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OFFON

ZYMERGEN INC.

(ZY)
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ZYMERGEN : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

05/27/2021 | 06:07am EDT
You should read the following discussion and analysis of our financial condition
and results of operations in conjunction with our unaudited Condensed
Consolidated Financial Statements and related notes included in Part I, Item 1
of this Quarterly Report on Form 10-Q and with our audited Consolidated
Financial Statements and related notes thereto for the year ended December 31,
2020, included in our final Prospectus.
In this section, the terms "we," "our," "ours," "us," and "the Company" refer
collectively to Zymergen Inc. and its consolidated direct and indirect
subsidiaries. This discussion contains forward-looking statements that involve
risks and uncertainties reflecting our current expectations, estimates and
assumptions concerning events and financial trends that may affect our future
operating results or financial position. Our actual results could differ
materially from those discussed below. Factors that could cause or contribute to
such difference include, but are not limited to, those identified below and
those discussed in the section of this Quarterly Report on Form 10-Q titled
"Risk Factors". Forward-looking statements speak only as of the date they are
made, and the Company assumes no duty to and does not undertake any obligation
to update forward-looking statements. Actual results could differ materially
from those anticipated in forward-looking statements and future results could
differ materially from historical performance.
                                    Overview
Zymergen partners with Nature to design, develop and commercialize bio-based
breakthrough products that deliver extraordinary value to customers in a broad
range of industries. Our first innovations include films designed for
electronics companies to use in new categories of smart devices, including
rollable tablets, and naturally derived UV protection. Our goal is to create new
products with a proprietary platform that unlocks the design and manufacturing
efficiency of the biological processes with technology's ability to rapidly
iterate and control diverse functions. We call our process biofacturing and we
expect it will create better products faster, cheaper and more sustainably than
traditional chemistry by engineering microbes to make novel biomolecules that
are the key ingredients in those products. Our goal is to launch our products in
about half the time and 1/10th of the cost of what traditional chemicals and
materials companies can deliver, which would allow us to address a wide array of
commercial applications. Substantially all of our revenue to date has been
generated from R&D service contracts and collaboration arrangements aimed at
developing, testing and validating our biofacturing platform by providing custom
services for use only by the collaboration partner. Over the next few years, we
seek to grow our product sales and commercialize additional products and our
long-term objective is to generate revenue from the sale of numerous
breakthrough products across a variety of industries.
                      Components of Results of Operations

