For new subscribers, please read the introductory article on Codexis from September 2022 that explained the company's historical trajectory, the value of enzymes, and breakdown of the overall business.

By the Numbers

Codexis was in the right place at the right time when the pandemic struck. It developed an enzyme named CDX-616 to help Pfizer simplify the manufacturing process of nirmatrelvir (the suffix -vir signifies this compound is an antiviral), one of two antiviral compounds in Paxlovid.

The business generated $34.5 million from sales of CDX-616 in 2021. That increased to $58.0 million during the first nine months of 2022. For comparison, Codexis generated $35.4 million in revenue from all other enzymes in all other applications so far this year.

Unfortunately, CDX-616 is becoming a headwind heading into 2023. Sales of Paxlovid have disappointed. Doctors are turning to it less frequently due to higher vaccination levels and questionable outcomes with new virus variants. As a result, Pfizer and Codexis entered into a supply agreement in July 2022 that cancelled all orders beginning in 2023 and provided a one-time fee of $25.9 million creditable against future orders. It's likely quarterly revenue from CDX-616 has already peaked.

The timing isn't ideal.

There's the less-than-favorable macroeconomic environment sucking liquidity out of financial markets. Codexis is also generating less R&D revenue from licensing intellectual property and its CodeEvolver software suite, as well as drug development milestones (the timing is less controllable here). This is non-recurring revenue, but it also has a gross profit margin close to 100%, making it important for offsetting expenses elsewhere. The business expects to generate roughly $23 million in R&D revenue during 2022, compared to $34.1 million in 2021.

Most problematic is the surge in operating expenses in recent years to fund growth investments. That didn't matter so much when CDX-616 was driving revenue growth, but removing it from the income statement will expose some of the operating inefficiencies that have crept in since 2020.

This is evident when operating results are broken out into core revenue (product and R&D) and CDX-616. Although some growth in operating expenses is linked to the Pfizer enzyme and will naturally subside with supply volumes, the trend suggests core operating expenses are growing faster than the core business. The trend began in 2020 (before Pfizer came along) when the company started investing more heavily in drug development, which has a revenue payoff far in the future.

‍Data Source: SEC filings.

To be fair, Codexis has done an excellent job increasing product revenue and diversifying the revenue mix. Product revenue is the most important source of business for just about every synthetic biology company because it's recurring and high margin. Meanwhile, adding more customers into the mix reduces the choppiness of quarter-to-quarter revenue generation from infrequent enzyme orders, which has historically frustrated investors and analysts.

But there's a bumpy road ahead. Codexis delivered record quarterly operating expenses of $35.3 million during the three months ended September 2022. The three highest quarterly totals in the last decade were each recorded this year. That led the third quarter to become the sharpest operating loss in the last 17 quarters and only the second time in that span quarterly operating loss exceeded $10 million. If management isn't careful, then that number could balloon next year.

The business exited September 2022 with a cash balance of $108.7 million. Management thinks cash on hand plus expected future revenues and milestone payments could fund operations through the end of 2024. That makes it crucial to intelligently reduce operating expenses where possible and successfully clear de-risking events in the drug development portfolio. The latter could make or break the share price in the next 12 months.

The drug development pipeline, referred to as the Biotherapeutics vertical, could earn milestone payments from Nestle Health Science and Takeda in 2023. Executing could extend the cash runway, start delivering returns from capital invested in recent years, and increase the company's valuation by increasing the value of drug pipeline assets.

Development, Regulatory, & Commercial Updates

Investors might expect the company's project pipeline to shrink as it boots programs with lower value-creation potential to manage costs, but volume will be less important going forward.

• Biotherapeutics: Three programs will dictate the direction of drug development efforts, help justify recent investments, and potentially deliver meaningful seven- to eight-digit milestone payments in 2023.
• CDX-7108 is being evaluated as a potential treatment for exocrine pancreatic insufficiency (EPI) in a 50/50 co-development agreement with Nestle Health Science. Results from a phase 1b study expected in the first quarter of 2023 will determine if the asset proceeds to phase 2 development in late 2023 or early 2024.
• CDX-6114 is being evaluated as a potential treatment for phenylketonuria (PKU) by Nestle Health Science. This was the original indication targeted by Codexis, but technical challenges shuffled timelines and molecules. Nestle now expects to initiate a phase 1 clinical trial in 2023.
• A gene therapy collaboration with Takeda could see the first asset begin a phase 1 clinical trial before the end of 2023. This program may also utilize ImmTOR from Selecta Biosciences.
• Biotherapeutics playbook: Codexis is outlining go/no-go criteria for how much to invest in any given asset or therapeutic area, when to partner programs, and when to stop development of assets. That's somewhat telling. I always felt the company jumped into drug development haphazardly, which is supported by frustrating delays and increasing expenses. These efforts can only lead to improved economics.
• Life Sciences shift: Codexis intends to prioritize product revenue for this vertical. That makes sense given the recurring, high-margin nature of kits and other consumables used in biology research. This could actually become the key source of revenue growth with the right strategy and execution.
• Pharmaceutical Manufacturing optimization: This vertical has long powered the business, so Codexis intends to maintain key relationships, expand into adjacent customer groups, and focus more resources on mid-sized drug developers. This is a solid strategy for reducing choppiness and staving off potential competition from Ginkgo Bioworks, which recently announced an enzyme partnership with Merck – one of Codexis' core customers.

