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KIOR > SEC Filings for KIOR > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for KIOR INC


10-May-2013

Quarterly Report


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

The following discussion and analysis of our financial condition and results of operations should be read together with our audited consolidated financial statements as of December 31, 2012, the notes accompanying those financial statements and management's discussion and analysis as contained in our Annual Report on Form 10-K, or Annual Report, filed with the SEC on March 18, 2013 and in conjunction with the unaudited condensed consolidated financial statements and notes in Item 1 of Part I of this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of various important factors, including those discussed below and in the section entitled "Risk Factors" included in Item 1A of Part I of our Annual Report. Due to the fact that we have generated only limited revenue to date, we believe that the financial information contained in this report is not indicative of, or comparable to, the financial profile that we expect to have if and when we begin to generate significant revenues. We undertake no obligation to update publicly any forward-looking statements, even if new information becomes available or other events occur in the future, except to the extent required by law.

Overview

We are a next-generation renewable fuels company. We have developed a proprietary catalytic process that allows us to produce cellulosic gasoline and diesel from abundant, lignocellulosic biomass. Our cellulosic gasoline and diesel are true hydrocarbon fuels which are similar to their traditional petroleum-based counterparts and yet result in over 60% less life cycle greenhouse gas emissions. While other renewable fuels are derived from soft starches, such as corn starch or cane sugar, for ethanol, or from soy and other vegetable oils for biodiesel, cellulosic fuel is derived from lignocellulose found in wood, grasses and the non-edible portions of plants. Our biomass-to-cellulosic fuel technology platform combines our proprietary catalyst systems with fluid catalytic cracking, or FCC, processes that have been used in crude oil refineries to produce gasoline for over 60 years.

In April 2012, we mechanically completed our initial-scale commercial production facility in Columbus, Mississippi. This first facility is designed to produce up to 13 million gallons of cellulosic diesel and gasoline per year. During the fourth quarter of 2012, we successfully commissioned our proprietary biomass fluid catalytic cracking, or BFCC, operation, and produced our first "on spec" cellulosic intermediate oil in limited quantities. In March 2013, we successfully commissioned the Columbus plant's hydrotreater and fractionation units, and began our first cellulosic diesel shipments. We have had limited continuous production at our Columbus facility and have not yet reached "steady state" production.

We currently intend to begin construction of our planned first standard commercial production facility in Natchez, Mississippi in the second half of 2013, subject to our ability to raise capital. We are designing our Natchez facility to produce up to 40 million gallons of cellulosic diesel and gasoline per year, approximately three times the amount of our Columbus facility. We believe the Natchez facility will be the model for our standard commercial facilities in order to take advantage of economies of scale. Our business plan contemplates that we will need to raise additional funds to build our planned standard commercial production facilities and subsequent facilities, continue the development of our technology and products and commercialize any products resulting from our research and development efforts.

We were incorporated and commenced operations in July 2007. Since our inception, we have operated as a development stage company, performing extensive research and development to develop, enhance, refine and commercialize our biomass-to-cellulosic fuel technology platform. Until recently, we have focused our efforts on research and development and the construction of our Columbus facility. As a result, we have generated $234.1 million of operating losses and an accumulated deficit of $258.1 million from our inception through March 31, 2013. We expect to continue to incur operating losses through at least 2015 as we continue into the commercialization stage of our business.

Financial Operations Overview

Revenue Recognition

We record revenue from the sale of cellulosic gasoline, diesel, and fuel oil. We generate renewable identification numbers ("RINs") by producing cellulosic biofuel as approved by the EPA under RFS2. The number of renewable identification numbers per gallon is defined by the Equivalence Value (EV) which is related to the relative energy content compared to corn ethanol. Our cellulosic gasoline and diesel have an EV of 1.5 and 1.7, respectively, RINs per gallon. RFS2 allows additional RINs to be granted to obligated parties who blend into their fuel more than the required percentage of renewable fuels in a given year. These RINs may be traded to other parties or may be used in subsequent years to satisfy RFS2 requirements. In March 2013, we commenced limited sales of our cellulose diesel. We have had only limited continuous production at our Columbus facility and have not yet reached "steady state" production.

Research and Development

Research and development expenses consist primarily of expenses for personnel focused on increasing the scale of the Company's operations to increase production capacity and reduce operating costs. These expenses also consist of facilities costs and other related overhead and lab materials. Research and development costs are expensed as they are incurred.

