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SZYM > SEC Filings for SZYM > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for SOLAZYME INC


6-Nov-2013

Quarterly Report


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

Forward-Looking Statements

The following discussion and analysis should be read together with our 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 and operating performance, future selling prices and margins for our products, attributes and performance of our products, manufacturing capacity, 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, 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 oils. Our proprietary technology transforms a range of plant-based sugars into high-value oils and innovative microalgal food ingredients. Our renewable products can replace or enhance oils derived from the world's three existing sources-petroleum, plants and animal fats. We are also able to tailor the composition of our oils to address specific customer requirements, offering superior performance characteristics and additional 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 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 such 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 longer term. 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 will, when implemented at scale, enable us to profitably engage in our target markets when implemented at full-scale.

We have scaled up our technology platform and have successfully operated at lab (3-15 liter), pilot (600-1,000 liter), demonstration (20,000 liter) and commercial (approximately 500,000 liter) fermenter scale. Our achievement of the following milestones demonstrates the ongoing development of our platform:

• The establishment of our pilot plant in South San Francisco, with recovery operations capable of handling material from both 600 and 1,000 liter fermenters, has enabled us to produce samples of our tailored oils for testing and optimization by our partners, as well as to test new process conditions at an intermediate scale.

• Since 2007, the operation of our fermentation process in commercial-sized standard industrial fermentation equipment (75,000 liter) accessed through manufacturing partners.

• Since 2009, the operation of downstream processing equipment at facilities in Iowa and Kentucky where we use commercially-sized, standard plant oil recovery equipment to recover the oil at low cost and high volume.


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• In 2012, the successful commissioning of our first fully integrated bio-refinery (IBR) in Peoria, Illinois (Peoria Facility), to produce algal oils. The IBR was partially funded with a federal grant that we received from the U.S. Department of Energy (DOE) to demonstrate integrated commercial-scale production of renewable algal-based fuels. The plant has a nameplate capacity of two million liters of oil annually and provides an important platform for continued work on feedstock flexibility. In 2012, we began commercial fermentation of our Alguronic Acid production at the Peoria Facility and we transferred a significant amount of our fermentation production of Alguronic Acid from contract manufacturers to the Peoria Facility. In the second half of 2013 the plant was modified to address our production requirements for sampling and market development needs for both whole algal flour and whole algal protein products.

• In April 2012, our entrance 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. The construction of the Solazyme Bunge JV's production facility began in the second quarter of 2012 and commissioning is underway, with expected first commercially saleable product in the first quarter of 2014.

• In November 2012, our execution of a strategic collaboration agreement with Archer-Daniels-Midland Company (ADM) to produce tailored triglyceride oil products at ADM's facility in Clinton, Iowa (the Clinton Facility). The initial target nameplate capacity of the facility is expected to be 20,000 metric tons per year of tailored triglyceride oil products. We have an option to expand the capacity to 40,000 metric tons per year with the goal to further expand production to 100,000 metric tons per year. We and ADM will also work together to develop markets for products produced at the Clinton Facility. Starting in the third quarter of 2013, downstream processing of biomass produced at the Clinton facility is being done at a facility in Galva, Iowa (Galva Facility) operated by a wholly owned subsidiary of American Natural Processors, Inc.

• In 2012 and 2013, we successfully completed fermentations of multiple oil-producing algal strains at the Clinton Facility. In these fermentation runs, we achieved commercial scale production metrics, exhibited linear scalability of our process from laboratory scale, and demonstrated the ability to run at this scale without contamination. The fermentation runs were conducted in approximately 500,000-liter vessels, which are about four times the scale of the vessels at our Peoria Facility. We expect that commercial products will be available from the Clinton and Galva Facilities by early 2014.

To date, our revenues have been generated from research and development programs and commercial sale of our skin and personal care products. Our research and development programs have been conducted primarily under key agreements with government agencies and commercial partners and starting in 2013 we have executed definitive commercial supply agreements with commercial partners, such as our supply agreement with Unilever. We have developed a portfolio of innovative skin care products based on our proprietary active ingredient, Alguronic Acid®. These products have been available internationally in the luxury market since March 2011 and are currently sold to consumers online and via distribution arrangements with Sephora, QVC Inc., Space NK and others. These arrangements provide marketing support and access to more than 1,350 retail stores worldwide. We expect to continue expanding distribution through the end of 2013. In November 2013, we launched EverDeep™, a new anti-aging skincare line that is distributed directly to consumers targeted through direct response infomercials via television broadcasts and the Internet.

