May 10, 2017
Executives
Jody Cain – Investor Relations-LHA John Nicols – President and Chief Executive Officer Gordon Sangster – Chief Financial Officer
Analysts
RK – H.C. Wainwright Matt Tiampo – Craig-Hallum Steve Schwartz – First Analysis
Operator
Operator
Good day, ladies and gentlemen, and welcome to the Codexis Inc's Q1 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode.
Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to introduce your host for today’s conference Ms. Jody Cain.
You may begin.
Jody Cain
This is Jody Cain with LHA. Thank you for participating in today's Codexis' call to discuss 2017 first quarter financial results and business progress.
Joining me from Codexis are John Nicols, President and Chief Executive Officer; and Gordon Sangster, the Company's Chief Financial Officer. This call is a re-recording read from the transcript of the original call, due to technical difficulties with the original recording.
During this call, management will be making a number of forward-looking statements within the meaning of private securities litigation reform act of 1995. To the extent the statements made by management are not descriptions of historical facts regarding projections.
The forward-looking statements reflect current beliefs and expectations of management as of May 9, 2017. You should not place undue reliance on these forward looking statements because they involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company’s control and that could materially affect actual results.
For details about these risks please see the Company’s SEC filings. Codexis expressly disclaims any intent or obligation to update these forward-looking statements, except as required by law.
Now, I’d like to turn the call over to John Nicols. John?
John Nicols
Thanks, Jody. Good afternoon everyone and thank you for joining us.
I’m excited to provide highlights from our solid start to the year in the first quarter plus share commentary on the multiple fronts of strategic progress we've been delivering in 2017, so far. Before that let me say a special thanks for all those who participated in our recent follow-on equity offering and an extra warm welcome to the many investors who joined the ranks of becoming shareholders in our common stock for the first time through the process.
We very much appreciate all of your confidence in Codexis. Accelerating product sales growth is the centerpiece of a strong start to our year in the first quarter.
Following our 34% growth in product sales for 2016, we stepped that up in the first quarter of 2017 by delivering 49% growth in product sales versus the prior year. Even better those sales were recorded at a 46% gross margin well above last year and exceeding our guidance range for this year.
Combining those gross profits on products sales more than doubled in the first quarter versus the same period last year, a great kick off for the Company on one of our most important success measures. Products sales are crucially important because they are the fruit of a lengthy sales cycle that often start years prior with a new protein idea followed by protein engineering R&D then commercial scale-up trials and registrations.
Product sales are the most sustaining revenue sources in our P&L and hence we are driven on a priority basis to continue to show them growing. Both for achieving 2017 guidance and continuing well into the future.
Products sales were distributed nicely in the first quarter as well, with four customers each generating sales greater than $500,000. Once again products sales were led by deliveries of our protein catalyst to our partner Merck for use in Januvia manufacturing.
We also recorded significant sales to two other customers for their manufacturing of generic drugs. And finally rounding out our strong product sales in the quarter we shipped our largest quarter to-date for advanced commercialization trials for a new manufacturing process for a top 10 pharmaceutical customers recently launched patented drug.
We are encouraged that the successful trials using this shift to protein catalyst will be for that customers for full commercial use in the near future. In addition to strengthened product sales in the quarter, we are proud of our execution on several important strategic objectives as we started 2017.
Topping the list is the growing partnership with Tate & Lyle in the food industry. You may recall we announced a multi-year exclusive supply agreement with them in December of last year.
So we did not ship any product against that contract in the first quarter, we secured million dollar plus orders for each of the second quarter and second half of 2017. Our second agreement with Tate & Lyle announced at the end of March is additive to our first deal with them.
It will work on the process for a larger food ingredient target that has prospects to lead to greater protein catalyst sales for Codexis down the road if ultimately successful. The first chapter of this project with Tate & Lyle starts with advancing the protein engineering R&D that we had previously self-funded.
We have received a payment in the low-single-digit million dollar range from Tate & Lyle already in this second quarter. And the R&D project teams have been mobilized for the new collaborative project.
Additional R&D revenues from the project are expected to be in the range of a few million dollars annually and are expected to last well into next year potentially longer, very likely this will be the largest funded R&D project, since I joined the Company nearly five years ago. It is great to see our progress accelerating the use of our CodeEvolver protein engineering technology in the food industry but even more so the growing validation from Tate & Lyle in partnering with us.
