A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management’s assessment. Policies were inadequate related to the retention of financial experts providing assistance in financial transactions. Additionally, the Company did not perform timely, comprehensive reviews of financial transactions, the collectibility of accounts receivable or the potential impairment of goodwill. These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2007 financial statements, and this report does not affect our report dated March 17, 2008.

In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2007, based on “criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).”

 

/s/ Perry-Smith LLP
Perry-Smith LLP Sacramento, California March 17, 2008

 

F-2

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REPORT OF INDEPENDENT REGISTERED

PUBLIC ACCOUNTING FIRM

 

Board of Directors

NutraCea and subsidiaries

El Dorado Hills, California

 

We have audited the accompanying consolidated statement of operations, comprehensive loss, changes in shareholders’ equity, and cash flows for year ended December 31, 2005. These financial statements are the responsibility of NutraCea’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NutraCea as of December 31, 2005, and the results of its operations and its cash flows for the one year then ended, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Malone & Bailey, PC
MALONE & BAILEY, PC www.malone-bailey.com Houston, Texas   March 15, 2006

 

F-3

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NUTRACEA AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

		As of December 31,
		2007			2006
ASSETS
Current assets:
Cash and cash equivalents		$	41,298,000		$	14,867,000
Restricted cash			758,000			-
Marketable securities			-			368,000
Trade accounts receivables, net of allowance for doubtful
accounts of $2,999,000 and $20,000, respectively			2,346,000			7,093,000
Inventories			1,808,000			796,000
Notes receivable, current portion, net of allowance for doubtful
notes receivable of $250,000 and $0, respectively			2,936,000			1,694,000
Deposits and other current assets			2,545,000			1,383,000
Total current assets			51,691,000			26,201,000
Restricted cash			1,791,000			-
Notes receivable, net of current portion			5,039,000			682,000
Property and equipment, net of accumulated depreciation			19,328,000			8,961,000
Investment in joint venture			1,191,000			-
Patents and trademarks, net of accumulated amortization			5,743,000			5,097,000
Goodwill			39,510,000			32,314,000
Total assets		$	124,293,000		$	73,255,000
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued liabilities		$	7,506,000		$	2,778,000
Deferred revenue			90,000			103,000
Note payable, current portion			23,000			-
Total current liabilities			7,619,000			2,881,000
Long-term liabilities:
Notes payable, net of current portion			77,000			-
Total liabilities			7,696,000			2,881,000
Commitments and contingencies
Shareholder’s equity:
Convertible, series B preferred stock, no par value, $1,000 stated value 25,000 shares authorized, 0 and 470 shares issued and outstanding			-			439,000
Convertible, series C preferred stock, no par value, $1,000 stated value 25,000 shares authorized, 0 and 5,468 shares issued and outstanding			-			5,051,000
Common stock, no par value, 350,000,000 shares authorized, 144,108,000 and 103,978,000 shares issued and outstanding			177,813,000			114,111,000
Accumulated deficit			(61,216,000	)		(49,305,000	)
Accumulated other comprehensive income, unrealized gain on marketable securities			-			78,000
Total shareholders’ equity			116,597,000			70,374,000
Total liabilities and shareholders’ equity		$	124,293,000		$	73,255,000

 

The accompanying notes are an integral part of these financials

 

F-4

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NUTRACEA AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF OPERATIONS

		For the Years Ended December 31,
		2007			2006			2005
Revenues
Product sales		$	18,372,000		$	17,105,000		$	5,545,000
Less sales returns			(1,551,000	)		-			-
Royalty, label and licensing fees			5,340,000			985,000			19,000
Total revenue			22,161,000			18,090,000			5,564,000
Cost of goods sold			9,898,000			9,130,000			2,878,000
Gross profit			12,263,000			8,960,000			2,686,000
Research and development expenses			878,000			377,000			191,000
Selling, general and administrative expenses			16,262,000			6,018,000			3,860,000
Allowance for bad debt expense			3,233,000			9,000			—
Impairment of intangible assets			1,300,000			—			—
Separation agreement with former chief executive officer			1,000,000			—			—
Professional fees			4,720,000			1,504,000			1,627,000
Total operating expenses			27,393,000			7,908,000			5,678,000
(Loss) income from operations			(15,130,000	)		1,052,000			(2,992,000	)
Other income (expense)
Interest income			2,809,000			545,000			18,000
Gain on settlement			1,250,000			-			-
Loss on equity investment			(309,000	)		-			-
Loss on retirement of assets			(347,000	)		-			-
Loss on sale of marketable securities			(163,000	)		-			-
Interest expense			(1,000	)		(7,000	)		(896,000	)
Total (loss) income before income tax			(11,891,000	)		1,590,000			(3,870,000	)
Income tax expense		$	20,000		$	5,000		$	2,000
Net (loss) income available to common shareholders		$	(11,911,000	)	$	1,585,000		$	(3,872,000	)
Basic and diluted (loss) earnings per share:
Basic (loss) income per share		$	(0.09	)	$	0.02		$	(0.10	)
Fully diluted (loss) income per share		$	(0.09	)	$	0.02		$	(0.10	)
Weighted average basic number of shares outstanding			125,938,000			76,692,000			38,615,000
Weighted average diluted number of shares outstanding			125,938,000			102,636,000			38,615,000

 

The accompanying notes are an integral part of these financials

 

F-5

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NUTRACEA AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF COMPREHENSIVE (LOSS) INCOME

 

		For the Years Ended December 31,
		2007			2006			2005
Net (loss) income available to common shareholders		$	(11,911,000	)	$	1,585,000		$	(3,872,000	)
Other comprehensive income (loss):
Unrealized (loss) gain on marketable securities			(78,000	)		78,000			(78,000	)
Net and comprehensive (loss) income		$	(11,989,000	)	$	1,663,000		$	(3,950,000	)

 

The accompanying notes are an integral part of these financials

 

F-6

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NUTRACEA AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

 

		Convertible, Redeemable Series A, B, C Preferred						Common Stock						Deferred			Other Comprehensive			Accumulated
		Shares			Amount			Shares			Amount			Compensation			Income (Loss)			Deficit			Total
Balance, January 1, 2005			-		$	21,000			36,130,000		$	48,123,000		$	(16,000	)		(2,012,000	)	$	(44,928,000	)	$	1,167,000
Amortization of deferred compensation															81,000									81,000
Common stock issues for
consultants service rendered									1,905,000			907,000												907,000
patent incentive plan									30,000			13,000												13,000
officers and directors									70,000			30,000												30,000
settlements									97,000			98,000												98,000
Preferred stock issued			8,000			7,301,000
RiceX acquisition						(21,000	)		28,272,000			40,029,000												40,029,000
Stock options/warrants exercised for
cash									531,000			104,000												104,000
cashless									67,000															—
Stock options/warrants issued for
consultants												349,000												349,000
employees												130,000			(65,000	)								65,000
Other comprehensive loss																		(78,000	)					(78,000	)
Net loss																					(3,872,000	)		(3,872,000	)
Balance, December 31, 2005 as originally reported			8,000			7,301,000			67,102,000			89,783,000			—			(2,090,000	)		(48,800,000	)		38,893,000
Implementation of SAB 108																		2,090,000			(2,090,000	)
Beginning balance, January 1, 2006 as adjusted			8,000			7,301,000			67,102,000			89,783,000			—			—			(50,890,000	)	$	38,893,000
Common stock issues for consultants service rendered									30,000			30,000												30,000
Preferred stock issued, net of expense			17,000			15,934,000																		5,490,000
Preferred stock conversions
series B			(7,000	)		(6,862,000	)		14,760,000			6,862,000												6,862,000
series C			(12,000	)		(10,883,000	)		14,226,000			10,883,000												10,883,000
Asset acquisition									382,000			350,000												350,000
RiceX options cancelled												(642,000	)											(642,000	)
Stock options/warrants exercised for
cash									5,635,000			5,784,000												5,784,000
cashless									1,843,000															—
Stock options/warrants issued for
consultants												375,000												375,000
employees and directors												686,000												686,000
Other comprehensive income (loss)																		78,000						78,000
Net income																					1,585,000			1,585,000
Balance, December 31, 2006			6,000			5,490,000			103,978,000			114,111,000						78,000			(49,305,000	)		70,374,000

 

The accompanying notes are an integral part of these financials

 

F-7

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CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY - (CONTINUED) 

 

		Convertible, Redeemable Series A, B, C Preferred						Common Stock						Deferred			Other Comprehensive			Accumulated
		Shares			Amount			Shares			Amount			Compensation			Loss			Deficit			Total
Conversion of Preferred to common stock			(6,000	)		(5,490,000	)		7,373,000			5,490,000												-
Stock options/warrants exercised for cash									9,927,000			9,240,000												9,240,000
Private placement of common stock									20,000,000			46,805,000												46,805,000
Stock options/warrants exercised (non-cash)									3,512,000															-
Cancellation of certificates									(700,000	)														-
Option and warrant expense												2,111,000												2,111,000
Common stock issued to director for outside services									18,000			55,000												55,000
Other comprehensive income (loss)																		(78,000	)					(78,000	)
Net loss																					(11,911,000	)		(11,911,000	)
Balance, December 31, 2007			-		$	-			144,108,000		$	177,813,000			-		$	-		$	(61,216,000	)	$	116,597,000

The accompanying notes are an integral part of these financials

 

F-8

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NUTRACEA AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF CASH FLOWS

 

		For the Years Ended December 31,
		2007			2006			2005
Cash flow from operating activities:
Net (loss) income		$	(11,911,000	)	$	1,585,000		$	(3,872,000	)
Adjustments to reconcile net (loss) income to net cash from operating activities:
Depreciation and amortization			2,202,000			1,150,000			1,091,000
Impairment of goodwill			1,300,000			-			-
Provision for doubtful accounts and notes receivable			3,229,000			-			-
Non-cash issuances of common stock			-			-			1,017,000
Loss on retirement of assets			347,000
Stock based compensation			2,166,000			1,091,000			510,000
Loss on equity investment			309,000			-			-
Loss on sale of marketable securities			290,000			-			-
Net changes in operating assets and liabilities:
(Increase) decrease in
Trade accounts receivable			(886,000	)		(4,578,000	)		(2,094,000	)
Inventories			(971,000	)		(202,000	)		(107,000	)
Deposits and other current assets			(1,167,000	)		(1,301,000	)		(106,000	)
Increase (decrease) in:
Accounts payable, accrued liabilities			2,739,000			1,531,000			354,000
Advances from related parties			-			(3,000	)		(71,000	)
Customer deposits			-			98,000			(100,000	)
Net cash used in operating activities			(2,353,000	)		(629,000	)		(3,378,000	)
Cash flows from investing activities:
Issuance of notes receivable			(7,828,000	)		(2,376,000	)		-
Proceeds of payments from notes receivable			5,410,000			-			-
Purchase of The RiceX Company, net of $546,148 cash received			-			-			33,000
Purchase of property and equipment			(11,652,000	)		(4,682,000	)		(14,000	)
Investment in Grainnovation, Inc.			(2,169,000	)		-			-
Investment in Vital Living, Inc.			(5,143,000	)		-			-
Investment in joint venture			(1,500,000	)		-			-
Restricted cash			(2,239,000	)
Issuance of long-term note			69,000			-			-
Proceeds from sale of assets			16,000			-			-
Purchase of other assets			(2,225,000	)		(2,640,000	)		(82,000	)
Net cash used in investing activities			(27,261,000	)		(9,698,000	)		(63,000	)
Cash flows from financing activities:
Private placement financing, net			46,805,000			15,934,000			7,301,000
Principal payments on notes payable, net of discount			-			(15,000	)		(2,402,000	)
Proceeds from exercise of common stock options and warrants			9,240,000			5,784,000			105,000
Net cash provided by financing activities			56,045,000			21,703,000			5,004,000
Net increase in cash and cash equivalents			26,431,000			11,376,000			1,563,000
Cash and cash equivalents, beginning of year			14,867,000			3,491,000			1,928,000
Cash and cash equivalents, end of year		$	41,298,000		$	14,867,000		$	3,491,000
Cash paid for interest		$	1,000		$	3,000		$	137,000
Cash paid for income taxes		$	20,000		$	5,000		$	2,400
Non-cash disclosures:
Payments for patents with common stock		$	-		$	-		$	13,000
Conversions of preferred stock to common stock		$	5,490,000		$	17,835,000		$	-
Accounts receivable converted to note receivable		$	3,881,000		$	-		$	-
Accounts receivable exchanged for an intangible assets		$	300,000		$	-		$	-
Settlement of accounts receivable, net, to acquire intangible asset		$	284,000		$	-		$	-
Common stock issued to acquire assets related to equine feed supplement business		$	-		$	350,000		$	-
Adjustment to allocation of RiceX purchase price of property and equipment		$	-		$	375,000		$	-
Reduce goodwill for RiceX options cancelled		$	-		$	642,000		$	-
Change in fair value of marketable securities		$	-		$	78,000		$	-

 

The accompanying notes are an integral part of these financials

 

F-9

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 — Organization and Line of Business

 

General

 

We are a health-science company focused on the development and distribution of products based upon the use of stabilized rice bran and proprietary rice bran formulations. Rice bran is the outer layer of brown rice which is typically a wasted by-product of the commercial rice industry. These products include food supplements and medical foods which provide health benefits for humans and animals (known as “nutraceuticals”) based on stabilized rice bran, rice bran derivatives and the rice bran oils.

