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CDXS > SEC Filings for CDXS > Form 10-K on 2-Apr-2013All Recent SEC Filings

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Form 10-K for CODEXIS INC


2-Apr-2013

Annual Report


`ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and the related notes that appear elsewhere in this Annual Report on Form 10-K. This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "should," "estimate," or "continue," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled "Risk Factors," set forth in Part I, Item 1A of this Annual Report on Form 10-K and elsewhere in this report. The forward-looking statements in this Annual Report on Form 10-K represent our views as of the date of this Annual Report on Form 10-K. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Annual Report on Form 10-K. Business Overview
We engineer enzymes for pharmaceutical, biofuel and chemical production. Our proven technologies enable scale-up and implementation of biocatalytic solutions to meet customer needs for rapid, cost-effective and sustainable process development, from research to manufacturing.
We have commercialized our technology and products in the pharmaceuticals market, which is our primary business focus. There are currently over 50 pharmaceutical firms using our technology, products and services in their manufacturing process development, including in the production of some of the world's bestselling and fastest growing drugs.
We are developing our CodeXyme® cellulase enzymes to convert non-food plant material, which we call cellulosic biomass, into affordable sugars, which can then be converted into renewable fuels and chemicals. We are also developing our own manufacturing process for CodeXol® detergent alcohols, which are bio-based chemicals. Detergent alcohols are used to manufacture surfactants, which are key, active cleaning ingredients in consumer products such as shampoos, liquid soaps and laundry detergents. We are seeking collaboration partners to assist us with the development and commercialization of CodeXyme® cellulase enzymes and CodeXol® detergent alcohols, and we are also exploring other strategic options with respect to these products and technologies.
We create our products by applying our CodeEvolver® directed evolution technology platform, which introduces genetic mutations into microorganisms, giving rise to changes in the enzymes that they produce. Once we identify potentially beneficial mutations, we test combinations of these mutations until we have created variant enzymes that exhibit marketable performance characteristics superior to competitive products. This process allows us to make continuous, efficient improvements to the performance of our enzymes. Results of Operations Overview
To date, we have generated revenues primarily from collaborative research and development funding, pharmaceutical product sales and government awards. Our revenues in 2012 were $88.3 million which is down significantly compared to our 2011


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revenues of $123.9 million and our 2010 revenues of $107.1 million. The decrease in revenues is primarily due to decreases in both our collaborative research and development revenue and pharmaceutical product sales.
Most of our revenues since inception have been derived from collaborative research and development arrangements, which accounted for 57%, 58% and 66% of our revenues in 2012, 2011 and 2010, respectively.
Our collaborative research agreement with Shell terminated effective August 31, 2012 and as a result, we no longer receive collaborative research and development revenues from Shell subsequent to August 31, 2012. This will significantly decrease our revenues as compared to prior periods and in all future periods. Collaborative research and development revenues received from Shell were $45.3 million, $63.2 million and $66.1 million in 2012, 2011 and 2010, respectively, and accounted for 51%, 51% and 62% of our total revenues in 2012, 2011 and 2010, respectively.
Our product sales accounted for 41%, 40% and 31% of our revenues in 2012, 2011 and 2010, respectively. Our product sales in 2012 were $35.9 million which is down significantly compared to our 2011 product sales of $49.0 million and only a marginal increase compared to our 2010 product revenues of $32.8 million. The decrease in product sales as compared to 2011 is primarily due to the timing of generic and innovator pharmaceutical product orders and due to the New Arch Enzyme Supply Agreement, which became effective on November 1, 2012, as described below.
We have experienced significant losses as we have invested heavily in research and development and administrative infrastructure in connection with the growth in our business. We intend to continue our investment in research and development. As of December 31, 2012, we had an accumulated deficit of $215.6 million. We incurred net losses of $30.9 million, $16.6 million and $8.5 million in the years ended December 31, 2012, 2011 and 2010, respectively. Termination of Shell Collaboration
In September 2012, we entered into the New Shell Agreement, which terminated our collaboration with Shell under the existing Shell Research Agreement and amended the existing Shell License Agreement. See "Collaborations and License Agreements-Shell" in Part I, Item 1 of this Annual Report on Form 10-K for a description of the New Shell Agreement.
The New Shell Agreement required Shell to pay us $7.5 million as full, complete and final satisfaction of amounts that Shell may have owed to us under the Shell Research Agreement with respect to (i) full-time employee equivalents, or FTEs, assigned by us to perform our obligations under the Shell Research Agreement and
(ii) milestones achieved or achievable by us under the Shell Research Agreement. We recognized this $7.5 million payment as collaborative research and development revenues during the year ended December 31, 2012. Beginning September 1, 2012, we have no further obligations to Shell under the Shell Research Agreement to provide any FTEs to perform work under or after the collaboration and Shell correspondingly has no future obligations to us under the Shell Research Agreement to provide funding for FTEs to perform work under or after the collaboration. Prior to the New Shell Agreement, Shell had an obligation under the Research Agreement to fund us at specified rates for each FTE, which as of 2012 were equal to $460,000 on an annual basis for each FTE in the United States and $399,000 on an annual basis for each FTE in Hungary. As of August 31, 2012, the number of FTEs assigned by us to perform our obligations under the Research Agreement was 116. For the year ended December 31, 2012, Shell accounted for 50% of our total revenues. As a result of the termination of the Shell Research Agreement, we initiated a series of cost reduction measures and refocused our business on the pharmaceuticals market. We terminated approximately 173 employees worldwide, consisting of 150 research and development staff and 23 general and administrative staff. We also closed our Singapore research and development facility. We estimate that we will incur $2.4 million in restructuring expenses related to these cost reduction measures, including severance for terminated employees, and other exit-related costs arising from contractual obligations associated with closed facilities under lease and equipment disposals. During 2012, we recorded $1.1 million of leasehold improvement write down, $0.7 million of employee severance and other termination benefits, $0.3 million of facility lease termination costs and $0.3 million of equipment disposal charges. We paid $0.6 million in cash during the fourth quarter of 2012 for these restructuring expenses and expect to pay a remaining $0.4 million in the first half of 2013. We anticipate our expected 2013 cost reductions resulting from restructuring our operation in the United States will be $22.1 million. Our total expected 2013 cost reductions resulting from closing our operations in Singapore is expected to be $7.1 million. We anticipate that these cost reduction measures will generate annual cost savings related to employee compensation costs of $20.9 million, specifically $3.3 million in general and administrative costs and $17.6 million in research and development costs. The remaining cost reduction measure will generate annual cost savings primarily related to outside services, information technology and laboratory equipment expenses, facilities expenses, and recruiting and relocation costs.


