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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 000-29173

 

 

VERENIUM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		22-3297375
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
4955 Directors Place, San Diego, CA		92121
(Address of principal executive offices)		(Zip Code)

(858) 431-8500

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨		Accelerated filer  ¨		Non-accelerated filer  ¨			Smaller reporting company	x
				(do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares of the registrant’s Common Stock outstanding as of November 8, 2011 was 12,611,436.

 

 

 

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VERENIUM CORPORATION

INDEX

 

				Page No.
PART I — FINANCIAL INFORMATION
Item 1.		Condensed Consolidated Financial Statements (unaudited):			3
		Condensed Consolidated Balance Sheets			3
		Condensed Consolidated Statements of Operations			4
		Condensed Consolidated Statements of Cash Flows			5
		Notes to Condensed Consolidated Financial Statements			6
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			35
Item 4.		Controls and Procedures			35
PART II — OTHER INFORMATION
Item 1.		Legal Proceedings			36
Item 1A.		Risk Factors			37
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			53
Item 3.		Defaults Upon Senior Securities			53
Item 4.		(Removed and Reserved)			53
Item 5.		Other Information			53
Item 6.		Exhibits			54
SIGNATURES					55

 

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VERENIUM CORPORATION

PART I—FINANCIAL INFORMATION

 

ITEM 1.

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

VERENIUM CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

		September 30, 2011 (Unaudited)				December 31, 2010
ASSETS
Current assets:
Cash and cash equivalents		$	35,672			$	87,929
Restricted cash			5,000				0
Accounts receivable, net of allowance for doubtful accounts of $0.1 million at September 30, 2011 and December 31, 2010			7,981				6,708
Inventories, net			5,948				5,316
Prepaid expenses and other current assets			2,715				2,694
Total current assets			57,316				102,647
Property and equipment, net			5,513				3,134
Restricted cash			0				5,000
Other long term assets			463				976
Total assets		$	63,292			$	111,757
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	4,566			$	8,631
Accrued expenses			5,572				8,218
Deferred revenue			3,894				894
Accrued restructuring			587				0
Convertible debt, at carrying value (face value of $34.9 million at September 30, 2011; maturity date of April 2027, and early put option dates of April 1, 2012, 2017 and 2022)			34,851				0
Current liabilities of discontinued operations			458				1,157
Total current liabilities			49,928				18,900
Convertible debt, at carrying value (face value of $74.7 million at December 31, 2010; maturity date of April 2027, and early put option dates of April 1, 2012, 2017 and 2022)			0				88,011
Other long term liabilities			980				1,216
Long term liabilities of discontinued operations			65				460
Total liabilities			50,973				108,587
Stockholders’ equity:
Preferred stock—$0.001 par value; 5,000 shares authorized, no shares issued and outstanding at September 30, 2011 and December 31, 2010			0				0
Common stock—$0.001 par value; 245,000 shares authorized at September 30, 2011 and December 31, 2010; 12,611 and 12,610 shares issued and outstanding at September 30, 2011 and December 31, 2010			12				12
Additional paid-in capital			610,139				609,133
Accumulated deficit			(597,832	)			(605,975	)
Total stockholders’ equity			12,319				3,170
Total liabilities and stockholders’ equity		$	63,292			$	111,757

Note: The condensed consolidated balance sheet data at December 31, 2010 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

See accompanying notes to condensed consolidated financial statements.

 

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VERENIUM CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Revenue:
Product		$	14,742			$	12,233			$	42,252			$	37,085
Collaborative and license			3,674				339				4,694				1,391
Total revenue			18,416				12,572				46,946				38,476
Operating expenses:
Cost of product revenue			8,698				7,833				26,174				23,179
Research and development			2,673				1,448				7,593				4,124
Selling, general and administrative			4,940				7,838				14,106				21,010
Restructuring charges			20				0				2,940				0
Total operating expenses			16,331				17,119				50,813				48,313
Income (loss) from operations			2,085				(4,547	)			(3,867	)			(9,837	)
Other income and expenses:
Interest and other income			7				12				50				103
Interest expense			(625	)			(2,084	)			(2,421	)			(6,282	)
Gain on debt extinguishment upon conversion of convertible notes			0				0				0				598
Gain (loss) on debt extinguishment upon repurchase of convertible notes			4,065				(3,384	)			15,349				(3,384	)
Gain (loss) on net change in fair value of derivative assets and liabilities			290				(299	)			(1,005	)			(1,017	)
Total other income (expenses), net			3,737				(5,755	)			11,973				(9,982	)
Net income (loss) from continuing operations before income taxes			5,822				(10,302	)			8,106				(19,819	)
Income tax benefit			0				7,928				0				7,928
Net income (loss) from continuing operations			5,822				(2,374	)			8,106				(11,891	)
Net income (loss) from discontinued operations, net of $56.5 million gain on divestiture of discontinued operations, net of income tax of $9.6 million for the three and nine months ended September 30, 2010			(24	)			31,980				37				9,841
Net income (loss)			5,798				29,606				8,143				(2,050	)
Less: Loss attributed to noncontrolling interests in consolidated entities – discontinued operations			0				10,108				0				25,283
Net income attributed to Verenium Corporation		$	5,798			$	39,714			$	8,143			$	23,233
Net income (loss) per share, basic and diluted:
Continuing operations		$	0.46			$	(0.19	)		$	0.64			$	(0.97	)
Discontinued operations		$	0.00			$	2.59			$	0.00			$	0.80
Net income per share		$	0.46			$	3.21			$	0.65			$	1.90
Shares used in calculating net income (loss) per share, basic and diluted			12,607				12,371				12,607				12,231

See accompanying notes to condensed consolidated financial statements.

 

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VERENIUM CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2011				2010
Operating activities:
Net income (loss)		$	8,143			$	(2,050	)
Net income from discontinued operations			(37	)			(9,841	)
Net income (loss) from continuing operations			8,106				(11,891	)
Adjustments to reconcile net income (loss) from continuing operations to net cash used in operating activities of continuing operations:
Depreciation and amortization			1,017				1,325
Reduction for uncollectible accounts receivable			0				(111	)
Share-based compensation			1,058				824
Loss (gain) on extinguishment of debt upon repurchase of convertible debt			(15,349	)			3,384
(Amortization) accretion of debt net premium/discount from convertible debt			(140	)			935
Gain on debt extinguishment upon conversion of convertible debt			0				(598	)
Loss on net change in fair value of derivative assets and liabilities			1,005				1,017
Non-cash restructuring charges			377				0
Non-cash income tax benefit			0				(7,928	)
Change in operating assets and liabilities:
Accounts receivable			(1,273	)			(1,855	)
Inventories			(632	)			(1,873	)
Other assets			278				3,147
Accounts payable and accrued liabilities			(6,017	)			3,315
Deferred revenue			2,986				177
Net cash used in operating activities of continuing operations			(8,584	)			(10,132	)
Investing activities:
Proceeds from sale of LC business			0				95,401
Purchases of property and equipment, net			(3,916	)			0
Restricted cash			0				5,400
Net cash provided by (used in) investing activities of continuing operations			(3,916	)			100,801
Financing activities:
Principal payments on debt obligations			0				(18	)
Proceeds from sale of common stock and warrants			0				7
Repurchases of convertible debt			(38,645	)			(20,550	)
Net cash used in financing activities of continuing operations			(38,645	)			(20,561	)
Cash provided by (used in) discontinued operations:
Net cash used in operating activities of discontinued operations			(1,112	)			(31,294	)
Net cash used in investing activities of discontinued operations			0				(3,328	)
Net cash provided by financing activities of discontinued operations			0				28,608
Net cash used in discontinued operations			(1,112	)			(6,014	)
Net increase (decrease) in cash and cash equivalents			(52,257	)			64,094
Cash and cash equivalents at beginning of year			87,929				24,844
Cash and cash equivalents at end of year			35,672				88,938
Supplemental disclosure of cash flow information:
Interest paid		$	2,428			$	2,411
Supplemental disclosure of non-cash operating and financing activities:
Conversions of convertible senior notes to common stock		$	0			$	2,200

See accompanying notes to condensed consolidated financial statements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Summary of Significant Accounting Policies

The Company

Verenium Corporation, Verenium or the Company, was incorporated in Delaware in 1992. The Company is 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. The Company operates in one business segment with three main product lines: animal health and nutrition, grain processing, and oilseed processing.

On September 2, 2010, the Company completed the sale of its ligno-cellulosic business (“LC business”) to BP Biofuels North America LLC (“BP”). See Note 2 for further details.

Recent Developments

Debt Repurchase

As more fully described in Note 3, on July 27, 2011 and September 23, 2011, the Company repurchased in total $5.2 million in principal amount of its 5.5% Convertible Senior Notes, or 2007 Notes, as well as the remaining $4.1 million outstanding in principal amount of its 9.0% Convertible Senior Secured Notes, or 2009 Notes. As part of these transactions the note holders released the Company from any and all commitments and indebtedness related to the 2007 and 2009 Notes repurchased. Immediately following the repurchase and as of September 30, 2011, no additional 2009 Notes remained outstanding and the Company had $34.9 million in principal amount of 2007 Notes outstanding.

Line of Credit

As more fully described in Note 10, on October 19, 2011 the Company entered into credit facilities with Comerica Bank (“Comerica”) consisting of a $3.0 million domestic receivables and inventory revolving line (the “Comerica Line”) and a $10.0 million foreign receivables revolving line (the “Ex-Im Line”). The credit lines have a maturity date of 18 months. The Comerica Line is pursuant to a Loan and Security Agreement with Comerica which allows for revolving cash borrowings under a secured credit facility of up to the lesser of (i) $3.0 million or (ii) 80% of certain eligible domestic accounts receivable held by the Company that arise in the ordinary course of business and 50% of eligible inventory held by the Company, not to exceed $0.5 million, consisting of raw materials and finished goods for sale in the ordinary course of our business. The Ex-Im Line is pursuant to a Revolving Credit Promissory Note between the Company and Comerica, with Comerica’s exposure under the line guaranteed by the Export-Import Bank of the United States (the “Ex-Im Bank”). The Company’s available borrowings under the Ex-Im Line will be equal the lesser of (i) $10.0 million or (ii) up to 90% of certain eligible export related accounts receivable, and which are subject to adjustment for the non-U.S. portion of costs included in the sales price of the Company’s products that arise in the ordinary course of business, and may be used by the Company for the purpose of financing the cost of manufacturing, producing, purchasing or selling finished goods or services in accordance with applicable Ex-Im Bank rules and regulations. Advances under the credit lines bear interest at a daily adjusting London Interbank Offered Rate plus a margin of 6.0%.

Separately, the Company has also put in place a facility for up to $3 million in secured equipment financing to help support the planned build-out of its research and bioprocess development laboratories and corporate headquarters in San Diego.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, which are necessary for a fair presentation of the results of the interim periods presented, have been included. The results of operations for the interim periods are not necessarily indicative of results to be expected for any other interim period or for the year as a whole. These unaudited condensed consolidated financial statements and footnotes thereto should be read in conjunction with the audited consolidated financial statements and footnotes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 filed with the Securities and Exchange Commission (“SEC”) on March 7, 2011.

The Company had income from operations of $2.1 million and a loss on operations of $3.9 million for the three and nine months ended September 30, 2011 and had an accumulated deficit of $597.8 million as of September 30, 2011. In connection with the sale of the LC business in September 2010, the Company received net cash proceeds of approximately $96.0 million. To date the Company has used net proceeds of approximately $59.2 million from the sale of the LC business for debt

 

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retirement. The Company intends to use the remaining net proceeds for continued investment in product development and manufacturing improvement efforts, build-out of the Company’s new research and development and corporate headquarters in San Diego, and for general corporate purposes, including working capital, and, as appropriate, for additional debt retirement. The holders of the 2007 Notes have the right to require the Company to purchase the 2007 Notes for cash (including any accrued and unpaid interest) on each of April 1, 2012, April 1, 2017 and April 1, 2022. Assuming the holders of the 2007 Notes exercise their put option in 2012, based on current cash resources and 2011 operating plan, the Company’s existing working capital will not be sufficient to meet the cash requirements to fund the retirement of the 2007 Notes, and planned operating expenses, capital expenditures and working capital requirements after such exercise without additional sources of cash. If the Company is unable to re-finance the 2007 Notes or raise additional capital, it will need to defer, reduce or eliminate significant planned expenditures, restructure or significantly curtail operations, issue equity in exchange for the 2007 Notes at substantial dilution to current stockholders, file for bankruptcy, or cease operations. The accompanying condensed consolidated financial statements have been prepared assuming that the Company will continue as a going concern.

The results of operations and assets and liabilities associated with the sale of the LC business have been reclassified and presented as discontinued operations in the accompanying Condensed Consolidated Statements of Operations and Balance Sheets for current and all prior periods presented.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, discontinued operations, and related disclosures. On an ongoing basis, the Company evaluates these estimates, including those related to revenue recognition, long-lived assets, accrued liabilities, its convertible debt and income taxes. These estimates are based on historical experience, on information received from third parties, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Impact of Recently Issued Accounting Standards

In October 2009, the Financial Accounting Standards Board (the FASB) issued an Accounting Standard Update which replaced the concept of allocating revenue consideration amongst deliverables in a multiple-element revenue arrangement according to fair value with an allocation based on selling price. The amended guidance also establishes a hierarchy for determining the selling price of revenue deliverables sold in multiple element revenue arrangements. The selling price used for each deliverable will be based on vendor-specific objective evidence (VSOE) if available, third-party evidence if VSOE is not available, or management’s estimate of an element’s stand-alone selling price if neither VSOE nor third-party evidence is available. The amendments in this update also require an allocation of selling price amongst deliverables be performed based upon each deliverable’s relative selling price to total revenue consideration, rather than on the residual method previously permitted. The updated guidance is effective for the first annual reporting period beginning on or after June 15, 2010, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date. The Company prospectively adopted the updated guidance on January 1, 2011 and applies the amended guidance to revenue arrangements containing multiple deliverables that are entered into or significantly modified on or after January 1, 2011. The Company now allocates revenue consideration, excluding contingent consideration, based on the relative selling prices of the separate units of accounting contained within an arrangement containing multiple deliverables. Selling prices are determined using fair value, when available, or the Company’s estimate of selling price when fair value is not available for a given unit of accounting. The Company evaluated its collaboration agreement with Novus International, Inc. (“Novus”) entered into in June 2011 using this guidance. See Note 6 for further details.

Effective January 1, 2011, the Company adopted the FASB’s revised authoritative guidance for research and development milestone recognition. The revised guidance is not required and does not represent the only acceptable method of revenue recognition. Milestones, as defined per the revised guidance, are (i) events that can only be achieved in whole or in part on either the entity’s performance or on the occurrence of a specific outcome resulting in the entity’s performance (ii) for which there is substantive uncertainty at the date the arrangement is entered into that the event will be achieved and (iii) that would result in additional payments being due to the Company. The Company evaluates events under this guidance at the inception of an arrangement to determine the existence of milestones and if they are substantive. The adoption of the revised guidance has not had, and is not expected to have, a material impact on the Company’s consolidated results of operations as it is consistent with its historical practice of milestone revenue recognition.

 

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Derivative Financial Instruments

Prior to the repurchase of the 2009 Notes during the three months ended September 30, 2011, the Company’s 2009 Notes (see Note 3) and certain warrants were accounted for in accordance with applicable authoritative guidance for derivative instruments which required identification of certain embedded features to be bifurcated from debt instruments and accounted for as derivative assets or liabilities. The derivative assets and liabilities were initially recorded at fair value and then at each reporting date, the change in fair value was recorded in the statement of operations.

Fair Value of Financial Instruments

Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The applicable authoritative guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability. The guidance establishes three levels of inputs that may be used to measure fair value:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.

The following table presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 (in thousands):

 

		September 30, 2011																December 31, 2010
		Level 1				Level 2				Level 3				Total				Level 1				Level 2				Level 3				Total
Assets:
Cash and cash equivalents (1)		$	40,672			$	0			$	0			$	40,672			$	92,929			$	0			$	0			$	92,929
Liabilities:
Derivative – warrants (2)			0				0				119				119				0				0				307				307
Derivative – 2009 Notes compound embedded derivative (3)			0				0				0				0				0				0				3,879				3,879
		$	0			$	0			$	119			$	119			$	0			$	0			$	4,186			$	4,186

 

(1)	Included in cash and cash equivalents and restricted cash on the accompanying Condensed Consolidated Balance Sheets.

 

(2)

Represents warrants issued in February 2008 and October 2009. The warrants issued in 2008 had a fair value of zero as of September 30, 2011 and December 31, 2010, using significant unobservable inputs (Level 3). The warrants issued in 2009 had a fair value of $119,000 and $307,000 calculated using the Black-Scholes Merton methodology, and were classified within other long-term liabilities at September 30, 2011 and December 31, 2010, using significant unobservable inputs (Level 3).

 

(3)	Represented the compound embedded derivative included in the Company’s 2009 Notes (see Note 3). The compound embedded derivative included, among other rights, the noteholders’ rights to put the 2009 Notes at par at certain future

 

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dates, as well as the right to receive “make-whole” amounts. The Company’s compound embedded derivatives were valued using a “lattice” model. The Company’s “lattice” valuation models assumed the noteholders’ exercise patterns will follow risk-neutral conversion behavior throughout the term of the instruments consistent with maximizing the expected present value of the 2009 Notes. The embedded derivatives were included as part of the 2009 Notes carrying value on the accompanying Condensed Consolidated Balance Sheet as of December 31, 2010.

The following table presents a reconciliation of the assets and liabilities measured at fair value on a quarterly basis using significant unobservable inputs (Level 3) from January 1, 2011 to September 30, 2011 (in thousands):

 

		Derivative Liability – Warrants				Derivative Liability – 2009 Notes Compound Embedded Derivative				Total
Balance at January 1, 2011		$	307			$	3,879			$	4,186
Adjustment to fair value included in earnings (1)			(48	)			1,861				1,813
Extinguishment of debt (2)			0				(4,094	)			(4,094	)
Balance at March 31, 2011		$	259			$	1,646			$	1,905
Adjustment to fair value included in earnings (1)			(199	)			(319	)			(518	)
Balance at June 30, 2011		$	60			$	1,327			$	1,387
Adjustment to fair value included in earnings (1)			59				(349	)			(290	)
Extinguishment of debt (3)			0				(978	)			(978	)
Balance at September 30, 2011		$	119			$	0			$	119

 

(1)

The derivatives were revalued at the repurchase date as well as at the end of each reporting period and the resulting difference is included in the results of operations. The fair value of the 2009 Notes compound embedded derivative was primarily affected by the Company’s credit spread, but was also affected by the Company’s stock price, stock price volatility, expected life, interest rates and the passage of time. For the three and nine months ended September 30, 2011, the net adjustment to fair value resulted in a gain of $0.3 million and a net loss of $1.0 million and is included in “Gain (loss) on net change in fair value of derivative assets and liabilities” on the accompanying Condensed Consolidated Statement of Operations (see Note 3).

 

(2)	Represents decrease in derivative liability related to the debt repurchase of $9.6 million in principal amount of the 2009 Notes (see Note 3).

 

(3)	Represents decrease in derivative liability related to the debt repurchase of $4.1 million in principal amount of the 2009 Notes (see Note 3).

Revenue Recognition

The Company recognizes revenue when the following criteria have been met: (i) persuasive evidence of an arrangement exists; (ii) services have been rendered or product has been delivered; (iii) price to the customer is fixed and determinable; and (iv) collection of the underlying receivable is reasonably assured.

Billings to customers or payments received from customers are included in deferred revenue on the balance sheet until all revenue recognition criteria are met. As of September 30, 2011, the Company had $4.7 million in current and long-term deferred revenue, of which $3.9 million related to funding from collaborative partners and $0.8 million related to product sales.

