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Verenium Corporation (NASDAQ:VRNM)

Q3 2008 Earnings Call Transcript

November 10, 2008, 5:00 pm ET

Executives

Kelly Lindenboom – VP of Corporate Communications

Carlos Riva – President and CEO

John McCarthy – CFO and EVP

Analysts

Silke Kueck – JP Morgan

Lucy Watson – Jefferies

Sanjay Shrestha – Lazard Capital Markets

Pamela Bassett – Cantor Fitzgerald

David Woodburn – ThinkEquity

Operator

Good day, ladies and gentlemen, and welcome to the quarter three 2008 Verenium Corporation earnings conference call. My name is Missa [ph] and I will be your operator for today. At this time, all participants are on listen-only mode. We will conduct a question-and-answer session towards the end of this conference.

(Operator instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over to Ms. Kelly Lindenboom, Vice President of Corporate Communications. Please proceed, ma’am.

Kelly Lindenboom

Good afternoon. Thanks, everyone, for joining Verenium third quarter 2008 conference call. I’m Kelly Lindenboom, Vice President of Corporate Communications, and with me today are Carlos Riva, our President and Chief Executive Officer, and John McCarthy, our Chief Financial Officer.

On today’s call, we will cover the following: First, we will discuss the overall progress the company has made in the third quarter and year-to-date, then John will provide the summary of our financial for the third quarter; and finally, we will review anticipated upcoming milestone.

Before we begin, I would like to advise you that this discussion will include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21A of the Securities Exchange Act of 1934 as amended. These statements involve a high degree of risk and uncertainty and relate to matters such as the company’s strategy, future operating plans, markets for the company’s products, strategic partnering activities, public policy initiatives, financing activities, technical and business outlooks. Such statements are only predictions and actual events and results may differ materially from those projected in such forward-looking statements. Factors that could contribute to differences include but are not limited to risks related to the company’s IPs, strategic partners, competitors, and regulatory and market forces. Certain of these factors and others are more fully described in the company’s filings with the SEC, including but not limited to the company’s quarterly report on Form 10-Q for the quarter ended September 30, 2008. These forward-looking statements speak only as of the date herein and the company expressly disclaims any intent or obligation to update these forward-looking statements.

I would now like to turn the call over to Carlos.

Carlos Riva

Thank you, Kelly. Good evening, everyone, and thank you for joining our call today.

Let me begin by saying how pleased we are with the continued progress we have made over the last quarter and throughout 2008 against the goals we established in the beginning of this year. It’s been an exciting time for the company as we continued to make important strides toward our goal of bringing cellulosic ethanol in commercial volumes to the market. Even against the backdrop of what are certainly very trying times for both global financial and first generation ethanol markets.

However, during the past quarter, we’ve made substantial progress in both of our business units. We have also had important developments on the corporate front and all of which are a testament to the world-class team we have assembled over the last year or so. That said, even as we continued to enthusiastically pursue our goals and make progress across the business, we’re ever mindful of today’s challenging economic environment and have taken steps as an organization to ensure that we’re being as fiscally prudent as possible.

I’d like to begin by touching on our collaboration with BP, which was announced on August of this year and which was truly a transformational event for Verenium. The collaboration not only brings $90 million of non-diluted capital to the company over 18 months but provides a solid foundation to accelerate technology development efforts at our pilot and demonstration-scale plants. Importantly, we’re also in discussions with BP on the second phase of the collaboration which will address the development construction and operation of commercial scale cellulosic biofuels facilities.

As we discussed last quarter, we believe this partnership is a critical one for the next generation industry as the mandate for delivering commercial products to the markets as set forth by Renewable Fuel Standard comes ever closer. The pairing of our two companies, an international energy company and the leading cellulosic ethanol company, brings together Verenium’s proprietary cellulosic technology and know-how with BP’s process engineering, logistics, marketing and supply chain experience and effectively positions our joint companies to be among the first movers to deliver commercial cellulosic ethanol at a time when the world very much needs alternatives to fuel, alternative fuel resources.

Since announcing the partnership, representatives from key functional areas on our respective teams, including R&D, engineering and agronomics, have rolled up their sleeves and begun to work closer together to accelerate the activities already in progress and to map out our plans for the future. In addition, the two companies have begun discussions around Phase II of the collaboration, which we hope to update you on shortly.

I’d now like to turn to a specific discussion on Verenium’s progress and achievements over the last quarter in our respective business units. I’ll begin with our biofuels business.