I am delighted to once again highlight the close in the projects press release stating that “We view Codexis as an extension of our internal research and development programs at Tate & Lyle.” Honestly there are no better words to hear than these to incite the pride and motivation of myself and the wider Codexis team.
Continued products sales growth as well as R&D revenues strengthened by the new Tate & Lyle deal are two of the three keys to reaffirming guidance for 2017. The third key is execution of a third CodeEvolver platform license transaction in the second half of this year, which is also on track.
The growth in the number of major pharmaceutical companies interested in a potential CodeEvolver license as well as the advancement of some of those negotiations continues to be encouraging both for this year and beyond. We again affirm our outlook for one new licensing deal every one to two years following the third deal.
We anticipate backend economics associated with our first two deals with GSK and Merck as being immaterial in 2017 with expectations to become significant in 2018 and there after. Rounding up my comments on the quarter, we continue to also make solid progress in advancing the reminder of our self funded protein investments.
To-date we filed our first patent application and started beta testing of our first enzyme for the molecular diagnostics industry and are on track with our entry plans for this new market. In the biotherapeutics arena, we have begun IND enabling work for our oral enzyme candidate for PKU disease including the signing of a contract securing a partners GMP manufacturing to produce clinical drug quantities for us.
This was a key to driving the timeline to enable an IND approval in the middle of 2018. In parallel, our discussions with potential strategic partners are encouraging as well as validating of attractive valuations for our PKU drug assets at this pre-clinical stage.
I’d now like to turn the call over to Gordon for a detailed review of our financial results for the quarter. Gordon?
Gordon Sangster
Thanks, John. I will share some financial highlights from the first quarter.
Total revenues were $8 million for both the first quarter of 2017 and 2016. As John stated, product sales from the 2017 quarter increased by 49% from the prior year to $5.6 million, due to increased demand for our enzymes for both brand and generic pharmaceutical products.
R&D revenues for the quarter were $2 million, this is down from $3.5 million, a year ago which included the recognition of a milestone payment from a collaboration agreement with a major biopharmaceutical company for the development of a preclinical asset. R&D revenues for the first quarter of 2016 also included $1.1 million of pro rata revenue recognition of upfront payments from GlaxoSmithKline and Merck related to our CodeEvolver licensing transaction.
These prior-year events were partially offset, in the 2017 first quarter by a significant increase in service revenues from Merck and from a continuing project with a major pharmaceutical customer for the development of an enzyme for a commercially available drug. Revenue from a revenue sharing arrangement for argatroban injectable drug with Exela contributed $384,000 in the first quarter of 2017, which is down from $722,000 in the first quarter of 2016.
We believe revenue from the Exela agreement has leveled off and will continue in this range for the coming quarters. Gross margin on product sales for the first quarter of 2017 was 46%, as John mentioned, this was above our guidance range of 37% to 39% for the year and well above the 33% gross margin a year ago.
Turning to operating expenses, R&D expenses increased slightly to $5.8 million for the first quarter of 2017 from $5.7 million in the prior year, primarily due to costs associated with higher headcount and increased outside services partially offset by lower amortization spend. SG&A expenses for the first quarter of 2017 decreased to $6.6 million from $6.8 million in the first quarter of 2016.
This was primarily due to lower legal fees and outside services expense partially offset by increased costs related to higher head count. The net loss for the first quarter of 2017 was $7.5 million or $0.18 per share and this compares to the net loss for the first quarter of 2016 of $7 million or $0.17 per share.
On a non-GAAP basis, adjusted net loss for the first quarter of 2017 was $5.5 million, or $0.13 per share versus an adjusted net loss for the first quarter of 2016 of $4.3 million or $0.11 per share. Cash and cash equivalents as of March 31, 2017 were $13.9 million versus $19.2 million as of December 31, 2016.
Our cash balance at the close of the first quarter does not include the receipt of the payment we received this month from Tate & Lyle relating to the development agreement we announced on March 31. Additionally in April we completed a public offering of common stock raising net proceeds of $23.3 million.
We are pleased with the success we have completed this offering and we intend to continue to tightly manage our expenses. We affirming financial guidance for 2017 as follows.
