Kelly Lindenboom – VP, Corporate Communications
Carlos Riva – President and CEO
Janet Roemer – President and COO
Jamie Levine – EVP and CFO
Rob Walker – Jefferies
Paul Resnick – Olympia Capital Markets
Verenium Corporation (VRNM) Q3 2010 Earnings Call Transcript November 9, 2010 5:00 PM ET
Thank you for holding. Welcome to Verenium's third 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, Kelly Lindenboom. Please go ahead.
Thank you for joining Verenium's third 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 provide some remarks on the company following the completion of the BP transaction in September. Then Janet will discuss key assets of our business operations, including each of the major industries, our enzymes currently served, as well as our manufacturing efforts and business development activities. Jamie will then summarize our financial results for the third quarter 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 Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements involve a high degree of risk and uncertainty and relate to matters such as our strategy, future operating plans, markets for our products, partnering, 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 those projected in such forward-looking statements. Factors that could cause or contribute to differences include, but are not limited to, risks related to our IP partners, competitors, and regulatory and market forces.
Certain of these factors and others are more fully described in our filings with the SEC, including but not limited to our report on Form 10-Q for the quarter ended September 30, 2010, which was filed with the SEC today. These forward-looking statements speak only as of 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.
Thanks, Kelly. Good afternoon, everyone, and thank you for joining us on today's call. Since our last quarterly earnings call, we have engineered a major transformation here at Verenium, returning our focus to our core enzyme business. As you are likely aware, in mid-July, we announced the transaction with BP, which subsequently closed in early September for the sale of our cellulosic biofuels business.
This is an important strategic win for several reasons. First, the transaction focuses the company’s efforts on the singular goal of discovering, developing, manufacturing and selling industrial enzymes to high-growth industries. In short, this is a return to our roots as an industrial enzyme company.
Secondly, we have now sold our capital intensive and higher risk cellulosic ethanol business to BP, thus dramatically reducing our cash needs, as Jamie will explain later in the call. Thirdly, the proceeds from this transaction provide us with a more stable platform for which to grow the business and address our outstanding debt obligations.
All of these factors taken together orient the company around two pillars for creating value for shareholders. First, our portfolio of commercial enzymes currently produced and sold to various industries; and second, our best-in-class for search and development capabilities supporting our pipeline of new enzyme products, which will support running future growth.
I’m pleased to report that despite the significant corporate organizational effort required to complete the BP transaction during the third quarter, we have continued to make steady progress in growing our enzymes business over this period. So notable recent highlights include, in September, we announced the launch of Deltazym, a highly active glucoamylase enzyme for the saccharification of liquefied starch in the fuel ethanol production process.
In October, we announced that we had licensed to Bunge a new lipase enzyme that creates enhanced health benefits when used in the production of edible oil products. This product is a result of a collaboration with Bunge, an event of the regulatory phase with some commercial development work being done in parallel.
We also announced the receipt of regulatory approval for the sale of purifying in China, which we see as a critical market. This now positions Verenium to sell Purifine PLC in all the major oilseed processing areas of the world, which include Argentina, Brazil, the United States, and China. And furthermore, we’ve announced the extension of our joint marketing agreement with Alfa Laval to further speed the adoption of our Purifine enzymatic degumming process.
Before I turn the call over to Janet for a more detailed review of the business, I would like to comment on two important strategic aspects of our business going forward, namely, our environmental profile and our biofuels business. With regards to our environmental profile, Verenium’s track record of growth for the last few years is built on our ability to design and then sell our enzyme products based on their high performance value-creating properties.
Going forward, we will continue to focus our efforts on creating and marketing commercially attractive products. However, a key aspect of our products value proposition is that they allow our customers to make a shift towards environmentally favorable biological processes. By reducing customers’ need to use harsh chemicals or by making their process more efficient with regard to matters such as water and power use, our products provide an important environmental benefit for our customers and the world we all live in.
Finally, as Janet will discuss later, after the BP transaction, we intend to remain an important and diversified biofuels and bioproducts player. Although we have transitioned from a capital intensive to capital light approach to the sector, our core expertise in enzyme application could be a valuable asset for many future biofuels and bioproducts opportunities. Through the BP transaction, we have retained the complete flexibility to design, manufacture and sell enzymes for all biofuels and bioproduct applications.