Our total revenues have increased in each of the last three fiscal years, growing from $38.0 million in 2010, to $39.0 million in 2011 to $44.1 million in 2012. In the nine months ended September 30, 2013, our revenues were $28.5 million compared to $35.7 million in the nine months ended September 30, 2012. Our revenues from development agreements with strategic partners decreased due to timing of agreements that ended and new agreements entered into with strategic partners. In general, we expect that our R&D program revenues will continue as work with our strategic partners under our existing and new R&D agreements enables important market development activities. In the near term, we expect government program revenues to decrease substantially compared to prior periods. We expect a larger percentage of our total revenues to be generated from product sales as we scale up our manufacturing capacity.

We incurred net losses of $16.4 million, $54.0 million and $83.1 million in 2010, 2011 and 2012, respectively. Our net loss was $83.1 million for the nine months ended September 30, 2013. In the near term, we anticipate that we will continue to incur net losses as we continue our research and development activities to further build on our library of oils that address the chemicals and fuels, nutrition and skin and personal care markets, continue work on feedstock flexibility and scaling of new tailored oils, nutrition ingredients and skin and personal care products in the marketplace and support commercialization activities for our products. In addition, as we continue to scale our capacity by entering into manufacturing capacity and joint venture agreements with other feedstock producers, we may incur additional net losses associated with the build-out and initial operations of those production facilities.

Through a combination of partnerships and internal development, we plan to scale rapidly. We expect that commercial products will be available from the Clinton and Galva Facilities by early 2014. Our Peoria Facility continues to provide an important platform for continued work on feedstock flexibility and has been modified to address production requirements for sampling and market development needs for both whole algal flour and whole algal protein products. In addition, we are currently in discussions with additional potential feedstock and manufacturing partners in Europe, Latin America and the United States to co locate oil production at their mills.


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Significant Partner Agreements

We currently have joint venture, joint development, supply 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 commitments. Our current principal partnerships and strategic arrangements include:

Bunge. In May 2011, we entered into a Joint Development Agreement (the JDA) with Bunge that extended through May 2013. In September 2013, the Company and Bunge agreed to extend the JDA, effective from May 2013 through September 2014. Pursuant to the JDA, we and Bunge are jointly developing microbe-derived oils, and exploring the production of such oils from Brazilian sugarcane feedstock.

In April 2012, we and Bunge formed the Solazyme Bunge JV to build, own and operate a commercial-scale renewable tailored oils production facility (the Solazyme Bunge JV Plant) adjacent to Bunge's Moema sugarcane mill in Brazil. The Solazyme Bunge JV 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 Solazyme Bunge JV 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 Solazyme Bunge JV Plant commenced in the second quarter of 2012 and commissioning is underway, with expected first commercially saleable product in the first quarter of 2014. The Solazyme Bunge JV is jointly financed by us and Bunge. In February 2013, the Solazyme Bunge JV entered into a loan agreement with the Brazilian Development Bank (BNDES), funding which supports the production facility in Brazil, including a portion of the construction costs of the Solazyme Bunge JV Plant. As a condition of the Solazyme Bunge JV drawing funds under the loan in excess of amounts supported by bank guarantees, we will be required to provide a corporate guarantee of a portion of the loan (in an amount that, when added to the amount supported by our bank guarantee, does not exceed our ownership percentage in the Solazyme Bunge JV).

In addition to forming the Solazyme Bunge JV in April 2012, we entered into a Development Agreement with the Solazyme Bunge JV to continue research and development activities that are intended to benefit the Solazyme Bunge JV, including activities in the areas of strain development, molecular biology and process development. The Development Agreement provides that the Solazyme Bunge JV will pay us a technology maintenance fee in recognition of our ongoing research investment in technology that would benefit the Solazyme Bunge JV. We also entered into a Technology Service Agreement with the Solazyme Bunge JV under which the 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 the third quarter of 2013, the Solazyme Bunge JV also agreed to pay us to support its commercial activities, including, but not limited to, facilitating supply agreements on behalf of the Solazyme Bunge JV and providing regulatory support.

In anticipation of the 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; (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. The second tranche of the Warrant shares (50%) vested in June 2012. The Warrant expires in May 2021.

