News Column

CRAILAR TECHNOLOGIES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of Financial Condition and Results of Operations

August 12, 2014

The following discussion and analysis of our results of operations and financial position should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this report. Our consolidated financial statements are prepared in accordance with U.S. GAAP. All references to dollar amounts in this section are in U.S. dollars unless expressly stated otherwise.

Overview

We are focused on bringing sustainable bast fiber-based products to market that are environmentally friendly natural fiber alternatives with equivalent or superior performance characteristics to cotton, wood or fossil-fuel based fibers. Our business operations consist primarily of the production of our natural and proprietary CRAiLAR® Flax fibers targeted at the natural yarn and textile industries, as well as the deployment of our CRAiLAR processing technologies in the cellulose pulp and composites industries. We believe that we offer two key opportunities for development:

• CRAiLAR fibers (using flax, hemp or other sustainable bast fiber) for

textiles (knit, woven and non-woven constructions) available in a variety of

blends, textures, colors and applications; and

• CRAiLAR technologies for processing cellulose-based fibers as a high grade

dissolving pulp for use in the additives, ethers and performance apparel

markets.

Effective in fiscal 2013, we began to report our first, second, third and fourth quarters on a 4-4-5 basis, with each quarter ending on the Saturday closest to the last day of each third month.

Acquisition of Production Facility

We commenced production of the first stage of the CRAiLAR flax fiber process in the first quarter of fiscal 2013 out of our decortication facility in Pamplico, South Carolina. Following the decortication process, the fibers were converted into CRAiLAR Flax fiber at a third party wet processing facility with initial fiber sales beginning in the second quarter of fiscal 2013. In December 2013, we acquired a European fiber dyeing facility with equipment similar to that used to produce CRAiLAR Flax fiber. The acquisition was made pursuant to an Asset Purchase Agreement dated November 6, 2013, which was amended and restated on December 13, 2013. The new facility allowed us to accelerate our timeline for establishing a company-controlled CRAiLAR wet processing capability. Production of CRAiLAR fibers at this facility commenced in January 2014. We believe the facility has the capacity to produce over 280,000 pounds of CRAiLAR Flax fiber per week with space to expand the capacity to over 800,000 pounds per week. Operations at our decortication facility in South Carolina have been suspended until improvements have been built and installed to the front end of the production line.

Debentures

On September 20, 2012, we completed the offering of $10.1 million (CAD$10.0 million) worth of convertible debentures (the "September 2012 Debentures"), which bear interest at a rate of 10% per year, payable semi-annually on March 31 and September 30 of each year and mature on September 20, 2017. The holders of the September 2012 Debentures have the option to convert, at any time prior to the maturity date, the September 2012 Debentures into shares of our common stock at a price of $2.85 (CAD$2.90) per share for each $972 (CAD$1,000) of principal amount converted. On February 25, 2013, we completed another offering of $4.9 million (CAD$5.0 million) convertible debentures (the "February 2013 Debentures") with essentially the same terms as the previously mentioned offering. Furthermore, on July 26, 2013, we completed a third offering of $3.4 million (CAD$3.5 million) worth of convertible debentures (the "July 2013 Debentures") with an interest rate of 10% payable semi-annually on March 31 and September 30 of each year, which mature on July 26, 2016. Originally, the holders of the July 2013 Debentures had the option to convert, at any time prior to the maturity date, such debentures into shares of our common stock at a price of $1.94 (CAD$2.00) per share for each $972 (CAD$1,000) of principal amount converted. However, pursuant to the Amended and Restated Convertible Debenture Indenture dated December 23, 2013, the conversion price for the July 2013 Debentures has been reduced to $1.21 (CAD$1.25) per share of common stock. The holders of the July 2013 Debentures also each received warrants to purchase 800 shares of our common stock at an exercise price of $1.21 (CAD$1.25) per share for each $972 (CAD$1,000) of principal amount of July 2013 Debentures purchased, which warrants are exercisable at any time prior to the maturity date of the debentures.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its six wholly-owned subsidiaries as of June 28, 2014: Crailar Inc., a Nevada incorporated company; Hemptown USA, Inc., a Nevada incorporated company; 0697872 B.C. Ltd., a British Columbia incorporated company; Crailar Fiber Technologies Inc., a British Columbia incorporated company, HTnaturals Apparel Corp, a British Columbia incorporated company; and Crailar Europe NV, a Belgian corporation. All intercompany transactions and account balances have been eliminated upon consolidation.

Cash and Cash Equivalents

Cash equivalents consist of cash on deposit and term deposits with original maturities of one year or less at the time of issuance. As of June 28, 2014, the Company had $0.5 million in cash and cash equivalents.