 

On October 4, 2005, we consummated the acquisition of The RiceX Company (“RiceX”) pursuant to the terms of an Agreement and Plan of Merger, dated April 4, 2005. RiceX survived the merger as a wholly-owned subsidiary of NutraCea. RiceX shareholders received .76799 of NutraCea common stock for each share of RiceX common stock. RiceX shareholders received 28,272,064 shares of NutraCea common stock, valued at $29,120,000 and NutraCea assumed the outstanding RiceX options and warrants to purchase 11,810,496 shares NutraCea common stock, valued at $11,422,000.

 

Due to the acquisition of RiceX, and the subsequent reorganization, NutraCea and its subsidiaries are operating as one segment.

 

Note 2 — Summary of Significant Accounting Policies

 

Principles of Consolidation - The consolidated financial statements include the accounts of NutraCea and its wholly-owned subsidiaries, NutraCea Technologies Incorporated, NutraGlo® Incorporated, The RiceX Company, Infomaxx, LLC, Grainnovations, Inc., and our interests in NutraCea-Cura LLC (10%), Rice RX LLC (50%), and Rice Science LLC (80%), (collectively, the “Company”). Additionally, due to our ownership of certain debt securities of Vital Living, Inc., we have included their results of operations for the period from April 20^th, 2007 to December 31, 2007 and their financial position at December 31, 2007 in our financial statements. All significant inter-company accounts and transactions are eliminated in consolidation.

 

Revenue Recognition - We derive our revenue primarily from product sales. Product is shipped when an approved purchase order is received. Products shipped by us are generally sold FOB Origin, with the customer taking title to the product once it leaves our plant via common carrier. At this point, the price to the customer is fixed and determinable, and collectability is reasonably assured. On occasion, we receive purchase orders for multiple product deliveries. In these situations, each delivery is individually evaluated to determine appropriate revenue recognition. Each delivery is generally considered to be a separate unit of accounting for the purposes of revenue recognition and, in all instances, persuasive evidence of an arrangement, delivery, pricing and collectability must be determined or accomplished, as applicable, before revenue is recognized. In addition, if the purchase order includes customer acceptance provisions, no revenue is recognized until customer acceptance occurs. Revenue is accounted for at the point of shipment FOB Origin, unless accompanied by a memorandum of understanding detailing the requirement of customer acceptance in order to transfer title, in which case revenue is recognized at the time of such acceptance.

 

Occasionally, we will grant exclusive use of our labels by customers in specific territories in exchange for a nonrefundable fee. Under EITF 00-21, Revenue Recognition with Multiple Deliverables, each label licensing provision is considered to be a separate unit of accounting. Each grant is then individually evaluated to determine appropriate revenue recognition in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition (SAB 104), SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts.

 

F-10

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2 — Summary of Significant Accounting Policies - (continued)

 

Provisions for allowances and other adjustments are provided for in the same period the related sales are recorded. If all criteria are met, revenue is recognized in the period in which the sale occurred and recorded in the financial statements as label fees.

 

Our royalty fees are generally recognized when it is probable that an economic benefit will flow to us, the amount of the benefit can be reliably measured and collectability is reasonably assured.

 

Cash and Cash Equivalents - We consider all highly liquid investments purchased with an original maturity of three months or less at the time of purchase to be cash equivalents. As of December 31, 2007, the Company maintains its cash, including $2,549,000 of restricted cash, and cash equivalents with a major investment firm and a major bank.

 

Cash Concentration - We maintain our cash in bank accounts, which at times may exceed federally insured limits. We have not experienced any losses on such accounts.

 

Short-Term Investments - As part of our cash management program, we maintain a portfolio of commercial paper. The securities are investment grade (AAA) and mature in thirty days.

 

Accounts Receivable - Accounts receivable consists of amounts due from customers for product sales, net of an allowance for losses. We determine the allowance for doubtful accounts by reviewing each customer account and specifically identifying any potential for loss. The allowance for doubtful accounts at December 31, 2007 is $2,999,000 and at December 31, 2006 and 2005 was $20,000. Uncollected accounts are written off after the customer has been past due in excess of twelve months. Past due status is determined based on contractual terms. Actual losses related to collection of accounts receivable for the years ended December 31, 2007, 2006 and 2005 were insignificant.

 

Marketable Securities - Marketable securities are marked to market at each period end. Any unrealized gains and losses on the marketable securities are excluded from operating results and are recorded as a component of Other Comprehensive Income (Loss). If declines in value are deemed other than temporary, losses are reflected in Net Income (Loss).

 

Inventory - Inventory is stated at the lower of cost (first-in, first-out) or market and consists of stabilized rice bran manufactured by RiceX, and nutraceutical products manufactured by NutraCea. We employ a full absorption procedure using standard cost techniques. The standards are customarily reviewed and adjusted annually. While the Company has an inventory of these products, any significant prolonged shortage of these ingredients or of the supplies used to enhance these ingredients could materially adversely affect the Company’s results of operations.

Inventories are composed of the following at December 31;

 

		2007			2006
Finished goods		$	1,396,000		$	533,000
Raw materials			184,000			168,000
Packaging supplies			228,000			95,000
		$	1,808,000		$	796,000

  

F-11

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2 — Summary of Significant Accounting Policies - (continued)

 

Property and Equipment - Property and equipment are stated at cost. The Company provides for depreciation using the straight-line method over the estimated useful lives as follows:

 

Furniture and equipment			3-7 years
Automobile			5 years
Software			3 years
Leasehold improvements			7 years
Property and equipment			7-10 years

 

Expenditures for maintenance and repairs are charged to operations as incurred while renewals and betterments are capitalized. Gains or losses on the sale of property and equipment are reflected in the statements of operations.

 

Impairment of Long-Lived Assets - We assess the carrying value of long-lived assets which includes property, plant and equipment, intangible assets and goodwill annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

 

·

significant adverse change in legal factors or in the business climate;

 

·

unanticipated competition;

 

·

a loss of key personnel;

 

·

significant changes in the manner of our use of the asset;

 

·

significant negative industry or economic trends; and

 

·

our market capitalization relative to net book value.

 

Annually and upon the existence of one or more of the above indicators of impairment, we would test such assets for a potential impairment. The carrying value of a reporting unit, including goodwill, is considered impaired when the fair value is less than the asset’s carrying value. In that event, an impairment loss is recognized based on the amount by which the carrying value exceeds the fair market value. Fair market value is determined primarily using quoted market prices and cash flow projections. During the year ended December 31, 2007 events indicated an impairment had occurred (see next paragraph). We have determined that there was no impairment as of December 31, 2006.

 

In April, 2007, we purchased, for $5,226,000, certain debt securities and certain preferred stock securities of Vital Living, Inc. (“VLI”) (see Note 10 to the Consolidated Financial Statements). In September 2007, we entered into an asset purchase agreement in which the company agrees to buy the assets of VLI for an additional $1,500,000 and the forgiveness of the debt securities and certain other indebtedness of VLI. We have recorded that contingent liability in our financial statements. As a result, the total increase in goodwill on our books associated with this transaction is $7,579,000. We have evaluated this intangible and determined that the value based upon our analysis is $6,279,000. Accordingly we have recorded an intangible impairment of $1,300,000.

 

Patents and Trademarks - In addition to patents filed and acquired directly by the Company, the Company owns several patents, which were acquired from independent third parties and a related party. All costs associated with the patents are capitalized. Patents acquired from related parties are recorded at the carryover basis of the transferor. The Company paid cash as consideration for all patents and trademarks acquired, except the Via-Bran registered trademark, which was acquired for 21,409 shares of common stock valued at $21,000.

 

In conjunction with the RiceX acquisition, NutraCea has been assigned five U.S. patents relating to the production or use of Nutraceutical or HVF products. The patents include:

 

(1)

Patent Number 5,512,287 “PRODUCTION OF BETA-GLUCAN AND BETA-GLUCAN PRODUCT,” which issued on April 30, 1996;

 

F-12

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2 — Summary of Significant Accounting Policies - (continued)

 

(2)

Patent Number 5,985,344 “PROCESS FOR OBTAINING MICRONUTRIENT ENRICHED RICE BRAN OIL,” which issued on November 16, 1999;

 

(3)

Patent Number 6,126,943 “METHOD FOR TREATING HYPERCHOLESTEROLEMIA, HYPERLIPIDEMIA, AND ATHEROSCLEROSIS,” which issued on October 3, 2000;

 

(4)

Patent Number 6,303,586 B1 “SUPPORTIVE THERAPY FOR DIABETES, HYPERGLYCEMIA AND HYPOGLYCEMIA,” which issued on October 15, 2001; and

 

(5)

Patent Number 6,350,473 B1 “METHOD FOR TREATING HYPERCHOLESTEROLEMIA, HYPERLIPIDEMIA AND ATHEROSCLEROSIS,” which issued on February 26, 2002.

 

We plan to apply for additional patents in the future as new products, treatments, and uses are developed.

 

Patents and trademarks are stated at cost. Amortization is computed on the straight-line method based on estimated useful lives as follows:

 

Patents (Domestic)			17 years
Patents (International)			20 years
Trademarks (Domestic)			10 years
Trademarks (International)			7 years

 

Fair Value of Financial Instruments - The fair value of the Company’s financial instruments approximated carrying value at December 31, 2007, and 2006. The Company’s financial instruments include cash, marketable securities and accounts receivable for which the carrying value approximates fair value due to the short maturity of the instrument.

 

Research and Development - Research and development expenses include internal and external costs. Internal costs include salaries and employment related expenses and allocated facility costs. External expenses consist of costs associated with product development. All such costs are charged to expense as incurred.

 

Stock and Warrants Issued to Third Parties - If the agreements do not have a disincentive for nonperformance, the Company records a charge for the fair value of the stock and the portion of the warrants earned from the point in time when vesting of the stock or warrants becomes probable. The fair value of certain types of warrants issued to customers is recorded as a reduction of revenue to the extent of cumulative revenue recorded from that customer.

 

Stock-Based Compensation - Management estimates the fair value of each option award as of the date of grant using a Black-Scholes-Merton option pricing model. Expected volatility is based on the historical volatility of the Company’s common stock. The expected term represents the period that the stock-based awards are expected to be outstanding. The risk free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend yield was not considered in the option pricing formula because the Company has not paid cash dividends historically and had no plans to do so at the grant date. In addition to these assumptions, management makes estimates regarding pre-vesting forfeitures that will impact total compensation expense recognized under the Plan.

 

As of January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Accounting for Stock-Based Compensation. Under the provisions of SFAS 123(R), we are required to measure the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which services are provided in exchange for the award, known as the requisite service period (usually the vesting period). The Company applied the alternative transition method in calculating its pool of excess tax benefits available to absorb future tax deficiencies as provided by FSP FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Prior to January 1, 2006, the Company accounted for those instruments under the recognition and measurement provisions of APB “Opinion” No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No 123, Accounting for Stock-Based Compensation.

