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Verenium Corporation (NASDAQ:VRNM)

Q2 2010 Earnings Call Transcript

August 9, 2010 5:00 pm ET

Executives

Kelly Lindenboom – VP, Corporate Communications

Carlos Riva – President & CEO

Janet Roemer – President & COO of Enzymes Business

Jamie Levine – EVP & CFO

Analysts

Laurence Alexander – Jefferies

Pamela Bassett – Cantor Fitzgerald

Paul Resnik – Olympia Capital Markets

David Kaye [ph] – Tenor Capital [ph]

Pete Finolie [ph] – River Ridge [ph]

Operator

Thank you for holding. Welcome to Verenium's second quarter 2010 financial results conference call. At this time, all participants are in a listen-only mode. There will be a question-and-answer session to follow. Please be advised that this call is being taped at the Company's request. At this time, I would like to introduce your host for today's call, Ms. Kelly Lindenboom. Ma’am, you may begin.

Kelly Lindenboom

Thank you for joining Verenium's second quarter 2010 conference call. I'm Kelly Lindenboom, Vice President of Corporate Communications and with me today are Carlos Riva, our Chief Executive Officer; Janet Roemer, our Chief Operating Office; and Jamie Levine, our Chief Financial Officer.

The agenda for today's call is as follows

First, Carlos will review business highlights, then Janet will review key accomplishments in the Enzyme business in the second quarter of 2010, Jamie will then summarize our financial results for the second quarter of 2010 and provide financial guidance for the remainder of 2010 and we will then 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 and Exchange Act of 1934, as amended. These statements involve a high degree of risk and uncertainty and relate to matters such as our pending transaction with BP, our strategy, future operating plans, markets for our products, partnering and collaboration activities, public policy and financing activities, technical and business outlooks.

Such statements are only predictions, and actual events or results may differ materially from these projected in such forward-looking statements. Factors that could cause or contribute to differences include, but are not limited to, risks related to our ability to satisfy all closing conditions in our pending transaction with BP, IP partners, competitors; and, regulatory and market forces. Certain of these factors and others are more fully described in our filings with the SEC, but not limited to our report on Form 10-Q for the quarter-ended March 31st, 2010.

These forward-looking statement speak only to the date hereof and the Company expressly disclaims any intent or obligation to update these forward-looking statements.

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. Today I am pleased to report that the second quarter was a very productive one for the company. It was an especially productive quarter for our Enzyme business. Product revenues increased significantly on both year-on-year and quarter-on-quarter basis. We believe this is a clear signal that the full impact of the recession in our target enzyme markets is behind us and that our newer products will continue to gain traction in the market as they become a larger proportion of the mix of total product revenue.

During the past quarter, we were also able to decrease our operating expenses. In addition, in April, we received a further $4.9 million award from the Department of Energy to fund activities at our demonstration plant in Jennings, thus further enhancing our cash position.

Critical importance, we recently announced an agreement for the sale of our cellulosic biofuels business to BP for $98.3 million. To recap the terms of this transaction, upon closing, BP will acquire Verenium’s facilities in Jennings, Louisiana, including our pilot plant and demonstration facility together with our R&D facilities in San Diego, our cellulosic biofuels technology and related IP as well as our holdings in the joint ventures we currently have with BP. In addition, BP will employ select scientists and personnel needed to continue the cellulosic biofuels development program.

In return, Verenium will receive a $98.3 million payment from BP. An additional $10.7 million currently in restricted cash will be released to Verenium upon BP’s assumption of the lease for our San Diego facility. After the close of the transaction, Verenium will retain our core commercial enzyme business, which will include approximately 80 of our 270 current Verenium employees who we believe make up the right team to support our business plan moving forward.

Select key hires have been identified to round out the team and we anticipate recruiting for those roles through 2011. We will also retain the supporting technology required to further develop our business, including enzymes for lignocellulosic biofuels as well as the potential to access certain biofuels applications developed by BP using the technology acquired from Verenium. And lastly, we will retain the option to remain in our San Diego facility over the next 24 months while we transition to new fit-for-purpose facility.

We believe firmly that the sale of capital intensive cellulosic biofuels business is the best path forward for Verenium and its stakeholders. This transaction provides us the financial flexibility to focus on what we do best, delivering high performance industrial enzymes to lucrative and growing markets.

In addition, Verenium will retain ownership of or royalty-free access to all the intellectual property we currently use in our commercial enzyme business. Finally, we may retain the option to license cellulosic technology now being developed by BP that the company may utilize in the future for its own advanced biofuels program.