Product Revenue

The Company recognizes product revenue at the time of shipment to the customer, provided all other revenue recognition criteria have been met. The Company recognizes product revenues upon shipment to distributors, provided that (i) the price is substantially fixed and determinable at the time of sale; (ii) the distributor’s obligation to pay the Company is not contingent upon resale of the products; (iii) title and risk of loss passes to the distributor at time of shipment; (iv) the distributor has economic substance apart from that provided by the Company; (v) the Company has no significant obligation to the distributor to bring about resale of the products; and (vi) future returns can be reasonably estimated. For any sales that do not meet all of the above criteria, revenue is deferred until all such criteria have been met.

The Company recognizes revenue from royalties calculated as a share of profits, from Danisco Animal Nutrition, or Danisco, which was acquired in 2011 by E. I. du Pont de Nemours and Company, or DuPont, during the quarter in which such revenue is earned. Danisco markets products based on the Phyzyme^® XP phytase enzyme. Revenue from royalties calculated as a share of operating profit as defined in the agreement is recognized generally upon shipment of Phyzyme^® XP phytase by Danisco to their customers, based on information provided by Danisco. Revenue from royalties is included in product revenue in the Condensed Consolidated Statement of Operations.

 

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The Company records revenue equal to the full value of the manufacturing costs plus royalties for the Phyzyme^® XP phytase product it manufactures through its contract manufacturing agreement with Fermic S.A. (“Fermic”) in Mexico City. The Company has contracted with Genencor, a subsidiary of Danisco, to serve as a second-source manufacturer of the Company’s Phyzyme^® XP phytase product. Genencor maintains all manufacturing, sales and collection risk on all inventories produced and sold from its facilities. A set royalty based on profit is paid to the Company on all sales. As such, revenue associated with product manufactured for the Company by Genencor is recognized on a net basis equal to the royalty on operating profit received from Danisco, as all the following conditions of reporting net revenue are met: (i) the third party is the obligor; (ii) the amount earned is fixed; and (iii) the third party maintains inventory risk.

Collaborative and License Revenue

The Company’s collaboration revenue consists of license and collaboration agreements that contain multiple elements, including non-refundable upfront fees, payments for reimbursement of third-party research costs, payments for ongoing research, payments associated with achieving specific development milestones and royalties based on specified percentages of net product sales, if any. The Company considers a variety of factors in determining the appropriate method of revenue recognition under these arrangements, such as whether the elements are separable, whether there are determinable fair values and whether there is a unique earnings process associated with each element of a contract.

The Company recognizes revenue from research funding under collaboration agreements when earned on a “proportional performance” basis as research hours are incurred. The Company performs services as specified in each respective agreement on a best-efforts basis, and is reimbursed based on labor hours incurred on each contract. The Company initially defers revenue for any amounts billed or payments received in advance of the services being performed and recognizes revenue pursuant to the related pattern of performance, based on total labor hours incurred relative to total labor hours estimated under the contract.

Prior to the revised multiple element guidance adopted by the Company on January 1, 2011, upfront, nonrefundable payments for license fees, grants, and advance payments for sponsored research revenues received in excess of amounts earned are classified as deferred revenue and recognized as income over the contract or development period. If and when the Company enters into a new collaboration or materially modifies an existing collaboration, the Company will be required to apply the new multiple element guidance. Estimating the duration of the development period includes continual assessment of development stages and regulatory requirements.

The Company adopted new authoritative guidance pertaining to milestones effective January 1, 2011, and recognizes milestone payments when earned, as evidenced by written acknowledgement from the collaborator, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) the milestone represents the culmination of an earnings process, (iii) the milestone payment is non-refundable and (iv) the Company’s past research and development services, as well as its ongoing commitment to provide research and development services under the collaboration, are charged at fees that are comparable to the fees that the Company customarily charges for similar research and development services.

Revenue Arrangements with Multiple Deliverables

The Company occasionally enters into revenue arrangements that contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria of revenue recognition have been met for each deliverable in order for revenue recognition to occur in the appropriate accounting period. For multiple deliverable agreements entered into after December 31, 2010, consideration is allocated at the inception of the agreement to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using VSOE of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, the Company uses its best estimate of the selling price for the deliverable.

The Company recognizes revenue for delivered elements only when it determines there are no uncertainties regarding customer acceptance. While changes in the allocation of the arrangement consideration between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could affect the Company’s results of operations.

 

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Comprehensive Income (Loss)

Comprehensive income (loss) is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on marketable securities. Comprehensive income (loss) equaled net income (loss) for all periods presented.

Computation of Net Income (Loss) per Share

Basic net income (loss) per share has been computed using the weighted-average number of shares of common stock outstanding during the period. For purposes of the computation of net income (loss) per share, unvested restricted shares are considered contingently returnable shares and are not considered outstanding common shares for purposes of computing net income (loss) per share until all necessary conditions are met that no longer cause the shares to be contingently returnable. The impact of these contingently returnable shares on weighted average shares outstanding has been excluded for purposes of computing net income (loss) per share.

Computation of net income (loss) per share for three and the nine months ended September 30, 2011 and 2010 was as follows (in thousands, except per share data):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Numerator
Net income (loss) from continuing operations		$	5,822			$	(2,374	)		$	8,106			$	(11,891	)
Net income (loss) from discontinued operations		$	(24	)		$	31,980			$	37			$	9,841
Net income attributed to Verenium Corporation		$	5,798			$	39,714			$	8,143			$	23,233
Denominator
Weighted average shares outstanding during the period			12,612				12,375				12,612				12,234
Less: Weighted average unvested restricted shares outstanding			(5	)			(4	)			(5	)			(3	)
Weighted average shares used in computing basic net income (loss) per share			12,607				12,371				12,607				12,231
Net income (loss) per share, basic and diluted:
Continuing operations		$	0.46			$	(0.19	)		$	0.64			$	(0.97	)
Discontinued operations		$	0.00			$	2.59			$	0.00			$	0.80
Net income attributed to Verenium Corporation		$	0.46			$	3.21			$	0.65			$	1.90

The Company has excluded all common stock equivalent shares issuable upon exercise or conversion of outstanding stock options, warrants and convertible debt from the calculation of diluted net income per share because all such securities are anti-dilutive for all applicable periods presented. In accordance with the treasury stock method, the convertible debt is antidilutive because its interest per common share obtainable on conversion exceeds basic net income (loss) per share.

2. Discontinued Operations

On September 2, 2010, the Company completed the sale of its LC business to BP. The transaction resulted in net cash proceeds to the Company of $96.0 million (including $5.0 million of the purchase price placed in escrow). Pursuant to the terms of the Asset Purchase Agreement, $5.0 million of the purchase price was placed in escrow and is subject to the terms of an escrow agreement, to cover the Company’s indemnification obligations for potential breaches of representations and warranties made by the Company in the Asset Purchase Agreement, most of which survive for a period of 18 months following the closing, or March 2, 2012. This amount is reflected as a current asset on the Company’s condensed consolidated balance sheets as of September 30, 2011 and as a non-current asset as of December 31, 2010. The Company is not required to make any indemnification payments until aggregate claims exceed $2.0 million, and then only with respect to the amount by which claims exceed that amount. The Company’s maximum indemnification liability is generally capped at $10.0 million with respect to most representations

The Company’s continuing operations focuses on the development, manufacturing and sale of industrial enzymes primarily within the animal health and nutrition, grain processing and oilseed processing markets. Revenue and expenses allocated to discontinued operations for the three and nine months ended September 30, 2010 were limited to revenue and expenses that were directly related to the operations of the LC business, or that were eliminated as a result of the sale of the LC business. As a result, certain continuing indirect costs that were previously allocated to the Company’s biofuels operating segment were not allocated to discontinued operations.

 

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The results of operations from discontinued operations for the three and nine months ended September 30, 2011 and 2010 are set forth below (in thousands):

 

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Revenue:
Grant		$	0			$	441			$	0			$	7,478
Collaborative			0				46				(23	)			185
Total revenue			0				487				(23	)			7,663
Operating expenses:
Research and development			(10	)			10,515				(29	)			37,813
Selling, general and administrative			34				4,822				(31	)			6,839
Total operating expenses			24				15,337				(60	)			44,652
Income (loss) from discontinued operations			(24	)			(14,850	)			37				(36,989	)
Gain on sale of LC Business			0				56,478				0				56,478
Income tax provision			0				(9,648	)			0				(9,648	)
Net income (loss) from discontinued operations		$	(24	)		$	31,980			$	37			$	9,841

The condensed consolidated financial statements for the three and nine months ended September 30, 2010 include the accounts of the Company and its previously jointly owned subsidiary Galaxy Biofuels LLC (“Galaxy”), which was determined to be a variable interest entity. As a result, the Company’s consolidated statement of operations includes a line item “Loss attributed to noncontrolling interests in consolidated entities – discontinued operations” which reflects BP’s share of Galaxy losses for the three and nine months ended September 30, 2010. Upon the completion of the sale of the LC business, BP became the sole investor in Galaxy. As a result, all results for Galaxy are reflected separately as discontinued operations on the Company’s condensed consolidated financial statements.

3. Convertible Debt

Carrying value of the Company’s convertible debt as of September 30, 2011 and December 31, 2010 is set forth below (in thousands):

 

			$26,978				$26,978				$26,978
		September 30, 2011
		2009 Notes				2007 Notes				Total
Principal amount		$	0			$	34,851			$	34,851
Debt premium, net			0				0				0
Derivative liabilities			0				0				0
Total carrying value		$	0			$	34,851			$	34,851

 

			$26,978				$26,978				$26,978
		December 31, 2010
		2009 Notes				2007 Notes				Total
Principal value		$	13,707			$	61,033			$	74,740
Debt premium, net			9,392				0				9,392
Derivative liabilities (1)			3,879				0				3,879
Total carrying value		$	26,978			$	61,033			$	88,011

 

(1)

Represented the 2009 Notes’ compound embedded derivative. The Company had the intent and the ability as of December 31, 2010 to settle the 2009 Notes’ “make-whole” provisions in shares of common stock. As such, the asserted derivative liability was included in the 2009 Notes’ carrying value on its condensed consolidated financial statements at December 31, 2010.

2007 Notes

In March and April 2007, the Company completed an offering of $120 million aggregate principal amount of 2007 Notes in a private placement. The 2007 Notes have been registered under the Securities Act of 1933, as amended, to permit registered resale of the 2007 Notes and of the common stock issuable upon conversion of the 2007 Notes. As more fully

 

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described below, $18.5 million and $30.5 million in aggregate principal amount of the 2007 Notes were exchanged in February 2008 and September 2009, respectively, for new debt pursuant to the Company’s issuance of its 8% Senior Convertible Notes due April 1, 2012, or 2008 Notes, and 2009 Notes. Further, in September 2010, March 2011 and July 2011, the Company repurchased 2007 Notes totaling $34.2 million in principal. As of September 30, 2011, the Company had $34.9 million in principal amount outstanding under the 2007 Notes.

The 2007 Notes bear interest at 5.5% per year, payable in cash semi-annually, and are convertible at the option of the holders at any time prior to maturity, redemption or repurchase into shares of the Company’s common stock at a conversion rate of 13.02 shares per $1,000 principal amount of 2007 Notes (subject to adjustment in certain circumstances), which represents a conversion price of $76.80 per share. The total common shares that would be issued upon conversion of the entire $34.9 million in principal amount outstanding of the 2007 Notes is 0.5 million shares.

On or after April 5, 2012, the Company may, at its option, redeem the 2007 Notes, in whole or in part, for cash at redemption price equal to 100% of the principal amount of the 2007 Notes to be redeemed plus any accrued and unpaid interest to the redemption date. On each of April 1, 2012, April 1, 2017 and April 1, 2022, holders may require the Company to purchase all or a portion of their 2007 Notes at a purchase price in cash equal to 100% of the principal amount of the 2007 Notes to be purchased plus any accrued and unpaid interest to the purchase date. Holders may also require the Company to repurchase all or a portion of their 2007 Notes upon a “fundamental change” at a repurchase price in cash equal to 100% of the principal amount of 2007 Notes to be repurchased plus any accrued and unpaid interest to the repurchase date. Pursuant to the terms of the 2007 Notes, a “fundamental change” is broadly defined as 1) a change in control, or 2) a termination of trading of the Company’s common stock.

In connection with the 2007 Notes offering, the Company paid $5.2 million in financing charges, which is reflected in other long term assets on the accompanying Condensed Consolidated Balance Sheets, and is being amortized to interest expense over the initial five-year term of the 2007 Notes using the effective interest method.

On September 23, 2010, the Company repurchased $8.0 million of principal amount of the 2007 Notes. A total cash payment, principal and accrued interest, of $7.0 million was paid to this holder of the 2007 Notes. As part of the transaction, the note holder released the Company from any and all commitments and indebtedness related to the 2007 Notes repurchased. A gain on debt extinguishment of $1.1 million was recognized representing the difference between the carrying value of the 2007 Notes repurchased of $7.9 million and the repurchase price of $6.8 million.

During 2011, the Company made total debt repurchases of $26.2 million of principal of the 2007 Notes. A total cash payment, principal and accrued interest of $25.2 million was paid to a holder of the 2007 Notes. As part of the transaction, the note holder released the Company from any and all commitments and indebtedness related to the 2007 Notes repurchased. A gain on debt extinguishment of $1.4 million was recognized representing the difference between the carrying value of the 2007 Notes repurchased of $26.0 million and the repurchase price of $24.6 million. A summary of the 2011 repurchases and related gain pertaining to the 2007 Notes is as follows:

 

		For the Three Months Ended September 30,				For the Nine Months Ended September 30,
		2011				2011
2007 Notes:
Principal		$	5,250			$	26,182
Issuance costs			(30	)			(220	)
Carrying value			5,220				25,962
Repurchase price			4,712				24,607
Gain on debt extinguishment		$	508			$	1,355

2008 Notes

On February 27, 2008, the Company completed a private placement of the 2008 Notes and warrants to purchase shares of the Company’s common stock. Concurrently with entering into the Purchase Agreement for the 2008 Notes, the Company also entered into senior notes exchange agreements with certain existing holders of the 2007 Notes pursuant to which such noteholders exchanged approximately $18.5 million in aggregate principal amount of the 2007 Notes for approximately $16.7 million in aggregate principal amount of the 2008 Notes and warrants to purchase common stock. Including the 2008 Notes issued in exchange for the 2007 Notes, the Company issued $71.0 million in aggregate principal amount of the 2008 Notes and warrants to purchase approximately 0.7 million shares of common stock.

 

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Since inception through extinguishment on September 23, 2010, holders of the 2008 Notes converted principal in the amount of $58.0 million into approximately 4.2 million shares of the Company’s common stock, including approximately 2.0 million shares to satisfy a portion of the related “make-whole” obligations.

On September 23, 2010, the Company repurchased $13.0 million of principal amount of the 2008 Notes. A total cash payment, principal and accrued interest of $14.0 million was paid to the noteholders of the 2008 Notes. As part of the transaction, the noteholders released the Company from any and all commitments and indebtedness related to the 2008 Notes repurchased. A loss on debt extinguishment of $4.5 million was recognized representing the difference between the carrying value of the 2008 Notes repurchased of $9.3 million and the repurchase price of $13.8 million .

2009 Notes

On September 1, 2009 and September 25, 2009, the Company completed privately negotiated exchanges with certain existing holders of its 2007 Notes. Pursuant to the exchange agreements, certain existing holders of the 2007 Notes agreed to exchange $30.5 million in aggregate principal of the 2007 Notes for $13.7 million in aggregate principal amount of the 2009 Notes. The 2009 Notes were secured by a first priority lien (subject to certain exceptions and permitted liens) on certain of the Company’s assets including, subject to certain limitations, present and future receivables, inventory, general intangibles, equipment, investment property, stock of subsidiaries, and certain other assets and proceeds relating thereto. The collateral securing the 2009 Notes was subject to certain carve-outs, including without limitation, cash and cash equivalents and intellectual property.

During 2011, the Company repurchased the full principal amount outstanding under the 2009 Notes of $13.7 million. A total cash payment, principal and accrued interest, of $14.6 million was paid to these noteholders of the 2009 Notes. As part of the transaction, the noteholders released the Company from any and all commitments and indebtedness related to the 2009 Notes repurchased. A gain on debt extinguishment of $14.0 million was recognized representing the difference between the carrying value of the 2009 Notes repurchased of $28.0 million and the repurchase price of $14.0 million. The 2009 Notes were carried at a higher value than face value as the exchange of the 2007 Notes qualified as a troubled debt restructuring requiring the Company to record the 2009 Notes at the 2007 Notes’ higher carrying value. A summary of the 2011 repurchases and related gain pertaining to the 2009 Notes is as follows (in thousands):

 

		For the Three Months Ended September 30,				For the Nine Months Ended September 30,
		2011				2011
2009 Notes:
Principal		$	4,081			$	13,707
Debt premium, net			2,717				9,253
Compound embedded derivative(1)			978				5,072
Carrying value			7,776				28,032
Repurchase price			4,219				14,038
Gain on debt extinguishment		$	3,557			$	13,994

 

(1)

The compound embedded derivative included, among other rights, the noteholders’ rights to put the 2009 Notes at par at certain future dates, as well as the right to receive “make-whole” amounts. The Company’s compound embedded derivatives were valued using a “lattice” model. The Company’s “lattice” valuation models assumed the noteholders’ exercise patterns will follow risk-neutral conversion behavior throughout the term of the instruments consistent with maximizing the expected present value of the 2009 Notes.

Interest Expense on Convertible Debt

The Company recorded interest expense related to convertible debt, as follows for the three and nine months ended September 30, 2011 and 2010 (in thousands):

 

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2011				2010				2011				2010
5.5% coupon interest, payable in cash		$	500			$	944			$	1,837			$	2,843
Non-cash amortization of debt issuance costs			77				149				293				446
2007 Notes Total			577				1,093				2,130				3,289
8% coupon interest, payable in cash or common stock			0				248				0				767
Non-cash accretion of debt discount			0				427				0				1,245
Non-cash amortization of debt issuance costs			0				16				0				51
2008 Notes Total			0				691				0				2,063
9% coupon interest, payable in cash or common stock			42				308				402				925
Non-cash amortization of debt premium(1)			(16	)			(106	)			(140	)			(310	)
2009 Notes Total			26				202				262				615

 

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(1)

The initial debt premium related to the 2009 Notes being recorded at the 2007 Notes’ carrying value in accordance with authoritative guidance partially offset by the debt discount recorded for the compound embedded derivative. The unamortized value of the debt premium was included in the carrying value of the 2009 Notes on the accompanying Condensed Consolidated Balance Sheets and was being amortized into interest expense through the maturity date of the 2009 Notes, April 1, 2027.

4. Balance Sheet Details

Inventory

Inventories are recorded at standard cost on a first-in, first-out basis. Inventories consist of the following (in thousands):

 

		September 30, 2011				December 31, 2010
Raw materials		$	253			$	515
Work in progress			419				258
Finished goods			5,600				4,768
			6,272				5,541
Reserve			(324	)			(225	)
Net inventory		$	5,948			$	5,316

The Company reviews inventory periodically and reduces the carrying value of items considered to be slow moving or obsolete to their estimated net realizable value. The Company considers several factors in estimating the net realizable value, including shelf life of raw materials, demand for its enzyme products and historical write-offs.

Property and equipment, net

Property and equipment is stated at cost and depreciated over the estimated useful lives of the assets (generally three to five years) using the straight-line method.

Property and equipment, net consists of the following (in thousands):

 

		September 30, 2011				December 31, 2010
Laboratory, machinery and equipment		$	26,423			$	22,901
Computer equipment			3,017				2,783
Furniture and fixtures			0				981
Leasehold improvements			0				570
Property and equipment, gross			29,440				27,235
Less: Accumulated depreciation and amortization			(23,927	)			(24,101	)
Property and equipment, net		$	5,513			$	3,134

Depreciation of property and equipment is provided on the straight-line method over estimated useful lives as follows:

 

Laboratory equipment			3-5 years
Computer equipment			3 years
Furniture and fixtures			5 years
Machinery and equipment			3-5 years
Office equipment			3 years
Software			3 years

 

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Leasehold improvements are depreciated using the shorter of the estimated useful life or remaining lease term.

