CODEXIS, INC. 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management's discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2019 included in our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on February 28, 2020 (the “Annual Report”). This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These statements include, but are not limited to, expectations regarding our strategy, business plans, financial performance and developments relating to our industry. These statements are often identified by the use of words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Part II, Item 1A: “Risk Factors” of this Quarterly Report on Form 10-Q and Part I, Item 1A: “Risk Factors” of our Annual Report, as incorporated herein and referenced in Part II, Item 1A: “Risk Factors" of this Quarterly Report on Form 10-Q and elsewhere in this report. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable law. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q. Business Overview We discover, develop and sell proteins that deliver value to our clients in a growing set of industries. We view proteins as a vast untapped source of value-creating materials, and we are using our proven technologies, which we have been continuously improving since our inception in 2002, to commercialize an increasing number of novel proteins, both as proprietary Codexis products and in partnership with our customers. We are a pioneer in the harnessing of computational technologies to drive biology advancements. Since 2002, we have made substantial investments in the development of our CodeEvolver ® protein engineering technology platform, the primary source of our competitive advantage. Our technology platform is powered by proprietary, artificial intelligence-based, computational algorithms that rapidly mine our large and continuously growing library of protein variants’ performance attributes. These computational outputs enable increasingly reliable predictions for next generation protein variants to be engineered, enabling delivery of targeted performance enhancements in a time-efficient manner. In addition to its computational prowess, our CodeEvolver ® protein engineering technology platform integrates additional modular competencies, including robotic high-throughput screening and genomic sequencing, organic chemistry and process development which are all coordinated to create our novel protein innovations. Our approach to developing commercially viable biocatalytic manufacturing processes begins by conceptually designing the most cost-effective and practical process for a targeted product. We then develop optimized protein catalysts to enable that process design using our CodeEvolver ® protein engineering platform technology. Engineered protein catalyst candidates many thousands for each protein engineering project are then rapidly screened and validated in high throughput screening under relevant manufacturing operating conditions. This approach results in an optimized protein catalyst enabling cost-efficient processes that typically are relatively simple to run in conventional manufacturing equipment. This also allows for the efficient technical transfer of our process to our manufacturing partners. The successful embodiment of our CodeEvolver ® protein engineering technology platform in commercial manufacturing processes requires well-integrated expertise in a number of technical disciplines. In addition to those directly involved in practicing our CodeEvolver ® protein engineering platform technology, such as molecular biology, enzymology, microbiology, cellular engineering, metabolic engineering, bioinformatics, biochemistry and high throughput analytical chemistry, our process development projects also involve integrated expertise in organic chemistry, chemical process development, chemical engineering, fermentation process development and fermentation engineering. Our integrated, multi-disciplinary approach to biocatalyst and process development is a critical success factor for the Company. 38 We initially commercialized our CodeEvolver ® protein engineering technology platform and products in the pharmaceuticals market, which remains a primary business focus. Our customers, which include many large global pharmaceutical companies, use our technology, products and services in their manufacturing processes and process development. We have also licensed our proprietary CodeEvolver ® protein engineering technology platform to global pharmaceutical companies so that they may in turn use this technology to engineer enzymes for their own businesses. Most recently, in May 2019, we entered into a Platform Technology Transfer and License Agreement (the “Novartis CodeEvolver ® Agreement”) with Novartis Pharma AG (“Novartis”). The Novartis CodeEvolver ® Agreement allows Novartis to use our proprietary CodeEvolver ® protein engineering platform technology in the field of human healthcare. As evidence of our strategy to extend our technology beyond pharmaceutical manufacturing, we have also used the technology to develop protein catalysts and industrial enzymes for use in a wider set of industrial markets. These target industries consist of several large market verticals, including food and food ingredients, animal feed, consumer care, flavors, fragrances and agricultural chemicals. In addition, we are using our technology to develop enzymes for customers using next generation sequencing ("NGS") and polymerase chain reaction ("PCR/qPCR") for in vitro molecular diagnostic and genomic research applications. In December 2019, we entered into a license agreement to provide Roche Sequencing Solutions, Inc. ("Roche") with our first enzyme for this target market, the Company's EvoT4™ DNA ligase. In June 2020, we entered into a co-marketing and enzyme supply collaboration agreement with Alphazyme LLC for the production and co-marketing of enzymes for life science applications including, initially, high-fidelity DNA polymerase, T7 RNA polymerase and reverse transcriptase enzymes We have also begun using the CodeEvolver ® protein engineering technology platform to develop early stage, novel biotherapeutic product candidates, both for our customers and for our own business. Our first lead program was for the potential treatment of phenylketonuria ("PKU") in humans. PKU is an inherited metabolic disorder in which the enzyme that converts the essential amino acid phenylalanine into tyrosine is deficient. In October 2017, we entered into the "Nestlé Agreement” with Nestlé Health Science to advance CDX-6114, our enzyme biotherapeutic product candidate for the potential treatment of PKU. In February 2019, Nestlé Health Science exercised its option to obtain an exclusive license to develop and commercialize CDX-6114. In January 2020, we entered a development agreement with Nestlé Health Science to advance a lead candidate, CDX-7108, into preclinical development and early clinical studies. CDX-7108 is the lead candidate for a potential treatment for a gastro-intestinal disorder. In parallel, the original Strategic Collaboration Agreement was extended through December 2021 to support the discovery of therapeutic candidates for additional disorders. In March 2020, we entered into a Strategic Collaboration and License Agreement (“Takeda Agreement”) with Shire Human Genetic Therapies, Inc., a wholly-owned subsidiary of Takeda Pharmaceutical Company Limited (“Takeda”), for the research and development of novel gene therapies for certain disease indications, including the treatment of lysosomal storage disorders and blood factor deficiencies. Business Segments We manage our business as two business segments: Performance Enzymes and Novel Biotherapeutics. Performance Enzymes We initially commercialized our CodeEvolver ® protein engineering technology platform and products in the pharmaceuticals market, and to date this continues to be our largest market served. Our customers, which include many large global pharmaceutical companies, use our technology, products and services in their manufacturing processes and process development. We have also used the technology to develop customized enzymes for use in other industrial markets. These markets consist of several large industrial verticals, including food and food ingredients, animal feed, consumer care, flavors, fragrances, and agricultural chemicals. We also use our technology to develop enzymes for customers using NGS and PCR/qPCR for in vitro molecular diagnostic and molecular biology research applications. 39 Novel Biotherapeutics We are also targeting new opportunities in the pharmaceutical industry to discover, improve, and/or develop biotherapeutic drug candidates. We believe that our CodeEvolver ® protein engineering platform technology can be used to discover novel biotherapeutic drug candidates that will target human diseases that are in need of improved therapeutic interventions. Similarly, we believe that we can deploy our platform technology to improve specific characteristics of a customer’s pre-existing biotherapeutic drug candidate, such as its activity, stability or immunogenicity. Our first lead program was for the potential treatment of hyperphenylalaninemia (“HPA”) (also referred to as PKU) in humans. PKU is an inherited metabolic disorder in which the enzyme that converts the essential amino acid phenylalanine into tyrosine is deficient. In October 2017, we announced a global development, option and license agreement with Nestlé Health Science, to advance CDX-6114, our own novel orally administrable enzyme therapeutic candidate for the potential treatment of PKU. In July 2018, we announced that we had dosed the first subjects in a first-in-human Phase 1a dose-escalation trial with CDX-6114 for the potential treatment of PKU. The initiation of the trial triggered a $4.0 million milestone payment from Nestlé Health Science. The $1.0 million milestone payment that was triggered by the achievement of a formulation relating to CDX-6114 was received in February 2019. In January 2019, we received notice from the U.S. Food and Drug Administration (the “FDA”) that it had completed its review of our investigational new drug application (“IND”) for CDX-6114 and concluded that we may proceed with the proposed Phase 1b multiple ascending dose study in healthy volunteers in the United States. In February 2019, Nestlé Health Science exercised its option to obtain an