To comment on the timing of the closing of this deal, last week we received early clearance of the waiting period under The Hart-Scott-Rodino Antitrust Act, thus satisfying one important closing condition. With this approval, we expect the transaction to close by the end of August. And to this end, we’ve been working diligently with BP on transition planning activities and anticipate completing this work over the coming weeks.

Overall, we believe we are now in a strong position to build a leading, commercial enzyme business that will help current and future customers replace harsh industrial chemical processes with sustainable, cutting-edge enzyme solutions. Furthermore, I believe that the proceeds from this deal will provide us with the financial flexibility to invest strategically in the business and address the transformational growth potential presented by the $3 billion global market for industrial enzymes.

Let me now turn the call over to Janet Roemer, our Chief Operating Officer, to review recent accomplishments in the Enzyme business.

Janet Roemer

Thank you, Carlos. Thank you, everyone, for joining us on today’s call. As Carlos mentioned, the second quarter of 2010 was a strong quarter for product sales and gross margin compared to the same period last year. Recall, in the second quarter of 2009, we saw the full impact of the worldwide recession in our core target markets, especially on poultry producers, the end market for our lead product, Phyzyme.

Jamie will go into more financial detail in a moment, but I am happy to report that total product revenue for the second quarter of 2010 increased by 27% on a year-over-year basis, and increased by 15% when compared to the first quarter of 2010. In particular, Phyzyme revenue increased 7% on a year-over-year basis and 12% over last quarter. We believe that as the demand for animal feed enzymes continues to rebound along with economic conditions, sales of Phyzyme, which we market through our partner Danisco will remain strong.

It is also important to note that we continue to see an improved product revenue mix from increasing sales of our newer enzyme products, including Fuelzyme, Veretase, Xylathin, and Purifine. While we don’t break out the revenue for each of these products, let me take a minute to touch on each. In the second quarter, Fuelzyme, our next generation alpha amylase used in the processing of corn-based bioethanol, returned to revenue levels achieved in the first quarter of 2009 due to the combined effects of recovery in the corn ethanol industry and continued strong demand for this product.

Revenue from our Veretase and Xylathin enzymes also increased as they continue to gain acceptance in the grain ethanol market. Veretase is an alpha amylase like Fuelzyme, targeted at the markets for portable alcohol and sweeteners and Xylathin, which was just launched in 2009 is a highly active xylanase designed to significantly improve the economics of fuel ethanol production from serial grains. And we have made significant inroads with Xylathin in the wheat-based ethanol industry in Europe.

Lastly, Purifine revenue also increased as it continues to gain traction at commercial scale with some of the world’s most significant oilseed refiners. With the interest generated from the adoption of the Purifine degumming process at the world’s largest oilseed refinery owned by Molinos, additional implementations of Purifine process are well underway we expect to see a ramp-up in demand for this enzyme through 2010 and beyond.

This further demonstrates Verenium’s evolution as a an Enzyme business, transitioning from a one-product, one-market business to one with a much more robust portfolio that is more resilient to fluctuations in any one target market.

Turning briefly to our pipeline of future products, I am pleased to announce that we recently advanced two of our product candidates into the regulatory phase. We have a track record of achieving regulatory approvals very efficiently and through the approval process – and though the approval process can be lengthy we had historically completed approvals well within the typical 18 to 24 month timeframe.

Lastly, I would like to provide some context on our current manufacturing position. Since 2002, we have produced enzymes under a manufacturing-service agreement with Fermic, a company specializing in fermentation with a plant in Mexico City. Working with Fermic, we have identified specific, relative low capital, fast payback projects to improve product yields and expand manufacturing capacity. Under the terms of out agreement with Fermic, Ramco [ph] invests in capacity improvement projects, and as a result of the transaction with BP we will be in a good position to makes these investments and support growth and product sales.

In addition to Mexico City, we will be developing options to manufacture our products in other locations to expand capacity and enhance security of supply. To support these important initiatives, I am happy to announce that Kevin Bracken will join Verenium as Vice President of Manufacturing. Kevin comes to us with over 30 years of manufacturing experience in the biotech industry. Kevin’s depth of experience in improving manufacturing processes, building new facilities and managing contract manufacturing relationships will make him a vital addition to our team as we look to optimistic and expand our capabilities. I look forward to working closely with Kevin to progress this critical part of our business.

Overall, I am very please with the second quarter results of the Enzymes business and I am enthusiastic with the prospects we now have for continuing to grow this business in the future.

I will now turn the call over to Jamie Levine, our Chief Financial Officer to review our second quarter and year-to-date financial results and other business highlights.

