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SZYM > SEC Filings for SZYM > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for SOLAZYME INC

Form 10-Q for SOLAZYME INC


14-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements reflecting our current expectations and involves risks and uncertainties. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "intend," "potential" or "continue" or the negative of these terms or other comparable terminology. For example, statements regarding our expectations as to future financial performance, expense levels and liquidity sources are forward-looking statements. Our actual results and the timing of events may differ materially from those discussed in our forward-looking statements as a result of various factors, including those discussed below and those discussed in the section entitled "Risk Factors" included in this Quarterly Report on Form 10-Q and in our other filings with the Securities and Exchange Commission (SEC).

Overview

We make oil. Our proprietary technology transforms a range of low-cost, plant-based sugars into high-value oils. Our renewable products can replace or enhance oils derived from the world's three existing sources-petroleum, plants and animal fats. We tailor the composition of our oils to address specific customer requirements, offering superior performance characteristics and value. Our oils can address the major markets served by conventional oils, which represented an opportunity of over $3 trillion in 2011. Initially, we are commercializing our products into three target markets: (1) chemicals and fuels,
(2) nutrition and (3) skin and personal care.

We create oils that mirror or enhance the chemical composition of conventional oils used today. Until now, the physical and chemical characteristics of conventional oils have been dictated by oils found in nature or blends derived from them. We have created a new paradigm that enables us to design and produce novel tailored oils that cannot be achieved through the blending of existing oils alone. These tailored oils offer enhanced value as compared to conventional oils. For example, our tailored, renewable oils can enable our customers to enhance product performance, reduce processing costs and/or enhance their products' sustainability profile. Our oils are drop-in replacements in that they are compatible with existing production, refining, finishing and distribution infrastructure in all of our target markets.

We have pioneered an industrial biotechnology platform that harnesses the prolific oil-producing capability of microalgae. Our technology allows us to optimize oil profiles with different carbon chain lengths, saturation levels and functional groups to modify important characteristics. We use standard industrial fermentation equipment to efficiently scale and accelerate microalgae's natural oil production time to a few days. By feeding plant sugars to our proprietary oil-producing microalgae in dark fermentation tanks, we are in effect utilizing "indirect photosynthesis," in contrast to traditional open-pond approaches. Our platform is feedstock flexible and can utilize a wide variety of renewable plant-based sugars, such as sugarcane-based sucrose, corn-based dextrose, and sugar from other sustainable biomass sources including cellulosics, which we believe will represent an important alternative feedstock in the future. Furthermore, our platform allows us to produce and sell specialty bioproducts from the protein, fiber and other compounds produced by microalgae.

We expect our products to generate attractive margins in our target markets. We anticipate that the average selling prices of our products will capture the enhanced value of our tailored oils. Based on the technology milestones we have demonstrated, we believe the conversion cost profile we have achieved to date, when implemented at scale, will enable us to profitably engage in our target markets. For example, our lead microalgae strains producing oil for the chemicals and fuels markets have achieved key performance metrics that we believe would allow us to generate attractive margins on the manufacture of oils today assuming the use of a larger scale, built-for-purpose commercial plant (inclusive of the anticipated cost of financing and facility depreciation).

Since 2007, we have been operating in commercially-sized standard industrial fermentation equipment (75,000-liter scale) with multiple contract manufacturing partners. In addition, in April 2012, we entered into a Joint Venture Agreement with Bunge Global Innovation, LLC and certain of its affiliates (collectively, Bunge), one of the largest sugarcane processing companies in Brazil, establishing a joint venture (Solazyme Bunge JV) to construct and operate an oil production facility adjacent to Bunge's sugarcane mill in Moema, Brazil, with an annual expected name plate capacity of 100,000 metric tons.

To date, we have generated revenues from research and development programs, license fees and product sales. Through September 30, 2012, our revenues were primarily generated from key agreements with government agencies and commercial partners. In 2010, we launched our first products, the Golden Chlorella® line of dietary supplements, as a market development initiative, with current sales of products incorporating Golden Chlorella ® at retailers including Whole Foods


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Markets, Inc. (Whole Foods) and General Nutrition Centers, Inc. (GNC). In the first quarter of 2011, we commenced commercial sale of our skin and personal care products, which were launched internationally with Sephora S.A. (Sephora EMEA) and domestically with Sephora USA, Inc. (Sephora Americas).

