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VRNM > SEC Filings for VRNM > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for VERENIUM CORP


1-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Explanatory Note Regarding Restatement

The following "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes the impact of our financial restatement as of and for the year ended December 31, 2011, as more fully described in the "Explanatory Note Regarding Restatement" immediately preceding Part I, Item 1 of this Annual Report on Form 10-K. The restatements are the result of a correction for the manner in which we account for our building lease at 3550 John Hopkins Court in San Diego, CA. In connection with the restatement, we also corrected certain immaterial amounts related to warrants issued in 2011, and recorded other immaterial corrections. In addition, we revised our consolidated statements of cash flows for the year ended December 31, 2011 and applicable interim periods in 2011 and 2012 for amounts previously reflected as cash paid for equipment purchases related to our new facility, but for which the cash had not been paid as of the applicable balance sheet dates. This adjustment had no impact on our reported cash and cash equivalents balance for such periods.

For more information regarding the impact of this revision on our financial results, see our Consolidated Financial Statements included in Part II, Item 8, including Note 2, "Restatement" and Note 14, "Selected Quarterly Data (Unaudited)."

Forward Looking Statements

Except for the historical information contained herein, the following discussion, as well as the other sections of this report, contain forward-looking statements that involve risks and uncertainties. These statements speak only as of the date on which they are made, and we undertake no obligation to update any forward-looking statement.

Forward-looking statements applicable to our business generally include statements related to:

• our estimates regarding market sizes and opportunities, as well as our future revenue, product and contract manufacturing revenue, profitability and capital requirements;

• our ability to increase or maintain our product revenue and improve or maintain product gross margins;

• the timing and amount of expected revenue from our Product Pipeline;

• our ability to secure partnerships for, and advance products from, our Expansion Pipeline;

• our strategy;

• our ability to improve manufacturing processes, reduce inventory losses and increase manufacturing yields in order to improve margins and enable us to continue to manage capacity in response to market conditions, such as the state of the corn ethanol industry;

• our ability to maintain good relationships with the companies with whom we contract for the manufacture of certain of our products;

• our expected future research and development expenses, sales and marketing expenses, and general and administrative expenses;

• our plans regarding future research, product development, business development, commercialization, growth, independent project development, collaboration, licensing, intellectual property, regulatory and financing activities;

• investments in our core technologies and in our internal product candidates;

• the opportunities in our target markets and our ability to exploit them;



• our plans for managing the growth of our business;

• the benefits to be derived from our current and future strategic alliances;

• our anticipated revenues from collaborative agreements and licenses granted to third parties and our ability to maintain existing or enter into new collaborative relationships with third parties;

• our expected cash needs, our ability to manage our cash and expenses and our ability to access future financing;

• the impact of dilution to our shareholders and a decline in our share price and our market capitalization from future issuances of shares of our common stock or equity-linked securities;

• the impact of litigation matters on our operations and financial results; and

• the effect of critical accounting policies on our financial results.

Factors that could cause or contribute to differences include, but are not limited to, our operations and ability to continue as a going concern, risks involved with our new and uncertain technologies, risks involving manufacturing constraints which may prevent us from maintaining adequate supply of inventory to meet our customers' demands, risks associated with our dependence on patents and proprietary rights, risks associated with our protection and enforcement of our patents and proprietary rights, our dependence on existing collaborations, our ability to enter into and/or maintain collaboration and joint venture agreements, our ability to commercialize products directly and through our collaborators, the timing of anticipated regulatory approvals and product launches, and the development or availability of competitive products or technologies, as well as other risks and uncertainties set forth below and in the section of this report entitled Risk Factors beginning on page 17.

Overview

We are an industrial biotechnology company that develops and commercializes high performance enzymes for a broad array of industrial processes to enable higher productivity, lower costs, and improved environmental outcomes. We operate in one business segment with four main product lines: animal health and nutrition, grain processing, oilfield services and other industrial processes. We believe the most significant near-term commercial opportunity for our business will be derived from continued sales and gross product margins from our existing portfolio of enzyme products; however, our long-term growth opportunities will be heavily dependent upon our continued development and commercialization of products from our pipeline.