exclusive, worldwide, royalty-bearing, sub-licensable license for the global development and commercialization of CDX-6114 for the management of PKU. As a result of the option exercise, we earned a milestone and recognized $3.0 million in revenues in the first quarter of 2019. Upon exercising its option, Nestlé Health Science assumed all responsibilities for future clinical development and commercialization of CDX-6114, with the exception of the completion of an extension study, CDX-6114-004, which was substantially completed in the fourth quarter of 2019. In October 2017, we separately entered into a Strategic Collaboration Agreement with Nestlé Health Science pursuant to which we and Nestlé Health Science are collaborating to leverage the CodeEvolver ® platform technology to develop other novel enzymes for Nestlé Health Science’s established Consumer Care and Medical Nutrition business areas. In January 2020, we and Nestlé Health Science entered into a development agreement pursuant to which we and Nestlé Health Science are collaborating to advance a lead candidate targeting a gastro-intestinal disorder discovered through our Strategic Collaboration Agreement into pre-clinical and early clinical studies. The Strategic Collaboration Agreement was extended through December 2021. Using our CodeEvolver ® protein engineering platform technology, we have also developed a pipeline of other biotherapeutic drug candidates, which are in preclinical development. We expect to continue to make additional investments in our pipeline with the aim of advancing additional product candidates targeting other therapeutic areas. In March 2020, we entered into the Takeda Agreement with Takeda pursuant to which we are collaborating to research and develop protein sequences for use in gene therapy products for certain disease indications in accordance with each applicable program plans for Fabry Disease, Pompe Disease, and an unnamed blood factor deficiency. In March 2020, we received a one-time, non-refundable cash payment of $8.5 million. For further description of our business segments, see Note 13, "Segment, Geographical and Other Revenue Information" in the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Business Update Regarding COVID-19 We are subject to risks and uncertainties as a result of the current COVID-19 pandemic. The COVID-19 pandemic has presented a substantial public health and economic challenge around the world and is affecting our employees, communities and business operations, as well as the U.S. economy and other economies worldwide. The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations and financial condition will depend on future developments that are highly uncertain and cannot be accurately predicted, including the duration and severity of the pandemic and the extent and severity of the impact on our customers, new information that may emerge concerning COVID-19, the actions taken to contain it or treat its impact and the economic impact on local, regional, national and international markets. To date, we and our collaboration partners have been able to continue to supply our enzymes to our customers worldwide. However, we are dependent on our manufacturing and logistics partners and consequently, disruptions in operations of our partners and customers may affect our ability to supply enzymes to our customers. Furthermore, our ability to provide future research and development ("R&D") services will continue to be impacted as a result of governmental orders and any disruptions in operations of our customers with whom we collaborate. We are continuing to assess the potential impact of the COVID-19 pandemic on our business and operations, including our product sales, R&D service revenue, expenses and manufacturing. However, we are unable to fully determine and quantify the extent to which this pandemic affected our total revenues due to complex accounting judgments. 40 In the U.S., the impact of COVID-19, including governmental orders ("Orders") governing the operation of businesses during the pandemic, caused the temporary closure of our Redwood City, California facilities and has disrupted our research and development operations. Research and development operations for all other projects were temporarily suspended from mid-March 2020 through the end of April in accordance with these Orders. In May 2020, we initiated limited operations and gradually ramped up our R&D operations so that we are currently utilizing the majority of our normal R&D capacity. Additionally, we have resumed small scale manufacturing at our Redwood City pilot plant in May 2020. Our future results of operations and liquidity could be adversely impacted by delays in payments of outstanding receivable amounts beyond normal payment terms, supply chain disruptions and uncertain demand, and the impact of any initiatives or programs that we may undertake to address financial and operations challenges faced by our customers. The extent to which the COVID-19 pandemic may materially impact our financial condition, liquidity, or results of operations is uncertain. For additional information on the various risks posed by the COVID-19 pandemic, please read Item 1A. Risk Factors included in this Quarterly Report on Form 10-Q. Recent Investing Activities In June 2020, we entered into a Master Collaboration and Research Agreement (“MAI Agreement”) with Molecular Assemblies, Inc. (“MAI”), to engineer enzymes to deliver differentiated and cost-effective solutions for the enzymatic synthesis of DNA. Under an associated stock purchase agreement, we purchased 1,587,050 shares of MAI's Series A preferred stock for $1.0 million and in connection with our investment, John Nicols, our chief executive officer, joined MAI’s board of directors. Under the MAI Agreement, for a fixed monthly fee payable in shares of Series A preferred stock, we will apply our CodeEvolver ® protein engineering platform technology to improve the DNA polymerase enzymes that are critical for enzymatic DNA synthesis. Through the provision of these services, we are eligible to earn additional shares of Series A preferred stock. MAI will combine its advanced chemistries with our enzymes to drive the process to commercialization. For additional information, see Note 12, "Related Party Transactions," in the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Results of Operations Overview Total revenues increased to $15.0 million for the second quarter of 2020 from $12.3 million for the second quarter of 2019, due to increases in research and development revenue partially offset by decreases in product revenue. Product revenue for the second quarter of 2020 decreased by $1.7 million to $4.5 million from $6.2 million for the second quarter of 2019 due to timing of customer demand for branded products. Research and development revenue increased by $4.4 million for the second quarter of 2020 to $10.5 million from $6.1 million in the second quarter of 2019, primarily due to revenues from Novartis under the Novartis CodeEvolver ® Agreement and recognition of license fees from Takeda under the Takeda Agreement, partially offset by lower revenue as a result of delays attributable to the COVID-19 pandemic. Product gross margins were 62% for the second quarter of 2020, compared to 56% in the second quarter of 2019, due to improved product mix. Our profit margins are affected by many factors including product pricing and costs of internal and third-party fixed and variable costs. Profit margin data are used as a management performance measure to provide additional information regarding our results of operations on a consolidated basis. Research and development expense increased by $2.6 million, or 31%, to $10.9 million for the second quarter of 2020, compared to the second quarter of 2019, primarily due to an increase in costs associated with outside services relating to Chemistry, Manufacturing and Controls ("CMC") and regulatory expenses, higher headcount, and higher allocable expenses, partially offset by lower lab supply expenses and outside services. Selling, general and administrative expense increased by $0.6 million, or 8%, to $8.5 million for the second quarter of 2020 compared to the second quarter of 2019, primarily due to an increase in costs associated with legal and accounting fees, higher facilities and headcount offset by lower allocable expenses. Income earned in certain countries outside of the United States is subject to the imposition of income tax withholding by foreign taxing authorities when the income is paid to the United States. We recognized $0.3 million in income tax expense in the second quarter of 2020 due to the imposition of income tax on revenue by foreign taxing authorities. 41 Net loss for the second quarter of 2020 was $6.3 million, representing a net loss of $0.11 per basic and diluted share. This compares to a net loss of $6.5 million, representing a net loss of $0.12 per basic and diluted share for the second quarter of 2019. The decrease in net loss for the second quarter over the same period of the prior year is primarily related to increases in research and development revenue partially offset by higher research and development expenses and lower product revenue and related costs. Cash and cash equivalents decreased by $14.8 million to $75.6 million as of June 30, 2020 compared to $90.5 million as of December 31, 2019. Net cash used in operating activities increased to $11.5 million in the six months ended June 30, 2020 compared to $7.9 million in the six months ended June 30, 2019. We believe that based on our current level of operations, our existing cash, and cash equivalents will provide adequate funds for ongoing operations, planned capital expenditures and working capital requirements for at least the next 12 months. In June 2017, we entered into a loan and security agreement that allows us to borrow up to $10.0 million under a term loan, and up to $5.0 million under a revolving credit facility with 80% of certain eligible accounts receivable as a borrowing base (the "Credit Facility"). Obligations under the Credit Facility are secured by a lien on substantially all of our personal property other than our intellectual property. In September 2019, we entered into a Seventh Amendment to the Credit Facility whereby the draw period on the term debt was extended to September 30, 2020. We may draw on the Term Debt at