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 endedDecember 31, 2020 , included in our final Prospectus. In this section, the terms "we," "our," "ours," "us," and "the Company" refer collectively toZymergen 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. OverviewZymergen 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 20 -------------------------------------------------------------------------------- TABLE OF CONTENTS 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 theSEC 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 ofthe 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. 21
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Results of Operations for the Three Months EndedMarch 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 endedMarch 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 endedMarch 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 endedMarch 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 theZymergen real estate costs. Operating Expenses 22 -------------------------------------------------------------------------------- TABLE OF CONTENTS Research and development Research and development expense increased by$18.0 million , or 83%, in the quarter endedMarch 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 endedMarch 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 endedMarch 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 newZymergen headquarters inmid-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 endedMarch 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 endedMarch 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 endedMarch 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 ofMarch 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 ofMarch 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 toJune 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 endedMarch 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 endedMarch 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 23 -------------------------------------------------------------------------------- TABLE OF CONTENTS From our inception throughMarch 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 ofMarch 31, 2021 of$121.0 million . In addition, we raised net cash proceeds of approximately$530.1 million from our IPO, which closed onApril 26, 2021 . Our primary uses of capital are, and we expect will continue to be for the near future, personnel costs, product pipeline development and commercialization costs, platform development costs, laboratory and related supplies, legal, patent and other regulatory expenses and general overhead costs. We may also pursue acquisitions, investments, joint ventures and other strategic transactions. We may need substantial additional funding to pursue our growth strategy and support continuing operations. Until such time as we can generate significant revenue from product sales or other customer arrangements to fund operations, we expect to use proceeds from the issuance of equity, debt financings or other capital transactions. We may be unable to increase our revenue, raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. If we are unable to raise capital when needed, we will need to delay, reduce or terminate planned activities to reduce costs. Doing so will likely harm our ability to execute our business plans. Cash Flows The following table summarizes our cash flows for the periods presented (in thousands): Three Months Ended March 31, 2021 2020 Net cash used in operating activities$ (83,048) $ (62,927) Net cash used in investing activities$ (8,639) $ (6,083) Net cash provided by financing activities $ 4,329
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 endedMarch 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 endedMarch 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 24 -------------------------------------------------------------------------------- TABLE OF CONTENTS Cash used in investing activities was$8.6 million for the quarter endedMarch 31, 2021 related to the purchase of property and equipment. Net cash used in investing activities was$6.1 million for the quarter endedMarch 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 endedMarch 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 endedMarch 31, 2020 , which consists of proceeds from the exercise of common stock options. Off Balance Sheet Arrangements As ofMarch 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 ofU.S. interest rates, particularly because our cash equivalents are primarily invested in short-termU.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 theSEC is recorded, processed, summarized and reported within the time periods specified in theSEC'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 25 -------------------------------------------------------------------------------- TABLE OF CONTENTS 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 inSEC 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. 26
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