Our business is supported by a research and development team with expertise in gene discovery and optimization, cell engineering, bioprocess development, biochemistry and microbiology. Over the past 20 years, our research and development team has developed a proprietary technology platform that has enabled us to apply advancements in science to discovering and developing unique solutions in complex industrial or commercial applications. We have dedicated substantial resources to the development of capabilities for sample collection from the world's microbial populations, generation of DNA libraries, screening of these libraries using ultra high-throughput methods capable of analyzing more than one billion genes per day, and optimization based on our gene evolution technologies. We have continued to shift more of our resources from technology development to commercialization efforts for our existing and future technologies and products. While our technologies have the potential to serve many large markets, our primary areas of focus for product development are enzymes for animal health and nutrition, grain processing, oilfield services, and other industrial enzyme markets. We have current collaborations and agreements with key partners such as Novus International, Inc. ("Novus"), DuPont Nutrition Biosciences ApS ("DuPont"), Fermic S.A., ("Fermic'), Tate & Lyle Ingredients Americas LLC ("Tate & Lyle"), WeissBioTech ("Weiss"), and DSM Food Specialties B.V. ("DSM"), each of which complement our internal technology, product development efforts, and distribution efforts.


As of December 31, 2012, we owned 217 issued patents relating to our technologies and had 152 patents pending. Also, as of December 31, 2012, we either jointly owned or in-licensed from BP Biofuels North America LLC, or BP, 138 patents and 144 patents pending. Our rights to sell our products and products in development are largely covered by the patents and patent applications we own, and to a lesser extent by patents and patent applications we jointly own with BP. Our rights to practice the discovery and evolution technology which we originally developed are covered by patents we in-license from BP. We believe that we can leverage our owned and licensed intellectual property estate to enhance and improve our technology development and commercialization efforts while maintaining protection on key intellectual property assets.

Excluding our gain on sale of assets to DSM in 2012 and our non-cash gains related to our debt repurchases in 2011, we have typically incurred net losses from our continuing operations since our inception. As of December 31, 2012, we had an accumulated deficit of $582.2 million. Our results of operations have fluctuated from period to period and likely will continue to fluctuate substantially in the future. During the year ended December 31, 2012, excluding the one-time gain on sale to DSM, we generated an operating loss of $9.6 million. We expect to incur losses throughout 2013, as a result of any combination of one or more of the following:

• continued research and development expenses for the progression of Product Pipeline candidates;

• our continued investment in manufacturing facilities and/or capabilities necessary to meet anticipated demand for our products or improve manufacturing yields;

• additional idle manufacturing capacity related to downtime to complete upgrades at our contracted manufacturing facility in Mexico City;

• maintaining or increasing our sales and marketing infrastructure to support our current products and the commercial launch of our Product Pipeline candidates;

• lower gross margins as a result of the contract pricing under the DSM supply agreement;

• uncertainties surrounding our ability to adequately maintain and grow our revenue base for our current products due to unfavorable market conditions in the corn ethanol industry; slower-then-anticipated customer adoption of our products for hydraulic fracturing; and/or the impact of the of launch next-generation-products by competitors in animal health and nutrition

Results of operations for any period may be unrelated to results of operations for any other period. In addition, we believe that our historical results are not a good indicator of our future operating results.

Results of Operations-Continuing Operations

Consolidated Results of Operations

Revenue

Revenue for the years ended December 31, 2012 and 2011 are as follows (in
thousands):



                                           2012         2011       % Change
           Revenue:
           Animal health and nutrition   $ 30,849     $ 33,850            (9 )%
           Grain processing                10,865       15,953           (32 )%
           Oilseed processing                 579        5,352           (89 )%
           All other products               1,062          840            26 %

           Total product revenue           43,355       55,995           (23 )%
           Contract manufacturing           5,547            0           100 %
           Collaborative and license        8,269        5,272            57 %

           Total revenue                 $ 57,171     $ 61,267            (7 )%


The decreased product revenue for the year ended December 31, 2012 was primarily attributed to a decline in grain processing revenue due to adverse business conditions impacting the corn ethanol industry, lower revenue from oilseed processing as a result of the sale of this product line to DSM in March 2012, and a decrease in animal health and nutrition due to toll manufacturing revenue included in 2011.