Accrued expenses

Accrued expenses consists of the following (in thousands):

 

		September 30, 2011				December 31, 2010
Employee compensation		$	2,227			$	3,311
Professional and outside services costs			1,282				1,753
Accrued interest on convertible notes			958				1,148
Royalties			680				1,219
Other			425				787
		$	5,572			$	8,218

5. Restructuring Activities

The Company’s former executive offices were located in a 21,000 square foot area in a building in Cambridge, Massachusetts, under an operating lease with a term through December 2013. Prior to the sale of the LC business on September 2, 2010, the office space was used by both the Company’s corporate management and by employees exclusively supporting the LC business. In connection with the sale of the LC business, the space used by the former LC business employees was vacated and a restructuring liability was recorded representing the present value of the remaining lease term, net of contracted sublease. The liability was classified into discontinued operations on the Company’s Condensed Consolidated Balance Sheet.

The following table sets forth the activity in the restructuring plan related to discontinued operations (in thousands):

 

		Facility Consolidation Costs				Employee Separation Costs				Total
Balance at January 1, 2011		$	938			$	679			$	1,617
Charged against accrual			(96	)			(411	)			(507	)
Adjustments and revisions			(193	)			(38	)			(231	)
Balance at March 31, 2011			649				230				879
Charged against accrual			(171	)			(130	)			(301	)
Adjustments and revisions			22				(4	)			18
Balance at June 30, 2011		$	500			$	96			$	596
Charged against accrual			(107	)			(95	)			(202	)
Adjustments and revisions			42				0				42
Balance at September 30, 2011		$	435			$	1			$	436
Restructuring reserve liability attributed to discontinued operations:
Current portion										$	371
Long-term portion											65
										$	436

The Company terminated operations in Cambridge, Massachusetts on March 31, 2011, and subleased its office space to a third party. In connection with these activities, a restructuring plan was initiated which primarily included one-time termination costs, such as severance costs related to the elimination of duplicative positions and separation costs for two executives as specified in their employment agreements. The restructuring plan also included charges associated with the estimated loss on sublease for the Cambridge facility as well as one-time relocation costs for the employees whose employment positions were moved to the Company’s San Diego location. The Company incurred total restructuring expense of $2.9 million for the nine months ended September 30, 2011 and had restructuring accruals of $0.6 million as of September 30, 2011, as detailed below, for which payments are expected to be substantially completed in early 2012.

 

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The following table sets forth the activity in the restructuring plan related to continuing operations (in thousands):

 

		Facility Consolidation Costs				Employee Separation Costs				Asset Impairment Costs				Total
Balance at January 1, 2011		$	0			$	0			$	0			$	0
Accrued and expensed			145				2,173				520				2,838
Charged against accrual			175				(664	)			(520	)			(1,009	)
Adjustments and revisions			0				0				0				0
Balance at March 31, 2011			320				1,509				0				1,829
Charged against accrual			(84	)			(634	)			0				(718	)
Adjustments and revisions			10				(8	)			0				2
Balance at June 30, 2011		$	246			$	867			$	0			$	1,113
Charged against accrual			(53	)			(465	)			0				(518	)
Adjustments and revisions			21				3				0				24
Balance at September 30, 2011		$	214			$	405			$	0			$	619
Restructuring reserve liability classification:
Current portion														$	587
Long-term portion															32
														$	619

6. Significant Collaborative Research and Development Agreements

Novus International, Inc.

On June 23, 2011, the Company entered into a collaboration agreement with Novus to develop, manufacture and commercialize a suite of new enzyme products from the Company’s late stage product pipeline in the animal health and nutrition product line (collectively referred to as “animal feed enzymes”). Novus’s business focuses on the research, development, manufacture, and sale of animal health and nutrition products for poultry, pork, beef, dairy, aquaculture, and companion animal industries on a worldwide basis. As of the effective date of the agreement and through a defined period, the development exclusivity term, both parties agreed to exclusivity to the type of enzymes specified in the agreement.

Upon signing, the Company granted to Novus a license to use, offer for sale, sell, import and export the animal feed enzymes to the extent necessary to make, have made, use, offer for sale, sell, import and export any product that contains, incorporates or comprises any form of such animal feed enzyme in the animal health and nutrition field. The animal feed enzymes are to be selected by a management team consisting of four individuals, two from each company, from a list of candidate enzymes. Once each candidate enzymes is selected, the license with respect to the animal feed enzyme will automatically become effective and be deemed to be delivered by the Company to Novus.

The Company received $2.5 million from Novus as an upfront non-refundable license fee. Additionally, in accordance with the agreement, the Company is entitled to an additional $2.5 million following certain regulatory or commercial events. Further, all development costs going forward will be shared equally between both partners. All future profits and losses also will be shared equally upon commercialization.

The agreement with Novus will continue in effect for so long as the Company and Novus are developing and commercializing animal feed enzymes or products in the animal health and nutrition field, unless earlier terminated under certain circumstances as provided below. Either party may terminate the agreement prior to expiration upon the material breach of the agreement by the other party, or upon the bankruptcy or insolvency of the other party. In addition, either party may terminate the agreement prior to expiration in the event the other party or any of its affiliates commences a patent challenge with respect to any patent of the non-challenging party specified by the agreement. Also, following the certain dates specified in the agreement, Novus may terminate the entire agreement for any reason or the management team, comprised of two representatives from both parties, may terminate certain aspects of the agreement for specified reasons.

 

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The agreement was deemed to be a collaborative arrangement with multiple deliverables as defined under authoritative accounting guidance. Several contingent and non-contingent deliverables were identified within the agreement. Contingent deliverables will be evaluated separately as the related contingency is resolved. The Company identified the licenses required to produce the final end products and the reimbursement of development costs as separate non-contingent deliverables within the agreement. The license deliverables are estimated to be delivered in the next twelve months. The development and regulatory activities are currently estimated to be ongoing through 2013. All non-contingent deliverables were determined to have standalone value and qualify as separate units of accounting, allowing independent revenue recognition of each deliverable. Revenue associated with each deliverable will be recognized when the item is delivered.

The animal feed enzyme licenses’ relative selling price was determined based on the Company’s analysis of the estimated future discounted cash flows. The reimbursement of development costs best estimate selling price was calculated based on a market rate established by evaluating historical collaboration agreements and calculations based on the actual expenses of the employees to be working on the collaboration. Collaboration revenue for the three and nine months ended September 30, 2011 included approximately $0.1 million for this collaboration and $2.8 million is included in deferred revenue related primarily to the upfront non-refundable license fee received.

Bunge Oils, Inc

The Company has two collaborations with Bunge Oils, Inc. (“Bunge”), a part of Bunge North America, as follows:

In February 2006, the Company entered into an agreement with Bunge to discover and develop novel enzymes optimized for the production of edible oil products with enhanced nutritional or health benefits. Under the terms of the agreement, the Company is responsible for discovering, optimizing, and manufacturing enzymes, and Bunge is responsible for commercializing oils using new enzyme-enabled processes. Under the terms of the agreement, the Company received an upfront technology access fee, is receiving research funding for its enzyme discovery and development activities under the project, and is also eligible to receive milestone payments for successful enzyme development activities as well as royalties on any products that are commercialized. Under this agreement, during 2010, the Company licensed to Bunge a new high-performance lipase enzyme. Commercial launch of the enzyme product is pending appropriate regulatory approvals in target markets.

In November 2007, the Company entered into an agreement with Bunge to promote the commercialization of its Purifine^® PLC enzyme, which is currently marketed, and the product development and commercialization of next-generation enzyme products for oilseed processing. Pursuant to the agreement, Bunge supplies process scale-up expertise for the development of the Purifine^® PLC degumming process at plant scale. Bunge and the Company currently share profits and losses on sales of Purifine^® PLC. In addition, Bunge contributes to the funding of research and development projects to develop next-generation enzyme products for oilseed processing. During the fourth quarter of 2009, the Bunge collaboration entered the regulatory phase for its next-generation oil processing enzyme.

Collaborative revenue recognized under the Bunge agreements was $0.2 million and $0.7 million for the three and nine months ended September 30, 2011 and $0.2 million and $1.1 million for the three and nine months ended September 30, 2010. Deferred revenue attributed to Bunge totaled $0.2 million as of September 30, 2011.

Cargill Health and Food Technologies

In 2005, the Company signed a collaboration agreement with Cargill Health and Food Technologies (“Cargill”) to discover and develop novel enzymes for the cost-effective production of a proprietary Cargill product involving multiple enzyme steps. In 2006, this collaboration agreement was expanded to include additional enzymes beyond the initial targeted set. In 2007, this agreement was further extended through May 2008. Under the terms of the agreement, the Company received upfront payments and research funding, and is entitled to receive milestone payments, license fees, and royalties on products that may be developed under the agreement. In May 2008, Cargill exercised an early option to license one of the enzymes under the agreement.

Revenue recognized under the Cargill collaboration was $47,000 and $0.2 million for the three and nine months ended September 30, 2011 and $46,000 and $0.1 million for the three and nine months ended September 30, 2010. Deferred revenue attributed to Cargill totaled $0.7 million as of September 30, 2011.

7. Concentration of Business Risk

A relatively small number of customers and collaboration partners historically have accounted for a significant percentage of the Company’s revenue. Revenue from the Company’s largest customer, Danisco, which was acquired by DuPont in 2011, represented 42% and 45% of total revenue for the three and nine months ended September 30, 2011, and 61% and 64% of total revenue from continuing operations for the three and nine months ended September 30, 2010. Accounts receivable from this one customer comprised approximately 59% of accounts receivable at September 30, 2011 and 64% at December 31, 2010.

 

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Revenue by geographic area was as follows (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
North America		$	4,785			$	2,712			$	15,525			$	9,345
Europe			9,488				7,688				22,100				23,300
South America			3,860				1,690				8,542				5,035
Asia			283				482				779				796
		$	18,416			$	12,572			$	46,946			$	38,476

The Company manufactures and sells enzymes primarily within three main product lines. The animal health and nutrition product line primarily includes the Phyzyme^® XP phytase enzyme and from time to time toll manufacturing of other products in this market, the grain processing product line includes Fuelzyme^® alpha-amylase, Veretase^® alpha-amylase, Xylathin™ xylanase and DELTAZYM^® GA L-E5 gluco-amylase enzymes, and the oilseed processing product line includes the Purifine^® PLC enzyme. The Company also generates nominal product revenue from enzymes outside its core product lines, for use in other specialty industrial processes.

During the three months ended September 30, 2011, in conjunction with a license agreement assigned to the Company as part of the separation agreement with Syngenta Participations AG in 2009, the Company received a non-recurring license fee of $3.25 million for a commercial enzyme candidate that Syngenta formerly licensed to a third party. This amount was received by the Company and recorded into collaboration revenue for the three and nine months ended September 30, 2011.

The following table sets forth product revenues by individual product line (in thousands):

 

		Three Months Ended September 30,
		2011				% of Product Revenue				2010				% of Product Revenue
Product revenues:
Animal health and nutrition		$	8,624				58	%		$	7,696				63	%
Grain processing			3,942				27	%			3,364				27	%
Oilseed processing			1,929				13	%			950				8	%
All other products			247				2	%			223				2	%
Total product revenue		$	14,742				100	%		$	12,233				100	%

 

		Nine Months Ended September 30,
		2011				% of Product Revenue				2010				% of Product Revenue
Product revenues:
Animal health and nutrition		$	24,734				59	%		$	24,537				66	%
Grain processing			12,371				29	%			9,605				26	%
Oilseed processing			4,541				11	%			2,258				6	%
All other products			606				1	%			685				2	%
Total product revenue		$	42,252				100	%		$	37,085				100	%

The Company manufactures most of its enzyme products through a manufacturing facility in Mexico City, owned by Fermic. The carrying value of property and equipment held at Fermic reported on the Company’s Condensed Consolidated Balance Sheets totaled approximately $1.0 million at September 30, 2011 and approximately $1.1 million at December 31, 2010.

 

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8. Share-based Compensation

The Company recognized share-based compensation expense for continuing operations of $0.2 million and $1.1 million and $0.3 million and $0.8 million during the three and nine months ended September 30, 2011 and 2010. These charges had no impact on the Company’s reported cash flows. Share-based compensation expense by category totaled the following (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Research and development		$	0			$	4			$	0			$	7
Selling, general and administrative			188				260				475				817
Restructuring charges			0				0				583				0
		$	188			$	264			$	1,058			$	824

As described in Note 5, in conjunction with the closure of the Cambridge office, two executives separated from the Company. Pursuant to their employment agreements, an additional 24 months of option vesting was accelerated for these executives as of their separation dates. This additional stock option expense attributable to the acceleration was classified as restructuring expense on the Company’s condensed consolidated financial statements during the nine months ended September 30, 2011.

At least annually, typically upon material option grants or material Company events, the Company performs a review and assessment of all valuation input assumptions used to compute share based payment expense to ensure they remain accurate and indicative of current Company trends. The assessment is conducted by evaluating historical trends, future expectations as well as a comparison to peers. In conjunction with the non-executive company-wide grant completed during the third quarter of 2011, the Company performed an analysis and determined the previous volatility assumption as well as the estimated forfeiture rate should be updated to reflect the business since the sale of the LC business. This change aligned the assumptions and resulting expense of the share based payments to be a better estimate of fair value. Volatility was adjusted lower to primarily reflect the Company’s historical stock price volatility over the last 12 months and the estimated forfeiture rate was adjusted lower to reflect the Company historical experience over the last 12 months. These adjustments impacted the grant value of option grants made during the three months ended September 30, 2011, but did not impact prior periods.

As of September 30, 2011, there was $1.3 million of total unrecognized compensation expense related to unvested share-based compensation arrangements granted under the Company’s equity incentive plans. All outstanding unvested options for employees that were assumed by BP as part of the sale of the LC business were cancelled. The remaining expense attributed to existing outstanding unvested options is expected to be recognized over a weighted average period of 0.8 years as follows (in thousands):

 

Fiscal Year 2011 (October 1, 2011 to December 31, 2011)		$	282
Fiscal Year 2012			913
Fiscal Year 2013			117
		$	1,312

9. Commitment and Contingencies

At September 30, 2011, the Company’s minimum commitments under non-cancelable operating leases were as follows (in thousands):

 

		San  Diego Gross Rental Payments				Cambridge Net Rental Payments
October 2011- September 2012		$	770			$	552
October 2012- September 2013			1,255				196
October 2013- September 2014			2,402				31
October 2014- September 2015			2,474				0
October 2015- September 2016			2,548				0
Thereafter			17,494				0
Total minimum lease payments		$	26,943			$	779

 

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San Diego Lease

On June 24, 2011, the Company signed a lease agreement for 59,199 square feet for new office and laboratory space in San Diego for a term of 126 months from the first day of the first full month after the commencement date. The agreement includes a build out of space with a targeted commencement date in June 2012. Upon lease commencement, rent will be approximately $192,000 a month, which includes both base rent and a tenant improvement allowance. The rent will be increased by 3% on each annual anniversary of the first day of the first full month during the lease term. Further, the lease agreement allows for a “free rent” term starting with the seventh full month in the lease through the end of the sixteenth month. In addition to the tenant allowance, additional tenant improvement and equipment allowances are also allowed, which, if exercised, must be paid back in monthly payments at a 9% interest rate. The lease provides the Company with two consecutive options to extend the term of the lease for 5 years each, which may be exercised with 12 months prior written notice. In the event the Company chooses to extend the term of the lease, the minimum monthly rent payable for the additional term will be determined according to the then-prevailing market rate.

In addition to the lease agreement, Verenium concurrently signed a license agreement with the same landlord for the rent-free use of 8,000 square feet of temporary space located adjacent to the permanent building under construction. The license commenced on July 1, 2011 and is to expire on the earliest of (i) 45 days after the commencement date of the lease, or (ii) the termination of the agreement for cause. The temporary space was licensed on an “as is” basis with no requirement for landlord improvements. The Company is currently recognizing straight line rent based on the relative fair value of the temporary space as compared to the new facility.

Cambridge Lease

The Company leases approximately 21,000 square feet of office space in a building in Cambridge, Massachusetts. The offices are leased to the Company under an operating lease with a term through December 2013. On March 31, 2011, the Company closed its office in Cambridge to focus all of its operations in San Diego to better align the Company with the evolving needs of the business and the market. Subsequently, the Company completed a sublease agreement in May 2011 for the full Cambridge facility, which will give the Company additional sublease income of approximately $0.3 million from October 2011 through September 2012, $0.7 million from October 2012 through September 2013 and $0.2 million from October 2013 through the end of the lease term.

Letter of Credit

Pursuant to the Company’s new facilities lease for office and laboratory space in San Diego, the Company is required to maintain a letter of credit of $3.2 million on behalf of its landlord in lieu of a cash deposit. The deposit is to be held as a security for the performance of the Company’s obligations under the lease and is not an advance rental deposit. The deposit will not be increased at any time but can be reduced based on certain financial and market capitalization requirements.

In connection with this requirement, as of September 30, 2011, the Company had an unsecured letter of credit in place pursuant to this agreement for approximately $3.2 million. The line of credit expires on December 31, 2012, and will be automatically extended annually without amendment through December 31, 2022. Subsequently, in conjunction with the credit lines entered with Comerica in October 2011, the letter of credit was amended to be cash secured for its full value.

Class Action Shareholder Lawsuit

In June 2004, the Company executed a formal settlement agreement with the plaintiffs in a class action lawsuit filed in December 2002 in a U.S. federal district court (the “Court”). This lawsuit is part of a series of related lawsuits in which similar complaints were filed by plaintiffs against hundreds of other public companies that conducted an Initial Public Offering, or IPO of their common stock in 2000 and the late 1990s, or the IPO Cases. On February 15, 2005, the Court issued a decision certifying a class action for settlement purposes and granting preliminary approval of the settlement subject to modification of certain bar orders contemplated by the settlement. On August 31, 2005, the Court reaffirmed class certification and preliminary approval of the modified settlement. On April 24, 2006, the Court held a Final Fairness Hearing to determine whether to grant final approval of the settlement. On December 5, 2006, the Second Circuit Court of Appeals vacated the lower Court’s earlier decision certifying as class actions the six IPO Cases designated as “focus cases.” The Company is not one of the six focus cases. Thereafter, the District Court ordered a stay of all proceedings in all of the IPO

 

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Cases pending the outcome of the plaintiffs’ petition to the Second Circuit for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Second Circuit denied plaintiffs’ rehearing petition, but clarified that the plaintiffs may seek to certify a more limited class in the District Court. Accordingly, the settlement as originally negotiated was terminated pursuant to stipulation of the parties and will not be finally approved. On or about August 14, 2007, plaintiffs filed amended complaints in the six focus cases, and thereafter moved for certification of the classes and appointment of lead plaintiffs and lead counsel in those cases. The six focus case issuers filed motions to dismiss the claims against them in November 2007 and an opposition to plaintiffs’ motion for class certification in December 2007. The Court denied the motions to dismiss on March 16, 2008. On October 2, 2008, the plaintiffs withdrew their class certification motion. On February 25, 2009, liaison counsel for plaintiffs informed the district court that a settlement of the IPO Cases had been agreed to in principle, subject to formal approval by the parties and preliminary and final approval by the court. On April 2, 2009, the parties submitted a tentative settlement agreement to the court and moved for preliminary approval thereof. On June 11, 2009, the Court granted preliminary approval of the tentative settlement and ordered that notice of the settlement to be published and mailed. The District Court held a final fairness hearing on September 10, 2009. On October 6, 2009, the District Court certified the settlement class in each IPO Case and granted final approval to the settlement. On or about October 23, 2009, three shareholders filed a Petition for Permission To Appeal Class Certification Order, objecting to the District Court’s final approval order and, in particular, asserting that the District Court’s certification of the settlement classes violates the Second Circuit’s earlier class certification decisions in the IPO Cases. Beginning on October 29, 2009, a number of shareholders also filed direct appeals to the second circuit, objecting to final approval of the settlement. All but one of the appeals were eventually dismissed, and the second circuit thereafter remanded to the district court for a determination whether the final shareholder appellant is a class member with standing to appeal. In August 2011, the district court found that the final shareholder was not a member of the class. In September 2011, the shareholder filed a notice of appeal of the district court’s determination. If that determination is affirmed on appeal, or if the shareholder is found to have standing and the settlement is thereafter affirmed on appeal, the settlement will result in the dismissal of all claims against the Company and its officers and directors with prejudice, and the Company’s pro rata share of the settlement fund will be fully funded by insurance.