Revenue

Research and Development Service Agreements Revenue. To date, we have earned
revenue by engaging in R&D services to help our customers improve the economics
of their bio-based products. In addition, the R&D services provided to our
customers test and validate our biofacturing platform. We account for R&D
service contracts when we have approval and commitment from both parties, the
rights of the parties are identified, payment terms are identified, the contract
has commercial substance and collectability of consideration is probable. The
research term of the contracts spans typically over several quarters and the
contract term for revenue recognition purposes is determined based on the
customer's rights to terminate the contract for convenience. Over the
longer-term, as and to the extent we grow our product sales and commercialize
additional products, we expect revenue from R&D services to represent a smaller
component of our total revenue.
Collaboration Revenue. Our collaboration revenue relates primarily to our
collaboration agreement with Sumitomo Chemical. Our agreement with Sumitomo
Chemical includes provision of R&D services by us through the joint innovation
of certain materials and applications of strategic interest to Sumitomo
Chemical. Under this arrangement R&D costs are shared equally between the
parties with settlement of such amounts on a quarterly basis. Amounts received
for those services are classified as collaboration revenue as those services are
being rendered because those services are considered to be part of our ongoing
major operations.
Cost of Service Revenue
Cost of service revenue represents costs we incur to service our contract
research efforts pursuant to our R&D service contracts, as well as certain costs
allocable to our Sumitomo Chemical collaboration arrangement. Costs include both
internal and third party fixed and variable costs including labor, materials and
supplies, facilities and other overhead costs.
Operating Expenses
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Our operating expenses are classified in the following categories: research and
development, sales and marketing and general and administrative. For each of
these categories, the largest component is personnel costs, which includes
salaries, employee benefit costs, bonuses and stock-based compensation expenses.
Research and development. Uncertainties inherent in the research and development
of customer products preclude us from capitalizing such costs. Research and
development expenses include personnel costs, the cost of consultants, materials
and supplies associated with research and development projects as well as
various laboratory studies. Indirect research and development costs include
depreciation, amortization and other indirect overhead expenses.
We expect research and development expenses to increase as we continue to
develop new products through investments in our biofacturing platform and
product pipeline.
Sales and marketing. Sales and marketing expenses consist primarily of personnel
costs, costs of general marketing activities and promotional activities,
travel-related expenses and other indirect overhead costs. We expect that our
sales and marketing expenses will increase as we expand our sales and marketing
efforts, our commercial capability and our brand awareness and customer base
through targeted marketing initiatives. We plan to invest in sales and marketing
initiatives to generate consumer awareness and sales of our new product
launches.
General and administrative. Our general and administrative expenses consist
primarily of personnel costs for our executive, finance, corporate and other
administrative functions, intellectual property and patent costs, facilities and
other allocated expenses, other expenses for outside professional services,
including legal, human resources, audit and accounting services and insurance
costs. We expect our general and administrative expenses to increase as a result
of operating as a public company, including additional costs to comply with the
rules and regulations of the SEC and stock exchange rules; for legal and
auditing services; for additional insurance; for investor relations activities;
and for other administrative and professional services. We also expect our
intellectual property expenses to increase as we expand and protect our
intellectual property portfolio.
Interest income
Interest income consists of income earned from our cash, cash equivalents and
short-term investments.
Interest expense
Interest expense consists of interest incurred from our term loan along with the
amortization of loan initiation fees and lender warrant expense.
Change in fair value of warrant liability
The change in the fair value of the warrant liability is due to the change in
the value of the underlying preferred Series C Preferred Stock. The change in
value reflects the change in fair value of the underlying shares of Series C
Preferred Stock through that period.
Other income (expense), net
Other income (expense), net relates to miscellaneous other income and expense
and foreign currency gains and losses.
Provision for Income Taxes
Provision for income taxes consists primarily of minimum tax payments at the
state level and income taxes paid outside of the United States for our overseas
subsidiaries. The factors that most significantly impact our effective tax rate
include realizability of deferred tax assets, changes in tax laws, variability
in the allocation of our taxable earnings among multiple jurisdictions, the
amount and characterization of our research and development expenses, the levels
of certain deductions and credits, acquisitions and licensing transactions.
We have various federal and state net operating loss carryforwards as well as
federal and state research and development tax credit carryforwards. Utilization
of some of the federal and state net operating loss and research and development
tax credit carryforwards are subject to annual limitations due to the "change in
ownership" provisions of the Internal Revenue Code of 1986 and similar state
provisions. The annual limitations may result in the expiration of net operating
losses and credits before utilization.
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    Results of Operations for the Three Months Ended March 31, 2021 and 2020
The following table set forth our results of operations for the periods (in
thousands):
                                                   Three Months Ended March 31,                          Change
                                                      2021                  2020                $                    %
Revenues from research and development service
agreements                                     $         2,614          $   1,904$     710                  37.3  %
Collaboration revenue                                    1,121              1,050                 71                   6.8  %
Total revenues                                           3,735              2,954                781                  26.4  %
Cost and operating expenses:
Cost of service revenue                                 21,130             24,576             (3,446)                (14.0) %
Research and development                                39,811             21,802             18,009                  82.6  %
Sales and marketing                                      6,872              5,541              1,331                  24.0  %
General and administrative                              19,331             13,693              5,638                  41.2  %
Total cost and operating expenses                       87,144             65,612             21,532                  32.8  %
Operating loss                                         (83,409)           (62,658)           (20,751)                 33.1  %
Other income (expense):
Interest income                                             43                377               (334)                (88.6) %
Interest expense                                        (2,727)            (2,684)               (43)                  1.6  %
Gain (loss) on change in fair value of warrant
liabilities                                              2,279               (450)             2,729                (606.4) %
Other expense, net                                        (763)               (32)              (731)              2,284.4  %
Total other expense                                     (1,168)            (2,789)             1,621                 (58.1) %
Loss before income taxes                               (84,577)           (65,447)           (19,130)                 29.2  %
(Provision for) benefit from income taxes                   (8)               107               (115)               (107.5) %
Net loss                                       $       (84,585)$ (65,340)$ (19,245)                 29.5  %


