Aug 9, 2017
Executives
Jody Cain - IR-LHA John Nicols - President & CEO Gordon Sangster - CFO
Analysts
Brandon Couillard - Jefferies Matt Hewitt - Craig Hallum
Operator
Good day, ladies and gentlemen, and welcome to the Second Quarter Codexis' 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 be given at that time. [Operator Instructions] As a reminder, today's conference call is being recorded.
I would now like to turn the conference over to Jody Cain. Please go ahead.
Jody Cain
This is Jody Cain with LHA. Thank you for participating in today's Codexis' call to discuss 2017 second 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. 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 Codexis. The forward-looking statements reflect current beliefs and expectations of management as of August 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 SEC the earnings release that accompanies this call and 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 another quarter of solid financial performance plus share commentary on the excellent progress we're making across the Board in 2017 so far. As in the first quarter, accelerating product sales growth continued to be a center piece of our progress in the second quarter.
Our product sales more than doubled over the prior year quarter to $6.6 million and year-to-date we are 74% ahead of last year, and the outlook for the second half of 2017 looked even stronger as we expect product sales to exceed those of the first half. Accordingly, we’re raising our product sales guidance for 2017 by $4 million to between $25 million and $27 million.
It's terrific to see the acceleration of product revenues unfold in 2017. Our new guidance range for product sales reflects step up growth of 63% to 76% over those generated in 2016.
Product gross margins for the quarter also continued to be strong at 43%. This is the second consecutive quarter in which gross margins on product sales exceeded 42% well ahead of the 36% we delivered in 2016 and warranting a 2017 guidance increase on this key financial metric as well.
Already just at the half way point of 2017, we have nearly matched all of the product gross profit dollars we earned in 2016, $5.4 million in the first half of this year versus $5.6 million for all of last year. In addition to accelerating growth at higher margins, our product sales continued to diversify across a growing set of customers in the second quarter.
Sales of to protein catalyst to Merck plus Tate & Lyle led the way, each generating more than $1 million. In addition, a diverse set of customer’s each thought significant amounts of enzymes during the second quarter.
Of those, one global top 20 pharmaceutical customer purchased two different product batches for two of its drugs in clinical development. A leading generic drug customer bought routine product protein catalyst batches for the production -- commercial production of two of its generic drug products, yet another global top 20 drug company bought a proprietary enzyme for one of its late-stage developmental drug candidates.
And finally, we sold one of the largest product patches in our history into Japan to enable the manufacturing of the Phase 3 drug candidate of a leading Japanese pharmaceutical company. We also delivered solid results in R&D revenues in the second quarter as well which grew by over a $1 million sequentially from the first quarter of 2017.
R&D revenues in the quarter benefited from the first revenues generated from the new low cost enzymatic process development partnering projects, we announced in March with Tate & Lyle. Excitingly, the results of that project to-date have exceeded our expectations and Tate & Lyle's.
R&D team is doing a great job unlocking the power of proteins for this important new food ingredient target for Tate & Lyle. In addition, we're thrill to have dedicated a Codexis' R&D product team to focus on serving the biocatalysis development needs of yet another global top 20 pharmaceutical customer.
Similar to the dedicated R&D change we have had in place for Merck for years and continue to today, this leading pharma customer will now have one of Codexis’ protein engineering teams working against their list of improved drug manufacturing process targets. This dedicated private team arrangement was initiated in the second quarter and is a significant step forward for us in developing intimacy with this great customer.
Where the partner, work flow efficiency benefits accrue, helping liberate more cost saving potential at a faster pace and our typical project by project approach. Before shifting gears to the exciting progress of our internal development programs, I'd like to highlight the growing customer diversification evident from my product and R&D revenues discourse.
Five major pharmaceutical companies contributed significantly to our second quarter revenues on top of our largest customers of Merck and Tate & Lyle. Our model continues to yield a broadening customer base across the world's leading pharmaceutical companies and that bodes well for the future growth of our pipeline.
Next, I'd like to shift gears and provide you with an update on our exciting progress with CDX-6114, our orally-dosable enzyme therapeutic candidate for phenylketonuria or PKY disease. Here the Codexis team has finalized efficacy testing in our fourth preclinical model, demonstrating step changes in efficacy as we move from lower order animal trials to trials involving larger more complex animals, growing confidence from successes in these four preclinical models coupled with reduced CDX-6114 dosage requirements are being well received in our continued discussions with potential commercial partners.
So, with our acceleration of the timeline to be able to start human trials, we now expect to start Phase 1 trial in early 2018, four to five months ahead of our prior schedule. To do so, we will be spending more heavily on CDX-6114 in the second half of 2017 and previously forecast.
