Jeff Black – SVP, CFO
Jamie Levine – President and CEO
Janet Roemer – EVP, COO
Laurence Alexander – Jefferies & Co.
Phil Shen – ROTH Capital
Verenium Corporation (VRNM) Q4 2012 Earnings Conference Call March 27, 2013 6:00 PM ET
Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Full Year 2012 Earnings Call for Verenium Corporation.
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. As a reminder, this conference call is being recorded.
I would now like to turn the call over to your host, Jeff Black, CFO. Please go ahead.
Thank you for joining Verenium's fourth quarter and full year 2012 conference call. I'm Jeff Black, Chief Financial Officer, and with me today are Jamie Levine, our Chief Executive Officer, and Janet Roemer, our Chief Operating Officer.
The agenda for today's call is as follows. First, Jamie will remark on Verenium's progress in 2012 to our goals for creating shareholder value. Next, Janet will discuss commercial operations, including fourth quarter product performance, and the outlook for 2013 in each of the major industries our enzymes currently serve. And then I will then summarize our full 2012 financial results and provide some commentary on our outlook for 2013.
Before we begin, I would like to advise you that this discussion will include certain statements that are not historical facts and are forward-looking statements that involve a high degree of risk and uncertainty. These statements relate to matters such as our strategy, future operating plans, markets for our products, including our ability to develop and launch new products and timelines for doing so, including their market size and our ability to access those markets, partnering and collaboration activities, including our ability to enter into any future partnership or collaborations, the benefits of our enzyme collection, public policy, financing activities, technical and business outlooks.
The company’s actual results may differ materially from those projected in such forward-looking statements. Factors that could cause or contribute to differences include, but are not limited to, those discussed in our filings with the SEC, including, but not limited to, our report on Form 10-K for the year ended December 31, 2011, and our subsequently filed quarterly reports on Form 10-Q. These forward-looking statements speak only as of the date hereof.
And with that, I will now turn the call over to Jamie.
Thanks, Jeff, and good afternoon, everyone. Thanks for joining us. Before Janet and Jeff review the details of our 2012 performance, I'd like to describe the four critical drivers of value for our company and the progress we've made against each in 2012.
The first driver of value is our current commercial products and manufacturing capabilities. Our main commercial products in animal feed and grain processing demonstrate that we create products that compete well in the marketplace. Particularly in corn bioethanol, 2012 was a difficult year for our customers, and that impacted us as plants reduced operating rates or temporarily idled operations.
However, these tough conditions also created opportunities for us because Fuelzyme's high-performance characteristics can offer customers substantial savings relative to our competitors' products. In 2012, we also made significant progress with potential customers in the oil and gas industry for our greener hydraulic fracturing enzyme product Pyrolase. Once again we've shown how our technology creates products with valuable performance characteristics such as resistance to the high temperatures and high pH conditions in a hydraulic fracturing job.
Finally, on manufacturing, 2012 was a year of substantial progress, and I encourage you to hear Janet's detailed review of that progress in our fall 2012 Capital Markets Day webcast available on our website.
Earlier I mentioned four drivers of value, and I see our current products and manufacturing base as only the first of these. The second driver of value is our late-stage product pipeline. Our most recent pipeline is described in significant detail in my presentation at the ROTH Capital Conference on our website, which shows our seven new products we intend to launch across all three of our current product lines, many in 2013. I believe the combined opportunity in our current products and our product pipeline represents substantial value and proves that our technology creates the highest-performing products.
The third driver of value is our expansion pipeline, which is the way that we described our current activities to expand our scope both deeper into our existing product lines with new products and broader into new product lines. We've demonstrated our competitive capabilities through our products and our strategy is to develop new areas to deploy our technology as we drive for growth and profitability, both alone and together with partners.
And since you heard me speak before about our focus on partners to help reduce the risks as we broaden our business, let me be clear about where we are in that process. Our approach to partnering is to demonstrate the value we bring to a potential collaboration at the outset of partnering discussions.
