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Verenium Corporation (NASDAQ:VRNM)

Q3 2012 Earnings Conference Call

November 07, 2012 5:00 PM ET

Executives

James Levine - President and CEO

Jeff Black - SVP and CFO

Janet Roemer - EVP and COO

Analysts

Unknown Analyst - Jefferies & Co

Operator

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

I’d now like to introduce your host for today’s conference, CFO Jeff Black. Mr. Black, you may begin your conference.

Jeff Black

Good afternoon an d thank you for joining Verenium’s third 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.

The agenda for today’s call is as follows. First, Janet will discuss commercial operations, including third quarter performance. Next I will review our financial results for the period and provide updated 2012 financial guidance. And Jamie will conclude with some commentary on the third quarter, the next strategy and outlook going forward.

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 our market size and our ability to access those markets, partnering and collaboration activities, including our ability to enter into 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 dates hereof.

I will now turn the call over to Janet.

Janet Roemer

Thank you, Jeff. Good afternoon everyone and thanks for joining us. I’ll now provide you some detail on our products and operational performance and our outlook. Our service revenue from our largest product line, animal health and nutrition and our lead product, Phyzyme Phytase. The decrease in our topline in the third quarter there is an explanation that is unrelated to market conditions.

Because we needed to take one of our three preventers out of service for planned upgrades in the third quarter, we chose to shift Phyzyme manufacturing to our partner, DuPont and consequently did not recognize the related manufacturing revenue ourselves, which carries no margin because we transferred the product at cost.

Gross revenue for the third quarter is down considerably versus the second quarter, though this did not impact product gross profit. Though we do not break out the components of revenue in the animal health and nutrition product line, after accounting for these factors, the underlying business is about on par with 2011 year-to-date despite generally soft market conditions.

Turning to our second largest product line, grain processing, revenues fell in the third quarter and is down year-to-date, reflecting continued adverse industry conditions, largely due to reduced demand for gasoline and therefore ethanol. Decreased ethanol prices combined with continued high corn prices have resulted in poor and even negative margins for ethanol producers, forcing plants to reduce operating rates or halt operations entirely until margins recover. We saw these effects in both the US where we sell directly and in Europe where we sell through a distributor.

On the positive side, trial activity for our lead product, Fuelzyme alpha-amylase, picked up in the third quarter and we are winning some new customers as a result of demonstrating the economic benefits of our product and recently we have seen some improvement in European demand. In concluding my commentary on grain processing, the outlook for the industry continues to be weak. For Verenium, our job is clear and that is to increase our share of the market by winning new customers and we are confident that our value proposition of reducing enzyme cost per gallon of ethanol resonates well with customers looking at all sorts of savings.

Turning now to oil field services, in the third quarter we continued to sell small volumes of Pyrolase cellulase enzyme used in hydraulic fracturing or fracking operations as an alternative to chemicals. While Pyrolase is a superior fluid breaker solution for use in situations with downhole temperatures up to 180 degrees Fahrenheit, we also announced last quarter that we developed a hypothermal stable guar breaker for use in more extreme temperature and PH condition and received EPA authorization to mark this product.

We recently named this product Pyrolase HT for high temperature and it’s one of the present products disclosed with last quarter’s conference call. Last month we presented a paper co-authored with Schlumberger summarizing their laboratory evaluation of this new product relative to chemical breakers at the Society Petroleum Engineers Conference. We are happy to report that we presented to a packed room and the paper generated significant interest from three important tiers in the oil and gas industry, oil field service companies, oil and gas producers and chemical suppliers. The paper is now available for purchase on the SPE website and the next important milestones will be producing this product at commercial scale and conducting field trials to confirm the performance parameters predicted by the lab data.

In addition to progressing Pyrolase HT through our pipeline, we made significant advances in the animal feed enzymes we are developing in partnership with Novus International, a leading animal health and nutrition company. In addition, we completed a commercial scale field trial of another pipeline product and remain on track with our project plan.

Though we have no specific milestones we can disclose publicly today, over the quarter, there was significant progress by our research and business development bio processed development, quality and regulatory team concentrated on moving our pipeline products closer to commercialization along with timelines disclosed last quarter.

Turning now to manufacturing, as I mentioned in my opening remarks, we had one fermentor representing one third of our capacity out of service in the third quarter to implement upgrades that are a major component of our longer term plan to improve operations. The fermentor is back in service and as we dial in various operating parameters we are encouraged by initial results.