The entire Verenium team is truly excited by the opportunities that our new unique capabilities allow us to pursue. We not only have the science to develop best-in-class products for high-growth enzyme markets like animal health and nutrition and biofuels, we also have considerable depth of experience, moving products from R&D to commercial scale manufacturing and industrial sales, a process some of our early stage peers have yet to experience.
With that, I’ll turn the call over to Janet.
Thank you. As Carlos mentioned, the third quarter had been a pivotal one for Verenium, and particularly, enzymes business. And I’m pleased with the terrific progress and accomplishments that have been made in just the last few months. We are all very enthusiastic for the many opportunities that exist for the enzymes business and are looking forward to continuing to build upon an established foundation of success.
I’d like to provide an outline for my remarks today, as I will be providing a significant amount of detail on our current operations. I will begin my comments by addressing our current performance and future outlook in each of our three targeted industries; animal health and nutrition, grain processing, and oilseed processing.
Next, I will discuss our approach to other product outside these areas and how we think about pursuing these types of opportunities. After that, I will address the challenges and progress made in manufacturing. Then I will shift to our R&D activities, including pipeline products. And finally, I will conclude with an overview of business development initiatives and the impact these can have on both our commercial business and R&D activities.
I will start with the animal health and nutrition industry and our foundational product in that area, Phyzyme phytase. Our current commercial focus in this industry is to sell through our partner Danisco of best-in-class phytase to produce in poultry and swine feed. Using our proprietary discovery and evolution tools, we design Phyzyme phytase with two benefits over competing phytases.
First, a higher level of activity, which has been demonstrated through studies comparing a critically important performance metric on weight gain called the seed conversion ratio of our phytase enzyme with competing enzymes. Second, its greater ability to maintain these activity levels after being exposed to high temperatures or thermostability. This trait is important to the industry as it moves towards adding enzyme into the feed mash prior to the holding process where high heat and steam are used to mow feed pellets. The market for phytase enzymes largely follows the market for broiler chickens, which after reaching a low point in the second quarter of 2009 has recovered well.
Currently, we would characterize the phytase market as growing, particularly as new geographies like China pursue higher efficiency farming techniques where the farmer values the technical benefits of utilizing a phytase enzyme like ours over the traditional approach of adding inorganic phosphorus in the animal feed. Our outlook for Phyzyme phytase is to see continued moderate near-term growth through a combination of market share gain resulting from higher performance relative to the competition, expanded geographic reach, and underlying market growth.
I’d now like to turn to the grain processing market. It is important to emphasize that even after the BP transaction, Verenium remains a significant player in the biofuels market with a portfolio of three enzymes used in the production of bioethanol from corn and other grains. Our lead product, Fuelzyme, is an alpha amylase used by the corn ethanol industry to liquefy the mash on the front end of a corn ethanol plant.
Together with Deltazym glucoamylase, we provide both of the enzymes that corn ethanol plants require. Like Phyzyme, we designed Fuelzyme to have superior operating characteristics over competing products, allowing the enzyme to have higher activity and to retain its activity levels at higher temperatures and lower pH, which provides direct cost savings through lower enzyme dosage, reduce use of chemicals, and greater operating flexibility.
Our outlook for our products targeted at the corn ethanol sector is to see continued growth due to two main factors. First, the EPA recently announced approval of E-15 for some cars in the US, will allow for increase in the amount of ethanol blended into gasoline to go from 10% to 15%. This should increase demand for corn ethanol and therefore benefit companies like Verenium who supply critical inputs to the ethanol production process.
Second, as a result of our recent marketing focus, we have a healthy schedule of Fuelzyme plant trials, a critical first step in capturing market share by converting the corn ethanol plant from a competitor’s product. While every trial did not always result in a new customer for Fuelzyme, we are pleased by the response in the industry to our marketing efforts.
Our two other products in the grain processing industry are Xylathin for re-ethanol processing and the industry largely based in Canada and Europe, as well as Veretase for the portable alcohol industry. Both of these products are based on molecules that we design and develop for other uses to determine that we can achieve attractive incremental sales and leverage existing overhead by targeting them these industries. While the revenues are small there, indicative of our creativity in maximizing the opportunities we see to sell our enzymes.