For example, in our enzyme collection created over a decade of intense investment, we have approximately 4,000 proprietary enzymes which we believe makes it the largest in the world. We have hundreds of amylases with unique approaches to the way they break down starches. We have hundreds of lipases with a variety of mechanisms for breaking down lipids and fats. We have hundreds of cellulases, proteases, esterases, and dozens more enzyme categories, all of which have significant potential value as high-performing products. During most of 2012 we were sending samples of some of these enzymes to potential partners, some of whom would be eventual customers and some of whom could be potential distributors.
First, we would screen our enzyme collection using lab-scale techniques for predicting potentially valuable products. Then we'd send quantities of the enzyme to potential partners to test in their process. We provide even more detail about this process in the R&D section of our Capital Markets Day webcast.
As you can tell, this is not a short process, but we believe the resulting partnerships will create the most value for our shareholders. We've made substantial progress, impressing many large companies with the value we can create through our unique access to nature's biodiversity. Now that in some cases we've completed this lengthy technology validation process with partners, we've been able to turn our focus to negotiating partnership terms, and I look forward to updating you on those efforts in the future.
So this brings me to the final of my four critical value drivers, namely, prudent financial management. In March of 2012 we removed a substantial debt overhang from the company by selling two products, with $7.5 million of trailing revenue for $37 million. While our strategy is not to sell products outright, in this case, the terms allowed us to eliminate our debt with no equity dilution to current shareholders.
At the end of 2012 we raised $22.5 million to support the final development and launch of new products from our pipeline. Considering our market capitalization at the time, we were able to structure that capital raise so as to again minimize dilution to current shareholders.
I raised these two examples to emphasize management's focus on not just creating the third major enzymes company with a diverse portfolio of high-performing products, but doing so in a way that retains value for our current shareholders.
So with that, I'll turn the call over to Janet and Jeff to review our performance in 2012 against the value drivers I just reviewed.
Thanks, Jamie. Good afternoon, everyone, and thank you for joining us. I'll begin today with a review of our fourth quarter and full year 2012 operating results, starting with our largest product line, Animal Health & Nutrition, and our lead product, Phyzyme phytase.
In the fourth quarter, revenue increased versus the third quarter as we manufactured more products at Fermic, our manufacturing partner's facility, and achieved a lower cost per kilogram as a result of manufacturing improvement which I will discuss later. For the full year 2012, Phyzyme phytase performance was on track with our expectations, in a market that was challenged by high commodity prices and high feed costs which impacted animal production.
In the long term, enzymes in the Animal Health & Nutrition market will grow in all regions of the world, and we expect phytases will continue to be the largest enzyme class sold to this market, increasing from a $350 million opportunity today to $450 million by 2016. Today, Phyzyme phytase remains a market-leading product, but as we have stated in the past, we expect sales to decline due to the previously anticipated introduction of a competing phytase enzyme by our marketing partner DuPont. However, we too are aggressively pursuing the phytase and broader animal feed enzyme opportunity by working in collaboration with Novus International.
We remain on track for launching a superior performing next-generation phytase, rolling it out in various countries over the period of 2013 to 2015, where the timing depends on complying with country by country regulatory regimes. This is a lengthy process in the US and the EU, largest markets, and we are progressing steadily along our planned timeline.
In addition to the launch of a next-generation phytase, we are also developing a suite of NSP or non-starch polysaccharide products through the Novus collaboration. And as we announced in January, we selected lead candidates for the component enzymes, which are designed to enhance the digestibility of feeds for poultry and swine.
The market for NSP enzymes provides us a broader market opportunity within Animal Health & Nutrition than we currently have today with our phytase-only relationship with DuPont. We estimate that the market size for NSPs in 2012 was $230 million and that it will grow to approximately $290 million by 2016. We expect to launch this product in select geographies in the 2014 to 2016 timeframe. We are very pleased with the way our collaboration with Novus is progressing and look forward to further updating you on advancements throughout the year.
Turning to our second largest product line, Grain Processing, revenue increased in the fourth quarter versus the third quarter of 2012 due primarily to the timing of Fuelzyme and Xylathin shipments and some new customers. Revenues decreased on a year-over-year basis, reflecting the continued adverse industry conditions attributed to depressed ethanol prices combined with continued high corn prices on the heels of the worst drought in 50 years. This resulted in poor and even negative margins for ethanol producers.
