Aug 6, 2014
Executives
Ina McGuinness – IR Doug Sheehy – EVP, Chief Administrative Officer, General Counsel and Secretary John Nicols – President and CEO Jim Lalonde – SVP, Research and Development David McCaman – VP, Corporate Controller
Analysts
Katja Jancic – Sidoti & Company Kevin Hanrahan – KMH Capital Advisors Austin Lewis – Lewis Asset Management James Liberman – Wells Fargo Advisors
Operator
Welcome to Codexis second quarter earnings conference call. This call is being webcast live on the investor’s section of Codexis’ website at codexis.com.
This call is the property of Codexis and any recording, reproduction or transmission of this call without the expressed written consent of Codexis is strictly prohibited. I would now like to turn the call over to Ina McGuinness with LifeSci Advisors, Codexis’ Investor Relations firm.
Please proceed.
Ina McGuinness
Thank you, Operator. Earlier this afternoon, Codexis released its financial results for the quarter-ended June 30, 2014.
The press release is available on the investor’s page of codexis.com. If you’ve not received the press release or if you’d like to be added to the company’s distribution list, please LifeSci Advisors in New York at 646-597-6979 and speak with Veronica (Malina).
This call is being webcast and a replay will be available on the company’s website for 30 days. All information provided on today’s call is as of the date of the live broadcast, Wednesday, August 6th, and except as required by law, Codexis disclaims any obligation to publicly update or revise any information to reflect events or circumstances that occur after this call.
Participating on today’s call from Codexis are President and Chief Executive Officer, John Nicols; EVP, Chief Administrative Officer, General Counsel and Secretary, Doug Sheehy; SVP, Research and Development, Dr. Jim Lalonde; and VP and Corporate Controller, David McCaman.
And with that, I’d like to turn the call over to Doug Sheehy. Doug?
Doug Sheehy
Thank you. During the course of today’s call, management will make a number of forward-looking statements.
These forward-looking statements include our forecast for a number of full-year 2014 financial metrics, including total revenue, total gross profit and cash flow, the ability of our biocatalysts to reduce our customer’s manufacturing costs, our expectation that we will collect on a $5 million milestone payment in 2014 under our agreement with GSK and the benefits that CodeEvolver license can bring to a potential licensee. These forward-looking statements are based on assumptions and are subject to risks and uncertainties that can cause actual results to differ significant from those projected during the call.
Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Please refer to our annual report on Form 10-K filed with the Securities and Exchange Commission on March 13, 2014 for some of the important risk factors that can cause actual results to differ materially from the forward-looking statements made on this call.
Now, I’d like to turn the call over to John Nicols.
John Nicols
Good afternoon and thank you for joining us. It is a very exciting time here at Codexis and, as promised, you are seeing the key deliverables for the breakout year of 2014 fall in place.
Our core biocatalyst business is spawning new blue chip customer partnerships, new commercial products and new leveraged business model offerings. The combination of these positive developments, along with our proven cost-controlled discipline and prudence, is enabling us to today substantially improve our financial guidance for fiscal year 2014.
Specifically, we now expect to generate a positive cash flow in 2014, a major financial milestone for the company and one to be delivered well ahead of any prior expectations. We’re very pleased to review each of these positive developments in today’s call with you.
Let me remind you about our passion here at Codexis proving that much of the world pharmaceutical and fine chemical manufacturing processes should be redesigned using better, more cost effective catalysts, catalysts derived from sustainable, biological sources, Codexis’ biocatalyst. Two fundamental premises drive our belief in biocatalyst.
First, biocatalyst can reduce our customers’ manufacturing costs and, second, biocatalysts are only installed in a small fraction of the potential drug manufacturing processes that would benefit from their application. When customers join us in becoming aware of these two points, they then focus on how to get biocatalyst more widely installed across their portfolio.
It is here that Codexis shines and wins business, showcasing our CodeEvolver protein engineering prowess and our speed and success rate at hitting or exceeding customers’ cost saving targets. As you are increasingly hearing from us, our CodeEvolver protein engineering is the key, the technology that we leverage to drive our business models and financial results.