Unlike the animal health and nutrition or grain processing industries, where re-developed higher performance enzymes to sell into existing markets, our efforts in the oilseed processing market are different. In that, enzymes are not broadly used in this industry. While the sales cycle is longer due to the capital investment required to convert the plant, to the Purifine degumming process, but we are gaining significant traction with this product for several reasons.
First, we offer an attractive value proposition because the oil processors yield of saleable oil improved by 1.5% to 2.0% using Purifine. Secondly, we have data from commercial scale demonstration by our partner Bunge, which substantiates our value proposition. Third, it is our strategy for marketing the Purifine degumming process through our partnership with Alfa Laval, a major engineering and construction firm that services the global oil processing industry.
And finally, given that Purifine is a unique enzyme for use in oil degumming, each conversion we make from water degumming to enzymatic degumming is both an expansion of our customer base and a validation of Verenium’s technical capabilities.
Our outlook for Purifine is as follows. Currently we target large and medium-sized soybean processing plants. Each plant we convert represents $500,000 to $2 million in annual revenue program. This range of revenue potential is driven by several factors, including the size of the plant, the phosphorous contents of the beans processed and other operational considerations.
Currently we have four plants using Purifine in Argentina and Brazil and in other ten plants in various stages of discussions from early-stage exploratory discussion to actual installation of the Purifine-related equipment. It is important to note that once a plant decides to convert to the Purifine degumming process, it can take six to nine months to be fully operational in light of the equipment our customers must install.
Regarding the recent announcement of our approval to sell Purifine in China, this is another area where our marketing partnership with Alfa Laval is critical to put marketing researches on the ground to sell the process. We are actively marketing the process now and look forward to penetrating a new growing market for enzymes in edible oil processing.
Finally, adoption of Purifine enzymatic degumming by the oilseed processing industry has an added benefit of overcoming to proceed new technology barrier, paving the way for future development and adoption of enzymes for other uses in this industry, as processors seek the combination of economic and environmental benefits that enzymes offer.
In addition to the products I’ve just discussed, we also sell enzyme products into other industrial processes, such as textile and hydraulic fracturing oil wells. While currently small, but profitable, we are evaluating the best strategies for these products, including partnering to drive growth.
In summary, regarding our current commercial products, we are optimistic about the growth opportunity across the industries we serve through continued market penetration, geographic penetration, and underlying market growth. With our renewed focus in financial resources, we look forward to updating you in the progress in these markets in the future.
I would now like to shift away from our commercial products to discuss our enzyme manufacturing capabilities, a critical underpinning of our sales efforts. As you may know, we manufacture our enzyme products to a manufacturing partnership with Fermic in Mexico City. For much of 2010, we had been chasing our marketing activity to sit with our manufacturing capabilities. In our near-term initiative, our aim to add improving manufacturing capacity to support the attractive growth opportunities I have just described and to reduce the cost of goods sold.
First, let me provide a description of how our products are made. The first step of the manufacturing process if fermentation where the enzyme is produced at very large scale, in our case, 90,000 to 190,000 liters depending on the product in a mixture with nutrients called broth. The second step is downstream recovery where the enzymes are separated from the broth, formulated and packaged for shipment.
Our near-term initiatives include improvements in both fermentation and downstream recovery. First, to increase available capacity for our products. During the third quarter, we exercised our options to take full time control of a third 190,000-liter fermentation unit, which had been shared part-time with Fermic for their own business. Second, to improve yield event times for fermentation, utilities are being expanded in the fourth quarter, which will enhance cooling and power supply.
Third, smaller debottlenecking projects such as upgrades to sensors are being pursued to better monitor and control fermentation. Finally, in the downstream recovery area, multiple projects to improve efficiency, each requiring limited amount of capital, are being developed and implemented. With the leadership of brand new Vice President of Manufacturing, Kevin Bracken, a highly experienced engineer and manufacturing leader; strong support from Fermic, our manufacturing partner; and the capital available from the BP transaction, we are well positioned to improve and expand our manufacturing capability.