While this will affect our second half operating expenses and P&L, total program costs through Phase 1 completion are not impacted, but rather simply accelerated and hence we expect this year's extra spending will translate into commensurate savings in 2018. With improved confidence from the preclinical trials, the lowering of dose levels to reduce the ultimate costs to administer the patients and earlier human data results, we're increasingly encouraged by the potential opportunities presented by our PKU program.
Our growing successes in applying our CodeEvolver technology into new uses outside of protein catalysis continue as well in molecular diagnostics, as our first product launch into that existing enzyme market is moving very nicely toward commercialization. Our initial offering is a patent pending DNA ligase engineered by CodeEvolver for rapid and efficient product formation at low DNA concentrations.
Reliable detection of trace DNA targets is a core need for players in the rapidly developing next generation sequencing and diagnostic markets especially for the detection of cancerous DNA from blood samples otherwise referred to as liquid biopsy. Validating the relevance of our DNA ligase enzyme for liquid biopsy, our internal testing has shown rapid nearly complete conversion of low concentration input DNA into sequencing compatible product, significantly exceeding the performance of DNA ligase is commonly used in next gen sequencing work flows.
Given these encouraging results, we are now currently expanding the data testing program to encompass a broad swap of new high volume enzyme users in the molecular diagnostics field. Marketing, sales and distribution channels to support the ligase product launch are being developed in parallel with a target release date for the availability of commercial material around year end.
We also have begun CodeEvolver engineering efforts targeting additional enzymes that are needed for the molecular biology and diagnostics markets. We’re very excited and pleased with our team solid progress in this new arena.
That rounds up the business highlights from our growing pipeline. For those seeking additional information about our pipeline, we’ve posted to the Investor session of our company website page, an update to our Codexis’ pipeline snapshot with data current as of June 30, 2017.
Note, there is a modified more informative format to this year’s pipeline chart and going forward, we’re are only focusing on projects directly controlled by Codexis. More importantly than the format is the content, our pipeline has grown by seven projects or 27% over the last year.
We’re very proud of our solid second quarter and first half results and the strength we see for the remainder of the year. Accordingly, we're reaffirming our annual revenue guidance between $50 and $53 million for 2017.
A significant part of that second half revenue step up will come from an anticipated major new deal that we expect to announce in the near future. We look forward to announcing and detailing that for you.
In addition, we’ve clear visibility for delivering continued growth in both product sales and R&D revenues in the second half as well. 2017 is shaping up extremely well accordingly.
Before handing over to Gordon, let me take a moment to provide an update on our litigation against enzyme works, which we initiated last year. It is with great pride that we can report that yesterday Judge Orrick at the Federal Court in San Francisco intern an order awarding summary judgment to Codexis on our 10 claims of patent infringement against enzyme works.
This stipulated order establishes enzyme works uncontested infringement of 10 our patterns that covered dozens of engineered enzymes and also establishes the validity of these Codexis’ pattern for purposes of the case. The summary judgment order is a key milestone in the lawsuit and eliminates the need to have a trial over enzyme works infringement of our patterns.
There are still some dispute that remained to be resolved at a jury trial like the willfulness of enzyme work infringement, the personal liability of enzyme works founder Alex Tao for the infringement, the monetary damages owe to Codexis and enzyme works misappropriation of Codexis’ trade secrets, still two sales order brings closer an important issue. Enzyme works is latent infringement of Codexis’ patterns.
We’re grateful that the legal process indicated our claims and has protected the Codexis’ innovations. With those opening remarks, let me now turn the call over to Gordon to provide more details on the financials.
Gordon.
Gordon Sangster
Thanks, John. I will share some highlights of our financial results starting with the second quarter.
Total revenues for the second quarter of 2017 were $10.3 million this compares to $60 million for the second quarter of 2016, which included $10 million on the recognition of the revenues from GSK related to R&D milestones. Excluding these milestones in the prior period, revenues for the second quarter increased by 72%.
As John stated, product sales for the 2017 second quarter increased by a 101% from the prior year to $6.6 million, which reflected an increase in demand for our enzymes for both branded and generic products. Product sales were generated across the broader customer base with increased enzyme deliveries to Merck for Januvia and shipments to Tate & Lyle under the multiyear product agreement was major contributor.
We expect our next product shipments to Tate & Lyle in the fourth quarter of this year. R&D revenues for the quarter were $3.4 million, this compares with $12.1 million for the prior year which included the recognition of a $7.5 million milestone payment for the completion of our CodeEvolver technology transfer to GSK and $2.5 million in deferred revenue related to the early completion of that transfer.
This prior year events were partly offset in the 2017 second quarter by a significant increase in service revenues from major pharmaceutical company as well as service revenues from Tate & Lyle under the R&D agreement which we announced in March of this year. Revenue from our revenue sharing arrangement for the argatroban injectable drug with Exela was $356,000 in the second quarter of 2017.