any time prior to September 30, 2020, subject to customary conditions for funding including, among others, that no event of default exists. As of June 30, 2020, no amounts were borrowed under the Credit Facility and we were in compliance with the covenants for the Credit Facility. See Note 11, "Commitments and Contingencies" in the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. Below is an overview of our results of operations by business segments: Performance Enzymes Revenues decreased by $3.1 million, or 29%, to $7.5 million for the second quarter of 2020, compared to the second quarter of 2019, Product gross margins were 62% in the second quarter of 2020, compared to 56% in the corresponding period in 2019 due to variations in product mix. Research and development expense decreased by $0.1 million, or 3%, to $5.0 million for the second quarter of 2020, compared to the second quarter of 2019, primarily due to lower allocable expenses and lab supplies costs partially offset by an increase in costs associated with higher headcount and outside services. Selling, general and administrative expense increased by $13 thousand, or 1%, to $2.4 million for the second quarter of 2020, compared to the second quarter of 2019, primarily due to higher stock compensation expense and allocable expenses partially offset by lower costs associated with travel and outside services. Novel Biotherapeutics Revenues increased by $5.7 million, or 331%, to $7.5 million for the second quarter of 2020, compared to the second quarter of 2019, primarily due to recognition of license fees from Takeda under the Takeda Strategic Collaboration and License Agreement, partially offset by a decrease in prior year functional license fee revenue from Nestlé Health Science. Research and development expense increased by $2.6 million, or 92%, to $5.5 million for the second quarter of 2020, compared to the second quarter of 2019, primarily due to an increase in costs associated with outside services relating to CMC regulatory expenses, higher outside services, higher headcount and higher stock compensation expense. Selling, general and administrative expense increased by $0.1 million, or 11%, to $0.6 million for the second quarter of 2020 compared to the second quarter of 2019, primarily due to an increase in costs associated with higher headcount, higher allocable expense and higher stock-based compensation. GSK Platform Technology Transfer, Collaboration and License Agreement In July 2014, we entered into a CodeEvolver ® protein engineering platform technology transfer collaboration and license agreement (the "GSK CodeEvolver ® Agreement") with GlaxoSmithKline ("GSK"). Pursuant to the terms of the agreement, we granted GSK a non-exclusive license to use the CodeEvolver ® protein engineering platform technology to develop novel enzymes for use in the manufacture of GSK's pharmaceutical and health care products. 42 We received an up-front fee upon the execution of the agreement in July 2014 and milestone payments in each of the years from 2014 through April 2016. We completed the transfer of the CodeEvolver ® protein engineering platform technology to GSK in April 2016 and all revenues relating to the technology transfer have been recognized as of April 2016. We have the potential to receive additional cumulative contingent payments that range from $5.75 million to $38.5 million per project based on GSK’s successful application of the licensed technology. We are also eligible to receive royalties based on net sales, if any, of a limited set of products developed by GSK using our CodeEvolver ® protein engineering platform technology. In September 2019, we recognized revenue of $2.0 million for the milestone payment from GSK relating to the advancement of an enzyme developed by GSK using our CodeEvolver ® protein engineering platform technology. We recognized no research and development revenue for the three and six months ended June 30, 2020 and 2019. Merck Platform Technology Transfer and License Agreement In August 2015, we entered into a CodeEvolver ® platform technology transfer collaboration and license agreement (the "Merck CodeEvolver ® Agreement") with Merck, Sharp & Dohme ("Merck"), which allows Merck to use the CodeEvolver ® protein engineering technology platform in the field of human and animal healthcare. We received an up-front license fee upon execution of the Merck CodeEvolver ® Agreement, and milestone payments in September 2015 and in September 2016, when we completed the transfer of the engineering platform technology. Additionally, we recognized research and development revenues of $0.2 million and $1.0 million for the three and six months ended June 30, 2020, respectively, compared to $1.0 million and $2.0 million for the three and six months ended June 30, 2019, respectively, for various research projects under our collaborative arrangement. We have the potential to receive payments of up to a maximum of $15.0 million for each commercial active pharmaceutical ingredient ("API") that is manufactured by Merck using one or more novel enzymes developed by Merck using the CodeEvolver ® protein engineering technology platform. The API payments are based on the quantity of API developed and manufactured by Merck and will be recognized as usage-based royalties. In January 2019, we entered into an amendment to the Merck CodeEvolver ® Agreement to install certain CodeEvolver ® protein engineering technology upgrades into Merck’s platform license installation and maintain those upgrades for a multi-year term. The license installation was completed in 2019 and we recognized $0.9 million as license fee revenue accordingly in three and six months ended June 30, 2019, respectively, under the amendment. Pursuant to the agreement, Merck has options to future technology enhancements for a specified fee. As of June 30, 2020, Merck has not exercised its option for technology enhancements. We recognized $25 thousand and $0.1 million in research and development revenues for the three and six months ended June 30, 2020, respectively. As of June 30, 2020 and December 31, 2019, we had deferred revenue balances of $0.1 million and nil, respectively. Global Development, Option and License Agreement, Strategic Collaboration Agreement, and Development Agreement In October 2017, we entered into the Nestlé Agreement with Societé des Produits Néstle S.A., formerly known as Nestec Ltd. ("Nestlé Health Science") and, solely for the purpose of the integration and the dispute resolution clauses of the Agreement, Nestlé Health Science S.A., to advance CDX-6114, our enzyme biotherapeutic product candidate for the potential treatment of PKU. We received an upfront cash payment of $14.0 million upon the execution of the Nestlé Agreement, a $4.0 million milestone payment after dosing the first subjects in a first-in-human Phase 1a dose-escalation trial with CDX-6114, and a $1.0 million milestone payment upon achievement of a milestone relating to formulation of CDX-6114. The $4.0 million milestone payment that was triggered by the initiation of the trial was received in September 2018 and the $1.0 million milestone payment that was triggered by the achievement of a formulation relating to CDX-6114 was received in February 2019. The upfront payment and the variable consideration relating to the progress payment of $4.0 million and milestone payment of $1.0 million were recognized over time as the development work was performed. Revenue was recognized using a single measure of progress that depicted our performance in transferring control of the services, which was based on the ratio of level of effort incurred to date compared to the total estimated level of effort required to complete all performance obligations under the agreement. We recognized nominal research and development revenue for the three and six months ended June 30, 2020, respectively, compared to $0.5 million and $1.7 million for the three and six months ended June 30, 2019, respectively. 43 In January 2019, we received notice from the U.S. Food and Drug Administration (the "FDA") that it had completed its review of our investigational new drug application (" IND") for CDX-6114 and concluded that we may proceed with the proposed Phase 1b multiple ascending dose study in healthy volunteers in the United States. In February 2019, Nestlé Health Science exercised its option to obtain an exclusive, worldwide, royalty-bearing, sub-licensable license for the global development and commercialization of CDX-6114 for the management of PKU. The option payment of $3.0 million was recognized in the first quarter of 2019 as research and development revenue. Upon exercising its option, Nestlé Health Science assumed all responsibilities for future clinical development and commercialization of CDX-6114, with the exception of the completion of an extension study, CDX-6114-004, which was substantially completed in the fourth quarter of 2019. We are eligible to receive payments from Nestlé Health Science under the Nestlé Agreement that include (i) development and approval milestones of up to $85.0 million, (ii) sales-based milestones of up to $250.0 million in the aggregate, which aggregate amount is achievable if net sales exceed $1.0 billion in a single year, and (iii) tiered royalties, at percentages ranging from the middle single digits to low double-digits, of net sales of Product. In October 2017, we also entered into a Strategic Collaboration Agreement (the “Strategic Collaboration Agreement”) with Nestlé Health Science pursuant to which we and Nestlé Health Science are collaborating to leverage the CodeEvolver ® protein engineering technology platform to develop novel enzymes for Nestlé Health Science’s established Consumer Care and Medical Nutrition business areas. Under the Strategic Collaboration Agreement, we received an upfront payment of $1.2 million in 2017 and an incremental $0.6 million payment in September 2018 for additional services. In January 2020, we and Nestlé Health Science entered into a development agreement pursuant to which we and Nestlé Health Science are collaborating to advance a lead candidate, CDX-7108, targeting a gastro-intestinal disorder discovered through our Strategic Collaboration Agreement into pre-clinical and early clinical studies. The Strategic Collaboration Agreement was extended through December 2021. We recognized research and development fees of $1.7 million and $3.3 million for the three and six months ended June 30, 2020, respectively, compared to $1.2 million and $2.5 million for the three and six months ended June 30, 2019, respectively. Strategic Collaboration Agreement In April 2018, we entered into the Porton Agreement with Porton to license key elements of our biocatalyst technology for use in Porton’s global custom intermediate and API development and manufacturing business. Under the Porton Agreement, we are eligible to receive annual collaboration fees and research and development revenues. We received an initial collaboration fee of $0.5 million within 30 days of the effective date, $1.5 million upon the first anniversary of the effective date of the agreement. We recognized revenue of $1.0 million upon the second anniversary of the effective date of the agreement. We are eligible to receive $1.0 million on the third anniversary of the effective date of the agreement. We completed the technical transfer in the fourth quarter of 2018. Revenue relating to the functional license provided to Porton was recognized at a point in time when control of the license transferred to the customer. We recognized research and development revenue related to the Porton Agreement of $1.0 million and $1.1 million in the three and six months ended June 30, 2020, respectively, compared to nil in the three and six months ended June 30, 2019. 