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Despite the termination of the Shell Research Agreement, we expect to continue our advanced biofuels program, primarily focusing on developing our CodeXyme® cellulase enzymes for use in producing advanced biofuels. We are actively seeking third party funding to support our CodeXyme® cellulase enzyme program. We are in early stage discussions with multiple parties about potential collaborations, but there can be no assurances that any of our discussions will lead to collaborations or that any new collaboration will fully substitute for the termination of the Shell collaboration. We are exploring other strategic options for the program. We currently do not expect to receive development funding from Raízen, our largest shareholder, to support our CodeXyme® cellulase enzyme program. If we are unable to agree to terms with new collaborators that provide us with the financial assistance and infrastructure necessary for us to develop and commercialize our products and execute our strategy with respect to CodeXyme® cellulase enzymes, or if we are unable to identify and effect attractive strategic options for that program, we will need to continue to fund this development ourselves, which will have a material adverse effect on our liquidity and financial condition, or we may need to suspend the program, which may have a material adverse effect on our business and prospects. Maxygen Transaction
In October 2010, we acquired Maxygen's directed evolution technology patent portfolio for net consideration of $20.2 million consisting of $20.0 million paid to Maxygen, related transaction costs of $0.7 million and a royalty payable extinguishment of $0.5 million. In conjunction with this transaction, we terminated our existing license agreement with Maxygen including terminating our obligation to pay biofuels royalties to Maxygen. CO2 Solutions Investment
Our investment in CO2 Solutions and the joint development agreement we signed with CO2 Solutions in 2009 was our initial entry into carbon management. We estimated the fair value of our investment in 10,000,000 common shares of CO2 Solutions using the market value of common shares as determined by trading on the TSX Venture Exchange. During 2012, we evaluated our investment in the common shares of CO2 Solutions and determined the impairment was other-than-temporary considering the length of time and extent to which the fair value has been less than our cost, the financial condition and near term prospects of CO2 Solutions, and our management's ability and intent to hold the securities until fair value recovers. As a result of our analysis, we recorded an impairment of $0.8 million during the year ended December 31, 2012 as an expense in our consolidated statement of operations as selling, general and administrative expense. As of December 31, 2012, the fair value of our investment in CO2 Solutions' common stock was $0.6 million with an unrealized gain of $47,000. Carbon Management Program
Our carbon management program received $1.6 million in 2012 and $2.2 million in 2011 in funding under a 2010 ARPA-E Recovery Act program award from the United States Department of Energy for development of innovative technology to remove carbon dioxide from coal-fired power plant emissions. The award supported development of biocatalysts for more efficient carbon capture from these plants. The award agreement concluded in June 2012. We also had a collaboration in carbon management with Alstom Power, Inc., or Alstom, which included funding for up to 12 FTEs. We recognized $3.8 million in revenue in 2011 from this collaboration. The Alstom collaboration concluded in October 2011. We are no longer actively developing our carbon capture technology. Singapore Economic Development Board Grant We also received award revenues of $0.6 million in 2012 and $1.3 million in 2011 from the Singapore Economic Development Board, or EDB, for our research and development center in Singapore. This award was terminated in December 2012 in conjunction with the closure of our Singapore research facility. Arch Collaboration
Since 2006, Arch of Mumbai, India has manufactured substantially all of our commercialized intermediates and APIs for sale to generic and innovator manufacturers. We were party to a number of agreements with Arch that govern the commercialization of various current and future products for supply into the generic and innovator marketplaces. In November 2012, we entered into the New Arch Enzyme Supply Agreement, which terminated our existing supply agreements with Arch. Under the New Arch Enzyme Supply Agreement, Arch agreed to exclusively purchase our proprietary enzymes from us for use in the manufacture of certain of Arch's products and we agreed to exclusively supply, with limited exceptions, certain of our proprietary enzymes to Arch at an agreed upon price for use in such manufacture. Arch will no longer produce API and intermediates for us to market and sell and Arch will no longer pay us royalties on the sale of APIs and intermediates to customers. We expect that selling our proprietary enzymes to Arch rather than selling the resulting APIs or intermediates that Arch manufactured for us will result in a decrease in our product revenues in all future periods. However, we expect that our product gross margin will be higher, which we expect to result in a product gross profit comparable with our historical product gross profit.


