, which was received on January 31, 2018.

On December 22, 2017, the Company and Anderson amended and restated in its entirety the terms of the October 2017 Convertible Note (“Secured December 2017 Convertible Note”). Under the amendment, the Secured December 2017 Convertible Note became a secured promissory note and the maturity date was reverted to the original terms, due on October 12, 2020 (the “Maturity Date”). The interest rate and conversion terms of the Secured December 2017 Convertible Note remain unchanged from the terms of the October 2017 Convertible Note as described above. As of December 31, 2017, the outstanding principal balance under the Secured December Convertible Note was $4,000,000, exclusive of a $510,000 discount. In January 2018, the Company borrowed the remaining available principal under the Secured December 2017 Convertible Note of $2,000,000, exclusive of an additional derivative liability discount of $574,000.

On February 5, 2018, the holder converted the entire outstanding principal of $6,000,000 under the Secured December 2017 Convertible Note into 12,000,000 each common stock and warrants units in accordance with the terms of the Securities Purchase Agreement which provided for conversion of the outstanding balance at a rate of $0.50 per common share. Upon the conversion on February 5, 2018, the outstanding principal balance under the Secured December 2017 Convertible Note was reduced to zero.

The Company accounted for the full conversion of the Secured December 2017 Convertible Note using the accounting guidance related to an induced debt conversion. Under the induced conversion guidance, the Company recognized a loss on conversion in the amount of $11,634,000 associated with the change between the debt’s original terms and the induced conversion terms. This loss related to the induced conversion feature was partially offset by a gain on extinguishment of $6,424,000 related to the fair value of the derivative liability on the date of conversion.

The following table reflects the accounting for the activities under the Secured December 2017 Convertible Note as follows (in thousands):

LSQ Financing

On March 24, 2017, the Company entered into an Invoice Purchase Agreement (the “LSQ Financing”) with LSQ Funding Group, L.C. (“LSQ”), pursuant to which LSQ may elect to purchase up to $7,000,000 of eligible customer invoices from the Company. The Company’s obligations under the LSQ Financing are secured by a lien on substantially all of the Company’s personal property; such lien is first priority with respect to the Company’s accounts receivable, inventory, and related property.

Advances by LSQ may be made at an advance rate of up to 80% of the face value of the receivables being sold. Upon the sale of the receivable, the Company will not maintain servicing. LSQ may require the Company to repurchase accounts receivable if (i) the payment is disputed by the account debtor, with the purchaser being under no obligation to determine the bona fides of such dispute, (ii) the account debtor has become insolvent or (iii) upon the effective date of the termination of the LSQ Financing. LSQ will retain its security interest in any accounts repurchased from the Company.

Under the initial agreement the Company would also pay to LSQ (i) an invoice purchase fee equal to 1.00% of the face amount of each purchased invoice, at the time of the purchase, and (ii) a funds usage fee equal to 0.035%, payable monthly in arrears. An aging and collection fee would be charged at the time when the purchased invoice is collected, calculated as a percentage of the face amount of such invoice while unpaid (which percentage ranges from 0% to 0.35% depending upon the duration the invoice remains outstanding).

In June 2018, the Company amended the LSQ Financing arrangement and effectively (i) decreased the invoice purchase fee from 1.00% to a range of 0.40% to 1.00%, (ii) decreased the funds usage fee from 0.035% to a range of 0.020% to 0.035% and (iii) extended the term of the agreement to June 30, 2019. In June 2019, the Company and LSQ Financing mutually agreed to further extend the terms of the LSQ Financing arrangement through November 2019.

The agreement contains representations and warranties by the Company and LSQ, certain indemnification provisions in favor of LSQ and customary covenants (including limitations on other debt, liens, acquisitions, investments and dividends), and events of default (including payment defaults, breaches of covenants, a material impairment in LSQ’s security interest or in the collateral, and events relating to bankruptcy or insolvency). The Company is in compliance with all terms of the agreement. As of September 30, 2019, $4,957,000 was outstanding under the LSQ Financing.

September 2018 Research Facility

On September 4, 2018, the Company’s subsidiary Pro Farm entered into a research loan facility under the Finnish Government Innovation Funding initiative with the Innovation Centre Business Finland, in the amount of $326,000 (€282,000). Pro Farm subsequently drew down $94,000 (€80,000) on September 21, 2018 in connection with research and development costs. The note bears interest at 3% below the reference rate for Finnish Government Aid, with a minimum of 1% interest annually. The current effective interest rate as of September 30, 2019 is 3.82%. The loan facility requires repayment in increments of 25% on each of the anniversary date of the loan after the third anniversary of the loan execution date as such the balance of the loan has been classified as long term. The terms of the loan facility allow for partial debt forgiveness if so determined by the State Council for the Financing of Research, Development and Innovation at the lender’s discretion. As of September 30, 2019, the outstanding principal balance net of imputed interest was $83,000 (€72,000).