44 Platform Technology Transfer and License Agreement In May 2019, we entered into a Platform Technology Transfer and License Agreement (the “Novartis CodeEvolver ® Agreement”) with Novartis Pharma AG (“Novartis”). The Agreement allows Novartis to use our proprietary CodeEvolver ® protein engineering platform technology in the field of human healthcare. Under the Novartis CodeEvolver ® Agreement, we are transferring our proprietary CodeEvolver ® protein engineering platform technology to Novartis over approximately 23 months starting with the date on which we commenced the technology transfer (the “Technology Transfer Period”). As a part of this technology transfer, the Company provided to Novartis our proprietary enzymes, proprietary protein engineering protocols and methods, and proprietary software algorithms. In addition, teams of the Company and Novartis scientists participated in technology training sessions and collaborative research projects at our laboratories in Redwood City, California and at a designated Novartis laboratory in Basel, Switzerland. Upon completion of technology transfer, Novartis will have the CodeEvolver ® protein engineering platform technology installed at its designated laboratory. Pursuant to the agreement, we received an upfront paym ent of $5.0 million shortly after the effective date of the Novartis CodeEvolver ® Agreement. In the second quarter of 2020, we completed the second technology milestone transfer under the agreement and became eligible to receive a milestone payment of $4.0 million, which we subsequently received in July 2020. We are eligible to receive an additional $5.0 million up on satisfactory completion of the third technology transfer milestone. In consideration for the continued disclosure and license of improvements to our technology and materials during a multi-year period that begins on the conclusion of the Technology Transfer Period (“Improvements Term”), Novartis will pay us annual payments which amount to an additional $8.0 million. The Company also has the potential to receive quantity-dependent, usage payments for each API that is manufactured by Novartis using one or more enzymes that have been developed or are in development using the CodeEvolver ® protein engineering platform technology during the period that begins on the conclusion of the Technology Transfer Period and ends on the expiration date of the last to expire licensed patent. These product-related usage payments, if any, will be paid by Novartis to the Company for each quarter that Novartis manufactures API using a CodeEvolver ® -developed enzyme. The usage payments will be based on the total volume of API produced using the CodeEvolver ® -developed enzyme. These usage payments can begin in the clinical stage and will extend throughout the commercial life of each API. Revenue for the combined initial license and technology transfer performance obligation, which is expected to occur over twenty-three months, is being recognized using a single measure of progress that depicts our performance in transferring control of the services, which is based on the ratio of level of effort incurred to date compared to the total estimated level of effort required to complete the performance obligation relating to the combined initial license and technology transfer. Revenue allocated to future improvements will be recognized during the Improvement Term. We recognized $0.9 million and $3.7 million in research and development revenue for the three and six months ended June 30, 2020, respectively, and no revenue for the three and six months ended June 30, 2019, respectively, from the Novartis CodeEvolver ® Agreement. Strategic Collaboration and License Agreement In March 2020, we entered into a Strategic Collaboration and License Agreement (the “Takeda Agreement”) with Shire Human Genetic Therapies, Inc., a wholly-owned subsidiary of Takeda Pharmaceutical Co. Ltd. (“Takeda”), under which we will collaborate to research and develop protein sequences for use in gene therapy products for certain diseases. On execution of the Takeda Agreement, we received an up-front non-refundable cash payment of $8.5 million. Revenue relating to the functional licenses provided to Takeda was recognized at a point in time when the control of the license transferred to the customer. We recognized license fees of $5.7 million and $8.0 million as research & development revenue in the three and six months ended June 30, 2020, respectively. Other potential payments from Takeda include (i) reimbursement of research and development fees and pre-clinical approval milestones for initial programs of up to $22.3 million, (ii) development and commercialization-based milestones, per target gene, of up to $100.0 million, the modulation of which leads to treatment of certain diseases by the applicable product, and (iii) tiered royalties, at percentages ranging from the middle-single digit to low single-digit of sales of the applicable product. Master Collaboration and Research Agreement and Stock Purchase Agreement In June 2020, we entered into a Stock Purchase Agreement with Molecular Assemblies, Inc. (“MAI”) pursuant to which we purchased 1,587,050 shares of MAI's Series A preferred stock for $1.0 million. In connection with the transaction, our chief executive officer, John Nicols, also joined MAI’s board of directors. 45 At the same time, we entered into a Master Collaboration and Research Agreement (the “MAI Agreement”) with MAI to engineer DNA polymerase enzymes to deliver differentiated and cost-effective solutions for the enzymatic synthesis of DNA. Under the MAI Agreement and its related statement of work (“SOW”), we will apply our CodeEvolver ® protein engineering platform technology to improve the DNA polymerase enzymes that are critical for enzymatic DNA synthesis. Based on these services, the Company is eligible to earn additional shares of MAI's Series A preferred stock. MAI will combine its advanced chemistries with our enzymes to drive the process to commercialization. Under the MAI Agreement and its associated SOW, we will engage in research and development activities to engineer DNA polymerase enzymes for the enzymatic synthesis of DNA in exchange for monthly fees in the form of shares of Series A preferred stock in MAI. We are eligible to earn such non-monetary payments over ten to thirteen months, and any such shares would be issued thirty days in arrears after each calendar quarter-end. We are also eligible to receive amounts for bonuses, targets and milestones on achievement of timeline and project goals specified in the SOW. Payments for bonuses, targets and milestones on achievement of timeline and project goals are to be issued thirty days after the Company provides notification of completion. Under the MAI Agreement, the Company will have the right to use and sell the engineered enzymes to third parties for any purpose other than for the synthesis of native DNA. Under the MAI Agreement, we would make a $0.5 million payment to MAI on meeting a milestone of $5.0 million in aggregate commercial sales by the Company to third parties of the engineered enzymes or any product incorporating or derived from the engineered enzymes for any purpose other than the synthesis of native DNA. The MAI Agreement contemplates that we and MAI will enter into a Commercialization and Enzyme Supply Agreement (the “CESA”) within six months following the completion of certain timelines specified in the SOW. In addition, we and MAI have agreed pursuant to the MAI Agreement to certain terms to be contained within the CESA in the event that the CESA becomes executed in the future. Those include: (a) that MAI would receive an exclusive license to use the DNA polymerase enzymes engineering by us under the MAI Agreement in the synthesis of native DNA and a non-exclusive license to use these enzymes for research and development on the synthesis of non-native DNA, and (b) that we would become the exclusive manufacturer of these enzymes for MAI, its affiliates and licensees. We recognized no research and development revenue in the three and six months ended June 30, 2020 from transactions with MAI. Results of Operations The following table shows the amounts from our unaudited condensed consolidated statements of operations for the periods presented (in thousands): Three months ended June 30, Change Six months ended June 30, Change 2020 2019 $ % 2020 2019 $ % Revenues: Product revenue $ 4,504 $ 6,249 $ (1,745) (28)% $ 9,604 $ 14,236 $ (4,632) (33)% Research and development revenue 10,463 6,070 4,393 72% 20,033 13,665 6,368 47% Total revenues 14,967 12,319 2,648 21% 29,637 27,901 1,736 6% Costs and operating expenses: Cost of product revenue 1,699 2,772 (1,073) (39)% 4,240 7,163 (2,923) (41)% Research and development 10,853 8,274 2,579 31% 21,820 16,290 5,530 34% Selling, general and administrative 8,522 7,896 626 8% 17,512 16,311 1,201 7% Total costs and operating expenses 21,074 18,942 2,132 11% 43,572 39,764 3,808 10% Loss