 

F-13

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2 — Summary of Significant Accounting Policies - (continued)

 

We have made the transition to SFAS 123(R) using the modified prospective method. Under the modified prospective method, SFAS 123(R) is applied to new awards and to awards modified, repurchased, or cancelled after

 

January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (such as unvested options) that are outstanding as of January 1, 2006 are being recognized over the period that the remaining requisite services are rendered. The compensation cost relating to unvested awards at January 1, 2006 is based on the grant-date fair value of those awards. Under this method of implementation, no restatement of prior periods has been made.

 

As a result of adopting Statement 123(R) on January 1, 2006, the Company’s net income for the year ended December 31, 2006 was $1,907,711 lower than if it had continued to account for share-based compensation under Opinion 25. Basic and diluted earnings per share for the year ended December 31, 2006 would have been $(0.26), if the Company had not adopted Statement 123(R), compared to reported basic and diluted earnings per share of $(0.29). We have not recorded income tax benefits related to equity-based compensation expense as deferred tax assets are fully offset by a valuation allowance. As a result, the implementation of SFAS 123(R) did not impact the Statement of Cash Flows for the year ended December 31, 2006.

 

The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of Statement 123(R) to options granted under the company’s stock option plans for the year ended December 31, 2005. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing model and amortized to expense over the options’ vesting periods.

 

		For The Year Ended
		December 31, 2005
Net loss, reported:		$	(3,872,000	)
Deduct: stock-based compensation expense included in reported net loss, net of $0 related tax benefits			1,511,000
(Add): stock-based compensation determined under fair value based method for all awards, net of $0 related tax benefits			(387,000	)
Pro forma net loss		$	(2,748,000	)
Basic loss per common share (basic and diluted):
As reported		$	(0.10	)
Pro forma		$	(0.07	)

 

Shipping and Handling Expenses - Expenses relating to shipping and handling are expensed and reported as a cost of sale or a selling expense as appropriate.

 

Advertising Expense - The Company expenses all advertising costs, including direct response advertising, as they are incurred. Advertising expense for 2007, 2006 and 2005 was $1,171,000, $307,000 and $8,000, respectively.

 

Income Taxes - The Company accounts for its income taxes by recording a deferred tax asset or liability for the recognition of future deductible or taxable amounts and operating loss and tax credit carry-forwards. Deferred tax expense or benefit is recognized as a result of timing differences between the recognition of assets and liabilities for book and tax purposes during the year.

 

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are recognized for deductible temporary differences and operating loss, and tax credit carry-forwards. A valuation allowance is established, when necessary, to reduce that deferred tax asset if it is “more likely than not” that the related tax benefits will not be realized.

F-14

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2 — Summary of Significant Accounting Policies - (continued)

 

Net Income (Loss) per Common Share - Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and potentially dilutive shares outstanding during the period. Potentially dilutive shares consist of the incremental common shares issuable upon the exercise of stock options and warrants. Potentially dilutive shares are excluded from the computation if their effect is anti-dilutive.

 

We had a net loss for 2007 and 2005 presented herein; therefore, none of the stock options and warrants outstanding during each of the periods presented, as discussed in Notes 16 and 17, were included in the computation of diluted loss per share as they were anti-dilutive.

 

For 2006, the dilutive effect of 5,873,738 outstanding options, 14,666,449 outstanding warrants, 940,000 convertible Series B preferred stock, and 6,430,368 convertible Series C preferred stock is calculated using the treasury stock method. Additionally, for 2,083,114 outstanding warrants and options there is no dilutive effect because the average market price of the common stock during the period is less than the exercise price of the warrants and options for 2006.

 

Estimates - The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

Concentrations of Credit Risk and Major Customers - On August 24, 2005, NutraCea signed an agreement with a direct response marketing company to market and sell products through infomercials. The agreement is for two years and may be extended for an additional year. The agreement covers pricing of specific products at wholesale prices which will be private labeled for direct sale by the marketing company. During the term of the agreement, NutraCea will not sell its products through any other infomercials so long as the marketing company maintains minimum quarterly orders beginning October 1, 2005 of $500,000. Additionally, NutraCea granted the company an option to purchase 250,000 shares of restricted common stock at a price of $1.275 per share. The options vest 50,000 shares upon payment in full of the contract quarter minimum purchase orders during the term of the agreement. At December 31, 2006, 100,000 options are fully vested. For the year ended December 31, 2005, sales to this customer totaled $3,013,000 or 54% of total sales and receivables were $1,910,000, or 76% of total receivables. For the year ended December 31, 2006, sales to this customer totaled $8,057,000 or 48% of total sales and receivables were $3,516,000, or 49% of total receivables. For the year ended December 31, 2007, sales to this customer totaled $1,946,000 or 11% of sales and the note receivable due from this customer was $1,978,000.

 

Reclassifications - Certain reclassifications have been made to the prior year statement of operations to conform to the current year presentation.

 

Recently Issued Accounting Pronouncements - In June 2006, the FASB issued Interpretation No.48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”, (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return that results in a tax benefit. Additionally, FIN 48 provides guidance on de-recognition, statement of operations classification of interest and penalties, accounting in interim periods, disclosure, and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 as of January 1, 2007, as required. The Company has determined that there is no impact in adopting FIN 48.

 

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” which addresses how uncorrected errors in previous years should be considered when quantifying errors in current-year financial statements. SAB 108 requires companies to consider the effect of all carry over and reversing effects of prior-year misstatements when quantifying errors in current-year financial statements and the related financial statement disclosures. SAB 108 must be applied to annual financial statements for the first fiscal year ending after November 15, 2006. The impact of adopting SAB 108 is discussed in Note 3.

 

F-15

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 2 — Summary of Significant Accounting Policies - (continued)

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurement”, (FAS 157). This Standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. As of December 1, 2007 the FASB has proposed a one-year deferral for the implementation of the Statement for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a non-recurring basis. We have not determined the effect that the adoption of FAS 157 will have on our consolidated results of operations, financial condition or cash flows.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115” (“FAS 159”). This statement provides all entities with an option to report selected financial assets and liabilities at fair value. The Statement is effective as of the beginning an entity’s first fiscal year beginning after November 15, 2007, with early adoption available in certain circumstances. We have not determined the effect that the adoption of FAS 159 will have on our consolidated results of operations, financial condition, or cash flows, accordingly, we have not decided whether or not to adopt this standard.

 

In September 2007 the FASB issued SFAS No. 141(R), “Business Combinations”. This statement requires all entity’s to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and be expensed as incurred, restructuring cost generally be expensed in period subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. The adoption of this statement will change the accounting treatment for business combinations on a prospective basis beginning in the first quarter of fiscal year 2009.

 

In December, 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements”. This statement changes the accounting and reporting for minority interests, which will be re-characterized as non-controlling interests and classified as a component of equity. This statement is effective for the Company on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2009.

 

In December 2007, the SEC issued Staff Accounting Bulleting (“SAB”) No. 110, “Share-Based Payment”. This bulletin amends the SEC’s views discussed in SAB 107 regarding the use of the simplified method in developing an estimate of expected life of share options in accordance with SFAS No. 123(R). SAB 110 is effective beginning in the first quarter of fiscal year 2008.

 

Note 3 — Implementation of Staff Accounting Bulletin No. 108

 

In preparing the financial statements for the year ended December 31, 2006, we undertook an evaluation of uncorrected misstatements arising in prior years for the purpose of implementing Staff Accounting Bulletin No. 108 (SAB 108). We identified an uncorrected misstatement arising during 2004, which at the time was considered to be immaterial relative to the net loss incurred for the period. We believe that this uncorrected misstatement resulted from the incorrect classification and recording of an investment’s decline in market value as a temporary impairment with a corresponding increase in other comprehensive loss. In accordance with the provisions of SAB 108, we have decreased accumulated other comprehensive loss at January 1, 2006 by $2,090,000 and we have increased our accumulated deficit at January 1, 2006 by $2,090,000 to recognize the other than temporary nature of the investment impairment.

 

F-16

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 4 — Marketable Securities

 

On September 8, 2004, NutraCea purchased 1,272,026 shares of Langley Park Investment Trust, PLC (“Langley”), a United Kingdom closed-end mutual fund that is actively traded on a London exchange. Per the Stock Purchase Agreement, NutraCea paid with 7,000,000 shares of its own common stock. On September 8, 2006, NutraCea commenced a lawsuit against Langley in the United States District Court for the Eastern District of California, Sacramento Division regarding this transaction. The matter was settled on March 27, 2007. Pursuant to the settlement, NutraCea received $1,250,000 from Langley in March 2007 and NutraCea retained all of the Langley shares. The $1,250,000 settlement is included in our December 31, 2007 statement of operations as other income.

 

During the third quarter of 2007 Langley ceased trading and began the process of liquidating the investments. NutraCea has received cash of $127,000 from this liquidation. The realizable value of the balance of the funds is uncertain and as a result we have recorded the fair market value of Langley as $0 at December 31, 2007, and recognized a loss of $163,000 (net of $169,000 of unrealized income) on the disposition of the investment.

 

Any unrealized holding gains and losses on the marketable securities are excluded from operating results and are recognized as other comprehensive income. Prior to liquidation the fair value of the securities is determined based on prevailing market prices

Note 5 — Stock-based Compensation

 

 On January 1, 2006, NutraCea adopted SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) replaced SFAS No. 123 and supersedes APB Opinion No. 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The pro forma disclosures previously permitted under SFAS 123 are no longer an alternative to financial statement recognition. NutraCea adopted SFAS 123(R) using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. The consolidated financial statements as of and for the twelve months ended December 31, 2007 and 2006 reflect the impact of adopting SFAS 123(R).  

 

For all agreements where stock is awarded as partial or full consideration, the expense is valued at the fair value of the stock. Expenses for stock options and warrants issued to consultants and employees are calculated based upon fair value using the Black-Scholes valuation method.

Stock-based compensation expenses consisted of the following for the twelve months ended December 31, 

 

		2007 (1)			2006 (2)			2005 (3)
Consultants		$	379,000		$	213,000		$	1,241,000
Directors			330,000			176,000			30,000
Employees			1,294,000			602,000			142,000
Research and development			108,000			-			-
To directors and former director for services outside of directors duties			55,000			100,000			-
Stock issued for a settlement			-			-			98,000
Total stock-based compensation expense		$	2,166,000		$	1,091,000		$	1,511,000

 

(1)	Includes $55,000 fair value of common stock issued, all other amounts are the fair value of options and warrants issued

 

(2)	Includes $30,000 fair value of common stock issued, all other Amounts are the fair value of options and warrants issue

 

(3)	Includes $949,000 fair value of common stock issued, all other amounts are the fair value of options and warrants issued

 

F-17

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 5 — Stock-based Compensation - (continued) 

 

As of December 31, 2007, there was $1,889,000 of total unrecognized compensation cost related to non-vested options granted under the plans. That cost is expected to be recognized over a weighted average period of one year.

 The weighted average grant date fair value of the stock options granted during the twelve months ended December 31 2007, 2006 and 2005 was $3.43, $1.35, and $0.54 per share, respectively.

Note 6 — (Loss) Earnings Per Share

 

Basic (loss) earnings per share are computed by dividing net (loss) income by the weighted average number of common shares outstanding during all periods presented.  Options and warrants are excluded from the basic (loss) earnings per share calculation and are considered in calculating the diluted (loss) earnings per share.

 

The dilutive effect of outstanding options and warrants is calculated using the treasury stock method and the dilutive effect of the convertible series B preferred stock, and convertible series C preferred stock is calculated using the as-if converted method.

As of December 31, 2007 and 2005, options and warrants to purchase approximately 41,981,000 and 38,293.000 shares of our common stock, respectively, were outstanding. Of these, approximately 25,915,000 and 33,602,000 were “in the money” at December 31, 2007 and 2005, respectively. These are excluded from the calculation of diluted loss per share at December 31, 2007 and 2005 because their inclusion would have been anti-dilutive. The weighted average exercise price of anti-dilutive options and warrants for the twelve months ended December 31, 2007 and 2005 was $0.60 and $0.45, respectively.