General and Administrative Expenses

General and administrative expenses consist primarily of personnel-related expenses related to our executive, legal, finance, human resource and information technology functions, as well as fees for professional services and allocated facility overhead expenses. These expenses also include costs related to our sales function, including marketing programs and other allocated costs. Professional services consist principally of external legal, accounting, tax, audit and other consulting services.


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Depreciation and Amortization Expense

Depreciation and amortization expense consists of depreciation of our property, plant and equipment over their estimated useful lives and amortization of our intangible assets, consisting primarily of purchased biomass conversion technology and technology licenses, which are amortized using the straight-line method over their estimated useful lives.

Interest Income

Interest income consists primarily of interest income earned on investments and cash balances. We expect our interest income to fluctuate in the future with changes in average investment balances and market interest rates.

Interest Expense, Net of Amounts Capitalized

We incur interest expense in connection with our outstanding equipment loans, our loan with the Mississippi Development Authority and our term loan with Khosla and the Alberta Lenders (as such terms are defined below). We capitalize interest on long-term construction projects relating to operating assets with a total expected expenditure generally in excess of $10.0 million until such assets are placed into service. To the extent our planned commercial production facilities are funded with debt, we anticipate capitalizing most of the interest costs that we incur. In March 2013, we placed our initial-scale commercial production facility in Columbus, Mississippi into service, which significantly reduced interest expense capitalized after the in-service date. Until we incur significant capital expenditures at our planned first standard commercial production facility in Natchez, Mississippi, we expect that the majority of our interest expense will not be capitalized.

Income Tax Expense

Since inception, we have incurred net losses and have not recorded any U.S. federal and state income tax provisions. We have a full valuation allowance for our net deferred tax assets because we have incurred losses since inception.

Costs of Start-Up Activities

Start-up activities are defined as those one-time activities related to opening a new facility, introducing a new product or service, conducting business in a new territory, conducting business with a new class of customer or beneficiary, initiating a new process in an existing facility, commencing some new operation or activities related to organizing a new entity. All the costs associated with a potential site are expensed and recorded within the general and administrative expenses until the site is considered viable by management, at which time costs would be considered for manufacturing costs based on authoritative accounting literature.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions.

We believe the following accounting policies are the most critical to a full understanding and evaluation of our reported financial results and reflect the more significant judgments and estimates that we use in the preparation of our consolidated financial statements.

Inventories

Inventory is valued at standard cost, which approximates actual cost computed on a first-in, first-out basis, not in excess of cost or net realizable market value. Inventories, which consist of cellulosic gasoline, diesel and fuel oil, renewable crude oil, renewable cellulosic biomass (primarily pine logs and wood chips), and catalyst, are categorized as finished goods, work-in-process or raw material inventories. Inventory costs include transportation, chipping and overhead costs incurred during production.

Impairment of Long-Lived Assets and Intangible Assets

We assess impairment of long-lived assets, including intangible assets, on at least an annual basis and test long-lived assets for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable. Circumstances which could trigger a review include, but are not limited to, significant decreases in the market price of the asset; significant adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset; a forecast of continuing losses associated with the use of the asset; or expectations that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.


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Recoverability is assessed by using undiscounted future net cash flows of assets grouped at the lowest level for which there are identifiable cash flows independent of the cash flows of other groups of assets. If the undiscounted future net cash flows are less than the carrying amount of the asset, the asset is deemed impaired. The amount of the impairment is measured as the difference between carrying value and the fair value of the asset.

The majority of our long-lived assets, other than intangible assets, consist of our initial-scale commercial production facility, demonstration unit, and pilot unit. The demonstration and pilot units are variations of common refinery equipment used in technology development and scale-up of processes that have been scaled and modified for our research and development purposes. Our intangible assets consist of purchased biomass conversion technology and technology licenses. Given our history of operating losses, we evaluated the recoverability of the book value of our property, plant and intangible assets by performing an undiscounted forecasted cash flow analysis. Based on our analysis, the sum of the undiscounted cash flows is in excess of the book value of the property, plant and equipment and intangible assets. Accordingly, no impairment charges have been recorded during the period from July 23, 2007 (date of inception) through March 31, 2013.

