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Executives

Kelly Lindenboom - VP of Corporate Communications

Carlos Riva - President and CEO

Jamie Levine - EVP and CFO

Jeff Black - CAO

Analysts

Amanda Sigouin - Jefferies & Company

David Woodburn - ThinkEquity

Sarah - Lazard Capital Markets

Verenium Corporation (VRNM) Q3 2009 Earnings Call November 9, 2009 10:00 AM ET

Operator

Welcome to Verenium's Third Quarter Financial Results 2009 Conference Call. (Operator Instructions) At this time I would like to introduce your host for today's call, Kelly Lindenboom. Please go ahead.

Kelly Lindenboom

Thank you for joining Verenium's third quarter 2009 financial results conference call. I'm Kelly Lindenboom, Vice President of Corporate Communications. With me today are Carlos Riva, our President and Chief Executive Officer, and Jamie Levine, our Chief Financial Officer. Jeff Black, our Chief Accounting Officer, will be joining us for Q&A.

The agenda for today's call is as follows: First Carlos will review the selective accomplishments and business highlights in the third quarter of 2009, then Jamie will provide a perspective and key corporate initiatives and the summary of our financial results for the third quarter, and finally we will open the call up for your questions.

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 21E of the Securities Exchange Act of 1934 as amended. These statements involve a high degree of risks and uncertainty and relate to matters such as the company's strategy; future operating plans; markets for the company's products; partnering and collaboration activities; public policy and financing activities; technical and business outlook. Such statements are only predictions and actual events or 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 risks related to the company's IP, partners, competitors and regulatory and market forces.

Certain of these factors and others are more described in the company's filings with the SEC, included but not limited to the company's report on Form 10-Q for the quarter ended September 30, 2009.

I will now turn the call over to Carlos.

Carlos Riva

Thanks, Kelly. Good afternoon, everyone, and thank you for joining us on today's call.

We are pleased with the results we achieved for the third quarter as we continue to make important progress throughout our organization and in both our bio-fuels and specialty enzyme businesses.

Let me begin by discussing some of the recent corporate initiatives we undertook on the financial front to improve our overall capital structure. Most recently in October we raised $12.3 million in net proceeds through a public stock offering.

In August, we were successful in exchanging a portion of our 5.5% convertible notes to reduce debt.

In September we effected a one for 12 reverse stock split in order reach a broader bases of institutional shareholders by elevating our share price to a more attractive level and while also addressing compliance with NASDAQ's listing requirements. In addition throughout the quarter we continued to aggressively manage expenses and to conserve cash.

Jamie will address these items in more details in a few minutes, but I want to reiterate the importance of achieving financial strength and flexibility to help ensure Verenium's future growth and success. This continues to remain a top priority going forward.

I would now like turn to our biofuels business, where we have continued to make progress on a number of fronts.

First, we announced in September that Carey Buckles joined as Vice President of Biofuels Operations, further strengthening the leadership team at our Jennings, Louisiana site. Carey comes to us with extensive expertise in both industrial and biotech facility operations. His experience will be of great help to our organization, as we optimize our biofuels operations through continued process improvements as we move closer to commercial scale production of cellulosic ethanol.

Second, we will continue the optimization phase at our 1.4 million gallon per year demonstration plant in Jennings. Essentially, optimization valves running a series of, what we refer to as campaigns, which we seek to closely and systematically reevaluate different stages of our process

As we discussed last quarter, we transitioned from operating the plant on sugarcane to gas to energy cane. I am pleased to report that we have been successful in running energy cane through a series of campaigns, as well as the fully integrated process from start to finish producing cellulosic ethanol.

This experience has provided a critical learning and know how that will serve us well as we focus on refining our process technology for our first commercial plant. Moving forward, we plan to start testing sorghum in addition to continuing work with energy cane.

Next importantly, we are able to escalate the scale of effectiveness of our onsite enzyme production putting us ahead of target with development plants in this area. This is a key achievement as enzyme production is the single largest cost in our production process. As we recently disclosed, we currently target the overall cost of ethanol production at about $2.10 per gallon for our commercial facilities.

We believe that there is a significant opportunity in the future to drive down that number and through the utilization of our pilot and demonstration plants and R&D facilities in the San Diego; we intend to continue to work to improve all elements of our process including enzymes.

Additionally, last month, we announced that we have signed an agreement with Value Prior to Pulping, or VPP, a consortium funded by the US Department of Energy, the State of Wisconsin and several large forest product companies to test the potential of Verenium's C5 technology to produce biofuels from feed stocks sourced from various pulp and paper mill processes.

