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Verenium Corporation (NASDAQ:VRNM)

Q1 2012 Earnings Call

May 10, 2012 5:00 p.m. ET

Executives

James Levine – President, Chief Executive Officer

Jeffrey Black – Senior Vice President, Chief Financial Officer

Janet Roemer – Chief Operating Officer

Analysts

Laurence Alexander - Jefferies & Co.

Operator

Good day ladies and gentlemen, and welcome to Verenium Corporation’s first quarter 2012 earnings conference call. [Operator instructions.] I would now like to hand the conference over to Mr. Jeff Black, chief financial officer. Sir, you may begin.

Jeffrey Black

Thank you, and good afternoon. Thank you for joining Verenium’s first quarter 2012 conference call. I’m Jeff Black, chief financial officer, and with me today are Jamie Levine, our CEO, and Janet Roemer, our chief operating officer.

The agenda for today’s call is as follows. First, Jamie will provide an outlook on the business moving forward in light of the transaction we recently announced with DSM. Janet will then discuss commercial operations, including Q1 performance, and I will then review our financial results for the first quarter of 2012 and provide updated 2012 financial guidance.

Before we begin, I would like to advise you that this discussion will include certain statements that are not historical facts and are forward-looking statements that involve a high degree of risk and uncertainty. These statements relate to matters such as our strategy, future operating plans, markets for our products, partnering, collaboration activities, public policy, financing, M&A activities, technical, and business outlooks.

The company’s actual results may differ materially from those projected in such forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed in our filings with the SEC, including, but not limited to, our report on Form 10-K for the year ended December 31st, 2011, and in our subsequently filed quarterly reports on form 10-Q. These forward-looking statements speak only as of the date hereof.

And I will now turn the call over to Jamie.

James Levine

Thanks Jeff. And good afternoon everyone, and thanks for joining us. I’d like to start with a few comments regarding the recent transaction with DSM. As you know, in March we announced that DSM has acquired certain commercial and pipeline products for a total consideration of $37 million. And I’d like to add two observations to the comments that we made at the time of the announcement.

First, you’ve heard us talk in the past about how our technology can create the highest-performing enzymes. Our sale of Purifine shows a global player like DSM clearly agreed with the substance of our claim. However, for our current portfolio, the same performance advantage is also true. Fuelzyme, our high-performance product for corn bioethanol, has a fundamentally different mode of action compared to competitors’ enzymes, and Janet will describe how this has allowed us to grow our sales of Fuelzyme in a very challenging period for corn bioethanol.

The second observation I’d make about the DSM deal is that a number of global companies we’ve met with in the past several weeks have emphasized that they’ve had a longstanding interest in accessing Verenium’s technology, but also a concern about the impact of the convertible notes on our financial health. With the debt now behind us, we’re finding that opportunities for partnering have expanded.

I’ll now turn to the meat of my comments regarding our sources of growth in light of the changes from the DSM transaction. Fundamentally, our future success relies on execution and not new technology development. It therefore follows that there’s a lot of transparency into our growth going forward. Today, we sell eight products under three product lines, and simply put, our growth is coming from these eight products and our product pipeline.

We anticipate providing more detail at our capital markets day this summer, but given the focus over the last few weeks from investors on our current growth profile, I’d like to be clear about our pipeline as it stands today. In our animal health and nutrition product line, we are developing four enzymes together with Novus. Given that Verenium developed two of the four high-performing Phytase enzymes serving this large market today, we have a strong view of what’s required to succeed in animal feed, and we believe our offering will be highly attractive to this market.

In our grain processing product line, our recent partnership with Tate & Lyle represents a new source of near term growth, and we believe we can add substantially to our grain processing pipeline through additional partnering discussions currently underway.

Finally, we come to oil field services. As of today, several large and mid-sized oil field services companies are testing our Pyrolase product used for breaking guar in the hydrolic fracturing process. The feedback indicates Pyrolase can cost-effectively address an area not well-served by the current breakers on the market. Namely, wells that are too hot for standard breakers, typically over 140 degrees Fahrenheit. The growth of this product is a critical area of focus for the company and we look forward to updating our progress in the future.

