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Verenium Corporation (NASDAQ:VRNM)

Q2 2012 Earnings Conference Call

August 06, 2012, 17:00 p.m. ET

Executives

James Levine - President and CEO

Jeff Black - SVP and CFO

Janet Roemer - EVP and COO

Analysts

Laurence Alexander - Jefferies & Company

John Roberts - Buckingham Research

Operator

Good day ladies and gentlemen, and welcome to Verenium Corporation Second Quarter 2012 Earnings Conference Call. (Operator Instructions)

I’d now like to introduce your host for today’s conference Jeff Black, Chief Financial Officer. Sir, you may begin.

Jeff Black

Thank you, and good afternoon. Thank you for joining Verenium’s second quarter 2012 conference call. I’m Jeff Black, Chief Financial Officer, and with me today are Jamie Levine, our Chief Executive Officer, and Janet Roemer, our Chief Operating Officer.

We plan to do something little different today, so before we get started I’d like to point out that later on in the call Jamie will be going through some slides which can viewed automatically via the webcast downloaded from the investor page of our website or download it as an attachment to the Form 8-K, that we filed today.

Before we begin, I would like to advise you that this discussion will include certain statements that are not historical facts and are forward-looking statements that involve a high degree of risk and uncertainty. These statements relate to matters such as our strategy, future operating plans, markets for our products, including our ability to develop and launch new product and timelines for doing so, including their market size and our ability to access those markets, partnering and collaboration activities, including our ability to entering the any future partnership or collaboration, the benefits of our invent collection, public policy, financing activities, technical, and business outlooks.

The company’s actual results may differ materially from those projected in such forward-looking statements. Factors that could cause or contribute to differences include, but are not limited to, those discussed in our filings with the SEC, including, but not limited to, our report on Form 10-K for the year ended December 31, 2011, and 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

Good afternoon, and Jeff said the agenda for today’s call is a bit different than our usual quarterly call, in a minute I’ll hand the call over to Janet who will discuss commercial and operational trends and the performance of the second quarter 2012. Then Jeff will provide an overview of our financial results for the first half of 2012 and finally I’ll discuss the details of our growth pipeline we are announcing today.

So, diving in the second quarter began with an important milestone with the repayment of our remaining debt on April 2, and while we are pleased with the outcome, today we are focused on our future which is about unique products, revenue growth and a focus on profitability. Janet and Jeff will speak in a minute about our performance of the second quarter, but I’d like to start by mentioning one important recent milestone which is our move to our new facility.

Over the past two years, the Verenium team has made some important steps forward in our development in commercial activities under challenging condition, in particular although we have limited access to a pilot plan for process development, we have made significant important to our manufacturing processes. The move to our new facility is more than just an administrative event. We now have far greater control over our operations by being in our own space, which we can use to accelerate our efforts and to achieve improved outcomes.

With that I’ll now turn the call over to Janet for an operational update.

Janet Roemer

Thanks Jamie. Good afternoon everyone, and thank you for joining us. Today I will provide you an update on the performance of our two largest product line animal health and nutrition and grain processing for the second quarter of the year. Summarized developments in our oil fields services product line and then discuss the progress we have made in manufacturing.

I’ll start with revenue from our largest product line animal health and nutrition and our lea product Phyzyme Phytase. Sales of finished product by our partner Danisco Animal Nutrition, a unit of DuPont strengthened in the second quarter. Poultry and pork which are the major markets for Phyzyme Phytase are favorably priced relative to beef and we expect this we will continue to be the case as the year progresses, the demand will likely be tampered by reduced animal production by some producers as margins are squeezed by continued high feed cost.

In addition, we manufactured more Phyzyme Phytase than in the first quarter which further increases our reported revenue for this product line. Also in the quarter an important ruling in Europe revoked a Novozymes patent, which related to manufacturing animal feed containing coded demonstrable enzyme granules. This removed uncertainty in the marketplace and clarified Danisco’s ability to sell the thermal stable version of Phyzyme Phytase in Europe. For a while it had been halted in Denmark under a preliminary injunction. This represents an important victory for customer choice and for Phyzyme Phytase.

Turning to our second largest product line grain processing, revenues decreased in the second quarter. Our results reflect very challenging industry wide condition which has compelled ethanol producers to reduce operating rate and in some cases shut down and response to weak margins, in both the Europe and the U.S.

Our outlook for the ethanol industry is cautious as we see the challenges of over capacity and high feedstock prices persisting. In addition, the decline in our grain processing revenue reflects the absence of revenue from Veretase, our food-grade alpha-amylase which was transferred to DSM at the end of the first quarter.