I would now like to shift from manufacturing to our product pipeline. We have a robust set of product candidates at various stages of developments that will provide for the future growth of the business. In general, there are two phases in the development of a pipeline product. First is the development phase where we determine the enzyme characteristics and industry values and then use our discovery and evolution tools to select and improve product candidates.
We then proceed to lab scale process stimulation to predict and quantify effectiveness in the targeted applications, and in parallel, develop a scalable production process, including engineering of the production for organism to express the enzyme at levels efficient to achieve favorable commercial scale economics. Second is the regulatory phase where outside laboratories perform required toxicity and safety tests, an extensive dossier is prepared and submitted to the relevant regulatory agencies for review and approval.
Broadly speaking, each of these two phases takes between two and three years, given the total product development timeline of four to six years. Overall, development costs generally range between $3.5 million and $5.0 million, which we may fund ourselves or share with a partner.
Most of the products currently in our fund were developed through our previous partnership with Syngenta. Much of the investments have already been made, and we have exclusive rights to develop and producing these enzyme products. Our pipeline products are at various stages of development, with some of the later-stage products entering the regulatory phase. I will now review these products by industry.
In animal health and nutrition, we are developing a next generation phytase, targeting higher activity and thermostability than all currently available competitive offerings. Together with the new xylanase and beta-gluconase, we have the three products well advanced in the pipeline for the animal health and nutrition industry.
In oilseed processing, we have two enzymes in our pipeline, one of which Carlos mentioned earlier that we recently licensed to Bunge for the production of healthier edible oil products. With each of these pipeline products, we demonstrate the depth of our position in critical areas of growth and we will evaluate the best path to market strategy, be it on our own through direct sales or with a partner.
Finally, I’d like to address our business development initiatives. Looking at the growth of our enzyme business over the past several years, one aspect that best demonstrates our capabilities as an operating team is our creativity in pursuing partnerships. Whether it’s a traditional marketing partnership with Danisco, a manufacturing partnership with Fermic, a commercial scale demonstration partnership with Bunge, or implementation partnership with Alfa Laval, we have used partnerships strategically to fill capability gaps and accelerate time-to-market.
Going forward, our business development efforts are largely focused around the pipeline products I described earlier. Currently, we are exploring options for partnering with companies to either reduce the near-term development cost, reduce the implementation risk, or speed time to market.
Before turning the call over to Jamie for a discussion of our financial performance in the third quarter, I’d like to comment on an area of significant opportunity for the enzyme sector, mainly biofuels and bioproducts. Notwithstanding the transaction we recently completed with BP, biofuels remain an important aspect of Verenium’s curve in future business with distinct opportunities for participating in the value chain.
First, this first generation biofuels, including US corn ethanol industry, where we currently sell high-performance versions of the two enzymes used by many corn ethanol plants. And the wheat processing industry, which was small as in corn ethanol, is an important biofuels opportunity in Canada and Europe where we currently supply Xylathin and Fuelzyme to our European distribution partner.
The second way we participate in the biofuels market is in biodiesel. As more story in grape seed oil is used to produce biodiesel, the opportunity for Purifine enzymatic degumming expands. Importantly, our participation in the first generation bioethanol and biodiesel markets enables us to build the sales capabilities, customer relationships, and industry knowledge needed to design future products for these segments.
The third is cellulosic enzymes. Two strategies we are exploring, including the partnership with third parties to undertake a cellulosic enzyme program. Secondly, we have done, as we have done in corn ethanol pursuing cellulosic enzymes as a best follower, designing enzymes and improve upon our complements to first generation to cellulosic enzymes.
Finally, we believe Verenium’s enzyme products and core capabilities in discovering and evolving enzymes and for metabolic engineering, that is modifying organisms to produce the targeted fuel or chemical economically in commercial scale. We believe these are highly translatable to algal biofuels into biochemicals, and we are exploring options for participating in the phase [ph].
In total, we believe biofuels, and more broadly, bioproducts are and will continue to be a critical source of growth for us going forward. Overall, we continue to see tremendous growth potential for our products, our pipeline and our business. We are continuing to actively market our lead products, improve efficiencies, and develop novel, high-value enzymes as we look forward to reporting our progress in all these initiatives.