In conjunction with the sale to DSM, we entered into a supply agreement to continue to produce and sell Purifine and Veretase to DSM at lower sales prices then prior periods when we sold directly to end customers. Revenue from the DSM supply agreement is reported as contract manufacturing above, while pre-DSM sale revenue for Purifine® PLC and Veretase ® alpha-amylase is included in oilseed processing and grain processing revenue respectively.

Animal Health and Nutrition

Revenues from the animal health and nutrition product line, primarily Phyzyme® XP phytase, decreased 9%, or $3.0 million for the year ended December 31, 2012, as compared to 2011 due to a decrease of $3.6 million in toll manufacturing included in animal health and nutrition revenues for the year ended December 31, 2011.

This decrease was partially offset by

• An increase in Phyzyme® XP phytase revenue in 2012 despite lower average selling prices across higher manufacturing volumes as compared to 2011. This was a result of lower cost of production from manufacturing improvements made at Fermic over the last couple of years; and

• An increase in Phyzyme® XP phytase royalty in 2012 due primarily to lower cost of goods sold and higher end sales reported by DuPont.

We have contracted with Genencor, a division of DuPont, to serve as a second-source manufacturer of Phyzyme® XP phytase . We recognize revenue from Phyzyme ® XP phytase manufactured at Fermic equal to the full value of the manufacturing costs plus royalties, as compared to revenue associated with product manufactured by Genencor which is recognized on a net basis equal to the royalty received from DuPont. While this revenue recognition treatment has little or no negative impact on the gross margin in absolute dollars we recognize for every sale of Phyzyme® XP phytase, it does have a negative impact on the gross product revenue we recognize for Phyzyme® XP phytase as the volume of Phyzyme® XP phytase manufactured by Genencor increases. Approximately 65% of PhyzymeXP® phytase production was manufactured by DuPont during both the years ended December 31, 2012 and December 31, 2011.

As our Product Pipeline candidates reach commercialization and demand for other product lines increase, we expect over time we will transition a greater proportion of our Phyzyme® XP phytase manufacturing to Genencor resulting in lower reported Phyzyme® XP phytase product revenue; however, we believe this will make available existing capacity to accommodate expected growth for other enzyme products.

Phyzyme ® XP phytase represented approximately 63% of total product and contract manufacturing revenues for the year ended December 31, 2012 and 54% for the comparable period in 2011. We expect that revenue from Phyzyme® XP phytase will gradually decrease due to the launch of a competing next-generation phytase enzyme by DuPont.

Grain Processing

Grain processing sales decreased by 32%, or $5.1 million over the year ended December 31, 2012 as compared to the same period in 2011, primarily attributed to a decrease in sales of Veretase® alpha-amylase as a result of the license granted to DSM in the first quarter of 2012 and all subsequent revenue reflected as contract manufacturing revenue, and a decrease in sales of Fuelzyme®alpha-amylase and DELTAZYM® GA L-E5 gluco-


amylase enzymes which is being impacted by adverse business conditions in the corn ethanol industry due largely to the following factors:

• Reduced demand for gasoline and thus for ethanol have depressed ethanol prices;

• Depressed ethanol prices combined with continued high corn prices have resulted in low to negative margins for corn ethanol producers, and they have responded by reducing operating rates or idling operations until margins improve;

These factors combined with rising corn prices and the impact of rising gasoline prices on consumer demand, suggest the sustained challenging industry conditions have continued to cause production rate cuts and plant suspensions or closures, which have negatively impacted our business. As a result of these factors, we experienced increased competitive pressure and delays or extensions of trials which consequently has affected the timing of new customer adoptions. While we have gained new customers in 2012, total ethanol production volume from our customers has declined compared to 2011, which in turn has decreased enzyme usage and demand for our products. We expect current industry conditions could continue to impact our revenue growth for our grain processing product line into 2013. In addition, reduced or idle operating rates combined with higher wheat prices in Europe impacting our Xylathin™ xylanase product sales have contributed to the overall decrease.