I would like to take a few extra minutes on today’s call to describe CodeEvolver in a bit more detail for you. For that, I am pleased to introduce Dr.
Jim Lalonde, Senior Vice President and Head of Research and Development at Codexis. While Jim may be new to our investors, he is no stranger to the industry and our customers having been a top R&D leader at Codexis for the last 10 years and a veteran of biotech and chemical industry for the last 24 years.
Jim?
Jim Lalonde
Thanks, John. We’re extremely proud of the CodeEvolver technology that we’ve developed at Codexis.
What we’ve been able to do is harness protein evolution, nature’s powerful algorithm for engineering in the biological world, and use it to create biocatalysts that enable highly efficient manufacture of chemicals. This protein engineering technology, this ability to create new enzymes by evolution in the lab, is a product of more than 12 years of development and hundreds of millions of dollars f investment integrating the best of silicon valley big data bioinformatics with best in class synthetic biology tools.
We use these tools to design and create diverse genetic libraries that code for our new enzymes. We then use proprietary methods to select from these libraries genes that code for our target enzymes.
Now, the key to our success has been the development of efficient methods for picking out the best performing enzymes for our customers’ tightly defined application. We work very closely with our customers to design the ideal process and then we evolve and enzyme that enables that ideal process.
So over the years we’ve developed highly automated methods for testing thousands of enzymes per week to pick out the best performing catalysts for the idealized process. We have used this technology to enable manufacturing methods that were previously not possible, knocking out several steps from the chemical manufacturing process, creating protein catalysts that are stable under harsh chemical manufacturing conditions or making and enzyme that can do a previously unknown chemical transformation.
These novel enzymes can many times eliminate the need for traditional capital intensive chemical manufacturing facilities. Our highly talented scientific team that we believe to be the best in the world at enzyme evolution has been recognized with awards from the US EPA, from the scientific community and from our customers.
Their efforts have produced more than 150 patents and patent applications for our CodeEvolver technology. But really, what gets us excited every day is doing things that were previously not possible working with our customers like Merck and GSK to create new enzymes that can solve important problems like the clean manufacture of a new drug or a protein therapeutic that can, itself, treat a disease.
I realize this explanation only touches the surface of this great CodeEvolver technology that we are harnessing for the business. My R&D team and I are continuously challenging ourselves to find and implement new ways to improve CodeEvolver even further.
We are committed to maintaining the protein engineering competitive advantage that we believe we have at this moment. Our ability to continue to do so will be critical for our future and there is no better team to deliver on that than the R&D team here at Codexis.
With that, let me turn the call back over to John.
John Nicols
Thanks, Jim. Let me now review some of the recent business highlights.
I’ll review the natural pipeline progression starting with new customer milestones, then cover new product commercializations and close with the new GSK deal and our new licensing business model for our CodeEvolver protein engineering platform technology. On the customer acquisition front, we are pleased to have recently executed two new master service agreements, or MSAs, with two major global customers.
As I discussed a few weeks ago, we have entered into a major partnership with GlaxoSmithKline, GSK. We did not have an MSA with GSK prior, so now we have added our 11th MSA with the top 20 major pharmaceutical companies and are 8th out of the top 10.
In addition, we executed an MSA with our second major customer in the wider fine chemicals arena outside of pharmaceuticals. While we are not allowed at this time to disclose the identity of this customer, we are very excited to begin working with them to bring our biocatalyst into their manufacturing processes going forward.
Entering into an MSA is an important milestone for our sales cycle with customers but the real fruit from our business model comes from projects that spawn commercialized products, licenses or services that we can deliver on a sustained, long-term basis to our customers. Last year in 2013, we added two material new commercial products to our growing list of sustained revenue generators.
Those were a chemical intermediate based on our proprietary biocatalyst for a Novartis generic drug, and the second, a revenue sharing arrangement with Exela Pharma Sciences for the injectable anticoagulant drug, argatroban. Both of these delivered material revenues in the second quarter.
This year in 2014, we are on a good pace to continue to add to our growing list of sustained commercial revenue generators spawned from our project pipeline. Today, we highlight our first two for 2014.