We expect total revenues to be between $50 million and $53 million. We expect product sales of $21 million to $23 million, which represents an increase of 37% to 50% over 2016 and we expect gross margin for product sales to be between 37% and 39%, which is above the 36% we recorded in 2016.
Our revenue guidance assumes the partial recognition of an upfront payment and the achievement of first milestone related to our third CodeEvolver licensing agreement, which we expect to announce in the second half of 2017. Given the anticipated timing of this agreement, we expect total revenues to be higher in the second half of 2017 versus the first half of the year with approximately 40% in first half and 60% in the second half.
Lastly, we expect operating expenses which is a combined total of R&D and SG&A to increase between 6% and 8% over 2016. This assumes the full year of expenses related to the development of our PKU drug candidate as we advanced this asset towards an IND.
With that, I'd like to turn the call back to John.
John Nicols
Thanks Gordon. I would like to close by coming back to our recent fundraise.
By far the most common question throughout that process was why fundraise and why now? Yes, this was our first fundraise in nearly seven years and especially over the last three years, the Company's balance sheet has been very stable and well controlled burning an average of less than $2 million per year of cash in 2014, 2015, and 2016.
You have all seen what we have done over those three years, turning around the company growing sales by over 50% more than doubling the Company’s gross profits all while spending over $10 million less in operating expenses in 2016 versus 2013. What we have delivered is clear from our financial schedules, but what may be less clear are the shifts in how we have been delivering those results.
Specifically, how we are accelerating growth by delivering returns from a growing list of our own self-directed investments. Three years ago our P&L was too fragile to incur much cost for our own investment ideas.
In contrast, in the first quarter of 2017 about a third of our roughly 15 R&D project teams were working on our own protein technology investments. And those investments are translating now into improved financial results.
Our second deal with Tate & Lyle first started as a self-directed protein catalyst investment. So that the protein catalyst, we are now selling to help overhaul the top 10 pharmaceutical customers recently launched drugs manufacturing process.
So back to the question, why the fundraise? We want to continue to do more of this and we believe you should want us too as well.
We will be using the investments to accelerate tomorrow's P&L results. A team working at our own expense for a few months on a protein catalyst, that the client doubts will show any yield, show them the progress, then sign them up.
One of our 15 teams working on a food ingredient process catalyst for about a year without a partner's funding, if we can prove our approach then create an auction to be our funding partner absolutely. As you heard recently we speak to earlier, these 2016 investment examples are delivering for the 2017 P&L.
Quick paybacks and these are only the beginning. We also expect returns from our PKU enzyme therapy, our biotherapeutic discovery pipeline and molecular diagnostic enzymes coming soon too.
All enabled and amplified for our strengthened balance sheet, thanks to you. With these comments, I'd like to open the call for questions.
Operator?
Operator
Thank you. [Operator Instructions]
John Nicols
While we're waiting for our first question, I'd like to mention two items. First, we have received a request for an updated version of our Codexis pipeline snapshot that we first introduced last August.
We have promised to update this snapshot annually and we look forward to presenting our new chart on our next quarterly call in August. And second, we will be participating in two upcoming investor conferences will be presenting at Craig-Hallum Institutional Investor Conference on May 31 in Minneapolis and at the Jefferies Healthcare Conference being held June 6 through 9 in New York.
A webcast of the Jefferies Conference presentation will be available on the Investors section of our website. Okay, operator.
We're ready for the first question.
Operator
And our first question comes from the line of RK with H.C. Wainwright.
Your line is now open.
RK
Thank you. Good afternoon, John.
John Nicols
Hey, RK.
RK
Just couple of quick questions, the first one – first of all congratulations on a very good quarter and I apologize I missed quite a bit of your remarks – opening remarks. However, I want to understand the revenue growth that you saw in the first quarter and you alluded to some sales to generic manufacturers.
Is this based on some of the molecules that you already have in sales to Merck [Audio Dip]?
John Nicols
That we had developed the enzyme in our prior history.
Operator
And our next question comes from the line of Matt Tiampo with Craig-Hallum. Your line is now open.
Matt Tiampo
Hey, guys. Apologies if I retrace the stuff, the call seems to be cutting out, in and out pretty materially.
John Nicols
Sorry about that.
