Codexis, Inc. Q1 FY2020 Earnings Call

Thank you for joining us for the first quarter 2020 Codexis earnings conference call. I will now turn the call over to Mr. Bruce Voss. Please proceed.

Thank you. This is Bruce Voss with LHA. Thank you all for participating in today's Codexis call to discuss first-quarter 2020 financial results and recent business progress. Joining me from Codexis are John Nicols, President and Chief Executive Officer and Ross Taylor, the company's Chief Financial Officer. During this call, management will be making a number of forward-looking statements within the meaning of the private Securities Litigation Reform Act of 1995. To the extent that statements made by management are not descriptions of historical facts regarding Codexis, they are forward-looking statements reflecting the beliefs and expectations of management as of May 7th, 2020. You should not place undue reliance on these forward-looking statements because they involve known and unknown risks, uncertainties, and other factors that are, in some cases, beyond the company's control and could materially affect actual results. In particular, there is significant uncertainty about the duration and impact of the COVID-19 pandemic. This means that results could change at any time and the currently contemplated impact of the virus on the company's operations, financial results, and outlook is the best estimate based on available information. For details about these risks, please see the quarterly news release that accompanies this call, as well as, the company's SEC filings. Codexis expressly disclaims any intent or obligation to update forward-looking statements, except as required by law. Today's conference call remarks will include both GAAP and non-GAAP financial results. Codexis believes the non-GAAP financial measures provide investors with useful supplemental information about the financial performance of its business, enable the comparison of financial results between periods where certain items may vary independently of business performance and allow for greater transparency with respect to key metrics used by management in operating the business. These non-GAAP financial measures are presented solely for informational and comparative purposes and should not be regarded as a replacement for corresponding GAAP measures. Reconciliations between GAAP and non-GAAP financial measures can be found at the end of the financial results news release that was issued earlier today. Now, I'd like to turn the call over to John Nicols. John?