In November 2012, we entered into a joint venture expansion framework agreement with Bunge. This framework agreement sets forth the intent of the partners to expand joint venture-owned oil production capacity from the current 100,000 metric tons under construction in Brazil to 300,000 metric tons by 2016 at select Bunge owned and operated processing facilities worldwide. We and Bunge also intend to expand the portfolio of oils to be produced out of the Solazyme Bunge JV facility in Brazil. The expanded field and portfolio of oils would include certain tailored food oils for sale in Brazil, where Bunge is the largest supplier of edible oils through several of its retail brands. We and Bunge intend to work together through joint market development to bring new, healthy, edible oils to the Brazilian market.

Refer to Note 8 and Note 10 in the accompanying notes to our condensed consolidated financial statements for further discussion of the Bunge JDA, Joint Venture Agreement and Warrant.

ADM. In November 2012, we entered into a strategic collaboration agreement with ADM, establishing a collaboration for the production of tailored triglyceride oil products at the Clinton Facility. The Clinton Facility will produce tailored triglyceride oil products using our proprietary microbe-based catalysis technology. Feedstock for the facility will be provided from ADM's adjacent wet


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mill. Under the terms of the strategic collaboration agreement, we will pay ADM annual fees for use and operation of a portion of the Clinton Facility, a portion of which may be paid in our common stock. In addition, we granted to ADM a warrant to purchase 500,000 shares of our common stock in January 2013, which vests in equal monthly installments over five years, commencing in November 2013. In addition, in March 2013 we issued a series of warrants to ADM for payment in stock, in lieu of cash, at our election, of future annual fees for use and operation of a portion of the Clinton facility. We currently anticipate that commercial production at the Clinton Facility will begin by early 2014. The initial target nameplate capacity of the facility is expected to be 20,000 metric tons per year of tailored triglyceride oil products. We have an option to expand the capacity to 40,000 metric tons per year with the goal to further expand production to 100,000 metric tons per year. We are also working together to develop markets for the products produced at the Clinton Facility. Starting in the second half of 2013, downstream processing of products produced at the Clinton Facility is being done at the Galva Facility.

Mitsui. In February 2013, we entered into a multi-year agreement with Mitsui & Co., Ltd. (Mitsui) to jointly develop triglyceride oils for use primarily in the oleochemical industry. The agreement includes further development of our myristic oil, a valuable raw material in the oleochemical industry, and additional oils that we are developing for the oleochemical and industrial sectors. End use applications may include renewable, high-performance polymer additives for plastic applications, lubricants and toiletry and household products.

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, we successfully completed all defined deliverables against the active Chevron research program which was funded through June 30, 2012.

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 called 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 as part of the US Navy's Green Strike Group demonstration at the 2012 Rim of the Pacific Exercise, the world's largest international maritime warfare exercise. The Great Green Fleet was powered by a 50/50 blend of biofuel and conventional petroleum-based fuel.

Dow. In May 2012, we and Dow entered into a Phase 2 Joint Development Agreement (Phase 2 JDA), an extension of the original exclusive joint development agreement related to dielectric insulating fluids.

Roquette. In November 2010, we entered into a joint venture agreement with Roquette. The purpose of the Solazyme Roquette JV was 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. In June 2013, we and Roquette agreed to dissolve the Solazyme Roquette JV and on July 18, 2013, the Solazyme Roquette JV was dissolved.

Algenist® Distribution Partners. 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. In March 2011, we entered into an agreement with QVC, Inc. (QVC) and launched the sale of our Algenist® product line through QVC's multimedia platform.


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Unilever. In October 2011, we entered into a joint development agreement with Unilever (our fourth agreement together) which expanded our current research and development efforts. In September 2013, we and Unilever agreed to extend this joint development agreement through September 30, 2014.

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. In the longer term, we expect that a significant portion of our revenues will come from the chemicals and fuels and nutrition 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 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 55% and 52% of our total revenues for the three and nine months ended September 30, 2013, respectively, as compared to 56% and 67% of our total revenues for the three and nine month periods ended September 30, 2012, respectively. Revenues from government grants and agreements represented 1% and 2% of total R&D program revenues for the three and nine months ended September 30, 2013, respectively, as compared to 54% and 55% of total R&D program revenues for the three and nine months ended September 30, 2012, respectively. Revenues from commercial and strategic partner development agreements represented 99% and 98% of total R&D program revenues for the three and nine months ended September 30, 2013, respectively, as compared to 46% and . . .

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