Matt Tiampo
Can you give us some color on the payments from the Tate & Lyle project you mentioned the mid single-digit millions but how does that compare to what you spent internally and what else can we expect from that project over the R&D period?
Gordon Sangster
Yes. Hey, Matt, so we actually received a payment since signing the deal in the low single-digit million dollar range, not the mid single-digit.
So low single-digit million range and that upfront payment would have certainly covered the costs associated with that program for that investment in the prior year, arguably more and the ongoing revenues from that project in the protein engineering R&D stage is estimated to be in the range of a few million dollars annually and we expect those to last well into next year possibly longer.
Matt Tiampo
Great. And then I guess additionally following up.
Tate & Lyle will be funding the entire project from here as I’m correct?
John Nicols
Yes. This project as it’s being funded by Tate & Lyle will be exclusive to Tate & Lyle.
Matt Tiampo
Great. And then maybe you can give us some color on Merck and GSK and how have they been – how have those progressing since coming on platform.
Do you have any visibility into the number of programs they're currently pursuing and are you getting any feedback on the first six to 12 months since the tech transfer were completed?
John Nicols
Sure. We of course stay in very close contact with both GSK and Merck.
Their teams are working approximately somewhere between we hear between 3 and 5 parallel projects. So smaller than our internal capacity but significant when consider and aggregate above our capacity.
And as you recall, they are both very, very pleased with their platform technology. They're both operating it very well independent of oversight by Codexis which was the goal, which is kept them very satisfied in their license acquisition.
And as far as the backend expectations, as you recall we had our first very modest backend payment from the GSK platform license in the second half of last year. We haven't received any backend payments yet from the Merck arrangement.
But as you recall they finished tech transfer very close to the end of last year. And we don't expect the material sales from the backend of these two deals this year.
But we expect it to become a significant part of our revenue in 2018 and beyond.
Matt Tiampo
Great. Can you give us any color on what the – or any update on what the pipeline looks like for any additional platform deal and how it's changed your progress since last quarter?
John Nicols
It’s progressed as expected and we just continue to have a significant number of major pharmaceutical companies showing interest and we continue to advance several of the deals to support our continuing affirmation of guidance for including the third platform license deal in the second half of this year.
Matt Tiampo
Great. And then maybe the last one, give an update on your previous commentary surrounding the additional therapeutic assets you're pursuing beyond your PKU asset, how many we're talking about as a change materially since Q1 and where are they in terms of development.
I think you gave a little color on the last call. Thanks.
John Nicols
Yes, I didn't give any color in the prepared remarks today, but we are targeting four additional disease targets and one of those had advanced to doing some modest animal – early animal research. And no real new updates on that, we continued to fund work against all four targets with several parallel project teams.
And we're encouraged; we’re looking forward to next milestones in the remainder of the drug development pipeline beyond PKU. The next milestones would be in the form of patent application filings, additional animal research successes, that's what we would hope to be announcing in the coming quarters.
Matt Tiampo
Great. Thanks guys.
John Nicols
Thank you, Matt.
Operator
[Operator Instructions] And our next question comes from the line of Steve Schwartz with First Analysis. Your line is now open.
Steve, your line is now open.
Steve Schwartz
John? Gordon?
John Nicols
Hey, there you are. Hi, Steve.
Steve Schwartz
Hey, good afternoon. Sorry.
I guess my first question refers to the press release in that first or second paragraph you talked about shipping a large order that advanced the timeline for switching a manufacturing process. Can you talk a little bit about the dynamics there?
How does the shipment have to do with you guys picking up another manufacturing site?
John Nicols
Sure. We're real pleased with the progress here.
We gave an early indication to this customer, this top 10 major pharma companies, drug process somewhere in the middle of last year. Maybe I think the third quarter, if Gordon remembers.
At that point in time, we had done some protein R&D work to get the protein catalyst to be improved to the point where the customer would view use of our catalyst as a lower cost alternative to their current process because again, these drugs are already on the market. So they're already producing with an alternative process that does not use any enzyme or protein catalyst.
So our job is to convert that process to use a catalyst that we've engineered. So we did the R&D back in last year and that project, the R&D went very well, such that now the customer is trialing that catalyst in a larger scale process to validate the yield, the stabilities, other measures of parameters that are critical for their process, they’re validating at on a larger scale; so critical step along the process for our catalyst to be commercially installed, not quite there, but excellent progress.
