3 Things to Watch at Solazyme

Solazyme (NASDAQ: SZYM  ) continues to trek ahead toward its ambitious goals of scaling one of the world's first industrial biotechnology platforms. The developmental stage company will bring 125,000 metric tons of annual nameplate renewable oil capacity online by mid-2014, which has many investors sizing up revenue growth models and profitability projections. The growth will be undeniable, but there are obstacles ahead as well. Here are three things investors need to watch at the often misunderstood company.

1. Capacity additions
The disruptive company finished 2012 on a high note with several upstream commercial partnerships. Solazyme accelerated its partnership for domestic renewable oils production with Archer Daniels Midland (NYSE: ADM  ) . The two will eventually produce an annual capacity of 100,000 metric tons -- all belonging to Solazyme -- at the Clinton, Iowa, biorefinery, which will have an initial nameplate capacity of 20,000 metric tons. The joint venture with Bunge (NYSE: BG  ) was also expanded from an initial agreement of 100,000-300,000 metric tons of annual nameplate production by 2016 -- half of which belongs to Solazyme.   

There are differences between the two. Whereas the ADM expansion will occur at Clinton, the Bunge expansion would require additional greenfield construction at locations other than the joint venture's current Moema, Brazil, facility. That entails additional permits for construction and operation, construction costs, off-take agreements for 200,000 metric tons of new products, and other big capital commitments. Luckily, those costs will be split between Solazyme and Bunge.

Adding all planned capacity to that currently under construction amounts to 450,000 metric tons. That's a big, big deal, but still 100,000 metric tons shy of the company's internal goals. There are currently no announced plans on where the extra 100,000 metric tons will come from. Investors will want to remain on their toes when it comes to costly additions with Bunge and any announcements regarding the unfilled capacity. The company's cash hoard will disappear pretty quickly, so bringing revenue-generating capacity on line as quickly as possible is crucial.  

2. Licensing for novel food oils
Solazyme Roquette Nutritionals, or SRN, has generated market interest from various food processing companies looking for nutritional supplements. The company's Almagine HL (flour) and Almagine HP (protein) have performed well in testing against industry standard applications from other plant-based sources. However, neither product is a novel tailored oil.

Qualifying as non-novel allows each of the two nutritional supplements to be sold to customers without special regulatory filings. That may not fly with several products under development today, but the degree of novelty remains to be determined by American and European regulatory agencies. Why does it matter?   

The SRN facility in Europe is currently undergoing a phase-two expansion to an annual capacity of 5,000 metric tons; up from the current 300 metric tons. Depending on market adoption, which seems to be sky-high for protein supplements, SRN can decide to expand the facility to an annual capacity of 50,000 metric tons under a phase-three agreement. Should the two products under development be labeled as novel Solazyme will have to go through the proper regulatory channels to gain approval for commercial sales in Europe and possibly the United States. CEO Jonathan Wolfson recently noted that could take "a couple years", which could delay the need for phase-three expansion.   

3. Manufacturing cost
The most important thing guiding Solazyme to a profitable future will be manufacturing costs. While the company has targeted $1,000 per metric ton of renewable oils as an initial floor, costs will depend on several factors. First, successfully scaling the technology platform is key to reaching that target. Solazyme ran two partial tests in 500,000 liter bioreactors last year and achieved a linear yield of product, but has yet to prove commercial productivity of its microbes at such levels.

The company is attempting to replicate its heterotrophic process in 625,000-liter bioreactors. Failing to do so could affect annual capacities of biorefineries and gross margin estimates. The Clinton and Moema facilities, which represent a total of 120,000 metric tons of nameplate capacity, will initially have 500,000-liter equipment installed. In other words, Solazyme will not reach its targeted margins -- even after ramp-up -- at these facilities with the current infrastructure.

Second, manufacturing cost is dependent on total scale. Although the facilities coming on line between this summer and early 2014 will have nameplate capacities totaling 125,000 metric tons, it will take between 12 and 18 months to ramp production up to those levels.

Third, feedstock costs will vary between the current ADM (corn, dextrose) and Bunge (sugarcane crush, sucrose) facilities. Similarly, manufacturing costs are likely to vary between products. Margins of various oil profiles will be affected by metrics such as yield, productivity, and titer (the efficiency of biological pathways is not constant between different sugars). Margins will gradually improve as scale is reached and process improvements are made, but investors won't have a clear picture on costs anytime soon.  

Foolish bottom line
Solazyme had a great 2012 and is now progressing through a critical 2013. The tremendous growth that investors are looking forward to depends on many moving parts that can be difficult to pin down. Nonetheless, the disruptive platform will continue to be de-risked as the company makes its way to commercialization. Just be sure that you don't overlook obstacles and project completely smooth sailing ahead. 

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