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Contract Manufacturers
We have limited internal manufacturing capacity at our headquarters in Redwood City, California. We expect to rely on third-party manufacturers for commercial production of our biocatalysts for the foreseeable future. Our in-house manufacturing is dedicated to producing both our Codex® Biocatalyst Panels and Kits and biocatalysts for use by our customers in pilot scale production. We also supply initial commercial quantities of biocatalysts for use by our collaborators to produce pharmaceutical intermediates and manufacture biocatalysts that we sell.
We actively seek contract manufacturers who are willing to invest in capital equipment to manufacture our products at commercial scale. As a result, we are heavily dependent on the availability of manufacturing capacity at, and the reliability of, our contract manufacturers. We also pursue collaborations with industry leaders that allow us to leverage our collaborators' engineering, manufacturing and commercial expertise, their distribution infrastructure and their ability to fund commercial scale production facilities. If our collaborators choose to utilize our technology to commercialize new products, we expect our collaborators will finance, build and operate the larger, more expensive facilities for the intermediate or end products in our markets, which will allow us to expand into new markets without having to finance or operate large industrial facilities.
We primarily rely on one contract manufacturer Lactosan, located in Austria, to manufacture substantially all of the enzymes used in our pharmaceutical business. We have qualified other contract manufacturers for the manufacture of our enzymes, but we do not currently use them for any of our supply commitments. In addition, we contract with other suppliers for the manufacture of our pharmaceutical intermediates and APIs.
Other Collaborations
Our strategy for collaborative arrangements is to retain substantial participation in the future economic value of our technology while receiving current cash payments to offset research and development costs and working capital needs. These agreements are complex and have multiple elements that cover a variety of present and future activities. In addition, certain elements of these agreements are intrinsically difficult to separate and treat as separate units for accounting purposes, especially exclusivity payments. Consequently, we expect to recognize these exclusivity payments over the term of the exclusivity period.
Revenues and Operating Expenses
Revenues
Our revenues are comprised of collaborative research and development revenues, product revenues and government awards.

•         Collaborative research and development revenues include license,
          technology access and exclusivity fees, FTE payments, milestones,
          royalties, and optimization and screening fees.


•         Product revenues consist of sales of biocatalysts, intermediates, APIs
          and Codex® Biocatalyst Panels and Kits.


•         Government awards consist of payments from government entities. The
          terms of these awards generally provide us with cost reimbursement for
          certain types of expenditures in return for research and development
          activities over a contractually defined period. Historically, we have
          received government awards from Germany, Singapore and the United
          States.

Cost of Product Revenues
Cost of product revenues includes both internal and third-party fixed and variable costs including amortization of purchased technology, materials and supplies, labor, facilities and other overhead costs associated with our product revenues.
Research and Development Expenses
Research and development expenses consist of costs incurred for internal projects as well as partner-funded collaborative research and development activities. These costs include our direct and research-related overhead expenses, which include salaries and other personnel-related expenses (including stock-based compensation), occupancy-related costs, supplies, depreciation of facilities and laboratory equipment and amortization of acquired technologies, as well as research consultants, and are expensed as incurred. Costs to acquire technologies that are utilized in research and development and that have no alternative future use are expensed when incurred.
Our research and development efforts devoted to our product and process development projects changed from 57 projects in 2010 to 38 projects in 2011 and 40 in 2012 as we have focused our research and development resources on fewer projects. Our internal research and development projects are typically completed in 12 to 24 months, and generally the costs associated with any single internal project during these periods were not material.