Jamie Levine

Thank you, Janet. I’d like to start by reviewing the company’s financial results for the second quarter. I’ll then highlight the financial guidance for 2010 we provided in our press release today and close with some comments on the impact of the transaction we announced with BP. In summary, during the second quarter we had a significant increase in product revenues, both when compared to second quarter of 2009 and the first quarter of 2010. Importantly, this growth is due to both an increase in the royalty we received by Phyzyme net profits as well as an increase in revenues from the other enzyme products, which Janet just discussed. We also continue to see strong dollar gross margin performance as well as decreased net operating expenses particularly relative to the second quarter of 2009.

Finally, regarding our cash position, we ended the second quarter with $16.5 million in unrestricted cash compared to $15.5 million we had available at the end of the first quarter of 2010.

With that, I will turn to a more detailed review of the financials. As Janet noted, we reported another strong quarter of Enzyme revenue and product gross margin performance. Our net product revenues of $13.3 million in the second quarter was up 27% over the same period last year and 15% over the first quarter of 2010. Because of the variability in our reported revenue due to how we recognize revenue from Phyzyme, we think it’s more meaningful to focus on product gross margin dollars as an indication of the net cash contribution to the company from our enzyme product sales.

During the second quarter of 2010, we saw a product gross margin of $4.5 million, which is an increase from $3 million in the same period in 2009 and down slightly from the record product gross margin of $5 million in the first quarter of 2010. The increase in a year-over-year basis was primarily due to our ability to spread our fixed manufacturing costs over a higher revenue base. We are pleased with the margin level we have been able to generate during the second quarter and the trend over the last year.

In terms of our operating expenses, excluding cost of sales and stock-based compensation, our gross operating expenses decreased during the second quarter of 2010 to $20.5 million from $27 million for the same period in 2009. This decrease was particularly due to the adoption of new accounting guidance that went into effect in 2010, causing us to exclude the operations of Vercipia from Verenium’s consolidated results from the first quarter of 2010 onward.

Keep in mind that the gross operating expenses on our income statement did not reflect the fact that a portion of these expenses are offset through our Galaxy joint venture with BP, which we continue to consolidate in our financial results. BP funded $7.7 million towards our expenses for the three months ended June 30th, 2010. This cost reimbursement is included below the operating expenses line in the caption entitled “Loss attributed to non-controlling interest in consolidated entities.” We tend to look at our expenses on a non-GAAP pro forma basis after considering the impact of BP’s cost reimbursement as a better indicator of operating results than the gross expenses we report on a GAAP basis.

On this pro forma basis, expenses decreased to $12.8 million in the second quarter of 2010 from $18.1 million in the same period last year. Due to the impact of the complex accounting related to our 8% and 9% notes, we think it’s important to understand our net loss on a non-GAAP basis. Excluding these non-cash impacts, on a non-GAAP basis, our pro forma net loss was $3.7 million for the second quarter of 2010 compared to a non-GAAP pro forma net loss of $12.5 million for the same period in 2009. This decrease is consistent with our ongoing expenses management efforts and BP’s reimbursement of a portion of our cost to our Galaxy and Vercipia joint ventures.

Finally, I would like to highlight a few items on our balance sheet. We ended our second quarter with unrestricted cash totaling $16.5 million compared to $15.5 million in the first quarter. As previously announced, we received $4.9 million from the Department of Energy to fund activity being performed at our demo plant as part of the ongoing optimization process. This is an extension of the $10 million grant previously awarded t us by the DoE in July of 2008. This was booked as revenue and reflected in our cash for the second quarter.

In addition, as part of the deal with BP to acquire our cellulosic ethanol business, we negotiated an extension of the Galaxy joint development agreement through which BP pay Verenium an initial $1.4 million payment followed by $5 million per month for the continued performance of Verenium’s obligations until the close of the acquisition by BP. Because the transaction was signed an announced in July after the close of the second quarter, these payments are not reflected in the June 30th balance sheet.

I’d now like take a moment to outline our financial guidance for the calendar year 2010 based on the successful close of the transaction with BP. For the full year of 2010, we expect that our product revenue will be between $48 million and $54 million and our product gross margin will be between $16 million and $18 million.

At this time we will not be providing financial guidance on the expected level of 2010 R&D or SG&A costs or the expected level of 2010 capital expenditures for the following reason:

Once we complete the transaction with BP, we have significantly greater control over our cost structure, and can decide what level of investment is appropriate given our overall business objectives and our financial resources. Given the opportunity Janet described to grow our current product sales, we’re currently reevaluating the 2010 budgeted investments we will make in our manufacturing, sales, and R&D functions. In addition, as we’ve done in the past, we will continue to consider whether to develop and to sell products independently or with partners.

We currently have discussions ongoing with potential partners and are therefore considering how we may accelerate investments in our sales and R&D efforts within the context of broader partner cost sharing relationships. Regarding guidance for future periods, we plan to provide guidance for 2011 in the early part of next year.

