Many synthetic biology companies have gone all in on business models that prioritize research and development (R&D) revenue. On one hand, collaboration deals grab headlines and create hype, which can be cashed in for venture capital or goodwill with investors. On the other hand, collaboration deals only lead to sustainable business success if they result in commercialized products that can be sold at a profit. The bill always comes due, as they say, and the field has paid a hefty price in credibility for relying too much on hype.

Codexis (NASDAQ:CDXS) hasn't exactly gone all in on the business model, but the company expects stagnant product revenue for the fourth consecutive year in 2020. Management has also devoted an increasing amount of bandwidth to drug development deals, which will force investors to rely on R&D revenue for growth for the foreseeable future.

The strategy could work better for Codexis than other synthetic biology companies chasing R&D deals in flavors, cannabinoids, and other trendy dead ends. But the coronavirus pandemic is expected to have a significant impact on the company's collaboration revenue. How should investors think about the small-cap stock in light of current events?

A wooden box holding many note cards each displaying a question mark.

Image source: Getty Images.

A strong headwind, but there's a silver lining

Codexis has developed a technology platform that combines scientists, robots, and machine learning to engineer enzymes. The biological molecules power all living things but can also be used in industrial settings and consumer products. For instance, many food and pharmaceutical ingredients are manufactured more efficiently with enzymatic process steps. Similarly, high-efficiency laundry detergent is made possible through the addition of certain enzymes. 

The business generates product revenue by selling enzymes to industrial customers in food and pharmaceutical markets. It also generates R&D revenue by selling licenses to its enzyme engineering software, CodeEvolver, and by entering into drug development partnerships with pharmaceutical companies. In the latter, enzymes can be the drug itself or be used in the design and discovery of drug candidates.

The combination of revenue streams creates intriguing growth potential. If Codexis can grow high-margin product revenue, then it would reduce operating losses, mitigate the revenue volatility from one-time R&D milestone payments, and de-risk future-oriented pipeline projects. 

But the intrigue has lost some of its luster in recent years. Codexis expects full-year 2020 product revenue to be at or below levels from 2017. That's disappointing for investors hoping the high-margin revenue stream could offset steep increases in operating expenses as the business invests in drug development services. The trend was beginning to show in the first quarter of 2020. 

Metric

Q1 2020

Q1 2019

Change (YoY)

Product revenue

$5.1 million

$8.0 million

(36%)

R&D revenue

$9.6 million

$7.6 million

26%

Total revenue

$14.7 million

$15.6 million

(6%)

Total costs and operating expenses

$22.5 million

$20.8 million

8%

Operating income

($7.8 million)

($5.2 million)

N/A

Operating cash flow

($1.4 million)

($2.8 million)

N/A

Data source: SEC filing. YoY = year over Year.

Of course, the arrival of the coronavirus pandemic in mid-March will inject volatility into the remainder of the year. Codexis withdrew original full-year 2020 guidance that expected around $80 million in total revenue, including $26 million in product revenue. 

However, management expects minimal impact on product revenue this year, while R&D revenue -- the most important source of growth under the current strategy -- is expected to be negatively affected by government restrictions on movement that will in turn affect the company's laboratory work. 

There's some irony to the situation. Had Codexis prioritized product revenue growth in recent years, then the business would be better positioned to respond to current uncertainty. Nonetheless, investors with a long-term mindset might not be too concerned. 

Codexis is spending relatively little cash at the present, ended March with $87 million in cash on the balance sheet, and has no debt. While R&D revenue is expected to be negatively affected by government restrictions on movement, the company expects to offset that with reduced operating expenses. Thinking longer term, the pipeline of drug discovery projects remains intact, as do efforts to expand into new markets and revive product revenue growth in the next few years, although it's prudent to expect most projects to be delayed. 

Maintain your pre-pandemic opinion of this stock

Shares of Codexis are down 40% in the past year. That primarily reflects the fact that investors have taken a wait-and-see approach with the company's increasing dependence on drug development deals and the R&D revenue they might bring in. The stock's recent sideways movement reflects expectations for the coronavirus pandemic to stall growth in 2020. Despite the delays from original guidance, the long-term potential of the technology platform remains in place and the business is well positioned to endure a prolonged slowdown.

For investors growing a little impatient with the continued need to rely on potential rather than sustainable market traction, relief isn't likely to arrive until 2021. That's when Codexis expects phase 1B results from its most advanced drug asset, the initiation of clinical trials for its second drug candidate, and preclinical progress in more nascent collaborations.