Inventory

The raw flax fiber feedstock, decorticated fiber and CRAiLAR fiber are valued at the lower of cost and market. All direct costs are capitalized to raw flax fiber inventory, decorticated fiber inventory and CRAiLAR fiber. Seed inventory is valued at the lower of average cost and market. Cost represents the cost to purchase seed and/or growing cost plus any related shipping costs. Other inventories, which primarily consist of production consumables, are recorded at the lower of cost and replacement cost, which approximates net realizable value.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Significant areas requiring management's estimates and assumptions are inventory costing and net realizable value, the expected future use and other impairment considerations of property and equipment, fair value of warrants, options, derivative liabilities, provision for income taxes, depreciation and financial instruments.

Property and Equipment

Property and equipment are stated at cost and are depreciated as follows:

Automobiles 20% declining balance Computer equipment 30% declining balance Computer software 100% declining balance Equipment 30% declining balance Furniture and fixtures 20% declining balance Production equipment 30% declining balance Leasehold improvements Term of lease Website development 100% declining balance



Depreciation is claimed at one-half of the regular rate in the year of addition. No depreciation is claimed in the year of disposal.

Intangible Assets

Intangible assets are stated at cost and are amortized as follows:

Trademarks 5 year straight - line License fee 10 year straight - line Patent 10 year straight - line Revenue Recognition



Revenue is recognized when there is persuasive evidence of a sale arrangement, delivery to the customer has occurred, the fee is fixed and determinable, and collectability is considered probable.

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Foreign Currency Translation

The Company's functional currency is Canadian dollars. The Company translates its financial statements to U.S. dollars using the following method: All assets and liabilities are translated into U.S. dollars at the exchange rate in effect at the period-end. Revenues and expenses are translated throughout the year at the weighted average exchange rate. Exchange gains or losses from such translations are included in accumulated comprehensive income (loss), as a separate component of stockholders' equity.

Foreign currency transaction gains and losses are included in the statement of operations and comprehensive loss.

Income Taxes

The Company utilizes the liability method of accounting for deferred income taxes. Under the liability method, deferred income taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. A valuation allowance is recorded when it is more likely than not that potential the future tax assets will not be realized.

Comprehensive Loss

Comprehensive loss is the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners. Other comprehensive income (loss) includes items of income and expense that are not recognized in net loss as required or permitted by U.S. GAAP.

Stock-based Compensation

The Company accounts for stock-based payment transactions in which an enterprise receives services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. The Company uses the Black-Scholes option-pricing model to establish the fair-value of stock-based awards.

Earnings (Loss) Per Share

Basic and diluted earnings (loss) per share are computed using the weighted average number of shares outstanding during the year. Common stock equivalents from stock options and warrants were excluded from the calculation of net loss per share for the periods ended June 28, 2014 and June 29, 2013 as their effect is anti-dilutive.

Long-Lived Asset Impairment

Long-lived assets of the Company are reviewed when changes in circumstances suggest their carrying value has become impaired. Management considers assets to be impaired if the carrying value exceeds the estimated discounted future projected cash flows to result from the use of the asset and its eventual disposition. If impairment is deemed to exist, the assets will be written down to fair value. Fair value is generally determined using a hierarchy of fair value methodologies under U.S. GAAP, primarily based on a discounted cash flow analysis.

Risk Management

Currency risk. The Company is exposed to currency risk to the extent that certain inventory and equipment is purchased from Europe. The purchase price for such inventory and equipment is generally in Euros. The Company does not currently hedge its foreign currency exposure and, accordingly, is at risk for foreign currency exchange fluctuations. The Company and its subsidiaries do not have significant transactions or hold significant cash denominated in currencies other than their functional currencies.

Credit risk. The risk in cash accounts is managed through the use of a major financial institution, which has high credit quality as determined by the rating agencies. Receivables are managed through the use of Letters of Credit and therefore credit risk is minimal.

Interest rate risk. Approximately $340,000 of the Company's debt bears interest at fluctuating rates. Consequentially the Company is exposed to interest rate fluctuations. The Company does not currently hedge its exposure to interest rate risk.

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Commodity price risk. Commodity price risk is the risk that the fair value of future cash flows will fluctuate because of changes in the market prices of commodities. The Company is exposed to commodity price risk as it purchases fiber feedstock from the flax producers in Europe. The Company purchases the short fiber waste product called "tow" and the price fluctuates based on supply. The Company has relationships with several short fiber producers and does not currently anticipate any issue in obtaining sufficient fiber for its needs. The Company does not currently enter into futures contracts or otherwise hedge its exposure to commodity price risk.