I’d now like to make a few comments on the impact that the successful closing of the transaction with BP could have on our business in light of the cash resources that it will provide. We see significant opportunities to build a leading commercial enzymes business. Eight of our nine currently marketed commercial products were developed from our unique technology for discovering and evolving enzyme products tailored to the needs of industrial process. Our financial performance trend demonstrates that while we are smaller than some of the other enzyme players, we create products that are highly competitive with or superior to the competing products from the largest companies in our sector. Upon the successful close of the transaction with BP, we will be in a far-improved position to support the development of this business through manufacturing improvements to support additional sales as well as investments in current products and products in our pipeline.

As I described earlier, at times we will share the cost burden with partners where the partner provides operating leverage we cannot achieve using our own resource, but we will also have the financial capacity to bring products to market ourselves where that provides the best return for the company.

Lastly, regarding our disclosure in today’s press release, as we had done previously, we provide pro forma income statement and balance sheet information as if the sale of the cellulosic ethanol business to BP had been consummated. While these historical data provide some insight into the nature of the revenue and the cost split as a result of the sale of the cellulosic ethanol business, the actual future performance is dependant on the decisions we make about the level of investment we will make in the enzyme business.

That being said, for the past several years, we have grown our commercial business in a highly capital constrained environment and we expect to continue to approach our investment decisions with a strong focus on allocating limited cash resources efficiently.

Overall, I am very pleased with the company’s accomplishments to-date. With the close of the transaction with BP, we will have the ability to invest strategically in the business in order to position Verenium for growth and continued success.

At this point, I’d now like to the call over to the operator to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Laurence Alexander from Jefferies.

Laurence Alexander – Jefferies

Good afternoon.

Carlos Riva

Good afternoon.

Jamie Levine

Hello, Laurence.

Laurence Alexander – Jefferies

I guess, first of all, just wanted to address the growth margin trends in the Enzyme business. Can you discuss the variance between the Q1 and Q2 results in gross margins, was there – what factors drove that?

Jamie Levine

I am sorry, what was the end of your question, I heard the beginning, what was the last–?

Laurence Alexander – Jefferies

I am sorry, I am sorry, what’s the – what factors drove the change in gross margins from Q1 to Q2 in product gross margins, looks like they are down about 10% sequentially?

Jamie Levine

Sure. Just as a general comment, when you look back over the last let’s say six quarters in terms of 2009 and 2010 performance, you will see that there is significant variability in the gross margins, so we think overall, looking quarter by quarter you are going to see that kind of variability, but we think the overall trend line shows a clear trend line that’s going in the upward direction. I think the second comment I would make is that as we are launching new products like Purifine, which we launched at the end of last year, new products tend to have a lower margin rate than more established products just because as the manufacturing is coming on line, we want to ensure that we optimize the manufacturing and that can take some time. So, very often those start at a lower gross margin and then move into a higher gross margin. And when you look at the overall revenue trend, last year we were about 75% Phyzyme, 25% other products. In this last quarter, that was actually own to one-third, two-thirds in terms of one-third other products and two-thirds Phyzyme. So, as you see start to see the business broaden in terms of it revenue base and pull revenue in from other product, as those products come up the learning curve of manufacturing, it’s going to start with lower margin business, but we think overall the trend is in the right direction both in terms of revenue mix and then we just need to focus on ensuring that the manufacturing investments we make generate the gross margin we are looking for.

Laurence Alexander – Jefferies

That’s very helpful. I think if you look forward, if you look out a couple of years, on a standalone basis, where do you think R&D to sales might trends towards and what consideration – I mean how are you looking at the trade-offs with respect to partnership? Verenium has very long history with various partnerships, what is your priorities now for the type of partnership you’d like to set up?

Jamie Levine

Sure, given that it’s easier to answer the second part first, I will do so. In terms of where we trend, I think it’s important that as we look at the lessons learned from our relationship with BP, I think one of the big lessons learned is that we work well with partners. We had a very effective relationship, and at the end of the day, as Carlos said the capital requirements of that business were really what driving those decision as much anything else. But we work well with partners and we continue – and we intend to continue to do so. And that’s really the difficulty in trying to say specifically where we think overall R&D spend will go, because we will invest more heavily potentially in areas where we are partnering with people than where we are not, we’ll allocate resource appropriately. In terms of the – so we intend to continue to do that where it makes sense. For Fuelzyme, which is one of our large products, we are not partnering with someone because we didn’t feel that it made sense, so we keep the options on the table.