The Company is covered by a claims-made liability insurance policy which it believes will satisfy any potential liability of the Company under this settlement. Due to the inherent uncertainties of litigation, and because the objecting shareholders are seeking to challenge the settlement on appeal, the ultimate outcome of this matter cannot be predicted, and an estimate of potential losses is not estimatable.

In addition to the matters noted above, from time to time, the Company is subject to legal proceedings, asserted claims and investigations in the ordinary course of business, including commercial claims, employment and other matters, which management considers to be immaterial, individually and in the aggregate. In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, the Company believes that it has valid defenses with respect to the legal matters pending against the Company. It is possible, nevertheless, that the Company’s consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.

10. Subsequent Event

On October 19, 2011, the Company entered into credit facilities with Comerica consisting of a $3.0 million domestic receivables and inventory revolving line and a $10.0 million export-import receivables revolving line. The credit lines have a maturity date of 18 months. The Comerica Line is pursuant to a Loan and Security Agreement with Comerica which allows for revolving cash borrowings under a secured credit facility of up to the lesser of (i) $3.0 million or (ii) 80% of certain eligible domestic accounts receivable held by the Company that arise in the ordinary course of business and 50% of eligible inventory held by the Company, not to exceed $0.5 million, consisting of raw materials and finished goods for sale in the ordinary course of our business. The Ex-Im Line is pursuant to a Revolving Credit Promissory Note between the Company and Comerica, with Comerica’s exposure under the line guaranteed by the Ex-Im Bank. The Ex-Im Line is a revolving credit facility of up to the lesser of (i) $10.0 million or (ii) up to 90% of certain eligible export related accounts receivable, and which are subject to adjustment for the non-U.S. portion of costs included in the sales price of the Company’s products, held by the Company that arise in the ordinary course of the Company’s business, and may be used by the Company for the purpose of enabling the Company to finance the cost of manufacturing, producing, purchasing or selling finished goods or services in accordance with applicable Ex-Im Bank rules and regulations. Advances under the credit lines bear interest at a daily adjusting London Interbank Offered Rate plus a margin of 6.0%.

 

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Subject to certain exceptions, all borrowings under the credit lines are secured by substantially all of the Company’s assets, including the Company’s intellectual property. Under the credit lines, subject to the satisfaction of certain conditions, the Company may incur additional debt that is senior to Comerica’s liens on its machinery and equipment and certain excess cash, equal in priority with respect to its intellectual property, and junior in priority to other assets, provided that such debt financing closes on or before March 31, 2012.

The credit lines include limitations on the Company’s ability to, among other things, dispose of assets, move cash balances on deposit with Comerica to another depositary, engage in any business not related to its current business strategy, engage in certain mergers and acquisitions, incur debt, grant liens, make certain restricted payments such as dividend payments, make certain investments, enter into certain transactions with affiliates, make payments on subordinated debt, and store inventory or equipment with certain third parties, and contains certain financial covenants. Additionally, the Company has agreed with Comerica that it will obtain additional financing of at least $7.5 million by March 31, 2012, or Comerica will be entitled to call any drawn but unpaid amounts under the Credit Lines, terminate the Credit Lines, and foreclose on all collateral to satisfy any unpaid obligations.

The events of default under the credit lines include, among other things, payment defaults, breaches of covenants, the occurrence of a material adverse change in the business, judgments against the Company, material misrepresentations by the Company and bankruptcy events. In the case of a continuing event of default, Comerica may, among other remedies, eliminate its commitment to make further credit available, declare due all unpaid principal amounts outstanding, and foreclose on all collateral to satisfy any unpaid obligations.

In connection with the Comerica Line, the Company issued to Comerica a warrant to purchase 246,212 shares of its common stock at a price per share of $2.64. The warrant is exercisable at any time commencing on April 19, 2012 through the expiration of the warrant on October 19, 2016.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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

 

•

our ability to repay outstanding debt upon maturity of $34.9 million face amount of our 5.50% Convertible Senior Notes due 2027, or 2007 Notes, in April 2027, or earlier, pursuant to the election of put options by holders of the 2007 Notes, on the put dates of April 1, 2012, April 1, 2017, or April 1, 2022;

 

•

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

 

•

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

 

•

our ability to improve manufacturing processes and increase manufacturing yields in order to improve margins and enable us to continue to meet supply demand from customers;

 

•

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;

 

•

our products and product candidates under development;

 

•

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;

 

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•

our anticipated revenues from collaborative agreements and licenses granted to third parties and our ability to maintain our collaborative relationships with third parties;

 

•

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 (including in connection with conversion of our convertible notes);

 

•

our exposure to market risk;

 

•

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, risks related to our ability to fund our operations and 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.”

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 three main product lines: animal health and nutrition, grain processing, and oilseed processing. 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.

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 nearly 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 specialty enzymes for animal health and nutrition, grain processing, oilseed processing, and emerging enzyme markets. We have current collaborations and agreements with key partners such as Bunge Oils, Novus International, Inc., or Novus, Alfa Laval, Desmet Ballestra, Danisco Animal Nutrition, or Danisco which was acquired in 2011 by E. I. du Pont de Nemours and Company, or DuPont, and WeissBioTech (formerly Add Food Services GmbH), each of which complement our internal technology, product development efforts, and distribution efforts.

As of September 30, 2011, we owned 193 issued patents relating to our technologies and had 226 patents pending. Also, as of September 30, 2011, we either jointly owned or in-licensed from BP 122 patents and 136 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 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 September 30, 2011, we had an accumulated deficit of approximately $597.8 million. Our results of operations have fluctuated from period to period and likely will continue to fluctuate substantially in the future. During the quarter ended September 30, 2011, we generated a quarterly operating profit of $2.1 million, due in part to a non-recurring $3.25 million license fee as well as product gross profit growth and expense management. We expect to incur losses in the near term, as a result of any combination of one or more of the following:

 

•

continued research and development expenses for the progression of internal product candidates;

 

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•

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

 

•

maintaining or increasing our sales and marketing infrastructure.

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.

As more fully described in the Liquidity and Capital Resources section beginning on page 31 and Note 1 of our Notes to Condensed Consolidated Financial Statements, in connection with the sale of our LC business in September 2010, we obtained net cash proceeds of approximately $96.0 million. To date, the Company has used net proceeds of approximately $59.2 million from the transaction for debt retirement. We intend to use the remaining net proceeds for continued investment in product development and manufacturing improvement efforts for our industrial enzyme business, for general corporate purposes, including working capital, and, as appropriate, for additional debt retirement. The holders of the 2007 Notes have the right to require us to purchase the 2007 Notes for cash (including any accrued and unpaid interest) on each of April 1, 2012, April 1, 2017 and April 1, 2022. Assuming this occurs in 2012, based on our current cash resources and 2011 operating plan, our existing working capital will not be sufficient to meet the cash requirements to fund our planned operating expenses, capital expenditures and working capital requirements after this date without additional sources of cash. If we are unable to raise additional capital, we will need to defer, reduce or eliminate significant planned expenditures, restructure or significantly curtail our operations, file for bankruptcy or cease operations.

Recent Strategic Events

Debt Repurchase

As more fully described in Note 3 of our Notes to Condensed Consolidated Financial Statements, on July 27, 2011 and September 23, 2011, we repurchased in total $5.2 million in principal amount of our 2007 Notes, as well as the remaining $4.1 million outstanding in principal amount of our 2009 Notes. As part of the transaction the note holders released us from any and all commitments and indebtedness related to the 2007 and 2009 Notes repurchased. Immediately following the repurchase and as of September 30, 2011, no additional 2009 Notes remain outstanding and we had $34.9 million in principal amount of 2007 Notes outstanding.

Line of Credit

On October 19, 2011 we entered into credit facilities with Comerica Bank, or Comerica, consisting of a $3.0 million domestic receivables and inventory revolving line, or the Comerica Line, and a $10.0 million foreign receivables revolving line, or the Ex-Im Line. The credit lines have a maturity date of 18 months. The Comerica Line is pursuant to a Loan and Security Agreement with Comerica which allows for revolving cash borrowings under a secured credit facility of up to the lesser of (i) $3.0 million or (ii) 80% of certain eligible domestic accounts receivable held by us that arise in the ordinary course of business and 50% of eligible inventory held by us, not to exceed $0.5 million, consisting of raw materials and finished goods for sale in the ordinary course of our business. The Ex-Im Line is pursuant to a Revolving Credit Promissory Note between us and Comerica, with Comerica’s exposure under the line guaranteed by the Export-Import Bank of the United States, or Ex-Im Bank. Our available borrowings under the Ex-Im Line will be equal the lesser of (i) $10.0 million or (ii) up to 90% of certain eligible export related accounts receivable, and which are subject to adjustment for the non-U.S. portion of costs included in the sales price of our products that arise in the ordinary course of business, and may be used by us for the purpose of financing the cost of manufacturing, producing, purchasing or selling finished goods or services in accordance with applicable Ex-Im Bank rules and regulations. Advances under the credit lines bear interest at a daily adjusting London Interbank Offered Rate plus a margin of 6.0%.

Separately, we have also put in place a facility for up to $3 million in secured equipment financing to help support the planned build-out of our research and bioprocess development laboratories and corporate headquarters in San Diego.

 

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Results of Operations – Continuing Operations

Consolidated Results of Operations

Revenues

Revenues for the three and nine month periods ended September 30, 2011 and 2010 are as follows (in thousands):

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				2010				% Change				2011				2010				% Change
Revenues:
Animal health and nutrition		$	8,624			$	7,696				12	%		$	24,734			$	24,537				1	%
Grain processing			3,942				3,364				17	%			12,371				9,605				29	%
Oilseed processing			1,929				950				103	%			4,541				2,258				101	%
All other products			247				223				11	%			606				685				(12	)%
Total product			14,742				12,233				21	%			42,252				37,085				14	%
Collaborative			3,674				339				984	%			4,694				1,391				237	%
Total revenues		$	18,416			$	12,572				46	%		$	46,946			$	38,476				22	%

Revenues increased 46%, or $5.8 million, to $18.4 million for the three months ended September 30, 2011 and increased 22%, or $8.5 million, to $46.9 million for the nine months ended September 30, 2011 as compared to $12.6 and $38.5 million for the three and nine months ended September 30, 2010.

Product revenues increased 21%, or $2.5 million, for the three months ended September 30, 2011 and 14%, or $5.2 million for the nine months ended September 30, 2011 as compared to the same periods in 2010. The increase for the year to date period was primarily due to revenues from our grain processing product line as a result of our increased market share of our Fuelzyme enzyme in the fuel ethanol markets. In addition, our Purifine^® PLC enzyme for the soybean oil processing market achieved significant revenue growth over the three and nine months ended September 30, 2010, resulting primarily from deployments by Molinos Rio de la Plata and Terminal 6 in Argentina.

Net revenues from the animal health and nutrition product line, primarily Phyzyme^® XP phytase, increased 12%, or $0.9 million, and 1%, or $0.2 million for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. Phyzyme^® XP represented approximately 53% and 50% of total product revenues for the three and nine months ended September 30, 2011 and 63% and 66% for the comparable periods in 2010. Although we expect that Phyzyme^® XP phytase will continue to represent a significant percentage of our total product revenues in the foreseeable future, we expect that net revenue from Phyzyme^® XP phytase will remain flat or gradually decrease in future periods. This is largely due to two factors.

 

•

A decrease in royalty from Danisco based on market conditions; and

 

•

A shift in manufacturing of Phzyme to Genencor, a subsidiary of Danisco, and our related method of revenue recognition for Phyzyme® XP phytase product sales. We also have contracted with Genencor 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 Danisco. 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.

We expect over time a greater proportion of our Phyzyme^® XP phytase manufacturing will transition 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 our other enzyme products, which we expect will generate higher gross margins than Phyzyme^® XP phytase over time.

Collaborative and license revenue increased $3.3 million, to $3.7 million and $3.3 million to $4.7 million, for the three and nine months ended September 30, 2011 as compared to the same periods in 2010. This increase was due to a license fee of $3.25 million we received for a commercial enzyme candidate that Syngenta Participations AG formally licensed to a third party and assigned to us in conjunction with the separation agreement with Syngenta in 2009. In addition, on June 23, 2011, we entered into a collaboration agreement with Novus to develop, manufacture and commercialize a suite of new enzyme products from our late-stage product pipeline in the animal health and nutrition product line. We expect to have increased collaboration revenue during the remainder of 2011 attributed to this new collaboration. 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.

 

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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.

Product Gross Profit & Margin

Product gross profit and margin for the periods ended September 30, 2011 and 2010 are as follows (in thousands):

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				2010				% Change				2011				2010				% Change
Product revenue		$	14,742			$	12,233				21	%		$	42,252			$	37,085				14	%
Cost of product revenue			8,698				7,833				11	%			26,174				23,179				13	%
Product gross profit			6,044				4,400				37	%			16,078				13,906				16	%
Product gross margin			41	%			36	%							38	%			37	%

Cost of product revenue includes both fixed and variable costs, including materials and supplies, labor, facilities, royalties and other overhead costs, associated with our product revenues. Excluded from cost of product 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 revenue increased 11%, or $0.9 million, to $8.7 million for the three months ended September 30, 2011, and 13%, or $3.0 million, to $26.2 million for the nine months ended September 30, 2011, as compared to the same periods in 2010. The increases in cost of product revenue from the comparable period in 2010 is primarily due to higher product revenue as well as higher rental expense for incremental fermentation capacity to support the expansion of product mix combined with variable costs associated with higher product revenues.

Our cost of product revenues will generally grow in proportion to revenues, although we expect to achieve benefits from the additional investments we are making at Fermic to better accommodate 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 if product revenues do not grow in line with our committed fermentation capacity at Fermic. We further expanded our fermentation capacity during the third quarter of 2010, which increased fixed manufacturing costs by an additional $0.7 million per quarter, including during the three and nine months ended September 30, 2011. In addition, gross margins are dependent upon the mix of product sales as the cost of product revenue varies from product to product. We typically experience lower margins in the early stages of commercial production for our newer enzyme products like Purifine^® PLC, as we optimize the manufacturing process for each particular product.

Product gross profit totaled $6.0 million for the three months ended September 30, 2011, and $16.1 million for the nine months ended September 30, 2011, compared to $4.4 million for the three months ended September 30, 2010 and $13.9 million for the nine months ended September 30, 2010. Gross margin increased to 41% and 38% of product revenue for the three and nine months ended September 30, 2011, compared to 36% and 37% for the three and nine months ended September 30, 2010. Gross profit and margin increased for the nine months ended September 30, 2011 primarily due to an overall growth and improvement from our non-Phyzyme^® XP phytase products.

In addition, because Phyzyme^® XP phytase represents a significant percentage of our product revenue, our product gross profit is impacted to a great degree by the gross profit achieved on sales of Phyzyme^® XP phytase. Under our manufacturing and sales agreement with Danisco, we sell our Phyzyme^® XP phytase inventory to Danisco at our cost and, under a license agreement, receive a royalty equal to 50% of Danisco’s profit from the sale of the product, as defined, when the product is sold to Danisco’s customer. As a result, our total cost of product revenue for Phyzyme^® XP phytase is incurred as we ship product to Danisco, 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 Danisco’s customer as reported to us by Danisco. We may record our quarterly royalty based on estimates from Danisco, 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 gross profit from quarter-to-quarter.

In addition, our supply agreement with Danisco for Phyzyme^® XP phytase contains provisions which allow Danisco, with six months advance notice, to assume manufacturing rights for Phyzyme^® XP phytase. If Danisco 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 Danisco 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.

 

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Operating Expenses (excluding cost of product revenue)

Operating expenses (excluding cost of product revenue) for the three months ended September 30, 2011 decreased 18%, or $1.7 million, to $7.6 million (including share-based compensation of $0.2 million) compared to $9.3 million (including share-based compensation of $0.3 million) for the three months ended September 30, 2010. Operating expenses for the nine months ended September 30, 2011 decreased $0.5 million, or 2%, to $24.6 million (including share-based compensation of $0.5 million and restructuring expense of $2.9 million) compared to $25.1 million (including share-based compensation of $0.8 million) for the nine months ended September 30, 2010. Excluding the impact of share-based compensation and restructuring expense, total operating expenses decreased $1.6 million and $3.1 million for the three and nine months ended September 30, 2011 as compared to the same period in 2010, primarily due to a reimbursement of legal fees of $1.1 million for expenses incurred during 2010, reduction of facilities related costs as a result of BP assuming our San Diego building leases, and to initiatives to decrease general and administrative expenses. Additionally, during the third quarter of 2010, we paid and expensed bonus payments of $1.4 million. As a partial offset, research and development costs for continued investment in pipeline products showed an increase.

Research and Development

Our research and development expenses for the periods ended September 30, 2011 and 2010 were as follows (in thousands):

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				2010				% Change				2011				2010				% Change
Research and development		$	2,673			$	1,448				85	%		$	7,593			$	4,124				84	%

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 on behalf of our collaborators.

Our research and development expenses increased 85%, or $1.2 million, to $2.7 million and 84%, or $3.5 million, to $7.6 million for the three and nine months ended September 30, 2011 as compared to the same periods in 2010, primarily due to our increased research and development efforts consistent with our shift in focus to higher investment in pipeline technologies. Historically, due to limited capital resources, challenging economic conditions, and a focus on cellulosic biofuels technology development through our recently sold LC business, we have not spent significant resources on early stage product development for the past three years. Beginning in the fourth quarter 2010, we began making additional investment for the development and commercialization of candidates in our enzyme product pipeline. We expect these expenses to further increase in 2011 as we further advance enzyme product candidates through the development pipeline.

For the three and nine months ended September 30, 2011, we estimate that approximately 71% and 82% of our research and development personnel costs, based upon hours incurred, were incurred for internally funded product development, and the remaining approximately 29% and 18% of such costs were incurred on research activities funded in whole or in part by our partners for both three and nine months ended September 30, 2011. For the three and nine months ended September 30, 2010, we estimate that approximately 75% and 62% of our research and development personnel costs, based upon hours incurred, were incurred for internally funded product and technology development, and the remaining approximately 25% and 38% of such costs were incurred on research activities funded by our collaborations. We will continue to pursue opportunities with strategic partners who can share our development costs and accelerate commercialization of, as well as enable us to expand commercial reach for, our pipeline products.

We determine which products and technologies to pursue independently based on various criteria, including: market opportunity, investment required, estimated time to market, regulatory hurdles, infrastructure requirements, and industry-specific expertise necessary for successful commercialization. Successful products and technologies require significant development and investment prior to regulatory approval and commercialization. As a result of the significant risks and uncertainties involved in developing and commercializing such products, we are unable to estimate the nature, timing, and cost of the efforts necessary to complete each of our major projects. These risks and uncertainties include, but are not limited to, the following:

 

•

Our products and technologies may require more resources than we anticipate if we are technically unsuccessful in initial development or commercialization efforts;

 

•

The outcome of research is unknown until each stage of testing is completed, up through and including trials and regulatory approvals, if needed;

 

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•

It can take many years from the initial decision to perform research through development until products and technologies, if any, are ultimately marketed;

 

•

We have product candidates and technologies in various stages of development related to collaborations as well as internally developed products and technologies. At any time, we may modify our strategy and pursue additional collaborations for the development and commercialization of some products and technologies that we had intended to pursue independently; and

 

•

Funding for existing products or projects may not be available on commercially acceptable terms, or at all, which may cause us to defer or reduce our product development efforts.