from operations (6,107) (6,623) 516 8% (13,935) (11,863) (2,072) (17)% Interest income 57 220 (163) (74)% 323 450 (127) (28)% Other income (expenses), net 13 (88) 101 115% (72) (211) 139 66% Loss before income taxes (6,037) (6,491) 454 7% (13,684) (11,624) (2,060) (18)% Provision for income taxes 307 16 291 1,819% 312 19 293 1,542% Net loss $ (6,344) $ (6,507) $ 163 3% $ (13,996) $ (11,643) $ (2,353) (20)% 46 Revenues Our revenues comprise product revenue and research and development revenue as follows: • Product revenue consists of sales of protein catalysts, pharmaceutical intermediates, and Codex ® biocatalyst panels and kits. • Research and development revenue include license, technology access and exclusivity fees, research services fees, milestone payments, royalties, optimization and screening fees. The following table shows the amounts of our product revenue and research and development revenue from our unaudited condensed consolidated statements of operations for the periods presented (in thousands): Three months ended June 30, Change Six months ended June 30, Change (In Thousands) 2020 2019 $ % 2020 2019 $ % Product revenue $ 4,504 $ 6,249 $ (1,745) (28)% $ 9,604 $ 14,236 $ (4,632) (33)% Research and development revenue 10,463 6,070 4,393 72% 20,033 13,665 6,368 47% Total revenues $ 14,967 $ 12,319 $ 2,648 21% $ 29,637 $ 27,901 $ 1,736 6% Revenues typically fluctuate on a quarterly basis due to the variability in our customers' manufacturing schedules and the timing of our customers' clinical trials. In addition, we have limited internal capacity to manufacture enzymes. As a result, we are dependent upon the performance and capacity of third-party manufacturers for the commercial scale manufacturing of the enzymes used in our pharmaceutical and fine chemicals business. We accept purchase orders for deliveries covering periods from one day up to approximately 14 months from the date on which the order is placed. However, a majority of the purchase orders can be revised or cancelled by the customer without penalty. Considering these industry practices and our experience, we do not believe the total of customer purchase orders outstanding (backlog) provides meaningful information that can be relied on to predict actual sales for future periods. Total revenues increased by $2.6 million and $1.7 million in the three and six months ended June 30, 2020, respectively, compared to the same periods in 2019, primarily due to higher research and development revenue offset by lower product revenue. Product revenue decreased by $1.7 million and $4.6 million in the three and six months ended June 30, 2020, respectively, compared to the same periods in 2019, primarily due to timing of customer demand for branded products. Research and development revenue increased by $4.4 million and $6.4 million in the three and six months ended June 30, 2020, respectively, compared to the same periods in 2019. The increase in research and development revenue was primarily due to revenues from Novartis Pharma AG under the Novartis CodeEvolver ® Agreement, recognition of license fees from Takeda under the Takeda Strategic Collaboration and License Agreement, and recognition of license fees from Porton, partially offset by lower revenue and prior year functional license fee revenue from Nestlé Health Science. 47 Cost and Operating Expenses Our cost and operating expenses comprise cost of product revenue, research and development expense, and selling, general and administrative expense. The following table shows the amounts of our cost of product revenue, research and development expense, and selling, general and administrative expense from our unaudited condensed consolidated statements of operations for the periods presented (in thousands): Three months ended June 30, Change Six months ended June 30, Change (In Thousands) 2020 2019 $ % 2020 2019 $ % Cost of product revenue $ 1,699 $ 2,772 $ (1,073) (39)% 4,240 7,163 $ (2,923) (41)% Research and development 10,853 8,274 2,579 31% 21,820 16,290 5,530 34% Selling, general and administrative 8,522 7,896 626 8% 17,512 16,311 1,201 7% Total costs and operating expenses $ 21,074 $ 18,942 $ 2,132 11% $ 43,572 $ 39,764 $ 3,808 10% Cost of Product Revenue and Product Gross Margin Our revenues from product revenue are derived entirely from our Performance Enzymes segment. Revenues from the Novel Biotherapeutics segment are from collaborative research and development activities and not from product revenue. The following table shows the amounts of our product revenue, cost of product revenue, product gross profit and product gross margin from our unaudited condensed consolidated statements of operations for the periods presented (in thousands): Three months ended June 30, Change Six months ended June 30, Change (In Thousands) 2020 2019 $ % 2020 2019 $ % Product revenue $ 4,504 $ 6,249 $ (1,745) (28)% $ 9,604 $ 14,236 $ (4,632) (33)% Cost of product revenue 1,699 2,772 (1,073) (39)% 4,240 7,163 (2,923) (41)% Product gross profit $ 2,805 $ 3,477 $ (672) (19)% $ 5,364 $ 7,073 $ (1,709) (24)% Product gross margin (%) 62 % 56 % 56 % 50 % Cost of product revenue comprises both internal and third-party fixed and variable costs, including materials and supplies, labor, facilities and other overhead costs associated with our product revenue. Product gross margins were 62% and 56% in the three and six months ended June 30, 2020, respectively, compared to 56% and 50% and in the corresponding periods in 2019 due to variations in product mix. Research and Development Expenses Research and development expenses consist of costs incurred for internal projects as well as collaborative research and development activities. These costs primarily consist of (i) employee-related costs, which include salaries and other personnel-related expenses (including stock-based compensation), (ii) various allocable expenses, which include occupancy-related costs, supplies, and depreciation of facilities and laboratory equipment, and (iii) external costs. Research and development expenses are expensed when incurred. Research and development expenses increased by $2.6 million, or 31%, during the three months ended June 30, 2020 and by $5.5 million, or 34%, in the six months ended June 30, 2020, compared to the same periods in 2019. The increase in research and development expenses was primarily due to an increase in costs associated with outside services relating to CMC and regulatory expenses, higher headcount, and higher allocable expenses partially offset by lower lab supplies and outside services. 48 Selling, General and Administrative Expenses Selling, general and administrative expenses consist of employee-related costs, which include salaries and other personnel-related expenses (including stock-based compensation), hiring and training costs, consulting and outside services expenses (including audit and legal costs), marketing costs, building lease costs, and depreciation and amortization expense. Selling, general and administrative expenses increased by $0.6 million, or 8%, in the three months ended June 30, 2020. and by $1.2 million, or 7%, in the six months ended June 30, 2020 compared to the same periods in 2019. The increase in selling, general and administrative expense was primarily due to an increase in costs associated with legal and accounting fees, higher facilities and headcount, and licensed technology partially offset by lower allocable expenses and lower travel expenses. Interest Income and Other Expense Three months ended June 30, Change Six months ended June 30, Change (In Thousands) 2020 2019 $ % 2020 2019 $ % Interest income $ 57 $ 220 $ (163) (74)% 323 450 $ (127) (28)% Other income (expense), net 13 (88) 101 115% (72) (211) 139 66% Total other income $ 70 $ 132 $ (62) (47)% $ 251 $ 239 $ 12 5% Interest Income Interest income decreased by $0.2 million and $0.1 million in the three and six months ended June 30, 2020, respectively, compared to the same periods in 2019 due to lower average interest rates on declining average cash balances. Other Income (Expense) Other income increased by $0.1 million in three and six months ended June 30, 2020, respectively, compared to the same period in 2019 due to increases in fluctuations in foreign currency. Provision for Income Taxes We recognized an income tax provision of $0.3 million in the three and six months ended June 30, 2020, respectively. We recognized an income tax provision of $16 thousand and $19 thousand in the three and six months ended June 30, 2019, respectively. The increase in income tax provision was primarily due to mandatory income tax withheld by a foreign taxing authority and additional interest recorded on uncertain tax positions from previous years. Net loss The net loss for the second quarter of 2020 was $6.3 million, representing a net loss of $0.11 per basic and diluted share. This compares to a net loss of $6.5 million, representing a net loss of $0.12 per basic and diluted share for the second quarter of 2019. The decrease in net loss for the three months ended June 30, 2020 compared to the same period of the prior year was primarily related to increases in revenue partially offset by higher operating expenses and the impact of the COVID-19 pandemic. For the six months ended June 30, 2020, the net loss was $14.0 million, representing a net loss of $0.24 per basic and diluted share. This compares to a net loss of $11.6 million, representing a net loss of $0.21 per basic and diluted share for the six months ended June 30, 2019. The increase in net loss for the six months ended June 30, 2020 compared to the same period of the prior year was primarily related to higher operating expenses and the impact of the COVID-19 pandemic partially offset by increases in revenue. 