In terms of the overall trend line, I can only say that we are not providing that kind of forward-looking guidance at this stage, but we certainly do look at some of the other enzyme players in this sector, and we think that they provide some benchmarks that are useful for looking at how an enzyme business can develop as it reaches higher stage of maturity, and we think overall while we are not necessarily specifically targeting somebody else’s cost structure, we think that we want to find our way as we grow revenues to become a more profitable business over time.

Laurence Alexander – Jefferies

And, Janet, just one quick question if I may tuck in, are there any areas where you see sort of white faces in the industrial enzyme market where you think you would have an edge developing new products?

Janet Roemer

Absolutely. I think our technology is the best in terms of addressing a brand new white space, where a traditional process can be transformed by bioprocess, I mean I think we are uniquely equipped for working with an industry to define the requirements and develop the right product and with the partner such as we’ve done with Bunge for Purifine, get the process to commercial scale and commercialize. So, we see that as a big part of our future.

Laurence Alexander – Jefferies

Thank you.

Jamie Levine

Thank you.

Janet Roemer

Thanks, Laurence.

Operator

Our next question comes from Pamela Bassett from Cantor Fitzgerald.

Pamela Bassett – Cantor Fitzgerald

Hi, everyone. Thanks for taking my question. Will you talk about the timeline and strategy for reentering the cellulosic ethanol space from a – just from a strictly enzyme development standpoint, what are the steps you’ll need to go through?

Carlos Riva

Hi, Pamela, it’s Carlos. I think there is a number of things that need to be taken into consideration. First of all, the cellulosic – lignocellulosic biomass to other products, fuels and chemicals like that – that industry needs to evolve. The players that are participating in it need to perfect their technologies and commercialize them. And that’s really going to be pacing item for the development of – for our participation in the cellulosic and biofuels business from an enzyme perspective. We have a number of very – or I should say a long history of having worked in developing those products. We have product candidates, but we are only going to move those forward as we see the industry itself evolving and we’re very convinced that that’s going to happen, but the pacing of that is something, which is uncertain. I think the other thing is that ultimately I think will also be part of our partnering strategy looking to evolve enzymes that will fit in with other people’s processes. And so that the timeline is a bit uncertain. In the near term though, our priorities are going to be to focus on the products and the markets that are here and now and preserve the potential for getting involved in cellulosic biofuels and other products down the road.

Pamela Bassett – Cantor Fitzgerald

Okay, that’s clear. So, following up to Laurence’s question about opportunities, could you define more specifically what the near term opportunities might look like and what specific industries or industry segments you will be examining?

Janet Roemer

Sure, Pamela, this is Janet. I’ll just say so in the very near term, it will be with the products we already have in the commercial space and continuing to expand their sales, gaining share in the markets we are currently in and expanding geographically. So, we have various regulatory approvals in process in geographies, for example, so that we can expand around the world. So, I think in the very near term that’s where you will see the growth come from. In the not-too-distant future, as we take products out of our pipeline, a good deal of them are actually targeted at markets where we already have knowledge and a presence. So, we know a bit about them about how to go to market, we are familiar with the major players in those markets for partnering opportunities. But I think that that’s all a bit far off because of the development and regulatory timeline for those products, but they will be in the animal feed space and in other related areas. We also have plans to enter some new markets where we don’t currently compete and we are evaluating various partner opportunities there.

Pamela Bassett – Cantor Fitzgerald

Thank you. And did you mention specifically that the two products that have entered regulatory phase?

Janet Roemer

Well, actually we are not going to talk specifically about what they are, but we do have partnerships around those products and we believe that we’ve got a very strong business case and very good products.

Pamela Bassett – Cantor Fitzgerald

And how long is the regulatory phase for both of them.?

Janet Roemer

Well, it’s – you know it can vary quite a bit depending on how many questions you get back after you send them the dossier. So, typically what we see is that if it’s an application that’s not food, the regulatory process can take as little as 18 months. If there is food involved, it can take as little as 24 months. It’s kind of the range of optimal outcomes. We’ve actually been able to get products through in those timelines whereas a number of our competitors I know have taken quite a bit longer. I think it’s because we actually have a very good approach to strategy upfront as far as determining what geographies that we’ll sell the products into. And having all of that thoroughly considered before we prepare the dossier for the agencies that are involved and doing it in such a way that the questioning period is very limited, in some cases not at all. So, I think that’s something we do quite well, but it can take quite a long time.

Pamela Bassett – Cantor Fitzgerald

Okay. And finally, should we be looking for additional Purifine users between now and the end of 2010?

Janet Roemer

Yes.

Pamela Bassett – Cantor Fitzgerald

Okay.

