You always remember your first. Codexis (NASDAQ: CDXS) was the first company I ever interviewed for research purposes – all the way back in late 2011.

A lot has changed for the protein engineering specialist in the last decade. The focus on cellulosic ethanol and an existential partnership with Royal Dutch Shell has long faded over the horizon. A brief flirtation with bio-based chemicals is a distant memory, too. The intellectual property for those enzymes (the C1 platform) was handed back to Dyadic International forever ago.

There's a new breadth of projects cooking in the pipeline spanning drug candidates, diagnostics, and even DNA synthesis tools. That includes a shelved portfolio of early-stage projects in areas such as enzymatic CO2 capture from industrial emissions. They don't receive much publicity, but some of these "hidden" assets could be sold off or partnered for additional upside potential.

At the same time, not much has changed. Codexis has a reliable base of customers who rely on it to manufacture steady, low-cost, and less-toxic streams of active pharmaceutical ingredients (APIs). Merck remains firmly reliant on the company and its tools; the pair have won multiple U.S. EPA Green Chemistry Challenge Awards together and individually. Novartis and others are now signed up, too.

Unfortunately, investors would rather wish a few important things did change over that span. The company's historical boogeyman continues to plague operations: Choppy, inconsistent revenue from non-recurring sources.

How should investors approach Codexis? And what does the company need to do to provide confidence that there really isn't anything lurking under the bed?

A Valuable Niche

Codexis engineers enzymes to improve manufacturing processes, power diagnostic tools, or become therapeutics.

An enzyme is a complex molecule that makes chemical processes more efficient. Enzymes are what make life possible. Biology often operates at low temperatures and pressures, which aren't the ideal conditions for most chemistry – otherwise all the things in all the places would be in a constant state of change all the time. That's why enzymes rely on quantum tunneling to lower energy requirements for chemical reactions. (Seriously.)

No one said enzymes had to be relegated to biological systems. These wonder molecules can be used in industrial processes to reduce energy, increase yield, and eliminate waste. They also make your laundry detergent work in cold water, and your ice cream last longer in the freezer by restructuring how water molecules form ice. (Seriously.)

Codexis has developed a technology platform called CodeEvolver to engineer enzymes for specific purposes. CodeEvolver is based on a Nobel Prize-winning technology called directed evolution (invented by a Pittsburgh native), which can be used to engineer proteins and enzymes with desired functions. A healthy dose of machine learning, gene editing, and other synthetic biology tools have since been added into the mix, too.

The business reports two segments:

• Performance Enzymes: Investors can think of these products as "everything outside of drug development," although it primarily involves industrial manufacturing processes and life science lab tools. Codexis has developed an enzyme used to manufacture diabetes medication Januvia (sitagliptin) more efficiently, even saving Merck from needing to build an additional facility. Another helps Tate & Lyle manufacture a zero-calorie sweetener. Another still is used in a Roche product that helps nerds in lab coats to purify biological samples in their research.
• Novel Biotherapeutics: These products are used in drug design, drug discovery, and drug development. Takeda is deploying the company's tools to develop multiple gene therapy candidates, including one that may use ImmTOR from Selecta Biosciences #smallworld. Nestle Health Science has tapped CodeEvolver to develop multiple drug candidates for gastrointestinal indications. Codexis is developing a wholly-owned pipeline, too.
• Codexis has sold software licenses for CodeEvolver to larger customers who want to use the tools in house. Licenses are reported in one of the two segments above.

There are many larger (Novozymes), more established (DSM), and better funded (Ginkgo Bioworks) companies across the competitive landscape, but Codexis was among the first to stake out ground in the manufacturing of APIs. That early bet on the largely shunned niche has paid off by building a foundation for expanding the business. The company has done well diversifying its customer base in recent years. For example, the number of commercialized performance enzymes has increased from nine (9) in June 2018 to 22 in June 2022.

Engineering enzymes is a pretty sweet (and valuable) niche.

• The business has posted product gross margin exceeding 50% in 14 of the last 16 quarters. It now routinely tops 60%.
• Management has steered the business relatively close to breakeven operations. Operating loss has only exceeded $10 million in one of the last 16 quarters.
• Full-year 2021 revenue grew 52% from the year-ago period – by far the largest increase since at least 2014.

The secret to the recent growth spurt is CDX-616, which Pfizer uses to manufacture nirmatrelvir, one of the two APIs in the COVID-19 antiviral Paxlovid. The enzyme reduces the number of manufacturing steps, improves yield, and eliminates several hard-to-find chemical inputs. Without CDX-616 there would be no Paxlovid.

Unfortunately for Codexis, without CDX-616 there would be no revenue growth either.

Choppy Revenue Still Haunts the Business

Despite greatly increasing the number of pipeline projects and revenue-generating products, the business has struggled to achieve reliable revenue growth.

Consider that it took seven years for the company to double the level of revenue achieved in 2014. That's a compound annual growth rate (CAGR) of "only" 10%. Growth has been difficult to sustain more recently. If sales of CDX-616 are excluded, then the business achieved total revenue of $68.5 million in 2019, $69.0 million in 2020, and $70.2 million in 2021.