As a result, according to Renewable Fuels Association, a trade industry group, of the 211 ethanol plants in the US, 36 were temporarily idled and operating rates were reduced, resulting in total ethanol production declining for the first time in 17 years. We saw the impact of these conditions in our results.
Despite the challenges, we did gain new customers in 2012 and a renewed interest in product trials. In reviewing multiple Fuelzyme trials in 2012 at comparably-sized plants of around 50 million gallons per year capacity, the data demonstrates that, on average, a plant would save between $260,000 and $550,000 annually by converting to Fuelzyme. This represents a significant savings and does not even include the very significant economic benefit of increased ethanol yields, which has been demonstrated in Fuelzyme trials where customers chose to make that part of the competitive assessment. The leaders in the corn ethanol industry are pursuing transformative innovations and are receptive to the adoption of new technologies to improve their bottom lines.
So, despite the challenges faced by the industry, we intend to grow through gains in market share and through the introduction of new process enhancing enzymes from our product pipeline beginning later this year in time for the new corn season.
The industry outlook for 2013 continues to be challenging. On the plus side, according to the USDA, more acreage of corn will be planted in the US, and presuming good growing conditions, there will be a record crop and corn prices will fall. On the negative side, we see the opponents of the corn ethanol industry continue their attacks on the renewable fuel standard, despite the benefits of job creation and energy security that this industry contributes to our society today, and the promise of an even greater contribution from the bio-refineries of the future.
Turning now to Oilfield Services, in the fourth quarter we continued to sell small volumes of Pyrolase cellulase enzyme used in hydraulic fracturing or fracking, as an alternative to chemicals. And we continue driving for further adoption in the oilfield services industry. We've made positive headway in understanding the unmet needs of the oilfield service companies and oil and gas producers, and greatly increased the number of companies evaluating our products.
Our next-generation breaker, Pyrolase HT, where HT designates high temperature, is designed to function in more extreme temperature ranges and higher pH conditions. It broadens our offerings to the industry and increases the number of oil and gas fields where [it then] can be used.
In the fourth quarter, at the Society of Petroleum Engineers conference, we presented the data from laboratory evaluation by Schlumberger showing the superior performance of Pyrolase HT relative to ammonium persulfate, the standard chemical breaker, and are now keenly focused on moving Pyrolase HT into field trials. I look forward to updating you as we continue to make progress with both Pyrolase and Pyrolase HT.
I'd now like to switch gears and discuss manufacturing and the important enhancements we implemented in 2012 and the results we've seen today. The projects completed include a utility upgrade such as improvements to the quality and quantity of steam available to fermentation, increases in chilling capacity for downstream recovery, and improvements in the quality of water use in enzyme recovery, as well as improvements to standard operating procedures. Fundamental improvements to the design of the fermenters began in late 2012 and will continue through the first half of this year.
Over 2012 we saw improvements in reduced variability and higher yields of Phyzyme and Fuelzyme, and since the second quarter of 2012, we have had quarter-on-quarter improvements in average Purifine yields. Specifically in the case of Fuelzyme, since the summer of 2011 when we began manufacturing at the 190,000-liter scale, average yields increased nearly 30% by the end of the fourth quarter, and there is still more opportunity for improvement. We will continue our manufacturing investment program in 2013 with the aim of continuously improving quality, yields, cost and capacity, and see ample room for increasing the profitability of our business without expending major amounts of capital.
Lastly, in 2012, we completed the startup phase of our pilot plant in San Diego, and I'm happy to report that, as of the first quarter, the plant is fully operational. The state-of-the-art facility is a key asset for driving continuous improvements in manufacturing of commercial products, for developing processes for new products, and for producing test article for the regulatory phase of pipeline product development.
And with that, I'll turn the call over to Jeff to review our financial performance.
Thank you, Janet. Over the next few minutes I will provide a brief overview of the financial results that we announced earlier today, as well as discuss our outlook for 2013.
