News Column

MARRONE BIO INNOVATIONS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 13, 2014

You should read the following discussion of our financial condition and results of operations in connection with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the Securities and Exchange Commission. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere, including Part II, Item 1A, "Risk Factors," in this Quarterly Report on Form 10-Q, and in Part I, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Overview We make bio-based pest management and plant health products. Bio-based products are comprised of naturally occurring microorganisms such as bacteria and fungi, and plant extracts. We target the major markets that use conventional chemical pesticides, including agricultural and water markets, where our bio-based products are used as substitutes for, or in connection with, conventional chemical pesticides. We also target new markets for which there are no available conventional chemical pesticides, the use of conventional chemical pesticides may not be desirable or permissible because of health and environmental concerns or the development of pest resistance has reduced the efficacy of conventional chemical pesticides. Our current portfolio of EPA-approved and registered "biopesticide" products and our pipeline address the growing global demand for effective, efficient and environmentally responsible products. Our goal is to provide growers with solutions to a broad range of pest management needs by adding new products to our product portfolio, continuing to broaden the commercial applications of our existing product lines, leveraging relationships with existing distributors and growers' positive experiences with existing product lines, and educating growers with on-farm product demonstrations and controlled product launches with key target customers and other early adopters. We believe this approach enables us to stay ahead of our competition in providing innovative pest management solutions, enhances our sales process at the distributor level and helps us to capture additional value from our products. The agricultural industry is increasingly dependent on effective and sustainable pest management practices to maximize yields and quality in a world of increased demand for agricultural products, rising consumer awareness of food production processes and finite land and water resources. In addition, our research has shown that the global market for biopesticides is growing substantially faster than the overall market for pesticides. This demand is in part a result of conventional growers acknowledging that there are tangible benefits to adopting bio-based pest management products into integrated pest management (IPM) programs. We believe that our competitive strengths, including our commercially available products, robust pipeline of novel product candidates, proprietary technology and product development process, commercial relationships and industry experience, position us for rapid growth by providing solutions for these global trends. To achieve the anticipated growth in revenue from the sale of our products in the agriculture industry, we need to develop, expand and maintain new and existing relationships with distributors, growers and end users. A consistent sales force and business development team are important factors to developing and maintaining these relationships. As a result, significant turnover in our sales group could negatively affect our revenues over the short term as replacements are found and trained. We currently offer four product lines for commercial sale: Regalia, an initial formulation of which we began selling in the fourth quarter of 2008, Grandevo, an initial formulation of which we began selling in the fourth quarter of 2011, Zequanox, an initial formulation of which we began selling in the second half of 2012 and Venerate, which we began selling in May 2014. In addition, we submitted MBI-011, another herbicide, MBI-302, a biological nematicide, and MBI-601, a biofumigant, to the EPA for registration, and we have submitted Haven, an anti-transpirant, to applicable state agencies for registration. A large portion of our sales are currently attributable to conventional growers who use our bio-based pest management products either to replace conventional chemical pesticides or enhance the efficacy of their IPM programs. In addition, a portion of our sales are attributable to organic farmers, who cannot use conventional pesticides and have few alternatives for pest management. We intend to continue to develop and commercialize bio-based pest management and plant health products that are allowed for use by organic farmers. We sell our crop protection products to leading agrichemical distributors while also working directly with growers to increase existing and generate new product demand. To date, we have marketed our bio-based pest management and plant health products for agricultural applications to U.S. growers, through distributors and our own sales force, and we have focused primarily on high value specialty crops such as grapes, citrus, tomatoes, leafy greens and ornamental plants. As we continue to demonstrate the efficacy of our bio-based pest management and plant health products on new crops or for new applications, we may either continue to sell our product through our in-house sales force or collaborate with third parties for distribution to select markets. For example, we demonstrated that there is a significant opportunity for selling Regalia as a yield enhancer for large-acre row crop markets such as corn, cotton and soybeans, which we began to sell through third-party distributors in the third quarter of 2013. 21



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We have historically sold a significant majority of our products in the United States, although we have strategically launched Regalia in select international markets. For example, we launched Regalia in the United Kingdom in 2009, Turkey in 2010, Mexico in 2011 and Canada in 2012. We are continuing to form strategic collaborations with major agrichemical companies such as FMC (for markets in Latin America) and Syngenta (for markets in Africa, Europe and the Middle East) to accelerate our entry into certain international markets where these distributors are already selling Regalia, as well as in Asia Pacific markets. In addition to engaging these large-scale international distributors, we intend to form new strategic collaborations with other market-leading companies in our target markets and regions to expand the supply of our products globally, particularly in markets for which our products fall under exemptions from registration. In the longer term, when we launch Grandevo and other products internationally, we expect to generate a significant portion of our revenues from international sales of our products. We currently market our water treatment product, Zequanox, through our sales and technical workforce to hydroelectric power generation companies, combustion power generation companies and industrial facilities at various geographical sites. We are in discussions with several potential leaders in water treatment technology and applications regarding potential arrangements to sell Zequanox in the United States and international markets to supplement the efforts of our sales force. We are also exploring other options for selling Zequanox, including entering into distribution arrangements with third parties to market Zequanox internationally. We may enter into similar arrangements for the distribution of Zequanox for use in certain applications such as treatment of lakes, aqueducts and drinking water facilities in the United States. We believe that Zequanox presents a unique opportunity for generating long-term revenue, as there are limited water treatment options available to date, most of which are time-consuming, costly or subject to high levels of regulation. Our ability to generate significant revenues from Zequanox is dependent on our ability to persuade customers to evaluate the costs of our Zequanox products compared to the overall cost of the chlorine treatment process, the primary current alternative to using Zequanox, rather than the cost of purchasing chemicals alone. Sales of Zequanox have also remained lower than our other products due to the length of the treatment cycle, the longer sales cycle (the bidding process with utility companies occurs on a yearly or multi-year basis) and the unique nature of the treatment approach for each customer based on the extent of the infestation and the design of the facility. In July 2014, we received a label from the EPA to use Zequanox for open water uses. Our biopesticide products cannot be sold in the United States except under an EPA-approved use label. As such, we launch early formulations of our products to targeted customers under EPA-approved use labels, which list a limited number of crops and applications, to gather field data, gain product knowledge and get feedback to our research and development team while the EPA reviews new product formulations and expanded use labels for already approved formulations covering additional crops and applications. Based on these initial product launches, sales and demonstrations in additional regions and other tests and trials, we continue to enhance our products and submit product formulations and expanded use labels to the EPA and other regulatory agencies. For example, we began sales of Regalia SC, an earlier formulation of Regalia, in the Florida fresh tomatoes market in 2008, while a more effective formulation of Regalia with an expanded use label, including listing for use in organic farming, was under review by the EPA. When approved, we launched this new formulation into the Southeast United States in 2009 and nationally in 2010. In 2011, we received EPA approval of a newly expanded Regalia label covering hundreds of crops and various new uses for applications to soil and through irrigation systems. Likewise, in May 2013, we received approval for an improved Grandevo label, which has been approved by 49 states, with a decision pending in Hawaii. Our total revenues were $3.6 million and $4.5 million for the three months ended June 30, 2014 and 2013, respectively, and $6.4 million and $7.2 million for the six months ended June 30, 2014 and 2013, respectively. We generate our revenues primarily from product sales, which are principally attributable to sales of our Regalia and Grandevo product lines. We believe weather conditions such as drought in the Western United States, freezing conditions in the Midwestern United States and heavy rains and flooding in the Southeastern United States have impacted purchases of our pest management and plant health products by our distributors, direct customers and end users. We believe that these conditions will also have an impact on annual sales as declining weather conditions led to a reduction in planted acres and reduced the risk of diseases and insect attacks. In addition, compressed blooming periods reduced the quantity of plant health and pesticide products used. Due to the compressed blooming period, aggressive spraying practices became necessary to control pests; however, Grandevo did not disperse optimally under these aggressive spraying conditions. We have since developed a more versatile formulation, which improves dispersion during mixing for all applications and crops, and is now pending at the EPA. In addition, we have recently developed and implemented procedures that can be used to improve application of the existing formulation. We anticipate that most of our revenue growth will occur during the second half of 2014 relating to growth in row crop and certain specialty crop markets, new product sales and entry into additional Latin American markets, particularly as weather patterns improve. Since 2011, we have also recognized license revenues from our strategic collaboration and distribution agreements, which amounted to $0.1 million and less than $0.1 million for the three months ended June 30, 2014 and 2013, respectively, and $0.1 million for each of the six months ended June 30, 2014 and 2013, respectively. We have strategic collaboration and distribution agreements with Syngenta, an affiliate of Syngenta Ventures Pte. LTD (Syngenta Ventures). Prior to our public offering in June 2014, Syngenta Ventures was one of our 5% stockholders, and as such, we included 22