September 2018 Bank Facility

On September 10, 2018, the Company’s subsidiary Pro Farm entered into a bank facility with Nordea Bank AB, under which the Company may borrow up to $266,000 (€230,000). The note bears interest at the Euribor three-month rates plus 2.4% which as of September 30, 2019 was increased to 2.60%. The bank facility includes a usage commitment fee of 0.95% and required repayment on its maturity date of February 28, 2019. On February 20, 2018, the bank facility was extended until August 31, 2019, and on August 30, 2019, the bank facility was again extended until February 29, 2020, The bank facility is 60% guaranteed by Export Credit Agency of Finland. In connection with the guarantee the Company pays a fee of 2.49% to the guarantor. As of September 30, 2019, the amount outstanding on the bank facility was $63,000 (€55,000).

March 2019 Factoring

On March 27, 2019, the Company’s subsidiary Pro Farm entered into a factoring agreement with Bab al Khail General Trading (“Bab al Khail”), in the amount of $1,314,000. The Bab al Khail agreement bears interest at an annual rate of 15% and matures on December 17, 2019. Certain of Pro Farm account receivables are pledged as collateral under the agreement. As of September 30, 2019, the amount outstanding under the factoring agreement was $1,315,000 (€1,163,200), which includes interest.

8. Warrants

On August 6, 2019, the Company entered into a warrant amendment and plan of reorganization agreement (“Warrant Reorganization Agreement”) with certain holders of the February 2018 Warrants. Pursuant to the Warrant Reorganization Agreement, the Company has agreed to extend the expiration date under the February 2018 Warrants held by such holders from December 2020 to December 2021, and the holders have agreed, at any time the Company’s stock trades above $1.00 and upon request by the Company, to exercise up to 36,600,000 of their respective February 2018 Warrants, in consideration for the delivery of (x) the shares subject to the February 2018 Warrants so exercised and (y) the delivery of new warrants (“August 2019 Warrants”) to purchase such additional number of shares of common stock equal to the amount of shares so exercised and delivered under February 2018 Warrants. Accordingly, up to a maximum of 36,600,000 new shares may be issued pursuant to the August 2019 Warrants, to the extent the Company exercises its rights to require exercise of the February 2018 Warrants.

The Warrant Reorganization Agreement was treated as a modification of an equity-classified instrument, which did not result in a change in the classification of the instrument pre- and post-modification. Analogizing to Accounting Standards Codification (“ASC”) 718 – Compensation – Stock Compensation, the Company accounted for the modification similarly to modification of stock option awards, which requires the Company to assess the fair value of the instrument pre- and post-modification. As a result of the modification of the February 2018 Warrants, the Company incurred a non-cash charge of $1,564,000, consistent with the increase in the fair value of the warrants which were not immediately called under the terms of the Warrant Reorganization Agreement.

The Company’s fair value of the warrant post modification was estimated utilizing a Monte Carlo univariate option pricing model based on the following assumptions which have been determined consistent with the Company’s historical methodology for such assumptions:

Expected Life. Expected life represents the period that the warrants are expected to be outstanding. The Company estimates the contractual period, the period between the date of the modification and the expiration date of the warrant, which is an appropriate estimate of the expected term.

Estimated Volatility Factor. As the Company’s common stock has a limited period of normalized trading history, the Company calculated the estimated volatility factor based on the Company’s trading history and calculated volatility of the common stock of comparable agricultural biotechnology companies. The Company’s estimation of the volatility factor gives weighting to both the volatility of its common stock and the volatility of the common stock of comparable agricultural biotechnology companies.

Risk-Free Interest Rate. The Company calculates the risk-free interest rate based on the implied yield currently available on U.S. Treasury constant-maturity securities with the same or substantially equivalent remaining term as the expected life of the stock options.

Expected Dividend Yield. The Company has not declared dividends, nor does it expect to in the foreseeable future. Therefore, a zero value was assumed for the expected dividend yield.

The August 2019 Warrants have a term expiring on January 1, 2023, an exercise price of $1.75 per share, and are first exercisable 180 days after issuance. The August 2019 Warrants are exercisable in cash, provided that they may be exercised via net exercise if the Company does not have a registration statement registering the shares underlying the August 2019 Warrants effective as of June 30, 2020. On August 7, 2019, the Company requested under the Warrant Reorganization Agreement, the exercise of 10,000,000 February 2018 Warrants, resulting in the Company issuing 10,000,000 common shares and 10,000,000 August 2019 Warrants. The issuance of the August 2019 Warrants resulted in the Company incurring non-cash charge of $4,751,000 in connection with the fair value of new warrants.