 

Components of basic and diluted (loss) earnings per share were as follow for the twelve months ended:

		December 31,
		2007			2006			2005
Net (loss) income		$	(11,911,000	)	$	1,585,000		$	(3,872,000	)
Weighted average outstanding shares of common stock			125,938,000			76,692,000			38,615,000
Convertible preferred stock			-			5,045,000			-
Common stock equivalents			-			20,899,000			-
Total diluted shares			125,938,000			102,636,000			38,615,000
(Loss) earnings per share:
Basic		$	(0.09	)	$	0.02		$	(0.10	)
Diluted		$	(0.09	)	$	0.02		$	(0.10	)

 

F-18

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 7 — Property and Equipment

 

Property and equipment consisted of the following at December 31:

 

		2007			2006
Land		$	15,000		$	9,000
Furniture and equipment			2,405,000			916,000
Automobile			-			73,000
Software			402,000			389,000
Leasehold improvements			700,000			430,000
Property and plant			14,243,000			4,197,000
Construction in progress			4,347,000			4,392,000
Subtotal			22,112,000			10,406,000
Less accumulated depreciation			2,784,000			1,445,000
Total		$	19,328,000		$	8,961,000

 

Depreciation expense was $1,431,000, $839,000 and $241,000 for 2007, 2006 and 2005, respectively. Interest expense incurred during 2007 was nominal and no interest was capitalized.

 

Note 8 — Patents and Trademarks

 

Patents and trademarks consisted of the following at December 31:

 

		2007			2006
Patents		$	2,657,000		$	2,540,000
Trademarks			3,288,000			2,987,000
Non-compete agreement			650,000			-
License and supply agreement			220,000			-
Subtotal			6,815,000			5,527,000
Less Accumulated Amortization			1,072,000			430,000
Total		$	5,743,000		$	5,097,000

 

Amortization expense was $642,000, $302,000 and $70,000 for 2007, 2006 and 2005, respectively. Amortization expense for the next five years will be approximately $3,200,000.

 

Note 9 — Notes Receivable

 

At December 31, 2007, we have nine secured promissory notes outstanding to the Company with an aggregate amount of $7,975,000; $2,936,000 reported as current (net of a $250,000 allowance for doubtful notes receivable) and $5,039,000 reported as long-term. These secured promissory notes bear interest at annual rates of either five (5%) or eight (8%) with the principals and all accrued interest due and payable to us at dates ranging from October 2007 to October 2012.

 

During the twelve months ended December 31, 2007 we loaned a total of $7,828,000, (net of the conversion of $3,881,000 of accounts receivables to a promissory note) to certain strategic customers, which loans were evidenced by promissory notes, and received payments totaling $5,410,000 on existing promissory notes. During this twelve month period we also accrued interest income of $472,000 and received cash payments of $135,000 for accrued interest.

 

In February 2007, we converted $3,516,000 of one customer’s accounts receivable to a note receivable included in the above total, bearing interest at 7% and due in December 2007. This note receivable was paid in full by January 2008.

 

F-19

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 8 — Notes Receivable - (continued)

 

In April 2007, we converted $365,000 of another customer’s accounts receivable to a note receivable included in the above total, bearing interest at 10% and due in October 2007. This note is past due as of December31, 2007. As of March 3, 2008 we have re-negotiated the settlement terms and extended the due date to April 2008 and received payment of the accrued interest due on this note. We have recorded an allowance for doubtful notes of $250,000 against this receivable which is included in our bad debt expense for the year ended December 31, 2007.

During the second quarter of 2007, we granted to Pacific Holdings Advisors Limited (“PAHL”) an exclusive, perpetual, royalty-free right and license to use and SRB and SRB derivative products in certain Southeast Asian countries. PAHL paid a one-time license fee of $5,000,000 for these rights. PAHL paid the license fee by issuing to NutraCea an interest bearing promissory note due within five years. In January 2008, in conjunction with another agreement (see Note 20 to the Consolidated Financial Statements) the we amended the payment terms. PAHL will pay NutraCea the license fee of $5,000,000 by March 31, 2008 in full satisfaction of its obligations under the Note. In consideration for this accelerated payment, NutraCea agrees to waive all accrued interest owed by PAHL ($118,000 at December 31, 2007).

 

During August 2007 we exchanged one customer’s note receivable of $300,000 for a certain trademark and associated rights to a product line (see Note 10 to the consolidated financial statements).

 

In December, 2007, we sold to one customer, $1,968,000 of infomercial products. This customer paid us by issuing a to NutraCea a promissory note bearing 7% interest, with even weekly payments, due in April 2008.

 

Note 10 — Acquisition and Joint Ventures 

 

Infomaxx, LLC

 

In December 2006, our wholly-owned subsidiary Nutramercials, Inc. became a 50% member of Infomaxx, LLC (“INFMX”). In accordance with FIN46R, INFMX was determined to be a variable interest entity and its’ financial position and operations were included in our consolidated financial statements at December 31, 2006.

 

In August 2007, we became the sole member of INFMX after we purchased from the other member of INFMX their 50% of INFMX’s outstanding membership interests by canceling a $300,000 note payable to NutraCea by that member of INFMX. We received along with the 50% interest, all rights to a certain trademark and product line of that member. We recorded an intangible asset of $296,000 (net of a valuation allowance of $280,000). Additionally, in order to consummate this transaction we agreed to accept the return of $275,000 of inventory from the other previous member of INFMX which we sold them in December 2006, for $1,551,000. The $1,551,000 return is recorded as a sales return on our consolidated statement of operations.

 

 For the twelve months ended December 31, 2007 our Infomaxx subsidiary generated sales of $315,000 which was not related to the product return mentioned above.

 

NutraCea/Cura LLC

 

In August 2007, we formed NutraCea/Cura, LLC (“NCC”) with Cura Pharmaceuticals (“CURA”). We formed this LLC with CURA to jointly develop, produce through third-party pharmaceutical-grade co-packers, market, and sell nutraceutical and pharmaceutical products. In the initial agreement our interest was 60%. In December we acquired from Cura 75% of their 40% interest, increasing our interest to 90%. Accordingly, NCC is included in our consolidated financial statements. For the twelve months ended December 31, 2007 NCC had sales of $230,000.

 

Under the agreement, NCC acquired the rights to a supply agreement for materials with minimum purchase requirements of approximately $1,150,000 for the first year, which increase 5% a year for 5 years. If the minimum purchase commitments are not met in any year the co-packer of the products may terminate the supply agreement. We recorded an intangible of $220,000 which we are amortizing on a straight-line basis over five years.

 

F-20

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 10 — Acquisitions and Joint Ventures - (continued)

 

Grainnovation, Inc.

 

In April 2007, we acquired 100% of the outstanding stock of Grainnovation, Inc. (“GI”) a privately held company that had equipment for pelletizing horse feed for equine customers of strategic value to NutraCea, and certain assets used in GI’s business for a total of $2,150,000, of which $1,605,000 of the purchase price was paid at closing, with the balance (“holdback”) being due in payments of $235,000 and $310,000 in six months and twelve months, respectively, subject to reduction in the event of breaches of representations, warranties and covenants contained in the transaction documents. The holdback is held in third-party escrow and is included in our consolidated condensed balance sheet as restricted cash and current liabilities. The investment is recorded in our financial statements included herein at the aggregate purchase price and its results of operations from the date of acquisition are reflected in our statement of operations for the period ended December 31, 2007. In November, 2007, the second installment of $235,000 due was distributed to the sellers from the third-party escrow as agreed.

 

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. We incurred $20,000 in legal fees relating to this purchase, which are added to the purchase price and Goodwill. The Company is in the process of obtaining third-party valuations of certain intangible assets; the allocation of the purchase price is subject to refinement:

 

Cash		$	1,000
Accounts receivable			26,000
Inventory			11,000
Property and equipment			623,000
Covenant not to compete			650,000
Goodwill			917,000
Total Assets			2,228,000
Accrued liabilities			58,000
Net assets acquired		$	2,170,000

 

For the eight months ended December 31, 2007 our Grainnovations subsidiary generated $490,000 in sales.

 

Grain Enhancements LLC

 

In June 2007, we entered into a joint venture with PAHL to form Grain Enhancements LLC (“GE”), a Delaware limited liability company. NutraCea and PAHL each hold a 47.5% share of Grain Enhancements. The remaining interest is held by Theorem Group LLC (“Theorem”) (3.333%) and Ho’okipa Capital Partners, Inc. (1.667%). The purpose of GE is to develop and market stabilized rice bran (“SRB”) and related products in certain Southeast Asian countries. GE will purchase SRB exclusively from NutraCea until its own facilities are in operation and NutraCea will lease to GE at cost the necessary equipment for such facilities. Payments under the equipment lease will be payable in full upon installation of the equipment.

 

Under the agreement, NutraCea and PAHL will contribute up to $5,000,000 each to Grain Enhancements to fund the operations, of which $1,500,000 each was due on June 30, 2007. Both members made their initial contribution in July 2007. Additionally, $2,000,000 each was to be contributed no later than October 2007, and the remaining $1,500,000 from each member is due no later than August 2008. Only the initial capital contribution due of $1,500,000 from each member has been made. On January 24, 2008, NutraCea and PAHL amended certain terms of the Operating Agreement. Pursuant to the modified agreement, the timing of mandatory capital contributions of the members was changed from an agreed upon schedule to a determination by the Finance Committee on an as-needed basis. In addition, PAHL will no longer receive a monthly management fee.

 

F-21

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10 — Acquisitions and Joint Ventures - (continued)

 

Theorem was paid $750,000 and $500,000 by NutraCea and GE, respectively, for services relating to the formation of the joint venture. Through December 31, 2007, our portion of Grain Enhancements net loss was $309,000.

 

Our investment in Grain Enhancements is accounted for under the equity method of accounting. At December 31, 2007 the value of our investment was $1,191,000.

 

Summary financial information of Grain Enhancements, LLC at December 31, 2007 is:

 

Assets
Cash		$	2,435,000
Liabilities and equity
Accounts payable and accrued liabilities		$	54,000
Members equity			3,000,000
Accumulated deficit			(619,000	)
Total equity			2,381,000
Total liabilities and equity		$	2,435,000

 

Vital Living, Inc.

 

In April 2007, we acquired certain securities of Vital Living, Inc. (“VLI”), a publicly traded company. VLI distributes nutritional supplements using similar processes as NutraCea for manufacturing and distribution. We paid $1,000,000 for 1,000,000 shares of outstanding preferred stock and $4,226,000 for the outstanding Senior Secured Notes (“Notes”). The Notes are convertible to VLI common stock and bear interest at 12% per annum, payable June 15 and December 15 and mature in December 2008. On September 11, 2007, NutraCea and VLI entered into a letter agreement confirming their agreement to eliminate the conversion rights of the Notes.  In addition, the parties agreed that until such time, if any, as NutraCea gives 30 days prior written notice to VLI, VLI may not pay accrued interest under the Notes in shares of VLI Common Stock, without NutraCea’s consent, and that during such time VLI will not be deemed to be in default under the Notes as a result of not paying accrued interest in such shares.

On September 28, 2007, NutraCea entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Vital Living.  The Purchase Agreement provides that NutraCea will purchase substantially all of Vital Living’s intellectual property and other assets used by Vital Living and certain subsidiaries in its business, including rights to nutritional supplements and nutraceutical products that are marketed for distribution to healthcare practitioners.  As part of the transaction, Vital Living will assign to NutraCea its rights under various distribution and other agreements relating to the products being acquired.  NutraCea will not acquire inventory, raw materials, cash or accounts receivable of Vital Living nor assume any accounts payable, liabilities, or other obligations of VLI.

 

The purchase price consists of (i) $1,500,000 to be paid by NutraCea at the closing, (ii) cancellation of outstanding indebtednesses of Vital Living, its subsidiaries and certain related entities to NutraCea, including all of the Notes, and (iii) cancellation of all shares of Series D Preferred Stock of Vital Living held by NutraCea.  

 

F-22

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  NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 10 — Acquisitions and Joint Ventures - (continued)

Completion of the transaction is subject to a variety of customary closing conditions, including, among other things, approval of the transaction by the shareholders of Vital Living at a special meeting of shareholders of Vital Living and the absence of a material adverse effect on the assets between the date of the agreement and the closing date.  NutraCea anticipates that Vital Living will prepare and file with the SEC a proxy statement relating to the transaction.  NutraCea expects that the transaction will close in the second quarter of 2008, although the actual timing of the closing will depend on many factors including preparation of the proxy statement and the SEC’s review of the proxy statement, and the closing may occur later than the second quarter of 2008.