Keep in mind that in this discussion I will refer to non-GAAP numbers when reporting operating expenses. These non-GAAP numbers exclude restructuring charges, the gain on sale of assets to DSM, and non-cash items related to the change in the fair value of derivative assets and liabilities. We believe that excluding the impact of these items provides a much more consistent measure of our financial results. A reconciliation of non-GAAP information to GAAP can be found in the earnings release that we issued earlier today.
So with that, let me start with the review of our top line results for 2012.
For the full year 2012, our product and contract manufacturing revenue decreased over last year from about $56 million to $49 million. And this decrease is primarily due to a couple of factors. First, as you're all well aware, along with our peers, conditions in the corn ethanol industry have negatively impacted our Grain Processing product revenue. And second, in Animal Health & Nutrition, while we saw a stable performance from our Phyzyme product and a slight increase in our profit share from DuPont, we also saw a decrease in non-recurring toll manufacturing revenue versus what we generated in 2011, and this brought our 2012 revenue from this product line below what we reported in 2011.
Also keep in mind that our Phyzyme revenue is based on the source of manufacturing. We've contracted with DuPont to serve as a second source manufacturer of Phyzyme, and we recognized revenue from Phyzyme manufactured at Fermic equal to the full value of the manufacturing cost plus royalties as compared to the revenue associated with product manufactured by DuPont which is recognized on a net basis equal to the royalty we see from DuPont.
While this revenue recognition treatment has little or no impact on the gross profit we recognize for every sale of Phyzyme, it could have a negative impact in the gross product revenue growth for any given period.
Our gross profit from combined products and contract manufacturing revenue for the full year end of December 31 decreased from $21.5 million in 2011 to just below $17 million in 2012, which is above our previous guidance of $14 million to $16 million. And our gross margin percent from combined products and contract manufacturing revenue decreased to 34% from 38% in 2011. And these decreases were primarily due to a few factors.
First, we saw a shift in sales mix from 2011 from higher-margin products in Grain Processing to lower-margin contract manufacturing revenue. Under our supply agreement with DSM, we saw Purifine and Veretase at substantially reduced rates than when we sold directly to customers in prior years, resulting in lower gross profit for these products, and as a result, lower overall gross profit.
Second, we incurred idle capacity charges related to downtime for in-process upgrades to one of the fermentation vessels at Fermic. And third, we recorded increased inventory reserves and write-offs over 2011.
Our collaborative and license revenue increased in 2012 from around $5 million to just above $8 million. And the major drivers here were license fees from Novus and DSM. And we continue to look to drive the business forward using our partnership strategy. As we said in the past, we think it's especially important to note the potential for variability on the collaborative and license revenues since it can impact our reported operating loss or income on a quarter-to-quarter basis.
Our operating expenses on a non-GAAP basis and excluding cost of revenue increased for the year in the December 31st to just below $35 million in 2012 from about $30 million in 2011. And as was the case in our third quarter results, while ongoing G&A costs have remained roughly flat year over year, our R&D expenses have increased by about $4 million, which reflects our continued investment in product pipeline support and driving forward our pipeline products. As Jamie mentioned, we expect to launch several new products from our pipeline in 2013, which is largely the result of our investments in 2012.
Turning to our balance sheet, in the end of 2012 we had a solid cash position of roughly $35 million in unrestricted cash and $2.5 million in restricted cash. And as Jamie mentioned, during the fourth quarter of 2012, we closed our $22.5 million financing with Athyrium Capital. And as a reminder, this is a five-year interest-only note with principal view at maturity in December 2017. We feel that this financing position serves well to execute on our business objectives, injecting the necessary capital to continue to advance our product pipeline to commercialization to enhance manufacturing capabilities and to fund our general working capital needs.
In connection with this financing, we also issued Athyrium $2.9 million warrants to purchase common stock at a strike price of $2.49. And that represents a 17.5% premium to the closing price on the daily closing agreement. We feel that this was the best way to address our capital needs while minimizing dilution per shareholders.