Now as you may know, a key element of our technical sales and process for grain processing enzymes is plant trial which is typically run over about a two week period to confirm and quantify our products benefits in actual use. So, in the positive side, we have a solid book of trial activities for our lead products Fuelzyme in the third quarter and are targeting adding new customers as a result.

In concluding my commentary on grain processing, I also see its well positioned to capitalize on emerging opportunities with new enzyme products in our pipeline as the corn ethanol industry evolves in terms of revenue diversification and innovated process improvements.

Turning to the oil field services market, we are selling small volumes of Pyrolase cellulase enzyme, an alternative to chemical guar breakers used in hydraulic fracturing or fracking operations. Well Pyrolase is a good product for use in situations with down hold temperatures up to 180 degrees Fahrenheit, we developed a hypothermal stable guar breaker for use in more extreme temperature and PH condition. And in the second quarter we were very excited to receive EPA authorization to mark this product.

The operational, economic and environmental benefits of this new product relative to chemical breakers are the subject of a paper to be presented at the Society of Petroleum Engineers conference in October. The next important milestone will be field trial to confirm the performance parameters predicted by the lab data.

Turning now to manufacturing. We saw notable improvements in Fuelzyme production in the second quarter reflecting the benefits from recent adjustments as well as process improvement demonstrated by improved GLs and improved batch-to-batch consistency. We are continuing with planned investments at our partner FERMIC's plant in Mexico City with the expectation of further improvements across all product lines.

Another important tool in the pursuit of continuous manufacturing improvement is our pilot plant, we have built a state-of-the-art pilot plant at our new facility in San Diego which we expect to be operational in the fourth quarter with multiple 40 liter fermenters and a 500 liter fermenters and appropriately match down recovery equipment. We are excited about the capability we will have to systematically evaluate production process improvement that can reap valuable reward when transferred to full scale at FERMIC as well as the ability to produce test article for regulatory approval, which we have had to accomplish was limited use of BPs pilot plan.

Increase closing which we remain cautious given the challenges being faced by the corn ethanol industry, we remain optimistic that the value proposition our enzyme products provide will continue to gain traction with customers looking for operational efficiency in these tight times. And we will remain intensive focused on continuously improving manufacturing operations.

And with that I’ll turn the call over to Jeff.

Jeff Black

Thank you, Janet. I’ll start today by summarizing the first half 2012 financial results we announced earlier today and then provide some brief commentary on our financial guidance for the remainder of 2012.

With respect to financial results, just a quick reminder on the impact of DSM transaction. The 2011 operating results from the oil seed processing business we sold to DSM and Veretase that we licensed to DSM and our grain processing this past March that is still included in our 2011 and in our first quarter 2012 reported continuing operations. In the first half of the year, our product and contract manufacturing revenue decreased over last year from $27.5 million to $26.5 million. As Janet mentioned we saw increased revenue in animal health nutrition from our Phyzyme product with overall product revenue decreased due to conditions in the corn ethanol industry which has impacted our grain processing revenues.

Our gross profit from combined product and contract manufacturing revenue in the first half of 2012 decreased from $10 million in the same period in 2011 to $9.2 million which is attributed to the overall decrease in our product revenues. Our gross margin percentage from combined product and contract manufacturing revenue decreased to 35% for the first half of 2012 compared to 36% in 2011. This gross margin decrease is primarily due to a shift in product mix.

And keep in mind that our gross margin percentage from our contract manufacturing will typically be lower than our own commercial products. Our collaborative licensed revenue increased in the first half of the year from about $1 million in 2011 to $6.5 million. The major drives here were the recognition of $2.9 million from our Phytase license to (inaudible), $1.5 million in license fees from a DFM transaction and a one-time upfront payment of $0.5 million associated with the development of a commercial product under our previously announced agreement with Tate & Lyle.

And as we stated before, the amount of our collaborative and licensed revenue will fluctuate in quarter-to-quarter this revenue stores is depended upon the timing of deliverables and milestones under our various development collaborations. We think it is especially important to note the potential for variability in this revenue line so that it can impact our reported operating loss or income on a quarter-to-quarter basis. As an example, we had pro forma operating income of about $800,00 during the first quarter of 2012 and this was largely driven by our Novus and DSM licensed revenue.

In terms of operating expenses excluding our cost of products and contract manufacturing revenue restructuring charges and our one-time gain from the sale to DSM, our operating expenses they increased in the first half of 2012 from $14.1 million to $17.4 million. Excluding the impact of about $1 million in legal fees reimbursement we received in the first quarter of 2011, and elevated expenses related to transaction fees during the first quarter of 2012 associated with financing alternatives we are pursuing. Our total operating expenses remain flat year-over-year.