Revenue
Revenue from research and development service agreements increased by $0.7
million, or 37%, for the quarter ended March 31, 2021 compared to the same
period of the prior year. This increase was primarily due to the following:
•$0.8 million increase as a result of new contracts, $0.7 million of which was a
point in time bonus for work earned in Q4 of 2020 but recognized in Q1 2021, due
to a delay in contract signing until Q1 2021;
•$0.5 million increase in revenue from acquired contracts, including a point in
time bonus of $0.3 million recognized in Q1 2021;
Off-set by:
•$0.5 million decrease in revenue from contracts ending in 2020.
Collaboration revenue increased by $0.1 million, or 7%, for the quarter ended
March 31, 2021 compared to the same period of the prior year. This increase was
due to the increased research activity under the partnership with Sumitomo
Chemical.
Cost of Revenue
Cost of service revenue decreased by $3.4 million, or 14%, for the quarter ended
March 31, 2021 compared to the same period of the prior year. This decrease was
primarily due to a $2.9 million decrease in labor cost and a $0.9 million
decrease in lab consumables costs associated with a shift of resources from
performing research and development activities for third parties to performing
research and development activities on our own product. In addition there was
$0.3 million decrease in other costs, primarily driven by a reduction in travel
costs in 2021 as a result of the COVID-19 pandemic. This was offset by an
increase in the use of contract research resources of $0.5 million due mainly to
the engagement of contract research resources to accelerate a client early stage
development work and an increase in rent allocation of $0.2 million due to the
expansion of the Zymergen real estate costs.
Operating Expenses
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Research and development
Research and development expense increased by $18.0 million, or 83%, in the
quarter ended March 31, 2021 compared to the same period of the prior year. The
overall increase is primarily due to the increase in resources allocated to our
own product development from customer research and development activities, along
with the further development of new products in our product pipeline, including
continued development of Hyaline. The overall increase includes $7.5 million
increase in manufacturing and lab consumables, largely attributable to the
development of Hyaline, ZYM0107, ZYM0101 and ZYM0301 products, and a $4.3
million increase in labor costs. The focus in Q1 2021 for Hyaline was to ensure
that full-scale production can be achieved. In addition, there has been a $3.5
million increase in expense related to utilization of subcontractors in
developmental activities. Further, there has been a $1.4 million increase in
allocated rent, and a $0.7 million increase in depreciation attributable to new
equipment and leasehold improvements entered into service throughout 2020 and
2021.
Sales and marketing
Sales and marketing expense increased by $1.3 million, or 24%, in the quarter
ended March 31, 2021 compared to the same period of the prior year. This
increase was primarily due to a $1.0 million increase in expense related to
subcontractors. This was largely due to an increase in customer and brand
marketing activities.
General and administrative
General and administrative expense increased by $5.6 million or 41%, in the
quarter ended March 31, 2021 compared to the same period of the prior year. The
increase in general and administrative expenses was primarily attributable to
the following:
•a $2.6 million increase in legal, strategy, investor relations and accounting
service fees, mainly associated with becoming a public company;
•a $2.4 million increase in labor costs and stock option expense, due to higher
allocation of common costs to G&A;
•an $0.8 million increase in rent and facilities costs. This was largely driven
by the increase in the property costs year on year, including the lease
commencement of the new Zymergen headquarters in mid-February 2021. This
property is under development and is expected to be available for occupancy in
early 2022.
Interest income (expense)
Interest income decreased by $0.3 million, or 89%, in the quarter ended
March 31, 2021 compared to the same period of the prior year. This decrease was
