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Edited Transcript of CDXS earnings conference call or presentation 9-Mar-17 9:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Codexis Inc Earnings Call

San Francisco Mar 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Codexis Inc earnings conference call or presentation Thursday, March 9, 2017 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jody Cain

LHA - SVP

* John Nicols

Codexis, Inc. - President and CEO

* Gordon Sangster

Codexis, Inc. - CFO

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Conference Call Participants

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* Matt Tiampo

Craig-Hallum Capital Group LLC - Analyst

* Kevin DeGeeter

Ladenburg Thalmann & Co. Inc. - Analyst

* Swayampakula Ramakanth

H.C. Wainwright & Co, LLC - Analyst

* Steve Schwartz

First Analysis Securities Corporation - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to Q4 2016 Codexis, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

It is now my pleasure to hand the conference over to Jody Cain. Ma'am, please proceed.

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Jody Cain, LHA - SVP [2]

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This is Jody Cain with LHA. Thank you for participating in today's call to discuss Codexis's 2016 fourth quarter and full year financial results and business progress. A slide deck to accompany today's call is available on the Investors section of the company's website at www.codexis.com.

Joining me from Codexis are John Nicols, President and Chief Executive Officer; and Gordon Sangster, the company's Chief Financial Officer.

During today's call, management will be making a number of forward-looking statements. These forward-looking statements include 2017 financial guidance, including total revenues, revenue growth and operating expenses as well as product revenue, product revenue growth and gross margin as a percentage of product revenues; the company's expectations that it will announce the third CodeEvolver licensing agreement in the second half of 2017, that it will receive revenues in 2017 from this licensing agreement, that as a result of total -- as a result, total revenues will be higher in the second half of 2017 than in the first half of 2017 and that it will continue to announce new CodeEvolver licensing agreements approximately every one to two years; the company's expectations regarding future revenues from this CodeEvolver licensing agreement with GSK and Merck; the company's expectations regarding continued development, partnering and regulatory approval efforts with CDX-6114 for its biotherapeutic candidate for the treatment of PKU; the company's expectations that it will continue developing additional biotherapeutic products; the company's expectations regarding sustained product sales under its enzymes supply agreement with Tate & Lyle; the company's expectations regarding the prospects and market availability of the company's first enzyme for the use in next-generation sequencing for molecular diagnostics and genomics research and its contribution to revenue in 2018; the company's expectations regarding technical improvements to its CodeEvolver platform licensing technology; the company's expectations regarding revenues from its revenue-sharing agreement with argatroban injectable drug with Alexa Pharma Sciences (sic - "Exela Pharma Sciences"); and the company's expectations regarding the introduction of a new -- of approaching for a new industrial vertical.

These forward-looking statements are based on assumptions and are subject to risks and uncertainties that can cause actual results to differ significantly from those projected during the call. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements.

Please refer to the company's annual report on Form 10-K filed with the Securities and Exchange Commission on March 8, 2016, and the company's Forms 10-Q filed on May 9, 2016, August 9, 2016, and November 8, 2016, for some of the important risk factors that can cause actual results to differ materially from the forward-looking statements made on this call.

The content of this call contains time-sensitive information that is accurate only as of today, March 9, 2017. Except as required by law, Codexis disclaims any obligation to publicly update or revise any information to reflect the events or circumstances that occur after this call.

Now I'd like to turn the call over to John Nicols. John?

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John Nicols, Codexis, Inc. - President and CEO [3]

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Thanks, Jody. Good afternoon, everyone, and thank you for joining us. We have posted a brief slide presentation to accompany today's call on the Investors section of our company website, and we invite you to follow along.

I'm proud to report on another highly productive year at Codexis. Turning to Slide 3 in our slide deck. 2016 was our third consecutive year in which we achieved our financial guidance. I'd like to share some highlights of our many accomplishments, beginning with revenues.

Our total revenues in 2016 increased 17% to $48.8 million, reaching the high end of our guidance range and representing a three-year compound annual growth rate of 15%. Additionally, we are reporting gross margin as a percentage of total revenues of 80%, similar to last year and remarkably up from three years ago when we achieved 54%. Sales growth in 2016 came from our core protein catalyst business, with product sales increasing 35% on higher demand for our enzymes and R&D revenues up 22%.

We delivered on multiple fronts throughout the year with many advancements that strengthen our business as we build a strong foundation for continued growth. Among these, we successfully completed the transfer of the technology portion of our CodeEvolver licensing agreements with GSK and Merck, both ahead of schedule. Discussions with other large pharmaceutical companies to follow GSK and Merck in securing a CodeEvolver platform license have grown and advanced.