49 Results of Operations by Segment (in thousands, except percentages) Revenue by segment Three months ended June 30, Change 2020 2019 Performance Enzymes Novel Biotherapeutics Performance Enzymes Novel Biotherapeutics Total Performance Enzymes Novel Biotherapeutics Total $ % $ % Revenues: Product revenue $ 4,504 $ — $ 4,504 $ 6,249 $ — $ 6,249 $ (1,745) (28) % $ — — % Research and development revenue 3,002 7,461 10,463 4,340 1,730 6,070 (1,338) (31) % 5,731 331 % Total revenues $ 7,506 $ 7,461 $ 14,967 $ 10,589 $ 1,730 $ 12,319 $ (3,083) (29) % $ 5,731 331 % Six months ended June 30, Change 2020 2019 Performance Enzymes Novel Biotherapeutics Performance Enzymes Novel Biotherapeutics Total Performance Enzymes Novel Biotherapeutics Total $ % $ % Revenues: Product revenue $ 9,604 $ — $ 9,604 $ 14,236 $ — $ 14,236 $ (4,632) (33) % $ — — % Research and development revenue 8,775 11,258 20,033 6,440 7,225 13,665 2,335 36 % 4,033 56 % Total revenues $ 18,379 $ 11,258 $ 29,637 $ 20,676 $ 7,225 $ 27,901 $ (2,297) (11) % $ 4,033 56 % Revenues from the Performance Enzymes segment decreased by $3.1 million, or 29%, to $7.5 million for the three months ended June 30, 2020, compared to the three months ended June 30, 2019. Revenues decreased by $2.3 million, or 11%, to $18.4 million for the six months ended June 30, 2020, compared to the six months ended June 30, 2019, primarily due to a de crease in product revenue due to timing of customer demand for branded products partially offset by recognition of r evenue from Novartis Pharma AG under the Novartis CodeEvolver ® Agreement, revenue under a license agreement with Roche Sequencing Solutions, Inc. licensing our EvoT4 DNA™ ligase high-performance molecular diagnostic enzyme, and license fees from Porton. Revenues from the Novel Biotherapeutics segment increased by $5.7 million, or 331%, to $7.5 million for the three months ended June 30, 2020, compared to the three months ended June 30, 2019. Revenues increased by $4.0 million, or 56%, to $11.3 million for the six months ended June 30, 2020, compared to the six months ended June 30, 2019, primarily due to recognition of license fees from Takeda under the Takeda Strategic Collaboration and License Agreement, partially offset by a decrease in prior year functional license fee revenue from Nestlé Health Science. 50 Cost and Operating Expenses by Segment Three months ended June 30, Change 2020 2019 Performance Enzymes Novel Biotherapeutics Performance Enzymes Novel Biotherapeutics Total Performance Enzymes Novel Biotherapeutics Total $ % $ % Cost of product revenue $ 1,699 $ — $ 1,699 $ 2,772 $ — $ 2,772 $ (1,073) (39) % $ — — % Research and development (1) 4,997 5,490 10,487 5,134 2,856 7,990 (137) (3) % 2,634 92 % Selling, general and administrative (1) 2,375 621 2,996 2,362 561 2,923 13 1 % 60 11 % Total segment costs and operating expenses $ 9,071 $ 6,111 15,182 $ 10,268 $ 3,417 13,685 $ (1,197) (12) % $ 2,694 79 % Corporate costs 5,386 4,830 Depreciation and amortization 506 427 Total costs and operating expenses $ 21,074 $ 18,942 (1) Research and development expenses and Selling, general and administrative expenses exclude depreciation and amortization of finance leases. Six months ended June 30, Change 2020 2019 Performance Enzymes Novel Biotherapeutics Performance Enzymes Novel Biotherapeutics Total Performance Enzymes Novel Biotherapeutics Total $ % $ % Cost of product revenue $ 4,240 $ — $ 4,240 $ 7,163 $ — $ 7,163 $ (2,923) (41) % $ — 0 % Research and development (1) 10,693 10,415 21,108 9,576 6,172 15,748 1,117 12 % 4,243 69 % Selling, general and administrative (1) 4,720 1,213 5,933 4,463 1,078 5,541 257 6 % 135 13 % Total segment costs and operating expenses $ 19,653 $ 11,628 31,281 $ 21,202 $ 7,250 28,452 $ (1,549) (7) % $ 4,378 60 % Corporate costs 11,293 10,510 Depreciation and amortization 998 802 Total costs and operating expenses $ 43,572 $ 39,764 (1) Research and development expenses and Selling, general and administrative expenses exclude depreciation and amortization of finance leases. 51 For a discussion of product cost of revenue, see " Results of Operations ". Research and development expense in the Performance Enzymes segment decreased by $0.1 million, or 3%, to $5.0 million in the second quarter of 2020, compared to the second quarter of 2019. The decrease was primarily due to lower allocable expenses partially offset by an increase in costs associated with higher headcount and outside services. Research and development expense in the Performance Enzymes segment increased by $1.1 million, or 12%, to $10.7 million in the six months ended June 30, 2020 compared to the corresponding period in 2019. The increase was primarily due to an increase in costs associated with higher headcount partially offset by lower allocable expenses and lab supplies costs. Selling, general and administrative expense in the Performance Enzymes segment increased by $13.0 thousand, or 1%, to $2.4 million in the second quarter of 2020, compared to the second quarter of 2019. Selling, general and administrative expense in the Performance Enzymes segment increased by $0.3 million, or 6%, to $4.7 million in the six months ended June 30, 2020, compared to the corresponding period in 2019. The increase was primarily due to higher stock compensation expense and allocable expenses partially offset by lower costs associated with travel and outside services. Research and development expense in the Novel Biotherapeutics segment increased by $2.6 million, or 92%, to $5.5 million in the second quarter of 2020, compared to the second quarter of 2019. Research and development expense in the Novel Biotherapeutics segment increased by $4.2 million, or 69%, to $10.4 million in the second quarter 2020, compared to the same corresponding period in 2019. The increase was primarily due to an increase in costs associated with outside services relating to CMC regulatory expenses for CDX-7108 which we are developing pursuant to our development agreement with Nestlé Health Science and higher headcount and higher allocable expenses. Selling, general and administrative expense in the Novel Biotherapeutics segment increased by $0.1 million, or 11%, to $0.6 million in the second quarter of 2020, compared to the second quarter of 2019. Selling, general and administrative expense in the Novel Biotherapeutics segment increased by $0.1 million, or 13%, to $1.2 million in the six months ended June 30, 2020, compared to the corresponding period in 2019. The increase was primarily due to an increase in costs associated with higher headcount and higher stock-based compensation partially offset by a reduction in allocable expenses. Liquidity and Capital Resources Liquidity is the measurement of our ability to meet working capital needs and to fund capital expenditures. We have historically funded our operations primarily through cash generated from operations, stock option exercises and public and private offerings of our common stock. We also have the ability to borrow up to $15.0 million under our Credit Facility. We actively manage our cash usage and investment of liquid cash to ensure the maintenance of sufficient funds to meet our working capital needs. The majority of our cash and cash equivalents are held in U.S. banks, and our foreign subsidiaries maintain a limited amount of cash in their local banks to cover their short-term operating expenses. The following is a summary of cash and cash equivalents balances and working capital as of June 30, 2020 and December 31, 2019 (in thousands): (In Thousands) June 30, 2020 December 31, 2019 Cash and cash equivalents $ 75,649 $ 90,498 Working capital $ 87,554 $ 98,817 We have historically experienced negative cash flows from operations as we continue to invest in key technology development projects and improvements to our CodeEvolver ® protein engineering technology platform and expand our business development and collaboration with new customers. Our cash flows from operations will continue to be affected principally by sales and gross margins from licensing our technology to major pharmaceutical companies, product revenue and collaborative research and development services provided to customers, as well as our headcount costs, primarily in research and development. Our primary source of cash flows from operating activities is cash receipts from licensing our technology to major pharmaceutical companies, and our customers for purchases of products and/or collaborative research and development services. Our largest uses of cash from operating activities are for employee-related expenditures, rent payments, inventory purchases to support our product revenue and non-payroll research and development costs. We are actively collaborating with new and existing customers in the pharmaceutical and food industries. We believe that we can utilize our current products and services, and develop new products and services, to increase our revenues and gross margins in future periods. 52 In addition to our existing cash and cash equivalents, we are eligible to earn milestone and other contingent payments for the achievement of defined collaboration objectives and certain royalty payments under our collaboration agreements. Our ability to earn these milestone and contingent payments and the timing of achieving these milestones is primarily dependent upon the outcome of our collaborators’ research and development activities and is uncertain at this time. In 2016, we completed the final phase in the transfer of CodeEvolver ® technology to Merck under the Merck CodeEvolver ® Agreement. Following the completion of the technology transfer to Merck, we are now eligible to receive payments of up to $15.0 million for each commercial API that is manufactured by Merck using one or more novel enzymes developed by Merck using the CodeEvolver ® technology. In addition, depending upon GSK's successful application of the licensed technology, we have the potential to receive additional contingent payments that range from $5.75 million to $38.5 million per project. In May 2019, we entered into a Platform Technology Transfer and License Agreement with Novartis Pharma AG. The Novartis CodeEvolver ® Agreement allows Novartis to use the Company's proprietary CodeEvolver ® protein engineering platform technology in the field of human healthcare. Pursuant to the agreement, we received an upfront payment of $5.0 million shortly after the effective date of the Novartis CodeEvolver ® Agreement. In the second quarter of 2020, we completed the second technology transfer milestone under the agreement and became eligible to receive a milestone payment of $4.0 million, which we subsequently received in July 2020. We are eligible to receive an additional $5.0 million upon satisfactory completion of the third technology transfer milestone. In consideration for the continued disclosure and license of improvements to the our technology and materials during a multi-year period that begins on the conclusion of the Technology Transfer Period, Novartis will pay us annual payments