So I'd now like to wrap up with our financial outlook for 2013. Today we're not providing specific financial guidance, but I would like to give you some general comments on our expected financial performance for the year.
So, first of all, we expect to see revenue and gross profit growth over 2012, and this level of growth will depend on a number of factors which include the following. First, the rate at which Phyzyme sales ramped down with the introduction of next-generation phytase products, which includes the launch of our own product with our partner Novus this year. Secondly, conditions in the corn ethanol industry could continue to impact demand for our Grain Processing enzyme throughout 2013. Third, the timing and speed of customer adoption of our Pyrolase products for hydraulic fracturing. And fourth, our ability to successfully bring in additional collaborative revenue through new partnerships, an area where we continue to see opportunities that will drive success for our business.
We expect to see operating expenses increase over 2012, primarily due to continued R&D investment in bringing our existing pipeline products to market and adding new candidates to the pipeline. Note that many of our -- much of our development expense was related to our Novus collaboration are 50% funded, and this is reflected in our collaborative revenue line.
We expect to see capital expenditures decrease in 2013 as our investment in our new facility and laboratory build-out is now complete, and we'll focus our 2013 capital investments on continued enhancements in manufacturing, with an eye toward decreasing manufacturing variability and bringing down our cost of goods. And finally, we expect our total cash burn in 2013 to end below the level we saw in 2012.
We look forward to providing you with 2013 financial guidance on our future calls.
And with that, we'll take your questions.
Our first question comes from Laurence Alexander from Jefferies. Your line is open.
Laurence Alexander – Jefferies & Co.
Hi there. For your existing product lines, can you give some sense for how you're seeing like, so to speak, like the two-year opportunity if the end-markets evolve reasonably well? Like how large could they get? Maybe if you can help segment the opportunities, you know, which ones are going to drive the volatility?
Well, in the next -- Laurence, this is Jamie, thanks for your question. And I commented in, if you're really kind of looking out, we tend to think in terms of what's going on in 2013 and then what we consider to be the medium term. If you look product line by product line, within Animal Health & Nutrition, we obviously have the upcoming launches of the products that are coming out of the Novus portfolio. So I think from our perspective, those are next-generation products with higher performance characteristics, and so we expect to see growth being driven within animal health because of the launch of Novus products.
When you look at the corn bioethanol market, again there we have several products in our pipeline that we talked -- that we say in that pipeline slide is launching in 2013, and that's about bringing the kind of innovation that Janet described to the market. And so we see opportunity for growth both within Fuelzyme, capturing market share as Janet referenced, but then also through having a broader product mix in order to bring different solutions to customers. So we think it's important that we have that kind of multi-solution approach to push through the sales force that we had applied towards corn bioethanol.
And then finally, we've also said that we see a lot more customer -- I should say potential customers testing our hydraulic fracturing products, and we also see the opportunities to continue to either evolve our current product or to formulate our current product in ways that allow it to perform well in fracturing jobs. And as we're working with customers and learning more about their needs, we're able to think about alternative formulations and alternative product approaches to make sure that we're bringing the best product to the market. So I think all of that says that we see near-term growth from those various opportunities, but I think all of that will still be very fresh as you're looking over a two-year horizon.
Laurence Alexander – Jefferies & Co.
And then I guess then just from another angle, do you have a sense of which of the products on your pipeline slide would have faster adoption curves, that is, you know, could have -- or do you have any real feedback from customers yet or potential customers yet as to which ones could be most significant in terms of the speed of adoption, not just the size of the opportunity?
Sure. I mean we do talk about not just the size of the opportunity but then also what we target in terms of our end-market position and where we think that that can get to. I don’t know that at this stage -- at this stage, I think partially a determinative factor is whether we're talking about replacing other products in the market with higher-performing products, and that's certainly the case that we see in our animal nutrition business.
Alternatively in some cases, we're actually bringing products that may not be marketed today, and so that has a potentially longer adoption cycle as think about customers getting used to running a new product. But it's also hard to generalize because at times, penetration, even with a replacement product, can be a long cycle. And so as we've built our model, we thought about what's a reasonable adoption curve to drive growth, and I think that's where we think about the product launches that we've made and the targets that we have for achieving operational profitability in 2014 on the back of both our current products and that pipeline.