Research and Development

Research and development costs are charged to operations as incurred.

Recent Accounting Pronouncements.

There are no recent accounting pronouncements that are applicable to the Company.

RESULTS OF OPERATIONS

Thirteen-Week Period Ended June 28, 2014 Compared to Thirteen-Week Period Ended June 29, 2013 Thirteen Weeks Ended June 28, 2014 June 29, 2013 (amounts in thousands, except per share data) Revenues $ 743 $ 182 Cost of sales Materials and direct production costs 685 201 Facility commissioning costs 251 207 Production facility overhead costs 77 163 Depreciation 132 257 1,144 828 Gross loss (402 ) (646 ) Expenses: Marketing and promotion 93 234 Amortization and depreciation 26 45 General and administrative 1,179 1,518 1,298 1,797 Loss before other items (1,700 ) (2,443 ) Other income (expense): Accretion expense (175 ) Interest (524 ) (483 ) Research and development (64 ) (37 ) Gain on disposal of assets 1 Gain on debt settlement 234 - Write down of inventory - (477 ) Fair value adjustment derivative liabilities 264 408 (265 ) (589 ) Net loss (1,965 ) (3,032 ) Exchange differences on translating to presentation currency (481 ) 525 Total comprehensive loss (2,446 ) (2,507 ) Loss per share (basic and diluted) $ (0.04 ) $ (0.07 ) Non GAAP Financial Measures: EBITDA $ (1,108 ) (2,245 ) Adjusted EDITDA $ (977 ) $ (1,453 )



(1) EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures. EBITDA consist of net loss before (a) interest expense; (b) accretion expense; and (c) depreciation and amortization. "Adjusted EBITDA" further adjusts EBITDA to exclude stock-based compensation expense, facility commissioning expense, fair value adjustment derivative liabilities, gain on settlement of debt, gain on disposal of assets, impairment loss and rent inducement expense.

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Revenue and Gross Margins

For the thirteen week period ended June 28, 2014 ("Second Quarter 2014") our revenues were derived from sales of CRAiLAR fiber and other fiber (non-CRAiLAR) at our new European production facility. For the thirteen week period ended June 28, 2013 ("Second Quarter 2013") our revenues were derived from CRAiLAR fiber.

Our gross loss for Second Quarter 2014 was $0.4 million (2013: $0.6 million). Cost of sales is comprised of $0.7 million (2013: $0.2 million) for flax feedstock, utilities, labor, chemicals and water directly related to sales of CRAiLAR Flax fiber and the non-CRAiLAR legacy fiber dyeing business; $0.3 million (2013: $0.2 million) to temporarily outsource the final CRAiLAR process until equipment is installed and training expenses for new employees to add more production shifts; $0.1 million (2013: $0.2 million) of facility overhead costs and $0.1 million (2013: $0.3 million) for depreciation of production equipment.

Operating Expenses

During the Second Quarter 2014 we recorded operating expenses of $1.3 million compared to operating expenses of $1.8 million for the Second Quarter 2013, a decrease of $0.5 million or approximately 27%. Causes for the reduction are a decrease in general and administrative expenses of $0.3 million and a reduction in marketing and promotion expense of $0.1 million.

Marketing and promotion expenses comprised of marketing salaries and sales development costs were $0.1 million for the Second Quarter 2014, a decrease of $0.1 million or approximately 40% from $0.2 million for the Second Quarter 2013. The decrease was primarily driven by a $0.1 million reduction in product development costs and investor relations and public relations expenses of $0.1 million.

General and administrative (G&A) expenses for the Second Quarter 2014 decreased to $1.2 million, a reduction of $0.3 million or approximately 23% from $1.5 million for the Second Quarter 2013. The decrease was primarily caused by a $0.2 million reduction in salaries and consultants expense, a decrease in professional fees of $0.2 million, and a $0.1 million reduction in stock-based compensation, partially offset by a $0.1 million cost increase associated with the South Carolina facility.

Other Items

Interest expense was $0.5 million for the Second Quarter 2014, approximately the same for the same period as last year Interest expense is attributable to the convertible debenture interest, European facility loan interest, IKEA loan interest and note payable interest of $0.4 million and the amortization of the deferred debt issuance costs of $0.1 million. Accretion expense was $0.2 million from the beneficial conversion feature of the promissory notes and amortization of bonus shares issued with promissory notes in the Second Quarter 2014. There was no accretion expense in the Second Quarter 2013. For Second Quarter 2014 compared to the Second Quarter 2013, research and development costs increased to $64,000 from $37,000 while the fair value adjustment of derivative liabilities was a gain of $264,000 compared to a gain of $407,000.