In addition to the GSK CodeEvolver license that I will address in a moment, I am also pleased to announce that we have executed a new multiyear contract to supply enzymes to a major European generic drug manufacturer in the second quarter. In addition to the multiyear contract signing, we also generated our first material revenues from this customer in the second quarter.
Again, this milestone demonstrates our continuing success in overhauling pharmaceutical manufacturing with our biocatalyst as well as evidence that our pipeline is producing commercially sustainable revenue generating business. Finally, I want to emphasize again our excitement for having recently executed the new CodeEvolver license agreement with GSK.
I spoke with you at length about this groundbreaking deal just a few weeks ago, so I won’t do so again here. We have collected our $6 million upfront payment from GSK in the last half of July and we are actively involved in CodeEvolver technology transfer efforts as I speak.
We remain confident in the collection of the next $5 million milestone payment from GSK in the second half of 2014. The CodeEvolver license, like we just executed with GSK, is a natural alternative for us to present to customers equally convinced as we are on the wider prospects for applying biocatalyst or protein engineering more generally.
The benefits versus our traditional offering are clear, enhanced stability and competitive advantage for the customer to develop novel products or processes, reduced variable cost to develop a biocatalyst and, finally, the enabling of a variety of additional controls versus working arm’s length with Codexis. We see these as compelling benefits to some select innovative customers.
We have recently begun promoting a CodeEvolver license to other companies besides GSK and we will keep you apprised of how those discussions unfold and advance over time. Now, let me turn the call over to David McCaman, our Vice President and Controller, to review our financial results for this year’s second quarter.
David McCaman
Thanks, John. Good afternoon, everyone.
In reviewing results for the quarter, I will make reference primarily to second quarter 2014 results as compared to the results for the second quarter of 2013 unless otherwise stated. For the second quarter of 2014, we reported total revenues of $6.6 million, a 6% decrease from the prior year.
Product revenues for the second quarter in 2014 were $2.8 million, a 44% decrease from the prior year. The decrease in product revenues was primarily due to a significant shipment of intermediate products in 2013 to the Hepatitis C drug market that is no longer shipping in 2014 as a result of newer products entering that market.
Biocatalyst, collaborative research and development revenues, which consist of license payments, R&D services and royalties, were $1.7 million for the second quarter, an increase of 6% from the prior year. Revenues from our revenue share arrangement with Exela Pharma Sciences for the anticoagulant drug, argatroban, grew to $2.1 million for the second quarter, a 410% increase over the prior year.
On a year-to-date basis, total revenues were $13.6 million for the six months ended June 30, 2014, a 26% decrease from revenues of $18.5 million for the six months ended June 30, 2013. Our gross margins, which we define throughout as total revenues less cost of product revenues, increased to 68% in the second quarter compared to 48% in the same quarter of 2013.
Gross margins increased to 66% on a year-to-date basis in 2014 compared to 50% in the same period of 2013. Gross margin improvement in 2014 is a result of more favorable revenue mix compared to the prior year period.
Research and development expenses in the second quarter was $7.7 million, a decrease of 10% from $8.6 million expense in the prior year. $11.7 million of expense for the quarter included non-cash impairment and equipment-related charges of approximately $2.5 million, which are primarily related to write down of assets associated with our (Codexal) program.
Excluding these equipment-related charges, R&D expense decreased $3.3 million or 38% compared to the prior year. The significant decrease was primarily due to headcount reductions and disposal of excess equipment as a result of winding down our (Codexime) and (Codexal) programs through restructuring efforts implemented in the second half of 2013.
Selling, general and administrative expenses in the second quarter were $5.6 million, a decrease of 22% compared to $7.2 million in the prior year. Net loss for the quarter was $8.5 million, or a loss of $0.22 per share based on 38 million weighted average common shares outstanding in the second quarter.
This compares to a net loss of $12.6 million or $0.33 price per share in the prior year. Net loss on a year-to-date basis for the six months ended June 30, 2014 was $14.9 million or a loss of $0.39 per share, a significant reduction from the net loss of $22.2 million or $0.59 loss per share for the six months ended June 30, 2013.
We ended the quarter with combined cash, cash equivalents and marketable securities of $21.5 million. That compares to $25.9 million as of December 31, 2014.