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license revenues recognized under these agreements in related party revenues. In connection with the public offering, Syngenta Ventures sold 0.6 million common shares and is no longer a 5% stockholder. As such, beginning in June 2014, we included license revenues recognized under these agreements in license revenues. For each of the three months ended June 30, 2014 and 2013, we recognized less than $0.1 million of related party revenues under these agreements. For the six months ended June 30, 2014 and 2013, we recognized $0.3 million and $0.1 million, respectively, of related party revenues under these agreements, of which, $0.3 million was recognized during the six months ended June 30, 2014 upon the termination of one of these agreements.



We currently sell our crop protection products through the same leading agricultural distributors used by the major agrichemical companies. Distributors with 10% or more of our total revenues consist of the following:

CROP PRODUCTION TITAN HELENA SERVICES PRO CHEMICALS

For the three months ended June 30, 2014 28 % 18 % 11 % 2013 60 % * * For the six months ended June 30, 2014 23 % 10 % 11 % 2013 43 % * *



* Represents less than 10% of total revenues

While we expect product sales to a limited number of distributors to continue to be our primary source of revenues, as we continue to develop our pipeline and introduce new products to the marketplace, we anticipate that our revenue streams will be diversified over a broader product portfolio and customer base. Our cost of product revenues was $2.8 million and $3.4 million for the three months ended June 30, 2014 and 2013, respectively, and $4.5 million and $5.2 million for the six months ended June 30, 2014 and 2013, respectively. Cost of product revenues included cost of product revenues to related parties of $0.1 million and $0.2 million for the three months ended June 30, 2014 and 2013, respectively, and $0.3 million and $0.4 million for the six months ended June 30, 2014 and 2013, respectively. Cost of product revenues consists principally of the cost of raw materials, including inventory costs and third-party services related to procuring, processing, formulating, packaging and shipping our products. We expect our cost of product revenues to increase as we expand sales of Regalia, Grandevo, Zequanox and Venerate. Our cost of product revenues has increased as a percentage of total revenues primarily due to a change in product mix, with Grandevo representing an increased percentage of total revenues as Grandevo is early in its life cycle. We expect to see a gradual increase in gross margin over the life cycle of each of our products, including Grandevo, as we improve production processes, gain efficiencies and increase product yields. Our research, development and patent expenses have historically comprised a significant portion of our operating expenses, amounting to $4.3 million and $3.9 million for the three months ended June 30, 2014 and 2013, respectively, and $8.5 million and $7.2 million for the six months ended June 30, 2014 and 2013, respectively. We intend to continue to devote significant resources toward our proprietary technology and adding to our pipeline of bio-based pest management and plant health products using our proprietary discovery process, sourcing and commercialization expertise and rapid and efficient development process. Selling, general and administrative expenses incurred to establish and build our market presence and business infrastructure have generally comprised the remainder of our operating expenses, amounting to $6.0 million and $3.1 million for the three months ended June 30, 2014 and 2013, respectively, and $12.3 million and $6.0 million for the six months ended June 30, 2014 and 2013, respectively. We expect that in the future, our selling, general and administrative expenses will increase as we continue to expand our sales force and marketing efforts and invest in the necessary infrastructure to support our continued growth. Historically, we have funded our operations from the issuance of shares of common stock, preferred stock, warrants and convertible notes, the issuance of debt and entry into financing arrangements, product sales, payments under strategic collaboration and distribution agreements and government grants, but we have experienced significant losses as we invested heavily in research and development. We expect to incur additional losses related to our investment in the continued development, expansion and marketing of our product portfolio.



Critical Accounting Policies and Estimates

Our condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated 23



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financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net revenue, costs and expenses, and any related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Changes in accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and our actual results, our future financial statement presentation, financial condition, results of operations, comprehensive loss and cash flows will be affected. We believe that the assumptions and estimates associated with revenue recognition, income taxes, inventory valuation, share-based compensation, and financial instruments with characteristics of both liabilities and equity have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates.