Any one of these risks and uncertainties could have a significant impact on the nature, timing, and costs to complete our product and technology development efforts. Accordingly, we are unable to predict which potential commercialization candidates we may proceed with, the time and costs to complete development, and ultimately whether we will have any products or technologies approved by the appropriate regulatory bodies. The various risks associated with our research and development activities are discussed more fully in this report under “Risk Factors.”

Selling, General and Administrative Expenses

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				2010				% Change				2011				2010				% Change
Selling, general and administrative expenses		$	4,940			$	7,838				(37	%)		$	14,106			$	21,010				(33	%)

Selling, general and administrative expenses decreased 37%, or $2.9 million, to $4.9 million (including share-based compensation of $0.2 million) for the three months ended September 30, 2011 and decreased $6.9 million, or 33%, to $14.1 million (including share-based compensation of $0.5 million) for the nine months ended September 30, 2011, compared to $7.8 million (including share-based compensation of $0.3 million) for the three months ended September 30, 2010 and $21.0 million (including share-based compensation of $0.8 million) for the nine months ended September 30, 2010. Excluding the impact of share-based compensation, selling, general and administrative decreased $2.8 million and $6.6 million for the three and nine months ended September 30, 2011 as compared to the same period in 2010. The decrease for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 is attributed to expense minimization efforts. The decrease for the nine months ended period is attributed to a reimbursement of legal fees of $1.1 million for expenses incurred during 2010, reduction of facilities related costs as a result of BP assuming our San Diego building leases, and to initiatives to decrease general and administrative expenses. Additionally, during the third quarter of 2010, we paid and expensed bonus payments of $1.4 million.

Restructuring Expenses

Effective March 31, 2011, we closed our office in Cambridge to better align us with the evolving needs of the business and the market. As the cease-use date was established on this date, a liability of $0.3 million was established for the facility as of March 31, 2011. Further, personnel termination costs of $1.3 million were incurred in conjunction with the closure of the office, as well as $0.4 million in relocation costs for certain employees who relocated to the San Diego facility as a result of the closure. In addition to these costs, $0.6 million in stock compensation costs were recognized as part of restructuring costs, which were incurred for option accelerations for two executives who terminated their employment with us, as provided in their respective employment agreements.

Share-Based Compensation Charges

We recognized $0.2 million and $0.3 million in share-based compensation expense for our share-based awards in continuing operations during the three months ended September 30, 2011 and 2010 and $1.1 million and $0.8 million during the nine months ended September 30, 2011 and 2010. Share-based compensation expense was allocated among the following expense categories (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Research and development		$	0			$	4			$	0			$	7
Selling, general and administrative			188				260				475				817
Restructuring charges			0				0				583				0
		$	188			$	264			$	1,058			$	824

 

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Share-based compensation decreased 29%, or $0.1 million and increased, 28%, or $0.2 million, for the three and nine months ended September 30, 2011 as compared to the same period in 2010, primarily related to a decrease in the amount of option grants, offset by a company-wide grant to all non executive employees granted during the three months ending September 30, 2011. Further, during the first quarter 2011, restructuring expense was incurred due to the separation of two executives in conjunction with the closure of the Cambridge office. Pursuant to their employment agreements, an additional 24 months of option vesting was accelerated for these employees as of their respective separation dates. This additional stock option expense attributable to the acceleration was classified into restructuring expense on the Company’s condensed consolidated financial statements.

Annually, upon material option grants or material company events, we perform a review and assessment of all valuation input assumptions used to compute share based payment expense to ensure they remain accurate and indicative of current company trends. The assessment is conducted by evaluating historical trends as well as a comparison to peers, consistent with prior periods. In conjunction with the non-executive company- wide grant completed during the quarter, we performed the analysis and determined the volatility assumption as well as the estimated forfeiture rate should be updated to reflect the business since the sale of the LC business. This change aligned the assumptions to our current conditions and, therefore, the resulting expense is a better estimate of fair value. Volatility was adjusted lower to primarily reflect our historical stock price volatility over the last 12 months and the estimated forfeiture rate was adjusted lower to reflect our historical experience over the last 12 months.

Interest expense

Interest expense was $0.6 million and $2.4 million for the three and nine months ended September 30, 2011 compared to $2.1 million and $6.3 million for the three and nine months ended September 30, 2010. This decrease in interest expense from 2010 was primarily attributed to the decrease in the outstanding convertible notes principal from repurchases. Total interest expense for the three and nine months ended September 30, 2011 and 2010 was comprised of the following (in thousands):

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
5.5% coupon interest, payable in cash		$	500			$	944			$	1,837			$	2,843
Non-cash amortization of debt issuance costs			77				149				293				446
2007 Notes Total			577				1,093				2,130				3,289
8% coupon interest, paid in cash			0				248				0				767
Non-cash accretion of debt discount			0				427				0				1,245
Non-cash amortization of debt issuance costs			0				16				0				51
2008 Notes Total			0				691				0				2,063
9% coupon interest, payable in cash or common stock			42				308				402				925
Non-cash amortization of debt premium			(16	)			(106	)			(140	)			(310	)
2009 Notes Total			26				202				262				615
Other			22				98				29				315
Total interest expense		$	625			$	2,084			$	2,421			$	6,282

 

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Gain (loss) on Debt Extinguishment upon repurchase of convertible notes

During the three and nine months ended 2011, we have repurchased $9.3 million and $39.9 million in principal amount of our 2009 and 2007 Notes, leaving an aggregate of $34.9 million, respectively, in principal amount outstanding as of September 30, 2011. A gain on debt extinguishment of $4.1 million and $15.3 million was recognized representing the difference between the carrying value of the notes repurchased of $13.0 million and $54.0 million for the three and nine months ended and the repurchase price of $8.9 million and $38.6 million calculated as follows for the nine months ended (in thousands):

 

		Three Months Ended September 30, 2011												Nine Months Ended September 30, 2011
		2009 Notes				2007 Notes				Total				2009 Notes				2007 Notes				Total
Principal		$	4,081			$	5,250			$	9,331			$	13,707			$	26,182			$	39,889
Debt premium, net			2,717				0				2,717				9,253				0				9,253
Compound embedded derivative			978				0				978				5,072				0				5,072
Issuance costs			0				(30	)			(30	)			0				(220	)			(220	)
Carrying value			7,776				5,220				12,996				28,032				25,962				53,994
Repurchase price			4,219				4,712				8,931				14,038				24,607				38,645
Gain on debt extinguishment		$	3,557			$	508			$	4,065			$	13,994			$	1,355			$	15,349

On September 23, 2010, we repurchased $21 million in principal amount of our 2008 and 2007 Notes for a total of $20.6 million in cash, excluding accrued interest as of the closing date. The repurchase allowed us to simplify our capital structure as well as avoid any potential further dilution through conversions. The repurchase qualified for debt extinguishment accounting resulting in a loss of approximately $3.4 million for the three and nine months ended September 30, 2010 representing the difference between the purchase price of $20.6 million and carrying value of $17.2 million calculated as follows (in thousands):

 

		2008 Notes				2007 Notes				Total
Principal		$	13,000			$	8,000			$	21,000
Debt discount			(3,944	)			—				(3,944	)
Compound Embedded Derivative			311				—				311
Issuance Costs			(98	)			(103	)			(201	)
Carrying Value			9,269				7,897				17,166
Repurchase price			13,750				6,800				20,550
Gain (loss) on debt extinguishment		$	(4,481	)		$	1,097			$	(3,384	)

Gain (Loss) on Net Change in Fair Value of Derivative Assets and Liabilities

The fair value of the 2008 Notes’ compound embedded derivative, the warrants issued in connection with the issuance of the 2008 Notes, the convertible hedge transaction in connection with our 2008 Notes and the 2009 Notes’ compound embedded derivative were recorded as a derivative asset or liability and marked-to-market at each balance sheet date. The change in fair value was recorded in the Condensed Consolidated Statement of Operations as “Gain (loss) on net change in fair value of derivative assets and liabilities.” We recorded a net gain of $0.3 million and a net loss of $0.3 million for the three months ended September 30, 2011 and 2010 and net loss of $1.0 million and $1.0 million for the nine months ended September 30, 2011 and 2010 related to the change in fair value of our recorded derivative asset and liabilities.

Gain on Debt Extinguishment Upon Conversion of Convertible Debt

During the three and nine months ended September 30, 2011, we recorded no gain or loss on debt extinguishment as a result of conversions. During the nine months ended September 30, 2010, we recorded a gain on debt extinguishment of $0.6 million. The gain is calculated as the difference between the carrying value of the converted 2008 Notes and the fair value of the shares of common stock delivered to the noteholders upon conversion. The carrying value of the converted 2008 Notes for the nine months ended September 30, 2010 was equal to the $2.2 million of principal less the unamortized debt discount and issuance costs, which totaled $1.7 million, as of the conversion date. During the nine months ended September 30, 2010, we issued a total of 0.2 million shares with a total market value as of the dates of conversion of $1.1 million to settle the converted 2008 Notes and “make-whole” payments.

Net Income (Loss) from Discontinued Operations

As previously noted, on September 2, 2010, we completed the sale of the LC business to BP for net proceeds to us of $96.0 million (including $5 million of the purchase price placed in escrow). As such, the current and prior periods presented in this report have been reclassified to reflect the legacy LC business as discontinued operations. Revenue and expenses allocated to discontinued operations for the three and nine months ended September 30, 2010 were limited to revenue and expenses that were directly related to the operations of the LC business, or that were eliminated as a result of the sale of the LC business. Net income from discontinued operations for the nine months ended September 30, 2011 was attributed primarily to net present value adjustments of future rent obligations related to a portion of the Cambridge office space attributed to the LC business.

Loss Attributed to Noncontrolling Interest in Consolidated Entities –Discontinued Operations

For the three and nine months ended September 30, 2010 we were considered the primary beneficiary of Galaxy and consolidated its financial results. As a result, BP’s share of losses in Galaxy are reflected in our Condensed Consolidated Statements of Operations as “Loss attributed to noncontrolling interests in consolidated entities.” Upon the completion of the sale of the LC business, BP became the sole investor in Galaxy. As a result, all results for Galaxy are reflected separately as discontinued operations on our condensed consolidated financial statements.

Liquidity and Capital Resources

Since inception, we have financed our business primarily through the sale of common and preferred stock, funding from strategic partners and government grants, the issuance of convertible debt, and product sales. As of September 30, 2011, we had an accumulated deficit of approximately $597.8 million.

In early 2011, we undertook restructuring activities in connection with the closure of our Cambridge, Massachusetts office which primarily include a one-time termination costs, such as severance costs related to the elimination of duplicative positions

 

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and separation costs due to executive employment agreements, charges associated with the closure of the leased office space and one-time relocation costs for the employees whose employment positions have been moved to our San Diego location. As a result of the plan, we have achieved, and expect to continue to achieve, operating efficiencies in future periods related to salary and overhead costs related to general and administrative costs. As of September 30, 2011, we have incurred total restructuring expense of $2.9 million and have restructuring accruals of $0.6 million, for which payments are expected to be substantially completed in early 2012.

Capital Requirements

As of September 30, 2011, we had available cash and cash equivalents of approximately $35.7 million, and restricted cash of $5.0 million. Historically, we have funded our capital requirements through available cash, issuances of debt and equity, product, collaboration and grant revenue, capital leases and equipment financing, and line of credit agreements. In September 2010 we raised approximately $96.0 million net of transaction costs through the sale of our LC business. To date we have used net proceeds of approximately $59.2 million from this transaction for debt retirement. We intend to use the remaining proceeds for continued investment in product development and manufacturing improvement efforts, build-out of our new research and development and corporate headquarters in San Diego, for general corporate purposes, including working capital, and, as appropriate, for additional debt retirement.

As more fully described in Note 3 of our Notes to Condensed Consolidated Financial Statements, the holders of our 2007 Notes aggregating a total of $34.9 million have the right to require us to purchase the 2007 Notes for cash (including any accrued and unpaid interest) on April 1, 2012, April 1, 2017 and April 1, 2022, in whole or in part, for cash at a redemption price equal to 100% of the principal amount of the notes to be redeemed plus any accrued and unpaid interest to the redemption date. Assuming this occurs in 2012, based on our current cash resources and 2011 operating plan, our existing working capital will not be sufficient to retire the 2007 Notes. If we are unable to re-finance our 2007 Notes or raise additional capital, we will need to defer, restructure or significantly curtail our operations, issue equity in exchange for our 2007 Notes at substantial dilution to current stockholders, file for bankruptcy, or cease operations.

Balance Sheet

Our consolidated assets have decreased by $48.5 million to $63.3 million at September 30, 2011 from $111.8 million at December 31, 2010. This decrease is primarily attributed to a decrease in cash of $52.3 million attributable primarily to the repurchase of certain of our 2007 and 2009 Notes principal and accrued interest of $39.8 million, payments against 2010 liabilities (including employee cash bonuses) and general operating burn.

Our consolidated liabilities have decreased by $57.6 million to $51.0 million at September 30, 2011 from $108.6 million at December 31, 2010. The decrease is primarily attributable to the reduction in convertible notes carrying value of $53.2 million, primarily from principal repurchases of $39.9 million with a carrying value of $54.0 million and changes in market value of the related derivative liabilities. The remainder of the decrease is attributed to a reduction in accounts payable and accrued expenses of $6.7 million primarily related to timing of cash payments, partially offset by (i) an increase in deferred revenue of $3.0 million due to cash received in advance of revenue recognition most notably the upfront payment related to the Novus collaboration, and (ii) the remaining restructuring accrual associated with the closing of the Cambridge, Massachusetts office space of $0.6 million.

Cash Flows Related to Operating, Investing and Financing Activities

For the nine months ended September 30, 2011 we used $8.6 million to fund our operations compared to $10.1 million for the nine months ended September 30, 2010. Although we had net income of $8.1 million for the nine months ended September 30, 2011, $15.3 million of such amount was related to non-cash gain on debt extinguishment upon repurchase of convertible notes. The remaining change in operating cash flows for the nine months ended September 30, 2011 primarily reflects an increase in accounts receivable and decrease in accounts payable and accrued liabilities due to timing of cash receipts and payments, partially offset by an increase in deferred revenue primarily related to an upfront cash payment received from Novus in June 2011. In addition, during the three months ended September 30, 2011 we received a license fee of $3.25 million for a commercial enzyme candidate that Syngenta Participations AG formally licensed to a third party and assigned to us in conjunction with the separation agreement with Syngenta in 2009.

Our investing activities for continuing operations used net cash of $3.9 million for the nine months ended September 30, 2011 consisting of purchases of property and equipment.

Our financing activities for continuing operations used cash of $38.6 million for the nine months ended September 30, 2011 due to our debt repurchases.

 

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Contractual Obligations

The following table summarizes our contractual obligations at September 30, 2011, including the principal and interest payments for our 2007 Notes, assuming such obligations are not redeemed pursuant to noteholder rights prior to maturity in April 2027 (in thousands):

 

						Payments due by Period
		Total				Less than 1 Year				1 - 3 Years				3 - 5 Years				More than 5 Years
Contractual Obligations
Operating lease – San Diego(1)		$	26,943			$	770			$	3,657			$	5,022			$	17,494
Operating lease – Cambridge, net (2)			779				552				227				0				0
Manufacturing costs to Fermic (3)			46,716				18,006				28,710				0				0
License and research agreements			500				70				140				140				150
Convertible Debt:
2007 Notes (principal of $34.9 million and interest of $30.6 million through April 2027 maturity) (4)			65,521	(4)			1,917				3,834				3,834				55,936
Total Contractual Obligations		$	140,459			$	21,315			$	36,568			$	8,996			$	73,580

 

 

(1)

On June 24, 2011, we signed a lease agreement for 59,199 square feet for new office and laboratory space in San Diego for a term of 126 months from the first day of the first full month after the commencement date. The agreement is for the build out of the space with a targeted commencement date in June 2012. Upon lease commencement, rent will be approximately $192,000 per month, which includes both base rent and a tenant improvement allowance. The rent will be increased by 3% on each annual anniversary of the first day of the first full month during the lease term. Further, the lease agreement allows for a “free rent” term starting with the seventh full month in the lease through the end of the sixteenth month.

 

(2)

We lease approximately 21,000 square feet of office space in a building in Cambridge, Massachusetts. The offices are leased to us under an operating lease with a term through December 2013. On December 14, 2010, we publicly announced that we were focusing all of our operations in San Diego and closed our office in Cambridge to better align us with the evolving needs of the business and the market. The closure was effective on March 31, 2011. We completed a sublease agreement in May 2011 for the full Cambridge facility, which will give us additional sublease income of approximately $0.3 million from October 2011 through September 2012, $0.7 million from October 2012 through September 2013, and $0.2 million from October 2013 through the end of the lease term.

 

(3)

Pursuant to our manufacturing agreement with Fermic, we are obligated to reimburse monthly costs related to manufacturing activities. These costs scale up as our projected manufacturing volume increases. Under the terms of the agreement, we can cancel the committed purchases with thirty months’ notice. This commitment represents thirty months of rent at current committed capacity, which is the maximum capacity allowed under the agreement.

 

(4)

The holders of the 2007 Notes have the right to require us to purchase the 2007 Notes for cash (including any accrued and unpaid interest) on April 1, 2012, April 1, 2017 and April 1, 2022. If the holders exercise their right to require us to purchase the Notes for cash on April 1, 2012, the total obligation would be $36.8 million, which would include $1.9 million of interest, for the 2007 Notes as of September 30, 2011.

Manufacturing and Supply Agreements

We have a manufacturing agreement with Fermic to provide us with the capacity to produce commercial quantities of enzyme products, pursuant to which we pay Fermic a fixed monthly rent for minimum committed manufacturing capacity. Under the terms of the agreement, we can cancel the committed purchases with 30 months’ notice. As of September 30, 2011, under this agreement our minimum commitments to Fermic were approximately $46.8 million over the next 30 months.

In addition, under the terms of the agreement, we fund, in whole or in part, capital expenditures for certain equipment required for fermentation and downstream processing of our enzyme products. Since inception through September 30, 2011, we have incurred costs of approximately $22.3 million for property and equipment related to this agreement, of which $0.5 million we funded in 2011. Our ongoing strategy is to remove our manufacturing bottlenecks, increase manufacturing efficiencies, and remove manufacturing variability, in order to manufacture more product and reduce our average production cost per unit. For much of 2010, we limited our marketing activities in line with our manufacturing capabilities. In order to improve our manufacturing capabilities, support growth, and reduce our average unit cost, we plan to make up to $1 million of additional capital investments at Fermic during the remainder of 2011. These investments should improve both our yield of enzymes and the profitability of our enzymes over time.

 

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In 2008, we contracted with Genencor, which was at that time was a subsidiary of Danisco, to serve as a second-source manufacturer for Phyzyme^® XP phytase. Our supply agreement with Danisco for Phyzyme^® XP phytase contains provisions which allow Danisco, with six months’ advance notice, to assume the right to manufacture Phyzyme^® XP phytase. If Danisco were 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 Danisco assumed the right to manufacture Phyzyme^® XP phytase and we were unable to absorb or otherwise reduce the excess capacity at Fermic with other products, our results of operations and financial condition would be adversely affected.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements that would give rise to additional material contractual obligations as of September 30, 2011.

Critical Accounting Policies

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 U.S. generally accepted accounting principles. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. On an ongoing basis, we evaluate these estimates, including those related to revenue recognition, long-lived assets, accrued liabilities, convertible senior notes, and income taxes. These estimates are based on historical experience, information received from third parties, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the year ended December 31, 2010, with the exception of the following:

Revenue Recognition

We follow the provisions as set forth by authoritative accounting guidance.