As we scale up our manufacturing capacity, we expect a large portion of our sales to be from products sold into the chemicals and fuels markets. Our revenues have increased in each of the last three fiscal years, growing from $9.2 million in 2009, to $38.0 million in 2010 to $39.0 million in 2011. In the nine months ended September 30, 2012, our revenues increased $11.6 million to $35.7 million from $24.1 million in the nine months ended September 30, 2011. We incurred net losses attributable to our common stockholders of $13.8 million, $16.4 million and $54.0 million in 2009, 2010 and 2011, respectively, and our net loss was $58.5 million for the nine months ended September 30, 2012.

We anticipate that we will continue to incur net losses as we continue our scale-up activities at our market development and commercial production facility located in Peoria, Illinois (Peoria Facility), expand our research and development activities and support commercialization activities for our products. In addition, as we enter into agreements with other companies to scale capacity, we will incur additional net losses associated with the build-out of those production facilities.

Through a combination of partnerships and internal development, we plan to scale rapidly. In 2012, we expect to utilize contract manufacturing to supplement our manufacturing capacity, which is comprised of the 2,000,000 liter annual capacity of our Peoria Facility that we acquired in May 2011, and the manufacturing capacity of Solazyme Roquette Nutritionals, LLC (Solazyme Roquette Nutritionals, or the Solazyme Roquette JV), one of our joint venture entities. We plan to launch a commercial chemicals and fuels production facility in 2013 in connection with the Solazyme Bunge JV and additional commercial capacity in 2014 and 2015. We are currently negotiating supply agreements with multiple potential feedstock partners in Latin America and the United States.

In May 2011, we entered into a Joint Development Agreement with Bunge. This Joint Development Agreement advances our work on Brazilian sugarcane feedstocks and extends through May 2013. Also in May 2011, we granted to Bunge Limited a performance-based warrant to purchase 1,000,000 shares of our common stock at an exercise price of $13.50 per share. Pursuant to the terms of the warrant, the warrant shares vest upon the successful completion of milestones that ultimately target the construction of a commercial facility with 100,000 metric tons of annual oil production capacity. In August 2011, we entered into a Joint Venture Framework Agreement with Bunge to accelerate entry into a joint venture with Bunge to construct this commercial production facility, and pursuant to that agreement jointly commenced engineering on the facility. In April 2012, we and Bunge entered into a definitive agreement forming a joint venture to build, own and operate a commercial-scale renewable tailored oils production facility adjacent to Bunge's Moema sugarcane mill in Brazil. We expect this production facility to have annual production capacity of 100,000 metric tons of oil. As of September 30, 2012, 750,000 of the warrant shares had vested.

Significant Partner Agreements

We currently have license agreements, joint development agreements, supply agreements and distribution arrangements with various strategic partners. We expect to enter into additional partnerships in each of our three target markets to advance commercialization of our products and to expand our upstream and downstream capabilities. Upstream, we expect partners to provide research and development funding, capital for commercial manufacturing capacity and/or secure access to feedstock. Downstream, we expect partners to provide expanded distribution channels, product application testing, marketing expertise and/or long-term purchase agreements (offtakes). Our current principal partnerships and strategic arrangements include:

Bunge. In May 2011, we entered into a Joint Development Agreement (the "JDA") with Bunge that extends through May 2013. Pursuant to the JDA, we and Bunge are jointly developing microbe-derived oils, and exploring the production of such oils from Brazilian sugarcane feedstock. The JDA also provides that Bunge will provide research funding to us through May 2013, payable quarterly in advance throughout the research term.

In April 2012, we and Bunge formed a joint venture (the Solazyme Bunge JV) to build, own and operate a commercial-scale renewable tailored oils production facility (the Plant) adjacent to Bunge's Moema sugarcane mill in Brazil. The Plant, which will leverage our technology and Bunge's sugarcane milling and natural oil processing capabilities, will produce our tailored triglyceride oils primarily for chemical applications. In addition, the Plant has been designed to be expanded for further production in line with market demand. We expect this production facility to have annual production capacity of 100,000 metric tons of oil. Construction of the Plant, which will be jointly financed by us and Bunge, commenced in the second quarter of 2012, and is targeted for start-up in the fourth quarter of 2013.