Net Loss

Our net loss for the Second Quarter 2014 was $2.0 million, or $0.04 per share, compared to $3.0 million, or $0.07 per share for the Second Quarter 2013. The reduction in loss was primarily attributable to the reduction in general and administration expenses of $0.3 million, a reduction in marketing and promotion expenses of $0.1 million, a reduction in gross margin loss of $0.2 million and a gain on settlement of debt of $0.3 million.

For the period ended June 28, 2014, the weighted average number of shares outstanding was 50,892,464 compared to 44,407,621 for the period ended June 29, 2013.

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First Half 2014 Compared to First Half 2013

Twenty-Six Weeks Ended June 28, 2014 June 29, 2013 (amounts in thousands, except per share data) Revenues $ 1,178 $ 182 - Cost of sales Materials and direct production costs 1,045 201 Facility commissioning costs 503 207 Production facility overhead costs 175 163 Depreciation 235 257 1,958 828 Gross loss (780 ) (646 ) Expenses: Marketing and promotion 176 433 Amortization and depreciation 50 97 General and administrative 2,414 3,797 2,640 4,327 Loss before other items (3,420 ) (4,973 ) Other income (expense): Accretion expense (437 ) - Interest (1,064 ) (795 ) Research and development (117 ) (93 ) Gain on disposal of assets - 1 Gain on debt settlement 234 - Impairment loss on inventory - (874 ) Fair value adjustment derivative liabilities 264 482 (1,120 ) (1,279 ) Net loss (4,541 ) (6,252 ) Exchange differences on translating to presentation currency 99 723 Total comprehensive loss (4,442 ) (5,529 ) Loss per share (basic and diluted) $ (0.09 ) $ (0.14 ) Non GAAP Financial Measures: EBITDA $ (2,754 ) (5,102 ) Adjusted EDITDA $ (2,301 ) $ (3,395 )



(1) EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures. EBITDA consist of net loss before (a) interest expense; (b) accretion expense; and (c) depreciation and amortization. "Adjusted EBITDA" further adjusts EBITDA to exclude stock-based compensation expense, facility commissioning expense, fair value adjustment derivative liabilities, gain on settlement of debt, gain on disposal of assets, impairment loss and rent inducement expense.

Revenue and Gross Margins

For the twenty-six week period ending June 28, 2014 ("First Half of 2014") our revenues were derived from sales of CRAiLAR fiber and other fiber (non-CRAiLAR) at our new European production facility. For the twenty-six week period ended June 29, 2013 ("First Half of 2013") our revenues were derived from CRAiLAR fiber.

Our gross loss for the First Half of 2014 was $0.8 million (2013: $0.6 million). Cost of sales is comprised of $1.0 million ( 2013: $0.2 million) for flax feedstock, utilities, labor, chemicals and water directly related to sales of CRAiLAR Flax fiber and the non-CRAiLAR legacy fiber dyeing business; $0.5 million (2013: $0.2 million) to temporarily outsource the final CRAiLAR process until equipment is installed and training expenses for new employees to add more production shifts; $0.2 million (2013:$0.2 million) of facility overhead costs and $0.2 million (2013: $0.3 million) for depreciation of production equipment.

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Operating Expenses

During the First Half of 2014 we recorded operating expenses of $2.6 million compared to operating expenses of $4.3 million for the First Half of 2013, a decrease of $1.7 million or approximately 39%. Causes for the reduction are a decrease in general and administrative expenses of $1.4 million and a reduction in marketing and promotion expense of $0.3 million.

Marketing and promotion expenses comprised of marketing salaries and sales development costs were $0.2 million for the First Half of 2014, a decrease of $0.3 million or approximately 49% from $0.4 million for the First Half of 2013. The decrease was primarily driven by a $0.1 million reduction in product development costs and investor relations and public relations expenses of $0.1 million.

General and administrative (G&A) expenses for the First Half of 2014 decreased to $2.4 million, a reduction of $1.4 million or approximately 23% from $3.8 million for the First Half of 2013. The decrease was primarily caused by a $0.1 million reduction in salaries and consultants expense, a decrease in professional fees of $0.2 million, a $0.6 million reduction in stock-based compensation, and a reduction of $0.5 million in the costs associated with the South Carolina facility.