The choppiness is more visible when looking at quarterly revenue since the beginning of 2018. Full-year revenue grew only 16% from 2018 to 2021 when CDX-616 sales are excluded.

The challenge is that significantly more customers are required to mitigate choppiness and deliver more reliable annual revenue growth.

What makes enzymes so amazing (their incredible efficiency – a tiny amount goes a long way) also makes it really difficult to build a business around them. Customers rarely require large volumes of highly-engineered enzymes and can order as infrequently as once per year. That creates choppiness in revenue from quarter to quarter, which can be exacerbated when one customer dominates the order list.

The reliance on Pfizer echoes the company's past reliance on Merck, which years ago suddenly reduced orders for the enzyme used to manufacture Januvia and Janumet due to dwindling prescriptions. That single decision led to multiple years of stalled growth for Codexis in the past.

This headwind is likely to keep the business subdued through at least 2023. Pfizer inked a supply agreement for CDX-616 in July 2022 that signaled reduced demand for Paxlovid. The pharma titan paid a $25.9 million retainer fee and cancelled existing orders for the enzyme in early 2023.

Codexis will recognize portions of the retainer fee as orders are placed through the end of 2024. For comparison, the business recorded $45.1 million in CDX-616 revenue in the first half of 2022.

Losing a big customer is never painless. However, this one could really hurt. Despite a surge in revenue from Pfizer, Codexis posted only one quarter of operating income since the beginning of 2021. That's because the business increased operating expenses to service its expanding project pipeline.

In other words, the company could see operating losses increase by nearly $10 million per quarter as orders for CDX-616 dry up. That may not stand out in the context of unprofitable growth stocks, but Codexis has kept quarterly operating losses below $10 million total in 15 of the last 16 quarters.

Any investors hoping the stock quickly climbs out of its rut and returns to the FOMO-#genomics-Cathie-cheerleading days of 2021 may be disappointed.

How to Approach Codexis

It's not all bad news. Codexis has all the pieces in place for success. It will just take a few years to play out.

Management's focus on diversifying and expanding the project pipeline has clearly paid off in the last decade. This is clearly visible in the trajectory of product revenue, which is the most important revenue category. Licenses and R&D payments come and go, but product revenue is stickier. Product sales are more likely to be a recurring source of revenue.

A quick look at the pipeline shows where management is focusing. In the 12 months ending June 2022, Codexis added:

• 10 new projects to the performance enzymes pipeline. This included eight (8) from life science tools and four (4) for manufacturing patented drug products. A few projects in other subcategories churned out in this period.
• Six (6) new projects to the biotherapeutics pipeline. This included five (5) from gene therapies.

The business counted 94 total projects in its pipeline, representing both customer-funded and wholly-owned assets, at the end of June 2022. That represents a healthy volume of shots on goal. Do any meet the sweet, sweet combination of high volumes and frequently recurring orders?

Perhaps. Investors should watch life science tools as a key source of future product revenue growth. Placing Codexis-developed enzymes into the right R&D tools – such as the high-margin consumables that power lab instruments – could smooth out choppy revenue for good. For example, 10x Genomics sells nearly $100 million of consumables every quarter.

The company is working closely with Molecular Assemblies to develop enzymatic DNA synthesis technology. This next-generation approach could theoretically deliver high volumes of low-cost synthetic DNA for a wide range of applications. However, compared to silicon-based synthesis from Twist Bioscience, enzymatic synthesis has more errors, higher costs, and creates shorter sequences. Twist Bioscience is developing its own enzymatic DNA synthesis tools without Codexis.

The overall drug development pipeline could represent significant upside in the form of cash payments for hitting certain milestones, but only two programs are in clinical trials. The pipeline is also dominated by Nestle Health Science and Takeda, which means losing one customer could sharply reduce and delay the opportunity for novel biotherapeutics.

Price Targets & Allocation

(Inaugural Price Targets)

Codexis is considered a Growth (Speculative) position. Current price targets for the company are as follows:

• Current Price (market close September 19):   $6.94 per share
• Prioritize Below:               $3.98 per share
• Midpoint:                            $5.31 per share
• Caution Above:                 $6.64 per share
• Allocation Range:             Up to 2.5%

Codexis reported 65.5 million shares outstanding as of August 2, 2022. The price targets above assume 75.325 million shares outstanding, which prices in 15% dilution. The allocation range above assumes a portfolio of 15 to 20 positions.

Ol' Maxxie's Position

I don't own shares of Codexis. Solt DB will provide coverage of many companies, including many I don't own. The goal is to provide unbiased research for biotech and synthetic biology stocks, not to have everyone copy my portfolio.

Further Reading

• July 2022 regulatory filing summarizing the new supply agreement between Codexis and Pfizer
• August 2022 press release announcing Q2 2022 operating results
• August 2022 presentation detailing the company's project pipeline as of June 2022
• For fun, check out the historical list of U.S. EPA Green Chemistry Challenge Winners. Solt DB will discuss and interact with this more once we officially launch.
• For fun, ice structuring proteins (ISP) or antifreeze proteins (AFP) are increasingly being used in frozen foods. Codexis doesn't currently supply these.

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