 

The Purchase Agreement contains customary representations and warranties of the parties, covenants, closing conditions, and certain termination rights for both NutraCea and Vital Living, and further provides that, upon termination of the Purchase Agreement under specified circumstances, Vital Living may be required to pay NutraCea a termination fee.  

 

 Our accounting for the purchase of these securities of VLI qualifies as a Variable Interest Entity (“VIE”) in accordance with FIN 46R . As the primary beneficiary, we have consolidated VLI into our financial statements.

 

The purchase price allocated to the assets and liabilities in April 2007 is as follows:

 

Assets
Cash		$	83,000
Accounts receivable			1,017,000
Inventory			30,000
Property and equipment			15,000
Other assets			15,000
Goodwill			6,278,000
Total assets			7,438,000
Liabilities
Accounts payable			737,000
Accrued liabilities			725,000
Notes payable			750,000
Total liabilities			2,212,000
Net assets acquired		$	5,226,000

 

The purchase price allocation will change when the asset purchase agreement anticipated to be consummated in 2008 and the additional cash payment of $1,500,000 is made. Under that agreement, NutraCea is not purchasing the cash, accounts receivable, inventory, other assets, nor any of the liabilities of VLI.

 

We have included in our balance sheet at December 31, 2007 the financial position of VLI for the period ended December 31, 2007, and VLI’s results of operations for the period from April 20, 2007 through December 31, 2007 in our statement of operations for the twelve months ended December 31, 2007, while eliminating inter-company balances. The effect on our consolidated balance sheet at December 31, 2007 was an increase in total assets of $8,154,000 (before inter-company eliminations), an increase in total liabilities of $2,762,000 (before inter-company eliminations) and an increase in shareholder equity of $5,392,000 (before inter-company eliminations). The effect on our consolidated income statement for the twelve months ended December 31, 2007 was an increase in revenues of $601,000 (net of inter-company eliminations), an increase in cost of goods sold of $378,000 (net of inter-company eliminations), an increase in operating expenses of $1,508,000, an increase of other expenses of $49,000 (net of inter-company eliminations), and an increase in net loss of $1,335,000. Additionally, we have accrued the $1,500,000 payment to be made under the terms of the asset purchase agreement which results in an increase in goodwill and accrued liabilities associated with this transaction. The total increase in goodwill associated with this transaction of $7,579,000. We evaluated this intangible and based upon our analysis determined the value of this goodwill is $6,279,000. Accordingly we have recorded an intangible impairment of $1,300,000.

 

F-23

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 10— Acquisitions and Joint Ventures - (continued)

 

Rice Science LLC

In December 2007 we formed Rice Science, LLC (“RS”), a Delaware LLC with Herbal Science Singapore PTe. Ltd. (“HS”), a Singapore corporation. We formed this LLC with HS to acquire from Herbal Science certain Isolates License Rights and to commercialize and sell the SRB Isolates. NutraCea.and HS have an 80% and 20% interest in the operating results, respectively, but HS has no interest in the initial capital contributions.

We made an initial capital contribution to RS in December 2007 of $1,200,000 as specified in the LLC agreement. We may make an additional $1,000,000 contribution at our discretion and maintain our 80% holding. HS contributed certain Licenses as their capital contribution with a deemed value of $440,000. There are no further capital contributions required of either member. However HS does not have an interest in the initial capital contributed by NutraCea and will not have a minority interest until there are results of operations.

NutraCea holds an 80% interest in RS and therefore will account for the investment as a fully consolidated subsidiary. As of December 31, 2007 the LLC had no sales, operations or expenses. Summary financial information for RS as of December 31, 2007 is as follows:

Assets
Cash		$	1,200,000
Liabilities and Equity
Members equity - NutraCea, Inc.			1,200,000
Total liabilities and equity		$	1,200,000

 

Rice RX LLC

 

In December 2007 we formed RICE Rx LLC (“RRX”), a Delaware LLC, with Herbal Science Singapore PTe. Ltd. (“HS”), a Singapore corporation. We formed this LLC with HS to obtain and commercialize certain patentable pharmaceutical license rights from HS. NutraCea, Inc. and HS each have a 50% interest in RRX.

 

Commencing in July 2008, if and to the extent the members determine that capital contributions are necessary, each member agrees to contribute capital of up to $150,000.

 

In conjunction with the formation of RRX, NutraCea, Inc. sold to HS, for $300,000 an exclusive license to develop, manufacture and sell certain SRB isolates and identify and commercialize certain patentable pharmaceuticals. Payment for this license was made in the form of $150,000 cash and the execution of a promissory note payable to NutraCea for $150,000 at the Bank of America prime rate of interest and due within one year.

 

Our investment in RRX is accounted for under the equity method of accounting. As of December 31, 2007 no capital contributions had been made, the LLC had no operations, expenses or income.

RixeX

 

In November, 2005, NutraCea merged with RiceX. See Note 15 to the Consolidated Financial Statements for a full discussion of the merger.

 

F-24

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11 — Concentration of Credit Risk

 

Financial instruments that potentially subject us to significant concentrations of credit risk consist primarily of trade accounts receivable and notes receivable for sales to major customers. We perform credit evaluations on our customers’ financial condition and generally do not require collateral on accounts receivable.

 

For the twelve months ended December 31, 2007, six customers accounted for a total of 51% of sales: 15%, 14%, 11%, 5%, 3% and 3% respectively. No other customer was responsible for more than 3% of total sales. At December 31, 2007, two of those customers accounted for 65% of total accounts receivable: 34%, and 31%, respectively. No other customer accounted for more than 3% of the total outstanding accounts receivable.

 

For the twelve months ended December 31, 2006, one customer accounted for a total of 48% of sales. At December 31, 2006, accounts receivable due from this customer was 49% of the total outstanding accounts receivable.

 

Accounts receivable:

 

We maintain an allowance for doubtful accounts on our trade receivables based upon expected collection of all accounts receivable. A summary of the activity in the allowance for doubtful accounts for the three years ended December 31, 2007 is summarized in the following table:

 

		December 31,
		2007			2006			2005
Balance, beginning of period		$	20,000		$	20,000		$	20,000
Provision for allowance for doubtful accounts
charged to operations			2,979,000			9,000			-
Losses charge against allowance						(9,000	)
Recoveries of accounts previously allowed for			-			-			-
Balance, end of period		$	2,999,000		$	20,000		$	20,000

 

During the twelve months ended December 31, 2007, 2006 and 2005 we recorded an allowance for doubtful accounts of $2,979,000, $0 and $0, respectively. The 2007 allowance consisted of provisions for doubtful accounts receivable of $1,601,000 and $1,378,000 for amounts due from two customers.

F-25

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 11 — Concentration of Credit Risk- (continued)

 

Notes receivable:

 

We maintain an allowance for doubtful accounts on our notes receivables based upon expected collection of individual notes receivable. A summary of the activity in the allowance for doubtful accounts for the twelve ended December 31, 2007, 2006, and 2005 follows:

 

		December 31,
		2007			2006			2005
Balance, beginning of period		$	-			-		$	-
Provision for allowance for doubtful notes receivable
charged to operations			250,000
Losses charged against allowance			-			-			-
Recoveries of accounts previously allowed for			-			-			-
Balance, end of period		$	250,000		$	-		$	-

 

During the twelve months ended December 31, 2007, 2006 and 2005, we recorded an allowance for doubtful notes receivable of $250,000, $0 and $0, respectively.

 

Bad debt expense:

 

Our bad debt expense for the twelve months ended December 31, 2007, 2006, and 2005, including the provisions for doubtful accounts receivable and doubtful notes receivable was $3,229,000, $9,000 and $0 respectively. Additionally, we wrote off $4,000 of accounts receivable we deemed to be un-collectible.

 

Note 12 — Notes Payable

 

 In October 2007, we executed a promissory note with the lessor of our new West Sacramento warehouse for $105,000 at 8% due over four years in payments of $2,572 per month for the build-out of tenant improvements. At December 31, 2007 the short-term portion of this note was approximately $23,000 and the remaining long-term portion was approximately $77,000. Future principle payments for the next four years are: 2008, $26,000; 2009, $26,000; 2010, $26,000; 2012, $22,000.

 

Note 13 — Income Taxes

 

Tax expense consisting of minimum franchise and capital taxes for the years ended December 31, 2007, 2006 and 2005 was of $20,000, $5,000 and $2,000, respectively.

 

F-26

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 13 — Income Taxes - (continued)

 

Deferred tax assets (liabilities) are comprised of the following at December 31:

 

		2007			2006
Net operating loss carry forward		$	19,740,000		$	14,860,000
Allowance for doubtful accounts			1,195,000			-
Marketable securities			-			801,000
Stock options and warrants			40,000			-
Other			175,000			39,000
Intangible assets			(622,000	)		(275,000	)
Property and equipment			(1,343,000	)		(1,341,000	)
Capitalized expenses			128,000			-
Merger expenses			70,000			-
			19,383,000			14,084,000
Less valuation allowance			(19,383,000	)		(14,084,000	)
		$	—		$	—

 

Deferred taxes arise from temporary differences in the recognition of certain expenses for tax and financial reporting purposes. At December 31, 2007 and 2006, management determined that realization of these benefits is not assured and has provided a valuation allowance for the entire amount of such benefits. At December 31, 2007, net operating loss carry-forwards were approximately $51,915,956 for federal tax purposes that expire at various dates from 2011 through 2021 and $35,828,480 for state tax purposes that expire in 2010 through 2016.

 

Utilization of net operating loss carry-forwards may be subject to substantial annual limitations due to the “change in ownership” provisions of the Internal Revenue Code of 1986, as amended, and similar state regulations. The annual limitation may result in the expiration of substantial net operating loss carry-forwards before utilization.

 

The Company is subject to taxation in the U.S. and various states. We record liabilities for income tax contingencies based on our best estimate of the underlying exposures. We have not been audited by any jurisdiction since our inception in 1998. We are open for audit by the U.S. Internal Revenue Service and U.S. state tax jurisdictions from our inception in 2003 to 2006.

 

The provision for income taxes differs from the amount computed by applying the U.S. federal statutory tax rate (34%) to income taxes as follows for the year ended December 31:

 

		2007			2006			2005
Income tax (benefit) expense at federal statutory rate		$	4,043,000		$	541,000		$	(1,316,000	)
Increase (decrease) resulting from:
State franchise tax expense (benefit), net of federal tax effect			1,403,000			92,000			(224,000	)
Change in valuation allowance			5,299,000			(608,000	)		(3,170,000	)
Goodwill impairment			442,000			-			-
True up to 2006 tax return			(102,000	)		-			-
Other, net			(2,999,000	)		(25,000	)		-
RiceX acquisition			-			-			4,710,000
		$	0		$	0		$	0

 

F-27

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 14 — Commitments and Contingencies

 

Employment contracts

 

Minimum future payments for key employees as of December 31 are as follows:

 

2008		$	978,000
2009			1,032,000
Total		$	2,010,000

 

Generally, if we terminate these agreements without cause or the employee resigns with good reason, as defined, we will pay the employees’ salaries, bonuses, and benefits payable for the remainder of the term of the agreements.

 

Leases

 

We lease our office and laboratory space in Phoenix, AZ under a lease agreement with Transwestern that expires in March 2016 and requires monthly payments that range from $58,831 to $142,135 during the lease term. We also lease warehouse space in West Sacramento, California, which expires in October 2011 for $11,000 per month, and warehouse space in Lake Charles, LA, for $3,500 per month through 2013. Additionally, we have a number of operating leases for small office space in Burley, ID, and Freeport, TX, and office equipment at all of our locations.

 

Future minimum payments under these leases at December 31, 2007 were as follows:

 

Year Ending December 31,
2008		$	1,289,000
2009			1,593,000
2010			1,622,000
2011			1,639,000
2012			1,581,000
2013			1,630,000
Total		$	9,354,000

 

Rent expense was $1,079,000, $124,000 and $111,000 for the years ended December 31, 2007, 2006 and 2005, respectively.

 

Litigation

 

Faraday Financial, Inc.