We successfully demonstrated the efficacy of our orally dosable enzyme therapeutic candidate for phenylketonuria, or PKU, disease now in four different animals, including a primate with its gastrointestinal similarities to humans. We built significant momentum in our protein catalyst pipeline, adding new protein engineering service deals throughout 2016 that widened the front end of the pipeline. And we advanced multiple proteins to commercialization, creating new sustainable revenue streams for our future in the form of product sales and/or licensing economics.

I'd like to highlight four of those pipeline advancements in 2016 to help illustrate the momentum we created in 2016, leveraging our CodeEvolver protein engineering core. First, highlighting that our cost savings model works not only in pharmaceuticals but also in other industries, we commercialized and installed our engineered protein catalyst into Tate & Lyle's food ingredient manufacturing operation. We signed a multiyear enzyme supply agreement with them, setting up sustained product sales into the food industry going forward.

Second, demonstrating that our protein engineering can also aid in the discovery and development of novel biotherapeutics, we delivered for our partnership with a leading biopharmaceuticals company. We exceeded the project's pre-negotiated performance targets, earning us a success fee, plus our first annual license fee payment when they exercise a nonexclusive license option to the technology we created.

Third, we started to show the revenue-generating engine from the back end of our CodeEvolver platform license deals, earning the first milestone payment from GSK for a CodeEvolver-developed enzyme targeting the transformation of a patented and approved GSK drugs process.

And finally, fourth, we developed our first enzyme for use in a fast-growing market of next-generation sequencing for molecular diagnostics and genomics research. We are confident our approved enzymes, the first in a series of products we plan to launch to these customers, will add value versus incumbent suppliers' enzymes.

These are just some of the successful examples of long-term value creation we are delivering currently from our protein-creating engine. The technology is at the core, but so is our competence to collaborate and partner by engineering a custom solution then supplying, by licensing the platform then training on its use, by discovering novel performance attributes then outlicensing its application.

We are a proven partner to a growing number of the world's great companies, nimble and experienced to find the ideal way to share the value created by a world-leading protein engineering platform. The universe of potential protein-based materials is vast and largely untapped. Our core technology and our partnering competences are increasingly tapping into that universe, increasingly creating value for our shareholders and clients.

Our outlook for 2017 clearly reinforces continuing this growth. Before I get into that, let me turn the call over to Gordon for a detailed review of our financial results in 2016 and to provide the details of our financial guidance measures for 2017. Gordon?

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Gordon Sangster, Codexis, Inc. - CFO [4]

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Thanks, John. Let me give you some financial highlights from the fourth quarter as well as the full year. Turning to Slide 4 in our presentation. Total revenues for the fourth quarter of 2016 were $10 million. This was a strong showing against the difficult comparison from the prior year that included a $3.1 million royalty settlement payment from a noncore legacy customer. So growth, excluding this onetime payment, was 17%, which is consistent with the full year. R&D revenues were $5.3 million for the quarter, down from $6.4 million in the prior year quarter, which included that $3.1 million royalty settlement payment.

In the 2016 fourth quarter, we recorded $1.8 million in previously deferred revenue from the early completion of our technology transfer to Merck. Product sales for Q4 2016 were $4.2 million, down about $200,000 from the prior year. While the decrease was due to fluctuations in demand for our enzyme products, we continue to increase shipments of enzymes to Merck for the production of sitagliptin, the active ingredient in Januvia.

Revenue from our revenue-sharing arrangement for argatroban injectable drug with Exela contributed $375,000 to the fourth quarter total. We expect revenues from this agreement to continue in this range in the coming quarters.

Gross margin as a percentage of total revenues for the fourth quarter of 2016 was 77%. This compares with 78% for the fourth quarter of 2015, which again reflected the recognition of the royalty settlement payment. Gross margin as a percentage of product revenues for the fourth quarter of 2016 was 46% compared to 42% for the fourth quarter of 2015, reflecting an improved sales mix.

Turning to operating expenses. R&D expenses were $6 million for the fourth quarter of 2016, a 14% increase from the prior year period primarily due to costs associated with higher headcount and higher outside services related to our PKU biotherapeutic development. SG&A expenses for the fourth quarter of 2016 were $7 million, a 16% increase from the prior year period, and reflected a foreign tax receivable write-off and increased costs due to higher headcount, mainly due to additions to our business development team.