Activities at our production facilities in Jennings, Louisiana continue to progress at a steady pace. We’ve now completed the startup phase of the demonstration-scale plant in a nearly halfway through a comprehensive commissioning. We’ll then begin an optimization phase by the end of the year that will further test predetermined performance and economic objectives as a basis for moving forward with our first commercial facility, which we plan to begin on the second half of 2009. We expect the commercial facilities will be one of several that we develop in partnership with BP over the next several years and will be an important next step for the developing next generation industry.

Let me talk for a moment on plans for our first commercial facilities. We made significant headwind on this front as we look toward next year and beyond. First, we have initiated a site design, which we expect to have construction ready by next year in preparation for the build-out of our first commercial facility. On the development front, we are pursuing activity on our portfolio sites in the Southeast US, including discussions with land owners, feedstock providers, local officials, as well as permeating another related activities, and expect to be making further announcements on these sites including the intended location of our first commercial facility over the next couple of months. Next, we are in continuing negotiations with engineering, procurement and construction partners and will soon make an announcement with whom we’ll be working with for our first commercial plant.

Also, as we’ve previously discussed, the availability of federal loan guarantees is a highly beneficial component for early projects that we’re aggressively pursuing to support for the Department of Energy and preparing our applications of their current solicitation. We, together with BP, have continued to refine a feedstock strategy for our first commercial plant and expect that dedicated energy crops, such as energy cane, will be our focus. Given what we know today, we anticipate building a facility that will produce 36 million gallons per year, roughly 20% larger than we had originally planned, and an estimated cost of roughly $250 million to $300 million.

Finally, on biofuels, the result of last week’s selection can be characterized as a major positive development for Verenium. Throughout this campaign, President-elect Obama has emphasized the support for green energy technology will be a cornerstone of his administration and he has been a consistent supporter of both traditional ethanol, as well as advanced biofuels. In terms of near-term impact on funding for biofuels technology development deployment, President-elect Obama has indicated that one of his top priorities will be to launch a 10- to 15-year program of up to $150 billion in size to develop and deploy green energy technologies that promote US energy independence and environmental sustainability. If this is realized, it would represent a considerable increase from current spending patterns and would imply greatly expanded funding opportunities for Verenium and other participants in the advanced biofuel space. While political support for biofuel has been stronger in the last administration, actual funding for biomass programs has been limited to a few hundred million dollars per year, a level that could see considerable growth as the industry turns its focus from research to commercial development.

In addition, the climate change legislation has emerged as one of the most high profile issues that the 111th Congress plans to take up in January. All major legislative proposals on this issue contain some form of cap-and-trade system governing carbon emissions. Enactment of the law targeting carbon emissions will be likely to take a – trying to gain passage to the legislature but from Verenium standpoint, the enactment of any system that puts the dollar value on avoided carbon emissions will be a major plus since producing advanced biofuels, especially cellulosic ethanol, can result to significant avoided carbon emissions.

Finally, as we’ve discussed previously, in addition to the Department of Energy’s long guaranteed program enacted into law last year, Congress directed the US Department of Agriculture to implement a program offering loan guarantees to biorefinery projects under the Farm Bill legislation enacted earlier this year. We, and others in the industry, have been informed by the Department of Agriculture that action to implement the new loan guarantee program is expected imminently. This new program is expected to make several hundred million dollars in loans available to biorefinery project developers in 2009 and over the following two to three years, which will be critically important to enabling early commercial projects.

I’d now like to update you on our Specialty Enzyme Business Unit. We are focused on building a leading specialty enzyme business through the development, manufacturing and sales of tailored enzyme products to strategic industrial markets. While this business unit is generating revenue from multiple sources, including technology licenses, collaborations and government grants, the primary focus of the business is commercial products sales. As we’ve seen throughout this year, during the third quarter, there was continued momentum in this part of the business. John will go in to more of the financial specifics but have note for the third quarter of 2008 we’re pleased to report another strong quarter for the business with total combined revenue of $16.4 million. Overall product sales were up 95% over the same period last year. Phyzyme continuous to show strong promise and represents the strongest product in our portfolio with year-over-year growth of 176%. We experienced continued progress with Fuelzyme in demonstrating economic benefits with grain ethanol production process resulting an additional commercial success for this product; and we have just find a non-exclusive agreement with ADD Foods [ph] of Germany, a respected supplier of custom-tailored enzymes to distribute the product in Europe.

Our market development activities with Purifine have been focused on Argentina and Brazil where the value proposition of increasing yield was particularly strong given the scale of soy bean crushing plants in those regions. Also, we are in the final phase of a major capacity expansion project at Fermic, our manufacturing partner which will greatly expand our ability to supply our fast growing products, Fuelzyme and Purifine.