 

On July 16, 2002, the Company was summoned to answer a Complaint filed by Faraday Financial, Inc. (“Faraday”) in District Court, County of Salt Lake, Utah (Case No. 020906477). The Complaint alleges that the Company issued convertible promissory notes totaling $450,000 and a promissory note totaling $50,000. On December 13, 2001, Faraday entered into a settlement agreement with the Company, whereby Faraday agreed to cancel the promissory notes in exchange for 735,730 shares of preferred stock. Faraday claims that the settlement agreement required that the Company effect a registration statement covering the preferred stock by June 30, 2002, which the Company failed to do, and demands the Company immediately forfeit to Faraday 735,730 shares of common stock owned by the Chief Executive Officer of the Company. Faraday has filed its fourth claim for relief for a judgment against the Company for $500,000, plus accrued, but unpaid interest, attorneys’ fees and costs, and other such costs. A Settlement Agreement was executed on December 10, 2003. In consideration for the mutual releases, Faraday converted 735,730 preferred into 735,730 common shares and $90,000 of accrued preferred dividends into 1,201,692 common shares. Within the next year, if Faraday cannot realize $552,000 and approximately $10,000 in legal expenses from the sale of the common shares, NutraCea will make up any deficiency. If stock sale exceeds $562,000, Faraday is entitled to keep any excess. Subsequent to December 31, 2003, the Company issued an additional 250,000 shares to Faraday. Concurrently, with the executed Settlement Agreement, a joint stipulated motion to stay all proceedings was filed with the Court. After all the above conditions are met, if Faraday has not lifted the stay within 18 months of December 10, 2003, NutraCea shall deliver to Faraday an executed stipulation for dismissal with prejudice of the Complaint and Counterclaim. In 2005, we issued the final 97,000 shares, valued at $98,000, to Faraday to settle in full the executed Settlement Agreement.

 

F-28

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 14 — Commitments and Contingencies - (continued)

 

Langley Park Investments

 

NutraCea commenced a lawsuit on September 8, 2006 against Langley Park Investments, PLC, a United Kingdom Corporation (“Langley”) in the United States District Court for the Eastern District of California, Sacramento Division. The factual basis underlying that case involved a private-placement transaction in which NutraCea exchanged 7 million restricted shares of its common stock for 1,272,026 ordinary shares of Langley common stock (the “Langley Shares”), half of which were immediately saleable by NutraCea and half of which were placed in escrow subject to certain conditions. After the commencement of the litigation, the parties entered into a Pre-Settlement/Escrow Agreement, pursuant to which they agreed that the proceeds from Langley’s sale of certain NutraCea shares, totaling $2.5 million, would be deposited into an escrow account. The matter has now been settled. Pursuant to the settlement, NutraCea received $1.25 million in March 2007 from the $2.5 million held in escrow (Langley received the remainder), and NutraCea retained all of the Langley Shares. During the third quarter of 2007 Langley ceased trading and began the process of liquidating the investments. NutraCea has received cash of $127,000 from this liquidation.

 

In addition to the matters discussed above, from time to time we are involved in litigation incidental to the conduct of our business. While the outcome of lawsuits and other proceedings against us cannot be predicted with certainty, in the opinion of management, individually or in the aggregate, no such lawsuits are expected to have a material effect on our financial position or results of operations.

 

F-29

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 15 - The RiceX Acquisition

 

On October 4, 2005, NutraCea merged with RiceX. The shareholders of RiceX received 28,272,064 shares of NutraCea common stock in exchange for 100% of the shares of RiceX common stock, and NutraCea assumed the outstanding options and warrants to purchase 11,810,496 shares of RiceX common stock.

 

On October 4, 2005, certain investors purchased an aggregate of 7,850 shares of Series B Convertible Preferred Stock at a price of $1,000 per share. Additionally, the investors were issued warrants to purchase an aggregate of 7,850,000 shares of common stock at an exercise price of $0.70 per share. An advisor for the financing received a customary fee based on aggregate gross proceeds received from the investors and a warrant to purchase 1,099,000 shares of common stock at an exercise price per share of $0.50 per share.

 

The acquisition was accounted for using the purchase method of accounting. The purchase price allocation included within these Consolidated Financial Statements is based on a purchase price of $40,542,000 calculated as follows:

 

NutraCea shares issued			28,272,064
Price per share (NutraCea closing price, October 4, 2005)		$	1.03
Aggregate value of NutraCea common stock consideration		$	29,120,000
Value of the RiceX warrants and options assumed			11,422,000
Total consideration		$	40,542,000
Fair value of identifiable net assets acquired:
Estimate of fair value adjustment of property, plant and equipment		$	5,600,000
Acquired other net tangibles assets			611,000
Estimate of fair value adjustment of RiceX intellectual property			2,000,000
Goodwill			32,331,000
Total		$	40,542,000

 

The purchase price allocation is based on estimates and assumptions. This information is presented for informational purposes only.

 

The accompanying unaudited pro forma condensed combined consolidated statement of operations for the year ended December 31, 2005 is presented for illustrative purposes only and does not give effect to any cost savings, revenue synergies or restructuring costs which may result from the integration of NutraCea and RiceX’s operations. In addition, actual results may be different from the projections set forth in this unaudited pro forma condensed combined consolidated statement of operations.

 

F-30

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 15 — The RiceX Acquisition - (continued)

 

Unaudited Pro Forma Condensed Combined Consolidated

Statement of Operations

Year Ended December 31, 2005

 

		HISTORICAL						PRO FORMA
Income Statement		NutraCea			RiceX			Adjustment			Combined
Revenues
Net sales		$	4,569,000		$	3,838,000		$	(325,000	(a)	$	8,082,000
Total Revenues		$	4,569,000		$	3,838,000		$	(325,000	)	$	8,082,000
Cost of Goods Sold		$	2,523,000		$	1,533,000		$	(325,000	(b)	$	3,731,000
Gross Profit		$	2,046,000		$	2,305,000		$	—		$	4,351,000
Sales, General and Administrative		$	2,853,019		$	5,085,000		$	(55,000	(c)	$	7,883,019
Research and Development		$	262,000		$	267,000					$	529,000
Stock Option and Warrant Expense		$	1,511,000		$	—					$	1,511,000
Investor Relations		$	-		$	41,000					$	41,000
Professional Fees		$	109,000		$	914,029					$	1,023,029
Loss From Operations		$	(2,689,019	)	$	(4,002,029	)	$	(55,000	)	$	(6,636,048	)
Interest Income					$	10,000		$	—		$	10,000
Interest Expense		$	(878,000	)							$	(878,000	)
Provision for income tax		$	—		$	(2,000	)				$	(2,000	)
Total other income (expense)		$	(878,000	)	$	8,000		$	—		$	(870,000	)
Net Loss		$	(3,567,019	)	$	(3,994,029	)	$	55,000		$	(7,506,048	)
Cumulative Preferred dividends		$	—		$	—		$	—
Net Loss Available to Common Shareholders		$	(3,567,019	)	$	(3,994,029	)	$	55,000		$	(7,506,048	)
Basic and Diluted Loss per share		$	(0.10	)					(0.01	)	$	(0.11	)
Basic Shares Outstanding			38,830,015						28,272,064	(d)		67,102,079

 

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(a)	Represents the elimination of intercompany sales

 

(b)	Represents the elimination of intercompany cost of sales

 

(c)	Represents the elimination of intercompany rent expense of sublease

 

(d)	Represents the net change in total combined common stock outstanding

 

Note 16 — Preferred and Common Stock

 

Convertible, Series B Preferred Stock

 

On October 4, 2005, certain investors purchased an aggregate of 7,850 shares of Series B Convertible Preferred Stock at a price of $1,000 per share pursuant to the Purchase Agreement. The preferred shares can be converted to shares of common stock at a conversion rate of 2,000 shares of common stock for each preferred share issued in the transaction. Additionally, pursuant to the Purchase Agreement, the investors were issued warrants to purchase an aggregate of 7,850,000 shares of common stock at an exercise price of $0.70 per share, valued at $7,690,000. The warrants have a term of five years and are immediately exercisable.

 

F-31

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 16 — Preferred and Common Stock - (continued)

 

An advisor for the financing received a customary fee based on aggregate gross proceeds received from the investors and a warrant to purchase 1,099,000 shares of common stock at an exercise price per share of $0.50 per share valued at $1,086,000.

 

During the year ended December 31, 2006, fourteen Series B shareholders converted 7,380 shares of preferred stock into 14,760,000 shares of common stock. The preferred shares converted at a conversion rate of 2,000 shares of common stock for each preferred shares.

 

During the year ended December 31, 2007, four Series B Shareholders converted 470 shares of preferred stock into 940,000 shares of our common stock. The preferred shares converted at a conversion rate of 2,000 shares of common stock for each preferred shares.

 

At December 31, 2007 there is no outstanding Series B preferred stock.

 

Convertible, Series C Preferred Stock

 

On May 12, 2006, we sold an aggregate of 17,560 shares of our Series C Convertible Preferred Stock at a price of $1,000.00 per share in connection with a private placement for aggregate gross proceeds of approximately $17,560,000 ($15,934,000 net after offering and related expenses). The Series C preferred shares can be converted to shares of our common stock at a conversion rate of approximately 1,176 shares of common stock for each preferred share. Additionally, the investors were issued warrants to purchase an aggregate of 10,329,412 shares of our common stock at an exercise price of $1.35 per share. The warrants have a term of five years and are immediately exercisable.

 

Halpern Capital, Inc. acted as advisor and placement agent for the financing and received a customary fee based on aggregate gross proceeds received from the investors and a warrant to purchase 500,000 shares of NutraCea’s common stock at an exercise price per share of $1.35. The warrants have a five-year term and are immediately exercisable.

 

During the year ended December 31, 2006, thirty Series C Shareholders converted 12,092 shares of preferred stock into 14,225,854 shares of common stock. The preferred shares converted at a conversion rate of 1,176 shares of common stock for each preferred shares.

 

During the year ended December 31, 2007, seventeen Series C Shareholders converted 5,486 shares of preferred stock into 6,432,932 shares of our common stock. The preferred shares converted at a conversion rate of 1,176 shares of common stock for each preferred shares.

 

At December 31, 2007 there is no outstanding Series C preferred stock.

 

Common Stock

 

F-32

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 16 — Preferred and Common Stock - (continued)

 

During the year ended December 31, 2005, we:

 

Issued 1,904,805 shares of common stock to seven consultants for services rendered, valued at $907,000;

 

Issued 70,000 shares of common stock to two officers and directors, valued at $30,000;

 

Issued a total of 30,000 shares of common stock to two consultants under the Patent Incentive Plan, valued at $13,000; and

 

Issued 97,000 shares of common stock, valued at $98,000, to Faraday, which was the last required payment to Faraday under the Settlement Agreement dated December 10, 2003.

 

During the year ended December 31, 2006, we:

 

Issued 29,999 shares of common stock to a consultant for services rendered, valued at $30,000;

 

Issued 1,742,723 shares of common stock for the cashless exercise of options/warrants.

 

During the year ended December 31, 2007 we:

 

Issued 20,000,000 shares of common stock to investors pursuant to the 2007 Preferred Private Placement, valued at $63,600,000:

 

Issued 17,500 shares of common stock to a past board member for past board service, valued at $56,350:

 

Issued 11,927,280 shares of common stock to 45 investors for the exercise of options or warrants:

 

Issued 1,512,218 shares of common stock to five employees for the exercise of options or warrants:

 

Cancelled 615,199 shares of common stock, returned to us by an investor in an exercise of options transaction:

 

Cancelled 84,889 shares of common stock which were returned to us because the holder did not complete certain performance criteria.

 

Note 17 — Stock Options and Warrants

 

Expense for stock options and warrants issued to consultants is calculated at fair value using the Black-Scholes valuation method.

 

On October 31, 2003, the Board of Directors approved and adopted the 2003 Stock Compensation Plan and authorized the President of the Company to execute a registration statement under the Securities Act of 1933 for 10,000,000 shares of common stock. As of December 31, 2007, 2006, and 2005, 9,966,208 shares of common stock and no options have been granted under the 2003 Stock Compensation Plan.