The net loss for the fourth quarter of 2016 was $5.3 million or $0.13 per share. This compares with a net loss of $2.1 million or $0.05 per share for the fourth quarter of 2015. On a non-GAAP basis, adjusted net loss for the fourth quarter of 2016 was $2.8 million or $0.07 per share, which compares with adjusted net income for the fourth quarter of 2015 of $600,000 or $0.02 per diluted share.

Turning to our full year financial results. Total revenues for 2016 were $48.8 million, which is up 17% compared with 2015. As John stated, this was at the high end of our 2016 revenue guidance range. Total revenues for 2016 included $31.3 million in R&D revenue, $15.3 million in product sales and $2.2 million from the revenue-sharing arrangement.

Gross margin as a percentage of total revenues for 2016 was 80%, also meeting our 2016 guidance. R&D expenses for 2016 were $22.2 million, which compares with $20.7 million for 2015. The increase was due to higher consulting fees, which we incurred for the evaluation of potential new drug development targets, marking an important investment in our future growth, as well as higher fees for outside services and increased costs associated with our higher headcount.

SG&A expenses were $25.4 million for 2016, up from $22.3 million for the prior year, mainly due to higher legal expense associated with our intellectual property litigation, higher consulting fees from the exploration of business development opportunities and the costs related to the higher headcount, as I previously mentioned.

For 2016, we reported a net loss of $8.6 million or $0.21 per share, and this compares with a net loss for 2015 of $7.6 million or $0.19 per share. On a non-GAAP basis, we are reporting an adjusted net income for 2016 of $1.7 million or $0.04 per diluted share. This compares with adjusted net income for 2015 of $3 million or $0.07 per diluted share. Cash and cash equivalents as of December 31, 2016, were $19.2 million versus $23.3 million as of December 31, 2015. We expect to continue to tightly manage our costs related to new product development and litigation.

Turning to Slide 5. We are introducing financial guidance for 2017 as follows. We expect total revenue to reach between $50 million and $53 million. We also provide guidance on product sales of $21 million to $23 million, which is a 37% to 50% increase over 2016.

Guidance on gross margin from product sales was between 37% and 39%, which is an increase over gross margin on product sales of 36% for 2016. Our revenue guidance assumes the recognition of an up-front payment and the achievement of our first milestone related to our third CodeEvolver licensing agreement, which we expect to announce in the second half of 2017. Given the anticipated timing of this agreement, we expect total revenues to be higher in the second half of 2017 versus the first half of the year.

Finally, we are providing guidance for operating expenses, which is the combined total of R&D and SG&A expenses, to increase by between 6% and 8% over 2016. This assumes a full year of expenses related to the development of our PKU drug candidate as we advance this asset towards an IND. Please note that a reconciliation of GAAP to non-GAAP financial metrics is included on Page 8 of this presentation.

With that, I'd like to turn the call back to John.

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John Nicols, Codexis, Inc. - President and CEO [5]

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Thanks for that financial review, Gordon. We are very proud to provide these strong guidance expectations for 2017, highlighting our confidence in the continued top line growth of the company. While single-digit percentage growth of our revenue is somewhat lower than our recent performance, note that we are offsetting -- more than offsetting the headwinds from the $15.5 million in milestone payments we recorded from the two early CodeEvolver tech transfer completions last year, plus the continuing declines expected from our Exela revenue sharing for argatroban. Core protein catalysts product and R&D service revenues from our pipeline momentum, quality sustaining revenue sources are stepping up to carry our growth in 2017.

Let me finish our prepared marks by reviewing our strategic objectives for 2017 on Page 6 of the investor call deck. Our business is accelerating and expanding on multiple fronts as we kick off 2017. First, our growth is driven by our CodeEvolver platform technology. In particular, the software and algorithms that enable us to engineer optimal proteins are a core source of competitive advantage for the company. We will continue to invest in upgrading CodeEvolver, in particular increasingly applying artificial intelligence and machine learning technologies to make us design better proteins even faster and less costly than today.

Second, we are focused on delivering on our core protein catalyst business with expected growth of 37% to 50% in product revenues at higher gross margin than reported in 2016. This includes continued growth of our R&D service revenues as we use our CodeEvolver technology to engineer new proprietary proteins. Furthermore, we will continue to accelerate our protein catalyst penetration into the food industry, expecting 2017 to be the highest revenue year in that industry of all time.