We’ve burned approximately $4.5 million in cash flow from operations for the first six months of 2014 inclusive of $1.5 million in cash proceeds from the sale of our Hungary entity in the first quarter. This compares to a cash burn of approximately $10.6 million for the same period of 2013.
Now, I’d like to turn the call back over to John for further discussion and a review of guidance and to close out the call.
John Nicols
Thanks, Dave, and thanks for stepping up to seamlessly take on the principal accounting role for the company during our CFO transition period. On August 18, Gordon Sangster will join the company as senior vice president and chief financial officer.
I am excited to bring Gordon onboard and am pleased that we executed his hiring in a way that ensured our time without a CFO was quite short. Gordon is a veteran of the CFO role in the biotech industry and we look forward to him hitting the ground running later this month and bringing value to the company and our investors thereafter.
Let me take the last few minutes to close out our prepared remarks by detailing the upward revisions we are making to all of our full-year 2014 financial guidance metrics. First, let me take account of our first half results against our prior annual guidance metrics.
Our prior 2014 guidance metrics were revenues of $33 million to $35 million, gross profits of $19 million to $20 million and a cash burn of no more than $8 million. Our second quarter and first half financials have delivered well against those guidance measures.
Our cash burn results for the first half of 2014 was $4.5 million, right in line with the prior annual guidance. Revenues have been tracking somewhat low so far this year but the reality is that we have been consistently driving a significantly higher profit margin mix from our revenues.
That is evidenced by our $9 million gross profit result for the first half of the year being right in line with our prior annual guidance. With our solid progress in the first half of 2014 to date, coupled with the financial expectations from the announced GSK agreement, we are now in a position to positively revise all of our 2014 guidance metrics.
First, we are raising our revenue guidance for 2014 to $35 million to $38 million. This reflects and expected revenue growth of between 10% to 19% versus our revenues in 2013.
Additionally, we are raising our gross profit guidance for 2014 to be between 70% to 75% as a ratio of our revenues. This represents a gross profit growth outlook for 2014 that is between 41% to 64% higher than 2013 and is a direct reflection of the high profit margins being delivered consistently from the biocatalyst business this year as well as the very high margins associated with recognized revenues from the GSK deal.
These guidance upgrades are great news for the company and show substantial P&L acceleration we have been engineering this year. The final 2014 guidance revision is that we expect to generate a positive cash flow from our operations in 2014.
This is a very critical financial milestone for a company like ours and is a dramatic improvements from our prior $8 million cash burn guidance. Achieving a positive cash flow result in 2014 will be substantially ahead of any prior expectation for this crucial, financial deliverable.
It should be clear to our investors based on these new annual guidance metrics that Codexis has entered into a very new and improved financial chapter in the second half of 2014 as compared to our past. We look forward to updating you on the delivery of those results in the coming quarters.
Thanks for taking the time to get updated on the excellent developments at Codexis and we hope that our prepared remarks have been informative. Let me now turn the call back to the operator for questions and answers.
Operator
(Operator Instructions) All right, and our first question comes from the line of Katja Jancic with Sidoti & Company. Please proceed.
Katja Jancic – Sidoti & Company
Hi, guys. Thank you for taking my call.
John Nicols
Thanks, Katja.
Katja Jancic – Sidoti & Company
So if I understand correctly, you expect to get about $11 million from the Glaxo contract in the second half of ‘14. Is that correct?
John Nicols
That is correct. $11 million in cash proceeds.
Katja Jancic – Sidoti & Company
But you raised it only to $35 million to $38 million. You’re expecting the other sales to slow down?
Are they going slower than you anticipated?
John Nicols
Let me be clear, Katja. The $11 million will be in cash proceeds.
Katja Jancic – Sidoti & Company
Okay.
John Nicols
But we have to treat the proceeds… we’re working with our auditors on how to treat those cash proceeds in terms of how we can recognize revenues associated with these milestone payments that we expect to get this year. And so the amount of revenue will be significantly less than the amount of cash that we’ll generate this year but it’s nowhere near $11 million.
It’s expected to be in the range of $5 million or $6 million.