Our undiscounted cash flow analysis involves significant estimates and judgments. Although our cash flow forecasts are based on assumptions that are consistent with our plans, there is significant exercise of judgment involved in determining the cash flow attributable to a long-lived asset over its estimated remaining useful life. Our estimates of anticipated cash flows could be reduced significantly in the future. As a result, the carrying amounts of our long-lived assets could be reduced through impairment charges in the future. Changes in estimated future cash flows could also result in a shortening of the estimated useful life of long-lived assets, including intangibles, for depreciation and amortization purposes.

Stock-Based Compensation

Compensation cost for grants of all share-based payments is based on the estimated grant date fair value. We attribute the value of share-based compensation to expense using the straight-line method. We estimate the fair value of our share-based payment awards using the Black-Scholes option-pricing model (the "Black-Scholes model"). The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. The Black-Scholes model requires the input of certain assumptions, including assumptions relating to the risk-free interest rate, the expected term and expected volatility which materially affect the fair value estimates. The risk-free interest rate was based on the market yield currently available on United States Treasury securities with maturities approximately equal to the option's expected term. Expected term represents the period that our stock-based awards are expected to be outstanding. The simplified method was used to calculate the expected term. Historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term, as we are a development stage company and fair market value of shares granted changed from our historical grants as a result of our initial public offering in June 2011. The expected volatility was based on the historical stock volatilities of several comparable publicly-traded companies over a period equal to the expected terms of the options, as we do not have a long trading history to use to estimate the volatility of our own common stock. Our expected dividend yield was assumed to be zero as we have not paid, and do not anticipate paying, cash dividends on our shares of common stock.

We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and other factors. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported stock-based compensation expense, as the cumulative effect of adjusting the rate for all expense amortization is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the consolidated financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in the consolidated financial statements.

We will continue to use judgment in evaluating the expected volatility, lives, forfeiture and dividend rate related to our stock-based compensation on a prospective basis and incorporating these factors into our option-pricing model.

Each of these inputs is subjective and generally requires significant management and director judgment to determine. If, in the future, we determine that another method for calculating the fair value of our stock options is more reasonable, or if another method for calculating these input assumptions is prescribed by authoritative guidance, and, therefore, should be used to estimate expected volatility or expected term, the fair value calculated for our stock options could change significantly. Higher volatility and longer expected terms generally result in an increase to stock-based compensation expense determined at the date of grant.

Income Taxes

We are subject to income taxes in the United States. We use the liability method of accounting for income taxes, whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income.

We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits and deductions and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expenses for tax and financial statement purposes. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.


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Recognition of deferred tax assets is appropriate when realization of such assets is more likely than not. We recognize a valuation allowance against our net deferred tax assets if it is more likely than not that some portion of the deferred tax assets will not be fully realizable. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. At March 31, 2013, we had a full valuation allowance against all of our deferred tax assets, including our net operating loss carryforwards.

We make estimates and judgments about our future taxable income that are based on assumptions that are consistent with our plans and estimates. Should the actual amounts differ from our estimates, the amount of our valuation allowance could be materially impacted. Any adjustment to the deferred tax asset valuation allowance would be recorded in the income statement for the periods in which the adjustment is determined to be required.

We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position's sustainability and is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether (i) the factors underlying the sustainability assertion have changed and (ii) the amount of the recognized tax benefit is still appropriate. The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available. We believe that it is more likely than not that our income tax positions and deductions will be sustained following an audit. Therefore, we have not recorded any liabilities in any of the periods presented in the consolidated financial statements resulting from uncertain tax positions taken or expected to be taken in our tax returns.

Results of Operations

Three Months Ended March 31, 2013 compared to the Three Months Ended March 31, 2012

Revenues



                                                  Three Months Ended March 31,                Change
                                                   2013                   2012            $           %
                                                                 (Dollars in thousands)
Revenues:
Product revenue                                $         68           $         -          68         N/A
Renewable identification number revenue                   3                     -           3         N/A

Total revenues                                 $         71           $         -        $ 71

Product revenue. Our product revenue was $68,000 for the three months ended March 31, 2013 compared to zero for the same period in 2012. All revenues in the three months ended March 31, 2013 are attributable to customers in the United States. In November 2012, we entered into a contract whereby we agreed to sell our cellulosic diesel produced from our research and development facilities to an obligated third-party to blend with diesel. We then purchased the blended diesel from the obligated third-party for sale to one of our offtake customers for fleet testing. During the first quarter of 2013, we sold the remaining blended diesel to our offtake customer to complete their fleet testing for revenues of approximately $52,000. Revenue consisted of our fuel price plus incremental fees incurred to purchase diesel and costs to blend it with our cellulosic diesel. The remaining product revenue of approximately $16,000 was generated by our first cellulosic diesel shipment in March 2013 from our initial scale commercial production facility in Columbus. We expect that our revenues from sales of cellulosic gasoline and diesel and RINs will be limited and unpredictable, at least in the near term, as we continue in the start-up phase at our initial-scale commercial production facility.