Thanks, Bruce. Good afternoon, everyone, and thank you for joining us. Much has transpired in the world since our last investor call barely over two months ago, and we sincerely hope that you and your families have stayed safe and well in the face of the COVID-19 pandemic. As you will hear today, Codexis is indeed safe and well. And while moderately affected in the short term, we are delivering remarkably well as we operate through the effects of the pandemic. To start, note that we entered the pandemic stronger than ever. We had a multi-year growth trajectory firmly in place and substantial resources on our debt-free balance sheet. But our pre-coronavirus strengths were even more about the organization. We have a growing super talented team driving more protein discovery capacity than ever before and exploiting an ever-improving CodeEvolver platform technology. Ensuring that team and their family safety has been primary for us. Even before the San Francisco Bay Area shelter-in-place orders were initiated, the leadership team and I were practicing measures of social distancing, and we have formalized and launched our COVID-19 task force which, under the seasoned, disciplined leadership of Dr. Bob Sato, our long-standing Head of Quality, Regulatory and Analytical, has been crucial to lead us through these unprecedented times. With shelter-in-place orders issued on March 17, we swiftly and smoothly affected a company-wide work-from-home policy, effectively shutting down our research and development operations. The benefits of being proactive are clear at this point. No confirmed cases of COVID-19 infection among any of our employees, an even more cohesive group who appreciate management's genuine concern for their well-being and the ensuing strengthening of our culture motivated by doing what's best for society and our community. From there, the collective attitudes and force of our organization through the pandemic have been remarkable. Researchers gathering virtually in teams to define new protein targets for us to pursue. Supply chain teams putting in extra work to ensure our products continue to flow for the essential needs of pharmaceutical manufacturing. Codexis teams collaborating with similarly affected customer teams, driven to make progress despite the inefficiencies, new company electronic bulletin board, sharing pictures of quarantine encouragement, et cetera. And delivering against the core strategic goals for the corporation. Here, the list makes us equally proud. We have delivered better-than-expected revenues in the first quarter despite R&D operations being shortened by shelter-in-place. We inked and initiated joint activities for a landmark biotherapeutic partnering deal with Takeda in the middle of the pandemic. We collaborated with Novartis despite their lab operation limitations to get their new CodeEvolver lab established and ready to practice. The enzyme manufacturing and supply chain team has successfully forged remote operational approaches, supported by the outstanding continuous operations of our equally competent external manufacturing partners, that have effectively ensured that our core product revenue stream remains largely unaffected by the pandemic. And recently, we have started up R&D operations again at limited capacity and in a socially distanced way, so that we are back conducting essential R&D activities in support of our customers and businesses. In the process of this limited and phased R&D restart, we are learning how to modify our rapid protein discovery workflow to ensure safe social distancing in tandem. And that learning will enable us to ramp more effectively and safely when local governments relax the strict shelter-in-place ordinances currently in place. R&D revenues have been most affected since the mid-March shelter-in-place restrictions, but only a portion, effectively, those R&D revenues that are customer-partnered, time-based projects. As these represent a meaningful portion of our total company revenues, and given that the magnitude of our R&D restrictions over time are impossible to accurately predict at this point, we are taking the prudent course of withdrawing our 2020 financial guidance. In contrast, other components of our R&D revenues are expected to be less impacted by operational limitations. In addition, we have been able to mitigate much of the cash flow impact from reduced R&D revenues through intelligently delaying or reducing third-party purchases and capital spending. We had plans to add to our protein engineering and commercialization capacities in 2020, but the vast majority of those headcount additions have been postponed to help preserve cash through the pandemic. However, several strategic hiring efforts continued as they are crucial to strengthen us over the long term. It is in this slide that we are pleased to have recently announced the arrivals of doctors Stephane Lutz and Karl Schoene to our executive team. Stephan brings unprecedented knowledge in protein engineering and synthetic biology to lead our research team and is highly regarded and well-known within our industry. Karl complements Stephan and the rest of the Codexis team given his broad-based technology development, scale-up, and commercial stage experiences. It is great to have Stephan and Karl join us as we build through and beyond the pandemic. Similarly, we are excited to have attracted two highly talented and networked prospective board members for proxy vote at our upcoming annual meeting. Dr. Alison Moore is a pharmaceutical development veteran with a career spanning Genentech, Amgen and now as chief technology officer of Allogene Therapeutics, a pioneering clinical-stage company in CAR-T therapeutics. Complementing Allison and the rest of our board, Dr. Stephen Dilly brings substantial clinical stage drug development leadership experience to Codexis, most notably, having recently served as CEO of Aimmune Therapeutics, which has recently received its first FDA drug approval. Before handing over to Ross to detail our financials, let me summarize our confidence in the ongoing strength of Codexis. At the core of our great biotechnology company is our talented 160-plus person organization and our success in retaining, caring for, and igniting them. They are responding brilliantly and are delivering in exceptional ways as we adjust to the pandemic. We are smartly and selectively attracting new, unique talent to make us even stronger, and we continue to strengthen and grow the list of great companies we proudly serve as collaborative partners. We are equipped to weather these uncertain times and are confident to be an even stronger, better poised Codexis on the other side. With that, let me turn the call over to Ross for a review of our financial performance. Ross?