Our board of directors adopted our 2005 Equity Incentive Plan. or 2005 Plan, in May 2005 and our shareholders approved the 2005 Plan in September 2005. Under the terms of the 2005 Plan. we may grant options to purchase common stock and shares of common stock to officers, directors, employees or consultants providing services to us on such terms as are determined by the board of directors. A total of 10,000,000 shares of our common stock are reserved for issuance under the 2005 Plan. As of December 31, 2007, no shares were issued under the 2005 Plan. 210,000 shares underlie outstanding stock option granted pursuant to the 2005 Plan and 9,790,000 shares were available for future grants under the 2005 Plan. Our board of directors administers the 2005 Plan, determines vesting schedules on plan awards and may accelerate these schedules for award recipients. The 2005 Plan has a term of 10 years and stock options granted under the plan may not have terms in excess of 10 years. All options will terminate in their entirety to the extent not exercised on or prior to the date specified in the written notice unless an agreement governing any change of control provides otherwise.

 

The expense, if any, of stock options issued to employees is recognized over the shorter of the term of service or vesting period. The expense of stock options issued to consultants or other third parties are recognized over the term of service. In the event services are terminated early or no specific future performance is required by the Company, the entire amount is recognized.

 

During the year ended December 31, 2005, we:

 

Assumed 11,810,496 options and warrants with exercise prices between $0.15 and $1.66 per share relating to the acquisition of RiceX. The warrants expire at varying times between 9 months and 10 years;

 

F-33

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 17 — Stock Options and Warrants - (continued)

 

Issued 1,305,000 options and warrants to purchase common stock to ten consultants valued at $349,000. The warrants expire from three-five years, and have exercise prices between $0.30 and $1.275 per share;

 

Issued 1,099,000 warrants to purchase common stock, valued at $1,086,000, for commissions to the underwriter relating to the private placement of Series B preferred stock. The warrants have an exercise price of $0.50 and expire in five years;

 

Issued 7,850,000 warrants to purchase common stock to 17 investors in conjunction with the Series B preferred stock private placement, valued at $7,690,000, exercisable for $0.70 and expiring in five years;

 

Issued 2,200,000 options to 3 employees, which are exercisable between $0.30 and $0.46 per share, expiring in ten years;

 

Exercised 531,000 options and warrants for common stock for cash in the amount of $105,000; and,

 

Issued 66,666 shares of common stock in exchange for 100,000 options and warrants for a cashless exercise.

 

During the year ended December 31, 2006, we:

 

Issued 17,560 shares of our Series C Convertible Preferred Stock at a price of $1,000 per share in connection with a private placement for aggregate gross proceeds of approximately $17,560,000 ($15,934,000 net, after offering and related expenses).

 

Issued 10,329,411 warrants to purchase common stock to 33 investors in conjunction with the series C preferred private placement, valued at $13,524,000, immediately exercisable for $1.35 and expiring in five years;

 

Issued 500,000 warrants to purchase common stock, valued at $655,000, for commissions relating to private placement of series C preferred stock. The warrants are immediately exercisable at $1.35 and expire in five years;

 

Issued a total of 1,600,000 options to purchase common stock to 17 employees, non-employee directors and a medical advisor to the board of directors, vesting from immediately to 2 years, expiring in 3-10 years, with exercise prices of $1.00 to $2.50 per share;

 

Issued a total of 700,000 warrants to purchase common stock to 12 consultants, vesting from immediately to performance contingencies, expiring in 3-4 years, with exercise prices of $1.00 to $2.40 per share;

 

Canceled and/or expired 869,150 options and warrants, including 626,030 RiceX options.

 

Exercised 5,635,064 options and warrants for common stock for cash in the amount of $5,784,000; and

 

Issued 1,842,723 shares of common stock in exchange for 2,520,000 options and warrants for a cashless exercise:

 

Issued 297,108 shares of common stock in connection with our equine feed assets purchase, valued at $350,000;

 

Issued 5,635,064 shares of common stock for the exercise of options and warrants for cash in the amount of $5,784.000;

 

During the year ended December 31, 2007 we:

 

Issued 10,000,000 warrants to purchase common stock to twenty-three investors in conjunction with the February 2007 Preferred Private Placement. The warrants are immediately exercisable, have an exercise price of $3.25 and expire in five years.

 

F-34

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 17 — Stock Options and Warrants - (continued)

 

Issued 1,200,000 warrants to purchase common stock, for commissions to the underwriter relating to the February 2007 Preferred Private Placement. The warrants are immediately exercisable, have an exercise price of $3.25 and expire in five years.

 

Issued 210,000 options to purchase common stock to six Directors for yearly board service: The options vest monthly over a twelve month period, have an exercise price between $3.76 and $3.83, and expire in ten years.

 

Issued 1,039,000 options to purchase common stock to thirty-two employees, with vesting terms of up to three years that have exercise prices between $1.02 and $4.04 per share and expire ten years from the date of grant: One employee received 250,000 of these shares at an exercise price of $2.63 which expire in ten years.

 

Issued 1,815,000 warrants to purchase common stock to five consultants, with exercise prices between $2.38 and $5.25 per share, expiring from one to five years:.

 

Issued to thirty-nine investors a total of 10,754,598 shares of our common stock for the exercises of options and warrants for cash in the amount of $8,952,161 and the surrender of our common stock of 615,199 shares:.

 

Issued to three employees 960,747 shares of our common stock for the exercises of 960,747 options or warrants and cash of $288,224:

 

Issued to eight investors 1,172,682 shares of common stock in cashless exercises of 1,638,352 options or warrants:

 

Issued to three employees 551,471 shares of common stock in cashless exercises of 603,933 options or warrants:

 

Cancelled or expired 3,401,112 options or warrants, including 1,000,000 owned by an officer of the company which expired due to performance goals of the company not being met.

 

The Company determines fair value at grant date using the Black-Scholes option pricing model that takes into account the stock price at the grant date, the exercise price, and the expected life of the option, the volatility of the underlying stock and the expected dividend yield and the risk-free interest rate over the expected life of the option.

 

The weighted average assumptions used in the pricing model are noted in the table below. The expected term of options is derived using the simplified method, which is based on the average period between vesting term and expiration term of the options. The risk free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected volatility is based on the historical volatility of the Company’s stock over a period commensurate with the expected term of the options. The Company believes that historical volatility is indicative of expectations about its future volatility over the expected term of the options.

 

For options granted after January 1, 2006, and valued in accordance with FAS 123 ®, the Company expenses the fair value of the option on a straight-line basis over the vesting period for each separately vesting portion of the award. The Company estimates forfeitures and only recognizes expense for those shares expected to vest. Based upon historical evidence, the Company has determined that an expected forfeitures rate ranging from 5% to 10%. Assumptions used in the Black-Scholes model in accordance with FAS 123 ® for the years ended December 31, 2007 and 2006 and summarized in the table below.

 

F-35

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 17 — Stock Options and Warrants - (continued)

 

In the year ended December 31, 2005, the fair value of compensation expense relating to non-employees stock option grants was estimated on the date of the grant in accordance with FAS123, using the Black-Scholes option-pricing model and the following weighted average assumptions:

 

		2007			2006			2005
Weighted average fair value of options granted		$	3.43		$	1.35		$	.54
Risk-free interest rate (2005)			n/a			n/a			2.0	%
Federal reserve treasury rates (2007 and 2006)			3.67-5.06	%		3.83-5.08	%		n/a
Expected life (years)			6.2			2-5			2-10
Expected volatility			67.9 - 80.5	%		124-305	%		112-166	%
Expected dividends			0			0			0

 

The Black-Scholes option valuation model requires the input of highly subjective assumptions, including the expected life of the stock-based award and stock price volatility. The assumptions listed above represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, the Company’s recorded stock-based compensation expense could have been materially different from that previously reported in pro-forma disclosures. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If the Company’s actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different.

 

A summary of option activity under our equity-based compensation plans as of December 31, 2007, and changes during the year then ended is presented below:

 

		Number of Options/Warrants			Weighted Average Exercise Price			Weighted Average Remaining Contractual Life (Years)			Aggregate Intrinsic Value
Outstanding at January 1, 2007			42,488,556		$	0.76			4.86		$	79,111,000
Granted			14,334,000		$	3.43
Exercised			(13,957,629	)	$	0.86						29,642,000
Forfeited/Expired			(1,400,242	)	$	0.77
Outstanding at December 31, 2007			41,464,685		$	1.65			4.57		$	20,916,000
Exercisable at December 31, 2007			39,481,749		$	1.55			4.36		$	20,859,000

 

The weighted-average grant-date fair value of options granted during 2007 and 2006 was $3.43 and $1.35, respectively. The weighted-average grant-date fair value of options calculated in accordance with FAS 123 granted during 2005 was $0.54.

 

The total intrinsic value of options exercised during the years ended December 31, 2007, 2006, and 2005 was $29,642,000, $6,329,380, and $575,364 respectively.

 

The total fair value of options vested during the years ended December 21, 2007, 2006, and 2005 was $2,950,000, $733,000, and $479,000, respectively.

 

F-36

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 17 — Stock Options and Warrants - (continued)

 

The Company’s stock options and warrants outstanding, exercisable, exercised and forfeited categorized as employees/directors and consultants/investors are as follows

 

		Employee and Directors						Consultants and Investors
Stock option and warrant transactions:		Weighted Average Exercise Price			Number of shares			Weighted Average Exercise Price			Number of shares
Outstanding balance January 1, 2005		$	0.34			8,289,700		$	0.85			6,095,156
Granted		$	0.31			2,200,000		$	0.67			10,554,000
Expired or canceled		$	-			-		$	0.01			(135,004	)
Exercised		$	-			-		$	0.12			(531,000	)
Assumed		$	0.36			8,047,765		$	0.69			3,762,742
Outstanding balance December 31, 2005		$	0.34			18,537,465		$	0.75			19,745,894
Exercisable balance December 31, 2005		$	0.35			16,837,465		$	0.74			19,115,894
Outstanding balance January 1, 2006		$	0.34			18,537,465		$	0.75			19,745,894
Granted		$	1.36			1,600,000		$	1.35			11,629,411
Expired or canceled		$	0.32			(693,244	)	$	0.54			(175,906	)
Exercised		$	-			-		$	0.65			(8,155,064	)
Outstanding balance December 31, 2006		$	0.43			19,444,221		$	1.03			23,044,335
Exercisable balance December 31, 2006		$	0.35			17,589,504		$	1.01			22,443,726
Outstanding balance January 1, 2007		$	0.43			19,444,221		$	1.03			23,044,335
Granted		$	2.97			1,319,000		$	3.47			13,015,000
Expired or canceled		$	0.68			(1,160,302	)	$	1.40			(239,940	)
Exercised		$	0.36			(1,564,679	)	$	1.06			(12,392,950	)
Outstanding balance December 31, 2007		$	0.67			18,038,240		$	2.38			23,426,445
Exercisable balance December 31, 2007		$	0.55			16,628,752		$	2.28			22,852,997

 

Cash received from warrant and stock options exercises for the years ended December 31, 2007, 2006, and 2005 was $9,241,000, $5,784,000, and $105,000, respectively.

 

There is no tax effect on the exercise of options in the statement of cash flows because the Company has a full valuation allowance against its deferred income tax assets.

 

Note 18 — Related Party Transactions

 

Year ended December 31, 2007

 

In November 2004, the Board of Directors resolved to purchase a new automobile valued at $73,000 for use by Patricia McPeak, the former Chief Executive Officer. Ms. McPeak waived a car allowance in exchange for use of the automobile. In the fourth quarter of 2007, this automobile was given to Ms. McPeak as part of her separation agreement. The company recorded a loss of $29,000 on this transaction which is included in our consolidated statements of operations.

 

F-37

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 18 — Related Party Transactions - (continued)

 

In November 2007, we reached an agreement with our former Chief Executive Officer, Ms. NutraCea, and paid her $1,000,000 in severance. She in turn, surrendered all rights to any previous patents issued during her tenure with RiceX and Nutracea. She also granted us the right of first refusal for the benefit of future patent filings for ten years.

 

In February 2007, we issued to one non-employee director an option to purchase 35,000 shares. The option expires in ten years, has an exercise price of $3.76 per share and vests evenly over twelve months.

 

In February 2007, we issued to one executive officer an option to purchase 250,000 shares. The option expires in ten years, has an exercise price of $2.63 per share and vests evenly over a 36 months.

 

In May 2007, we issued to one non-employee director an option to purchase 35,000 shares of our common stock. The options expire in ten years, have an exercise price of $3.76 per share and vest evenly over twelve months.