For the oil field services pipeline, we are announcing today that in the first quarter we submitted for regulatory authorization a more thermostable version of our Pyrolase product, which will expand the potential portion of the fracturing market our products can serve. We expect that process will allow us to bring this new product to market in 2013, if not sooner, because the regulatory process for this product is shorter than we usually describe. We are already allowing potential customers to test this product candidate in their labs, and they are seeing strong performance at very high temperatures.

Importantly, with this announcement of a new oil field services product candidate entering regulatory, we now expect to begin commercial sale in 2013 of pipeline products from each of our three product lines. This lays out our product pipeline and our current product lines.

We remain committed to adding new development candidates to our portfolio. Our platform has created products with industry-leading performance, yet we only have products to address around 20% of the broader industrial enzymes market. In fact, BCC Research recently issued a new report on the global industry enzymes industry that increases the estimated size of the industry to $3.9 billion in 2011 and increases the future growth rate of the industry to 9.1%.

This is more bullish than previous forecasts, and is driven by the global increase in demand for enzymes, given their high-performance and environment benefits. The partnership discussions we are having today are focused on broadening the portion of the enzyme market we target, creating the opportunity for near term revenue from collaborations, and achieving medium-term revenue from new commercial products.

Looking ahead through the end of the year, we expect to announce milestones relating to improvements in our current product sales performance, particularly for Pyrolase, as well as additional partnerships within, and outside, of our current three product lines.

I’ll close with a few comments from our participation in the industrial biotechnology industry conference a few weeks ago in Florida. One significant area of discussion and concern at the conference was the business volatility we have seen from some of the recent IPOs in the broader clean tech space. For Verenium, as a more mature operating platform, we have already gone through the process of scaling up our manufacturing processes, and today our goals rely on executing our sales plans for the high-performance products we already have on the market.

A second observation from the conference is that we received significantly more interest than in the past in using our technology to create high-performance enzymes for cellulosic conversion. Recall that after the transaction with BP, Verenium retains the right to use all of our discovery and evolution tools to develop enzymes for use in the cellulosic industry. And while we don’t believe it’s a place where we will invest our own resources, we believe we have a unique offering to partners in the cellulosic area.

In closing, I’d like to mention the National Bioeconomy Blueprint released by the White House in April. Industrial enzymes like ours clearly address many of the objectives laid out in that report, and given our technology is well-validated and widely applicable, we’re focused on looking at all opportunities, with companies and with government support, to deploy our technology.

Overall, I’m very encouraged with the outlook for Verenium. With our debt issue now behind us, and with the ability to focus on developing the business, and particularly the pipeline, we believe we have ample opportunities for important value creation. Our vision continues to be building a leading industrial enzymes business with high-performance, sustainable products, with a focus on profitability.

I look forward to updating you on continued progress on all these fronts. And with that, I’ll turn the call over to Janet.

Janet Roemer

Thank you Jamie. While we are facing some challenging market conditions for our core products, I’m nevertheless pleased to provide an update on operational results from the first quarter of 2012.

Revenue from our largest product line, animal health and nutrition, decreased 8% in the first quarter over the same period last year. Total revenue from Phyzyme Phytase was essentially flat, and the decline was largely due to the absence of a short term opportunity we had in 2011 to [unintelligible] produce.

Revenue from our second-largest product line, grain processing, decreased 8% when compared to the same period in 2011, which reflects lower sales of Xylathin Xylanase used in Europe for wheat ethanol and DELTAZYM glucoamylase, a product we distribute. However, sales of our lead product, Fuelzyme Alpha-amylase, were up versus the same period of 2011 as we added new customers and saw an improvement in European Fuelzyme sales.