which amount to an additional $8.0 million. In October 2017, we entered into the Nestlé Agreement with Nestlé Health Science. Pursuant to the Nestlé Agreement, Nestlé Health Science paid us an upfront cash payment of $14.0 million. In July 2018, we announced that we had dosed the first subjects in a first-in-human Phase 1a dose-escalation trial with CDX-6114 for the potential treatment of PKU. The initiation of the trial triggered a $4.0 million milestone payment from Nestlé Health Science and the $1.0 million milestone payment that was triggered by the achievement of a formulation relating to CDX-6114 was received in February 2019. In February 2019, Nestlé Health Science exercised its option to obtain an exclusive, worldwide, royalty-bearing, sub-licensable license for the global development and commercialization of CDX-6114 for the management of PKU. The option payment of $3.0 million was recognized in the first quarter of 2019 as research and development revenue. Upon exercising its option, Nestlé Health Science assumed all responsibilities for future clinical development and commercialization of CDX-6114, with the exception of the completion of an extension study, CDX-6114-004, which was substantially completed in the fourth quarter of 2019. Other potential payments from Nestlé Health Science to us under the Nestlé Agreement include (i) development and approval milestones of up to $85.0 million, (ii) sales-based milestones of up to $250.0 million in the aggregate, which aggregate amount is achievable if net sales exceed $1.0 billion in a single year, and (iii) tiered royalties, at percentages ranging from the middle single digits to low double-digits, of net sales of Product. In March 2020, we entered into a Strategic Collaboration and License Agreement with Takeda under which we received an up-front non-refundable cash payment of $8.5 million in March 2020. Other potential payments from Takeda include (i) of research and development fees and pre-clinical approval milestones for initial programs of up to $22.3 million, (ii) development and commercialization-based milestones, per target gene, of up to $100.0 million, the modulation of which leads to treatment of certain diseases by the applicable product, and (iii) tiered royalties, at percentages ranging from the middle-single digit to low single-digit of sales of the applicable product. In December 2018, we filed an automatic shelf registration statement on Form S-3 (the “2018 Registration Statement”) with the SEC, under which we may sell common stock, preferred stock, debt securities, warrants, purchase contract and/or units, which immediately became effective upon filing. Subsequently in 2019, we entered into a Securities Purchase Agreement with an affiliate of Casdin Capital, LLC (“Casdin”) pursuant to which we issued and sold to Casdin 3,048,780 shares of our common stock at a purchase price of $16.40 per share (the “Private Offering”). After deducting issuance costs of $0.1 million from the Private Offering, our net proceeds were $49.9 million. 53 In June 2017, we entered into the Credit Facility, which consists of term debt for loans that allow us to borrow up to $10.0 million and a revolving credit facility that allows us to borrow up to $5.0 million with a certain eligible accounts receivable borrowing base of 80% of eligible accounts receivable. In January 2019, we entered into a Fifth Amendment to the Credit Facility to allow for the Company to obtain a letter of credit of up to $1.1 million to secure its obligations under the Lease with MetLife. In July 2019, we entered into a Sixth Amendment to the Credit Facility to increase permitted indebtedness to $0.7 million for financing insurance premiums in the ordinary course of business. In September 2019, we entered into a Seventh Amendment to the Credit Facility whereby the draw period on the term debt was extended to September 30, 2020. We may draw on the term debt at any time prior to September 30, 2020, subject to customary conditions for funding including, among others, that no event of default exists. Draws on the Credit Facility are secured by a lien on substantially all of our personal property other than our intellectual property. We may draw on the revolving line of credit at any time prior to the maturity date. On October 1, 2023, any loans for Term Debt mature and the Revolving Line of Credit terminates. No amounts were drawn down under the credit facility as of June 30, 2020. At June 30, 2020, we believe we were in compliance with the covenants for the Credit Facility. The Credit Facility requires us to maintain compliance with certain financial covenants including attainment of certain lender-approved projections or maintenance of certain minimum cash levels. Restrictive covenants in the Credit Facility restrict the payment of dividends or other distributions. For additional information about our contractual obligations, see Note 11, "Commitments and Contingencies" in the Notes to Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. We are subject to risks and uncertainties as a result of the current COVID-19 pandemic. The COVID-19 pandemic has presented a substantial public health and economic challenge around the world and is affecting our employees, communities and business operations, as well as the U.S. economy and other economies worldwide. The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations and financial condition will depend on future developments that are highly uncertain and cannot be accurately predicted, including the duration and severity of the pandemic and the extent and severity of the impact on our customers, new information that may emerge concerning COVID-19, the actions taken to contain it or treat its impact and the economic impact on local, regional, national and international markets. To date, we and our collaboration partners have been able to continue to supply our enzymes to our customers worldwide. However, we are dependent on our manufacturing and logistics partners and consequently, disruptions in operations of our partners and customers may affect our ability to supply enzymes to our customers. Furthermore, our ability to provide future research and development ("R&D") services will continue to be impacted as a result of governmental orders and any disruptions in operations of our customers with whom we collaborate. We are continuing to assess the potential impact of the COVID-19 pandemic on our business and operations, including our product sales, R&D service revenue, expenses and manufacturing. However, we are unable to fully determine and quantify the extent to which this pandemic affected our total revenues due to complex accounting judgments. In the U.S., the impact of COVID-19, including governmental orders ("Orders") governing the operation of businesses during the pandemic, had caused the temporary closure of our Redwood City, California facilities from mid-March 2020 through the end of April and has disrupted our research and development operations. In May 2020, we initiated limited operations and gradually ramped up our R&D operations so that we are currently operating utilizing the majority of our normal R&D capacity. Our future results of operations and liquidity could be adversely impacted by delays in payments of outstanding receivable amounts beyond normal payment terms, supply chain disruptions and uncertain demand, and the impact of any initiatives or programs that we may undertake to address financial and operations challenges faced by our customers. While we believe we have adequate cash on hand to manage through the disruptions being caused by the COVID-19 pandemic, the extent to which the pandemic may materially impact our financial condition, liquidity, or results of operations is uncertain. For additional information on the various risks posed by the COVID-19 pandemic, please read Item 1A. Risk Factors included in this Quarterly Report on Form 10-Q. As of June 30, 2020, we had cash and cash equivalents of $75.6 million and $15.0 million available to borrow under the Credit Facility. Our liquidity is dependent upon our cash and cash equivalents, cash flows provided by operating activities and the continued availability of borrowings under our Credit Facility. We may need additional capital if our current plans and assumptions change. Our need for additional capital will depend on many factors, including the financial success of our business, the spending required to develop and commercialize new and existing products, the effect of any acquisitions of other businesses, technologies or facilities that we may make or develop in the future, our spending on new market opportunities, and the potential costs for the filing, prosecution, enforcement and defense of patent claims, if necessary. We believe that based on our current level of operations, our existing cash and cash equivalents will provide adequate funds for ongoing operations, planned capital expenditures and working capital requirements for at least the next 12 months. 