We generally recognize revenue when we have satisfied all contractual obligations and we are reasonably assured of collecting the resulting receivable. We are often entitled to bill our customers and receive payment from our customers in advance of recognizing the revenue under current accounting rules. In those instances where we have billed our customers or received payment from our customers in advance of recognizing revenue, we include the amounts in deferred revenue on our balance sheet.

We recognize revenue related to the sale of our inventory as we ship or deliver products, provided all other revenue recognition criteria have been met. We recognize revenue from products sold through distributors or other third-party arrangements upon shipment of the products, if the distributor has a right of return, provided that (a) the price is substantially fixed and determinable at the time of sale; (b) the distributor’s obligation to pay us is not contingent upon resale of the products; (c) title and risk of loss passes to the distributor at time of shipment; (d) the distributor has economic substance apart from that provided by us; (e) we have no significant obligation to the distributor to bring about resale of the products; and (f) future returns can be reasonably estimated. For any sales that do not meet all of the above criteria, revenue is deferred until all such criteria have been met. We include revenue from our royalty on operating profit in product revenues on the statement of operations. We recognize royalty calculated as a share of profits, as defined by our agreement, during the quarter in which such revenues are earned based on calculations provided by our partner. To date, we have generated a substantial portion of our product revenues, including royalty, through our agreements with Danisco. We may record our quarterly royalty based on estimates from Danisco, and the final calculation of the royalty is sometimes finalized in the subsequent quarter; accordingly, we are subject to potential adjustments to our actual royalty from quarter-to-quarter.

We have contracted with Genencor, a subsidiary of Danisco, to serve as a second-source manufacturer of Phyzyme^® XP phytase. Under current accounting guidance, product manufactured for us by Genencor is recognized on a net basis equal to the royalty received from Danisco, as all the following indicators of net revenue reporting are met: (i) the third party is the obligor; (ii) the amount earned is fixed; and (iii) the third party maintains inventory risk, as compared to the full value of the manufacturing costs plus royalty we currently recognize for Phyzyme^® XP phytase we manufacture.

        We sometimes enter into revenue arrangements that include the delivery of more than one product or service. In these cases, we recognize revenue from each element of the arrangement as long as we are able to determine a separate value for each element, we have completed our obligation to deliver or perform on that element and we are reasonably assured of collecting the resulting receivable.

 

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Effective January 1, 2011, in conjunction with the adoption of a new accounting pronouncement, for multiple deliverable agreements, including contract manufacturing agreements and license agreements, consideration is allocated at the inception of the agreement to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence, or VSOE, of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, we use our best estimate of the selling price for the deliverable.

Effective January 1, 2011, in conjunction with the adoption of a new accounting pronouncement, at the inception of each agreement that includes milestone payments, we evaluate whether each milestone is substantive and at risk to both parties on the basis of the contingent nature of the milestone, specifically reviewing factors such as the scientific and other risks that must be overcome to achieve the milestone, as well as the level of effort and investment required. Revenues from milestones, if they are nonrefundable and deemed substantive, are recognized upon successful accomplishment of the milestones. Milestones that are not considered substantive are accounted for as license payments and recognized on a straight-line basis over the remaining period of performance.

Recently Issued Accounting Standards

Information with respect to recent accounting standards is included in Note 1 of our Notes to Condensed Consolidated Financial Statements.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Our exposure to market risk is limited to interest rate risk and, to a lesser extent, foreign currency risk.

Interest Rate Exposure

As of September 30, 2011, all of our outstanding debt obligations were comprised of fixed rate interest and, therefore, there is minimal interest rate exposure.

Foreign Currency Exposure

We engage third parties, including Fermic, our contract manufacturing partner in Mexico City, to provide various services. From time to time certain of these services result in obligations that are denominated in other than U.S. dollars.

Additionally, under our manufacturing and sales agreement with Danisco, we sell our Phyzyme^® XP phytase inventory to Danisco at our cost and, under a license agreement, receive a royalty equal to 50% of Danisco’s profit from the sale of the product, as defined, when the product is sold to Danisco’s customer. This profit share is denominated in other than U.S. dollars and is converted to U.S. dollars upon payment. Consequently, our reported revenue may be affected by fluctuations in currency exchange rates.

 

ITEM 4.

CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities and Exchange Act of 1934, as amended, or Exchange Act, reports is recorded, processed, summarized and reported within the timelines specified in the Securities and Exchange Commission, or SEC, rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we carried out an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in SEC Rules 13a-15(e) and 15d-15(e)) as of September 30, 2011. Based on such evaluation, such officers have concluded that, as of September 30, 2011, our disclosure controls and procedures were effective at the reasonable assurance level.

There were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management continues to improve the design and effectiveness of our disclosure controls and procedures and internal control over financial reporting and intends to continue to implement improvements in its internal control over financial reporting and hire additional finance and accounting personnel as necessary to prevent or detect deficiencies, and to timely address any deficiencies that we may identify in the future.

PART II—OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS.

Class Action Shareholder Lawsuit

In June 2004, the Company executed a formal settlement agreement with the plaintiffs in a class action lawsuit filed in December 2002 in a U.S. federal district court (the “Court”). This lawsuit is part of a series of related lawsuits in which similar complaints were filed by plaintiffs against hundreds of other public companies that conducted an Initial Public Offering, or IPO of their common stock in 2000 and the late 1990s, or the IPO Cases. On February 15, 2005, the Court issued a decision certifying a class action for settlement purposes and granting preliminary approval of the settlement subject to modification of certain bar orders contemplated by the settlement. On August 31, 2005, the Court reaffirmed class certification and preliminary approval of the modified settlement. On April 24, 2006, the Court held a Final Fairness Hearing to determine whether to grant final approval of the settlement. On December 5, 2006, the Second Circuit Court of Appeals vacated the lower Court’s earlier decision certifying as class actions the six IPO Cases designated as “focus cases.” The Company is not one of the six focus cases. Thereafter, the District Court ordered a stay of all proceedings in all of the IPO Cases pending the outcome of the plaintiffs’ petition to the Second Circuit for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Second Circuit denied plaintiffs’ rehearing petition, but clarified that the plaintiffs may seek to certify a more limited class in the District Court. Accordingly, the settlement as originally negotiated was terminated pursuant to stipulation of the parties and will not be finally approved. On or about August 14, 2007, plaintiffs filed amended complaints in the six focus cases, and thereafter moved for certification of the classes and appointment of lead plaintiffs and lead counsel in those cases. The six focus case issuers filed motions to dismiss the claims against them in November 2007 and an opposition to plaintiffs’ motion for class certification in December 2007. The Court denied the motions to dismiss on March 16, 2008. On October 2, 2008, the plaintiffs withdrew their class certification motion. On February 25, 2009, liaison counsel for plaintiffs informed the district court that a settlement of the IPO Cases had been agreed to in principle, subject to formal approval by the parties and preliminary and final approval by the court. On April 2, 2009, the parties submitted a tentative settlement agreement to the court and moved for preliminary approval thereof. On June 11, 2009, the Court granted preliminary approval of the tentative settlement and ordered that notice of the settlement to be published and mailed. The District Court held a final fairness hearing on September 10, 2009. On October 6, 2009, the District Court certified the settlement class in each IPO Case and granted final approval to the settlement. On or about October 23, 2009, three shareholders filed a Petition for Permission To Appeal Class Certification Order, objecting to the District Court’s final approval order and, in particular, asserting that the District Court’s certification of the settlement classes violates the Second Circuit’s earlier class certification decisions in the IPO Cases. Beginning on October 29, 2009, a number of shareholders also filed direct appeals to the second circuit, objecting to final approval of the settlement. All but one of the appeals were eventually dismissed, and the second circuit thereafter remanded to the district court for a determination whether the final shareholder appellant is a class member with standing to appeal. In August 2011, the district court found that the final shareholder was not a member of the class. In September 2011, the shareholder filed a notice of appeal of the district court’s determination. If that determination is affirmed on appeal, or if the shareholder is found to have standing and the settlement is thereafter affirmed on appeal, the settlement will result in the dismissal of all claims against the Company and its officers and directors with prejudice, and the Company’s pro rata share of the settlement fund will be fully funded by insurance

The Company is covered by a claims-made liability insurance policy which it believes will satisfy any potential liability of the Company under this settlement. Due to the inherent uncertainties of litigation, and because the objecting shareholders are seeking to challenge the settlement on appeal, the ultimate outcome of this matter cannot be predicted.

In addition to the matters noted above, from time to time, the Company is subject to legal proceedings, asserted claims and investigations in the ordinary course of business, including commercial claims, employment and other matters, which management considers to be immaterial, individually and in the aggregate. In accordance with generally accepted accounting principles, the Company makes a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. Litigation is inherently unpredictable. However, the Company believes that it has valid defenses with respect

 

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to the legal matters pending against the Company. It is possible, nevertheless, that the Company’s consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.

 

ITEM 1A.

RISK FACTORS.

Except for the historical information contained herein, this quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed here. Factors that could cause or contribute to differences in our actual results include those discussed in the following section, as well as those discussed in Part I, Item 2 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere throughout this quarterly report on Form 10-Q. You should consider carefully the following risk factors, together with all of the other information included in this quarterly report on Form 10-Q. Each of these risk factors could adversely affect our business, operating results, and financial condition, as well as adversely affect the value of an investment in our common stock.

We have marked with an asterisk those risk factors that reflect substantive changes from the risk factors previously discussed in our Form 10-K for the year ended December 31, 2010.

Risks Applicable to Our Business Generally

*We will need to raise additional capital or refinance our debt in 2011. If we are unable to do so, we may have to curtail or cease operations.

We will need to refinance our 2007 Notes, or raise more money to pay down our 2007 Notes and to continue to fund our business. Our capital requirements in 2011 and beyond will depend on several factors, including:

 

•

The election of any or all of our noteholders to require us to repurchase the 2007 Notes, pursuant to the exercise of their respective put options in April 2012, 2017, and 2022;

 

•

Our ability to retire/refinance existing indebtedness;

 

•

The level of research and development investment required to maintain our technology leadership position;

 

•

Our ability to borrow from Comerica under our existing credit lines;

 

•

The capital required to build out our new facility in San Diego;

 

•

Our ability to enter into new agreements with collaborative partners or to extend the terms of our existing collaborative agreements, and the terms of any agreement of this type;

 

•

The success rate of our discovery efforts associated with milestones and royalties;

 

•

Our ability to successfully commercialize products developed independently and the demand for such products, including our existing products;

 

•

The timing and willingness of strategic partners and collaborators to commercialize our products that would result in royalties;

 

•

Costs of recruiting and retaining qualified personnel; and

 

•

Our possible acquisition or licensing of complementary technologies or acquisition of complementary businesses.

We may seek additional funds through a combination of existing and additional corporate partnerships and collaborations, federal, state and local grant funding, product sales, selling or financing assets, and the sale of equity or debt securities. Such funds may not be available to us or may be available on terms not satisfactory to us. Our inability to raise adequate funds to retire the Notes, if necessary, and to support the growth of our product and product candidate portfolio will materially adversely affect our business.

If we are unable to raise more money or refinance our 2007 Notes, we will have to implement one or more of the following remedies:

 

•

issue equity in exchange for all or a portion of our 2007 Notes at substantial dilution to current stockholders;

 

•

reduce our capital expenditures;

 

•

further scale back our development of new enzyme products;

 

•

significantly reduce our workforce;

 

•

sell some or all of our assets;

 

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•

seek to license to others products or technologies that we otherwise would seek to commercialize ourselves; and/or

 

•

curtail or cease operations.

*We may not have adequate funds to pay interest on our 2007 Notes, or to purchase the 2007 Notes on required purchase dates or upon a fundamental change in our business.

In April 2007, we completed the sale of $120 million of 2007 Notes, the terms of which include provisions whereby on each of April 1, 2012, April 1, 2017 and April 1, 2022, holders of the 2007 Notes may require us to purchase, for cash, all or a portion of their 2007 Notes at 100% of their principal amount, plus any accrued and unpaid interest up to, but excluding, that date. As of September 30, 2011, approximately $34.9 million of the 2007 Notes remained outstanding. If a “fundamental change,” which is defined in the indenture related to the 2007 Notes, occurs, holders of the 2007 Notes may require us to repurchase, for cash, all or a portion of their 2007 Notes. We may not have sufficient funds to pay the interest, purchase price or repurchase price of the 2007 Notes when due in 2027, or earlier if the 2007 noteholders exercise their put options on April 1, 2012, April 1, 2017, or April 1, 2022 or in connection with any “fundamental change.” In addition, the terms of any borrowing agreements which we may enter into from time to time may require early repayment of borrowings under circumstances similar to those constituting a “fundamental change.” Those agreements may also make our repurchase of 2007 Notes in an event of default under the agreements. If we fail to pay interest on the 2007 Notes or to purchase or repurchase the 2007 Notes when required, we will be in default under the indenture for the 2007 Notes which may also cause an event of default under the terms of other borrowing arrangements that we may enter into from time to time. Any of these events could have a material adverse effect on our business, results of operations and financial condition, up to and including causing us to cease operations altogether.

*Conversion of the 2007 Notes, exercise of our outstanding warrants, anti-dilution adjustments that may occur under certain of our outstanding warrants and will dilute the ownership interest of existing stockholders.

The conversion or exercise of some or all of the 2007 Notes and/or the warrants related to the issuance in 2008 of our 8% Senior Convertible Notes due April 1, 2012 (all of which were repurchased by us in 2010) payment of interest, could significantly dilute the ownership interests of existing stockholders. In April 2008, the conversion price of the 2007 Notes decreased from $97.92 per share to $76.80 per share, based on a reset provision contained in the 2007 Notes. These resets and other reductions in the applicable conversion prices for the 2007 Notes have caused, and will continue to cause, additional shares to be issued upon conversion of these instruments compared to the number of shares initially issuable upon such conversions.

The warrants related to the 2008 Notes and certain warrants held by Syngenta contain weighted average anti-dilution protection that could also cause more shares to become issuable under those warrants if we engage in subsequent issuances that trigger those provisions. Sales in the public market of the common stock issuable upon conversion of the 2007 Notes or exercise of our outstanding warrants, could adversely affect prevailing market prices of our common stock. In addition, the existence of the 2007 Notes may encourage short selling by market participants because the conversion of the 2007 Notes could be used to satisfy short positions, or the anticipated conversion of the 2007 Notes into shares of our common stock could depress the price of our common stock.

*Our high level of debt limits our ability to fund general corporate requirements, limits our flexibility in responding to competitive developments, increases our vulnerability to adverse economic and industry conditions, and may harm our financial condition and results of operations.

The face value of our total consolidated long-term debt as of September 30, 2011, which includes the 2007 Notes, was approximately $34.9 million, representing approximately 74% of our total capitalization as of such date.

Our level of indebtedness could have important adverse consequences on our future operations, including:

 

•

making it more difficult for us to meet our payment and other obligations under the 2007 Notes;

 

•

reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes, and limiting our ability to obtain additional financing for these purposes;

 

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•

resulting in an event of default if we fail to comply with the financial and other restrictive covenants contained in our debt agreements, which could result in all of our debt becoming immediately due and payable;

 

•

limiting our flexibility in planning for, or reacting to, and increasing our vulnerability to, changes in our business, the industries in which we operate and the general economy;

 

•

placing us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged; and

 

•

requiring us to issue equity in exchange for all or a portion of our Notes, at substantial dilution to current stockholders.

Moreover, if we fail to make any required payments under our debt, or otherwise breach the terms of our debt, all or a substantial portion of our debt could be subject to acceleration. In such a situation, it is unlikely we would be able to repay the accelerated debt, which would have a material adverse impact on our business, results of operations and financial condition, up to and including causing us to cease operations.

*We have a history of net losses, we expect to continue to incur net losses, and we may not achieve or maintain profitability.

Excluding 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 September 30, 2011, we had an accumulated deficit of approximately $597.8 million. We expect to continue to incur additional losses for the foreseeable future.

Product revenues currently account for the majority of our annual revenues, and we expect that a significant portion of our revenue for 2011 will continue to result from the same sources. Future revenue from collaborations is uncertain and will depend upon our ability to maintain our current collaborations, enter into new collaborations and to meet research, development, and commercialization objectives under new and existing agreements. Over the past two years, our product revenue in absolute dollars and as a percentage of total revenues has increased significantly. Our product revenue may not continue to grow in either absolute dollars or as a percentage of total revenues. If product revenue increases, we would expect sales and marketing expenses to increase in support of increased volume, which could negatively affect our operating margins and profitability. In addition, the amounts we spend will impact our ability to become profitable and this will depend, in part, on:

 

•

the time and expense to build or retrofit, rent, operate and maintain our new facility in San Diego;

 

•

the time and expense to complete improvements to our manufacturing capabilities at Fermic;

 

•

the time and expense required to prosecute, enforce and/or challenge patent and other intellectual property rights;

 

•

how competing technological and market developments affect our proposed activities; and

 

•

the cost of obtaining licenses required to use technology owned by others for proprietary products and otherwise.

We may not achieve any or all of our goals and, thus, we cannot provide assurances that we will ever be profitable on an operating basis or maintain revenues at current levels or grow revenues. If we fail to achieve profitability and maintain or increase revenues, the market price of our common stock will likely decrease.

*If we are unable to access the capacity to manufacture products in sufficient quantity, we may not be able to commercialize our products or generate significant sales.

We have only limited experience in enzyme manufacturing, and we do not have our own internal capacity to manufacture enzyme products on a commercial scale. We expect to be dependent to a significant extent on third parties for commercial scale manufacturing of our enzyme products. We have arrangements with third parties that have the required manufacturing equipment and available capacity to manufacture our commercial enzymes. Additionally, one of our third party manufacturers is located in a foreign country, and is our sole-source supplier for most of our commercial enzyme products. Any difficulties or interruptions of service with our third party manufacturers or our own pilot manufacturing facility could disrupt our research and development efforts, delay our commercialization of enzyme products, and harm our relationships with our enzyme strategic partners, collaborators, or customers.

*We have experienced inventory losses and decreased manufacturing yields related to our manufacturing processes in the past for our enzyme products, and may continue to experience such losses, which could negatively impact our product gross margins.

 

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We have experienced inventory losses and decreased manufacturing yields related to contamination issues of our enzyme products. While we continue to address contamination issues and, in the past, have recovered a substantial portion of such losses from our third-party manufacturer Fermic, there can be no assurance that such losses will not occur in the future or that any amount of future losses will be reimbursed by Fermic. If such contamination issues continue in future periods, or we are not able to otherwise improve our manufacturing yields, our sales would suffer and our results of operations and financial condition would be adversely affected.

We are currently experiencing manufacturing constraints which may prevent us from maintaining adequate supply of inventory to meet our customers’ demands.

We are experiencing constraints within our downstream recovery capabilities at our third-party manufacturing site, Fermic. We currently do not have adequate processing equipment deployed to accommodate expected increased demand for our products. This has created inefficiencies and bottlenecks in our enzyme manufacturing process, which has compromised our manufacturing yields and has extended manufacturing cycle times at the Fermic plant. To address these shortcomings, together with Fermic, we plan to implement several manufacturing expansion and process improvement projects, which we anticipate will require additional capital expenditures over the next 12-18 months. If such projects are delayed, or do not adequately resolve our current manufacturing limitations, we may not be able to produce sufficient quantities of our enzyme products, and our results of operations and financial condition would be adversely affected.

If Genencor assumes all or a part of our Phyzyme^® XP phytase manufacturing, our gross product revenues will be adversely impacted and our product gross margins could decline.

Due to capacity constraints at Fermic in 2008, we were not able to supply adequate quantities of Phyzyme^® XP phytase necessary to meet the increased demand from Danisco. As a result, we contracted with Genencor, a subsidiary of Danisco, to serve as a second-source manufacturer for Phyzyme^® XP phytase. Pursuant to current accounting rules, revenue from Phyzyme^® XP phytase that is supplied to us by Genencor is recognized in an amount equal to the royalty calculated as a percentage of operating profit received from Danisco, as compared to the full value of the manufacturing costs plus the royalty we currently recognize for Phyzyme^® XP phytase we manufacture at Fermic. While this revenue recognition treatment has little or no negative impact on the gross margin 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.