 

In June 2007, we issued to each of our five non-employee directors options to purchase 35,000 shares of our common stock (totaling 175,000 options). The options expire in ten years, have an exercise price of $3.83 per share and vest evenly over twelve months.

 

Year ended December 31, 2006:

 

In February 2006, we issued a warrant to purchase 100,000 shares of common stock to a member of our Board of Directors for services rendered outside of his directors duties. The warrant expires in five years, has an exercise price of $1.00 per share, and was charged to stock, stock option and warrant expense in the amount of $100,000.

 

In May 2006, we issued to each of our six non-employee directors an option to purchase 35,000 shares (totaling 210,000 option shares). The options expire in ten years, have an exercise price of $1.14 per share and vest evenly over twelve months

 

In May 2006, we issued 381,996 shares of common stock to a customer in an asset purchase agreement related to their trademarks associated with the equine market valued at $450,000.

 

In December 2006, we issued 75,000 warrant shares of common stock to a member of our limited liability company, contingent upon certain performance. A portion of these warrants were deemed to be probable of vesting. The value of the 25,000 probable vesting warrant shares was $16,000 and had an exercise price of $2.38. They will expire in December of 2009.

 

Year ended December 31, 2005:

 

In the first quarter of 2005, 70,000 shares of common stock, valued at $30,000, were issued to two directors.

 

Outside compensation of former Chief Executive Officer:

 

In April 2005, a direct response marketing company agreed to compensate our former Chief Executive Officer, Patricia McPeak, whereby she will receive a royalty per unit sold resulting from infomercials that will demonstrate specific products of ours. Pursuant to this agreement, Ms. McPeak should have earned approximately $311,000, $1,176,000 and $270,000 in 2007, 2006 and 2005, respectively from this direct marketing company. The agreement provides for royalty payments to be made for two years by the direct response marketing company and is not an obligation of ours.

Vital Living, Inc.:

In conjunction with our purchase of certain securities of VLI (Note 10), we consolidated VLI financial results for the period April 20, 2007 to December 31, 2007 into our financial results for the year ending December 31, 2007. Also during the three months ended June 30, 2007, we entered into a business relationship with a new customer that is also the principle customer of VLI. The CEO of VLI is also a principal partner with this new customer. During the twelve months ended December 31, 2007, we recorded sales of $2,461,000 to this new customer. At December 31, 2007 we had $1,465,000 due from this customer included in our accounts receivable of $5,345,000. The entire amount is past due at December 31, 2007 and we have recorded an allowance for doubtful accounts of $1,378,000 against this receivable. We have agreed upon a payment plan and received $65,000 in payments in February 2008 and continued to make sales on a cash basis. We believe the receivable is ultimately collectable.

 

F-38

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 18 — Related Party Transactions - (continued)

 

Also included in the summary financial statements of VLI, which is included in our consolidated balance sheet at December 31, 2007, is $557,000 of accounts receivable, which includes $539,000 due from VLI’s principle customer. During the year ended December 31, 2007 the CEO of VLI has advanced VLI $407,000 of short-term, non-interest bearing loans which are included in the accrued liabilities of VLI on our consolidated balance sheet. Because the CEO of VLI is also a principle member of VLI’s major customer, and because under the terms of the pending asset purchase agreement we will not be acquiring the receivables or any liabilities of VLI, we have offset the $407,000 due to the officer of VLI against the $539,000 of receivables due from the customer on our financial statements.

 

Note 19 — 401(K) Profit Sharing Plan

 

At the time of the merger with RiceX, we adopted RiceX’s 401(k) profit sharing plan (the “Plan”) for the exclusive benefit of eligible employees and their beneficiaries. Substantially all employees are eligible to participate in the Plan. Safe harbor contributions to the Plan are a mandatory 3% of the qualified employees’ gross salary, whether or not the employee is a participant in the Plan. Also, in addition to any safe harbor contributions, the Company may contribute to the Plan matching contributions, discretionary profit sharing contributions and Qualified Non-Elective Contributions. For 2007, 2006 and 2005, we made matching contributions of $113,000, $69,000, and $41,000, respectively.

 

Note 20 — Subsequent Events

Medan, LLC.

On January 24, 2008, NutraCea, through a newly formed wholly-owned subsidiary, Medan, LLC, a Delaware limited liability company (“Medan”), entered into a Stock Purchase Agreement (“Purchase Agreement”) with Fortune Finance Overseas Ltd., a British Virgin Islands company (“FFOL”). Pursuant to the Purchase Agreement, Medan will purchase 9,700 shares of capital stock of PT Panganmas Inti Nusantara, an Indonesian Company (“PIN”), from FFOL for $8,175,000 upon approval of PIN’s Foreign Investment Application. In addition, following the closing, Medan will purchase an additional 3,050 shares from PIN for $2,500,000. Upon completion of these transactions, Medan will own 51% of the capital stock of PIN and FFOL will own 49%. Medan and FFOL will enter a voting agreement where each party will vote all of their shares in a manner that PIN’s Board of Directors and Board of Commissioners shall consist of an even number of persons designated by each party. NutraCea entered into this Purchase Agreement to construct and operate a full scale, wheat bran stabilization facility in the Republic of Indonesia.

Concurrently with the Purchase Agreement, NutraCea entered into a Wheat Bran Stabilization Equipment Lease (“Lease”) with PIN. Pursuant to the Lease, NutraCea will lease to PIN wheat stabilization equipment developed by NutraCea for use at PIN’s facility. The term of the lease will be for 15 years with an automatic extension of 5 years if the facility is fully operational and the equipment is still being used in the operations of the facility. The lease amount payable by PIN will be the actual cost incurred for manufacturing and installing the equipment at the facility.

 

F-39

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 20 — Subsequent events - (continued)

In a separate transaction, on January 24, 2008, NutraCea and Pacific Advisors Holdings Limited (“PAHL”), a British Virgin Islands company and affiliate of FFOL, amended certain terms of the Operating Agreement (“Amendment”) of Grain Enhancement, LLC, a Delaware limited liability company (“Joint Entity”). The Joint Entity was formed on June 22, 2007 by NutraCea and PAHL to construct and operate multiple rice bran stabilization facilities in the Republic of Indonesia, Vietnam, Malaysia, Singapore and Thailand and was granted an exclusive license and distribution rights for the sale of NutraCea’s stabilized rice bran (“SRB”) and other products throughout these countries, and Australia and New Zealand (the “Territory”). Pursuant to the Amendment, the timing of mandatory capital contributions of the members was changed from an agreed upon schedule to a determination by the Finance Committee on an as needed basis. In addition, PAHL will no longer receive a monthly management fee.

Concurrently with the Amendment, NutraCea and PAHL amended the terms of the License and Distribution Agreement dated June 22, 2007. In that agreement, NutraCea granted PAHL a perpetual and exclusive license and distribution rights for the production and sale of SRB and SRB derivative products in the Territory (the “License”). PAHL agreed not to distribute or market any items competitive with NutraCea’s SRB and SRB derivative products outside of the Territory. In exchange for the License, PAHL agreed to pay NutraCea a fee in the amount of $5,000,000 (U.S.) on five year payment terms, together with interest. The parties have agreed to amend the payment terms. PAHL now agrees to pay NutraCea the license fee of $5,000,000 by March 31, 2008. In consideration for this payment, NutraCea agrees to waive all accrued interest owed by PAHL ($118,000 at December 31, 2007).

Also concurrently with the Amendment, NutraCea has agreed to issue to PAHL a new warrant for the purchase of 1,000,000 shares of NutraCea common stock at an exercise price of $2.50 per share (“Warrant”), and PAHL has agreed to cancel the existing warrant currently held by PAHL for the purchase of 1,500,000 shares at an exercise price of $5.25. NutraCea has agreed to register the shares underlying the Warrant subject to certain cutback restrictions set forth in the Warrant. The Warrant shall vest and become exercisable in full upon the Joint Entity depending on certain conditions agreed to upon the parties.

Irgovel:

On January 31, 2008, NutraCea entered into a Quotas Purchase and Sale Agreement (“Purchase Agreement”) with the Quota Holders (“Sellers”) of Irgovel - Industria Riograndens De Oleos Vegetais Ltda., a limited liability company organized under the laws of the Federative Republic of Brazil (“Irgovel”). Irgovel, located in Brazil, owns and operates a rice bran oil processing facility in South America.

 

In February 2008, we completed the purchase of Irgovel paying $14,080,000 for 100% of the company. Additionally, we agreed to fund as necessary up to $5,300,000 to pay deferred taxes due to the Brazilian government. These deferred taxes are payable over a period of 10 years.

 

Purchase commitments:

 

In January 2008 we signed a letter of intent to purchase a building in Phoenix for our planned SRB stage II processing facility for $8,250,000. We expect to close escrow in March 2008. Additionally, we estimate our costs to equip the facility for the production of our products to be $5,000,000. We plan for the facility to be operational in the fourth quarter of 2008.

 

In March 2008, we entered an agreement to purchase a customer list from a supplier for $3,000,000. We expect to finalize that purchase in the second quarter of 2008.

 

F-40

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 20 — Subsequent events - (continued)

 

Options and Warrants Issued

 

In January 2008, we issued options to purchase 1,650,000 shares to five (5) Executive Officers of the Company, with an exercise price of $1.49, vesting contingent upon the certain performances of the company, all expire in five.

 

In January 2008, we issued options to purchase 600,000 shares to six outside Directors with an exercise price of $1.49 per share, vesting monthly over a twelve month period, all expire in five years.

 

In January 2008, we issued warrants to purchase 100,000 shares to one consultant with an exercise price of $1.21 per share, vesting over a five year period, and expire in eight years.

 

In January 2008, we issued warrants to purchase 1,000,000 shares to one consultant with an exercise price of $2.50 per share, vesting is contingent upon certain performances, expire in three years.

 

In February 2008, we issued a warrant to purchase 100,000 shares to one consultant with an exercise price of $1.45 per share, vesting over a six month period once certain performance contingencies are met, and expire in three years.

 

In January and February 2008, we issued options to purchase 135,000 shares to four employees with exercise prices from $1.26 to $1.47 per share, vesting over three years, and expire in five years.,

 

Options and Warrants Exercised

 

In January and February 2008, we issued 1,096,316 shares of common stock to eleven investors in an exercise of options or warrants for cash in the amount of $623,821.

 

In January, we issued 165,080 shares of common stock to two investors in cashless exercises of 231,322 options or warrants.

 

F-41

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 21 — Quarterly Financial Data (Unaudited)

 

		2007
		First Quarter			Second Quarter			Third Quarter			Fourth Quarter
Revenues		$	1,997,000		$	12,996,000		$	1,520,000		$	5,648,000
Operating (loss) income			(2,009,000	)		1,770,000			(5,593,000	)		(9,298,000	)
Net (loss) income			(247,000	)		2,002,000			(4,784,000	)		(8,882,000	)
Basic net income (loss) per common share			0.00			0.01			(0.03	)		(0.07	)
Diluted net income (loss) per common share			0.00			0.01			(0.03	)		(0.07	)

 

		2006
		First Quarter			Second Quarter			Third Quarter			Fourth Quarter
Revenues		$	3,782,000		$	4,166,000		$	4,946,000		$	5,196,000
Operating (loss) income			(254,000	)		290,000			460,000			556,000
Net (loss) income			(233,000	)		399,000			641,000			778,000
Basic net income (loss) per common share			0.00			0.01			0.01			0.00
Diluted net income (loss) per common share			0.00			0.01			0.01			0.00

 

F-42

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NUTRACEA AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 22 — Geographic Operations

 

For purposes of geographic reporting, revenues are attributed to the geographic location of the sales organization. The following table presents net revenues and long-lived assets by geographic area:

 

Fiscal Year Ended December 31,		2007			2006			2005
Net revenue from customers:
United States		$	21,209,000		$	17,748,000		$	5,564,000
International			952,000			342,000			-
Total revenues		$	22,161,000		$	18,090,000		$	5,564,000
Property, plant and equipment, net:
United States		$	19,328,000		$	8,961,000		$	5,493,000
Other countries			-			-			-
Total property, plant and equipment		$	19,328,000		$	8,961,000		$	5,493,000

 

The accompanying notes are an integral part of these financials

 

F-43

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