Renewable identification number revenue. Our renewable identification number revenue was $3,000 for the three months ended March 31, 2013 compared to zero for the same period in 2012. We generated cellulosic diesel RINs along with our first cellulosic diesel shipment from our initial scale commercial production facility in Columbus in March 2013, and we sold the RINs to the purchaser of the shipment.

Operating Expenses



                                                Three Months Ended March 31,               Change
                                                  2013                 2012             $           %
                                                               (Dollars in thousands)
Operating expenses:
Cost of product revenue                      $        5,408       $           -      $  5,408       N/A
Research and development expenses                     9,166                8,431          735         9 %
General and administrative expenses                  14,676                8,119        6,557        81 %

Total operating expenses                     $       29,250       $       16,550     $ 12,700


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Cost of product revenue. Our cost of product revenue was $5.4 million for the three months ended March 31, 2013 as compared to zero for the same period in 2012. Although the Columbus facility has not yet achieved steady state production, because in March 2013 we produced finished products and had our first cellulosic diesel shipment from the facility, we placed it into service. As a result, depreciation and operating and manufacturing costs, which we have included in general and administrative expenses as start-up costs prior to our placing the facility into service, will now be presented as cost of product revenue. Cost of product revenue, including incremental costs incurred in connection with our efforts to achieve steady state operations, primarily consists of: repair and maintenance of $1.4 million for our Columbus facility; $0.9 million of payroll and related expenses and consultant fees; $0.9 million of inventory charges; $0.7 million relating to depreciation of the Columbus facility; $0.6 million for increased utility usage, such as natural gas, electricity, and water; $0.3 million for leased equipment to operate the facility; and the remaining operating costs relate to items such as disposal fees, property taxes, property insurance, and freight costs incurred for operations.

Research and Development Expenses. Our research and development expenses increased by $0.7 million, or 9%, for the three months ended March 31, 2013 as compared to the same period in 2012. This increase was primarily the result of a $0.7 million increase in payroll and related expenses. Payroll and related expenses for the three months ended March 31, 2013 included stock-based compensation of $0.6 million compared to $0.2 million in the same period in 2012. Increase to payroll and related expense is also due to an increase in our research and development staff to approximately 106 employees at March 31, 2013 compared to approximately 100 employees at March 31, 2012 and overtime hours incurred to operate our research and development facilities. The remaining change in research and development expenses relates primarily to increased depreciation expense due to our expanding the demonstration unit in 2012 and pilot plant in the first quarter of 2013, partially offset by reduced operating costs and maintenance at our demonstration unit as the focus of our efforts shifted to the start-up of our initial-scale commercial production facility in Columbus.

General and Administrative Expenses. Our general and administrative expenses increased by $6.6 million, or 79%, for the three months ended March 31, 2013 as compared to the same period in 2012. This increase was primarily the result of $6.6 million of start-up costs incurred at our initial-scale commercial production facility in Columbus, Mississippi, an increase of $4.7 million compared to the same period in 2012. The costs incurred during the three months ended March 31, 2013 primarily consist of repair and maintenance to our Columbus facility as well as increased utility usage, such as natural gas, electricity, and water, and leased equipment to operate the facility prior to us having our first cellulosic diesel shipment and placing the asset into service in March 2013; such costs were not significant during the three months ended March 31, 2012 due to the facility being under construction during such time period. The remaining increase to general and administrative expenses of $1.9 million primarily related to payroll and related expenses, excluding payroll and related expenses for our Columbus employees that are included in start-up costs. Payroll and related expenses included stock-based compensation of $3.1 million for the three months ended March 31, 2013 compared to $1.8 million for the same period in 2012, an increase of $1.3 million. The remaining increase to payroll and related expenses, excluding payroll and related expenses for our Columbus employees that are included in start-up costs, is due to an increase in headcount to approximately 45 employees at March 31, 2013 compared to approximately 32 employees at March 31, 2012.

Other Income (Expense), Net


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