The report lacked excitement. There weren't any positive or negative surprises. But enzyme engineering leader Codexis (NASDAQ:CDXS) delivered a solid, albeit boring, operational performance in the first quarter of 2019. The business reaffirmed its original full-year guidance calling for 14% to 19% revenue growth year over year, even though revenue in the year's first quarter only eked out 11% growth from the same period last year.

Developments that took place after the end of the quarter show why management is so confident. Codexis announced a new multiyear deal to supply catalysts for the manufacturing of food ingredients for Tate & Lyle. The arrangement has the potential to grow into the company's single largest source of product revenue over time. It also announced a multiyear licensing agreement with Novartis for its CodeEvolver protein engineering software platform. The deal could provide up to $22 million in up-front and milestone payments, plus newly negotiated "usage payments."

Here's what investors need to know about the company's Q1 operating results and how recent developments fit into the bigger picture.

A hand holding out a canvas sack with a dollar sign on it.

Image source: Getty Images.

By the numbers

While Codexis has grown revenue and reduced operating losses in recent years, it has struggled with choppy quarter-to-quarter performances and disappointing growth in product revenue. Those trends have been driven by the nature of the business (up-front payments, counted as collaboration revenue, are inherently variable) and the scramble to replace product revenue from fading agreements with newer, more diverse, and longer-lasting sources.

Judging from first-quarter revenue and management's reaffirmation of full-year guidance, investors should expect that choppiness to remain throughout the year. Codexis expects no more than $29 million in product revenue for the year, but exited the quarter on pace to realize $32 million. Similarly, management expects no less than $40 million in collaboration revenue, but is on pace for only $31 million. 

Metric

Q1 2019

Q1 2018

Change (YOY)

Product revenue

$8.0 million

$6.1 million

30%

R&D revenue

$7.6 million

$7.9 million

(4%)

Total revenue

$15.6 million

$14.0 million

11%

Product gross margin

45%

37.9%

19% (relative)

Operating expenses

$16.4 million

$14.9 million

10%

Operating income

($5.2 million)

($4.7 million)

N/A

Data source: Earnings press release. YOY = year over year.

The surge in product revenue in Q1 was driven by over $1 million in sales to Urovant Sciences. The pharmaceutical company and its partner, Kyorin Pharmaceutical, earned marketing approval in Japan for an overactive-bladder drug that is manufactured with enzyme catalysts supplied by Codexis.

Investors might expect more of these "commercialization events" -- meaning when drug candidates earn marketing approval, catalyst supply volumes increase to support commercial drug sales -- thanks to a growing pipeline of customers with drugs in phase 2 or phase 3 clinical trials. That would help to usher in stable revenue growth over time. A new approach to collaboration agreements could do the same.

A handshake.

Image source: Getty Images.

A new deal that's a big deal

On the earnings conference call, CEO John Nichols went into great detail about the structure of the new software license with Novartis announced in early May. While similar to existing agreements with Merck and GlaxoSmithKline, it differs in subtle but important ways.

The licensing agreement with Novartis is worth up to $22 million in up-front and milestone payments spread over three technology transfer periods lasting up to 22 months combined. For comparison, the 2015 deal with Merck comprised two technology transfer waves lasting up to 15 months in total. Codexis actually earned $10 million of that deal's $18 million value in the first two months, resulting in volatile collaboration revenue totals around that time. Stretching out the new deal over more tranches and a longer time frame should help to reduce volatility. 

Perhaps more important for investors is the back end of the deal. Novartis is paying $22 million for the ability to use the CodeEvolver protein engineering platform in-house, but it also must separately compensate Codexis for drugs produced using enzymes designed with the software. The new deal includes "usage payments" calculated from the total volume of drug product produced, which has the potential to add significant long-term value beyond the cited $22 million figure. For comparison, the original deal with Merck put a fixed value of $15 million on each drug product enabled by catalysts designed with the software platform. In other words, management has learned some valuable lessons from previous agreements and isn't wasting time putting that knowledge to good use. 

The stage is set for a strong 2019

Management's full-year guidance calls for total revenue of $69 million to $72 million, product revenue of $26 million to $29 million, and product gross margin in the neighborhood of 50%. While expectations remain unchanged after the Q1 report, and the stock has moved little recently thanks to a significant amount of growth potential being priced in already, investors should have confidence in the company's trajectory after learning of recent developments. Codexis remains on track for another solid year of operations.