There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

Key Components of Our Results of Operations

Product Revenues

Product revenues consist of revenues generated primarily from sales to distributors, net of rebates and cash discounts. Our product revenues through 2012 were primarily derived from sales of Regalia, but now are increasingly impacted by new products such as Grandevo. Product revenues, not including related party revenues, constituted 94% and 92% of total revenues for the three months ended June 30, 2014 and 2013, respectively, and 86% and 90% of total revenues for the six months ended June 30, 2014 and 2013, respectively. Product revenues in the United States, not including related party revenues, constituted 90% and 86% of our total revenues for the three months ended June 30, 2014 and 2013, respectively, and 81% and 82% of our total revenues for the six months ended June 30, 2014 and 2013, respectively. In 2013, we began to offer extended payment terms in excess of those historically offered to our customers. We believe our competitors and other vendors in the pest management and plant health industry also offer extended payment terms and, in the aggregate, we believe that by expanding the use of extended payment terms, we have provided a competitive response to the market. When we offer terms that are considered to be extended in comparison to our historical terms, we defer recognizing revenue until payment is due. As of June 30, 2014 and December 31, 2013, we had current deferred product revenues of $0.3 million and $1.0 million, respectively.



License Revenues

License revenues generally consist of revenues recognized under our strategic collaboration and distribution agreements for exclusive distribution rights, either for Regalia or for our broader pipeline of products, for certain geographic markets or for market segments that we are not addressing directly through our internal sales force. Our strategic collaboration and distribution agreements generally outline overall business plans and include payments we receive at signing and for the achievement of testing validation, regulatory progress and commercialization events. As these activities and payments are associated with exclusive rights that we provide over the term of the strategic collaboration and distribution agreements, revenues related to the payments received are deferred and recognized as revenues over the term of the exclusive period of the respective agreements, which we estimate to be between 5 and 17 years based on the terms of the contract and the covered products and regions. License revenues constituted 1% of total revenues for each of the three and six months ended June 30, 2014 and 2013. As of June 30, 2014, we had received an aggregate of $2.4 million in payments under these agreements, and there are up to $2.9 million in payments under these agreements that we could potentially receive if the testing validation, regulatory progress and commercialization events occur. Related Party Revenues Related party revenues consist of both product revenues and license revenues. Les Lyman, who joined our board of directors in October 2013, is the chairman and significant indirect shareholder of The Tremont Group, Inc., which purchases our products for further distribution and resale. We have reclassified sales to and accounts receivable due from the Tremont Group, Inc. into related party revenues and accounts receivable from related parties for all prior periods presented. In addition, we have strategic collaboration and distribution agreements with Syngenta, an affiliate of Syngenta Ventures Pte. LTD (Syngenta Ventures). Prior to our public offering in June 2014, Syngenta Ventures was one of our 5% stockholders, and as such, we included license revenues recognized under these agreements in related party revenues. In connection with the public offering, Syngenta Ventures sold 0.6 million common shares and is no longer a 5% stockholder. As such, beginning in June 2014, we included license revenues recognized under these agreements in license revenues. 24



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For the three months ended June 30, 2014 and 2013, related party revenues constituted 5% and 7% of total revenues, respectively, with related party product revenues totaling $0.2 million and $0.3 million, respectively, and related party license revenues totaling less than $0.1 million for each of the three months ended June 30, 2014 and 2013. For the six months ended June 30, 2014 and 2013, related party revenues constituted 13% and 9% of total revenues, respectively, with related party product revenues totaling $0.5 million and $0.5 million, respectively, and related party license revenues totaling $0.3 million and $0.1 million, respectively.



Cost of Product Revenues and Gross Profit

Cost of product revenues consists principally of the cost of raw materials, including inventory costs and third- party services related to procuring, processing, formulating, packaging and shipping our products. Cost of product revenues also may include charges due to inventory adjustments. Gross profit is the difference between total revenues and the cost of product revenues. Gross margin is the gross profit as expressed as a percentage of total revenues. We have entered into in-license technology agreements with respect to the use and commercialization of three of our commercially available product lines, including Regalia, Grandevo and Zequanox, and certain products under development. Under these licensing arrangements, we typically make royalty payments based on net product revenues, with royalty rates varying by product and ranging between 2% and 5% of net sales, subject in certain cases to aggregate dollar caps. These royalty payments are included in cost of product revenues, but they have historically not been significant. In addition, costs associated with license revenues have been included in cost of product revenues, as they have not been significant. The exclusivity and royalty provisions of these agreements are generally tied to the expiration of underlying patents. The patents for Regalia and Zequanox will expire in 2017 and the in-licensed U.S. patent for Grandevo is expected to expire in 2024. There is, however, a pending in-licensed patent application relating to Grandevo, which could expire later than 2024 if issued. After the termination of these provisions, we may continue to produce and sell these products. While third parties thereafter may develop products using the technology under expired patents, we do not believe that they can produce competitive products without infringing other aspects of our proprietary technology, including pending patent applications related to Regalia, Zequanox and Grandevo, and we therefore do not expect the expiration of the patents or the related exclusivity obligations to have a significant adverse financial or operational impact on our business. We expect to see increases in gross profit over the life cycle of each of our products because gross margins are expected to increase over time as production processes improve and as we gain efficiencies and increase product yields. While we expect margins to improve on a product-by-product basis, our overall gross margins may vary as we introduce new products. In particular, we are experiencing and expect further near-term downward pressure on overall gross margins as we expand sales of Grandevo, Zequanox and Venerate and when we introduce additional products. Gross profit has been and will continue to be affected by a variety of factors, including product manufacturing yields, changes in product production processes, new product introductions, product mix and average selling prices. To date, we have relied on third parties for the production of our products. However, we believe reliance on third parties has resulted in lower gross margins for Grandevo, a fermentation-based product. Accordingly, in July 2012, we acquired a manufacturing facility, which began operating in May 2014, and we plan to continue to expand the manufacturing capacity at this facility. Although we expect margins to be negatively impacted initially as production shifts from third parties to our own facility, we expect gross margins to improve over time as we gain efficiencies and increase production.



Research, Development and Patent

Research, development and patent expenses principally consist of personnel costs, including salaries, wages, benefits and share-based compensation, related to our research, development and patent staff in support of product discovery and development activities. Research, development and patent expenses also include costs incurred for laboratory supplies, field trials and toxicology tests, quality control assessment, consultants and facility and related overhead costs. We expect to increase our investments in research and development by hiring additional research and development staff, increasing the number of third-party field trials and toxicology tests for developing additional products and expanding uses for existing products. As a result, we expect that our research, development and patent expenses will increase in absolute dollars for the foreseeable future. As our sales increase, we expect our research, development and patent expenses to decrease as a percentage of total revenues, although, we could experience quarterly fluctuations.