With that, I will now turn the call over to Jamie.
Thank you, Janet. As Carlos and Janet have discussed, the third quarter was an important one for the company. We have focused our activities on our growing commercial enzyme business, sold the business with significant cash burn, and have taken important steps in recapitalizing our balance sheet.
With our financial results today, we are providing a clear picture of the ongoing shape of the business in light of these changes. By categorizing the assets and liabilities sold to BP as discontinued operations, the operating section of our financial statements supplement the pro forma information on our continuing operations we have previously reported.
I’ll now turn to the company’s financial results for our third quarter. First, we have grown our product revenues by 16% on a year-to-date basis over 2009 and by 11% as compared to the third quarter of 2009. Second, our gross margin dollars have increased by 20% on a year-to-date basis over 2009 and 17% compared to the third quarter of 2009.
Finally, regarding our cash position, we ended the third quarter with $89 million in unrestricted cash compared to the $17 million we had at the end of the second quarter. In addition, we have decreased the principal amount of our debt outstanding from $96 million to $75 million. In summary, we believe these third quarter results confirm our progress in growing and diversifying our business. And proceeds from the BP transaction have provided us a much more stable platform from which to continue to build our operations.
With that, I’ll turn to a more detailed review of the financials. Our product revenue of $12 million in the third quarter was up 11% from $11 million over the same period last year. More notably, on a year-to-date basis, our product revenues were $37 million, up 16% from $32 million in the same period in 2009. This increase is driven by market penetration of our products targeted at the grain processing and oilseed processing industries.
I’d now like to provide some contracts for the reported revenue based on the detailed reporting we provide for animal health and nutrition and grain processing product lines. While our revenues from our animal health and nutrition products for the 2010 year-to-date period increased 3% versus the same period in 2009, the gross margin from this product line increased by 34%.
The difference between 3% revenue growth and 34% growth at the gross margin level results how we report revenue for product we manufacture versus product our partner manufactures. This gross margin reflects the growing earnings we have achieved from our animal health and nutrition product line regardless of manufacturing source. This quarter is the first quarter for which we are separately reporting the revenue from our products targeted at the grain processing industry, including Fuelzyme, Deltazym, Xylathin and Veretase.
For the 2010 year-to-date period, our revenues from the grain processing industry have increased 37% to nearly $10 million. This reflects both a general recovery in the grain processing sector as well as our ability to further penetrate the market with our existing products and the new product we launched. As a result of this growth, our products, other than Phyzyme phytase, accounted for 27% of product revenues this quarter, continuing our trend toward a more diversified product revenue stream.
During the third quarter of 2010, we generated a product gross margin of $4.4 million, which is an increase of 17% over the same period in 2009. For the first nine months of 2010, we generated a product gross margin of $14 million, an increase of 20% over the first nine months of 2009.
Overall, we are very pleased with the margin level we have been able to generate during the third quarter and the trend over the last year for several reasons. First, this was a demanding quarter for a lean company like Verenium to execute a complex transaction while keeping an appropriate focus on operations. Second, during the third quarter, we launched several new operational initiatives, including ramping up production of Purifine and increasing our fermentation capacity at Fermic, and therefore our fixed manufacturing costs.
These activities tend to have a negative impact on margins. Yet in the face of these challenges, we have been able to maintain gross margin growth. Effective with the sale of our cellulosic biofuels business to BP, our historical cellulosic biofuels operations are now retroactively included in discontinued operations and presented separately in our statement of our operations.
This presentation, which is pursuant to current account rules, enables us to show operating results from our continuing operations, which reflect the historical results of our current business. In terms of our operating expenses from continuing operations, excluding cost of sales, our gross operating expenses decreased during the third quarter of 2010 to $9 million compared to $11 million for the same period in 2009 and decreased for the year-to-date period to $25 million in 2010 from $29 million in 2009.
I’d like to highlight one extraordinary item in the operating expense that I just reviewed. In the third quarter of 2010, our operating expenses include $1.4 million in companywide employee bonus payments made under our 2009 bonus plan. While we generally accrue employee bonuses evenly over the course of a fiscal year, because our 2009 bonus was contingent on the closing of the BP transaction, we were required to recognize the full amount as an expense during this third quarter, in addition to accruing one quarter of our 2010 expected employee bonuses in the usual manner. Excluding the 2009 employee bonus, our total operating expenses from continuing operations would be $7.9 million rather than $9.3 million during the third quarter.