In addition to forming the Solazyme Bunge JV in April 2012, we entered into a Development Agreement with Solazyme Bunge JV to continue to conduct research and development activities that are intended to benefit Solazyme Bunge


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JV, including activities in the areas of strain development, molecular biology and process development. The Development Agreement provides that Solazyme Bunge JV will pay us a technology maintenance fee in recognition of our ongoing research investment in technology that would benefit Solazyme Bunge JV. We also entered into a Technology Service Agreement with the Solazyme Bunge JV under which Solazyme Bunge JV will pay us for technical services related to the operations of the Plant, including, but not limited to, engineering support for Plant operations, operation procedure consultation, product analysis and Microbe performance monitoring and assessment.

In anticipation of Solazyme Bunge JV's formation, in May 2011, we granted Bunge Limited a warrant ("the Warrant") to purchase 1,000,000 shares of our common stock at an exercise price of $13.50 per share. The Warrant vests as follows:
(i) 25% of the warrant shares vest on such date that we and Bunge Limited (or one of its affiliates) enter into a joint venture agreement to construct and operate a commercial-scale renewable oil production facility sited at a sugar mill of Bunge Limited or its affiliate (the Joint Venture Plant); (ii) 50% of the warrant shares vest on the earlier of the following: (a) execution of the engineering, procurement and construction contract covering the construction of the Joint Venture Plant and (b) execution of a contract for the purchase of a production fermentation vessel for the Joint Venture Plant; provided, however, that such date occurs on or prior to ten weeks after certain technical milestones set forth in the JDA are achieved; and (iii) 25% of the warrant shares vest on the date upon which aggregate output of triglyceride oil at the Joint Venture Plant reaches 1,000 metric tons. The number of warrant shares issuable upon exercise is subject to downward adjustment for failure to achieve the performance milestones on a timely basis as well as adjustments for certain changes to capital structure and corporate transactions. The first tranche of the Warrant shares (25%) vested in April 2012 (see below). The second tranche of the Warrant shares (50%) vested in June 2012. The Warrant expires in May 2021.

Refer to Note 8 and Note 13 in the accompanying notes to our unaudited condensed consolidated financial statements for further discussion of the Bunge JDA, Joint Venture Agreement and Warrant.

Chevron. We have entered into multiple research and development agreements with Chevron to conduct research related to algal technology in the fields of diesel fuel, lubes and additives and coproducts. Under the terms of the most recent agreement, Chevron provided research funding through June 30, 2012, subject to specified maximum amounts to be allocated to particular activities. The agreement contemplates that the parties may consider commercializing licensed products in a number of different ways.

US Navy. In September 2010, we entered into a firm fixed price research and development contract with the Department of Defense (DoD), through the Defense Logistics Agency, Fort Belvoir, VA (DLA), to provide marine diesel fuel. We agreed to produce up to 567,812 liters of HRF-76 marine diesel for the US Navy's testing and certification program. This contract is the third contract that we have entered into with the DoD and the largest of the three. We completed two earlier contracts to research, develop and demonstrate commercial-scale production of microalgae-based advanced biofuels to establish appropriate status for future commercial procurements. We completed the first phase of our 567,812 liter contract in July 2011, with the delivery of 283,906 liters of HRF-76 marine diesel to the US Navy for their testing and certification program. In August 2011, the DoD exercised its option to pursue the second phase of the current DoD contract, which calls for the delivery of the remainder of the 283,906 liters of HRF-76 marine diesel for the US Navy's testing and certification program. We completed the second phase of our contract in June 2012, with the delivery of 283,906 liters of HRF-76 marine diesel to the US Navy.

In November 2011, Dynamic Fuels, LLC (Dynamic) was awarded a contract to supply the US Navy with 450,000 gallons (1,703,000 liters) of renewable fuels. The contract involves supplying the US Navy with 100,000 gallons (379,000 liters) of jet fuel (Hydro-treated Renewable JP-5 or HRJ-5) and 350,000 gallons (1,325,000 liters) of marine distillate fuel (Hydro-Treated Renewable F-76 or HRD-76). We were named a subcontractor and we entered into a subcontractor agreement with Dynamic effective January 2012 to supply Dynamic with algal oil to fulfill Dynamic's contract with the US Navy to deliver fuel by May 2012. We delivered our commitment of algal oil pursuant to this subcontract in February 2012. The fuel was used by the US Navy in July 2012, as part of its efforts to demonstrate a Green Strike Group composed of vessels and ships powered by biofuels.