We expect to bring two additional vessels down for similar upgrades over the next six months. Once fully implemented and back on line, these upgrades are intended to improve overall manufacturing quality, improve yields and as a result, reduce overall cost of goods sold. In addition, we recently completed the construction phase of our private plant in San Diego and are in startup mode. This state of the art facility is a key asset for driving continues improvements in manufacturing of commercial products, for developing processes for new products and for producing test article for the regulatory phase of pipeline product development.

And with that, I’ll turn the call over to Jeff to review our financial performance.

Jeff Black

Thank you, Janet. Over the next few minutes I will provide a brief overview of the financial results that we announced earlier today and provide some commentary on our updated financial guidance for 2012.

For the nine months ended September 30, 2012, our product and contract manufacturing revenue decreased over last year from about $42 million to $36 million. This decrease is primarily due to a few main factors. First, as Janet mentioned, in animal health nutrition, our gross revenue from Phyzyme which we manufacture and transfer at no margin, is down due to a shift in production to DuPont. We also saw a decrease in toll manufacturing revenue that we generated in 2011.

Second thing is, Janet also mentioned conditions in the corn ethanol industry that impacted our grain processing product revenue. And third, the sale and license of our purified and Veretase products to DSM earlier this year has resulted in a reduction of our year-over-year revenues. Our gross profit from combined product and contract manufacturing revenue for the nine months ended September 30, decreased from $60 million in 2011 to just about $4 million and our gross margin percentage from combined product and contract manufacturing revenues decreased to 33% from 38%.

Our gross profit dollars and associated gross margin percentage have decreased primarily due to a couple of factors. First, out of capacity due to downtime from our plant manufacturing upgrades. The negative margin impact related to idle capacity from downtime was roughly $800,000. The second, a shift in sales mix from higher margin grain processing revenue to a lower margin supply agreement with DSM.

Our collaborative license revenue increased in the nine months ended September 30, 2012 from just below $5 million in 2011 to just above $7 million and the major drivers here were license fees from Novus and DSM. We think it’s especially important to note that the potential for variability in our collaborative and license revenue can impact our reported operating loss or income on a quarter to quarter basis. Our operating expenses, excluding our cost of product and contract manufacturing revenue, restructuring charges and the onetime gain from the sale of DSM increased for the nine months ended September 30 to about $26 million in 2012 from just under $20 million in 2011. While our ongoing general administrative expenses remain flat year-over-year, research and development expenses have increased by about $3.5 million which reflects our continued investment in product technical support and pipeline products.

We ended the quarter with unrestricted cash of roughly $13 million and $4 million in restricted cash.

Subsequent to our third quarter, we entered into a $10 million revolving credit facility with Comerica bank, and this credit facility will allow us to borrow up to $8.4 million against certain eligible receivables and will also cover an existing cash through our letter of credit commitment to our landlord, which immediately frees up $1.6 million in restricted cash. To date, we have not drawn down on this facility.

Before I turn the call over to Jamie, let me provide some commentary on the updated financial guidance for 2012 that we released earlier today. For the full year 2012 we now expect total revenue between $53 million and $55 million. We expect to generate gross profit between $14 million and $16 million and excluding the gain on DSM transaction we expect an operating loss between $11 million and $13 million.

Our revised guidance reflects a couple of notable shifts from our initial expectations. From a revenue perspective, as we’ve mentioned challenges in corn ethanol industry had impacted overall industry production volume. As a result we’ve seen increased dependent pressure as well as delays or extensions of trials which consequently have affected the timing of new customer adoption. In addition, while we are encouraged by the continued interest we are seeing from potential customers for Pyrolase products, in oil field services, customer adoption has been slower than anticipated.

From a gross profit perspective, our revised guidance reflects a reduction in expected revenue as well as the negative margin impact of downtime related to our manufacturing upgrades that we previously mentioned.

With respect to operating loss, while our revised operating loss guidance is higher than our initial estimated range, we’ve been able to mitigate the overall impact of reduced revenue in gross profit guidance to prudent operating expense management.

Finally, we expect capital expenditures between $8 million and $9 million in line with guidance we previously issued and this includes both investments in manufacturing in Fermic, as well as capital that was required to complete the build out of our new San Diego facility.

Despite shortfalls in revenue and gross profit against our initial expectations we expect our yearend cash position to be in line with our initial expectations.

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

James Levine

Thanks, Jeff. I’d like to end today’s call with a few comments. First, from a high level perspective I’d summarize our third quarter with the following points. We took significant steps forward operationally this quarter installing some of the important upgrade equipment at our manufacturing plant in Mexico, and are now in the installation and optimization phase of our manufacturing improvement program.