I’d now like to comment on our goals for our cost structure going forward, including cost of goods sold, R&D, selling expenses, and G&A. Going forward, our cost of goods sold will generally grow proportional to our product revenues although we expect to achieve benefits from the investments we are currently making in our manufacturing capabilities, which Janet described earlier. As these improvements come online and as we optimize the manufacturing of our newer products like Purifine, we are focused on maintaining and improving our gross margin profitability.
For our research and development expenditures, current and anticipated R&D is tied to the level of investment we choose to make developing our pipeline and advancing new products to the commercial fees. By our sales, we’re working together with partners to share the costs. This is an area where we have significant ability to control costs as we determine the level of reinvestment and growth we choose to make.
Regarding our selling costs, while we will need to make limited investments in sales and marketing support our expected growth and demand for our products, we do not anticipate these costs to be grow proportional to our revenues, given the nature of our sales process. Finally, regarding our G&A expense, as a public company, we have a certain level of expenses required to support our commercial objectives and reporting requirements. But we believe we can grow the business significantly before we would need to make material additions to our G&A functions.
In summary, we continue to remain focused on containing and where possible, reducing expenditures. Our overall objective to develop a profitable business will come through a mix of the factors I discussed, namely revenue growth, improved manufacturing, expense controls and cost sharing through partnerships. Importantly, while we remain a significant biofuels player for the reasons Janet mentioned earlier, we have taken a capital light strategy focused on certain high-value areas of the value chain where we have significant expertise.
Finally, we’d like to reiterate the guidance we issued previously for 2010. We are still projecting to end 2010 with $48 million to $54 million in product revenue and $16 million to $18 million of product gross margin. We plan to provide guidance for the full year 2011 in the early part of next year.
Overall, I’m very pleased with the progress we’ve made this quarter and the significant opportunity for growth, as we build our leading industrial enzymes business. Not only do we have the financial flexibility to invest in the business, but we also have a well seasoned team of industry experts to execute on that plan and lead Verenium forward.
At this point, I’d now like to turn the call over to the operator to take your questions.
Thank you, sir. (Operator instructions) Our first question comes from Laurence Alexander of Jefferies.
Rob Walker – Jefferies
Good afternoon. Hi, this is Rob Walker in for Laurence.
Rob Walker – Jefferies
I’d start on the new operating model on growth, you’re clearly growing at above market rates. What are you guys targeting for longer term revenue growth? You mentioned market share, geographic reach, and bringing your line pipeline to market as levers. So how would you rank order those? And should we expecting a continued sort of two or three times market growth going forward?
Sure. I think – in terms of going forward, I think part of that is what we expressly intend to address when we are talking about forward guidance in 2011. But I think that at several points over the call, we tried provide some perspective on where we saw the growth to come from in these markets. And I think a lot of times, we’re looking at additional geographic penetration and additional market penetration as sources of growth. So I don’t want to provide at this stage specific revenue numbers, but I think we’ve given a sense by – first of all, we’ve given a sense for how we look at the business thinking about the three product segments and then also how we expect those to grow.
Rob Walker – Jefferies
Sure. I think in terms of your first question, the CapEx during the quarter was under $1 million as we are currently still ramping up some of the investments that we’re considering making. And this is for the third quarter. So some of the additional initiatives that Janet talked about in manufacturing are yet to really flow through. I think for the use of cash, obviously during the quarter, we did repurchase certain number of notes. And I think we, at this point, see that as opportunistic, and while not a focus on the use of cash, certainly something that’s an opportunity.
I think overall, supporting the reinvestment in the business is going to be important. And when we look at manufacturing, these are small scale investments typically, so in the single-digit millions of dollars type investments that we are looking to make. But we’re still evaluating the rollout of these investments, the timing of these investments. And so we don’t have specific guidance to give in terms of where CapEx is headed. But certainly, as we put together our plans, we are seeing significant investments that we’re going to need to be making over the near-term.
Rob Walker – Jefferies
Okay. That’s helpful. Thank you.