Katja Jancic – Sidoti & Company
So basically this is not recognized as revenue. Am I understanding this correctly?
John Nicols
We’re going to have to amortize the upfront payment across the transfer term of the agreement with GlaxoSmithKline. And so the $6 million will not all be recognized in 2014.
It’ll be spread out over 2014, 2015 and thereafter.
Katja Jancic – Sidoti & Company
Okay. That makes sense.
Just one more question, in your prepared remarks you mentioned that your product gross margin declined in the second quarter. What’s the reason behind that?
John Nicols
Product revenues were relatively modest in the quarter and the products that we made sales on this quarter were generally slightly lower margin mix, not much but slightly lower margin mix than they have been in recent prior quarters.
Katja Jancic – Sidoti & Company
Okay. That’s all for me.
Thank you.
John Nicols
Thank you, Katja.
Operator
Your next question comes from the line of Kevin Hanrahan with KMH Capital Advisors. Please proceed.
Kevin Hanrahan – KMH Capital Advisors
Hello, John. Thanks for taking my question.
My first question would be have you already gotten the $6 million upfront payment from Glaxo?
John Nicols
We did. We received that in the second half of July.
Kevin Hanrahan – KMH Capital Advisors
Okay, so that’s where I was going. So basically the cash balance today would be higher than it was on June 30th.
John Nicols
Right.
Kevin Hanrahan – KMH Capital Advisors
Okay, that’s good. My next question, you announced a master services agreement with a major pharma company in the fourth quarter, maybe in November timeframe and that was not Novartis but you couldn’t say who it was.
Can you tell us if that was Glaxo if there was another company?
John Nicols
It was not Glaxo because Glaxo really we entered into an equivalent master service agreement with Glaxo as we finalized this large CodeEvolver license deal. So the major pharmaceutical company that we entered into a new MSA at the end of last year was a different drug company than Glaxo.
Kevin Hanrahan – KMH Capital Advisors
Okay, so it was not Glaxo and it was not Novartis.
John Nicols
That is correct.
Kevin Hanrahan – KMH Capital Advisors
That’s interesting. And on the last call, when you just had the call when you had the major announcement with Glaxo, which I think was July 15th you had a call.
John Nicols
Right.
Kevin Hanrahan – KMH Capital Advisors
You talked about new business model. Can you talk a little bit about that?
In other words, you’re going to try to duplicate this with some of your other major pharma partners that you have.
John Nicols
That is correct and I spoke a little bit to that in the prepared remarks. Basically we approach drug companies either on a project-by-project basis where we get access to the kind of chemistry they’re working on and their developmental pipeline.
And when we get access like that, we’ll try to entice them to redesign the process for one of those developmental drugs to be built with a biocatalyst that we could design. We’ll call that a project-by-project model, business model with the customer.
When we do that project in-house, we are deploying our CodeEvolver platform technology that Dr. Jim Lalonde spoke to today on the call.
But we’re doing that in our house by ourselves. The customer’s not involved.
The case of Glaxo, we have decided and worked with Glaxo in an arrangement where we will enable them to practice this CodeEvolver protein engineering technology on their own. They’ve decided to install it in an R&D facility in Pennsylvania and we’re going to be working over the next couple of years to train them on how they can do the protein engineering in the future without us.
We see that this is a very viable model and option for other major drug companies who, like Glaxo, have a wide and large and diverse pipeline and can apply biocatalyst on a multiple and many different products at once. And so these are our target customers, major drug companies with wide diverse pipelines.
So we think we can entice over time to enter into a similar CodeEvolver license like we just executed with Glaxo. Hopefully that helped you with your question.
Kevin Hanrahan – KMH Capital Advisors
It was good. And then one other question from your announcement on July 14th, it says you have potential to receive numerous milestone payments in the future ranging from $5.75 million to $38.5 million per project.
So is there two projects or eight or six or unknown?
John Nicols
Yeah, it depends on the kind of project and some categories of projects we can have unlimited numbers of milestones to work on biocatalyst for their small molecule drugs. In other categories of projects, there are negotiated limits on how many milestones Codexis can ultimately earn in the future from Glaxo.