Collaborative and license

Collaborative revenue increased $3.0 million, or 57%, to $8.3 million for the year ended December 31, 2012 as compared to the same periods in 2011. The increase for the year ended December 31, 2012 was attributed to the following:

• Collaborative revenue associated with our Novus collaboration increased $3.3 million in 2012 primarily due to recognition of $2.9 million related to the delivery of a license under our existing collaboration agreement;

• Our collaboration agreements associated with our commercial products, including our 2012 collaboration with Tate & Lyle, which generated revenue for the year ended December 31, 2012 of $1.0 million related to a one-time up front license payment during the first quarter 2012 and one milestone payment during the fourth quarter 2012 for the further development of one of our alpha amylases; and

• In conjunction with our agreement with DSM, we recognized collaborative revenue for the year ended December 31, 2012 of $2.8 million, including $1.5 million for the alpha amylase and xylanase licenses granted to DSM that were deemed to be delivered as of the end of the first quarter of 2012 in accordance with authoritative accounting guidance; partially offset by

• A license fee of $3.3 million we received in 2011 for a commercial enzyme candidate that Syngenta Participations AG formerly licensed to a third party and assigned to us in conjunction with the separation agreement with Syngenta in 2009.

We expect to have collaborative and license revenue attributable to our collaborations with Novus, Tate & Lyle and DSM into 2013. We continue to pursue opportunities to expand, renew, or enter into new collaborations that we believe fit our strategic focus and represent product commercialization opportunities in the future; however, there can be no assurance that we will be successful in renewing or expanding existing collaborations, or securing new collaboration partners.

Our revenues have historically fluctuated from period to period and likely will continue to fluctuate in the future based upon the adoption rates of our new and existing commercial products, timing and composition of funding under existing and future collaboration agreements, as well as regulatory approval timelines for new products. In addition, due to authoritative accounting guidance, cash may be received in advance of revenue recognition.


Product and Contract Manufacturing Gross Profit and Margin

Product and contract manufacturing gross profit and margin for the year ended
December 31, 2012 and 2011 are as follows (in thousands):



                                                     2012             2011           % Change
Product and contract manufacturing revenue         $ 48,902         $ 55,995               (13 )%
Cost of product and contract manufacturing
revenue                                              32,096           34,481                (7 )%

Product and contract manufacturing gross
profit                                             $ 16,806         $ 21,514               (22 )%
Product and contract manufacturing gross
margin                                                   34 %             38 %

Cost of product and contract manufacturing revenue includes both internal and third party fixed and variable costs, including materials and supplies, labor, facilities, royalties, idle capacity charges and other overhead costs associated with our product and contract manufacturing revenues. Excluded from cost of product and contract manufacturing revenue are costs associated with the scale-up of manufacturing processes for new products that have not reached commercial-scale production volumes, which we include in our research and development expenses. Cost of product and contract manufacturing revenue decreased 7%, or $2.4 million, to $32.1 million for the year ended December 31, 2012, as compared to the same periods in 2011, primarily due to lower overall product and contract manufacturing revenue.

Product and contract manufacturing gross profit totaled $16.8 million for the year ended December 31, 2012 compared to $21.5 million for the year ended December 31, 2011. Gross margin decreased to 34% of product and contract manufacturing revenue for the year ended December 31, 2012, compared to 38% for the year ended December 31, 2011. The decrease in our product and contract manufacturing gross profit was due to the following factors:

• Our grain processing gross profit has decreased based on decreased sales compared to 2011 due to challenges in the corn ethanol market;

• Pursuant to our supply agreement with DSM, we sell Purifine® PLC and Veretase®alpha-amylase at substantially reduced rates than when we sold directly to customers in prior years, resulting in lower gross profit for these products;

• During the third quarter of 2012, we incurred idle capacity charges related to downtime for in-process upgrades to one of the fermentation vessels at Fermic. Under current accounting rules, we expense the idle capacity charges related to downtime taken for such upgrades. We expect to incur additional idle capacity charges during 2013 as we bring two additional vessels down for similar upgrades. Once fully implemented and back on line, these upgrades are intended to improve overall manufacturing quality and improve yields, and as a result reduce overall cost of goods sold; and

• Incremental inventory reserves and write-offs associated with certain lots of inventory which did not meet quality specifications which had a negative impact on our gross profit and related gross margin.