Currently, hemicelluloses are not effectively utilized in many existing pulp and paper mills and this represents a potentially attractive feedstock resource. If our testing in this area is successful Verenium will be well-positioned to produce a further supply of low-cost cellulosic ethanol from an already established industry.

We are very pleased to collaborate with VPP in this effort and are enthusiastic about the opportunity to demonstrate broader ways to commercialize our technology. We believe this could represent a significant additional opportunity for cellulosic ethanol with potential production in the US alone between 1.5 billion to 2 billion gallons per year.

Turning briefly to the biofuels industry as a whole, we believe the sentiment and support for next generation biofuel remains strong, particularly at federal government level. Both the Department of Energy and the US Department of Agriculture continue to demonstrate a commitment to developing the market for cellulosic ethanol and their support of Verenium in particular.

Just last week Undersecretary for Research, Education and Economics of the US Department of Agriculture joined us along with representatives from BP and Vercipia in Highlands, Florida as the future site of our first commercial facility. The overall objective of this visit was to get a better understanding for how the site is being designed, with particular emphasis on our feedstock plan, in order to get a hands-on-feel for how future commercial cellulosic ethanol facilities will be developed.

Overall, we are very pleased with the message that cellulosic ethanol continues to be well received and that interest in our Jennings and Highlands sites continues to grow.

Furthermore, we believe that next generation biofuels such as cellulosic ethanol offer the best near-term solution for meeting our nation’s liquid fuel requirements, while addressing the critical issues of energy, security, climate change and unstable oil prices and that Verenium is well positioned to be one of the first commercial producers to help meet these challenges.

I’d now like to comment on our Specialty Enzyme business, our focus with specialty enzymes is to build a profitable business through the development, manufacture and sale of sale of high-value tailored enzyme products to strategic industrial markets.

Over the third quarter, we saw strong performance across this business, including increasing revenue contribution from our newer products to overall sales and significant year-to-date and third quarter product gross margin increases.

Jamie will go into more detail on revenue and margin but over the quarter, we saw a shift in our product revenue mix with an increase of sales from key product sales such as Fuelzyme and Veretase. This shift means that the specialty enzyme business is transitioning from a business dominated by a single product to a business with a more robust product portfolio providing more resilience to market fluctuations, such as those seen over the past year in the animal feed industry.

To touch briefly in our lead products, demand for a top product Phyzyme remains affected by recessionary softening of consumer demand for protein. However, we remain optimistic that as markets begin to rebound, our Phyzyme product sales will stabilize.

Sales of Fuelzyme however, increased significantly year-over-year reflecting continued conversion by customers of trial volumes to commercial orders in what has been a weak market for corn ethanol. We also have a healthy line of requests for new plant trials of Fuelzyme as producers seek to reduce their cost and the industry conditions generally improve.

Purifine, our enzyme used in the production of edible oil also continues to gain traction. As we announced in our press release this morning, we've recently signed a long-term supply contract with a major soybean oil processor in Latin America. This is a significant commercial achievement for Purifine and for our partnership with Alfa Laval. In addition, this contract provides a strong endorsement of Purifine's effectiveness and as a result we've already begun discussions with other large potential customers.

As we've previously discussed, our strategy for growing the enzyme business is two- pronged. First, we are exploring opportunities that will allow us to expand customer base and to address adjacent markets where we can supply other industries with our current enzyme products.

Second, we continue to pursue corporate level partnership opportunities for especially enzyme business that will allow the business to realize its full potential.

Finally, I would like to take a moment to discuss in more detail the announcement we made last week regarding the completion of our research collaboration with Syngenta. This is a long-term relationship that originated with a series of predefined programs all of which have been successfully completed. Based on our respective areas of business focus, we and Syngenta divided rights to the enzyme product candidate that were developed as a result of the collaboration between the two companies.

Syngenta receive rights to molecules produced through plant expression and Verenium receive rights to molecules produced through microbial expression. The party share rights outside of these categories. Of important for Verenium, this significantly enhances our enzyme product pipeline with several late stage development candidates including enzyme for Biofuels production and for use in the animal feed industry the second largest market for enzymes.

Also, as a result of this transaction Verenium will receive license fees including future royalties for commercial enzyme candidates previously licensed to a third party.

We are very pleased with the success and productivity of this collaboration and are enthusiastic about the exciting new product candidates that have been generated for both companies as a result.