Third, we expect to announce our third CodeEvolver licensing agreement with another large pharma company, including recognition of the up-front and first milestone payments. We are affirming our outlook for one new deal every one to two years. The back-end economics associated with our GSK and Merck deals will be minimal revenue contributors in 2017 but are expected to ramp up in 2018 and thereafter.

Fourth, we will continue to expand and advance our pipeline of internally developed biotherapeutics. We are performing the necessary preclinical development activities for CDX-6114, our candidate for PKU disease, with aim to receive an IND approval from the FDA in the middle of 2018. We are in discussion with -- discussions with prospective partners for CDX-6114, encouraging us that we have a valuable, marketable preclinical asset based on our successful animal research. And we are advancing the discovery of several other promising biotherapeutic candidates in 2017 in hopes to build follow-on successors to what we have been able to do with CDX-6114.

Fifth, we expect to demonstrate credible market acceptance for our new enzymes that validate improvements to customers' next-gen sequencing and PCR diagnostic results and setting up for what we believe will be a multimillion-dollar revenue contributor for Codexis in 2018.

And finally, we expect to position our protein-creating engine into another new industrial vertical as we move toward 2018, further highlighting the vast applicability of our versatile CodeEvolver platform technology. It's an exciting time here at Codexis. We look forward to updating you on all of these developments as we move through this year.

With these comments, I'd like to open the call to questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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John Nicols, Codexis, Inc. - President and CEO [2]

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While we're waiting for our first question, I'd like to mention that we will be participating in two upcoming investor conferences. We will be presenting at the Craig-Hallum Institutional Investor Conference on May 30 in Minneapolis and at the Jefferies Healthcare Conference being held June 6 through 9 in New York. A webcast of the Jefferies conference presentation will be available on the Investors section of our website. Okay, operator, we are ready for the first question.

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Operator [3]

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Yes, sir. Our next question will come from the line of Matt Tiampo with Craig-Hallum. Please proceed.

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Matt Tiampo, Craig-Hallum Capital Group LLC - Analyst [4]

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I wanted to start off maybe with if we could drill down a little bit on contract R&D and specifically on the -- on sort of the regular way contract R&D. It looks like kind of back of the envelope, backing out the milestone payments, that, that was probably about $9 million this year. What are your expectations for growth there going forward? And is that back of the envelope math sort of in the right ballpark?

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John Nicols, Codexis, Inc. - President and CEO [5]

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Matt, thanks for your question. I'll let Gordon answer the back of the envelope. This is a really strong part of the revenue outlook for the company. We grew our R&D service deals and revenues from those deals in 2016 compared to 2015. And we expect this area to be a continued significant source of growth for us as we have started 2017 and have built in growth expectation for larger R&D service revenues in 2017 as we've built and provided you our guidance.

It's part of what's led us to increase our headcount in R&D as we ended last year. That moderately increased headcount R&D enables us to do more projects. And in addition, the productivity of our protein engineering continues to improve. So we're able to deliver results in quicker periods of time. So the net effect is we're able to produce -- engineer more and more new proteins with our R&D capacity. That's a key source of our revenue growth in the recent past and certainly moving through 2017.

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Gordon Sangster, Codexis, Inc. - CFO [6]

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Yes. So to your question about the calculation, Matt, you need to remember that we had -- we were able to recognize deferred revenue on the completion of the tech transfers to both Merck and GSK, which totaled $3 million to $4 million during the year and about $1.8 million for Q4. The R&D service revenues are certainly growing, and we expect them to grow even faster. And partly, that's enabled by Merck paying for -- and not only having the lab in their own facility back East, but also paying for additional teams here because they're embracing the technology so much that they're seeing more and more products that it can be used on. So it's helped by Merck, but certainly, we're seeing that grow in other areas as well.

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Matt Tiampo, Craig-Hallum Capital Group LLC - Analyst [7]

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Great. Just maybe another point of clarification on your expense guidance. Gordon, is that 6% to 8% OpEx growth, is that in reference to GAAP or non-GAAP operating expenses?

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Gordon Sangster, Codexis, Inc. - CFO [8]

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That's GAAP expenses.

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Matt Tiampo, Craig-Hallum Capital Group LLC - Analyst [9]

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GAAP. Okay, great. And then just sort of last one from me. And it's nice to hear the update on the PKU program. But maybe moving forward, what are the boxes that are left to be checked this year in terms of getting us to the point where we're ready for an IND submission? And if you could remind us and maybe refresh how much you've spent to date and then what your thoughts are on your path forward over the next year. And when do you think might be the optimal time to seek a partner?