Finally, Verenium’s program to develop ligno-cellulosic enzymes continuous to advance with increased external support including a grant from the Department of Energy and a grant-funded collaboration with Scion in New Zealand. As part of a large research and development program, and a leveraging Verenium’s technologies for enzyme discovering evolution, we make great strides towards improving these cellulase enzymes to make them cheaper, more robust and more effective.

These second generation of ligno-cellulosic enzymes are expected to not only create significant value for Verenium’s Biofuel’s operations, but will also represent the strategic product opportunity for our specialty enzyme business unit as we seek to identify other industrial opportunities by unlocking cheap sugars from biomass using these products.

Overall, we’re quite please with our expanding base of products and sales with a strong market leader Phyzyme and follows by emerging but up and coming new products including Fuelzyme and Purifine.

And now I’d like to turn the call over to John McCarthy, our CFO, to review our second quarter financial results.

John McCarthy

Thanks, Carlos. Q3 represented a solid quarter progress against our major corporate objectives. With our biofuels business, we remain on track to commission our Jennings demo plant by year end, which will then form the foundation for validating key production cost metrics, as we plan for our first commercial facility. Moreover, the Verenium and BP teams are actively engaged in important work under the joint development agreement executed this past August, and we’ve made good progress this fall towards an important second phase of our partnership focused on acceleration our joint commercial cellulosic ethanol plants.

Our specialty enzyme business also produced solid gains from Q3 as product revenue remains strong based on continued market penetration of Phyzyme in the animal health market, as well as strong traction achieved with Fuelzyme in the grain ethanol market.

Before I provide a brief financial summary from Q3, let me first highlight two items for the quarter worth noting. First, Q3 represents the first quarter of activity for the phase of our BP partnership executed this past August. Recall that the transaction provides Verenium with $45 million in payments through July 2009 related top access to Verenium’s technology platform through Galaxy Biofuels LLC, the special purpose entity we established as part of the transaction. The second financial component of the transaction involves funding of $2.5 million per month over an 18-month period representing BP’s co-funding of our biofuels R&D program.

Technical accounting rules require that we record these payments from BP on to our balance sheet as the minority interest called “non-controlling interest in Galaxy Biofuels LLC” in order to account for BP’s 50% equity in the special purpose entity. As a result for the next 18 months, through January 2010, BP’s $2.5 million of funding toward our monthly development cost will be recorded as a credit to our statement of operations below the operating loss on a line entitled “loss attributable to non-controlling interest in Galaxy Biofuels.”

Secondly, as detailed in our press release and 10-Q filing this evening, we took $106.1 million non-cash Goodwill impairment charge in the third quarter which represents the entirety of the carrying value of our goodwill balance from the Celunol merger. Despite the significant progress we’ve made with our biofuels business, as most recently displayed by the announcement of our strategic partnership with the world’s leading biofuels company, BP, a significant contraction experienced across the worldwide public markets over the past several months had significantly impacted public equity and dead valuations including Verenium’s. Based on applicable accounting rules related to annual Goodwill impairment assessment, we concluded that it was appropriate to write off the full carrying value of our goodwill.

I will now turn briefly to discussion the financial highlights of the quarter.

Total revenues for Q3 in the first nine months of ’08 grew approximately 51% and 50% to $16.4 million and $49.9 million respectively, compared to $10.9 million and $33.3 million for the same periods last year. More importantly, however, the year-to-date portfolio mix representing continued progress being made to accelerate the commercial traction of our product portfolio.

Product revenue in these periods increased 96% and 108% to $12.4 million and $37 million respectively from the comparable periods in’07 due on large part to continued strong growth in the market for Phyzyme. Our total product revenue sales of Phyzyme which is sold through the company’s partnership with Danisco Animal Nutrition grew approximately a 176%, and a 152% year-over-year in Q3 and year-to-date ’08 respectively to $9.9 million and $27.8 million as Phyzyme’s differentiated product characteristics continued to expand its worldwide phytase position in the animal feed industry.

In addition to the strong progress being made with Phyzyme, other products within the portfolio made solid progress in the quarter including, most importantly, Fuelzyme LF which is the company’s alpha amylase enzyme used in grain-based ethanol production.

Since we begin selling Fuelzyme LF through our own dedicated sales force in mid ’07, we’re pleased with the performance in important plant trials and early adoption into commercial production. Year-to-date ’08 also included roughly $2.5 million in product revenue from two discontinued products, those being Bayovac and Quantum, which will not occur in future quarters.