Next, it was a challenging quarter for our product revenue and gross profit. If you look at our first half performance and our previous guidance, you can see we had forecast higher costs in the second half of the year but given the impact on revenue from having our partner DuPont manufacture more of our lead product, and a combined impact of absorbing the manufacturing downtime while we install the upgrades, and the headwinds we continue to see in the corn ethanol industry, we feel the need to lower our full year guidance.

But finally we’ve always said that we can manage the business to reflect the environment and we’ve done just that. We managed cash cost and expense so that even with the lower performance year to date, our overall cash position is in line with the cash position implied by our guidance issued on our Q1 call.

My second comment relates the recent announcement from BP regarding to their decision not to move forward with the planned commercial scale Cellulosic Ethanol plant in Florida. When we announced the transaction with BP in July of 2010, our core principle of that sale was that neither party was dependent in any way on the other. Today, we are operationally independent from BP, and BP’s decision regarding its approach to its Cellulosic Ethanol development efforts have no impact on our business or our future growth plans.

My third comment relates to the future partnerships we’ve spoken about in the past and I can only say our efforts are on track. In most of the end markets we’ve identified for expansion, we are progressing multiple discussions with the largest players in their respective industries and in many instances our prospective partners are already testing samples of enzymes from our enzyme collection to accelerate our partnership discussions and our product development timeline. We will update you as appropriate on the results of these efforts in the future.

My fourth comment relates to the impact of all of these events on our strategy. Currently we have a narrow product portfolio but its position in the market shows that our strategy of targeting markets with the benefits of high performance enzymes are both measured and rewarded by customers is sound. Our products compete well in the market place and our strategic focus remains on launching new products like those on our product type line, and improving our manufacturing capabilities to reduce costs. And that requires investments like the type we made in the third quarter. Simply put the volatility in our current product revenue reflects the narrow portfolio we have today and that’s why we are still focused on diversifying going forward.

Finally, I am frequently asked about our market value and my main comment would be the focus on facts. In Q1 of this year, we sold two commercial products with $7.5 million in LTM revenues as well as certain products under development to DSM for $37 million. Today we have eight commercial products and total LTM revenues of $58 million. We have late-stage pipeline products that we identified in our Q2 earnings call with launches beginning in 2013. We have our commercial scale manufacturing platform, we have our vast R&D capabilities including our state of the art pilot plant in San Diego, and we have a highly protected IP position through our 657 owned and in-licensed patents and patent applications. Our current partners like Novus, DuPont, Cargill and Tate & Lyle, see the value in our products and our technology and we believe our strategy of creating the highest performing products is not impacted by the challenges we discussed this quarter.

In addition, I’d like to point out that we recently held our capital markets day in New York and the slides and audio presentation is available in the investor section of our website. While we look forward to making further announcements of our progress with partners and executing against the 2013 milestones we laid out in our capital markets day presentation, I hope the detailed review in our capital markets day presentation of the products that we are selling today, the product pipeline that we have today, the major partners that we have today and the support of capital structure we have today demonstrates the substantial value that exists today within the company.

With that, we’d be happy to take your questions.

Question-And-Answer Session

Operator

Thank you. Ladies and gentlemen, (operator instructions). Our first question comes from Laurence Alexander. Sir, you may begin.

Unknown Analyst - Jefferies & Co

I’m in for Laurence, thanks for taking my question. At the investor day you guys outlined a handful of products mainly in grain processing that will be commercial in 2013 and I know you just touched on it briefly. But are those products still on track for 2013 release or are these prolonged customer trials more of a broad based issue? And more so, what are customer interest in like and which products would you have to sort of think that you might launch first?

Janet Roemer

So to answer your question I think the – this is Janet Roemer, I would say that we are on track with the products that are in the pipeline for the grain processing in overall that customer recent activity for doing the commercial field trial as we have a choice of more than one customer interested in doing that. So I think there is great interest in proving the economics of the ethanol process using new novel enzyme approaches. And I say that the current industry conditions -- I don’t think that the new offerings would face the same challenges that we faced with our core products in approaching the industry because I think there is a great deal of interest in some of the more progressive companies in looking at new technologies.

Unknown Analyst - Jefferies & Co

Okay. Great. Thanks.

Operator

Okay. Ladies and gentlemen (operator instructions). Okay, I am showing no further questions so I’ll turn the conference back over to you Mr. Black.

Jeff Black

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

Operator

Thank you ladies and gentlemen, this does conclude your conference and you may disconnect.

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