Other Items

Interest expense increased to $1.1 million for the First Half of 2014, compared to $0.8 million for the First Half of 2013, an increase of $0.3 million, resulting from a full year's interest on certain convertible debentures in 2013, amortization of deferred debt issuance cost and debt discount. Interest expense is attributable to the convertible debenture interest, European facility loan interest, IKEA loan interest and note payable interest of $0.4 million and the amortization of the deferred debt issuance costs of $0.1 million. Accretion expense increased to $0.4 million from the beneficial conversion feature of the promissory notes and amortization of bonus shares issued with promissory notes in the First Half of 2014, compared to $0 for the First Half of 2013. During the First Half of 2014 there was a gain in the settlement of debt of $0.2 million, compared to $0 in the First Half of 2013. For the First Half of 2014 compared to the First Half of 2013, the fair value adjustment of derivative liabilities was a gain of $0.3 million compared to a gain of $0.5 million.

Net Loss

Our net loss for the First Half of 2014 was $4.5 million, or $0.09 per share, compared to $6.3 million, or $0.14 per share for the First Half of 2013..

For the First Half of 2014, the weighted average number of shares outstanding was 49,540,232 compared to 44,392,374 for the First Half of 2013.

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Non-GAAP Financial Measures

The table below reconciles net loss to Adjusted EBITDA for the periods presented (in thousands): Thirteen Weeks Ended Twenty-six Weeks Ended June 28, June 29, June 28, June 29, 2014 2013 2014 2013 Consolidated Net loss $ (1,965 )$ (3,032 )$ (4,541 )$ (6,252 ) Interest expense 524 483 1,064 795 Accretion expense 175 - 437 - Depreciation and amortization 158 303 286 355 EBITDA (1,108 ) (2,245 ) (2,754 ) (5,102 ) Stock-based compensation 378 480 448 1,035 Facility commissioning expense 251 207 503 207 Fair value adjustment derivative liabilities (264 ) (408 ) (264 ) (482 ) Gain on settlement of debt (234 ) - (234 ) - Gain on disposal of assets - (1 ) - (1 ) Impairment loss - 477 - 874 Rent inducement expense - 37 - 74 Adjusted EBITDA $ (977 )$ (1,453 )$ (2,301 )$ (3,395 )



Regulation G, "Conditions for Use of Non-GAAP Financial Measures," and other provisions of the Securities Exchange Act of 1934, as amended (the "Exchange Act") define and prescribe the conditions for use of certain non-GAAP financial information. We provide "EBITDA," which is a non-GAAP financial measure that consists of net income (loss) before (a) interest expense, (b) accretion expense, and (c) depreciation and amortization. "Adjusted EBITDA" further adjusts EBITDA to exclude stock-based compensation expense, facility commissioning expense, fair value adjustment derivative liabilities, gain on settlement of debt, gain on disposal of assets, impairment loss and rent inducement expense.

We believe that these non-GAAP financial measures provide important supplemental information to management and investors. These non-GAAP financial measures reflects an additional way of viewing aspects of our operations that, when viewed with the U.S. GAAP results and the accompanying reconciliation to corresponding U.S. GAAP financial measures, provides a more complete understanding of factors and trends affecting our business and results of operations.

Our management uses EBITDA and Adjusted EBITDA as a measure of our Company's operating performance because it assists in comparing our operating performance on a consistent basis by removing the impact of items not directly resulting from core operations. Internally, these non-GAAP measures are also used by management for planning purposes, including the preparation of internal budgets; for allocating resources to enhance financial performance; for evaluating the effectiveness of operational strategies; and for evaluating our capacity to fund capital expenditures and expand our business. We also believe that analysts and investors use these measures as supplemental measures to evaluate the overall operating performance of development stage companies. Additionally, we believe that lenders or potential lenders use EBITDA and Adjusted EBITDA to evaluate our ability to repay loans.

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These non-GAAP financial measures are used in addition to and in conjunction with results presented in accordance with U.S. GAAP and should not be relied upon to the exclusion of U.S. GAAP financial measures. Management strongly encourages investors to review our consolidated financial statements in their entirety and to not rely on any single financial measure. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies' non-GAAP financial measures having the same or similar names. In addition, we expect to continue to incur expenses similar to the non-GAAP adjustments described above, and exclusion of these items from our non-GAAP measures should not be construed as an inference that these costs are unusual, infrequent or non-recurring.