Selling, General and Administrative

Selling, general and administrative expenses consist primarily of personnel costs, including salaries, wages, benefits and share-based compensation, related to our executive, sales, marketing, finance and human resources personnel, as well as professional fees, including legal and accounting fees, and other selling costs incurred related to business development and to building product and 25



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brand awareness. We create brand awareness through programs such as speaking at industry events, trade show displays and hosting local-level grower and distributor meetings. In addition, we dedicate significant resources to technical marketing literature, targeted advertising in print and online media, webinars and radio advertising. Costs related to these activities, including travel, are included in selling expenses. Our administrative expenses have increased in recent periods primarily as a result of becoming a public company. We expect our selling expenses to increase in the near term, both in absolute dollars and as a percentage of total revenues, particularly as we market and sell new products or product formulations to the marketplace. In the long term, we expect our selling, general and administrative expenses to decline as a percentage of total revenues. We expect our overall selling, general and administrative expenses to increase in absolute dollars in order to drive product sales, and we will incur additional expenses associated with operating as a public company. Such increases may include increased insurance premiums, investor relations expenses, legal and accounting fees associated with the expansion of our business and corporate governance, financial reporting expenses, expenses related to Sarbanes-Oxley and other regulatory compliance obligations. We expect to hire additional personnel, particularly in the area of general and administrative activities to support the growth of the business.



Interest Expense

We recognize interest expense on notes payable, convertible notes and other debt obligations. During 2012, we entered into a $0.5 million term loan and issued $24.1 million in convertible notes and $17.5 million in promissory notes, including a $10.0 million promissory note paid off prior to its maturity date. During 2013, we issued $4.95 million in promissory notes, including the conversion of $1.25 million of a convertible note into a promissory note. In May 2013, we issued a $3.0 million convertible note and incurred $1.2 million of interest expense for the three and six months ended June 30, 2013 as a result of the excess in the $4.2 million estimated fair value of the convertible note on the date of issuance compared to the cash received. Immediately following the completion of our initial public offering (IPO) in August 2013, the convertible notes converted into shares of our common stock. Accordingly, our interest expense decreased both in absolute terms and as a percentage of total revenues for the three and six months ended June 30, 2014. In June 2014, we entered into a $10.0 million promissory note with a variable interest rate that varies with the prime rate. Accordingly, our interest expense will increase as the prime rate increases. Interest Income Interest income consists primarily of interest earned on investments and cash balances. Our interest income will vary each reporting period depending on our average investment and cash balances during the period and market interest rates.



Change in Estimated Fair Value of Financial Instruments and Deemed Dividend on Convertible Notes

In August 2013, we closed an IPO, at which time all shares of our outstanding convertible preferred stock and all of our outstanding convertible notes automatically converted into shares of common stock, and all outstanding warrants to purchase convertible preferred stock and certain warrants to purchase common stock were exercised for shares of common stock.

Until the effective date of our IPO in August 2013, we accounted for the outstanding warrants exercisable into shares of our Series A, Series B and Series C convertible preferred stock as liability instruments, as the Series A, Series B and Series C convertible preferred stock into which these warrants were contingently convertible upon the occurrence of certain events or transactions. We also accounted for the outstanding warrants exercisable into a variable number of common shares at a fixed monetary amount as liability instruments. Our convertible notes were recorded at estimated fair value on a recurring basis as the predominant settlement feature of the convertible notes was to settle a fixed monetary amount with a variable number of shares. We adjusted the warrants and the convertible notes to fair value at each reporting period and on the effective date of the IPO with the change in estimated fair value recorded in the condensed consolidated statements of operations. Based on our operating performance (including the closing of several debt financings and the IPO) and changes in the probability and timing of, and estimated proceeds from, the completion of a qualified IPO or an acquisition between reporting dates or the issuance dates of the warrants, we recognized a net gain due to the change in the estimated fair value of financial instruments related to the warrants of $0.4 million for the three and six months ended June 30, 2013. We issued $24.1 million in convertible notes during the year ended December 31, 2012. During the year ended December 31, 2013, we issued $6.5 million in convertible notes and converted $1.25 million of a convertible note into a promissory note. Based on our operating performance and changes in the probability and timing of, and estimated proceeds from, the completion of a qualified IPO or an acquisition between the reporting dates, or the issuance dates of these notes, we recognized a net gain due to the change in estimated fair value of financial instruments of $6.2 million and $2.6 million for the three and six months ended June 30, 2013, respectively, relating to convertible notes. In addition to the ongoing adjustments to the estimated fair value of our convertible notes, we also recognized a one-time deemed dividend in connection with the issuance of certain convertible notes to preferred shareholders 26



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because we estimated the fair value of the convertible notes as of the issuance dates to be greater than the cash proceeds received. Accordingly, we determined that the excess of the estimated fair value of the convertible notes on the dates of issuance over cash proceeds to us represents a deemed dividend to preferred stockholders, and $1.4 million was reflected in the net loss attributable to common stockholders during the three and six months ended June 30, 2013 As a result of the automatic exercise of all Series A and Series B convertible preferred stock warrants and certain common stock warrants for shares of common stock, the automatic conversion of all convertible notes into common stock in accordance with their terms, and the exercise of all Series C convertible preferred stock warrants for shares of common stock in connection with our IPO in August 2013, there will not be any further adjustments to these warrants and convertible notes. In addition, upon completion of the IPO, the exercise price and number of shares to be issued upon exercise of the remaining outstanding common stock warrants became known. Accordingly, after the IPO, the fair value of the outstanding common stock warrant liability on the date of the IPO was reclassified to equity and will no longer be adjusted to its estimated fair value on each reporting date.



Income Tax Provision

Since our inception, we have been subject to income taxes principally in the United States. We anticipate that as we further expand our sales into foreign countries, we will become subject to taxation based on the foreign statutory rates and our effective tax rate could fluctuate accordingly. Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. As of June 30, 2014, based on the available information, it is more likely than not that our deferred tax assets will not be realized, and accordingly we have taken a full valuation allowance against all of our deferred tax assets.



Results of Operations

The following table sets forth certain statements of operations data as a percentage of total revenues:

THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, 2014 2013 2014 2013 Revenues: Product 94 % 92 % 86 % 90 % License 1 1 1 1 Related Party 5 7 13 9 Total revenues 100 100 100 100 Cost of product revenues (1) 79 76 70 72 Gross profit 21 24 30 28 Operating expenses: Research, development and patent 117 87 133 100 Selling, general and administrative 165 69 192 82 Total operating expenses 282 156 325 182 Loss from operations (261 ) (132 ) (295 ) (154 ) Other income (expense) Interest income - - - - Interest expense (23 ) (50 ) (25 ) (59 ) Change in estimated fair value of financial instruments - 145 - 41 Gain on extinguishment of debt - 1 - 1 Other income (expense) (3 ) -



(2 ) -

Total other income (expense), net (26 ) 96 (27 ) (17 ) Income taxes - - - - Net loss (287 )% (36 )% (322 )% (171 )% 27



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(1) Includes cost of product revenues to related parties of 2% and 4% for the three months ended June 30, 2014 and 2013, respectively, and 4% and 5% for the six months ended June 30, 2014 and 2013, respectively. See Note 12 of our accompanying Notes to Condensed Consolidated Financial Statements included in Part I, Item 1, "Financial Statements (Unaudited)" of this Quarterly Report on Form 10-Q for further discussion.