In light of generating $36 million in product revenue through the first nine months of this year, relative to current full year product revenue guidance of $38 million to $40 million, we are raising our full year ’08 product revenue guidance to a range of $46 million to $48 million. We were expected to provide full year ’09 guidance early next year as part of our year-end ’08 earnings call.

Product gross margin was 23% and 27% in Q3 in the first nine months of ’08 respectively versus 25% and 22% last year. While gross profit dollars were substantially greater in the ’08 period versus ’07 due to significant product revenue growth, the quarter-over-quarter declined in gross margin percentage resulted from increased cost related to sustaining rapid Phyzyme volume growth as well as certain manufacturing inefficiencies experienced during the quarter. We expect to rectify both of these issues and subsequent choice [ph].

In terms of operating expenses, R&D expense for Q3 in year-to-date ’08 totaled $15.3 million and $45 million respectively versus $14.7 million and $37.5 million for the comparable periods in ’07. The increase in year-to-date period-over-period R&D expense was primarily related to the inclusion of Celunol operating expense in the end of June ’07.

Our SG&A expense in Q3 in year-to-date ’08 totaled $13.7 million and $32.5 million respectively versus $11.3 million and $24.5 million ’07. The ’08 year-over-year increases related primarily to the inclusion of Celunol SG&A expenses beginning at the end of June of ’07. Approximately $4 million in total advisory fees related to the BP transaction, plan acceleration of the company’s biofuels program, and increased non-cash stock-based compensation expense.

Included in both R&D and SG&A expense for all periods is non-cash stock-based compensation expense in a rough 40%, 60% proportion. For Q3 in year-to-date ’08, stock-based compensation totaled $3.2 million and $9.4 million respectively versus $5.1 million and $8.4 million for the same periods last year, resulting primarily from additional option grants in connection with the Celunol merger as well as several new senior level hires and company-wide grants since that time.

Recall from prior quarters that I described the process undertaken by the company to establish the proper accounting treatment for its 8% convertible bonds issued in February earlier this year. Having finalized the rather complicated accounting treatment for the convertible bonds, are financial statements reflect the dynamic nature of certain components of the dead instrument, many of which will produce non-cash interest expense as well as require courtly revaluations resulting in gains and losses on our P&L for the duration of the bonds through their maturity in 2012.

While details of this transaction are more explicitly described in our third quarter 10-Q filing this evening recalls that the cash interest on our two convertible bonds approved based on a coupon of 5.5% on roughly $102 million of face value for our first issue and 8% on approximately $59 million of face value for our second issue. You’ll note that approximately $12 million of voluntary conversions on our 8% bonds have occurred since issuance in February of this year.

Despite the rather severe capital markets conditions we have experienced over the past several months and that are likely to persist for some time, we remain confident in our business model, the breadth of our strategic partners, and our continuing ability to execute against our aggressive plans. Moreover, we are more focused than ever on allocating finite resources to our highest value initiatives only.

I’d like to now turn the call back to Carlos for a few closing remarks before we open up the line for Q&A. Carlos?

Carlos Riva

Thanks, John. I’d now like to turn to the milestones that we anticipate to be able to update you on in the coming months.

As I’ve mentioned previously, we’ll be updating you on progress around the development sites for commercial projects, including the location of our first commercial site in the next few months. We also expect to provide updates on the ongoing progress that our demonstration-scale plant in Jennings, including progress on commissioning and performance optimization, and also to provide updates on our existing relationship with BP as well as progress on the development of Phase II of our collaboration, which we expect to focus on developing, building and operating a portfolio of commercial cellulosic facilities.

In closing, I’d like to reiterate that Verenium remains committed to building a leading industrial biotechnology company and we believe that our achievements over the last several months have us on the path to delivering on our vision of developing and commercializing next generation biofuels and specialty enzyme products.

At this point, I’d like to turn it back to the operator for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jeff Zekauskas with JP Morgan. Please proceed.

Silke Kueck – JP Morgan

Good afternoon. This is Silke Kueck for Jeff. How are you?

John McCarthy

Hey, Silke.

Carlos Riva

Yes.

Silke Kueck – JP Morgan

A couple of questions. First on BP. I understand how the $2.5million flow through income statement as a reimbursement to your cost and can you explain how the other part, the other $45 million will flow through income statement? Meaning, there is $24.5 million you’ve received in August and should that amount be somehow amortized over some period of time and should that somehow appear on your income statement?