Laurence Alexander – Jefferies & Co.
Okay. Okay, thank you.
Thanks a lot, Laurence.
Our next question comes from Phil Shen from ROTH Capital. Your line is open.
Phil Shen – ROTH Capital
Hi everyone. Thank you for taking my questions.
Phil Shen – ROTH Capital
When do you expect the next-gen phytase be launched in the US? I know you have a range of launch dates or years and I know it varies by region. But given that you access one of the largest markets, what are your expectations for the US?
I'd say that we see both the US and Europe as being very large markets and there are also frankly good opportunities in a number of other geographies. I mean Janet commented that, if anything, we see US and Europe as having a longer regulatory profile. Europe potentially longer than the US. But we haven't commented on specifically years of launch within that range. But overall as we look at our model, we expect to be launching this year, getting the product introduced and understood by customers this year, and generating the kind of data that will show its performance characteristics. And we have obviously internal timelines, but we haven't delineated that externally.
Phil Shen – ROTH Capital
Okay. And then my next question might be a similar type answer, but what are your expectations for when you could generate commercial sales for the Pyrolase HT product?
Well, actually I'm glad to say that's a different answer because that's a product that we did launch earlier this year. So that's on the market, it's on the market in really the critical geographies that we're targeting particularly. It is authorized by the EPA for use in the US. And so from that perspective, we already have it available for sale in potential customers' labs. Janet talked about the Schlumberger paper and the data that was generated on its performance there. And so that is a different circumstance and we see that as more of a near-term driver because it is authorized for use in the largest market and we're out selling it now.
Phil Shen – ROTH Capital
Great. So, can you give us a sense for how long the sales cycle might take? I know that it can take a while, so if you can frame that for us, that might be helpful.
Sure. This is a product that, while we launched earlier in 2013, we've had available for customers to test in laboratory conditions in, you know, as early as -- much earlier in 2012. And so there is a cycle, because we often find that fracturing fluid and downhaul conditions vary. And so we need to ensure that the element of the fracturing process we're providing, which is called a breaker, effectively liquefies a starch [glar] that's put into the fracturing fluid, we need to be sure that it's going to work under the relevant conditions for a given job. So what we're going through right now is actually working with customers, and typically those are oilfield services companies or distributors to oilfield services companies, and we're bidding on jobs to use our product as part of the overall hydraulic fracturing mix. And that's the process we're going through. So, to a large extent, it depends on what type of wells are being fractured at any given point and whether we bring the right solutions. We think that Pyrolase has, you know, a good large sweet spot, but we think adding Pyrolase HT just expands the products that we have and the sweet spot that we can target within the market in terms of going to higher temperature wells.
So it's not necessarily that it's just about a kind of a smooth adoption curve, it's about bidding on individual jobs, winning individual jobs, and selling our products. And fortunately, we have a number of distributors and oilfield services companies that are testing it with their fluids, so we understand the types of jobs that we can bid on. So that might have been a bit complicated, but that's the way the sales cycle actually works, and since we started in 2012, now we're at a point of actually bidding on jobs.
Phil Shen – ROTH Capital
Great. One last question here for me. On CapEx, I know Jeff talked about how you expect a decrease year over year. Would it be helpful or can you guys quantify perhaps to a greater degree what CapEx might look like in 2013?
We haven't issued that specific guidance, but we can say as we're talking about CapEx related to optimizing manufacturing, we're not talking about putting feet on the ground. What we're talking about is optimization. So we should see that CapEx number. We spent I think $8.7 million last year on CapEx. The large portion of that was related to the new building. We will spend CapEx on manufacturing but it won't be near the level of that $8.6 million next year.
Phil Shen – ROTH Capital
Okay, great. Thanks very much.
Thank you. I will turn it back to management for closing remarks.
Thank you for joining us today. We look forward to giving you future updates.
Ladies and gentlemen, thank you for participating in today's program. This concludes the program. You may all disconnect. Have a good day.
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