primarily due to a reduction in the principal balance held in certain money
market funds combined with a decrease in overall market interest rates.
Interest expense was flat in the quarter ended March 31, 2021 compared to the
same period of the prior year.
Gain (loss) on change in fair value of warrant liability
A gain on change in fair value of warrant liability of $2.3 million was recorded
in the quarter ended March 31, 2021, compared to a loss of $0.5 million in the
same period of the prior year, a change in the fair value of warrant liability
of $2.7 million. This change was primarily due to the assumption used in the
valuation of the warrants which as of March 31, 2021 used a weighted average
derived from a Black-Scholes (BSM) option model with a term consistent with the
time to the expected IPO date as of March 31, 2021 based on the expectation that
the warrant would be exercised at the IPO (conditioned upon the consummation of
a public offering of the Company's common stock on or prior to June 30, 2021)
and the value derived from the option pricing model with a term consistent with
the remaining term until a future liquidity event, other than the IPO scenario
described above.
Other expense
Other expense increased by $0.7 million in the quarter ended March 31, 2021
compared to the same period of the prior year. This increase was primarily due
to an unrealized loss on a currency balance following a strengthening of the US
dollar primarily against the Japanese Yen.
Income Taxes
Income taxes increased by $0.1 million in the quarter ended March 31, 2021
compared to the same period of the prior year, this was due to the impact of the
tax credit arising from the enEvolv acquisition in the first quarter of 2020.
Liquidity, Capital Resources and Plan of Operations
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From our inception through March 31, 2021 we had generated $2,000 revenue from
product sales and had incurred significant operating losses and negative cash
flows from our operations as we developed our biofacturing platform.
Our Hyaline product, from which we generated the product revenue, is still in
the qualification process with customers. If there is a delay in the time
required to complete the process it will have an impact on our operating plan,
and we may need additional funds to meet operational needs and capital
requirements for product development and commercialization.
To date, we have financed our operations primarily with proceeds from the sale
of convertible preferred shares, proceeds from debt arrangements and revenue
from R&D service and collaboration arrangements. We had unrestricted cash and
cash equivalents as of March 31, 2021 of $121.0 million. In addition, we raised
net cash proceeds of approximately $530.1 million from our IPO, which closed on
April 26, 2021.
Our primary uses of capital are, and we expect will continue to be for the near
future, personnel costs, product pipeline development and commercialization
costs, platform development costs, laboratory and related supplies, legal,
patent and other regulatory expenses and general overhead costs. We may also
pursue acquisitions, investments, joint ventures and other strategic
transactions.
We may need substantial additional funding to pursue our growth strategy and
support continuing operations. Until such time as we can generate significant
revenue from product sales or other customer arrangements to fund operations, we
expect to use proceeds from the issuance of equity, debt financings or other
capital transactions. We may be unable to increase our revenue, raise additional
funds or enter into such other agreements or arrangements when needed on
favorable terms, or at all. If we are unable to raise capital when needed, we
will need to delay, reduce or terminate planned activities to reduce costs.
Doing so will likely harm our ability to execute our business plans.
Cash Flows
The following table summarizes our cash flows for the periods presented (in
thousands):
                                                   Three Months Ended March 31,
                                                       2021                   2020
Net cash used in operating activities       $       (83,048)$ (62,927)
Net cash used in investing activities       $        (8,639)$  (6,083)
Net cash provided by financing activities   $         4,329                