Thank you, John. Starting with the Q1 top line. Total revenues for the first quarter of 2020 were $14.7 million, and this compares with $15.6 million for Q1 of 2019. The 2019 quarter included a $3 million milestone payment from Nestle Health Science, making for a challenging comparison. Revenue for the 2020 quarter included $10.9 million from the performance enzymes segment and $3.8 million from the novel biotherapeutics segment. Product revenue for the first quarter of 2020 was $5.1 million, on track with our expectations, compared with $8 million for the prior-year period, with the decrease due to the timing of demand for various enzymes. Within product sales, Merck once again had the strongest showing during Q1 and Allergan also made a meaningful contribution. R&D revenue for the 2020 first quarter increased 26% to $9.6 million, primarily due to revenue from the Novartis CodeEvolver agreement that we announced a year ago as well as the Takeda collaboration that we announced in March. R&D revenue for the first quarter of 2020 included $5.8 million from the Performance Enzymes segment and $3.8 million from the Novel Biotherapeutics segment. Gross margin on product revenue for the first quarter of 2020 was 50% compared with 45% a year ago with the increase due to product mix. Turning to operating expenses. R&D expenses for the first quarter of 2020 were $11.0 million. This included $5.7 million from the Performance Enzymes segment and $4.9 million from the Novel Biotherapeutics segment, plus $0.3 million allocated to corporate expense. The increase in R&D expenses from $8.0 million a year ago was primarily due to higher outside services fees, higher salaries, and personnel costs associated with higher headcount and higher allocation of occupancy-related costs. SG&A expenses in Q1 of 2020 were $9.0 million, which included $2.3 million from the Performance Enzymes segment and $0.6 million from the Novel Biotherapeutics segment. The remaining $6.1 million is included in corporate overhead and depreciation. The increase in SG&A expenses from $8.4 million a year ago was primarily due to higher accounting and outside services fees and higher facilities and headcount expenses, partially offset by lower allocable expenses. The net loss for the first quarter of 2020 was $7.7 million or $0.13 per share, and this compares with a net loss for the first quarter of 2019 of $5.1 million or $0.09 per share. Cash and equivalents as of March 31, 2020, were $87.3 million. Importantly, we believe this large cash balance provides ample liquidity to manage through the current COVID-19 situation. In addition, we are continually monitoring the pandemic and its impact on our business, such that we will be able to strategically manage operating expenses and capital expenditures in response to any changes in revenues. As John mentioned, we have already chosen to delay the majority of previously planned new hires in 2020. We are delaying some of our capital expenditures, and we have reduced some discretionary operating expenses as well.

Thanks, Ross. Before moving on to questions, let me take a minute to share our enthusiasm for our new biotherapeutic deal with Takeda. In its essence, we have struck a multi-program partnership that leverages our CodeEvolver platform to enable improved gene therapy candidates with one of the world's top 10 drug companies. The deal validates preclinical work we had advanced on our own against two lysosomal storage disorders, Fabry disease and Pompe disease, plus brings Codexis into a new therapeutic area targeting a rare blood factor deficiency. Takeda also has a time-limited option to call in a fourth program at their sole discretion and for a fee selected from a shortlist of reserved indications. The unique value that CodeEvolver can deliver for gene therapies is simple. Improve the protein encoded by the gene delivered to the patient via the gene therapy vector. In other words, improve the transgene component of the gene therapy system so that the target cell expresses a better protein. Make that protein more stable, more expressive, more organ directed or any combination of those, etc. These types of benefits we have shown preclinically for Fabry disease in our recent corporate presentation, the types of protein engineering improvements that only CodeEvolver can deliver. We have been promoting the benefits of CodeEvolver to uniquely improve gene therapies for the last year or more. So convincing Takeda of that is a truly gratifying accomplishment for our novel biotherapeutics team. We are excited to work to attract other partnerships with other gene therapy companies outside of the limited Takeda partnership list in the future as well. We received an upfront payment of $8.5 million from Takeda shortly after signing. The majority of this payment, net of certain fees, will be recognized in 2020, with nearly all of the remaining balance to be recognized in 2021 and 2022. In addition, during the R&D phase, we are eligible to receive combined payments of up to $22.3 million as reimbursement for our services and achievement of certain preclinical milestones. With programs advancing from there, we are eligible for additional development and commercialization milestone payments of up to $100 million for each target gene. On top of those, we could receive tiered low- to mid-single-digit royalties on those products' net sales in the market. Let us now move quickly to field and address the specific questions you may have on your mind. The fundamentals of our business are strong. We're well-positioned to manage through the COVID-19 pandemic, given the strength of our team, our multifaceted business model, our partnerships with world-class companies across a growing list of industries, the value-creating opportunities afforded by our CodeEvolver protein engineering platform and our strong balance sheet. Though some elements may take a little more time to execute given the pandemic. We remain confident in our ability to deliver substantially against all of the strategic objectives we outlined in our February call. Those include the advancement of our novel biotherapeutics pipeline, especially our partnerships with Nestle Health Science and Takeda, plus expanding the penetration and deal-making across our growing performance enzyme verticals in pharmaceutical manufacturing, molecular diagnostics, and life science applications, and finally, in food and more traditional industrial enzyme sectors. I want to thank you all for joining us today and hope you and your families remain safe and well through these challenging times. With that overview, I'd like to open up the call for questions. Operator?