This is down from $658,000 in the second quarter of 2016, but roughly in line with first quarter of 2017. Gross margin on product sales for the second quarter of 2017 was 43%, compared with 32% from the prior year period with the improvement due to product mix.
Turning to operating expenses, R&D expenses were $6.3 million for the second quarter of 2017 up from $5.1 million in the prior year. The increase was primarily due to costs associated with higher outside service expenses including increased cost associated with the production of our CDX-6114 enzyme to support this accelerated development as well as cost associated with higher headcount partially offset by lower amortization spend.
SG&A expenses for the second quarter of 2017 increased slightly to $6.5 million from $6.4 million for the prior year. This increase was primarily due to higher headcounts partially offset by lower legal expenses, lower depreciation and lower costs related to outside services.
The net loss for the second quarter of 2017 was $6.3 million or $0.13 per share this compares with net income from second quarter of 2016 of $2.2 million or $0.05 per diluted share which again reflected the recognition of milestone payments and deferred revenue of $10 million. On a non-GAAP basis, adjusted net loss for the second period of 2017 was $4.3 million or $0.09 per share versus adjusted net income for the second quarter of 2016 of $4.8 million or $0.12 per diluted share.
Turning to our year-to-date financial results, total revenues for the first six months of 2017 $18.3 million compared with $24 million for the prior year. First half 2017 revenues included $5.4 million in R&D revenues and $12.2 million in product sales.
Gross margin on product revenues was 44% for the first six months of 2017. R&D expenses for the first half of 2017 were $12.2 million and increased primarily due to higher service fees and increased costs associated with higher headcount.
SG&A expenses for the first six months of 2017 were flat for the prior year at $13.2 million. We reported net loss for the six months of 2017 of $13.7 million or $0.31 per share compared with a net loss for the prior year first half of $4.7 million or $0.12 per share.
On a non-GAAP basis adjusted net loss for the first six months of 2017 was $9.8 million or $0.22 per share versus adjusted net income of $507,000 or $0.01 per diluted share in the prior year. Cash and cash equivalents as of June 30, 2017 were $28.8 million versus $19.2 million as of December 31, 2016.
Importantly during the second quarter, we significantly improved the capital structure of the Company. In April, we completed a public offering with common stock raising net proceeds of $23.3 million, also at the end of June we signed an agreement for a bank debt facility and revolving line of credit for a total of $50 million.
Let me now turn to our financial guidance for 2017. We are affirming our expectation for total revenues for the year to be between $50 million and $53 million.
This guidance assumes revenue from an anticipated major new deal that the Company expects to announce in the near future. It also assumes significantly hard revenues in the fourth quarter compared third quarter.
We are increasing our guidance for 2017 product sales to $25 to $27 million, which represents an increase of 63% to 76% over 2016. As I mentioned earlier, product sales of the first half of 2017 were more than $12 million.
We are also increasing our expectation for 2017 gross margin on product sales to be between 40% and 43%. Lastly, we're updating out outlook for 2017 operating expenses which are the combined total of R&D and SG&A.
We expect operating expenses of approximately $15 million per quarter with the third and fourth quarters of 2017. This is an increase by $2 million per quarter from the second quarter operating expenses and includes additional costs for the accelerated development of our PKU drug candidate to move this asset more rapidly towards a Phase 1 trial.
With that, I'd like to turn the call back to John.
John Nicols
Thanks for that financial review, Gordon. As Gordon and I have detailed on this call, we're off to a great start across the Board in first half of 2017.
Our leading edge protein engineering platform technology CodeEvolver continues to create new proteins, using proprietary machine learning algorithms to find out proverbial needle in a haystack that novel protein sequence from a nearly infinite selection that enables previously unachievable performance attributes quickly. In parallel, we’re growing and choosing what proteins to target in what applications end markets with what value creating possibilities with which partners in what collaborative model better and better as well.
This all adds up to our dynamic driving company with leverage to help us achieve and sustain profitability. These are exiting times here at Codexis with more to come.
With these comments, I would like to open up the call for the questions. Operator?
Operator
Thank you. [Operator Instructions]
John Nicols
While we waiting for our first question, I would like to alert you to our busy schedule participating at upcoming investor conferences. We will be presenting at BioCentury NewsMakers in The Biotech Industry Conference on September 8th in New York, at the Rodman and Renshaw's Annual Global Investment Conference being held September 11th and 12th also in New York, at KeyBanc’s Basic Materials & Packaging Conference being held September 12th and 13th in Boston, and at Janney Montgomery Scott's Biostorage and Bioproduction Forum on September 19th in New York.
Webcast of our presentations at the BioCentury and Rodman and Renshaw Conferences will be posted to our Investor sections of www.codexis.com. Okay, operator, we're ready for the first question.