*If Danisco exercises its right to assume manufacturing rights of Phyzyme^® XP phytase, we may experience significant excess capacity at Fermic which could adversely affect our financial condition.

In addition, our supply agreement with Danisco for Phyzyme^® XP phytase contains provisions which allow Danisco, with six months advance notice, to assume manufacturing rights of Phyzyme^® XP phytase. If Danisco were 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 were unable to absorb this excess capacity with other products, our results of operations and financial condition would be adversely affected.

*Significant fluctuations in commodity availability and price, or a change in the use of production facilities that use our enzymes, could have a negative effect on demand for our enzymes.

Our product lines may be directly or indirectly dependent upon the pricing of commodities and, therefore, may be subject to changes in availability and price of such commodities such as corn, wheat and ethanol in our grain processing product line; soy beans and soy bean oil in our oilseed processing product line; and poultry and phosphorous in our animal nutrition and health product line. Competitive conditions, governmental restrictions, natural disasters and other events could limit the production of our customers’ products that use our enzymes. As a result, the price and availability of the raw materials used, or the end products which our enzymes are used to produce, may fluctuate substantially, and could significantly impact both the demand for, and average sales price of, our enzymes.

In addition, our customers may have alternative uses for the production facilities they use to manufacture the end products which our enzymes are used to produce. Such uses may require reduced volumes of our enzymes, or may not require our enzymes at all. Any change in the use of production facilities that currently use our enzymes to manufacture products could significantly impact the demand for, and average sales price of, our enzymes.

Any of these factors may materially and adversely affect our business, financial conditions and results of operations.

 

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*Because a significant portion of our revenue comes from a few large customers, any decrease in sales to these customers could harm our operating results.

Our revenue and profitability are highly dependent on our relationships with a limited number of customers. For the nine months ended September 30, 2011, our four largest largest customers accounted for approximately 69% of product revenue. We are likely to continue to experience a high degree of customer concentration. The loss or a significant reduction of business from any of our major customers would adversely affect our results of operations.

*The existing global economic and financial market environment has had and may continue to have a negative effect on our business and operations.

The existing global economic and financial market environment has caused, among other things, lower consumer and business spending, lower consumer net worth, a general tightening in the credit markets, and lower levels of liquidity, all of which has had and may continue to have a negative effect on our business, results of operations, financial condition and liquidity. Many of our customers have been severely affected by the current economic turmoil. Current or potential customers may no longer be in business, may be unable to fund purchases or determine to reduce purchases, all of which could lead to reduced demand for our products, reduced gross margins, and increased customer payment delays or defaults. Further, suppliers may not be able to supply us with needed raw materials on a timely basis, may increase prices or go out of business, which could result in our inability to meet consumer demand or affect our gross margins. We are also limited in our ability to reduce costs to offset the results of a prolonged or severe economic downturn given certain fixed costs associated with our operations, difficulties if we overstrained our resources, and our long-term business approach that necessitates we remain in position to respond when market conditions improve. The timing and nature of any recovery in the credit and financial markets remains uncertain, and there can be no assurance that market conditions will significantly improve in the near future or that our results will not continue to be materially and adversely affected.

Such conditions make it very difficult to forecast operating results, make business decisions and identify and address material business risks. The foregoing conditions may also impact the valuation of certain long-lived or intangible assets that are subject to impairment testing, potentially resulting in impairment charges which may be material to our financial condition or results of operations. See “—Risks Related to Financing Activities” below for a discussion of additional risks to our liquidity resulting from the current economic and financial market environment.

*The financial instability of our customers could adversely affect our business and result in reduced sales, profits and cash flows.

We sell our products to and extend credit to our customers based on an evaluation of each customer’s financial condition, usually without requiring collateral. Our Fuelzyme^® alpha-amylase customers are particularly exposed to the challenges facing the corn ethanol industry. While customer credit losses have historically been within our expectations and reserves, we cannot assure you that this will continue. The financial difficulties of a customer could cause us to curtail business with that customer or the customer to reduce its business with us and cancel orders. Our inability to collect on our trade accounts receivable from any of our major customers could adversely affect our results of operations and financial condition. Our international manufacturing operations are subject to the risks of doing business abroad, which could affect our ability to manufacture our products in international markets, obtain products from foreign suppliers or control the costs of our products.

We manufacture a majority of our commercial enzyme products through a manufacturing facility in Mexico City owned by Fermic. As a result, we are subject to the general risks of doing business outside the U.S., particularly Mexico, including, without limitation, work stoppages, transportation delays and interruptions, political instability, organized criminal activity and violence, expropriation, nationalization, foreign currency fluctuation, changing economic conditions, the imposition of tariffs, import and export controls and other non-tariff barriers, and changes in local government administration and governmental policies, and to factors such as the short-term and long-term effects of health risks like the recent outbreak of swine flu. There can be no assurance that these factors will not adversely affect our business, financial condition or results of operations.

We have only limited experience in independently developing, manufacturing, marketing, selling, and distributing commercial enzyme products.

We currently have only limited resources and capability to develop, manufacture, market, sell, or distribute enzyme products on a commercial scale. We will determine which enzyme products to pursue independently based on various criteria, including: investment required, estimated time to market, regulatory hurdles, infrastructure requirements, and industry-specific expertise necessary for successful commercialization. At any time, we may modify our strategy and pursue collaborations for the development and commercialization of some enzyme products that we had intended to pursue independently. We may pursue enzyme products that ultimately require more resources than we anticipate or which may be technically unsuccessful. In order for us to commercialize more

 

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enzyme products directly, we would need to establish or obtain through outsourcing arrangements additional capability to develop, manufacture, market, sell, and distribute such products. If we are unable to successfully commercialize enzyme products resulting from our internal product development efforts, we will continue to incur losses. Even if we successfully develop a commercial enzyme product, we may not generate significant sales and achieve profitability in our business.

We are dependent on our collaborative partners, and our failure to successfully manage our existing and future collaboration relationships could prevent us from developing and commercializing our enzyme products, and achieving or sustaining profitability.

Revenue from our collaborations has decreased both as a proportion of our total revenue and in absolute dollars in recent years. Since we do not currently possess the resources necessary to independently fund the development and commercialization of all the potential enzyme products that may result from our technologies, we expect to continue to pursue, and in the near-term derive additional revenue from, strategic alliance and collaboration agreements to develop and commercialize products and technologies that are core to our current market focus. We will have limited or no control over the resources that any strategic partner or collaborator may devote to our products and technologies. Any of our present or future strategic partners or collaborators may fail to perform their obligations as expected. These strategic partners or collaborators may breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, our strategic partners or collaborators may not develop technologies or products arising out of our collaborative arrangements or devote sufficient resources to the development, manufacture, marketing, or sale of these technologies and products. If any of these events occur, or we fail to enter into or maintain strategic alliance or collaboration agreements, we may not be able to commercialize our technologies and products, grow our business, or generate sufficient revenue to support our operations.

Our present or future strategic alliance and collaboration opportunities could be harmed if:

 

•

We do not achieve our research and development objectives under our strategic alliance and collaboration agreements;

 

•

We are unable to fund our obligations under any of our other strategic partners or collaborators;

 

•

We develop technologies or products and processes or enter into additional strategic alliances or collaborations that conflict with the business objectives of our strategic partners or collaborators;

 

•

We disagree with our strategic partners or collaborators as to rights to intellectual property we develop, or their research programs or commercialization activities;

 

•

Our strategic partners or collaborators experience business difficulties which eliminate or impair their ability to effectively perform under our strategic alliances or collaborations;

 

•

We are unable to manage multiple simultaneous strategic alliances or collaborations;

 

•

Our strategic partners or collaborators become competitors of ours or enter into agreements with our competitors;

 

•

Our strategic partners or collaborators become less willing to expend their resources on research and development due to general market conditions or other circumstances beyond our control;

 

•

Consolidation in our target markets limits the number of potential strategic partners or collaborators; or

 

•

We are unable to negotiate additional agreements having terms satisfactory to us.

*We have relied, and will continue to rely, heavily on strategic partners to support our business.

Historically, we have relied upon a number of strategic partners, including those with Bunge Oils, Novus International Inc, or Novus, Alfa Laval, Desmet Ballestra, Danisco Animal Nutrition, or Danisco (now part of DuPont), and WeissBioTech GmbH (formerly Add Food Services GmbH), to enhance and support our development and commercialization efforts for our industrial enzymes.

Historically, Danisco has accounted for a significant percentage of our product revenue. However, Danisco is under no obligation to continue to market Phyzyme^® XP phytase and may introduce competing or replacement products at any time. Danisco represented approximately 53% and 50% of total product revenues for the three and nine months ended September 30, 2011. Under our agreement with Danisco, we receive a royalty equal to 50% of Danisco’s operating profit from their sales of Phyzyme^® XP phytase, as defined. We record our quarterly royalty defined by our agreement based on information reported to us by Danisco. We have limited visibility into Danisco’s sales or operating profits related to Phyzyme^® XP phytase. During the nine months ended September 30, 2011, we experienced a decrease in the royalty as compared to the same period in the prior year and may continue to experience future declines that would negatively impact our product revenue and gross profit.

 

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These arrangements with collaborative partners are, and will continue to be, critical to the success of our business. We cannot guarantee that any collaborative relationship(s) will be entered into, or if entered into, will continue or be successful. Our collaborative partners could experience business difficulties which eliminate or impair their ability to effectively perform under our arrangements with them. Failure to make or maintain these arrangements or a delay or failure in a collaborative partner’s performance under any such arrangements would materially adversely affect our business and financial condition.

We cannot control our collaborative partners’ performance or the resources they devote to our programs. We may not always agree with our partners nor will we have control of our partners’ activities. The performance of our programs may be adversely affected and programs may be delayed or terminated or we may have to use funds, personnel, equipment, facilities and other resources that we have not budgeted to undertake certain activities on our own as a result of these disagreements. Performance issues, program delays or termination or unbudgeted use of our resources may materially adversely affect our business and financial condition. Disputes may arise between us and a collaborative partner and may involve the issue of which of us owns the technology and other intellectual property that is developed during a collaboration or other issues arising out of the collaborative agreements. Such a dispute could delay the program on which we are working or could prevent us from obtaining the right to commercially exploit such developments. It could also result in expensive arbitration or litigation, which may not be resolved in our favor. Our collaborative partners could merge with or be acquired by another company or experience financial or other setbacks unrelated to our collaboration that could, nevertheless, adversely affect us.

We have licensed certain intellectual property from BP, and we must rely on BP to adequately maintain and protect it.

In connection with the sale of our LC business to BP on September 2, 2010, we transferred ownership of certain intellectual property for which BP has granted us a license for use within our enzymes business. While the provisions of the purchase agreement provide that BP maintain and protect such intellectual property, there can be no assurance that BP will continue to do so. In addition, BP may be unsuccessful in protecting the intellectual property which we have a license to, if such intellectual property rights are challenged by third parties. While we have certain rights to take action to maintain or protect such intellectual property, in the event that BP determines not to, we may be unsuccessful in protecting the intellectual property if challenged by third parties. If either of these events were to occur, we may lose our rights to certain intellectual property, which could severely harm our business. Similarly, we license additional intellectual property that we use to manufacture our products and otherwise use in our business. In the event that the licensors of this technology do not adequate protect it, our ability to use that technology will also be restricted, resulting in harm to our business.

In addition, BP’s rights to use the intellectual property that we have licensed are limited only by the non-competition agreements entered in connection with the sale of our LC business, which agreements have a limited duration. Following expiration of these agreements, BP will have the right to use without limitation the same intellectual property that we have used and still use to develop our products. Should BP elect to compete with us following such expiration, such competition could harm our business.

 

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*We should be viewed as an early stage company with limited experience bringing products to the marketplace.

You must evaluate our business in light of the uncertainties and complexities affecting an early stage biotechnology company. Our existing proprietary technologies are new and in an early stage of development and commercialization. We may not be successful in the continued commercialization of existing products or in the commercial development of new products, or any further technologies, products or processes. Successful products and processes require significant development and investment, including testing, to demonstrate their cost- effectiveness prior to regulatory approval and commercialization. To date, we have commercialized 14 of our own products, including our Purifine^® PLC, Fuelzyme^® alpha-amylase, Veretase^® alpha-amylase, Xylathin™ xylanase, and Luminase^® PB-100 enzymes. In addition, five of our collaborative partners, Invitrogen Corporation, Danisco Animal Nutrition, Givaudan Flavors Corporation Cargill Health and Food Technologies, and Syngenta Animal Nutrition (formerly known as Zymetrics, Inc.), have incorporated our technologies or inventions into their own commercial products from which we have generated and/or can generate royalties. Our products and technologies have only recently begun to generate significant revenues. Because of these uncertainties, our discovery process may not result in the identification of product candidates that we or our collaborative partners will successfully commercialize. If we are not able to use our technologies to discover new materials, products, or processes with significant commercial potential, we may continue to have significant losses in the future due to ongoing expenses for research, development and commercialization efforts and we may be unable to obtain additional funding to fund such efforts.

*If the volatility in the United States and global equity and credit markets and the decline in the general world economy continue for an extended period of time, it may become more difficult to raise money in the public and private markets and harm our financial condition and results of operations.

The United States and global equity and credit markets have recently been extremely volatile and unpredictable, reflecting in part a general concern regarding the global economy. This volatility in the market affects not just our stock price, but also the stock prices of our collaborators. In addition, this volatility has also affected the ability of businesses to obtain credit and to raise money in the capital markets. If we or our collaborators are unable to obtain additional credit or raise money in the capital markets, we may not be able to continue to fund our current research and development projects, fund our current products, or otherwise continue to maintain or grow our business.

We do not anticipate paying cash dividends, and accordingly, stockholders must rely on stock appreciation for any return on their investment in us.

We anticipate that we will retain our earnings, if any, for future growth and therefore do not anticipate paying cash dividends in the future. As a result, only appreciation of the price of our common stock will provide a return to stockholders. Investors seeking cash dividends should not invest in our common stock.

We may encounter difficulties managing our growth, which could adversely affect our results of operations.

Our strategy includes entering into and working on simultaneous projects, frequently across multiple industries. This strategy places increased demands on our limited human resources and requires us to substantially expand the capabilities of our administrative and operational resources and to attract, train, manage and retain qualified management, technicians, scientists and other personnel. Our ability to effectively manage our operations, growth, and various projects requires us to continue to improve our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees, which we may be unable to do. In addition, we may not be able to successfully implement improvements to our management information and control systems in an efficient or timely manner. Moreover, we may discover deficiencies in existing systems and controls. The failure to successfully meet any of these challenges would have a material adverse impact on our financial condition and results of operations.

*Our building sublease in San Diego will expire within the next 10 months, and we will be required to relocate our research and development and corporate operations to our newly leased facility.

Our research and development, business development and corporate operations are conducted mainly from a single facility in San Diego, which we currently sublease from BP through August 2012. We have entered into a lease for a new facility in San Diego, but commencement of that lease is subject to the build-out of the leased premises, including new pilot fermentation / recovery and automation labs. The cost of the facility and the equipment required for the facility will require the expenditure of significant amounts of capital, which we expect to be financed through existing cash and/or additional sources of capital. If we are unsuccessful in transitioning operations to a new facility, there are significant delays in the build-out or we are unable to obtain adequate financing to do so, our business will be adversely impacted.

 

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Our business is subject to complex corporate governance, public disclosure, and accounting requirements that have increased both our costs and the risk of noncompliance.

Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Financial Accounting Standards Board, the Public Company Accounting Oversight Board, the SEC, and NASDAQ, have implemented requirements, standards and regulations, including expanded disclosures, accelerated reporting requirements and more complex accounting rules, and continue developing additional requirements. Our efforts to comply with these regulations have resulted in, and are likely to continue resulting in, increased general and administrative expenses and diversion of management time and attention from operating activities to compliance activities. We may incur additional expenses and commitment of management’s time in connection with further evaluations, either of which could materially increase our operating expenses or accordingly increase our net loss.

Because new and modified laws, regulations, and standards are subject to varying interpretations, in many cases due to their lack of specificity, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This evolution may result in continuing uncertainty regarding financial disclosures and compliance matters and additional costs necessitated by ongoing revisions to our disclosures and governance practices. This further could lead to possible restatements, due to the complex nature of current and future standards and possible misinterpretation or misapplication of such standards.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud and as a result, investors may be misled and lose confidence in our financial reporting and disclosures, and the price of our common stock may be negatively affected.

The Sarbanes-Oxley Act of 2002 requires that we report annually on the effectiveness of our internal control over financial reporting. A “significant deficiency” means a deficiency or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness yet important enough to merit attention by those responsible for oversight of our financial reporting. A “material weakness” is a deficiency, or a combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

In the past, we have disclosed material weaknesses with our financial statement close process that we have since remediated. If we discover other deficiencies or material weaknesses, it may adversely impact our ability to report accurately and in a timely manner our financial condition and results of operations in the future, which may cause investors to lose confidence in our financial reporting and may negatively affect the price of our common stock. Moreover, effective internal controls are necessary to produce accurate, reliable financial reports and to prevent fraud. If we experience deficiencies in our internal controls over financial reporting, these deficiencies may negatively impact our business and operations.

*Our ability to compete in the commercial enzymes industry may decline if we do not adequately protect our proprietary technologies.

Our success depends in part on our ability to obtain patents and maintain adequate protection of intellectual property rights to our technologies and products in the United States and foreign countries. If unauthorized parties successfully copy or otherwise obtain and use our products or technology the value of our owned and in-licensed technology could decline. Monitoring and preventing unauthorized use of our intellectual property is difficult, time-consuming and expensive, and we cannot be certain that the steps we have taken or will take in the future will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States or at all. If competitors are able to use our technology, our ability to compete effectively could be significantly harmed. Although we seek patent protection in the United States and in foreign countries with respect to certain of the technologies used in or relating to our products, as well as anticipated production capabilities and processes, others may independently develop and obtain patents for technologies that are similar to or superior to our technologies. If that happens, we may need to license these technologies and we may not be able to obtain licenses on reasonable terms, if at all, which could greatly harm our business and results of operations.

Our commercial success depends in part on not infringing patents and proprietary rights of third parties, and not breaching any licenses or other agreements that we have entered into with regard to our technologies, products, and business. The patent positions of companies whose businesses are based on biotechnology, including our patent position, involve complex legal and factual questions and, therefore, enforceability cannot be predicted with certainty. Although we have and intend to continue to apply for patent protection of our technologies, processes and products, even the resulting patents, if issued, may be challenged, invalidated, or circumvented by third parties. We cannot assure you that patent applications or

 

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patents have not been filed or issued that could block our ability to obtain patents or to operate our business as currently planned. In addition, if third parties develop technologies that are similar to or duplicate our technologies, there can be no guarantee that our existing intellectual property protections will prevent such third parties from using such similar or duplicative technologies to compete with us. There may be patents in some countries that, if valid, may block our ability to commercialize processes or products in those countries. There also may be claims in patent applications in some countries that, if granted and valid, may block our ability to commercialize our processes or products in those countries. In such any event there can be no assurance that we will be able to secure the rights under such patents to commercialize our processes and products on reasonable terms or at all. Third parties may challenge our intellectual property rights, which, if successful could prevent us from selling products or significantly increase our costs to sell our products and we may be prevented from competing in our industry.

*Disputes concerning the infringement or misappropriation of our proprietary rights or the proprietary rights of others could be time consuming and extremely costly and could delay or prevent us from achieving profitability.

Our commercial success, if any, will be significantly harmed if we infringe the patent rights of third parties or if we breach any license or other agreements that we have entered into with regard to our technology or business.