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John Nicols, Codexis, Inc. - President and CEO [10]

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Matt, so I'd say -- I think I'll answer your question in a slightly different order. Through last year, we have invested, including internal expenses, in the range of $2 million to develop the PKU biotherapeutic candidate. Those costs increased in 2017 compared to 2016 as we move towards seeking the IND approval of the FDA. And that the major elements of the preclinical development work that we're spending on this year will be the creation of stockpiles of material to do toxicology and to ultimately prepare for the early trials in humans and also the expense associated with actually doing longer-term toxicological assessment of our drug candidate.

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Matt Tiampo, Craig-Hallum Capital Group LLC - Analyst [11]

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Okay. And then in terms of the box that's left to check to get us to IND from here. Is it just that tox work?

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John Nicols, Codexis, Inc. - President and CEO [12]

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Those are the primary boxes. They take time. It takes time to produce these materials. The particular toxicologies work that we're doing is a 28-day study. That's misleading in terms of how long it takes. It actually takes the better part of three to four months to do a 28-day study, including all of the analytical work associated with that. And so that's -- those are the primary elements of workflows to move towards an IND.

We'll also have communications with the FDA along the way. We're developing what will be our approach for doing clinical trial work -- Phase 1 trial work. But that's really mostly consultancy work along with the team to assess the various optionality for testing this drug in early human trials. So those are the major boxes to check to reach an IND.

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Matt Tiampo, Craig-Hallum Capital Group LLC - Analyst [13]

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Okay. And then maybe just to give us a little bit of sense for the magnitude. I mean -- I think BioMarin spent roughly $20 million to get their products -- their enzyme products to an IND. Are we talking about another $18 million? Or your guidance would suggest it's significantly less than that?

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John Nicols, Codexis, Inc. - President and CEO [14]

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Yes. Our guidance does suggest it's significantly less than that. We have included the full year of IND-enabling costs in the OpEx guidance that we provided on today's call. And while it is greater than the $2 million we spent, it's certainly remarkably less than $10 million built into our OpEx outlook for 2017.

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Operator [15]

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Our next question will come from the line of Kevin DeGeeter with Ladenburg. Please proceed.

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Kevin DeGeeter, Ladenburg Thalmann & Co. Inc. - Analyst [16]

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I want to kind of get into a question of how much visibility you have on product revenue growth and maybe kind of start by looking at this in the context of 2016, the 35% growth year-over-year. Gordon, how much of that was principally new customers that contributed to that 35% growth? And how much of it was existing and/or expansion on existing relationships and contracts?

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Gordon Sangster, Codexis, Inc. - CFO [17]

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It's a mixture of new and existing customers, Kevin. A big contributor was sitagliptin for Merck. They're rolling out the production of sitagliptin for Januvia to a second and then a third facility worldwide. And so we are benefiting from that push on sitagliptin as it takes over using our technology in different manufacturing facilities. So we're expecting to see that continue to grow pretty strongly in 2017. And the rest is a mixture of kind of generic and branded pharmaceutical customers mainly, who are adding to the strong growth that we saw with 35% for the year.

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Kevin DeGeeter, Ladenburg Thalmann & Co. Inc. - Analyst [18]

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Okay, great. No, that's helpful. And with regard to your guidance for a third CodeEvolver agreement in 2017, can you just kind of walk me through what appears to be a really high level of confidence that you have with regard to a timing in the second half of '17? Specifically, you have significant interval from kind of where we stand today. So what are you seeing today that gives you a high-level visibility on BD outcome that you're projecting being three-plus months off?

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John Nicols, Codexis, Inc. - President and CEO [19]

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Sure. Sure, Kevin. So first, there's increasing awareness of the value of the type of deal we did with GSK and the world of larger pharmaceutical companies. That's enabled us to really deepen and expand the number of significant conversations we're having with other large pharmaceutical companies about the value and the applicability of this kind of platform licensing arrangement for them as well. I said that bodes well not only for the third deal but also thereafter.

With respect to the third deal, I would say that we're in significant discussions with several that have advanced to the point where we believe that we're within that six or so months window of actually having a transaction. And so clearly, that indicates a reasonably advanced state, but not a complete state, of finalizing the transaction. We obviously still have drafting and contractual work to be done before we can announce the effective transaction milestone for the company.