Dow. In February 2011, we entered into a joint development agreement with Dow in connection with the development of microalgae-based oils for use in dielectric insulating fluids. This initial research program was completed in September 30, 2011. In March 2012, we entered into a multi-year extension of this joint development agreement, including accelerated commercialization time lines based on our progress in the production of tailored algal oils. The extended agreement enables additional application development work to be conducted by Dow, due to our accelerated ability to scale up our tailored algal oil feedstocks. In conjunction with entry into the expanded development agreement, the parties entered into a contingent offtake agreement in which Dow agreed to purchase from us all of its requirement of non-vegetable microbe-derived oils for use in dielectric fluid applications through 2015, contingent upon our ability to supply such oils within agreed specifications


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and certain terms and conditions of the sale. Provision of our algal oil feedstocks is expected to start in the second half of 2013. The offtake agreement contemplates that final pricing for the oil will be linked to certain items including our sugar-based feedstock costs.

Roquette. In November 2010, we entered into a joint venture agreement with Roquette. The purpose of the Solazyme Roquette Nutritionals joint venture (the Solazyme Roquette JV) is to engage in manufacturing, distribution, sales, marketing and support of products and services related to the use of microalgae to which we have not applied our targeted recombinant technology in a fermentation production process to produce materials for use in the following fields: (1) human foods and beverages; (2) animal feed; and (3) nutraceuticals. Solazyme Roquette Nutritionals is 50% owned by us and 50% by Roquette. While the Solazyme Roquette JV will establish a manufacturing platform for the products, Roquette has committed to provide expertise and resources with respect to manufacturing, including such volumes of corn-based dextrose feedstock as the Solazyme Roquette JV may request subject to the terms of a manufacturing agreement. Roquette has also agreed to provide (1) a full capital commitment for two Solazyme Roquette JV-dedicated, Roquette-owned facilities that are expected to have aggregate capacity of approximately 5,000 metric tons per year,
(2) subject to the approval of the board of directors of the Solazyme Roquette JV, debt and equity financing for a larger Solazyme Roquette JV-owned facility that is expected to have capacity of approximately 50,000 metric tons per year, and (3) working capital financing during various scale-up phases. In October 2011, the Solazyme Roquette JV determined that its first committed manufacturing facility would be located at Roquette's commercial production plant in Lestrem, France, and production began on its microalgae-derived food ingredients in the first quarter of 2012. In addition, we anticipate the Phase 2, 5,000 metric ton facility to be expanded from the Phase 1 facility in Lestrem in 2012. In November 2011, we and Roquette amended the joint venture agreement to provide that Roquette would make available to the Solazyme Roquette JV during Phase 1 and Phase 2 additional working capital in the form of debt financing (Roquette Loan). We agreed to guarantee payment of a portion, up to a maximum amount, of 50% of the aggregate draw-downs from the additional Roquette Loan, if and when drawn, plus a portion of the associated fees, interest and expenses.

Sephora. In December 2010, we entered into an exclusive distribution contract with Sephora EMEA to distribute our Algenist® product line in Sephora EMEA stores in certain countries in Europe and select countries in the Middle East and Asia. In January 2011, we also made arrangements with Sephora Americas to sell our Algenist® product line in Sephora Americas stores (which currently includes locations in the United States and Canada). In October 2011, we launched our Algenist® product line at Sephora inside jcpenney stores in the United States.

Unilever. In October 2011, we entered into a joint development agreement with Unilever (our fourth agreement together) which expands our current research and development efforts. Upon successful completion of the development agreement and related activities, we have agreed with Unilever to the terms of a multi-year supply agreement in which Unilever would purchase commercial quantities of our renewable oils.

Financial Operations Overview

Revenues

To date, we have focused on building our corporate infrastructure, developing our core technology and designing a manufacturing process to scale up our biotechnology platform to position us in our target markets. Prior to our agreement with Roquette, which generated license fees, our revenues were primarily from collaborative research and government grants. We expect to sell our products in the future into three target markets: chemicals and fuels; nutrition; and skin and personal care. The products that we sell and intend to sell into our target markets have significantly different selling prices, volumes and expected contribution margins. We expect our product revenues in the near term to be comprised almost entirely from the sale of products into the skin and personal care market. We expect that this market will provide us with the highest gross margin of our three target markets. Solazyme Roquette Nutritionals intends to continue to sell the Golden Chlorella® line of dietary supplements and we expect to broaden our range of commercial products sold into the nutrition market, which we believe also has attractive margins. In the longer term, we expect that a significant portion of our revenues will come from the chemicals and fuels markets, which have lower, but still attractive, margins and higher volumes.