But at the same time our R&D expenses increased by $2.9 million reflecting our continued focus on investing in a product by [client] while controlling SG&A cost. From a cash perspective, we ended the quarter with unrestricted cash of $14.4 million and $5.7 million in restricted cash. As of June 30, our restricted cash consisted of $2.5 million related to our BP escrow agreement and $3.2 million that secured a letter of credit for our landlord. Based upon the operating covenants in that lease, an additional $1.6 million in restricted cash under this letter of credit will become unrestricted during the third quarter of 2012. In April we repurchased the remaining $34.9 million n principle amount over 5.5% convertible notes, for total cash of 35.8 million including accrued and unpaid interest.

To reiterate my comments from earlier today we are pleased overall with our financial results. We have our convertible debt obligation behind us, we are aggressively pushing to increase customer adoption rate, grow our top line and improve product gross margins, but at the same time we continue to maintain our focus on prudent cost management and cash conservation.

With respect to financial guidance while we are cautious about the current state of the corn ethanol industry and its potential impact on our product revenues, based upon our first half 2012 results, we believe that we are in line to meet our previously published financial guidance for the full-year.

And with that I will turn the call over to Jamie.

James Levine

Thanks Jeff. As I said it earlier, I will spend the final few minutes of the call going through some slides which provide more detail on our development activities. As you can see on the agenda slide. Our product revenue model is actually pretty simple, we have three primary growth drivers. First there are the current commercial products we markets today; Janet and Jeff, described their performance in the second quarter and the near-term outlook we have for them. As for a brief comment, I’ll focus on the second and third component which are our product pipeline and our expansion pipeline.

Turning to Slide 4, one thing I’d like to emphasize our commercial product is that while our product revenue for the last 12 months was $55 million our product address almost $1 billion in potential market opportunity. These products still have room for growth. And they have validated our technology platform is a tool to create innovative products.

This takes me to Slide 5, which contains the [meat] of my comment, and the new information we are releasing today. Over the past 18 months we have made several announcements regarding the new product we expect to bring to market to drive our revenue growth and meet our target for operating profitability in 2014. On this Slide we lay out our product pipeline, which only includes candidates, where we have met both of the following criteria namely that we have a well defined target molecule and second that we are implementing the development process.

For animal health and nutrition, the product pipeline slide provides information on candidates we have previously announced as part of our collaboration with Novus including the details on the potential market size and our view of the type of market position we are targeting, given our current position in this competitive market, where we created two of the highest performing products currently sold, we have strong expectations for the next generation products we intent to launch.

For the grain processing market, today we are disclosing several new product candidates some of which we currently plan t launch in the next 6 to 12 months. While some of the markets we are targeting in grain processing maybe small in size, these product candidates require relatively little investment in regulatory activity or sales and marketing.

We see them as near-term opportunities to create profitable growth and keep our product portfolio fresh, helping our sales force to grow revenues in our larger established commercial products like Fuelzyme and Deltazyme.

As Janet said, the U.S. corn ethanol industry is looking for innovation right now and providing solutions to our customers that improve their profitability even at small scale can have benefit to our overall franchise.

Finally, for our oil field services enzymes, our Pyrolase product is a toe hold for us into this market, and our focus now is to take what we are learning about the industry’s unmet needs. And turn it into new products. For example, the hypothermal stable guar breaking product we will launch in the second half of 2012 is a direct result of our work with industry players and as we indicate here, we are working on additional product candidate with other performance improvement desired by the industry.

While we think today on this slide layout a clear path for growth that’s not the whole story our future. We expect that we will be adding new lines to this chart over the coming quarters and the source of this new product pipeline candidate is our expansion pipeline which I will describe next.

We define our expansion pipeline as the market including those shown on Slide 6, where we have product candidates under active discussion and planning with potential collaborative partners or where we are currently screening for opportunities in our enzyme collection. Specifically, today we are in active discussions with more than a dozen companies about product development collaborations, most of these companies have deep expense with industrial enzymes and use enzymes to make products commonly found in your home. The markets we are discussing with the companies include not only expansion in our current areas of animal health, grain processing and oil field services, but also enzymes for food processing applications such as baking, for producing sweeteners and syrups, for personal care products and for detergents and cleaners.

It's a long list and in many instances we are discussing any individual opportunity with multiple potential collaborative partners, while I can’t say much about the discussion s until they are finalized and announced while I can’t say is that we are speaking to many of the global leaders in their field.