The industry overall continues to be seriously challenged by the blend wall, which has resulted in an oversupply of ethanol and depressed its price. This has caused many ethanol producers to reduce operating rates. In addition, enzyme dose is being more closely monitored and minimized.

We do not expect the industry to recover soon, but such challenging conditions increase interest in sources of cost savings, which we can demonstrate with our Fuelzyme product, and we will continue to pursue growth by gaining share based on its unique characteristics, supported by improved manufacturing capability, which I will describe later.

We will be promoting Fuelzyme and our entire portfolio of products for this industry through more aggressive advertising, marketing, and by raising our profile in the industry through activities such as our sponsorship of the upcoming Fuel Ethanol Workshop in Minneapolis, where we will also have a booth.

Now I’ll move to our product pipeline, and important driver of future growth. As Jamie mentioned, we have an active suite of products in development. Of particular note, along with our partner Novus, we achieved an important milestone in the first quarter by selecting the specific Phytase enzyme from among the finalist candidates as the lead candidate to take forward to commercialization.

As previously discussed, together with Novus we have three additional product candidates currently in late-stage development for animal health and nutrition. Through the first quarter, these projects remained on track for achieving commercialization targets.

Turning now to manufacturing, we continued to make progress in our operations at Fermic, in Mexico City, including increasing capacity for manufacturing Fuelzyme by removing minor bottlenecks.

Recently we’ve achieved improvements in average yield per fermentation batch and reduction in unit cost. These initial positive results stem from the planning and execution of several relatively small projects, and importantly, we expect further improvements from our manufacturing investment program being implemented over the summer.

Reducing manufacturing costs and improving gross margins were priorities we laid out at last year’s capital markets day, and I’m pleased to see these initial results, which will benefit Verenium as well as DSM, as we will continue to manufacture Purifine PLC, the product line they purchased, and [Veritase] alpha-amylase and a xylanase, which they licensed for the food industry.

This agreement will allow us to keep asset utilization high, and the initiatives we have underway will further benefit the products we supply to DSM as well as our own current and future products.

In closing, I’m encouraged by operational accomplishments to date, especially in light of market conditions, and look forward to reporting continued progress throughout the rest of the year. With that, I’ll turn the call over to Jeff.

Jeff Black

Thank you Janet. Over the next few minutes, I will provide some commentary on the quarterly financial results we announced earlier today, and then provide updated financial guidance for 2012.

With respect to financial results, some quick commentary on the DSM transaction reflected in our financials for the quarter. Based on current accounting rules, the DSM transaction contained multiple elements that we are required to separately value and account for, and as a result, in our first quarter our statement of operations reflects the allocation of the cash proceeds in two different line items.

We allocated $1.5 million of the proceeds to license fee revenues, and we allocated about $31.5 million to a gain on the sale of our oil seed business, which is reflected net of transaction costs. For purposes of reviewing the first quarter results, we think it’s important to exclude the impact of this gain.

In the first quarter, our product revenue decreased over last year from about $13 million to $11.7 million. In animal health and nutrition, as Janet mentioned, Phyzyme revenue was flat, but product revenue decreased in total due to a short term [total] manufacturing arrangement in 2011.

In grain processing, Xylathin revenue is down year over year, and while we remain cautious about our expectations for continued growth of Fuelzyme, we did see growth in Fuelzyme sales in the first quarter as compared to 2011. We also saw a decrease in oil seed processing revenue, which is due primarily to lower Purifine sales volumes to one customer that suspended operations for a plant modification. Although we sold our Purifine business to DSM at the end of the first quarter, we expect to continue to manufacture the product for them into the foreseeable future.

Our product gross profit for the first quarter decreased from $4.9 million in 2011 to $4.4 million, which is largely attributed to the overall decrease in product revenues. Product gross margin percentage remained flat at 38% as compared to 2011.

Our collaborative and license revenue increased in the first quarter from just below $400,000 in 2011 to $5.5 million. The major drivers of this growth were the recognition of $2.9 million from our Phytase license to Novus and the $1.5 million in license fees from the DSM transaction.