Steve Schwartz
So this is a brand new opportunity. This is not an add-on facility where you're already have some commercial sites, right?
I mean like city in Clifton you're looking for perhaps some international sites that might get changed over. But it sounds like this opportunity is completely new for you.
John Nicols
That's correct, Steve. It’s a new target.
This is the first significant products sale into that drug process with about $0.5 million per my commentary and all the progress is positive to-date such that the next – in the not too distant future we’re hopeful that we’ll get the green light that were registered to be used, they’re cleared to be used by that customer, so we can start supplying our catalyst on a routine basis, which will be a nice chunk of products sales growth for the company when we get to that point.
Steve Schwartz
I see, okay. And then as a follow on question, if I could ask about how you’re presenting your strategy currently.
Particularly with respect to this enzyme for NGS, you note in your presentations that it's clinical diagnostics and certainly our researchers here cover that under the area of life sciences. But you're presenting it within a market opportunity that's defined as industrial enzymes.
How is it that you're classifying it in the industrial space?
John Nicols
Yes, that's a good question, Steve, and I don't want to confuse with labels. I think you understand the target market correctly as enzymes that are used by customers – potential customers who run next gen sequencing machines, to do genomic diagnostics.
Now genomic diagnostics can be performed by researchers under non-clinical criteria, but it also ultimately be used by customer, who are running clinical diagnostic to actually work on, for example, blood samples from patients to help diagnose and to determine disease states. The reason that I'd like – that we like to classified as an industrial enzyme is the following; unlike our catalyst business, unlike our therapeutic enzymes business where we're trying to convince customers or the world to use an enzyme and they're not using an enzyme or a protein today.
In this case, we're walking into a customer who is already using an enzyme, and we're convincing them that our enzyme is better. And there's a large universe of customers in many different industrial segments who are already buying enzymes from incumbent competitive enzyme companies.
And so this is a signaling that unlike the past we're going to start to do more of that kind of business development create a protein with our own self-funded investment money, validate in our own R&D that our enzymes are better than competitor’s enzymes. And then walk into those competitors’ customers to show why and how our enzymes are better.
We hope and believe that that will lead to an easier sales cycle than our historical business model where you have to help the customer understand how enzymes work and convince them that enzymes are applicable. Here you don’t want to convince the customers that enzymes are applicable, they're already buying them and paying money for them.
So that's kind of the universe of the broader industrial enzyme market. In our corporate presentation we have posted on our website, we refer to that industry but we also are very clear that our initial marketing is to a small subset of current enzyme users that are running next gen sequencers for genomic diagnostics.
Sorry for the long answer, hopefully that helped.
Steve Schwartz
Yes, it does help, but it makes me wonder and you do know you're targeting another industrial enzyme segment in 2018. I mean, are we talking about Ag and perhaps boal wine for food production or even industrial intermediate chemicals.
Is that what we're talking about here in terms of industrial enzymes?
John Nicols
First, in our corporate presentation we refer to setting up for another industrial entry, as we end this year move into next year. We didn't necessarily say it was an industrial enzyme the other possibility.
And if you list several potential industrial enzymes and they are theoretically targets. The other vector would be to bring protein catalysts into other manufacturing processes besides pharmaceutical manufacturing and food ingredient manufacturing.
So we've been characteristically vague on this new sector. We are confident, because we're confident in the broad applicability of our platform technology to potentially enter more industrial enzyme segments like the molecular diagnostics space as I’ve broadly defined or new catalyst industrial markets like we've already historically done a lot of in pharma and food manufacturing.
Steve Schwartz
Got it, got it. Okay, no, that’s very helpful.
Thank you, John.
John Nicols
Thanks, Steve. I appreciate it.
Operator
And I'm showing no further questions at this time. I would now like to turn the call back over to Mr.
John Nicols for closing remarks.
John Nicols
Okay. Relentless focused on our CodeEvolver protein engineering platform technology, getting more customers using that technology, and capturing more of the value we delivered to those customers to our own bottom line, that’s our success recipe.
We look forward to providing a progress report on our next quarterly conference call. Thank you, and have a great day.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program.
You may all disconnect. Everyone have a great day.