Comparison of Three Months Ended June 30, 2014 and 2013

Product Revenues THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Product revenues $ 3,414$ 4,152 % of total revenues 94 % 92 % Product revenues decreased by approximately $0.7 million, or 18%, due to severe weather conditions in the U.S. in 2014 that have impacted purchases of our pest management and plant health products by distributors and end users and which has had a significant effect on the agricultural industry in the U.S. This decrease in sales was offset by the recognition of $0.8 million in revenue that was deferred in prior periods and sales following the launch of the Venerate product line during the three months ended June 30, 2014. License Revenues THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) License revenues $ 51$ 48 % of total revenues 1 % 1 % License revenues related to certain strategic collaboration and distribution agreements increased by 6% but do not comprise a significant portion of our total revenues. Related Party Revenues THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Related party revenues $ 164$ 300 % of total revenues 5 % 7 %



For the three months ended June 30, 2014 and 2013, related party revenues totaled $0.2 million and $0.3 million, respectively, which was primarily related to product revenues and timing of purchases.

Cost of Product Revenues and Gross Profit

THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Cost of product revenues $ 2,849$ 3,398 % of total revenues 79 % 76 % Gross profit $ 780$ 1,102 % of total revenues 21 % 24 % Cost of product revenues decreased by $0.5 million, or 16%, and our gross margins decreased from 24% to 21%. Cost of product revenues decreased primarily due to the decrease in revenues. The decrease in cost of product revenues was offset by an increase in inventory adjustments, which also negatively affected gross profit, totaling approximately $0.6 million, recorded as a component of cost of product revenues, primarily relating to additional reserves for excess and obsolete inventory and warranties. However, gross profit was positively affected by a change in product mix, with Regalia representing an increased percentage of total sales, which has a higher margin than Grandevo. 28



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Research, Development and Patent Expenses

THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Research, development and patent expenses $ 4,264$ 3,941 % of total revenues 117 % 87 % Research, development and patent expenses increased by approximately $0.3 million, or 8%, primarily due to an increase of $0.5 million in employee related expenses driven by increased headcount, which includes an increase in share-based compensation of $0.2 million, offset by a decrease of $0.2 million in direct research and development testing and other costs.



Selling, General and Administrative Expenses

THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Selling, general and administrative expenses $ 5,989$ 3,107 % of total revenues 165 % 69 % Selling, general and administrative expenses increased by approximately $2.9 million, or 93%, due to an increase of $1.4 million in employee related expenses driven by increased headcount, which includes an increase in share-based compensation of $0.6 million, $0.7 million in start-up costs associated with the Company's manufacturing plant, $0.2 million in outside services, $0.1 million in travel and $0.5 million in supplies, general and other costs. Other Income (Expense), Net THREE MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Interest income $ 11 $ - Interest expense (825 ) (2,285 ) Change in estimated fair value of financial instruments -



6,550

Gain on extinguishment of debt - 49 Other income (expense), net (98 ) (7 ) Total other income (expense), net $ (912 )



$ 4,307

Interest expense decreased due to the conversion of convertible notes into shares of our common stock immediately following the completion of the IPO in August 2013. Accordingly, we ceased to incur the interest expense associated with these convertible notes. In addition, in May 2013, we issued a $3.0 million convertible note and incurred $1.2 million of interest expense for the three months ended June 30, 2013 as a result of the excess in the $4.2 million estimated fair value of the convertible note on the date of issuance compared to the cash received. This was partially offset by an increase in interest expense as we issued promissory notes in the amount of $4.95 million in April 2013 and $10.0 million in June 2014. The change in the estimated fair value of financial instruments was associated with outstanding warrants and convertible notes issued in 2012 and 2013. Upon the closing of the IPO, all shares of our outstanding convertible preferred stock and convertible notes automatically converted into shares of common stock and outstanding warrants to purchase convertible preferred stock and certain warrants to purchase common stock were exercised for shares of common stock. Accordingly, we ceased to incur the interest expense and change in estimated fair value of financial instruments associated with the convertible preferred stock and convertible notes. 29



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Comparison of Six Months Ended June 30, 2014 and 2013

Product Revenues SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Product revenues $ 5,511$ 6,525 % of total revenues 86 % 90 % Product revenues decreased by approximately $1.0 million, or 16%, due to severe weather conditions in the U.S. in 2014 that have impacted purchases of our pest management and plant health products by distributors and end users and which has had a significant effect on the agricultural industry in the U.S. This decrease in sales was offset by the recognition of $1.0 million in revenue that was deferred in prior periods and sales following the launch of the Venerate product line during the six months ended June 30, 2014. License Revenues SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) License revenues $ 96$ 96 % of total revenues 1 % 1 % License revenues related to certain strategic collaboration and distribution agreements remained constant and do not comprise a significant portion of our total revenues. Related Party Revenues SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Related party revenues $ 812$ 609 % of total revenues 13 % 9 % For the six months ended June 30, 2014 and 2013, related party revenues totaled $0.8 million and $0.6 million, respectively, of which $0.5 million and $0.5 million, respectively, was related to product revenues, and $0.3 million and less than $0.1 million, respectively, was related to license revenues. Related party revenues increased by approximately $0.2 million, or 33%, as a result of approximately $0.3 million that was recognized during the six months ended June 30, 2014 upon the termination of one of our agreements with Syngenta, an affiliate of one of our 5% stockholders.



Cost of Product Revenues and Gross Profit

SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Cost of product revenues $ 4,501$ 5,193 % of total revenues 70 % 72 % Gross profit $ 1,918$ 2,037 % of total revenues 30 % 28 % Our cost of product revenues decreased by $0.7 million, or 13%, and our gross margins increased from 28% to 30%. Cost of product revenues decreased primarily due the decrease in revenues. The decrease was offset by an increase in inventory adjustments, which also negatively affected gross profit, totaling approximately $0.6 million, recorded as a component of cost of product revenues, primarily relating to changes in estimates for the reserves for excess and obsolete inventory and warranties. Gross profit was positively affected by a change in product mix with Regalia representing an increased percentage of total sales, which has a higher margin than Grandevo. In addition, as discussed above, there was an increase in related party revenues as a result of $0.3 million that was recognized during the six months ended June 30, 2014 upon the termination of one of our agreements with Syngenta for which there was no corresponding cost of product revenues. 30



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Research, Development and Patent Expenses

SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Research, development and patent expenses $ 8,546$ 7,224 % of total revenues 133 % 100 %



Research, development and patent expenses increased by approximately $1.3 million, or 18%, primarily due to an increase of $1.3 million in employee related expenses driven by increased headcount, which includes an increase in share-based compensation of $0.4 million.