Janet Roemer

We do have – there are companies who are currently already in the implementation phase, which is the addition of the capital investment required to run the product, so I can say with confidence, the answer is yes.

Pamela Bassett – Cantor Fitzgerald

Okay, I heard plural –

Jamie Levine

That’s right.

Pamela Bassett – Cantor Fitzgerald

More than one, more than one.

Janet Roemer

That’s right, Pamela. Yes.

Pamela Bassett – Cantor Fitzgerald

Okay. Great. Thanks so much.

Janet Roemer

Sure.

Operator

Our next question comes from Paul Resnik from Olympia Capital Markets.

Paul Resnik – Olympia Capital Markets

Good afternoon.

Janet Roemer

Good afternoon, Paul.

Paul Resnik – Olympia Capital Markets

Hi. In your guidance for revenues for this year, those numbers that indicate that revenues in the third and fourth quarter give or take will pretty much match the second quarter and there won't be any further – no clear growth trend sequentially there. What are dynamics of the various products that there is a kind of at least temporarily the revenue levels have flattened out here starting in the second quarter.

Jamie Levine

Sure. I think one commend I would make is in terms of the revenue level compared to last year, I mean when looking at our product revenue guidance at $48 million to $54 million the product revenue in 2009 was $44 million.

Paul Resnik – Olympia Capital Markets

Yes.

Jamie Levine

So, I think that in terms of the overall perspective, we see variability in terms of quarter by quarter performance, but overall we still certainly see growth in that’s what we are indicating with the guidance that we’ve put out. And in addition, I think right now as Janet referred the manufacturing, the ability to ensure that we are always supplying the customers that we take on is of critical importance and so we had – right now we are looking forward to increasing capacity in manufacturing, as Janet said, in order to continue to increase sales. And the pace of that manufacturing expansion and improvement is in some ways going to pace how we consider growing the top line of the business. But with the BP transaction it provides the capital to be able to address those issues.

Paul Resnik – Olympia Capital Markets

So the additional movement into new products and adjusting manufacturing, would that also be a factor in the – again going out into the second quarter a somewhat lower margin anticipation.

Jamie Levine

As we start to see the revenue mix, we would say improve because it starts to show the broader revenue base as new products come in and we are not seeing a lack of growth in Phyzyme, we are just seeing new products, frankly, growing faster, and therefore that overall product mix trending the way that it’s trended, that does tend to initially be lower margin revenue but, frankly, it just all has to do with manufacturing approach to get up to the kind of steady state margins that we target.

Paul Resnik – Olympia Capital Markets

Okay, thank you.

Jamie Levine

Thank you.

Janet Roemer

Thanks, Paul.

Operator

Our next question comes from David Kaye [ph] from Tenor Capital [ph].

David Kaye – Tenor Capital

Hi, guys, how are you.

Carlos Riva

Hi, David.

David Kaye – Tenor Capital

So, I wanted to just – and I know everyone is sort of harping on the margin, but again my question is a little bit different in that I sort of want to understand what are in the revenue and margin projections. So, for example, are there manufacturing investments that you are planning on making included in that? Are additional Purifine customers included in that? I just would like to get an understanding of which of the potential eventualities in the six months are included in that number and which are not.

Jamie Levine

Well, David, in terms of the type investments, I mean we are guiding around revenues and gross margin because we are not talking bout investments that may be in the SG&A bucket or may be CapEx, which I think relate more to your first question in terms of where we are thinking about investing in manufacturing, I mean some of that may end up in COGS, and therefore be in the gross margin, but we think that this is of a scale that it’s probably more related to CapEx in terms of the way they are likely to address the manufacturing approaches that we are in, investment that we want to make.

In terms of the relative mix, I think there frankly we are providing an overall revenue number, we are not trying to guide towards the target split of revenue from Phyzyme and revenue from other products, so I don’t think that we want to provide that level of details around the forecasted revenue. We just think it’s important to give the guidance around the overall product revenue number. But certainly we continue to focus on growing new products. We continue to try to capture share, as Janet mentioned, and all of that factors into the revenue focus and big center we can hit on all products then that will put us hopefully at the top end of the range.

David Kaye – Tenor Capital

Okay, thanks. Let me just clarify what I meant. As far as the investment, I didn’t mean as far the CapEx, I meant as far as the effect on your gross margin. So, in other words, these – in your internal forecast, is the effect on gross margin of doing this additional investment factored in to the margin that you are going to be seeing there? And same thing with Purifine, I am not really talking so much about product as you know if we see in the news that you guys have another customer, should I think well, that means that they are probably going to have revenue above what they are forecasting or is some of that actually included in your forecast? It seem like you were saying the – if those come through that it is included in your forecast and may be to the higher end of the forecast, but I am just trying to get an understanding of what maybe upsides and what may not be.