But again, we're quite confident. We've built it into our guidance. It's looking very solid with respect to continuing CodeEvolver platform licensing accordingly.

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Kevin DeGeeter, Ladenburg Thalmann & Co. Inc. - Analyst [20]

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Okay. Terrific. Then maybe just one last one for me. And it pertains to development of additional biotherapeutic programs and enzymes. Can you just walk us through what you've learned in the context of development of PKU and how you're applying that to both selection of additional potential opportunities and your thought process with regard to, in general, the optimal time line or position for being able to extract value through a partnership? Should we expect any future compounds to also go closer to IND filing before a potential partner?

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John Nicols, Codexis, Inc. - President and CEO [21]

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Sure. You had a couple of questions in there. So first, we see that our CodeEvolver protein engineering can enable improvements in multiple kinds of biotherapeutics, obviously like in the case of PKU, the creation of improved enzyme therapeutics. And that's a very natural target for our company. And that's a pretty wide user -- universe of potential disease targets that we can go after theoretically with a novel enzyme therapeutic. So we've been -- the technology bodes well to create new improved biotherapeutics in the enzyme therapeutic space.

I'd say much of what we have learned in 2016 was actually studying those various disease targets. They are the current solutions, if any, to those potential targets. And basically, some economic and business analysis around those targets that we factor, together with the technical feasibility of coming up with a better product using our platform together to create our follow-on pipeline, it's pretty early days for these follow-on projects because we've been primarily focused on the advancement of the candidate for PKU. But we're excited about the prospects. We're confident about the success of CodeEvolver to create new candidates to assess in animal models, et cetera.

I think the second question was when do -- when does the stage of our development warrant kind of talking to external parties. And I think that's pretty clear that it's no sooner than after you've gotten some data that a candidate we've created with the technology actually delivers attributes -- efficacy results in animals. So we'll need to be creating candidates using CodeEvolver, identifying lead candidates from CodeEvolver and then trialing them in animals and getting successful animal results before we would ever show off a new candidate to a strategic company. In addition, we would, of course, want to get our patent filings and our intellectual property in place as well.

So those are -- once we've got those two in place, then it's time, if we want to, to start sharing our biotherapeutic candidates with third parties. So did that answer your questions?

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Kevin DeGeeter, Ladenburg Thalmann & Co. Inc. - Analyst [22]

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It does.

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Operator [23]

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Our next question will come from the line of Swayampakula Ramakanth with H.C. Wainwright. Please proceed.

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Swayampakula Ramakanth, H.C. Wainwright & Co, LLC - Analyst [24]

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A couple of questions. For me to think in a different way in terms of R&D revenue and the sustainable deals of that R&D revenue going forward is to kind of think through the pipeline snapshots that you had provided in the middle of the year last year. I know it was one of those one-off things that you tried to do for us last time. But at least at the -- at a high level, could you kindly tell us where you are in terms of the number of projects on the commercial side and the pre-commercial side so we can kind of have an idea as to how you are doing and where there could be some growth between those two areas?

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John Nicols, Codexis, Inc. - President and CEO [25]

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Sure. We intend -- like when we rolled out the pipeline summary slides, which we still post on our Investors section of our website, we promised that we would do that at least annually. And I think that the -- that's what you should expect is that we'll formally update. It takes a fair amount of work, and we have to be very rigorous in looking at the data to fill out that kind of a chart. But you should expect that again in the middle of the year.

I think Matt started off questions around R&D service revenues. That has been a core growing part of our revenue in 2016, and it's a growing part of our revenue in 2017. So that's strongly indicative of the growth of pre-commercial protein engineering projects. When we do R&D services, we are doing pre-commercial work. We're engineering proteins that never existed before. So obviously, before commercial.

So we see growth in that area. We see growth across the various sectors of pharmaceutical. We're, in particular, growing our successes in creating new proteins for existing patented, approved drugs. One of the programs we have worked on in the CodeEvolver license with GSK is a patented and approved drug. We also have been successful in advancing an enzyme development for another major pharmaceutical company for another patented and approved drug. So that's a nice growing area, and we like the business case profile of engineering proteins for drugs that are already on the market.

The volumes were known and derisks the project to know that there's an actual production versus projects that are in the earlier stage where they can fall off because of bad clinical results. So that's the pre-commercial side.