John McCarthy

It’s a good question, Silke. If you look at our financial statements and again, it’s more detailed in the 10-Q than it is in the press release, but what you’ll see is a line item, effectively, a minority interest line item that’s $19.5 million in the September 30 statement. What you don’t see is another $5 million that’s running through the equity line item, the two of which total $24.5 million that we repaid as part of the closing of the transaction. That $24.5 million, as we get paid the balance in January and July of this year, will accrete up to $45 million on the balance sheet, okay? So that’s one – that’s the $45 million license fee, if you will, and the $2.5 million per month funding from BP to co-fund our biofuels development will run through the P&L below the operating expense line item as you see in the third quarter, and that’s how it gets accounted for. It’s technical, it’s pretty technical accounting through what’s called FIN 46 and we spend a lot of time with ENY and in company, making sure that we had what we felt was a proper accounting treatment here.

Silke Kueck – JP Morgan

So, I guess, I’ve understood that right. It means that the $45 million will go through a cash flow statement chart on the balance sheet, but it doesn’t really run through the P&L.

John McCarthy

Yes, the $45 million license fee, if you will, if you want to think about it in that manner, will go directly on to the balance sheet, $24.5 million of which is already there by virtue of having gotten paid $24.5 million, as we’ve detailed in prior descriptions. $6.5 million gets paid early January, another $14 million related to that component of the transaction gets paid in July, so those three elements will go directly onto the balance sheet. The $2.5 million monthly payments that would be getting paid through January of 2010 will run through the P&L.

Silke Kueck – JP Morgan

That’s very helpful.

Carlos Riva

Sure.

Silke Kueck – JP Morgan

Secondly, on interest expense. So if I understood that correctly, there is about maybe $2.7 million or $2.8 million in actually cash expenses related to the convertibles?

John McCarthy

Right.

Silke Kueck – JP Morgan

And there is something like $7 million in non-cash charges?

John McCarthy

That’s correct. Yes, related to the accounting treatment primarily for the 8% convertibles. So, when you take a look at the 10-Q you’ll see, similar to last quarter all the details of what gets made up of the interest expense. And as you noted, Silke, which is the reason I wanted to call it out in this call is that the cash component is a minority piece of the interest expense and that’s really the most operative element here.

Silke Kueck – JP Morgan

Will the – is the $7 million a six number that should appear every quarter, like a life of the convertible or it won’t?

John McCarthy

No, it’s not. What you’ll see in the 10-Q is that a significant piece of the incremental interest expense for the quarter is related to conversions that were done primarily in the third quarter, conversions of the 8% bond. So there were about $12 million worth of voluntary conversions that investors did in total and so when you reverse out the accounting for the conversions, you end up having to take a non-cash charge associated with those conversions and it just happens to run through interest expense, unfortunately. So again, it’s detailed in the 10-Q but to your question, that shouldn’t be something that you factor on in subsequent quarters. If there are continuous conversions of the 8% bonds, then you’ll see incremental interest expense, non-cash interest expense running through there as well.

Silke Kueck – JP Morgan

Okay, that’s helpful. If I can ask my last question, it’s just for clarification. If I remember right, I thought the slogan “initial estimate” that may have been made for a commercial ethanol plant with 25 million gallon commercial plant, would someone knew what else like, maybe like $180 million or $200 million, and the 36 million gallon plant was like a much bigger taken off [ph], like $250 million to $300 million. What is more expensive? It’s just that steel is more expensive. It’s structurally more expensive or is permeating more expensive? Or what’s – why these costs increase?

Carlos Riva

Well, first of all, we’ve increased the size of the plant and that’s principally driven by the optimal size of the hydrolysers, which is the first stage of the process. They’re made commercially for both the paper [ph] industry and the size which seems to fit our design best would have us building a plant which was 36 million gallons per year rather than 25 or 30 million gallons, which were earlier estimates of the commercial size. So there is – and of course, that scales through and has an increase in terms of volume for steel and piping and all the rest. Also, there have been some additional cost increases in commodities since the point where we did start to make those estimates; and I think just finally, right now, we know a lot of the detail of what’s going to be required, so our design certainty has increased. Having said all that, there’s also a very significant effort ongoing on the part of our cells with our engineer to look to optimize cost and even bring cost down where we can.

Silke Kueck – JP Morgan

Okay, that’s really helpful. Thank you. I’ll get back in the queue.

John McCarthy

Thanks, Silke.

Operator

Your next question comes from the line of Laurence Alexander with Jefferies. Please proceed.

Lucy Watson – Jefferies

Hi. This is Lucy Watson sitting in for Laurence. Just a couple of questions. I’m wondering if you’ve given update on your gross margin expectations for the full year.

