Enzyme engineering leader Codexis (NASDAQ:CDXS) achieved a long-awaited milestone in the third quarter of 2019: positive operating income. Investors shouldn't expect it to become a trend due to the inherent choppiness of the business. In fact, the business reported a deeper operating loss through the first nine months of 2019 compared to the year-ago period despite a 12% increase in revenue in that span. Nonetheless, the quarterly milestone provides a glimpse of what might be possible if the company can live up to its potential.

One sign of the business model's lumpiness is the fact that Codexis nearly met its full-year 2019 product revenue guidance in the first nine months of the year but declined to raise guidance. Is the company positioning itself to beat its own guidance, or will product revenue fall off a cliff in the fourth quarter? Here's what investors need to know about the latest operating results.

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Image source: Getty Images.

An accumulation of small wins

Success can be defined as the accumulation of many small wins over time (and many learnings from failures along the way). In that case, Codexis is still in the accumulation phase of its trajectory, but the wins are beginning to pile up.

As a refresher, the enzyme engineering leader generates revenue from selling enzymes to customers (product revenue) and reaching milestones within collaborative agreements (research and development, or R&D revenue). The business generated at least $250,000 in revenue from 11 unique customers in the third quarter of 2019. That includes four customers that contributed at least $1 million apiece such as blue chip companies GlaxoSmithKline, Nestle Health Science, and Tate & Lyle.

The diversifying customer base allowed Codexis to generate $21.9 million in total revenue, or 44% of its year-to-date total, in the most recent quarter. The business also squeaked out a quarterly operating profit of $0.26 million, although it wasn't enough to erase losses from the first half of the year.

Metric

First Nine Months 2019

First Nine Months 2018

Change

Product revenue

$24.6 million

$18.3 million

34%

R&D revenue

$25.2 million

$26.2 million

(4%)

Total revenue

$49.8 million

$44.5 million

12%

Total costs and operating expenses

$61.4 million

$55.2 million

11%

Operating income

($11.3 million)

($10.4 million)

N/A

Operating cash flow

($8.9 million)

($13.3 million)

N/A

Data source: Press release.

While the company had been preparing investors to expect a second-half surge in revenue, the strength of product revenue in the third quarter was a bit of a surprise. Codexis expects to generate $26 million to $29 million in product revenue for all of 2019, but it generated $24.6 million of that in the first nine months of the year.

Curiously, Codexis maintained full-year 2019 revenue guidance calling for total revenue of $69 million to $72 million, including the range mentioned above for product revenue. Based on the performance through the first nine months of the year, the affirmed guidance implies that the business will record roughly $4.5 million in product revenue and at least $15 million in R&D revenue in the final three months of 2019.

Perhaps management is underpromising so the company can overdeliver, but investors might not want to get too carried away. Codexis sells enzymes to customers eager to improve their manufacturing processes, namely in food ingredients with Tate & Lyle and pharmaceutical manufacturing, but the relatively low number of customers results in choppy sales.

For instance, in the third quarter of 2019, Novartis made a $2 million purchase for a manufacturing process that takes place less than once per year. Tate & Lyle is still ramping up the marketing of its core sweetener ingredient produced with help from Codexis enzymes and appears set for the remainder of the year. And other important projects and partnerships, such as one with pharmaceutical ingredient manufacturer Porton Pharma Solutions, are still getting off the ground.

The slow and steady march continues

Given the high number of enzyme projects in development, investors shouldn't expect Codexis to achieve consistent product revenue growth until many more are commercialized. But the company still boasts intriguing potential as a growth stock.

After all, the main ingredient produced by Tate & Lyle could require $10 million in enzymes per year. Throw in a number of late-stage pharmaceutical assets that could rely on Codexis enzymes and an end-of-September cash balance of $92 million, and investors with a long-term mindset should be comfortable with the pace of progress.

That said, there's a lot riding on the fourth-quarter and full-year 2019 operating results update to be made at the beginning of next year. That's when Codexis should issue revenue guidance for 2020, and considering the near-stagnant growth in product revenue the last three years, investors will want to start seeing the diversification of the customer base lead to tangible wins in the market.