Selling, General and Administrative Expenses

SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Selling, general and administrative expenses $ 12,319$ 5,954 % of total revenues 192 % 82 % Selling, general and administrative expenses increased by approximately $6.4 million, or 107%, due to an increase of $3.3 million in employee related expenses driven by increased headcount, which includes an increase in share-based compensation of $1.6 million, $1.5 million in start-up costs associated with the Company's manufacturing plant, $0.2 million in fixed expenses primarily related to an increase in insurance costs as a result of being a public company, $0.8 million in outside services, $0.2 million in travel and $0.4 million in supplies and general costs.



Other Income (Expense), Net

SIX MONTHS ENDED JUNE 30, 2014 2013 (Dollars in thousands) Interest income $ 21$ 1 Interest expense (1,598 ) (4,270 ) Change in estimated fair value of financial instruments -



2,987

Gain on extinguishment of debt - 49 Other income (expense), net (107 ) (14 ) Total other expense, net $ (1,684 )$ (1,247 ) Interest expense decreased due to the conversion of convertible notes into shares of our common stock immediately following the completion of the IPO in August 2013. Accordingly, we ceased to incur the interest expense associated with these convertible notes. In addition, in May 2013, we issued a $3.0 million convertible note and incurred $1.2 million of interest expense for the six months ended June 30, 2013 as a result of the excess in the $4.2 million estimated fair value of the convertible note on the date of issuance compared to the cash received. This was partially offset by an increase in interest expense as we issued promissory notes in the amount of $4.95 million in April 2013 and $10.0 million in June 2014. The change in the estimated fair value of financial instruments was associated with outstanding warrants and convertible notes issued in 2012 and 2013. Upon the closing of the IPO, all shares of our outstanding convertible preferred stock and convertible notes automatically converted into shares of common stock and outstanding warrants to purchase convertible preferred stock and certain warrants to purchase common stock were exercised for shares of common stock. Accordingly, we ceased to incur the interest expense and change in estimated fair value of financial instruments associated with the convertible preferred stock and convertible notes. 31



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Seasonality and Quarterly Results

Our sales of individual products are generally expected to be seasonal. For example, we expect that our Regalia, Grandevo and Venerate product lines will be sold and applied to crops in greater quantity in the second and fourth quarters. These seasonal variations may be especially pronounced because sales have been primarily limited to our Regalia and Grandevo product lines in the Northern Hemisphere. In addition, in May 2014, we began to sell Venerate, a bioinsecticide, in the Northern Hemisphere. As we expand the registration and commercialization of our product lines into the Southern Hemisphere, where seasonality of sales should be counter cyclical to the Northern Hemisphere, we expect worldwide sales volatility to decrease over time. In addition, we expect that our sales of Zequanox will be seasonal. Invasive zebra and quagga mussels typically feed and reproduce at water temperatures above 59F. Treatments to kill these mussels are therefore most effective from June through September in the Eastern United States, Canada and Europe and from April through October in the Southwestern United States. Planting and growing seasons, climatic conditions and other variables on which sales of our products are dependent vary from year to year and quarter to quarter. As a result, we have historically experienced substantial fluctuations in quarterly sales. In particular, weather conditions and natural disasters such as heavy rains, hurricanes, hail, floods, tornadoes, freezing conditions, drought or fire, affect decisions by our distributors, direct customers and end users about the types and amounts of pest management and plant health products to purchase and the timing of use of such products. For example, in 2013 and 2012, the United States experienced nationwide abnormally low rainfall or drought, reducing the incidence of fungal diseases such as mildews, and these conditions have been present in some of our key markets in the first half of 2014 as well. In addition, disruptions that cause delays by growers in harvesting or planting can result in the movement of orders to a future quarter and a reduction in orders over the growing season, which would negatively affect the quarter and cause fluctuations in our operating results. For example, late snows and cold temperatures in the Midwestern and Eastern United States in the first half of 2014 have delayed planting and pesticide applications, reduced the number of acres planted and reduced the risk of disease and insect attacks. In addition, blooming crops in Florida in the first half of 2014 had a shortened bloom period, compressing the time upon which sprays could be applied and reduced the quantity of plant health and pesticide products used. We believe that these conditions will have an impact on annual sales. Since Regalia and Grandevo products have different margins, changes in product mix due to these conditions could affect our overall margins. The level of seasonality in our business overall is difficult to evaluate as a result of our relatively early stage of development, our relatively limited number of commercialized products, our expansion into new geographical territories, the introduction of new products and the timing of introductions of new formulations and products. It is possible that our business may be more seasonal, or experience seasonality in different periods, than anticipated. For example, if sales of Zequanox become a more significant component of our revenue, the separate seasonal sales cycles could cause further shifts in our quarterly revenue. Other factors may also contribute to the unpredictability of our operating results, including the size and timing of significant distributor transactions, the delay or deferral of use of our products and the fiscal or quarterly budget cycles of our distributors, direct customers and end users. Customers may purchase large quantities of our products in a particular quarter to store locally and use quickly when weather permits growers to get into the fields and also to use over longer periods of time as conditions may change rapidly thus customers may time their purchases to manage their inventories, which may cause significant fluctuations in our operating results for a particular quarter or year.