As we’ve stated before, the amount of our collaborative and license revenue will fluctuate from quarter to quarter, and this revenue source is largely driven by the timing of deliverables and milestones related to our development partnerships.

We think it’s especially important to note that the potential for variability in our collaborative and license revenue, since it can impact our reported operating loss or income on a quarter to quarter basis. As an example, we reported pro forma operating income of about $800,000 during the first quarter of 2012, and this was largely driven by our Novus and DSM license revenue.

Our operating expenses, excluding restructuring charges and cost of product revenue, increased in the first quarter of 2012 from $7.1 million to $9.1 million. However, excluding the impact of $1.1 million in legal fees reimbursed in the first quarter of 2011 in connection with the settlement of our note holder lawsuit, and transaction fees during the first quarter of 2012 associated with the financing alternatives we were pursuing, our total operating expenses remained flat year over year. And at the same time, our R&D expenses increased, which reflects our continued focus on investing in the product pipeline while controlling SG&A costs.

From a cash perspective, we ended the quarter with unrestricted cash, net of outstanding convertible notes and accrued interest, of $22.8 million and $5.7 million in restricted cash. Our restricted cash consists of $2.5 million related to our BP escrow agreement and $3.2 million that secures a letter of credit for our new landlord. After our debt retirement, and based upon the operating covenants in the lease, we anticipate that an additional $1.6 million in restricted cash under this letter of credit will free up during the third quarter.

Now turning to our updated financial guidance for 2012. In 2012 we expect total revenue between $58 million and $62 million, with approximately 10-15% of total revenue coming from collaborations and license fees. We expect to generate product gross profit between $19 million and $21 million, and excluding the gain on the DSM transaction we expect to end 2012 with an operating loss between $7 million and $9 million.

And finally, we expect capital expenditures between $8 million and $9 million. This includes both investments and manufacturing at Fermic, as well as capital required to complete the buildout of our new facility in San Diego.

And as Jamie mentioned earlier, we are targeting operating profitability in 2014. This assumes we achieve continued revenue and margin growth from Fuelzyme, a ramp up from Pyrolase, and successful commercial launch of our Phytase product with Novus.

We look forward to updating you with more details on our projections during our capital markets day this summer. And with that, we will now open the call up to take your questions.

Question-and-Answer Session

Operator

[Operator instructions.] We have a question from Laurence Alexander from Jefferies.

Laurence Alexander - Jefferies

As you look at Fuelzyme, at the market opportunity, how much of the U.S. and European market is easily addressable? That is, you have a clear and fairly sharp value proposition. And then how much of the market is addressable, but it might take a long time to convince people to switch over?

Janet Roemer

That’s a good question. Looking at the U.S. market of about 14.5 billion gallons, roughly speaking, about 11.5 of that is addressable, theoretically. So if we have to back out [unintelligible], which has a unique process. So we consider that the addressable market. And as we look at it today, a fairly large percentage of that market is in corporate hands. In other words, multiple plants or buying groups. And those are more challenging to capture. However, once you do, the prize is much bigger. And so I’d say it’s kind of a matter of how well we can penetrate some of those multi-fleet plants that will really ramp up the sales of the product.

And in Europe, it continues to be a relatively much smaller market. Our distributor has done well there, but we don’t expect growth particularly in that market as it’s going forward.

Laurence Alexander - Jefferies

I guess on Purifine, can you give a little bit more granularity about how you see market adoption evolving? That is, should it be fairly linear from here? Or should we be looking at a little bit of a bump, three or four quarters out?

James Levine

I think the biggest relevance for us now going forward on Purifine will be as a manufacturing opportunity, because obviously DSM will be responsible for the selling, etc. We’ll just be on the manufacturing side. And I’d say that while there is certainly a margin in that for us, and it may be something that we manufacture for a few years, I don’t think it will be a major contributor to the business going forward, at least as compared to Fuelzyme.