On the commercial side, that's strongly indicative and strongly tied to our product sales, which Gordon and I have both highlighted remarkably on this call. We're very strong in 2016 and are a very key part of very strong growth outlook for product sales in 2017. And we expect both existing products that were already commercial last year to show growth characteristics in 2017. We also expect growth of products for new installations to contribute to our growth in product sales for 2017 as well.

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Swayampakula Ramakanth, H.C. Wainwright & Co, LLC - Analyst [26]

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In terms of talking about commercial products and going back to thinking about Januvia-Janumet franchise, what percent of the manufacturing capacity has been converted by Merck to utilize the enzyme through the CodeEvolver project? And also, do you think that Merck at some point will convert all of its facilities that produce this franchise, the Januvia-Janumet franchise to your system, the CodeEvolver protein system?

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Gordon Sangster, Codexis, Inc. - CFO [27]

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[R.K.], this is Gordon. I don't think they'll convert all their manufacturing facility to our technology. There are certain countries where it just wouldn't be worth our while to qualify our new way of making sitagliptin for them because the markets are too small. But they're roughly, say, 40% to 50% of the way there right now, and it's continuing to grow. We expect growth in 2017.

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Swayampakula Ramakanth, H.C. Wainwright & Co, LLC - Analyst [28]

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Okay. No, that's good. And then two other questions. The first one is on the next-generation sequencing product line that you had indicated to us in the middle of last year -- or the second half of last year. And it looks like some work is being done on this at this point so that you can get it to the market at a big -- at a higher level in 2018. But what should we expect to see in 2017 in that sector? Would you be able to introduce something -- some enzymes into the market and start some commercialization? And as the year progresses, we should see that sector get speeded up so that it becomes a multimillion-dollar sales in 2018. What's the strategy there?

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John Nicols, Codexis, Inc. - President and CEO [29]

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I think what you said was very close to what you should expect to see from us. So we made the announcement, actually, in January. We did disclose that we were working on creating enzymes for a new sector in the middle of last year, and those connect together. I think that's why you referred to us talking about this last year.

In our announcement in January, we said we would be making beta quantities available for customers. We have an enzyme -- our first enzyme that's targeting the next-generation sequencing machines. We are very proud of the performance of that enzyme. We've been testing it in house. We are making materials available to clients roughly currently.

And so what you would see next is continued encouragement that the customers are saying that our enzymes are better than incumbent enzymes that they are used to using. And if that follows to the next step, we would be generating at least some sales in 2017. It'll take some time.

We wouldn't want to set an expectation for you or other investors, R.K., that it's going to be significantly material revenues this year. But if we're successful, we should be setting up for these sales to be significant for us in 12 months. So that when we're coming out with our guidance for 2018 around this time next year where it's a significant part of those -- the total revenues of the company next year, we would expect to validate our belief that these would be, overall, higher-margin product sales than our standard product sales, which we gave guidance on, expect to be 37% to 39% aggregate in 2017.

The sales of enzymes into the next-gen sequencing, we expect to be higher than that because we think we're going to be able to deliver value in ways that are quite value-creating for our customers, helping them to do and to use the next-gen sequencing machines, to get better diagnostics results, for example, than they're able to with the enzymes that prepare the samples today.

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Swayampakula Ramakanth, H.C. Wainwright & Co, LLC - Analyst [30]

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And the last question from me. Thanks for giving us the teaser on going to introduce a new industrial vertical. But can you give us any more color than that in terms of getting into a new vertical in 2018?

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John Nicols, Codexis, Inc. - President and CEO [31]

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No. Actually, yes, that's a quick answer, but we're talking with customers in multiple other industry sectors. Our catalyst -- our protein catalyst can reduce the cost of making any complex chemical. There are many complex chemicals being developed and made in the pharmaceutical industry. And some of the most complicated chemistry takes place in that industry. So that's why it's been a great target for the entire history of our company over the last 15 years. But there's a lot of complex chemistry being developed and being manufactured in many other industries.

So we've already had remarkable success in the food industry. We're now applying our protein engineering and novel proteins into next-gen sequencing. I'm encouraged that we will continue to show off applicability with new customers in new industries. And that's why we're setting out a qualitative guidance for -- in this call is that you should expect to continue to see us do that.

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Operator [32]

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(Operator Instructions) Our next question will come from the line of Steve Schwartz with First Analysis.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [33]

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So I guess, the first question is with respect to your CodeEvolver discussions that are going on right now for the next licensing agreement. I think I have a picture of this, but I'd like your color. The conversations are not so much that there is a competitive technology to CodeEvolver. I suspect it comes down to more on whether or not the economics of a licensing deal makes sense to the licensee -- potential licensee. Is that correct?