What gives us traction with large global players is the breadth of capabilities, we can bring to a collaboration and which we outlined on Slide 7. In one of our most important assets is that we can offer access to the more than 4,000 unique enzymes in our collection which we believe is the largest in the world and which we created over the years through various resource intensive efforts which accumulated and catalogue a portion of our biodiversity. For example, when a company has a targeted need for a unique amylase or unique lipase enzyme, we can offer them access to 10, 50 or 200 unique starting point, each with a different origin and therefore a potentially different set of functional characteristics. Mining that rich collection as enormous potential.

Slide 8, shows the reason for our excitement, mainly the potential for diversified revenue growth. As I said earlier our commercial product addressed around the billion in market opportunity. When you add in the expected launch of new products from our product pipeline we will increase the market opportunity we addressed to $1.4 billion and have a broader higher performing set of products to increase our market share. You can understand how even with a modest market share increase we see the potential for significant revenue growth from this well defined set of products and candidates.

And finally, turning to the expansion pipeline, through the new candidates under discussion today, we can gain access to the majority of the $4 billion industrial enzymes market. And by focusing on bringing products to market from our enzyme collection, we believe we can develop new products through to launch in the medium timeframe.

In conclusion, you can measure our progress against our objectives and milestones in several tangible ways identified on Slide 9. For our commercial products in the short-term, we are focused on growing revenue and reducing our cost of goods, which will become apparent through our quarterly performance. In the medium term, for our product pipeline, our milestones will be the launch of these product candidates on schedule and to add new product candidates to this list to our own efforts or together with partners. And for our expansion pipeline you can expect us to announce new collaborations to support product development in our current product line and to support our entry into new product lines.

As I said at the outset we have a simple business model, our technology is developed and it is proven its effectiveness through the creation of over 10 commercial products, some of which we licensed or sold out to major players like DuPont and DSM. We have shown in highly competitive markets, we can create products with differentiated performance. And that simply put is what’s going to create substantial value for our shareholders.

I look forward to updating you on our continued progress on all of this front. And we will now open up the call to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Laurence Alexander of Jefferies, your line is now open.

Laurence Alexander - Jefferies & Company

Can you give update on your very rough framework for, if you want to move a product from the expansion pipeline into commercialization pipeline, what does that imply in terms of cash flow outlay or R&D cost for you for the first year or two to get commercializations. And then how you think about what volume threshold we need to get even on a new product and then what kind of incremental margins you expect subsequent lines. So, if you can just help trying to (inaudible) for the P&L over like two or three year period.

James Levine

Sure, a couple of pieces that we can talk about; first as we have said in the past when we look at product development, we are typically thinking about an overall investment of about 4 to $6 million across both the discovery and potential evolution process as well as the regulatory process for bringing a product to market. With certain markets where you may have an implication for going into the food supply that tends to put you towards the higher end of that range, if you are going more into an environmental process because it doesn’t touch the animal feed industry than at times that can be a simpler and potentially less expensive process. So, there is a fair amount of variation in terms of what we see.

In addition on that front end of development where you are looking at research and development, it kind of depends on the starting point. If we are entering into a new full blown discovery and evolution process it might take the full amount of dollars I talked about. If we find a good candidate this in our collection, that can reduce not only the time to market but also obviously the expense for developing that product. So, that at least scopes out what we are talking about in terms of dollars for product development. I think that when we look at what it takes to get to breakeven, there are some products where we will start off by saying how do we become a major player in this market, because that’s what it takes to really drive the kind of scale that makes sense.

In other circumstances, like in particular some of the process enhancing products or product candidates that we have in our pipeline, because we already have the sales force infrastructure because we are basically talking about bolting on this products onto an existing franchise, the hurdle is lower, because the breakeven point can be that much lower, there is very limited incremental regulatory in some cases in sales and marketing expense.

So, it really comes down to our goal of creating a portfolio, where we may create some large new products for large markets but we will also want to be creating the smaller bolt-on products that might have a lower risk of execution but they can really build us the scale that we are looking for to get to the operating profitability in 2014.

I don’t think that I can really spell out for you more than that except to say that we have obviously tried to provide a lot of information on slide 5 that helps to build out where we see these products going. Certainly, as we look at the point of what we call the bottom of penetration and maturity, we are thinking that products get to maturity depending on the market in the 3 to 5 year timeframe. Some maybe sooner, some maybe longer, a lot of it depends on the market and also frankly whether we are partnered whether we are doing at ourselves and what of investment we are putting into that launch.