LIQUIDITY AND CAPITAL RESOURCES

First Half 2014 Compared to Fiscal Year Ended December 28, 2013

2014 2013 (in thousands) Cash and cash equivalents $ 489$ 1,193 Working capital $ (1,989 )$ (3,426 ) Total assets $ 22,818$ 21,490 Total liabilities $ 25,606$ 23,504 Shareholders' equity (deficit) $ (2,788 )$ (2,014 )



The Company has historically relied on equity financings, and more recently on sales of convertible debentures, to fund its operations. On June 2, 2014 the Company completed an equity financing for settlement of $927,944 in debts. On March 20, 2014, the Company completed an equity financing with gross proceeds of $3.1 million. On December 20, 2013, the Company completed an equity financing with gross proceeds of $1.9 million (CAD$2.0 million). On December 19, 2013, but having an effective date of November 29, 2013, we entered into a loan agreement to borrow up to $2.9 million (€2.2 million, approximately CAD$3.2 million). The Company has drawn on the loan $2.9 million (€2.2 million), which was used for capital expenditures for the European processing facility and general working capital. In February 2013, the Company completed a convertible debt financing for gross proceeds of $4.9 million (CAD$5.0 million). In July 2013, the Company completed an additional convertible debt financing for gross proceeds of $3.4 million (CAD$3.5 million). In September 2012, the Company completed a convertible debt financing for gross proceeds of $10.1 million (CAD$10.0 million). The Company expects to fund future operations and expansion through bank debt, government loan programs, customer financing, lease programs and additional equity and debt financings, as well as through cash generated from operations.

Net Cash Used in Operating Activities

Net cash flows used in operating activities for the First Half of 2014 were $4.9 million compared with $4.4 million for the First Half 2013. Cash flows used in operations for the First Half of 2014 consisted primarily of a net loss of $4.5 million offset by the following items: amortization and depreciation of $0.3 million (2013: $0.6 million), primarily related to production equipment in Europe for 2014 and to the decortication facility in the USA in 2013; accretion expense of $0.4 million (2013: $nil) related to the beneficial conversion feature of a promissory notes and amortization of the bonus shares issued pursuant to the promissory note; amortization of deferred debt issuance costs of $0.2 million (2013: $0.2 million); fair value adjustment of derivative liability of $(0.3 million) (2013: $(0.5 million)), the gain in 2013 related to the expiration of warrants having an exercise price in a currency other than the Company's functional currency; rent of $(0.0 million) (2013: $0.1 million) related to the lease deferral at the South Carolina decortication facility; stock-based compensation of $0.4 million (2013; $1.0 million) was lower because of fewer options vesting in 2014 than in 2013; gain on settlement of debt $(0.2 million) (2013:$0); impairment of inventory of $0 (2013: $0.9 million) relating to the write down of raw feedstock and Crailar fiber to market price; (increase) decrease in accounts receivable of $(0.9 million) mainly due to sales tax receivable in Europe, and for Crailar sales (2013: $(0.1 million)); a decrease (increase) in inventory of $0.0 million (2013: $(0.5 million)); an (increase) in prepaid expenses of $(0.5 million) (2013: $0.2 million) mostly due to the timing of insurance and listing costs; an increase in accounts payable of $0.3 million (2013: $0.4 million) associated with the start of production in Europe; an increase (decrease) in accrued liabilities of $(0.2 million) (2013: $(0.1 million)) mostly related to debenture interest.

Net Cash Used in Investing Activities

Net cash flows used in investing activities for the First Half of 2014 were $1.1 million, compared to $2.5 million for the First Half of 2013. Cash flows used in investing activities consisted primarily of the acquisition of property and equipment for the European production facility of $1.1 million (compared with $2.5 million for the purchase of equipment at the U.S. decortication plant in 2013).

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Net Cash Provided by Financing Activities

Cash flows provided by financing activities for the First Half of 2014 totaled $5.3 million compared to $3.9 million during for the First Half of 2013. The Company received proceeds from private placements of $3.1 million (2013: $0.2 million); proceeds from long term debt of $3.0 million (2012: $0) and had debt issuance costs of $0 (2013: $0.5) . The Company also repaid promissory notes and loans $0.8 million (2013: $0). During the First Half of 2013, we received proceeds of $4.2 million from the issuance of convertible debentures.

Effect of Exchange Rate

The effect of exchange rates on cash resulted in an unrealized gain of $3,014 for the First Half of 2014, as compared with an unrealized gain of $723,253 for the First Half of 2013.