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John Nicols, Codexis, Inc. - President and CEO [34]

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Some partially. The other reality is that these customers can garner some benefits from our protein catalysts just by working with us on a project-by-project basis. So of course, we'll do R&D services work for all of the pharmaceutical companies. We're doing some measure of business with 15 out of the top 20, as you know already, Steve.

So the choice is really which is a better way to apply protein catalysis into their company; to apply protein engineering into their company; to continue to work on a project-by-project, one-off basis with Codexis; or to step up, to build a team, to work on more projects more quickly with more control without having to work with a third party. And as you know, we've [commenced] the GSK and Merck of that, and we continue to make great traction with other companies as well.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [35]

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Yes. Yes. Okay. So is it safe to say then that the potential licensees here that you might close a deal with this year are people you're already doing work with through your R&D services?

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John Nicols, Codexis, Inc. - President and CEO [36]

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Yes. I mean, all things equal, if they have worked with us, they've seen our protein engineering work for projects of relevance to their company, they're much more inclined to work a platform license, of course.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [37]

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Yes. Yes. In the presentation with respect to CodeEvolver, you talked about, with the strategic objectives, your artificial AI algorithms, improving those. Is that something then that automatically, as part of a licensing agreement, gets passed on to GSK and Merck? Or does that offer you additional revenue opportunities with your licensees. How does that play through?

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John Nicols, Codexis, Inc. - President and CEO [38]

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Yes. Potentially is the quick answer. When we have struck our deals with GSK and Merck, they get the state-of-the-art of our technology all the way through the technology transfer completion. And as you know, both GSK and Merck are finished with the technology transfer. So they have locked in our state-of-the-art as of the completion date. So 2Q last year for GSK and 3Q for Merck. So they have the state-of-the-art at those points in time in the past. And as we've said in the presentation and it's fairly obvious, we continue to improve the CodeEvolver technology. And we, of course, have ongoing, very intimate conversations with our two key licensees and potentially future licensees about how we're improving the CodeEvolver technology, and it could, indeed, lead to some opportunities for follow-on licensing upgrades.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [39]

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Fantastic. That's good to hear. My two next questions, I think, have been answered. So the answer should be quick. But with respect again to the outlook for your outsourced work to licensees, namely Merck, you've added personnel. It sounds like you expect the revenue related to that work to be increasing in '17.

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John Nicols, Codexis, Inc. - President and CEO [40]

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Yes. Yes. It's going to be a key part. I mean, the growth of revenues from product sales and the growth of revenues from R&D service deals are the key underpinning for our year-on-year growth for the company in 2017.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [41]

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Yes. And then the last one is just with respect to a PKU, but more broadly, molecule development. So there's been a lot of discussion about your activities with PKU today. But are you working on developing other molecules that are not related to PKU?

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John Nicols, Codexis, Inc. - President and CEO [42]

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Yes. All of our follow-on biotherapeutics, first, they're all biotherapeutics, so they're all large molecule biologics because our core technology creates proteins. They're targeting other disease conditions. They are not targeting PKU. We think an enzyme therapy or another protein-based therapeutic could help alleviate the disease conditions of these other targets. And that's what we're working on.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [43]

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Can you put a number around what is in that pipeline, at least those that have come far enough along that you think there might be potential three, four, five years out for an IND?

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John Nicols, Codexis, Inc. - President and CEO [44]

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Sure. The only real information we provided is that last year, last quarterly earnings call, I mentioned that one of our follow-on biotherapeutics beyond PKU has begun animal research. And then there's a couple of other targets where we're in discovery, where we haven't even identified a candidate that warrants doing any animal research. So that's pretty much where we are still.

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Steve Schwartz, First Analysis Securities Corporation - Analyst [45]

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One preclinical, one -- and several in discovery?

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John Nicols, Codexis, Inc. - President and CEO [46]

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Well, I think that's fair.

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Operator [47]

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Thank you. There are no further questions in the queue. So now it's my pleasure to [turn] the conference back over to management for closing comments and remarks.

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John Nicols, Codexis, Inc. - President and CEO [48]

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Okay. Thank you very much. I'd like to close by thanking you for joining us this afternoon. We are very proud of our strong financial and operational performance and are excited about our future prospects. We look forward to providing progress report on our next quarterly conference call. Everyone, have a great day. Thanks.

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Operator [49]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Everybody, have a wonderful day.