Let me sum up. I believe we are at a critical point in our company's development. Given the valuable assets we possess from both a technological and human capital standpoint we are well-positioned to make important progress in both our Biofuels and Specialty Enzyme business in the coming months.

In addition to our continued work at our Jennings demonstration plant and our focus on product sales and market expansion in our enzyme we are also focused on some key initiatives that are critical to the business. These include the due diligence effort and negotiations with the Department of Energy on a loan guaranteed for our Highlands project and our ongoing discussions with BP on extending our Galaxy partnership.

With that I'd now like to turn the call over Jamie Levine, our Chief Financial Officer to review our third quarter financial results and other business highlights.

Jamie Levine

Thank you, Carlos. I'd like to start my remarks with a few high level observations. First, as we had previously announced, our commercial development joint venture with BP, Vercipia, has entered the due diligence phase of the DOE loan guarantee program. We are encouraged by the positive feedback we are receiving with regards to our feedstock strategy, technology, processes, and site development plans. We remain optimistic and as we have said before we are the first and as far as we now only biofuel company currently going through the due diligence process.

From a timing perspective, if we are successful in the due diligence phase, the next several process would be the signing of the term sheet, representing a conditional commitment from the DOE for the loan guarantee, which could occur as soon as the first quarter of 2010. Ultimately, the timing will be determined by the Department of Energy's process requirements and time table.

Next, regarding our technology development joint venture with BP/Galaxy Biofuels, the original 18 months term of the joint technology development program, setup is part of the venture is scheduled to conclude on January 31, 2010. As we have previously said, in the original agreement both parties agreed to come together before the expiration of the development program to discuses terms for a possible extension and those discussions are ongoing.

Finally, turning to our Enzyme business, we continued to see and improve mix of product sales coming from our overall enzyme product offerings indicating further commercial traction for some of our newer products, also our product dollar gross margin has increased on both the both a year-over-year and sequential basis. Like our peers in the enzyme business, we felt the impact of the recession through our customers, however, we remain optimistic that the markets for our products will continue to stabilize and improve. In the meantime we continue to focus on improving product profitability through efficiencies at our contract manufacturing facility in Mexico City.

I’d now like to provide some detail on the quarterly performance. As noted in our press release, we ended the third quarter with a decrease in product revenue as compared to 2008, primarily due to global economic challenges that had impacted the sectors targeted by our enzyme business. Regarding our main products, we have seen a softening in the phytase animal feed market attributed to a recessionary decline over the past few quarters and as a result gross shipments phytase had remained relatively flat as compared to 2008.

Demand for Fuelzyme, which has impacted by challenges in the quarter for the oil industry over the past quarters, has improved recently due to customer conversions and modestly improved underlying growth in demand.

Regarding Purifine as Carlos already mentioned, we recently signed a long-term supply agreement with a major soya bean oil in Latin America together with our joint marketing partner Alfa Laval. With this contract and other recent interests shown for the product, we anticipate a ramp-up in Purifine revenues in 2010.

Our net product revenue for the third quarter declined compared to the third quarter of 2008 as well as on year-to-date basis, it’s important to note that the majority of this year-to-date decrease is attributed to our method of revenue recognition for Phyzyme product sales. As we’ve discussed in the past Genencor who sell product using [adapted] our Phyzyme enzyme technology, manufactured some of the Phyzyme product on our behalf.

For sales of Purifine manufactured for us by Genencor based on applicable accounting rules, we do not recognize product revenue. We only recognize revenue equal to the running profit share derived from the use of our enzyme in certain of its animal feed products. On a year-to-date basis, gross product sales including both manufacturing sources for the nine month ended September 30 2009 increased slightly versus the same period of 2008.

Because of the variability in our reported revenue, due to the revenue recognition treatment for Phyzyme manufactured in different location, we think it's more meaningful to focus on gross margin dollars as an indication of the net cash contribution to the company from our product sale.

During the third quarter of 2009, our total product gross margin increased to $3.7 million from $3 million in the second quarter of 2009 and $2.8 million in the third quarter of 2008. The increase in our third quarter product gross margin was due to improvements in the mix of products being sold at higher operating rates than the second quarter and the assets of inventory loses recorded in the third quarter of 2008 due to contamination.

In terms of our operating expenses, excluding the cost of sales and the goodwill impairment charge in 2008, our gross operating expenses during the third quarter of 2009 of $28 million decreased $1 million versus the third quarter of 2008 and increased $1 million versus the second quarter of 2009, primarily due to the acceleration of Biofuels development and commercialization efforts in 2009.