MATERIAL COMMITMENTS Debt Offerings



We completed the following three convertible debt offerings in 2012 and 2013: (i) the September 2012 Debentures with gross proceeds of $10.1 million (CAD$10.0 million) on September 20, 2012; (ii) the February 2013 Debentures with gross proceeds of $4.9 million (CAD$5.0 million) on February 25, 2013; and (iii) the July 2013 Debentures with gross proceeds of $3.4 million (CAD$3.5 million) on July 26, 2013. The September 2012 Debentures mature on September 30, 2017 and bear interest at a rate of 10% per year, payable semi-annually on March 31 and September 30 of each year, starting March 31, 2013. The February 2013 Debentures mature on September 30, 2017 and bear interest at a rate of 10% per year, payable semi-annually on March 31 and September 30 of each year, starting on September 30, 2013. The February 2013 Debentures are ranked subordinate to the September 2012 Debentures. Non-Canadian resident holders of the February 2013 Debentures will receive additional interest equal to the amount of the withholding taxes paid by us for Canadian tax purposes. The July 2013 Debentures mature on July 26, 2016 and bear interest at a rate of 10% per year, payable semi-annually on March 31 and September 30 of each year, commencing on September 30, 2013. The July 2013 Debentures are secured by production equipment and fixtures located at our South Carolina facility that are different from the production equipment and fixtures at the South Carolina facility that were used to secure the September 2012 Debentures and the February 2013 Debentures. In the event we complete one or more equity financings between July 26, 2013 and July 26, 2016 with gross proceeds of at least an aggregate of $19.4 million (CAD$20.0 million), we must, subject to providing no less than 60 days prior notice to each holder of the July 2013 Debentures, redeem the July 2013 Debentures in whole at face value plus all accrued and unpaid interest thereon. The initial conversion rates of each of the September 2012 Debentures, the February 2013 Debentures and the July 2013 Debentures were $2.85 (CAD$2.90), $2.85 (CAD$2.90) and $1.94 (CAD$2.00), respectively, and are subject to anti-dilution provisions.

Holders of the September 2012 Debentures and the February 2013 Debentures have the option to convert their debentures into common stock at a conversion price of $2.85 (CAD$2.90) per share of common stock at any time prior to their respective maturity date. We may redeem the September 2012 Debentures and the February 2013 Debentures after September 30, 2015 provided that the market price at the time of the redemption notice is not less than 125% of the conversion price.

In accordance with the conditions of the IKEA Loan (defined below), we approached the debenture holders (the "Debentureholders") of the July 2013 Debentures about releasing their security over certain assets held by our subsidiary, CRAiLAR Inc., having an acquisition cost of $1.3 million, which form a portion of the assets securing the July 2013 Debentures pursuant to the Guaranty and Security Agreement (the "Guaranty") between CRAiLAR Inc. (the "Guarantor") and Computershare Trust Company of Canada (the "Trustee"), dated July 26, 2013, as set forth in Schedule "A" to the Guaranty, to be used as separate security for the IKEA Loan to us. As consideration for such alteration to the secured assets, the conversion price of the July 2013 Debentures was reduced from $1.94 (CAD$2.00) per share to $1.21 (CAD$1.25) per share. On December 23, 2013, the Trustee and us entered into an Amended and Restated Convertible Debenture Indenture which reflects the modification and alteration of the rights of the Debentureholders and the Trustee against us with respect to (i) the secured assets to now only include those specific assets held by the Guarantor as set forth in Schedule "F" to the Amended and Restated Convertible Debenture Indenture having an acquisition cost of $3.9 million, and (ii) the reduction of the conversion price of the July 2013 Debentures from $1.94 (CAD$2.00) per share to $1.21 (CAD$1.25) per share. In addition, on the same date, the Guarantor and the Trustee entered into an Amended and Restated Guaranty and Security Agreement, which reflects the modification and alteration with respect to the secured assets as discussed above.

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Debt

On December 1, 2013, we purchased certain assets of a European fiber dyeing facility. We acquired these assets by assuming an aggregate of $1.2 million of the seller's debts, which we have agreed to repay on the earlier of their respective due dates and December 1, 2018. On December 13, 2013, we entered into an amended asset purchase agreement for such assets, which replaced the initial asset purchase agreement and provides that the title to and economic risk in respect of the environmental permit and the employees passed to us on December 1, 2013, however, the title to the equipment at the facility shall only pass to us upon full payment of the foregoing assumed indebtedness of the seller, notwithstanding the fact that physical possession and economic risk of all assets of the acquired facility passed to us on December 1, 2013. We have reached an oral agreement with the seller to lease the real property for the facility and are in the process of formalizing that oral agreement.

On December 19, 2013, but having an effective date of November 29, 2013, we entered into a loan agreement (the "Loan Agreement") with IKEA Supply AG ("IKEA"), whereby IKEA agreed to loan us $3.0 million (€2.2 million, approximately CAD$3.2 million) (the "IKEA Loan") having a term until June 25, 2016 and bearing interest at a rate of 1.9% per annum. As security for the IKEA Loan, IKEA required that the IKEA Loan be secured by assets purchased with the proceeds of the IKEA Loan, as well as a portion of the secured assets used to secure the July 2013 Debentures. The proceeds from the IKEA Loan are designated for the installation of equipment to support and expand our European production facility and for working capital to fulfill IKEA orders. During the First Half 2014 the Company received $2,906,985 (€2,200,000) pursuant to the loan agreement.