So, I think that there are a number of factors, but hopefully with the information on slide 5 and some of what I just talked about, that gives you a sense for how we expect the portfolio scale. And maybe I’ll just make one other comment, we have said in the past as well, that we think we can put a lot more through our existing SG&A infrastructure. And so while there will be some increases in SG&A as we scale up revenue we certainly have room to scale up revenue with very limited amounts of incremental SG&A and so we are talking about really significant revenue ramps. And I think from an R&D perspective, we think that overall you have seen the reinvestment, you can see those dollars going up, but we also feel that we can get a lot out of our enzyme collection and that’s really going to be with lower research and development dollars behind it.

So, I think that kind of covers all of the pieces down through profitability and for us now it's very much about execution.

Laurence Alexander - Jefferies & Company

And then maybe if you could also just address, has the tone changed over the last couple of years as you negotiate with potential partners about the tradeoff between having them subsidized the initial R&D and the economic that you get later on the partnership. I imagine that it will be previously, there might have been a bit more, so you give up a little bit more on the back end to get cash upfront or maybe if you got (inaudible).

James Levine

Yes, I think there is a couple of tone dynamics going on. I’d say one of them very squarely is that the companies that we are talking to understand that they need to have an industrial enzyme strategy, meaning that it's now with all of the activity that’s been going on, I think a lot of it generated if not before than with the announcement of DuPont’s decision to acquire Danisco and Genencor in the process. I think that put industrial enzymes squarely on the map. So, I think as we go out talking to folks, what we certainly find is that people understand, that what enzymes have done in industries like detergents and animal feeds and understand if there are lot of other applications for industrial enzymes. And so, certainly from that perspective we are seeing a lot more pull.

I think in terms of the nature of the collaborations, we are seeing alignment, where it's in our interest and it's our potential collaborative interest to start with the collection. And so under very clear and strict material transfer agreement, we do send out samples of enzymes and as I was saying before we can send out 10 lipases we can send out 10 amylases and we are doing that. So, people with the expertise in the application can spend the money to try to understand is there an interesting candidate already or with a slight amount of evolution can we get to a very interesting candidate for a certain application or process.

And then finally, to come to your point on terms, I think part of it may come down to our philosophy as well. I think the market has moved on now to the point where we are okay with co-investing in the development of an enzyme and to put skin in the game because we expect to be able to achieve a very substantial portion of the end profitability of the enzyme. So, I think that our view is the objective is not so much to look to outsource all of the R&D dollars, but we can co-invest but it's going to be because we are going to look to negotiate it good portion of the backend economic that the product achieves. So, we are not really pushing for a fully funded model as a matter of the business model, but again we are very much looking to avoid becoming just a technology provider, we have the full suite of applications. We can go all the way from R&D to commercial scale manufacturing. So, our goal is to enter farther down to value chain even to the point of having customer intimacy and to do that we are willing to pay some of the upfront development cost.

Operator

(Operator Instructions) And our next question comes from John Roberts of Buckingham Research, your line is now open.

John Roberts - Buckingham Research

You mention the caution that animal populations might decline little bigger in the short-term with high corn prices, how do farmers or animal growers change their feed formulas with high corn prices. Do they use more feed enzymes to be more efficient or because their budgets are constraint they use less on the remaining animals. And then secondarily, if they switch do they use same more weed in their feed. I know it's not popular, but when prices get out of whack here farmers sometimes change a little bit their ratios. Does that affect as well the formula they are going to feed the animals?

Janet Roemer

I’d say that from what I have read and understand about this industry that any change in feed composition requires a rebalancing of all of the nutrients that are used including the enzymes, but there has been some research and some movement towards using increased doses of enzymes in order to get a more effective amino acid release. Phytase enzymes specifically, like our Phyzyme Phytase, were designed to release phosphorous from the feed; but it's also found that it can improve the nutritional benefit in other ways and so there is actually an incentive for increasing the dose of Phyzyme Phytase in order to get greater efficiency. And that’s something that we are watching.

Another part of the equation is that, cattle farmers for example, can reduce their feed cost by incorporating more distilled or dried grains or solubles, which actually come from the corn ethanol process into the diets and that’s something that is being looked at as well. So, I think in summary yes any change in diet has to have a very thoughtful approach to all of the micro nutrients like enzymes that are part of the equation, but in general enzymes can tend to benefit in this scenario.

John Roberts - Buckingham Research

But you still say the net effect would be negative because of the reduced animal populations just maybe not as negative because of this secondary trend?

Janet Roemer

Yes, I think that’s best, I think animal producers see their margins squeeze they may make the decision to reduce their production. And that’s something we have seen in the past and looking forward is something that may happen as well.

Operator

Thank you. And at this time I’m not showing any further questions and I’d like to turn the call back to Mr. Jeff Black for any closing remarks.

Jeff Black

So, thank you for joining us today and we look forward to updating you on our continued progress.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program you may all disconnect. Everyone have a great day.

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