Forecast & Modeling

Codexis is difficult to model given the diversity of products and customers, choppiness of orders, and early-stage nature of the always delayed drug development pipeline. Until the statistical fog clears, investors can only focus on the most important drivers:

• Product revenue excluding CDX-616
• Program pipeline for the Pharma Manufacturing vertical, specifically programs related to phase 2 assets, phase 3 assets, and marketed drug products. These have the highest probability of success (POS) and therefore the highest value and revenue potential.
• Program pipeline for the Life Sciences vertical, which might be in flux with the new management team.

Product revenue: Codexis has historically struggled to consistently grow product revenue, but there are signs that could be changing. The business generated almost as much product revenue in the first nine months of 2022 ($35.4 million) as it did in all of 2021 ($36.2 million). It appears on track to deliver full-year 2022 product revenue of approximately $44 million, representing growth of 23% from the prior year. That would mark the second consecutive year of 20% growth.

Maintaining or accelerating that pace in the next few years could help the business achieve profitable operations by 2025, assuming moderate success in the Biotherapeutics vertical. There aren't any obvious product launches on the horizon, so investors might want to brace for full-year 2023 revenue guidance to be a little underwhelming.

Program pipeline, Pharma Manufacturing: Codexis provides a pipeline snapshot every June detailing the state of programs across its three core verticals.

As of June 2022, Codexis counted nine (9) programs for drug products on the market. That means the company was supplying enzymes to manufacture these drug products and generating recurring revenue.

The pipeline snapshot also listed 20 programs for drug assets in phase 2 or phase 3 clinical development. That means the company was supplying enzymes to help manufacture these drug candidates, but the revenue won't be meaningful or recurring until and unless they receive FDA approval.

Based on historical POS outcomes for clinical-stage drug candidates, the drug candidates in these programs have between a 15% and 52% chance of reaching market and generating sustaining revenues for the business. That suggests Codexis could increase the number of commercial programs (currently at nine) to between 12 and 19 in the next three to five years.

It's impossible to model the revenue potential without knowing the stages of development, therapeutic areas, and chemical classes of the drug assets. But anything in the range of outcomes above would represent a meaningful level of revenue growth from this vertical in that span.

Program pipeline, Life Sciences: Codexis doesn't break out revenue from Life Sciences tools. As you can tell by now, the company is hellbent on thwarting my modeling at every turn.

But the company has clearly focused on this new vertical in recent years. As of June 2022, Codexis was generating revenue from five (5) life science products on the market. It counted another 16 in development, including nine (9) partnered with customers. The 21 total programs represented year-over-year growth of 61%.

The new management team is still developing the strategy for this vertical, but it quietly represents the best growth potential for the business. Codexis may focus on becoming a valuable partner for established lab hardware platforms from companies such as Illumina, PacBio, and 10x Genomics. Additionally, cozying up to Roche (already a commercial partner) could toss another log onto the fire.

This vertical also houses the company's experimental DNA synthesis tools being developed by Molecular Assemblies. The market opportunity is new and large, but competing with more established providers such as Twist Bioscience and Danaher Corporation (via its Integrated DNA Technologies subsidiary) will pose a challenge.

Margin of Safety & Allocation

(No change.)

Codexis is considered a Growth (Speculative) position. The current margin of safety range for the company is below:

• Current Price (market close November 11):  $6.84 per share
• Likely Undervalued:          <$3.98 per share
• Midpoint:                            $5.31 per share
• Likely Overvalued:           >$6.64 per share
• Allocation Range:              Up to 2.5%

Codexis reported 65.687 million shares outstanding as of November 1, 2022. The margin of safety range above assumes 75.540 million shares outstanding, which prices in 15% dilution to account for the next public offering of common stock.

Further Reading

• November 2022 press release announcing third-quarter 2022 operating results
• November 2022 SEC filing (10-Q) detailing third-quarter 2022 operating results
• September 2022 research note initiating coverage and providing a business overview, including the outsized contributions from CDX-616

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