To date our revenues have consisted of research and development program revenues and license fees, and beginning in the first quarter of 2011, included product revenues.

• Research and Development Program Revenues

Revenues from research and development (R&D) programs are recognized in the period during which the related costs are incurred, provided that the conditions under which the government grants and agreements were provided have been met and only perfunctory obligations are outstanding. We currently have active R&D programs with


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governmental agencies and commercial partners. These R&D programs are entered into pursuant to grants and agreements that generally provide payment for certain types of expenditures in return for research and development activities over a contractually defined period. Revenues related to R&D programs include reimbursable expenses and payments received for full-time equivalent employee services recognized over the related performance periods for each of the contracts. We are required to perform research and development activities as specified in each respective agreement based on the terms and performance periods set forth in the agreements as outlined above. R&D program revenues represented 56% and 67% of our total revenues for the three and nine months ended September 30, 2012, respectively, as compared to 79% and 77% of our total revenues for the three and nine months ended September 30, 2011, respectively. Revenues from government grants and agreements represented 54% and 55% of total R&D program revenues in the three and nine months ended September 30, 2012, respectively, as compared to 50% and 42% of total R&D program revenues in the three and nine months ended September 30, 2011, respectively. Revenues from commercial and strategic partner development agreements represented 46% and 45% of total R&D program revenues in the three and nine months ended September 30, 2012, respectively, and 50% and 58% of total R&D program revenues in the three and nine months ended September 30, 2011, respectively.

• Product Revenues

Product revenues consist of revenues from products sold commercially into each of our target markets.

Starting in 2011, we recognized revenues from the sale of our first commercial product line, Algenist ®, which we distributed to the skin and personal care end market through arrangements with Sephora EMEA, Sephora Americas, QVC, The Shopping Channel, Space NK and Sephora inside jcpenney locations. We launched our Algenist®product line in certain countries in Europe and the United States in the first quarter of 2011, through The Shopping Channel in Canada in the second quarter of 2011, and through Space NK in the United Kingdom and Sephora inside jcpenney locations in the third quarter of 2011. We may also launch the Algenist® product line in additional geographies and/or through additional distribution channels. Product revenues represented 44% and 33% of our total revenues in the three and nine months ended September 30, 2012, respectively. Product revenues represented 21% and 23% of our total revenues in the three and nine months ended September 30, 2011, respectively.

Costs and Operating Expenses

Costs and operating expenses consist of cost of product revenue, research and development expenses and sales, general and administrative expenses. Personnel-related expenses including non-cash stock-based compensation, third-party contract manufacturing, reimbursable equipment and costs associated with government contracts, consultants and facility costs comprise the significant components of these expenses. We expect to continue to hire additional employees, primarily in research and development, manufacturing and commercialization as we scale our manufacturing capacity and commercialize our technology in target markets.

• Cost of Product Revenue

In the first quarter of 2011, we launched our first commercial product line, Algenist ®. Cost of product revenue consists primarily of third-party contractor costs associated with packaging, distribution and production of Algenist® products, internal labor, supplies and other overhead costs associated with production of Alguronic Acid®, a microalgae-based active ingredient used in our Algenist ® product line, as well as shipping costs. We expect our third-party contractor costs related to the distribution and production of Algenist®, as well as our other costs of product revenue, to increase as the demand for our Algenist® product line grows.

• Research and Development

Research and development expenses consist of costs incurred for internal projects as well as partner-funded collaborative research and development activities with commercial and strategic partners and governmental entities (partners). Research and development expenses consist primarily of personnel and related costs including non-cash stock-based compensation, third-party contract manufacturing, reimbursable equipment and costs associated with government contracts, consultants, facility costs and overhead, depreciation and amortization of property and equipment used in development, and laboratory supplies. We expense our research and development costs as they are incurred. Our research and development programs are undertaken to advance our overall industrial biotechnology platform that enables us to produce tailored, high-value oils. Although our partners fund certain development activities, they benefit from advances in our technology platform as a whole, including costs funded by other development programs. Therefore, costs for such activities have not been separated as these costs have all been determined to be part of our . . .

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