54 However, we may need additional capital if our current plans and assumptions change. Our need for additional capital will depend on many factors, including the financial success of our business, the spending required to develop and commercialize new and existing products, the effect of any acquisitions of other businesses, technologies or facilities that we may make or develop in the future, our spending on new market opportunities, and the potential costs for the filing, prosecution, enforcement and defense of patent claims, if necessary. If our capital resources are insufficient to meet our capital requirements, and we are unable to enter into or maintain collaborations with partners that are able or willing to fund our development efforts or commercialize any products that we develop or enable, we will have to raise additional funds to continue the development of our technology and products and complete the commercialization of products, if any, resulting from our technologies. If future financings involve the issuance of equity securities, our existing stockholders would suffer dilution. If we raise debt financing or enter into credit facilities, we may be subject to restrictive covenants that limit our ability to conduct our business. We may not be able to raise sufficient additional funds on terms that are favorable to us, if at all. If we fail to raise sufficient funds and fail to generate sufficient revenues to achieve planned gross margins and to control operating costs, our ability to fund our operations, take advantage of strategic opportunities, develop products or technologies, or otherwise respond to competitive pressures could be significantly limited. If this happens, we may be forced to delay or terminate research or development programs or the commercialization of products resulting from our technologies, curtail or cease operations or obtain funds through collaborative and licensing arrangements that may require us to relinquish commercial rights, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to successfully execute our business plan or continue our business. Cash Flows The following table is our statements of cash flows for six months ended June 30, 2020 and 2019: Six months ended June 30, (In Thousands) 2020 2019 Net cash used in operating activities $ (11,498) $ (7,909) Net cash used in investing activities (2,490) (1,257) Net cash provided by (used in) financing activities (903) 49,851 Net increase (decrease) in cash, cash equivalents and restricted cash $ (14,891) $ 40,685 Cash Flows from Operating Activities Cash used in operating activities was $11.5 million net for the six months ended June 30, 2020, which resulted from a net loss of $14.0 million for the six months ended June 30, 2020 adjusted for non-cash charges for depreciation of $0.9 million, ROU lease asset amortization expense of $1.3 million and stock-based compensation of $4.1 million. Additional cash used by changes in operating assets and liabilities was $3.8 million. Changes in operating assets and liabilities included a $2.3 million decrease in unbilled receivables and a $5.0 million decrease in accounts receivables, partially offset by an increase of $3.0 million in deferred revenue and $1.9 million in other accrued liabilities. Cash used in operating activities was $7.9 million net for the six months ended June 30, 2019, which resulted from a net loss of $11.6 million for the six months ended June 30, 2019 adjusted for non-cash charges for depreciation of $0.7 million, ROU lease asset amortization expense of $1.5 million and stock-based compensation of $4.1 million. Additional cash used by changes in operating assets and liabilities was $2.7 million. Changes in operating assets and liabilities included an increase of $0.9 million in prepaid expenses and other current assets due mainly to stock exercises and a decrease of $1.6 million in accounts payable due to timing of vendor payments. Cash Flows from Investing Activities Cash used in investing activities was $2.5 million and $1.3 million for the six months ended June 30, 2020 and 2019, respectively. Cash used in investing activities for the six months ended June 30, 2020 was primarily attributable to the purchase of 1,587,050 shares of MAI's Series A preferred stock for $1.0 million and $1.5 million for purchases of property and equipment. Cash used in investing activities for the six months ended June 30, 2019 was primarily attributable to the purchase of property and equipment. 55 Cash Flows from Financing Activities Cash used in financing activities was $0.9 million for the six months ended June 30, 2020 and primarily included taxes paid related to net share settlement of equity awards. Cash provided by financing activities was $49.9 million for the six months ended June 30, 2019 which included $49.9 million of net proceeds from a private placement in June 2019 and $2.8 million of proceeds from exercises of stock options offset by $2.8 million for taxes paid related to net share settlement of equity awards. Contractual Obligations The following table summarizes our significant contractual obligations at June 30, 2020 (in thousands): Payments due by period (In Thousands) Total Less than 1 year 1-3 years 4-5 years >5 years Operating leases obligations (1) 33,333 4,136 8,677 9,455 11,065 (1) Represents future minimum lease payments under non-cancellable operating leases in effect as of June 30, 2020 for our facilities in Redwood City, California. The minimum lease payments above do not include common area maintenance charges or real estate taxes. In February 2019, we have entered into an Eighth Amendment to the Lease (the “Eighth Amendment”) with MetLife for our facilities, extending the lease terms from May 2027 to May 2029. For additional information see Note 11, “Commitments and Contingencies” in the Notes to Unaudited Condensed Consolidated Financial Statements. Other Commitments We have other commitments related to supply and service arrangements entered into the normal course of business. For additional information about other commitments, see Note 11, "Commitments and Contingencies" in the notes to the unaudited condensed consolidated financial statements. Future minimum payments reflect amounts those obligations are expected to have on our liquidity and cash flows in future periods and include obligations subject to risk of cancellation by us (in thousands): Other Commitment Agreement Type Agreement Date Future Minimum Payment (In Thousands) Manufacture and supply agreement with expected future payment date of December 2022 April 2016 $ 704 Development and manufacturing services agreements September 2019 3,785 Strategic collaboration and license agreement March 2020 364 Total other commitments $ 4,853 Credit Facility In June 2017, we entered into a credit facility (“Credit Facility”) consisting of term loans (“Term Debt”) up to $10.0 million, and advances (“Advances”) under a revolving line of credit (“Revolving Line of Credit”) up to $5.0 million with an accounts receivable borrowing base of 80% of eligible accounts receivable. At June 30, 2020, we have not drawn from the Credit Facility. We may draw on the Revolving Line of Credit at any time prior to the September 30, 2020 maturity date. On October 1, 2023, loans drawn under the Term Debt mature and the Revolving Line of Credit terminates. Loans made under the Term Debt bear interest through maturity at a variable rate based upon the LIBOR rate plus 3.6%. Advances made under the Revolving Line of Credit bear interest at a variable annual rate equal to the greater of (i) 1.00% above the prime rate and (ii) 5.00%. 56 Our obligations under the Credit Facility are secured by a lien on substantially all of our personal property other than our intellectual property. The Credit Facility includes a number of customary covenants and restrictive financial covenants including meeting minimum product revenues levels and maintaining certain minimum cash levels with the lender. The Credit Facility’s financial covenants restrict the ability of the Company to transfer collateral, incur additional indebtedness, engage in mergers or acquisitions, pay dividends or make other distributions, make investments, create liens, sell assets, or sell certain assets held at foreign subsidiaries. A failure to comply with these covenants could permit the lender to exercise remedies against us and the collateral securing the Credit Facility, including foreclosure of our properties securing the Credit Facilities and our cash. At June 30, 2020, we were in compliance with the covenants for the Credit Facility. For additional information about our credit facility, see Note 11 "Commitments and Contingencies" in the accompanying notes to the unaudited condensed consolidated financial statements. Off-Balance Sheet Arrangements As of June 30, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4) of Regulation S-K as promulgated by the SEC. Critical Accounting Policies and Estimates The preparation financial statements in conformity with generally accepted accounting principles requires management to make judgments, estimates and assumptions in the preparation of our consolidated financial statements and accompanying notes. Actual results could differ from those estimates. There have been no material changes to our critical accounting policies or estimates during the three and six months ended June 30, 2020 from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on February 28, 2020, except for changes due to adoption of Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which are described below: Financial Instruments - Credit Losses (Topic 326) On January 1, 2020, we adopted the provisions of ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, using a modified retrospective approach. The standard changes the impairment model for most financial assets measured at amortized cost, requiring the use of a "current expected credit loss" model. Under this model, we are required to estimate the lifetime expected credit loss on financial assets, and to record the estimate to an allowance for credit loss. The allowance offsets the amortized cost basis of the financial asset, resulting in a net presentation of the amount expected to be collected on the financial asset or liability. Financial assets measured at amortized cost Financial assets measured at amortized cost include loans receivable, debt security assets, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, contract assets and any other financial assets not excluded from the scope that have the contractual right to receive cash. These assets are not accounted for at fair value through net income. Current expected credit model The model requires that credit loss estimates include forecasted information in its formulation. In addition, the model requires recognition of credit loss estimates to be reflected in the financial statements before actual losses are incurred. Allowance for credit losses The allowance for credit losses is a valuation account that reflects recognition of losses under the current expected credit loss model. The allowance for credit losses is deducted from the amortized cost basis of financial assets and is presented net on the balance sheet. The net represents the expected to be collected on the financial asset. 57 Intangibles - Goodwill and Other (Topic 350) On January 1, 2020, we adopted the provisions of ASU No. 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment," using a prospective approach. The standard simplifies the accounting for goodwill impairments by eliminating step two from the goodwill impairment test. Goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value. The adoption of ASU 2017-04 had no impact on our unaudited condensed consolidated financial statements. 58