The Company’s fair value of the new warrants issued was estimated utilizing a Black Scholes option pricing model. Due to the insignificant time lapse between the warrant call and the date of the warrant modification, the same assumptions as outlined above were utilized to fair value the new warrants issued in connection with the warrant exercise.

The following table summarizes information about the Company’s common stock warrants outstanding as of September 30, 2019 (in thousands, except exercise price data):

The weighted average remaining contractual life and exercise price for these warrants is 2.37 years and $1.24, respectively.

9. Share-Based Plans

On May 31, 2019, the Company’s stockholders approved an Employee Stock Purchase Plan (the “ESPP”) whereby employees may purchase Company stock through payroll deductions over each six-month period beginning on June 1 and December 1 (the “Offer Period”). The total maximum number of shares available for purchase under the ESPP is 1,000,000. The purchase price of the shares will be 85% of the lower of the fair market value of the shares at the beginning or at the end of the Offer Period. The ESPP is a tax qualified plan under Section 423 of the Internal Revenue Code. All employees, including officers, are eligible to participate in the ESPP. A participant may withdraw all uninvested payment balances credited to their account at any time. An employee whose stock ownership in the Company exceeds 5% of the Company’s outstanding common stock is not eligible to participate in the ESPP. The ESPP is compensatory and the 15% discount will be expensed over the Offer Period. The Company has accounted for the ESPP in accordance with ASC 718, Compensation – Stock Based Compensation. As of the three and nine months ended September 30, 2019 the Company recorded stock-based compensation expense of approximately $13,000 and $18,000, respectively.

As of September 30, 2019, there were options to purchase 12,056,000 shares of common stock outstanding, 1,918,000 restricted stock units outstanding and 4,269,000 share-based awards available for grant under the outstanding equity incentive plans.

For the three and nine months ended September 30, 2019 and 2018, the Company recognized share-based compensation of $742,000 and $437,000, respectively, and $1,906,000 and $1,310,000, respectively.

During the three months ended September 30, 2019 and 2018, the Company granted options to purchase 5,363,000 and 39,000 shares of common stock, respectively, at a weighted average exercise price of $1.43 and $1.99, respectively. During the three months ended September 30, 2019 and 2018, 13,000 and 53,000 options, respectively, were exercised at a weighted average exercise price of $1.16 and $1.17, respectively.

The Company’s fair value of the option grants for the three months ended September 30, 2019 was estimated utilizing a Black Scholes option pricing model based on the following range of assumptions which have determined consistent with the Company’s historical methodology for such assumptions:

Expected Life.  Expected life represents the period that share-based payment awards are expected to be outstanding. The Company uses the “simplified method” in accordance with Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment (“SAB No. 107”), and SAB No. 110, Simplified Method for Plain Vanilla Share Options (“SAB No. 110”), to calculate the expected term of stock options determined to be “plain vanilla.” Under this approach, the expected term is presumed to be the midpoint between the vesting date and the contractual end of the stock option grant. For stock options granted with an exercise price not equal to the determined fair value, the Company estimates the expected life based on historical data and management’s expectations about exercises and post-vesting termination behavior. The Company will use the simplified method until it has sufficient historical data necessary to provide a reasonable estimate of expected life in accordance with SAB No. 107 and SAB No. 110.

Estimated Volatility Factor. As the Company’s common stock has limited period of normalized trading history, the Company calculated the estimated volatility factor based on the Company’s trading history and calculated volatility of the common stock of comparable agricultural biotechnology companies. The Company’s estimation of the volatility factor gives weighting to both the volatility of its common stock and the volatility of the common stock of comparable agricultural biotechnology companies. 

Risk-Free Interest Rate. The Company calculates the risk-free interest rate based on the implied yield currently available on U.S. Treasury constant-maturity securities with the same or substantially equivalent remaining term as the expected life of the stock options.

Expected Dividend Yield. The Company has not declared dividends, nor does it expect to in the foreseeable future. Therefore, a zero value was assumed for the expected dividend yield.

During the nine months ended September 30, 2019 and 2018, the Company granted options to purchase 5,485,000 and 4,509,000 shares of common stock, respectively, at a weighted average exercise price of $1.43 and $1.78, respectively. During the nine months ended September 30, 2019 and 2018, 47,000 and 56,000 options, respectively, were exercised at a weighted average exercise price of $1.18 and $1.17, respectively.

The following table summarizes the activity of stock options from December 31, 2018 to September 30, 2019 (in thousands, except weighted average exercise price):

The following table summarizes the activity of restricted stock units from December 31, 2018 to September 30, 2019 (in thousands, except weighted average grant date fair value):