Operator
And our first question comes from Brandon Couillard of Jefferies. Your line is now open.
Brandon Couillard
John, we'd love as you could perhaps elaborate little bit on your progress on the molecular diagnostic front with some of the initial assays how that's progressed relatively your expectations? And what the portfolio looks like today?
I think it's my understanding that you have maybe four enzymes on hand and you needed perhaps another four to get a more complete offering for the market, just an updated kind of along the proceeding of that initial rollout?
John Nicols
Sure, Brandon. So, we little bit different than what you said.
We have developed our first enzyme for next and sequencing use, the dominant enzymes that are used are four. So, our medium term intention is to create all four of those enzymes ideally at or better than existing enzyme performance for next gen sequencing.
We're really encouraged by the performance results in our internal testing from the first enzyme the DNA ligase. We saw the DNA ligase as a weak link in our customers' ability to generate reliable results at low DNA concentrations like liquid biopsy.
We saw this enzyme particularly deficient from incumbent suppliers, that was our first target and our testing so far is bearing up that our enzymes will indeed enhance the reliability and the results of liquid biopsy testing, using our enzymes. And we're out right now working with a growing slot of customers to prove that out in the customers' hands.
We started in addition, we started work on additional enzymes to use our CodeEvolver to engineer improvements to the other three primary enzymes that are used in next gen sequencing, and we look forward to providing more detail on that as we move through the rest of this year.
Brandon Couillard
Thanks, it's helpful. And then Gordon in terms of the outlook for the year two questions.
What would you say are the biggest -- the couple of biggest drivers to the increased product revenue growth outlook? And then secondly despite that the $4 million product revenue bump, what's the offset that keeps the total revenue the same for the year?
Gordon Sangster
Yes, let me do the first question first. We were seeing increased shipments to Merck in particular in the fourth quarter as well as the second shipment to Tate & Lyle.
So that counts for a large portion of the increase in product revenues in Q4 versus Q3. The offset to the product revenue increase would be an R&D fees to try and make sure that we maintain our guidance of 50 to 53.
So, some of the views depending on the structure that we employ for revenue in these collaborations can affect the timing of the revenue recognition, so that's basically the reason we offset our R&D revenues.
Operator
Thank you. [Operator Instructions] And our next question comes from Matt Hewitt of Craig Hallum.
Your line is now open.
Matt Hewitt
Couple of questions for me I guess. Following up on the next gen sequencing opportunity, as you progress on that, is this an area that you intend to go direct in?
Or do you anticipate partnering with a larger life science tools distributor to get that product to market?
John Nicols
Yes, Matt we have optionality there. We could partner which could speed up our entry into these markets, but it would come at the expense of margins being shared with the partner.
But we're also lining up to have the option to go direct at least to the major users. And so, we're holding that option open for now and we think either prospect would be very significant for the Company as we finish the year.
Moving to next year, we’re very encouraged by the results. This is a fairly large target market for the Company and so we would -- we’re well on track to deliver what we help be multi-million dollar for sales -- product sales into that market next year.
And we see the margins in this market being significant and above our typical product margins. So, we’re very excited about how the rule out is progressing for us.
Matt Hewitt
That’s great. And shifting gears to PKU opportunity, I think you mentioned that you're accelerating the R&D expense this year that should translate into lower expense next year.
At what point so you get through Phase 1, but assume it’s a good data, then you start thinking about Phase 2. So from a modeling prospective, shouldn’t we just maintain that elevated rate or give anticipated pause or may be after Phase 1 that is going potentially sign of partnership agreement in some of that expense falls into your partners’ hands?
John Nicols
I think it could be the ladder -- as we also said in the call, we’re in discussions with multiple potential commercial partners and those partnering discussions could translate into a partnering transaction that could be even before we initiate Phase 1 trials or during the Phase 1 trials. I think it's fairly low probability that could excess itself for our first therapeutic asset with Bayer, the cost and risk based to two trials by itself.
So, the probability I was carrying it into inter Phase 2 is pretty low and we’re encouraged by these partnering discussions at this point in time. So the comment about the timing of spending is really in relationship to the total cost of preclinical plus the Phase 1 expenses.
Our previous outlook would have been a little less preclinical expense and more Phase 1 expense next year and now we’re bringing some of that forward to enable us to see and get the results from human trials sooner, which we think is definitely a significant benefit for the program.
Operator
Thank you. And I'm showing no further questions at this time.
I would like to turn the conference back over to Mr. Nicols for closing remarks.
John Nicols
Okay. Thanks everybody for your time and interest in Codexis this afternoon.
We look forward to providing progress report on our next quarterly conference call. In the meantime have a great evening.
Thank you.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program.
You may all disconnect. Have a great day everyone.