Jamie Levine

Well, I think I’d probably try to answer that with a more general statement that says the gross margin performance in the first half of 2010 was $9.5 million. So when you put that together with $16 million from 2009, and you put that together with our $16 million to $18 million in 2010 guidance, I think it indicates that we are currently not assuming because some of these CapEx investments are not things that you are going to do immediately over night, while others we do think that we can get some near term benefit from. But overall I think that gives you at least some indication that we are not looking to push through significant results and new investments in the second half of this year, necessarily.

David Kaye – Tenor Capital

Okay. That’s helpful. Thank you. As far as the incremental revenue is concerned, are we – is the company not able to meet all of the demand that’s out there with this current manufacturing base and if that’s true, are there facilities that the company can go to while it sort gets manufacturing footprint where it wants it to be, where, while the margins may not be great, there is incremental revenue and building – really continuing the relationships with customers.

Janet Roemer

Yes, so I would say that we will be able to expand relatively easily at Fermic. As Jamie mentioned some of the project we’ve put in place won't necessarily unlock additional capacity in the very near term. But they won't – it won't be very long before we will be able to grow really substantially from our existing facility with relatively low investment. And I would say that as far as how we are operating now, and through the balance of the year, we are absolutely committed and are supplying our customer without hiccup, and that’s what we will continue to do and we’ll take on new business as we are able to, as we see improvements in manufacturing and we’re convinced that they are sustainable, then we’ll to grow and then we’ll unlock some of these incremental capacity with through projects that we’ve alluded to in this conversation.

David Kaye – Tenor Capital

But to be clear, if you had additional capacity today, there is demand out there to fill that capacity?

Janet Roemer

I’d say that’s a correct statement, yes.

David Kaye – Tenor Capital

Okay, the sooner the better, guys (inaudible)

Janet Roemer

Oh, you bet.

David Kaye – Tenor Capital

It’s obviously a good position to be in. And then I guess a couple of just minor questions and I’ll go back into the queue, but as far as the SG&A cost going forward, you had said you were decreasing headcount from 210 to I think you said around 80. And there will be some in that I understand. But is that – when you guys are doing the pro forma numbers in the press release that you gave us, is that including the full or I guess not – approximately that cut in SG&A or is there – is that bring down of employees going to further decrease the SG&A cost going forward.

Jamie Levine

I don’t think that you can – so, first of all, just for the numbers, we are at about 270 employees and there will be about 80 employees at Verenium on the go-forward model and those are the numbers that Carlos gave. The way that we approach the pro formas is that we look at all of the GAAP oriented costs and revenues, et cetera that are in our P&L and we have to allocate those between the biofuels business and Verenium remaining co., effectively. And that’s how we create the carve-out pro formas. So, when you ask is that just the 80 personnel, it’s more complicated than that because we don’t create the pro formas in a way that tries to shape the resulting, remaining company in a way that’s accurate on a go-forward basis as an objective. What we do is we have to allocate all of the elements in our P&L and balance sheet between one business and the other, so I think that there are – it is imperfect at best and it’s why we will seek to continue to provide guidance and also future quarters that are clean we’ll provide more information about the go-forward cost structure and frankly why we are very focused on making sure that we cut costs in a way that makes sense at this point in our development, but overall, in terms of trying to get a forward-looking view from the backward looking pro formas, they are not done on the basis of trying to give a clear forward picture. They are done to allocate between the two businesses, according to the way performance should be done.

David Kaye – Tenor Capital

Okay. And then I guess one last question, which is going forward, it looks as though and we haven’t had that much time with the numbers, but it looks as though in the second half of 2010 that outside of your capital expenditure cost, that the company will be pretty close to cash breakeven. Is that your goal for 2010–?

Jamie Levine

Sure. We have not provided guidance for 2010 on anything below the gross margin line, so certainly I can't go there and I think it’s in part why we are not providing that guidance is part of the factors the level of investment that we choose to make. In 2010 it’s perhaps less variable, but certainly in 2011 it’s going to be heavily dependent on what we think is the opportunity, both from a partnership opportunity and the financial resources of the company. So, I don’t think that we’ve made those decisions in light of the fact that this transaction is something that we’ve only just announced. So, I can't speak at all to where we are on a cost structure perspective for 2010, but we will certainly provide what we think is the right view of the revenues and gross margin.

David Kaye – Tenor Capital

Alright, guys. I really appreciate the timing. Keep up the good work.

Jamie Levine

Thanks, David.

Operator

(Operator instructions) Our next question comes from Colin Wilson-Murphy [ph] from River Ridge [ph].