So yeah, it a bit depends but the range of potential cumulative milestones from initiation to application in a major successful commercial drug to a customer can range anywhere, as you’ve highlighted, from almost $6 million to greater than $38 million across that set of milestones. So it’s a nice longer-term potential stream of revenues for the company.
We also said in the July 14th call that we don’t expect that we’ll earn any of those milestones this year and next and maybe thereafter, that they’re likely to layer in in later years.
Kevin Hanrahan – KMH Capital Advisors
Okay. Thanks very much, guys.
John Nicols
Thanks, Kevin. I appreciate your calls.
Operator
And your next question comes from the line of Austin Lewis with Lewis Asset Management. Please proceed.
Austin Lewis – Lewis Asset Management
Hey, John, great quarter. Congratulations.
John Nicols
Hey, thanks a lot, Austin. I appreciate it.
Austin Lewis – Lewis Asset Management
I just wanted to clarify in the first six months the loss from operations was $15 million and so are you expecting… is there some non-cash components in that? Are you expecting to generate more than $15 million in the second half of the year?
David McCaman
Hey, Austin, this is Dave McCaman. So within the $15 million of the six months, as we mentioned earlier, there’s $2.5 million of impairment and other equipment-related non-cash charges.
So that’s the component primarily of R&D.
Austin Lewis – Lewis Asset Management
So you would take $2.5 million out of that $15 million, so it would be somewhere in the neighborhood of $12.5 million in the next six months of positive cash flow.
David McCaman
Well, that’s certainly an understanding of the first six months you could take out $2.5 million and that would give you kind of an ongoing run rate.
John Nicols
Yeah, just to be clear, Austin… this is John… you’re referring to $15 million of operating losses, income losses. When we say we’re going to be cash flow positive, we are factoring in the reality that a lot of our costs are non-cash related.
A lot of our R&D and SG&A are non-cash in nature and so we’re not going to generate $12.5 million of cash in the second half because you’re comparing the net income loss of the first half with the full-year cash expectations of the company. We burned $4.5 million of cash in the first half of this year.
And so by saying we will be cash flow positive for the full year, we’re saying that we’ll at least generate $4.5 million of cash in the second half.
Austin Lewis – Lewis Asset Management
Got it. That does clear things up.
Thank you.
John Nicols
Any other questions, Austin?
Austin Lewis – Lewis Asset Management
No, that’ll do it for now. Thank you.
John Nicols
Thank you, too. Appreciate it.
Operator
(Operator Instructions) Your next question comes from the line of James Liberman with Wells Fargo Advisors. Please proceed.
James Liberman – Wells Fargo Advisors
Thank you. I apologize for being on the road while asking this.
I hope you can hear me.
John Nicols
No problem, Jim, thanks. We can hear you.
James Liberman – Wells Fargo Advisors
Thanks. Could you give a little further clarification in terms of the revenue model as you build these relationships?
Would they involve certain royalties in addition to possible sales of enzymes from you, yourself, or do you see your transfers allowing pharmaceutical companies like Glaxo doing their own enzyme based on your modeling?
John Nicols
Good question. So we’re speaking to deals like GSK, the recent deal with GSK.
So clearly with this deal with GSK, we’re building in a model, an economic model, which has got more milestone and potential royalty opportunities than our traditional project-by-project model. However, we still retain the opportunity and the possibilities of selling the enzymes on a continuous basis to Glaxo.
And I would project any other potential future licensee going forward. So additional sales and profits from sales of biocatalyst could layer on top of the milestones or royalty payments that we could own from Glaxo and other CodeEvolver license customers.
James Liberman – Wells Fargo Advisors
It really sounds like a wonderful program that you’re entering into and I’m very excited by what looks like a golden age for you guys. Congratulations.
John Nicols
Thank you, Jim. Thanks for your continuous interest in the company.
Thank you.
Operator
(Operator Instructions) And at this time, I’m showing no further questions, so I will turn it over to the management for any closing remarks.
John Nicols
Okay, this is John. Thank you very much for your participation in our second quarter earnings call and we look forward to updating you again next quarter.
Thank you very much.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference. That concludes the presentation.
You may now disconnect and have a wonderful day.