$ 166



Net Cash Used in Operating Activities
The cash used in operating activities resulted primarily from our net losses
adjusted for non-cash charges and changes in components of operating assets and
liabilities, which are generally attributable to timing of payments, and the
related effect on certain account balances, operational and strategic decisions
and contracts to which we may be a party.
Cash used in operating activities for the quarter ended March 31, 2021 of $83.0
million primarily related to our net loss of $84.6 million, adjusted for
non-cash charges of $5.3 million and net cash outflows of $3.8 million due to
changes in our operating assets and liabilities. Non-cash charges primarily
consisted of depreciation and amortization of property and equipment,
stock-based compensation, and gain on fair value change of warrant liability.
The main drivers of the changes in operating assets and liabilities were a
$6.5 million decrease in accounts payable, accrued expenses and other
liabilities resulting primarily from a pay down of vendor balances; an increase
in inventories of $0.7 million, a $0.7 million increase in other current assets
and a decrease of $0.3 million in deferred revenue. These changes resulted in a
cash outflow and were partially offset by cash inflows resulting from an
increase in deferred rent of $3.1 million, resulting from the straight-line
impact of leases, and a reduction in prepaid expenses of $1.0 million.
Cash used in operating activities for the quarter ended March 31, 2020 of $62.9
million primarily related to our net loss of $65.3 million, adjusted for
non-cash charges of $6.1 million and net cash outflows of $3.7 million provided
by changes in our operating assets and liabilities. Non-cash charges primarily
consisted of depreciation and amortization of property and equipment and
stock-based compensation. The main drivers of the changes in operating assets
and liabilities were a $4.8 million decrease in accounts payable, accrued
expenses and other liabilities resulting primarily from a pay down of vendor
balances; offset by a $1.1 million decrease in accounts receivable, billed and
unbilled, resulting primarily from timing differences in customer billings and
cash receipts. In addition there was a $0.6 million inflow resulting from an
increase in the deferred rent balance resulting from the straight-line impact of
leases.
Net Cash Used in Investing Activities
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Cash used in investing activities was $8.6 million for the quarter ended
March 31, 2021 related to the purchase of property and equipment.
Net cash used in investing activities was $6.1 million for the quarter ended
March 31, 2020 related to the purchase of property and equipment, of which a
substantial majority related to purchases of laboratory equipment and facilities
improvements.
Net Cash Provided by Financing Activities
Net cash provided by financing activities was $4.3 million for the quarter ended
March 31, 2021, which consisted primarily of proceeds from the repayment of
non-recourse loans and the exercise of common stock options.
Net cash provided by financing activities was $0.2 million for the quarter ended
March 31, 2020, which consists of proceeds from the exercise of common stock
options.
Off Balance Sheet Arrangements
As of March 31, 2021 and 2020, we did not have any relationships with any
entities or financial partnerships, such as structured finance or special
purpose entities that would have been established for the purpose of
facilitating off balance sheet arrangements or other purposes.
                          Critical Accounting Policies
We have prepared our financial statements in accordance with GAAP. Our
preparation of these financial statements requires us to make estimates,
assumptions, and judgments that affect the reported amounts of assets,
liabilities, expenses, and related disclosures at the date of the financial
statements, as well as revenue and expenses recorded during the reporting
periods. We evaluate our estimates and judgments on an ongoing basis. We base
our estimates on historical experience and on various other factors that we
believe are reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources. Actual results could therefore
differ materially from these estimates under different assumptions or
conditions.

There have been no material changes to our critical accounting policies from
those described in "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included in our Prospectus.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to market risk related to changes in interest rates. Our primary
exposure to market risk is interest rate sensitivity, which is affected by
changes in the general level of U.S. interest rates, particularly because our
cash equivalents are primarily invested in short-term U.S.Treasury obligations,
and our term loan bears interest at a variable rate.
Our term loan bears a variable interest rate which is the sum of 9.25% plus the
greater of the one-month LIBOR and 2.25%. Accordingly, increases in LIBOR could
increase our interest payments under the term loan. An increase of 100 basis
points in the interest rate of the term loan would not have a material impact on
our financial position or results of operations.
Foreign Currency Risk
We are not currently exposed to significant market risk related to changes in
foreign currency exchange rates; however, we have contracted with and may
continue to contract with foreign vendors. Our operations may be subject to
fluctuations in foreign currency exchange rates in the future.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide
reasonable assurance that information required to be disclosed in our periodic
and current reports that we file with the SEC is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and our Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure.
Our management, with the participation and supervision of our Chief Executive
Officer and our Chief Financial Officer, have evaluated our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
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Exchange Act of 1934, as amended, or the Exchange Act) as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based on that evaluation,
our Chief Executive Officer and our Chief Financial Officer have concluded that,
as of the end of the period covered by this Quarterly Report on Form 10-Q, our
disclosure controls and procedures were effective to provide reasonable
assurance that information we are required to disclose in reports that we file
or submit under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in 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.
Changes in Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting as such term is defined in Rule 13a-15(f) of
the Exchange Act. An evaluation was also performed under the supervision and
with the participation of our management, including our Chief Executive Officer
and our Chief Financial Officer, of any change in our internal control over
financial reporting that occurred during our last fiscal quarter and that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting. That evaluation did not identify any change in
our internal control over financial reporting that occurred during our latest
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the controls and procedures, management recognizes
that any controls and procedures, no matter how well designed and operated, can
provide only reasonable and not absolute assurance of achieving the desired
control objectives. In reaching a reasonable level of assurance, management is
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. In addition, the design of any system of
controls also is based, in part, upon certain assumptions about the likelihood
of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected.



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