3 Myths Solazyme Investors Should Better Understand

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If investors have learned anything about industrial biotechnology from the first batch of publicly traded companies, it's that achieving the originally promised high-growth futures will take longer, be more expensive, and have more twists and turns than anyone imagined -- if success comes at all. That's now obvious for Solazyme (NASDAQ: SZYM), which owns one of the first wave's leading technology platforms. While share price and investor morale are both near all-time lows already, it's still important to keep expectations in check. Here are five myths I've seen floating around that Solazyme investors should better understand before making major decisions.

Myth 1: It's impossible to calculate true product gross margin on non-cosmetic products.
The products manufactured at the company's commercial scale facilities, where all eyes remain on the pace at which these facilities can ramp up, all come from non-cosmetic portfolios. It's important to keep an eye on true product gross margin to gauge progress in reducing production costs, which have yet to be proven at commercial scale.

It is true that investors cannot calculate true production costs on a "$per MT" basis without knowing production volumes, which is an unknown metric at this time. But you can calculate true product gross margin on non-cosmetic products with reasonable confidence. The all-important metric is the combination of three expenses separated by Solazyme in its SEC filings: cost of product revenue, excess capacity charge (an expense incurred from not running facilities at full capacity), and scale-up expense.

It takes a bit of extra work to find each of the three components in SEC filings, but the exercise does yield true production costs for any period -- no guesswork or estimates required. Consider the results of the exercise for the first two quarters of 2015.

Source: SEC filings.

To be fair, Solazyme explains how it separates true production costs in SEC filings, although management only discussed it publicly for the first time on the second quarter 2015 earnings conference call. This is a great example of why it's so important to read the SEC filings of the companies you own.

Myth 2: Solazyme is balancing product revenue with operating expenses at Clinton.
Taking that analysis one step further makes it pretty clear that Solazyme is not balancing production costs with product revenue in 2015.

To recap, in late 2014 management pivoted away from low-value commodity products to focus on high-value products like cosmetics. The idea -- which is also explicitly communicated in SEC filings -- was to slow cash burn and balance production costs with revenue generation from the manufacturing facility in Clinton, Iowa while the company focused on getting its flagship facility in Moema, Brazil back on track.

While adjusted product gross margin (what Solazyme reports) appears to be accomplishing this goal, calculating true product gross margin shows that operating expenses still far exceed product revenue from Clinton. To be fair, it was always going to be an impossible goal to meet, since the excess capacity charge alone inflates production costs. But management should have never made such promises in the first place.

Myth 3: Future capital raise may not be needed.
Solazyme ended the first half of 2015 with over $147 million in cash and cash equivalents and roughly $170 million in current assets. Additionally, the cash burn rate in the second quarter decreased 22% from the first quarter of this year. The company is easily the best-financed industrial biotech on public markets at the moment. But that doesn't mean it has enough cash to fund itself to profitable operations.

Even in the most optimistic production ramp-up scenarios, it's easy to see that Solazyme will need additional outside funding. Remember that the company's cash hoard will exhaust itself by the end of 2016 at the current quarterly cash burn rate, or 18 months from the end of this past June.

Here's the hard truth, Solazyme would need to generate $200 million in non-cosmetic product revenue in 2016 -- at 50% gross margin -- to reverse operating losses before cash runs out. That would be a more than 1,000% increase over the non-cosmetic revenue that will likely be achieved this year, which is also nowhere near target gross margins. In other words, be prepared for an additional capital raise before the end of 2016. If the company can prove certain production metrics before the capital raise, then it will be able to wrestle much more favorable terms on financing, whether in the form of a loan, debt offering, or share offering.

What does it all mean for investors?
It's important to note that I'm not picking on Solazyme. This myth-busting experiment is not intended to paint a negative picture of the company, but rather to give investors more realistic expectations for the road ahead. True product gross margin would fall significantly if Clinton produced near full capacity (assuming the company's "scale-up" expenses in R&D also fall, although it's unclear what production expenses are allocated there and what the totals amount to in 2015). Similarly, while a capital raise could be dilutive, investors would much rather see an adequately funded company that is closer to fulfilling its long-term mission

As stated in the introduction, every publicly traded industrial biotech company faces similar problems related to generating market demand, ramping production, accessing capital, driving down production costs, and the like. Investors in this space need to have realistic expectations, to fairly assess management teams heading the companies they own, and to not blindly believe some of the overly optimistic reporting on this company in particular. A successful, high-growth Solazyme (and other industrial biotech companies) will take much longer to materialize than many currently expect, if it arrives at all. Personally, I'll remain on the sidelines until true production costs fall and demand picks up.