John McCarthy

Lucy, it is John. We haven’t changed our gross margin guidance since we made it back, I think, early part of this year, so the only thing that we’ve altered here is the product revenue number.

Lucy Watson – Jefferies

Okay. And with the $2.8 million in product gross profit in the third quarter, would the contributions on Phyzyme be relatively proportional to Phyzyme’s contribution to product revenue or higher or lower?

John McCarthy

Well, we’ve never broken out gross margin or gross profit, Lucy, by product so we – it’s confidential information, so we just haven’t broken it out.

Lucy Watson – Jefferies

Okay. And moving to the Jennings facility, any clarity on the process economics there?

Carlos Riva

I think it’s still pretty mature to be able to give any specific update. We will be running it to test different strategies and optimize it over the course of the next several months, and it’s really only in that time when we’ll have clarity on process economics.

Lucy Watson – Jefferies

Okay. And the location for the commercial plant. You’ve stated, I guess, five locations in the past. Any changes?

Carlos Riva

Well, we’ve mentioned sites in five different states and we continue to pursue those various sites. In fact, it’s more than five individual sites. I think that in the coming weeks, we’ll be being more specific about which one is going to be the site that we go forward with for our first. Frankly, one of the issues that we’re – one of the reasons why we’re not being more specific now is because we’re in various discussions with the state agencies about support for those facilities, but we expect in the coming weeks to be able to give clarity on that.

Lucy Watson – Jefferies

Thank you.

Operator

Your next question comes from the line of Sanjay Shrestha with Lazard Capital Markets. Please proceed.

Sanjay Shrestha – Lazard Capital Markets

Great, thank you. Good afternoon, guys. A couple of quick questions. So obviously, we have a huge platform under Obama for the ethanol and then we’ve got the overall commodity market dynamics at hand, and we also have what’s going on with some of the corn-based ethanol, so how do you see that playing out as it relays to the cellulosic opportunity as well as more specific to you, guys, as we go forward here?

Carlos Riva

Well, I think politically, we continue to believe that there’s going to be major support for cellulosic ethanol program and, in fact, probably as well for a grain-based ethanol, first generation ethanol program, that, of course, is important in looking to build up the infrastructure of demand and transport and the like for ethanol, but everything that we hear is that there’s likely to be increase support in terms of absolute dollar value. But I think as important as the absolute amount is, I think the other thing that we’ll be looking for is more aggressive support for that money being made available to commercial projects, and so I think it speaks very positively for the cellulosic ethanol prospects.

Sanjay Shrestha – Lazard Capital Markets

Got it. That’s very helpful. And in terms of the federal loan guarantees that you guys are talking about, that you’re pursuing aggressively at this point in time, so how exactly would those work then? Can you talk about that a little bit?

Carlos Riva

Well, there’s two parts. One is long-guaranteed programs that would be provided under the Department of Energy and the others that would be provided potentially under the Department of Agriculture. Just turning to agriculture for a moment, the rules for that have not been issued yet. The legislation was enabled under the Farm Bill, but the actual rules haven’t come out yet although they are expected any day, I guess if they could slip into the next administration, but we’ve been told that they should be coming out imminently. But those would be likely to support new biofuels or biomass-based biofuels facilities with new technology, as well as importantly support the establishment of dedicated energy crop plantations and work on the feedstock side.

In terms of the long-guaranteed programs under the Department of Energy, we’re in the process of putting together our application. The solicitation that the agency noted, I think was middle of this year, was going to have a due date for applications of the end of December of 2008. They’ve recently put out a memo that it’s being pushed back by two months, so applications will be being submitted up to the end of February of 2009. But there, again, it’s – the agency provides for loan guarantees on a specific debt, which it could go up to 80% of the overall facility, although there are a number of different provisions that assign points and scores to various features and components of the applications, so it’s not clear that we would necessarily seek the full amount available. And this would be, again, covered by rules that were earlier promulgated but effectively support a non-recourse loan with the US funds

Sanjay Shrestha – Lazard Capital Markets

Got it, that’s great. And one last question here then, guys. I mean, maybe it’s just me thinking out loud here, but given what’s going on in the commodity dynamics and given that cellulosic has the environmental dynamics and everything, under the new regime, wouldn’t it be fair to assume even though we don’t know exactly what happens is that more support for cellulosic rather than the grain-based ethanol?

Carlos Riva

I think that’s – that’s our belief. Again, for the reasons you stated because it – cellulosic does address many of the shortcomings of first generation ethanol, in terms of being having a better carbon footprint, ultimately being less impactful of water resources, the food chain and the like, and generally has deemed to have a better energy balance, so we think all that will mean that cellulosic will continue to have a lot of support and more support than grain-based.