Your first question...

While we're waiting for the first question, I'd like to alert you to our participation in several upcoming virtual investment conferences. We will be presenting at the UBS Global Healthcare Conference on May 18th and the Jefferies Healthcare Conference being held June 2nd through the 4th. We'll be announcing the details of each conference as we get closer and the webcast of our presentation at the UBS conference will be posted to the Investors section of codexis.com. Okay, operator, we're ready for the first question.

Your first question comes from the line of Brandon Couillard from Jefferies.

John, maybe just start with sort of the R&D project deferrals from COVID-19. I imagine those are likely to get recouped in future periods, right? But is there a fixed amount of R&D capacity that you have? Do you think that will all be a gating factor to catching up on any work that might be delayed near term later in the year?

The effects of the R&D shutdown and the limited start-up during the strict local shelter-in-place are really delaying our ability to execute deals that we’ve secured and those we plan to make in order to deliver the growth we previously projected for the company this year. So, there’s a delay, and this will naturally be influenced by how quickly the shelter-in-place restrictions can be relaxed or lifted, which will determine how fast we can transition from our current limited R&D capacity back to full capacity. We are confident that we can return to full capacity, even while implementing enhanced social distancing measures and operational changes to our protein engineering process. I hope this addresses your questions.

Yes, I think you've got something like 41 or so different R&D programs. Any chance you could quantify those might be deferred right now? Is it a relatively small number that we're relatively kind of talking about?

Yes, a lot of those programs, we don't need to do any more R&D. We did the R&D in the past. We're waiting for the proteins that we've already engineered to ultimately get taken up in commercial operations. So a good chunk of those 41 projects like that are really not governed by R&D capacity. So the more directly relevant number is how many protein engineering teams pre-COVID we had operating. So we've been off-quoted as saying we have about 15, maybe up to 16 or more teams that are working on new protein discovery in parallel. So from March 17, those 15 teams went home. And they weren't able to operate the workflow, of course, from home. But now a portion of them, a minority of them have returned to the lab to work on essential projects. We're instilling this new workflow arrangement, which is going to spread us out over wider distances and may have us work over shifts and weekends. And ultimately, that's going to enable us to get those 15 teams running again. So right now, we're roughly two months into not being able to discover those 15 proteins. Those have been put on pause. Some of those are coming back. So really, the pace with which we can get back to that protein discovery capacity is really the governing factor. It's really hard to predict, as you well know. But we're confident that we're going to be able to get the capacity up and running again. The team is incredibly supportive. The kinds of processes that we're putting in place are ensuring social distancing and proper safety measures to give the confidence to our team. So it's a multi-month period where those 15 programs have had the slide sideways. Some of those are generating revenue. Some of those are advancing our own products and not revenue generating. So, it's quite qualified the revenue impact of the R&D shutdown that we've had to go through because of shelter in place.

I didn't hear you mention either Tasteva or the molecular diagnostics, NGS programs. Any material updates this year, perhaps relative to last time we saw on the fourth quarter call?