Pete Finolie – River Ridge

Hi, guys, this is Pete Finolie from River Ridge on for Colin. You can hear me right?

Jamie Levine

I can, hi, Pete.

Pete Finolie – River Ridge

Okay. Great. Just out of curiosity, the BP, the grant money that you got in this quarter, did that – that stays with the company or does that go along with the acquisition?

Jamie Levine

That stays with the company. There is no sense in which BP is taking – those are cash – that’s basically cash that came to offset costs that we incurred prior to receiving the cash. So–

Pete Finolie – River Ridge

Okay, got it.

Jamie Levine

So, that’s effectively for previous spend, and there is now way in which BP is taking cash resources out of Verenium as part of the transaction. So–

Pete Finolie – River Ridge

Okay, good, that was my next question, just to make sure. And then just to be clear on the arrangement that you have with BP by way of transitioning, it sounds like if everything goes the way you guys expect it and the deal closes by the end of the month, that will net five million plus to you guys. If the deal doesn’t close for some reason, is it fair to say that that transition services agreement will remain in place beyond that and so we will continue to make that further contract?

Jamie Levine

That’s correct. We receiver $5 million a month to support the Galaxy activities during the period from signing – or frankly from signing to closing or from signing to termination because there is s termination provision in this contract like there is an old contract in believe at the end of October, so until that point of closing or termination, we will receive that payment for all Galaxy, just for the Galaxy program.

Pete Finolie – River Ridge

Okay, great. And then I just had two more questions, one was just to clarify what I thought was a very helpful question from the last caller with regards to the 80 employees on a run rate basis versus the 270 and how we might or might not be able to reconcile that with the pro formas of the historical results. It sound like what you are saying is that it’s very tough to think that the historical results give a view of what this business like with the 80 run rate employees because there is a lot of GAAP [ph] noise in there with respect to allocating historical costs, is that right?

Jamie Levine

That’s correct although by and large the split of employee does reflect that split – the performance does reflect that split of employees, I mean the pro formas are not divorced from the reality of the carve out. And because the carve-out does have that approximate split of employees, frankly there are also some reductions in employees there as well. So, that’s why I say approximate. So there is – they certainly are related. It’s just they are not dollar-for-dollar in a way that you can tie them together that way.

Pete Finolie – River Ridge

Okay, so, that’s understood and that’s actually a helpful qualification of the answer you gave which was good. It sounds like you have to careful of thinking that there is 270 employees that are going to do down to 80. That is not the case and part of the GAAP adjustments were designed to at least ballpark in some way, shape or form.

Jamie Levine

Yes, part of the pro forma adjustment was designed to give that picture.

Pete Finolie – River Ridge

Okay, good. And then the final question is more just a high-level question. You know, pro forma for the deal, obviously the cash number is going to be very big and I think you’ve addressed conceptually what the goals are for the company. Have you sort of given or have you been – can you provide us with a sort of use of proceeds so to speak as it pertains to at least minimum levels of manufacturing investments, R&D investments and such so that we can may be understand what at least a required spending is that needs to take place over the next 12 or 18 months?

Jamie Levine

Well, I think because those are still being determined, they are also going to be made according to our own financial resources, so that’s why there is slightly a chicken and egg type issue. Some of the initial investments in manufacturing frankly are sub $1 million and those will have impacts on the yields that we see out of manufacturing. So, there is some what you can call low-hanging fruit.

Pete Finolie – River Ridge

Yes.

Jamie Levine

And on the other hand, from the – from your broader high level picture perspective, in terms of use of proceeds, we obviously have the notes outstanding, and those are outstanding through April of 2012. We have worked with our note holders in the past to address and try to find deals that makes sense for the company and for note holders and it’s not clear whether or not that’s possible in the future. But we’ve considered it in the past, so it’s something we will consider in the future as part of normal course of operations. But in terms of the overall level of kind of required CapEx, or maintenance CapEx, we are not really providing a run rate for that because this is giving us a new opportunity to invest in this business in a way that we haven’t in the past. And so right now we are going through the process of determining what are our financial resources and what investments are we going to make in the business plan, on the manufacturing side, on the sales side, new products, pipeline products, et cetera.

Pete Finolie – River Ridge

Okay. That’s helpful. Thanks, guys.

Jamie Levine

Thank you.

Janet Roemer

Thank you.

Operator

I am showing no further questions at this time. I will now like to hand the conference back over to Ms. Kelly Lindenboom for any final closing remarks.

Kelly Lindenboom

Thank you for joining us today. This concludes today’s call. Have a nice evening.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program for today. You may all disconnect. And have a wonderful day.

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Source: Verenium Corporation Q2 2010 Earnings Call Transcript
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