Keep in mind that the gross operating expenses on our income statement do not reflect the fact that a portion of these expenses are offset through our joint ventures with BP. BP funded $8.7 million towards our expenses during the third quarter. This cost reimbursement is included below the operating expenses line in the caption entitled, loss attributed to non-controlling interests in consolidated entity.

On a non-GAAP pro forma basis after considering the impact of BP's cost reimbursement our net operating expenses for the first three quarters of 2009 have actually decreased by approximately $16 million over 2008, reflecting the costs sharing through the joint ventures and the company’s expense control efforts.

Due to impact of the complex accounting related to our 8% and 9% notes and the non-cash, goodwill, impairment charge in 2008, we think it is important to understand our net loss on a non-GAAP basis. Excluding this non-cash impact, on a non-GAAP, our pro forma net loss was $10.5 million in the third quarter of 2009 compared to a non-GAAP pro forma net loss of $19.5 million for the third quarter of 2008. The decrease is consistent with our ongoing expense management efforts and BPs reimbursement of a portion of our costs through our Galaxy and Vercipia joint ventures.

Finally, I'd like to highlight a few items on our balance sheet. We ended our third quarter with unrestricted cash and cash equivalent totaling $21 million of which $6.4 million with held by our consolidated development joint venture Vercipia and can be used solely for the operations of Vercipia. After the end of the third quarter, we raised net proceeds of approximately $12.3 million through a public offering in common stock, allowing the company to fund our short-term working capital needs that will in turn allow us to maintain the momentum towards achieving our priority business objectives. Because the equity offering closed after the end of the third quarter, this $12.3 million are not included in our end of quarter cash balance.

In addition, during the third quarter the company entered into privately negotiated agreements with certain holders of our 5.5% convertible notes to exchange $30.5 million in aggregate principal of the 5.5% notes for $13.7 million of new 9% convertible senior secured notes. Through these exchanges we were able to reduce our debt and create a more appropriate capital structure for our business going forward.

Through a combination of our notes exchanges and conversions, the face value of our total outstanding debt has decreased from approximately $159 million at the beginning of 2009 to just below $99 million as of September 30, 2009. Due to accounting rules, our balance sheet shows $106 million of total debt as of the end of the quarter due to certain non-cash impact, but the notes to our financial statements provide reconciliation to the actual face value of debt outstanding of $99 million.

Finally, I would like to take a moment to discuss the recent volatility in the Verenium stock prices. During the third quarter, we undertook several actions designed to enhance our ability to execute on our business strategy, including the debt exchanges, the reverse split and most importantly an equity offering, which brought material capital into the company to support our commercial development efforts. We believe that by reducing our debt and increasing our working capital these actions created a better situation for our equity and debt holders.

While I won't comment on the specific drivers of our share price, we believe these steps have also improved our ability to attract capital to fund our business and represent a meaningful shift towards the balance sheet that's more appropriate for a growth-oriented company like Verenium.

Carlos?

Carlos Riva

Thanks Jamie. Let me close by thanking our shareholders for their continued support and patience as we take the steps necessary in the short-term to build and grow a successful advanced Biofuels and our Specialty Enzymes business. We anticipate an exciting 2010 and are enthusiastic about the continued prospects for the company.

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

Question-and-Answer Session

Operator

(Operator Instructions). The first question will come from Laurence Alexander with Jefferies & Company.

Amanda Sigouin - Jefferies & Company

Hi this is Amanda Sigouin and I’m in for Laurence. First question, along the recently announced agreement with Value Prior to Pulping for the C5 technology, could you give us any details around the timeline for this project.

Carlos Riva

Well the project is essentially one where we are looking to assess the effectiveness of our technology in that and we’ll be commencing the testing of a variety of samples in the near-term and I think it’s hard to be specific on how long it’s going to take to have a full assessment but I would say over the next several months.

Amanda Sigouin - Jefferies & Company

Okay. Then do you think that there is other opportunities for this sort for bolt-on technology to existing industrial processes and are there any other kind of examples you could think of where this could be used.

Carlos Riva

Well this is a particularly focused one on the pulp and paper industry. There suggestions have been made that also within the brewing industry obviously, within the corn ethanol industry there is a lot of effort to by others to look at putting cellulosic bolt-ons. So these and other areas are ones that represent opportunities for future assessment, but right now we think that Value Prior to Pulping opportunity is the one, which probably has the nearest or the best near-term potential.