Tasteva is currently managed by our partner, Tate and Lyle, who is promoting it to their customers. We are optimistic that they will effectively encourage downstream food ingredient companies to use this better tasting, more naturally derived stevia. Communication with Tate & Lyle and our customers continues despite the shelter-in-place measures. We are conducting video meetings with clients, and they have assured us that they are engaging their customers. While COVID-19 may cause some delays in their downstream efforts, they remain positive about the ongoing adoption of Tasteva M and their increasing requirements for our enzymes used in its production. Overall, this aspect is progressing well and only slightly impacted by COVID-19, without any long-term effects. In terms of molecular diagnostics, we have been working on transferring our ligase technology to Roche and have made headway even during the pandemic, despite some inefficiencies. The progress is promising. We are also focused on commercializing our DNA polymerase, which relies more on establishing a supply chain for production rather than on R&D teams in the labs. Therefore, we have made strides in bringing the DNA polymerase and some other molecular biology enzymes to market. We are optimistic about the launch of these products. We have additional molecular diagnostic enzymes that we aim to develop with CodeEvolver, but those efforts have been slightly delayed due to lab operational restrictions. Nonetheless, our commercialization efforts have been fruitful, and we are confident that this will continue to be a positive narrative for the company as we advance through 2020.

Your next question comes from the line of Doug Schenkel from Cowen. Your line is open.

John and Ross, appreciate you taking the questions. I was looking back at my model, at least I think it was my most recent model from before the pandemic, and I think you guys came in above what I was forecasting for Q1 at that point. Based on your prepared remarks, it seems like you got pretty close to what you expected to do in Q1 in spite of the pandemic and in spite of the fact that you started sheltering-in-place with a couple of weeks to go in March. So is that right? Did you actually hit or exceed your target? Do you think there was any revenue that got pushed out of Q1? Is there any possibility that there is actually maybe some pull forward of revenue given all that's going on?

I believe we performed slightly better than anticipated as the first quarter progressed. Some revenues were postponed because we had to pause our R&D operations. Ross, feel free to add to this. I think this was addressed in our upcoming 10-Q filing, but it was a minor impact. I wouldn't categorize it as pull forward. Overall, we started the year strong in terms of revenue generation, both from products and R&D services.

Yes, I'll just add maybe two or three bullet points to that, Doug. But yes, we actually disclosed this. I think it's in the press release also, but we estimate that we lost about $0.6 million in R&D services revenue in the quarter due to the pandemic. And we did come in a little bit better than we expected in revenues in the quarter. I think we did a little better than expected on product sales. And we recognized a little more revenue from Takeda than we, frankly, had been expecting as well. So that certainly helped in the quarter.

Could you clarify if I'm understanding this correctly? Some of your customers are experiencing the same cash generation pressures as others, trying to reduce their spending, but there are limits to how much they can cut back. Given this situation, in addition to customers dealing with their own lab shutdowns, are they requesting to delay milestone payments or any other cash flow to you? I'm asking to better understand the situation with your customers. This could indicate that the current issues are temporary, and if they return to work later this quarter, it may just be a matter of timing, with expected cash flow for Q2 shifting to the second half. Any insight you can provide or confirmation on my thoughts would be appreciated.

Yes, our partner-funded, time-based project work represents a significant part of our R&D revenue stream, but we had to pause it because we are not producing the products needed to generate those deliverables and revenues. We informed our customers, who understood as they are in a similar situation. They are eager for us to resume the work we've been doing with them on those projects. While there might be a slight concern about starting before our customers can receive our products, I don't anticipate that being a major issue since we can share results virtually with their R&D teams working from home. The effort required from our partners to work with our products in their labs is less demanding than the work we perform in ours. So, this really is just a pause and restart. Most of these partner-funded, time-based projects are governed by existing agreements, which obligate them to accept the deliverables and compensate us once we can resume. Our partners are well-funded, so we expect to catch up in time. We aim to return to full R&D capacity soon, but we won't be able to dramatically accelerate our progress because we've consistently been operating near our full capacity. This has led us to gradually add personnel over the years to expand that capacity, but we have always been close to our limits. So, it's important to manage expectations and understand that our goal is to return to our previous operational pace, rather than catch up significantly once back to full capacity.