Sanjay Shrestha – Lazard Capital Markets

That’s terrific. Thanks a lot, guys.

Operator

Your next question comes from the line of Pamela Bassett with Cantor Fitzgerald. Please proceed.

Pamela Bassett – Cantor Fitzgerald

Hi. Thanks for taking my call. Congratulations on all the progress.

John McCarthy

Thanks so much.

Pamela Bassett – Cantor Fitzgerald

I’m wondering – hi. What – can you talk about some specific activities that have been going on with respect to optimization in Jennings? Have you found – I mean, on the last call, you mentioned that you’ve been able to eliminate certain processes and reduce and create efficiencies in the process. Can you talk a little bit about what you’re doing in that regard or have you already reached a certain threshold there?

Carlos Riva

Well, I think that the – again, as I think we’ve mentioned in the past, this is about finding what I call nickels and dimes of improvement and optimization, relating principally to the variable cost component of the cellulosic ethanol, and that means findings ways to make enzymes more – less expensively finding ways to be the cause of nourishing our fermentation organisms using less electric power, recycling water as much as possible and that therefore, reduces the amount of treatment in treatment chemicals, and it’s really a whole series of these things that lead up to or that constitute our efforts to improve the product performance and performance cell unit. I think the other thing that’s obviously ongoing now in conjunction with our design efforts for the first commercial unit is we’re taking the lessons learned for the demonstration plant and applying that to design for the scaled up unit. So again, a lot of different things that may be small when they’re individual in pack but collectively add up to significant progress.

Pamela Bassett – Cantor Fitzgerald

So it sounds like the focus is really on nailing down the design for the commercial, and I wonder to what extent going forward will you continue to focus on the long-term building a center of excellence and being able to switch from one feedstock to another? Or will you be looking for what gets supported for dedicated energy crops in the Farm Bill to steer your focus?

Carlos Riva

Well, generally, let me –

Pamela Bassett – Cantor Fitzgerald

This is strictly at Jennings I’m talking about, not necessarily the commercial operations.

Carlos Riva

Right. Well, none of Jennings is – I didn’t really touch on feedstock, but we are using Jennings both the pilot and the demo to improve our understanding not only of the gas, which is where a lot of our work has been done on, but on energy cane and sorghum, and then ultimately we’ll look to other grasses. In Jennings, we anticipate. It continued to be a very, very important center for improving the understanding of how these biofuels, the feedstocks rather, how they react, how they’re best process, how the process has changed with atmospheric temperature and pressure, and these various things. So there’s a lot of learning that will take place there. I think we’re beginning to see the value of that as an asset, as a scientific and engineering asset is becoming increasingly apparent to us.

Pamela Bassett – Cantor Fitzgerald

Great. And you may have answered this already earlier in the call. I’m sorry for some repeating. Phyzyme sales were a little lower anyway than I expected. Can you talk a little bit about the outlook for Phyzyme? And again, if you have answered this already, I apologize.

John McCarthy

No. Pamela, it is John. We didn’t – the question wasn’t asked, so we didn’t answer it. As we’ve said, there were – we’re not in a position now to provide guidance for next year. And the thing that we’ve always been hesitant to do is to provide guidance for Phyzyme because recall that that get sold ultimately through our partner Danisco. So, at this point in time, I mean, we’re quite pleased; and then, I can tell you Danisco is quite pleased with the substantial progress that’s been made on Phyzyme over the past 12- to 15 months, but no forward-looking view at this point in time, and we won’t be providing guidance overall for the company until probably early next year.

Pamela Bassett – Cantor Fitzgerald

Okay, great. Thanks very much.

John McCarthy

Sure.

Operator

(Operator instructions) Your next question comes from the line of David Woodburn with ThinkEquity. Please proceed.

David Woodburn – ThinkEquity

Hi, thanks for taking the questions. I’ll start with the specific one. John, since you’re working on the second agreement with BP, is it fair to expect that the Q4 and/or potentially Q1 of ’09 SG&A might include $1 million or $2 million or $3 million related to advisory services like we saw in Q3 this year?

John McCarthy

David, we haven’t provided and we don’t expect to provide guidance on those types of things, but while we are actively working as we’ve talked about with BP on this second phase of the partnership, there is certainly ancillary work that is getting done. I can tell you, most of which, is internal work that’s getting done. So, I’ll probably hold off on any comment on that until we release our full year earnings, again, early part of next year.