And maybe just to add one other thing to your earlier point, as Janet said in her comments, we’ve often talked about how we’ve scaled our Fuelzyme sales with our manufacturing ability, and as Janet commented, with some of the recent benefits in manufacturing we’re starting to see greater opportunities for growing Fuelzyme through having supply.

And also, in terms of looking at addressable plants, it also comes down to the overall cost proposition. I don’t think that’s a major driver, but it’s certainly a part of the overall equation for getting a plant to convert from a competitor enzyme to our enzyme is the overall value proposition. And the ability to think about being able to reduce the cost, we have more flexibility to think about how we try to penetrate the market.

Laurence Alexander - Jefferies

And then for the product that you’re launching next year, would it be fair to use the Fuelzyme ramp as a good proxy? Any way that you can help us envisage how you see that play into contribution in 2013 as opposed to 2014? And I realize you’ll address this at the capital markets day.

James Levine

I think that’s right. I think it will be useful to take some time at the capital markets day to talk about each of the pipeline products, particularly the ones that are in the near term launch phase, because they’re all very different. Some are addressing a more traditional market for enzymes, but also we have products in the near term pipeline that are creating new markets, and so therefore it’s as much about adoption rate and selling rates as it is about how quickly we can penetrate or take share.

So I think we’ll be able to go through that in some more detail at the capital markets day this summer, but I do think that we wanted to emphasize that we see pipeline products coming to market from each of the three areas in 2013.

Laurence Alexander - Jefferies

And then just to be clear on two other things, just in terms of broad messaging, selling additional product lines is not a priority at this point? And second, the target of getting to operating profitability in 2014 does not rely on any new adjacencies beyond the three products you’ve addressed?

James Levine

Yes. I think that’s right. To your first point, correct, selling new product lines is not strategic. I do think that we’ll always be looking at our products and what we have to partner, because very often through partnerships we can take our products to new markets, and so those may be opportunities. But as we look at our target for profitability in 2014, operational profitability in 2014, that is about the products that we sell today and the products that we have in our near term pipeline, not new technology development or fundamentally new partnerships that are going to change the profile of the business.

Laurence Alexander - Jefferies

And then roughly how much of an R&D drag will you have just for development of new technology products that are not part of these three categories?

James Levine

Well, I think the important thing about that question, Laurence, is it will be dependent, and certainly within our control, based on where we choose to go with partnerships. So we’ve said that we’re in a whole series of discussions right now, and just to be clear when we talk about partnerships, what we talk about is how do we think about either co-funding, together with a partner, or derisking, the approach of bringing product to market.

And I think therefore if we do find that those partnerships come to fruition and the partner is cofounding a lot of the development costs, we may choose to do more. But to the extent that that’s not the case, we can scale back, obviously bearing in mind that we’re going to continue to move forward on the products we currently have in our pipeline. So we have a lot of flexibility is the answer, and part of it will depend on how the partnerships play out.

Jeffrey Black

To answer that question a little bit differently - maybe it’s helpful for you - is when you look at the last couple of quarters, when you take a look at the R&D expense, roughly 65% to 70% of that expense relates to pipeline development, and the rest would relate to supporting existing commercial products.

Laurence Alexander - Jefferies

And just to try and simplify, or try and tease out a nuance, I guess the underlying message is that, at least for the next couple of years, there should not be a significant cash burn associated with new R&D projects above and beyond the three core growth areas. Is that a fair way to characterize it? You will spend the money if people come to you and are willing to partner and fund it?

James Levine

Yes, and I would say co-fund it would be the only nuance. There are circumstances where in order to preserve our share of the back end revenues and profitability, we’re willing to co-fund. And so we may choose to do that, but each one of those decisions will be made on situation by situation basis. But the strategy is very much about bringing current pipeline products to market and focusing on commercial sales of our current products.

Operator

I’m showing no further questions at this time. I would like to hand the conference back over for any closing remarks.

Jeffrey Black

Thank you for joining us today, and we look forward to updating you in the future.

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