Amanda Sigouin - Jefferies & Company

Okay. Then just one more on the DOE's decision and if we were to see a term sheet signed in Q1 which sounds like that's the soonest, when would you expect the first commercial facility to be kind of up and running, at say a 70% or so operating rate, what would be the timeline to get there? Thanks.

Carlos Riva

We have continued to have early 2012 as the commercial operations date for the first commercial unit and a term sheet in the first quarter of next year with DOE would continue to support that timeframe.

Operator

(Operator Instructions) Next we'll hear from David Woodburn with ThinkEquity.

David Woodburn - ThinkEquity

Thanks and nice quarter, guys. Carlos, how do you anticipate the progress with the DOE loan application and the due diligence in the term sheet being communicated? Is the next thing we're going to hear a press release from Verenium on reaching a term sheet or is there something else there?

Carlos Riva

I'll have Jamie comment on that, other than to say that, that's short of other interim steps, we would at the time but we have this conditional commitment, which is a commitment with the term sheet be an announcement. Jamie do you want to add to that?

Jamie Levine

I would have to say David, that that’s correct. The next phase in our successful process would be that if we signed a term sheet now would be that we generate the announcement of the conditional commitment. So, that’s correct and that’s what we talking about for early next year.

David Woodburn - ThinkEquity

Okay. Then somewhat related to this, it kind of seems like the consideration under the DOE loan programs is largely tied to having either a large pilot or demonstrations skill and application of the technology, you guys are seem to be the farthest along and one of the few with Biofuels. So, while it may be kind of seen like slow-going for us, watching you guys today in the process, could this actually serve as maybe a barriers to country for other technologies considering the capital markets today.

Carlos Riva

Well, I think certainly there are number of barriers to entry. Having a industrial scale demonstration plant, certainly represents one of them. I think that that’s been a key element in the DOE's decision to move forward with us. I would also add though that we have put a lot of focus on developing a very comprehensive feedstock strategy that enables us to demonstrate to the DOE that we are able to source a long-term reliable supply of feedstock with economics but or rather with costs that fit our project economics and that also is an important factor I think in our selection by DOE.

David Woodburn - ThinkEquity

Then quickly on that last topic, is your selection of feedstock for the second commercial facility is that sort of the main driver of what you are looking at for a location right now? In choosing is it going to be fresh supplies of an energy cane crop or utilizing existing supplies of the gas or sorghum?

Jamie Levine

This is Jamie. I'll just comment there. I would say it's more holistic than that, so certainly the ability to continue at the same type of feed stock strategy that we've had is important but we are also looking towards final end markets for the product because at the end of the day we have to be driven by a revenue line and so thinking about how we act in terms of the most attractive markets for cellulosic ethanol or what we expect to be the attractive markets for cellulosic ethanol is just as important a driver.

Operator

(Operator Instructions). Next we'll here from Sanjay Shrestha with Lazard Capital Markets.

Sarah - Lazard Capital Markets

Hi, this is [Sarah] in for Sanjay. How should we think about grant revenues going forward? You came in a little bit about what we were modeling and better than last quarter?

Carlos Riva

We haven't given guidance in terms of how we would think about grant revenue and I think we want to continue to take that approach just because of the variability part of it, can't permit variability of just timing in terms of when we happen to hit certain events that cause the grant revenues.

So, I think broadly said if there is a difference, you can see what we put forward in our public discussions about where it comes from but also say that its difficult to predict the exact timing of the grant revenues as well. It is something that we look at on an opportunistic basis and to the extent that we can look to source capital from various grants and other resources, we will do so and continue to do so.

Sarah - Lazard Capital Markets

Okay. Any timeline update on this second facility or anything else you can add on about that?

Carlos Riva

I think right now Vercipia, as we announced when we form the joint venture with BP, Vercipia has two facilities envisioned and one is the Highlands project and the second we've set it on the Gulf Coast. Right now as we continue to progress on our land acquisition strategy and other technical development for the venture we don’t feel like we want to commit to any specific public announcement about when we would be talking about where it is and then the details of the project but I think we going to let the advance of the project by the timetable. So I don’t want to make any predictions in terms of what would happen but we are continuing to look to push the project forward.

Operator

At this point there are no further questions I’d like to turn the call back to our presenters for any additional or closing remarks.

Kelly Lindenboom

We just like to thank all of you for joining us today, we look forward to updating you on Vernium's continue progresses. Have a nice morning.

Operator

That does conclude today’s teleconference. Thank you all for your participation.

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