Gross margins are dependent upon the mix of product sales as the cost of product and contract manufacturing revenue varies from product to product. We typically experience lower margins in the early stages of commercial production for our newer enzyme products, as we optimize the manufacturing process for each particular product.

Our cost of product and contract manufacturing revenues will generally grow in proportion to revenues, although we expect to achieve benefits from the additional investments we are making at Fermic to improve our enzyme manufacturing capabilities. Because a large percentage of total manufacturing costs are fixed, we should realize margin improvements as product revenues increase; however, margins could be negatively impacted in the future by several factors, including the following:

• We may incur idle capacity charges associated with additional downtime for implementing improvements to manufacturing equipment, or unplanned downtime from equipment failures;



• We may incur idle capacity charges if product revenues do not increase as expected and production volume is not sufficient to our committed fermentation capacity at Fermic;

• We will experience lower margins when contract manufacturing revenue comprises a larger percentage of our total product and contract revenue due to lower pricing under our supply agreement with DSM;

• We will experience lower margins as we may be obligated to share in cost overruns or increases, in whole or in part, in connection with our contract manufacturing agreement with DSM.

Because Phyzyme ® XP phytase represents a significant percentage of our product and contract manufacturing revenue, our product and contract manufacturing gross profit is impacted to a great degree by the royalty achieved on sales of Phyzyme®XP phytase. Under our manufacturing and sales agreement with DuPont, we sell our Phyzyme® XP phytase inventory to DuPont at our cost and, under a license agreement, receive a royalty equal to 50% of DuPont's profit from the sale of the product, as defined, when the product is sold to DuPont's customer. As a result, our total cost of product revenue for Phyzyme® XP phytase is incurred as we ship product to DuPont, and the royalty calculated as a share of profits, as defined by our agreement, is recognized in the period in which the product is sold to DuPont's customers as reported to us by DuPont. We may record our quarterly royalty based on estimates from DuPont, and the final calculation of profit share is sometimes finalized in the subsequent quarter; accordingly, we are subject to potential adjustments to our actual royalty from quarter-to-quarter. These adjustments, while typically considered immaterial in absolute dollars, could have a significant impact on our reported product and contract manufacturing gross profit from quarter-to-quarter.

In addition, our supply agreement with DuPont for Phyzyme® XP phytase contains provisions which allow DuPont, with six months' advance notice, to assume manufacturing rights for Phyzyme® XP phytase. If DuPont decides to exercise this right, we would also have the right to reduce our capacity commitment to Fermic; nevertheless we may still experience significant excess capacity at Fermic as a result. If we are unable to absorb this excess capacity with other products in the event that DuPont assumes all or a portion of Phyzyme ® XP phytase manufacturing rights, this may have a negative impact on our revenues and our product gross profit.

Research and Development

Our research and development expenses for the year ended December 31, 2012 and
2011 were as follows (in thousands):



                                               2012         2011       % Change
         Commercial products                 $  2,991     $  2,792             7 %
         New product development                8,774        6,959            26 %
         Contract research and development      1,222            0           100 %
         Other                                  2,073        1,287            61 %

         Research and development            $ 15,060     $ 11,038            36 %

Research and development expenses consist primarily of costs associated with internal development of our technologies and our product candidates, manufacturing scale-up and bioprocess development for our current products, and costs associated with research activities performed under our collaboration agreements.

Our research and development expenses increased 36%, or $4.0 million to $15.1 million for the year ended December 31, 2012 primarily due to our increased research and development efforts consistent with our planned investment in our Product Pipeline as well as higher allocated corporate overhead due to higher occupancy-related costs associated with our new building. We expect these expenses to continue to increase in 2013 as we expand our pipeline products and further advance enzyme product candidates through the development pipeline and commercialization efforts. The increase in other research and development over the prior year is primarily due to activities associated with the move to our new building during the year ended December 31, 2012.


We estimate that our allocation of research and development costs for the years ended December 31, 2012 and 2011 was as follows:

                                                    2012       2011
. . .
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