We repaid the following loan arrangements with each of the following directors: Jason Finnis, Kenneth Barker and Robert Edmunds during Second Quarter 2014:

• Finnis. Pursuant to a convertible promissory note, dated for reference

October 11, 2013, Mr. Finnis provided us a loan in the principal amount of $96,180 (CAD$100,000) bearing interest at a rate of 12% per annum and due on December 11, 2013. On November 7, 2013, we repaid to Mr. Finnis$47,885 (CAD$50,000), such that a principal amount of $47,885 (CAD$50,000) remained due and payable on the loan. Pursuant to a loan extension agreement, dated for reference December 18, 2013, Mr. Finnis and we agreed to extend the term for repayment of the loan and interest thereon until the earlier of (i) December 20, 2014 and (ii) such time as we complete our next public offering of registered securities by way of a registration statement on Form S-1 of not less than $2.8 million (CAD$3.0 million) in gross proceeds to us. We repaid this loan and interest thereon in full in April 2014.



• Barker. Pursuant to a convertible promissory note, dated for reference

October 11, 2013, Mr. Barker provided us a loan in the principal amount of $50,000 bearing interest at a rate of 12% per annum and due and payable on December 11, 2013. Pursuant to a loan extension agreement, dated for reference December 18, 2013, Mr. Barker and we agreed to extend the term for repayment of the loan and interest thereon until the earlier of (i) December 20, 2014 and (ii) such time as we complete our next public offering of registered securities by way of a registration statement on Form S-1 of not less than $2.8 million (CAD$3.0 million) in gross proceeds to us. We repaid this loan and interest thereon in full in April 2014.



• Edmunds. Pursuant to demand convertible promissory notes, dated for

reference October 11, 2013 and December 4, 2013, respectively, Mr. Edmunds provided us loans in the aggregate principal amount of $509,624 (CAD$545,000) bearing interest at a rate of 20% per annum. Pursuant to a loan extension agreement, dated for reference December 18, 2013, Mr. Edmunds and we agreed to extend the term for repayment of the loan and interest thereon until the earlier of (i) December 20, 2014 and (ii) such time as we complete our next public offering of registered securities by way of a registration statement on Form S-1 of not less than $2.8 million (CAD$3.0 million) in gross proceeds to us. As consideration for the extension, we issued to Mr. Edmunds 181,666 shares of our common stock at a deemed value of $0.56 (CAD$0.60) per share. We repaid this loan and interest thereon in full in April 2014. 28



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We are committed to annual debt and debenture interest payments over the next five years as follows (in thousands):

2014 $ 898 2015 1,762 2016 1,592 2017 1,028 2018 3 Total $ 5,283 Annual Leases



We are committed to current annual lease payments totaling $1.1 million for all of our premises under lease. Approximate minimum lease payments over the next five years are as follows (in thousands):

2014 $ 140 2015 264 2016 264 2017 264 2018 209 Total $ 1,141



OFF-BALANCE SHEET ARRANGEMENTS

As of the date of this report, we do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term "off-balance sheet arrangement" generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have any obligation arising under a guarantee contract, derivative instrument or variable interest; or a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

SUBSEQUENT EVENT

On August 6, 2014, we completed the public offering of 13,000,000 units (the "Units") at a price of $0.50 per unit for aggregate gross proceeds of $6,500,000 (the "Offering"). Each unit is comprised of one common share and one common share warrant (each common share purchase warrant, a "Warrant"). Each warrant entitles the holder thereof to acquire one common share at an exercise price of $0.535 per common share at any time prior to August 6, 2019.

We paid 7% of gross proceeds of the offering to the underwriters and have granted them an option (the "Over-Allotment Option"), exercisable in whole or in part at any time up to 30 days following the closing of the Offering. The Over-Allotment Option allows the underwriters to purchase an additional 15% of the Offering solely to cover over-allotments, if any, and for market stabilization purposes. The Over-Allotment Option entitles the underwriters to purchase a maximum of 1,950,000 units or 1,950,000 common shares and/or 1,950,000 warrants.

The Over-Allotment Option has been partially exercised and the underwriters have purchased 1,950,000 warrants at $0.001 per warrant for proceeds of $1,950.


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Source: Edgar Glimpses


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