Liquidity and Capital Resources

From our inception until the closing of our IPO in August 2013, our operations have been financed primarily by net proceeds from the private placements of convertible preferred stock, convertible notes, promissory notes, term loans, as well as proceeds from the sale of our products and payments under strategic collaboration and distribution agreements and government grants. In June 2014, we completed a public offering of 4.6 million shares of our common stock (inclusive of 0.7 million shares of common stock sold upon the exercise of the underwriters' option to purchase additional shares). The public offering price of the shares sold in the offering was $9.50 per share. The total gross proceeds from the offering to us were $43.5 million, and after deducting underwriting discounts and commissions and offering expenses payable by us, the aggregate net proceeds received totaled approximately $40.0 million. In addition, in June 2014, we borrowed $10.0 million pursuant to a promissory note with a bank. As of June 30, 2014, our cash, cash equivalents and short-term investments totaled $57.9 million. We believe our current cash and cash equivalents and short-term investments, along with cash from revenues, will be sufficient to satisfy our liquidity requirements for at least the next 12 months. However, we may seek additional funding through debt or equity financings that may be used, among other things, to expand our product development and marketing efforts, to complete or expand our manufacturing facility, to complete strategic transactions and/or for working capital. Adequate funds for this and the other purposes may not be available to us when needed or on acceptable terms, and we may need to raise capital that may not be available on favorable or acceptable terms, if at all. If we cannot raise money when needed, we may have to reduce or slow sales or product development activities or reduce capital investments. 32



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Since our inception, we have incurred significant net losses, and, as of June 30, 2014, we had an accumulated deficit of $126.1 million, and we expect to incur additional losses related to the continued development and expansion of our business. Our liquidity may be negatively impacted as a result of slower than expected adoption of our products and higher than anticipated costs incurred in connection with repurposing our manufacturing facility acquired in July 2012. We have certain strategic collaboration and distribution agreements under which we receive payments for the achievement of testing validation, regulatory progress and commercialization events. As of June 30, 2014, we had received an aggregate of $2.4 million in payments under these agreements, and there are up to $2.9 million in payments under these agreements that we could potentially receive if certain testing validation, regulatory progress and commercialization events occur. For the six months ended June 30, 2014 and 2013, we used $9.4 million and $1.3 million, respectively, in cash to fund capital expenditures. In July 2012, we acquired a manufacturing facility, including associated land, property and equipment, located in Bangor, Michigan, for approximately $1.5 million. Our business plan contemplates developing significant internal commercial manufacturing capacity using this facility. Repurposing and expansion of the facility will be completed in multiple phases with an anticipated total capital expenditure of $32.0 million. Approximately half of the total expenditures were spent on Phase 1, which is expected to be completed in the third quarter of 2014. Phase 1 of the project includes installation of the first of three fermentation tanks, and the construction of a dedicated building to house them and is expected to handle sales requirements through 2015. We produced the first test batch of Grandevo at this facility in December 2013, and we began production of our Regalia product line using our own manufacturing capacity in the second quarter of 2014 and Zequanox in July 2014. Future phases will include increasing the capacity of the facility's utilities, installing drying capacity and installing larger fermenters that will accommodate production of multiple products at higher volumes. We will make decisions about the timing of future phases as we get closer to full utilization on Phase 1.



We had the following debt arrangements in place as of June 30, 2014, in each case as discussed below (dollars in thousands):

PRINCIPAL AMOUNT BALANCE (INCLUDING DESCRIPTION INTEREST RATE ACCRUED INTEREST) PAYMENT/MATURITY Promissory Note (1) 7.00 % $ 50 Monthly/November 2014 Term Loan (1) 7.00 % $ 247 Monthly/April 2016 Promissory Notes (2) 12.00 % $ 12,450 Monthly (4)/October 2015 Promissory Note (3) 5.25 % $ 10,000 Monthly/June 2036 (1) See "-Five Star Bank."



(2) See "-October 2012 and April 2013 Junior Secured Promissory Notes."

(3) See "-June 2014 Secured Promissory Note."

(4) Monthly payments are interest only until maturity.

Five Star Bank

We have entered into two promissory notes with Five Star Bank. In May 2008, we entered into a promissory note that we fully repaid in May 2013, and in March 2009, we entered into a promissory note that we repay at a rate of approximately $13,000 per month through maturity in November 2014. In addition, in March 2012, we entered into a term loan agreement with Five Star Bank, which replaced our existing revolving line of credit with the bank. Under the term loan agreement, we are obligated to repay the loan at a rate of approximately $12,000 per month through maturity. Under the terms of the promissory notes and the term loan agreement, all of our outstanding debt to Five Star Bank is secured by all of our inventory, chattel paper, accounts, equipment and general intangibles (excluding certain financed equipment and any intellectual property). Among other things, a payment default with respect to each of the promissory notes and the term loan, as well as other events such as a default under other loans or agreements that would materially affect us, constitute events of default. Upon an event of default, Five Star Bank may declare the entire unpaid principal and interest immediately due and payable.



October 2012 and April 2013 Junior Secured Promissory Notes

In October 2012, we completed the sale of promissory notes in the aggregate principal amount of $7.5 million to 12 lenders in a private placement. In addition, in April 2013, we completed the sale of an additional $4.95 million of promissory notes to 10 investors in a private placement under an amendment to the note purchase agreement in exchange for $3.7 million in cash and $1.25 million in cancellation of indebtedness under the October 2012 Subordinated Convertible Note, an outstanding convertible note. Maturity, currently October 2015, may be extended in one year increments for a period of no more than two years. In the event the maturity date is extended, the interest rate increases to 13% in the first year of the extension and the note matures in October 2016, and if extended 33



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for an additional year thereafter, the interest rate increases to 14% in the second year of extension and the note matures in October 2017. These promissory notes are secured by a security interest in all of our present and future accounts, chattel paper, commercial tort claims, goods, inventory, equipment, personal property, instruments, investment properties, documents, letter of credit rights, deposit accounts, general intangibles, records, real property, appurtenances and fixtures, tenant improvements and intellectual property, which consists in part of our patents, copyrights and other intangibles.



June 2014 Secured Promissory Note

In June 2014, we borrowed $10.0 million pursuant to a promissory note with a bank (Lender) which bears interest at prime rate plus 2.00% per annum. The interest rate is subject to change from time to time to reflect changes in the prime rate; however, the interest rate shall not be less than 5.25% or more than the maximum rate allowed by applicable law. If the interest rate increases, the Lender, may, at its option, increase the amount of each monthly payment to ensure that the note would be paid in full by the maturity date, increase the amount of each monthly payment to reflect the change in interest rate, increase the number of monthly payments, or keep the monthly payments the same and increase the final payment amount. As of June 30, 2014, the interest rate was 5.25%. The June 2014 Secured Promissory Note is repayable in monthly payments of $64,395 commencing July 13, 2014, with the final payment due on June 13, 2036. All of our deposit accounts and MMM, LLC's inventories, chattel paper, accounts, equipment and general intangibles have been pledged as collateral for the promissory note. We are required to maintain a deposit balance with the Lender of $1.6 million, which was recorded as a non-current asset. In addition, until we provide documentation that the proceeds were used for construction of the manufacturing plant, proceeds from the loan will be maintained in a restricted deposit account. As of June 30, 2014, we had $3.3 million remaining in this restricted deposit account, which was recorded as a current asset as we believe we will use the funds within one year. We may prepay 20% of the outstanding principal loan balance each year without penalty. A prepayment fee of 10% will be charged if prepayments exceed 20% in the first year, and the prepayment fee will decrease by 1% each year for the first ten years of the loan. We are required to maintain a current ratio of not less than 1.25 to 1.0, a debt-to-worth ratio of no greater than 4.0-to-1.0 and maintain a loan-to-value ratio of no greater than 70% as determined by the Lender. We are also required to comply with certain affirmative and negative covenants under the loan agreement discussed above. In the event of default on the debt, the Lender may declare the entire unpaid principal and interest immediately due and payable. The following table sets forth a summary of our cash flows for the periods indicated: SIX MONTHS ENDED JUNE 31 2014 2013 (In thousands) (Unaudited) Net cash used in operating activities $ (16,335 ) $