Are those all your questions, Rob? I’m not sure if I hit them all, but –
Rob Walker – Jefferies
No, that was actually very helpful. And then I just want to follow up on your comments on gross margins. It sounds like that you may have had this third unit for Fermic that wasn’t fully utilized in the quarter. Overall the margins perform pretty well. Kind of, were there any capacity constraints of sell-through from prior quarter to this quarter? And kind of, what’s the level of utilization that extra unit has hit her margins? And then kind of following up with that, why not no conference to increase the gross margin target, gross profit target, given your strong performance this quarter, the fact that margins may have been impacted by that lack of that even in the extra investments.
Yes. Sure, Rob. This is Janet Roemer. I just want to comment on that particular fermenter has been fully occupied. We kept it fully utilized by sharing it with Fermic during the time when we did not have the full demand for our products to occupy that 100%. In recent – kind of in recent months though, we have needed to have that extra capacity and so we did take that option that we have under our contract with Fermic to take full accountability for that particular fermenter. So it has not heard our margin in past quarters, recent quarters, but now we see demand is at a really good place, and we expect to retain – maintain pretty high utilization rates. Did that answer your question?
I mean, I’d just potentially follow up on the second half of your question regarding the guidance as well as the use. So, bringing on that or taking that option does involve a fixed rent payment because we are taking on the capacity. So, to a certain extent, that does increase the fixed cost for manufacturing that obviously we look to allocate over the product we manufacture. So it scales together when everything works well. The overall view of guidance is that at this stage, we were prepared to reiterate. We didn’t feel the need to really change, and we think we are comfortable with what we had said previously. So that was how we chose to go forward on the guidance front. But certainly, as we think about how we are communicating future expectations, next year we’ll be looking to that for next year’s guidance.
Rob Walker – Jefferies
Okay. Sure. And then just in terms of the low end of that range, I mean, would imply, I mean, a significant decline quarter-over-quarter in gross margin dollars, I think. $13.9 million is what I have heard year-to-date gross margin given kind of your GAAP and then your current reported this year versus your guidance, which is a midpoint will be $17 million and the low end will be $16 million, that would imply about $2.1 million in fourth quarter. I mean, is there anything that is making in you nervous about the fourth quarter or is it just sort of kind of what you are saying earlier and not wanting to make a – take us down until 2011 guidance when you kind of updated that?
I think I have limited to say. I think it’s more the latter. There is nothing that’s particularly concerning right now.
Rob Walker – Jefferies
Okay, thanks. I’ll jump in the queue.
Thank you. (Operator instructions) Our next question comes from Paul Resnick of Olympia Capital Markets.
Paul Resnick – Olympia Capital Markets
Couple questions here. One, tax rate. Do you have any sense what your future tax rate is going to be in the coming quarters?
We haven’t provided levels of use on the tax rate. I think that – couple of comments. One, there are some technical tax issues flowing through our income statement because of the way that we’ve had to allocate earnings between our discontinued operations and our continuing operations. I probably would suggest that we can talk about that after the call as opposed to taking people through the way that one is required to account for that under GAAP. So at least make that comment with regards to the presentation that you see in our third quarter 10-Q. With regard to future tax rate, at this point, certainly we will have certain NOLs, but our ability to use NOLs after a significant transaction like BP can be limited. So we’re still doing additional work to ensure that we get the best tax position that we can. So I don’t think we’re prepared to provide any specific guidance on tax rate, but certainly we’ll be looking to use all the tax benefit for the accrued over the losses that we generated.
Paul Resnick – Olympia Capital Markets
And in case you haven’t noticed, I have an incredible cold. And I was (inaudible) while you were talking about the bonus and the impact on the third quarter cost. So that was $1.4 million. In looking at SG&A and R&D, can one assume that the level of expense there is – the ongoing level of expense is actually maybe $1.4 million less?