Your next question comes from the line of Matt Hewitt from Craig-Hallum Capital. Your line is open.

Good afternoon. Thank you for taking the questions. I'm glad to hear that everyone is safe and healthy. First question for me. Regarding the shelter in place, was that an elective decision that you made to keep your team safe and healthy? Or was that part of the government regulations? The reason I ask is, I guess, it's been kind of hit or miss a lot of pharma companies, med device companies, those types of industries have been unable to work, where possible while keeping social distancing. So, I'm just curious if this was your decision to keep the team safe or if this was more of the government regulations.

You have a really, really good question. I think it's predominantly the government regulations. When the first shelter in place order came out, there was vagaries in there that we needed to assess. Maybe a very liberal interpretation of the initial orders could have led us to continue to operate, but we didn't feel right about that. And ultimately, we expected that those orders would get clearer and tighter with respect to things like are these projects COVID related? Are these projects for essential business? And they did, and they bore out that our interpretation, which was more in favor of ensuring the safety and social distancing of our employees was more accurate. So, I think we landed exactly where we should have. And so the real question, while we're under these current strict orders in the San Francisco Bay area through the end of May, is it essential business? Is it code related and we have some work that is directed toward essential business, and our employees are confident in our guidelines to operate in a given COVID-19 risks, and we work carefully with them to Stage 4 and ultimately get their full support for the limited start-up in the recent past. Hopefully that sheds light on your question.

And then regarding COVID, I'm curious as pharma scrambles to try and find treatments and ultimately vaccines, I'm curious if this is creating any opportunities for you to potentially be a solution to either the treatments or vaccines?

Yes, there are some potential involvement of Codexis, that haven't been central to our go-forward growth strategy. We're assessing those. I think we'll just leave it as a light. But previously unforecasted upside may unfold, but I wouldn't want our investors focused on that at this point in time. So we've been thinking about that. Our scientists have been considering that as they've been working virtual team innovation processes. But I would hold back from setting any kind of upside expectation at this point.

Your next question comes from the line of James Lieberman from Revere Securities.

It's great seeing how the company has been evolving over the years. And I know you've addressed this several times already, but I just want to make just a further clarification. Regarding the enhanced enzymes part of the business and the opportunities there, are you seeing at least an acceleration of interest because of the pressing need to get more accurate gold standard diagnostics?

Yes, how is the world going to respond to an immediate scale-up of diagnostic, high-fidelity diagnostic techniques to both be able to diagnose the infection early and then later to diagnose the antibodies to show immunity thereafter. These are crucial global needs and topics. We're not a diagnostic development company, but we do have the ability to provide inputs to enable better diagnosis on various biological samples for various targets. So yes, the interest is there. Like I said to Matt, there are ideas, there are opportunities, and they could become real business prospects for us, but I think it's premature for us to set any significant expectation on those at this point. So any sort of acceleration of interest will come from your partners and contacts already in place, and they could come back to pretty much at any time as people realize what the news or world order is going to look like, type of thing.

Presenters, there are no further questions at this time, please continue.

Okay. Well, thank you, everyone, for your questions. We will look forward to providing updates as we continue to manage effectively through the pandemic and ultimately ramp our R&D operations back up once today's strict shelter-in-place restrictions are relaxed and lifted. We look forward to that and hope it is not too far off. We'll continue to stay strong and navigate effectively until then. Thanks again, and stay safe and well. Bye-bye.

Ladies and gentlemen this concludes today's conference call. Thank you for participating. You may now disconnect.