We are not currently a party to any litigation, interference, opposition, protest, reexamination, reissue or any other potentially adverse governmental, ex parte or inter-party proceeding with regard to our owned or in-licensed patents or other intellectual property rights. However, the biotechnology industry is characterized by frequent and extensive litigation regarding patents and other intellectual property rights. Many biotechnology companies with substantially greater resources than us have employed intellectual property litigation as a way to gain a competitive advantage. We may become involved in litigation, interference proceedings, oppositions, reexamination, protest or other potentially adverse intellectual property proceedings as a result of alleged infringement by us of the rights of others or as a result of priority of invention disputes with third parties. Third parties may also challenge the validity of any of our issued patents. Similarly, we may initiate proceedings to enforce our patent rights and prevent others from infringing our or our licensed intellectual property rights. In any of these circumstances, we might have to spend significant amounts of money, time and effort defending our position and we may not be successful. In addition, any claims relating to the infringement of third-party proprietary rights or proprietary determinations, even if not meritorious, could result in costly litigation, lengthy governmental proceedings, divert management’s attention and resources, or require us to enter into royalty or license agreements that are not advantageous to us.

We are aware of a significant number of patents and patent applications relating to aspects of our technologies filed by, and issued to, third parties. We cannot assure you that if we are sued on these patents we would prevail.

Should any third party have filed, or file in the future, patent applications or obtained patents that claim inventions also claimed by us, we may have to participate in an interference proceeding declared by the relevant patent regulatory agency to determine priority of invention and, thus, the right to a patent for these inventions in the United States. Such a proceeding, like the one described above, could result in substantial cost to us even if the outcome is favorable. Even if successful, an interference may result in loss of claims. The litigation or proceedings could divert our management’s time and efforts. Even unsuccessful claims could result in significant legal fees and other expenses, diversion of management time, and disruption in our business. Uncertainties resulting from initiation and continuation of any patent or related litigation could harm our ability to compete and could have a significant adverse effect on our business, financial condition and results of operations.

*If we engage in any acquisitions, we will incur a variety of costs, may dilute existing stockholders, and may not be able to successfully integrate acquired businesses.

If appropriate opportunities become available, we may consider acquiring businesses, assets, technologies, or products that we believe are a strategic fit with our business. As of September 30, 2011, we have no commitments or agreements with respect to any material acquisitions. If we further pursue such a strategy, we could:

 

•

issue additional equity securities which would dilute current stockholders’ percentage ownership;

 

•

incur substantial additional debt; or

 

•

assume additional liabilities.

We may not be able to successfully integrate any businesses, assets, products, technologies, or personnel that we might acquire in the future without a significant expenditure of operating, financial, and management resources, if at all. In addition, future acquisitions might negatively impact our business relations with our current and/or prospective collaborative partners and/or customers. Any of these adverse consequences could harm our business.

 

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Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

In order to protect our proprietary technology and processes, we also rely in part on trade secret protection for our confidential and proprietary information. We have taken measures to protect our trade secrets and proprietary information, but these measures may not be effective. Our policy is to execute confidentiality agreements with our employees and consultants upon the commencement of an employment or consulting arrangement with us. These agreements generally require that all confidential information developed by the individual or made known to the individual by us during the course of the individual’s relationship with us be kept confidential and not disclosed to third parties. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us shall be our exclusive property. Nevertheless, our proprietary information may be disclosed, and others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Ethical, legal, and social concerns about genetically engineered products and processes could limit or prevent the use of our products, processes, and technologies and limit our revenue.

Some of our anticipated products and processes are genetically engineered or involve the use of genetically engineered products or genetic engineering technologies. If we and/or our collaborators are not able to overcome the ethical, legal, and social concerns relating to genetic engineering, our products and processes may not be accepted. Any of the risks discussed below could result in expenses, delays, or other impediments to our programs or the public acceptance and commercialization of products and processes dependent on our technologies or inventions. Our ability to develop and commercialize one or more of our technologies, products, or processes could be limited by the following factors:

 

•

public attitudes about the safety and environmental hazards of, and ethical concerns over, genetic research and genetically engineered products and processes, which could influence public acceptance of our technologies, products and processes;

 

•

public attitudes regarding, and potential changes to laws governing, ownership of genetic material which could harm our intellectual property rights with respect to our genetic material and discourage collaborative partners from supporting, developing, or commercializing our products, processes and technologies; and

 

•

governmental reaction to negative publicity concerning genetically modified organisms, which could result in greater government regulation of genetic research and derivative products, including labeling requirements.

The subject of genetically modified organisms has received negative publicity, which has aroused public debate in the United States and other countries. This adverse publicity could lead to greater regulation and trade restrictions on imports and exports of genetically altered products.

Compliance with regulatory requirements and obtaining required government approvals may be time consuming and costly, and could delay our introduction of products.

All phases, especially the field testing, production, and marketing, of our current and potential products and processes are subject to significant federal, state, local, and/or foreign governmental regulation. Regulatory agencies may not allow us to produce and/or market our products in a timely manner or under technically or commercially feasible conditions, or at all, which could harm our business.

In the United States, enzyme products for our target markets are regulated based on their use, by either the FDA, the EPA, or, in the case of plants and animals, the USDA. The FDA regulates drugs, food, and feed, as well as food additives, feed additives, and substances generally recognized as safe that are used in the processing of food or feed. While substantially all of our current enzyme projects to date have focused on non-human applications and enzyme products outside of the FDA’s review, in the future we may pursue collaborations for further research and development of drug products for humans that would require FDA approval before they could be marketed in the United States. In addition, any drug product candidates must also be approved by the regulatory agencies of foreign governments before any product can be sold in those countries. Under current FDA policy, our products, or products of our collaborative partners incorporating our technologies or inventions, to the extent that they come within the FDA’s jurisdiction, may be subject to lengthy FDA reviews and unfavorable FDA determinations if they raise safety questions which cannot be satisfactorily answered, if results from pre-clinical or clinical trials do not meet regulatory requirements or if they are deemed to be food additives whose safety cannot be demonstrated. An unfavorable FDA ruling could be difficult to resolve and could prevent a product from being commercialized. Even after investing significant time and expenditures, our collaborators may not obtain regulatory approval for any drug products that incorporate our technologies or inventions. Our collaborators have not submitted an investigational new drug application for any product candidate that incorporates our technologies or inventions, and no drug product

 

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candidate developed with our technologies has been approved for commercialization in the United States or elsewhere. The EPA regulates biologically derived chemical substances not within the FDA’s jurisdiction. An unfavorable EPA ruling could delay commercialization or require modification of the production process resulting in higher manufacturing costs, thereby making the product uneconomical. In addition, the USDA may prohibit genetically engineered plants from being grown and transported except under an exemption, or under controls so burdensome that commercialization becomes impracticable. Our future products may not be exempted by the USDA.

Our results of operations may be adversely affected by environmental, health and safety laws, regulations and liabilities.

We are subject to various federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the air, water and ground, the generation, storage, handling, use, transportation and disposal of hazardous materials, and the health and safety of our employees. In addition, some of these laws and regulations require our contemplated facilities to operate under permits that are subject to renewal or modification. These laws, regulations and permits can often require expensive pollution control equipment or operational changes to limit actual or potential impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns.

Furthermore, as we operate our business, we may become liable for the investigation and cleanup of environmental contamination at each of the properties that we own or operate and at off-site locations where we may arrange for the disposal of hazardous substances. If these substances have been or are disposed of or released at sites that undergo investigation and/or remediation by regulatory agencies, we may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act, or other environmental laws for all or part of the costs of investigation and/or remediation, and for damages to natural resources. We may also be subject to related claims by private parties alleging property damage and personal injury due to exposure to hazardous or other materials at or from those properties. Some of these matters may require expending significant amounts for investigation, cleanup, or other costs.

In addition, new laws, new interpretations of existing laws, increased governmental enforcement of environmental laws, or other developments could require us to make additional significant expenditures. Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls at ethanol production facilities. Present and future environmental laws and regulations, and interpretations thereof more vigorous enforcement policies and discovery of currently unknown conditions may require substantial expenditures that could have a material adverse effect on our results of operations and financial position.

We use hazardous materials in our business. Any claims relating to improper handling, storage, or disposal of these materials could be time consuming and costly and could adversely affect our business and results of operations.

Our research and development processes involve the controlled use of hazardous materials, including chemical, radioactive, and biological materials. Our operations also produce hazardous waste products. We cannot eliminate entirely the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state, and local laws and regulations govern the use, manufacture, storage, handling, and disposal of these materials. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our total assets. In addition, compliance with applicable environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development, or production efforts.

Many competitors and potential competitors who have greater resources and experience than we do may develop products and technologies that make ours obsolete or may use their greater resources to gain market share at our expense.

The biotechnology industry is characterized by rapid technological change, and the area of biomolecule discovery and optimization from biodiversity is a rapidly evolving field. Our future success will depend on our ability to maintain a competitive position with respect to technological advances. Technological development by others may result in our products and technologies becoming obsolete.

We face, and will continue to face, intense competition in our business. There are a number of companies who compete with us in various steps throughout our technology process. For example, Dyadic, Codexis and Direvo have alternative evolution technologies; Novozymes A/S and Genencor International Inc. are involved in development, expression, fermentation, and purification of enzymes. There are also a number of academic institutions involved in various phases of our technology process. Many of these competitors have significantly greater financial and human resources than we do. These organizations may develop technologies that are superior alternatives to our technologies. Further, our competitors may be more effective at implementing their technologies for modifying DNA to develop commercial products.

 

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Our ability to compete successfully will depend on our ability to develop proprietary products that reach the market in a timely manner and are technologically superior to and/or are less expensive than other products on the market. Current competitors or other companies may develop technologies and products that are more effective than ours. Our technologies and products may be rendered obsolete or uneconomical by technological advances or entirely different approaches developed by one or more of our competitors. The existing approaches of our competitors or new approaches or technology developed by our competitors may be more effective than those developed by us.

If we lose key personnel or are unable to attract and retain additional personnel, it could delay our product development programs, harm our research and development efforts, and we may be unable to pursue collaborations or develop our own products.

The loss of any key members of our senior management, or business development or scientific staff, or failure to attract or retain other key management, business development or scientific employees, could prevent us from developing and commercializing new products and entering into collaborations or licensing arrangements to execute on our business strategy. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among biotechnology and other technology-based businesses, particularly in the San Diego area. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to meet the demands of our collaborative partners in a timely fashion or to support our internal research and development programs. In particular, our product and process development programs are dependent on our ability to attract and retain highly skilled scientists, including molecular biologists, biochemists, and engineers. Competition for experienced scientists and other technical personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. All of our employees are at-will employees, which means that either the employee or we may terminate their employment at any time.

Members of our senior management team have not worked together for a significant length of time and they may not be able to work together effectively to develop and implement our business strategies and achieve our business objectives. Management will need to devote significant attention and resources to preserve and strengthen relationships with employees, customers and others. If our management team is unable to develop successful business strategies, achieve our business objectives, or maintain positive relationships with employees, customers, suppliers or other key constituencies, including our strategic collaborators and partners, our ability to grow our business and successfully meet operational challenges could be impaired.

Our planned activities will require additional expertise in specific industries and areas applicable to the products and processes developed through our technologies or acquired through strategic or other transactions. These activities will require the addition of new personnel, including management, and the development of additional expertise by existing management personnel. The inability to acquire these services or to develop this expertise could impair the growth, if any, of our business.

We may be sued for product liability.

We may be held liable if any product or process we develop, or any product which is made or process which is performed with the use of any of our technologies, causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing, or sale. We currently have limited product liability insurance covering claims up to $10 million that may not fully cover our potential liabilities. In addition, if we attempt to obtain additional product liability insurance coverage, this additional insurance may be prohibitively expensive, or may not fully cover our potential liabilities. Inability to obtain sufficient insurance coverage at an acceptable cost or otherwise to protect against potential product liability claims could prevent or inhibit the commercialization of products or processes developed by us or our collaborative partners. If we are sued for any injury caused by our products, our liability could exceed our total assets.

Macroeconomic conditions beyond our control could lead to decreases in demand for our products, reduced profitability or deterioration in the quality of our accounts receivable.

Domestic and international economic, political and social conditions are uncertain due to a variety of factors, including

 

•

global, regional and national economic downturns;

 

•

the availability and cost of credit;

 

•

volatility in stock and credit markets;

 

•

energy costs;

 

•

fluctuations in currency exchange rates;

 

•

the risk of global conflict;

 

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•

the risk of terrorism and war in a given country or region; and

 

•

public health issues.

Our business depends on our customers’ demand for our products and services, the general economic health of current and prospective customers, and their desire or ability to make investments in technology. A deterioration of global, regional or local political, economic or social conditions could affect potential customers in a way that reduces demand for our products and disrupts our manufacturing and sales plans and efforts. These global, regional or local conditions also could disrupt commerce in ways that could interrupt our supply chain and our ability to get products to our customers. These conditions may also affect our ability to conduct business as usual. Changes in foreign currency exchange rates may negatively impact reported revenue and expenses. In addition, our sales are typically made on unsecured credit terms that are generally consistent with the prevailing business practices in the country in which the customer is located. A deterioration of political, economic or social conditions in a given country or region could reduce or eliminate our ability to collect accounts receivable in that country or region. In any of these events, our results of operations could be materially and adversely affected.

 

 

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Risks Related to Owning Our Common Stock

We are subject to anti-takeover provisions in our certificate of incorporation, bylaws, and Delaware law that could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our stockholders.

Provisions of our certificate of incorporation, our bylaws and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. These provisions in our charter documents and under Delaware law could discourage potential takeover attempts and could adversely affect the market price of our common stock. Because of these provisions, our common stockholders might not be able to receive a premium on their investment.

We expect that our quarterly results of operations will fluctuate, and this fluctuation could cause our stock price to decline, causing investor losses.

Our quarterly operating results have fluctuated in the past and are likely to do so in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Revenue and expenses in future periods may be greater or less than in the immediately preceding period or in the comparable period of the prior year. Some of the factors that could cause our operating results to fluctuate include:

 

•

termination of strategic alliances and collaborations;

 

•

the success rate of our discovery efforts associated with milestones and royalties;

 

•

the ability and willingness of strategic partners and collaborators to commercialize, market, and sell royalty-bearing products or processes on expected timelines;

 

•

our ability to enter into new agreements with potential strategic partners and collaborators or to extend the terms of our existing strategic alliance agreements and collaborations, and the terms of any agreement of this type;

 

•

our need to continuously recruit and retain qualified personnel;

 

•

our ability to successfully satisfy all pertinent regulatory requirements;

 

•

our ability to successfully commercialize products or processes developed independently and the demand and prices for such products or processes and for our existing products; and

 

•

general and industry specific economic conditions, which may affect our, and our collaborative partners’, research and development expenditures.

A large portion of our expenses, including expenses for facilities, equipment and personnel, are relatively fixed. Failure to achieve anticipated levels of revenue could therefore significantly harm our operating results for a particular fiscal period.

Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would probably decline.

*Our stock price has been and may continue to be particularly volatile.

The market price of our common stock has in the past been and is likely to continue to be subject to significant fluctuations. Between January 1, 2006 and November 8, 2011, the closing market price of our common stock has ranged from a low of $1.42 to a high of $138.95. Since the completion of our merger with Celunol on June 20, 2007, the closing market price of our common stock has ranged from $1.42 to $81.96. The closing market price of our common stock on September 30, 2011 was $2.40, and the closing price of our common stock on November 8, 2011 was $2.46. Some of the factors that may cause the market price of our common stock to fluctuate include:

 

•

the entry into, or termination of, key agreements, including key collaboration agreements and licensing agreements;

 

•

any inability to obtain additional financing on favorable terms to retire the 2007 Notes, if necessary, to fund our operations and pursue our business plan;

 

•

future royalties from product sales, if any, by our collaborative partners, and the extent of demand for, and sales of, our products;

 

•

future royalties and fees for use of our proprietary processes, if any, by our licensees;

 

•

the initiation of material developments in, or conclusion of litigation to enforce or defend any of our intellectual property rights or otherwise;

 

•

our results of operations and financial condition, including our cash reserves and cost level;

 

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•

general and industry-specific economic and regulatory conditions that may affect our ability to successfully develop and commercialize products;

 

•

developments involving our 2007 Notes;

 

•

the loss of key employees;

 

•

the introduction of technological innovations or other products by our competitors;

 

•

sales of a substantial number of shares of our common stock by our large stockholders;

 

•

changes in estimates or recommendations by securities analysts, if any, who cover our common stock;

 

•

future sales of our common stock or other capital-raising activities;

 

•

issuance of shares by us, and sales in the public market of the shares issued, upon conversion of the 2007 Notes or exercise of our outstanding warrants; and

 

•

period-to-period fluctuations in our financial results.

Moreover, the stock markets in general are currently experiencing substantial volatility related to general economic conditions and may continue to experience volatility for some time. The stock markets have experienced in the past substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may also adversely affect the trading price of our common stock.

In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our profitability and reputation.

*Concentration of ownership among our existing officers, directors and principal stockholders may prevent other stockholders from influencing significant corporate decisions and depress our stock price.

Our officers, directors, and stockholders with at least 10% of our stock together controlled approximately 24% of our outstanding common stock as of September 30, 2011. If these officers, directors, and principal stockholders act together, they will be able to exert a significant degree of influence over our management and affairs and matters requiring stockholder approval, including the election of directors and approval of mergers or other business combination transactions. The interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders. For instance, officers, directors, and principal stockholders, acting together, could heavily contribute to our entering into transactions or agreements that we would not otherwise consider. Similarly, this concentration of ownership may have the effect of delaying or preventing a change in control of our company otherwise favored by our other stockholders. This concentration of ownership could depress our stock price.

*Future sales of our common stock in the public market could cause our stock price to fall.

Sales of a substantial number of shares of our common stock in the public market, or the perception that these sales might occur could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. As of September 30, 2011, we had 12,611,436 shares of common stock outstanding.

 

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ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES.

None.

 

ITEM 4.

(REMOVED AND RESERVED)

 

ITEM 5.

OTHER INFORMATION.

None.

 

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ITEM 6.

EXHIBITS.

(a)

 

Exhibit Number		Description of Exhibit
2.1		Asset Purchase Agreement, dated as of July 14, 2010, by and between BP Biofuels North America LLC and Verenium Corporation – filed as an exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on July 19, 2010, and incorporated herein by reference.
3.1		Amended and Restated Certificate of Incorporation – filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2000 (File No. 000-29173), filed with the Securities and Exchange Commission on May 12, 2000, and incorporated herein by reference.
3.2		Certificate of Amendment of Restated Certificate of Incorporation – filed as an exhibit to the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 16, 2007, and incorporated herein by reference.
3.3		Certificate of Amendment of Restated Certificate of Incorporation – filed as an exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 26, 2007, and incorporated herein by reference.
3.4		Certificate of Amendment of Restated Certificate of Incorporation – filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on March 16, 2009, and incorporated herein by reference.
3.5		Certificate of Amendment of Restated Certificate of Incorporation – filed as an exhibit to the Company’s Current Report on Form 8-K, filed with Securities and Exchange Commission on September 9, 2009, and incorporated herein by reference.
3.6		Amended and Restated Bylaws – filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2000 (File No. 000-29173), filed with the Securities and Exchange Commission on May 12, 2000, and incorporated herein by reference.
3.7		Amendment to Bylaws of Verenium Corporation – filed as an exhibit to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 27, 2007, and incorporated herein by reference.
4.1		Form of Common Stock Certificate of the Company – filed as an exhibit to the Company’s Registration Statement on Form S-1 (No. 333-92853) filed with the Securities and Exchange Commission on January 20, 2000, as amended, and incorporated herein by reference.
31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended – filed herewith.
31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities and Exchange Act of 1934, as amended – filed herewith.
32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – filed herewith.
101†		The following financial statements and footnotes from the Verenium Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 2011 formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) the Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.

 

†	Furnished and not filed.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				VERENIUM CORPORATION
Date: November 14, 2011				/S/ JEFFREY G. BLACK
				Jeffrey G. Black
				Senior Vice President and   Chief Financial Officer
				(Principal Financial Officer)

 

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