David Woodburn – ThinkEquity

Okay. And then, a more general question on Phyzyme. What are you saying in terms of increase adoption of overall phytase enzymes now, versus the past summer? And I think price phosphate [ph] supplements are repeat additives are probably quite a bit different now than they were three months ago.

John McCarthy

Yes, it’s a good question. And again, one of the things that we tried not to do is just to put ourselves in a position of Danisco who has much greater insight in to the end user marketplace than we do, because they’re out there selling to the customer-based. And having said that, as you noted one of the primary reasons in the first half of this year, that Phyzyme, and know the phytase is really expanded significantly because of what was happening on the commodity side with phosphates, while those have certainly moderated with all the other commodities. I think one of the things that we here from Danisco is that the increased market share penetration that they’ve obtained with Phyzyme is quite significant and they haven’t seen any reversal to the use of phosphates of late. But this has always one of these challenges with commodities products. But we haven’t seen any indication of any slowdown to date.

David Woodburn – ThinkEquity

Okay. And I guess one last here. You talked about gross margin being impacted by higher distribution cost and some manufacturing challenges. If we actually saw a decline in sales in phytase, would it actually improve gross margin? I’m not trying to get specific on what the gross margin is for Phyzyme, but I’m just wondering if some of those rapid market expansion cost would then, essentially disappear if sales volume slowed down a bit.

John McCarthy

I think one of the things that caused some of the contraction in gross profit is associated with Phyzyme as we said in the formal discussion is that this was a relatively rapid increase in market volume growth across the world with this product and as a result, I think it took Danisco and it took us by some surprise in terms of how much the volume grew. And as a result, because we wanted to and Danisco wanted to absorb as much market share as they could and take advantage of it, that we and they absorbed more distribution expenses associated with getting that product out there than we otherwise would have if it was a more traditional gross trajectory. And so, I think, that’s what you’re seeing in some of the gross margin reduction in Q3. Again, as we tried to indicate, we expect to be able to moderate that and turn that around going forward.

David Woodburn – ThinkEquity

Okay, that’s good. Thank you.

John McCarthy

Sure, David.

Kelly Lindenboom

Thanks, David.

Operator

Your next question comes from the line of Jeff Zekauskas with JP Morgan. Please proceed.

Silke Kueck – JP Morgan

Yes, good afternoon. I have like one follow-up. In terms of the Goodwill impairment charge, can you just explain what has been written down? Are these just patents or the right to technology, or what was the write-down related to?

John McCarthy

Silke, this is John. It was entirely goodwill. We’re called back when we closed the transaction and officially closed it in June of ’07. There were two elements, two primary elements associated with the merger between Diversa and Celunol. We took a non-cash charge called in process, research and development, which is about $43 million in round terms that ran through our P&L as part of the closing, and we bought the preponderance of the balance of $106 million as goodwill. So it’s an intangible, that’s what’s it’s related to and is – certainly, in this third quarter, I think everybody has seen announcement after announcement from major public companies that have gone through the same exercise we went through, which is you look at the value of your goodwill and the accounting firms describe a very precise set of analytics that one has to go through to support the existence and the valuation of goodwill. And that’s what we went through with our accounting firms and came to a conclusion that was an inevitable conclusion and started to write off the full $106 million, so it’s all intangibles, all goodwill.

Silke Kueck – JP Morgan

Okay, that’s helpful. And one question on the enzyme side. So again, like everybody pointed out, very good results on the enzyme side, also outside of Phyzyme considering that Bayovac isn’t and then Quantum. How large was the Fuelzyme business today if you would annualize it, just in a ballpark figure? Is it now like twice the $2 million that had massed [ph] at the end of ’07?

John McCarthy

Well, we haven’t provided that level of detail by design, Silke, and as I think what we said when about a year ago at this time is that as the business begin to get larger in size, that we will look to dimensionalize that further for focus. And I think what we’d like to do is get through the balance of this year and then come back and probably talk about it in terms of the guidance for ’09, depending upon where we are with Fuelzyme but as Carlos noted and I noted, the traction with Fuelzyme has been very positive.

Silke Kueck – JP Morgan

That’s great. Thanks very much.

John McCarthy

Thank you.

Kelly Lindenboom

Thank you so much.

Operator

At this time, there are no additional questions in the queue. I would now like to turn the call back over to Ms. Kelly Lindenboom. Please proceed.

Kelly Lindenboom

On behalf of the team here today, I’d like to thank you all for joining us and we look forward to providing future updates from the Verenium’s continued progress. Have a nice evening, everyone.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Verenium Corporation Q3 2008 Earnings Call Transcript
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