(14,409 )

Net cash provided by (used in) investing activities 3,993 (1,338 )

Net cash provided by financing activities 45,517



9,978

Net increase (decrease) in cash and cash equivalents $ 33,175$ (5,769 )

Cash Flows from Operating Activities

Net cash used in operating activities of $16.3 million during the six months ended June 30, 2014 primarily resulted from our net loss of $20.6 million, increases in inventories of $0.8 million and prepaid expenses and other assets of $0.3 million, and decreases in accrued and other liabilities of $0.6 million, deferred revenue of $0.8 million and deferred revenue from related parties of $0.3 million. This was offset by $1.1 million in depreciation and amortization expense, $2.7 million in share-based compensation expense, $0.5 million in non-cash interest expense, a decrease in accounts receivable of $2.1 million, accounts receivable from related parties of $0.4 million and an increase in accounts payable of $0.3 million. Net cash used in operating activities of $14.4 million during the six months ended June 30, 2013 primarily resulted from our net loss of $12.4 million and increases of accounts receivable of $0.8 million, accounts receivable from related parties of $0.1 million, inventory of $2.1 million and prepaid expenses and other assets of $1.6 million, a decrease in deferred revenue and deferred revenue from related parties of $0.2 million, a $0.1 million gain on extinguishment of debt and a $3.0 million change in the fair value of financial instruments. This was offset by $3.4 million in non-cash interest expense, a net increase of $1.5 million in accounts payable and accrued liabilities, $0.6 million in share-based compensation expense and $0.4 million in depreciation and amortization expense. 34



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Cash Flows from Investing Activities

Net cash provided by investing activities of $4.0 million during the six months ended June 30, 2014 consisted primarily of maturities of short-term investments in the amount of $13.5 million, offset by $0.1 million used for the purchase of short-term investments and $9.4 million used for the purchase of property, plant and equipment, primarily associated with a manufacturing plant and its subsequent improvement.



Net cash used in investing activities of $1.3 million during the six months ended June 30, 2013 was due to the purchase of property and equipment to support growth in our operations.

Cash Flows from Financing Activities

Net cash provided by financing activities of $45.5 million during the six months ended June 30, 2014 consisted primarily of $40.0 million in proceeds from the public offering of the Company's stock in June 2014, net of costs, $9.6 million from the issuance of a promissory note in June 2014, $4.7 million in proceeds from a line of credit and $1.2 million from the exercise of stock options and warrants. This was offset by $4.9 million of restricted cash relating to the promissory note entered into in June 2014, $4.7 million in repayments on a line of credit and $0.4 million in payments on our debt and capital leases. Net cash provided by financing activities of $10.0 million during the six months ended June 30, 2013 consisted primarily of $6.5 million from the issuance of convertible notes, $3.7 million from the issuance of debt and a $9.1 million release of restricted cash. This was offset by $9.3 million in payments on our debt. Contractual Obligations The following is a summary of our contractual obligations as of June 30, 2014: 2019 AND TOTAL 2014 2015-2016 2017-2018 BEYOND (In thousands) (Unaudited) Operating lease obligations $ 5,227$ 635$ 2,110$ 1,886$ 596 Debt and capital leases 25,467 1,165 14,931 595 8,776 Interest payments relating to debt and capital leases 9,055 1,110 2,251 967 4,727 Total $ 39,749$ 2,910$ 19,292$ 3,448$ 14,099



Operating leases consist of contractual obligations from agreements for non-cancelable office space and leases used to finance the acquisition of equipment. Debt and capital equipment leases and the interest payments relating thereto include promissory notes and capital lease obligations.

In September 2013, we entered into a lease agreement, which was amended in April 2014, for a new 27,303 square foot office and laboratory facility located in Davis, California. The initial term of the lease is for a period of 60 months commencing on the later of the date of substantial completion of initial improvements to the leased property, or August 2014. The monthly base rent is $44,000 for the first 12 months with a 3% increase each year thereafter. We will have the option to extend the lease term twice for a period of five years each. Upon moving into the new office facility, we will vacate the office facility that we currently occupy. The lease expires between February 2015 and October 2016 with respect to various portions of the premises of the 24,500 square foot office facility that we currently occupy. The cost per square foot of the lease agreement for the new office facility is less than the cost per square foot of the lease for the current office facility. We expect to enter into agreements to sublease the portions of the current office facility that remain under the lease agreement at the time that we vacate the premises. We believe that the expenses associated with the lease for the new office facility will be lower than if we remain in the current office facility. Concurrent with this amendment, in April 2014, we entered into a lease agreement with an affiliate of the landlord to lease 17,438 square feet of office and laboratory space in the same building complex. The initial term of the lease is for a period of 60 months commencing on the date of substantial completion of initial improvements. If the premises are not delivered by September 1, 2014, we can terminate the lease at any time prior to January 1, 2015. The premises are not expected to be delivered until the latter half of 2014. The monthly base rent is $28,000 with a 3% increase each year thereafter. 35



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Since June 30, 2014, we have not added any additional leases that would qualify as operating leases.

Inflation



We believe that inflation has not had a material impact on our results of operations for the three and six months ended June 30, 2014 and 2013.

Off-Balance Sheet Arrangements

We have not been involved in any material off-balance sheet arrangements.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09). ASU 2014-09 provides a framework, through a five-step process, for recognizing revenue from customers, improves comparability and consistency of recognizing revenue across entities, industries, jurisdictions and capital markets, and requires enhanced disclosures. Certain contracts with customers are specifically excluded from the scope of ASU 2014-09, including amongst others, insurance contracts accounted for under Accounting Standard Codification 944, Financial Services - Insurance. ASU 2014-09 is effective on January 1, 2017 with retrospective adoption required for the comparative periods. We are currently assessing the impact the adoption of ASU 2014-09 will have on future financial statements.


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