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Selling, General and Administrative Expenses Selling, general and administrative expenses consist of compensation expenses (including stock-based compensation), hiring and training costs, consulting and service provider expenses (including patent counsel related costs), marketing costs, occupancy-related costs, depreciation and amortization expenses, and travel and relocation expenses.
Critical Accounting Policies and Estimates Management's discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States and include our accounts and the accounts of our wholly-owned subsidiaries. The preparation of our consolidated financial statements requires our management to make estimates, assumptions, and judgments 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 applicable periods. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis.
The critical accounting policies requiring estimates, assumptions, and judgments that we believe have the most significant impact on our consolidated financial statements are described below.
Revenue Recognition
Revenues are recognized when the four basic revenue recognition criteria are met: (1) persuasive evidence of an arrangement exists; (2) products have been delivered, transfer of technology has been completed or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.
Our primary sources of revenues consist of collaborative research and development agreements, product revenues and government awards. Collaborative research and development agreements typically provide us with multiple revenue streams, including up-front fees for licensing, exclusivity and technology access, fees for full-time employee equivalent ("FTE") services and the potential to earn milestone payments upon achievement of contractual criteria and royalty fees based on future product sales or cost savings by our customers. Our collaborative research and development revenues consist of revenues from Shell, which revenues have ceased as a result of the termination of the Shell Research Agreement, and revenues from other collaborative research and development agreements.
For each source of collaborative research and development revenues, product revenues and award revenues, we apply the following revenue recognition criteria:

•         Up-front fees received in connection with collaborative research and
          development agreements, including license fees, technology access fees,
          and exclusivity fees, are deferred upon receipt, are not considered a
          separate unit of accounting and are recognized as revenues over the
          relevant performance periods.


•         Revenues related to FTE services recognized as research services are
          performed over the related performance periods for each contract. We
          are required to perform research and development activities as
          specified in each respective agreement. The payments received are not
          refundable and are based on a contractual reimbursement rate per FTE
          working on the project. When up-front payments are combined with FTE
          services in a single unit of accounting, we recognize the up-front
          payments using the proportionate performance method of revenue
          recognition based upon the actual amount of research and development
          labor hours incurred relative to the amount of the total expected labor
          hours to be incurred by us, up to the amount of cash received. In cases
          where the planned levels of research services fluctuate substantially
          over the research term, we are required to make estimates of the total
          hours required to perform our obligations. Research and development
          expenses related to FTE services under the collaborative research and
          development agreements approximate the research funding over the term
          of the respective agreements.


•         A payment that is contingent upon the achievement of a substantive
          milestone is recognized in its entirety in the period in which the
          milestone is achieved. A milestone is an event (i) that can only be
          achieved based in whole or in part on either our performance or on the
          occurrence of a specific outcome resulting from our performance, (ii)
          for which there is substantive uncertainty at the date the arrangement
          is entered into that the event will be achieved, and (iii) results in
          additional payments being due to us. Milestones are considered
          substantive when the consideration earned from the achievement of the
          milestone (i) is commensurate with either our performance to


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achieve the milestone or the enhancement of value of the item delivered as a result of a specific outcome resulting from our performance, (ii) relates solely to past performance, and (iii) is reasonable relative to all deliverable and payment terms in the arrangement.

•         Other payments received for which such payments are contingent solely
          upon the passage of time or the result of a collaborative partner's
          performance are recognized as revenue when earned in accordance with
          the contract terms and when such payments can be reasonably estimated
          and collectability is reasonably assured.


•         We recognize revenues from royalties based on licensees' sales of
          products using our technologies. Royalties are recognized as earned in
          accordance with the contract terms when royalties from licensees can be
          reasonably estimated and collectability is reasonably assured.


•         We generate a significant percentage of our sales in India and other
          emerging markets. Customers in these countries are subject to
          significant economic and other challenges that affect their cash flow,
          and many customers outside the United States are generally accustomed
          to vendor financing in the form of extended payment terms which may
          exceed contractual payment terms. To remain competitive in markets
          outside the United States, we may offer selected customers such payment
          flexibility. We consider arrangements with extended payment terms not
          to be fixed or determinable, and accordingly, we defer revenue until
          payment is received. The costs associated with such revenue deferral
          are also deferred and classified as other current assets in the
          financial statements.


•         Product revenues are recognized once passage of title and risk of loss
          has occurred and contractually specified acceptance criteria have been
          met, provided all other revenue recognition criteria have also been
          met. Product revenues consist of sales of biocatalysts, intermediates,
          active pharmaceutical ingredients and Codex® Biocatalyst Panels and
          Kits. Cost of product revenues includes both internal and third party
          fixed and variable costs including amortization of purchased
          technology, materials and supplies, labor, facilities and other
          overhead costs associated with our product revenues.

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