We wanted to highlight that in this quarter when you combine R&D plus SG&A, there is a $1.4 million charge. And that – it's broken over those two items for 2009 bonuses. Typically, when we report, we take a quarter of the bonus and we report it each quarter. Because that bonus was conditional and not paid until the closing of the BP transaction, you can say that we had five-fourth of typical bonus flowing through this year – sorry, this quarter. So the $1.4 million was in addition to the usual quarter of our 2010 bonus. So that was intended to just provide some visibility that on an ongoing basis, we would typically only accrue one quarter of our employee bonuses in any given quarter period. So the $1.4 million, we think, can be considered as extraordinary, but not from a GAAP accounting perspective.
Paul Resnick – Olympia Capital Markets
Right, yes. So – in looking forward to SG&A and R&D, most likely I should start from a lower base than was reported in the third quarter?
From an ongoing perspective, I think that’s a fair statement.
Paul Resnick – Olympia Capital Markets
Okay. That’s all I have.
Actually we do have a follow-up question. Laurence Alexander of Jefferies, your line is open.
Rob Walker – Jefferies
Thanks for taking my follow-up. I just wanted to follow up a little bit on the pipeline and the current products. You guys gave a lot of great detail on the call, and thank you for that, it definitely helped with your model. In terms of the cost to bring your enzyme portfolio to market, it sounds that the $3.5 million to $5.0 million per enzyme you mentioned, most of those costs have already been paying your current pipeline of about nine or so enzymes. So, should we expect that the current pipeline is significant? It’s going to be significantly lower per enzyme to bring those to market. And should we kind of roughly estimate how much for on average?
What I’d say is that for the products in our pipeline, for a good deal of the discovery and evolution programs are essentially done – we've done some applications work. So, a good portion of that $3.5 million to $5.0 million development cost is already behind us. However, there still remains significant cost associated with regulatory filings in outside toxicology testing associated with most of the enzymes in the pipeline. And that’s also included in that $3.5 million to $5.0 million. And I think on prior calls, we’ve assigned about $1.5 million – anywhere from $500,000 to $1.5 million for regulatory filings depending on the end use of the products and the geography that covers.
Rob Walker – Jefferies
Okay, great. Thanks. And then just in terms of Purifine, you mentioned that sales cycle is longer and gave good color on what the opportunity is per plant conversion. Given that, I mean, should we expect – you've seen some good sequential growth. Should we expect that revenue could be lumpy going forward or would you expect to see kind of a continuation of sequential growth as that product penetrates?
I would say in my view, because the discussions are at various phases of development with customers and there always new customers are being engaged that I would see it more of a ramping up as opposed to lumpy. On the other hand, lumpiness could occur. I just wouldn’t expect it necessarily.
Rob Walker – Jefferies
Okay, great. Thanks. And then maybe finally, in terms of ongoing processing, it looks like this is the first time you’ve broken that out exactly, but back of the envelope it looks as if there is not too much sequential growth there given the nine months and then the three months. Is there something in there that is kind of making that? I would imagine that you might be – should be thinking more growth there. And is there any reason why you’re not seeing out there? And it sounds like you’re very positive going forward on that. So if you could just help reconcile that?
Sure. I think what I would say is that, as I stated, we have been pacing our marketing activities to match our manufacturing capabilities. So our first and foremost priority is ensuring that our existing customers have uninterrupted line. So we don’t overly aggressively market in times when we feel that we are nearing our capacity limitations. And so by making some improvements in the near-term and some of the investments we are making and we’ll make over the next few quarters, we’re more confident that we can step up our marketing efforts. And as I mentioned, we have a healthy – now have a healthy calendar of trial opportunities grow up.
Rob, I would just add – so you can see in the numbers that for the nine months ended, we’ve got $7 million in 2009 growing to $9.6 million in 2010. So I think overall, a reasonable level of growth for that business given that that’s a business that’s not impacted by any kind of revenue reporting issues, the kind of which we’ve obviously discussed for our Phyzyme based on the nature of the manufacturing location.
Rob Walker – Jefferies
Sure, yes. I guess I was just looking at the first nine months of 2010, and I think that makes sense what Janet was saying. You’ve got clearly strong growth year-over-year though.
Rob Walker – Jefferies
Okay. Thank you very much.
There appear to be no further questions in queue. I’d like to turn the call back to Kelly Lindenboom for any closing remarks.
We’d like to thank you all for joining us today. We look forward to updating on our continued progress. Have a nice evening.
That does conclude your program. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time.
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