Codexis Inc (CDXS) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Codexis 2016 Third Quarter Conference Call. (Operator Instructions) As a reminder, this call is being recorded today, November 8, 2016.

I'd now like to turn the call over to Bruce Voss. Please go ahead.

This is Bruce Voss with LHA. Thank you all for participating in today's Codexis call to discuss 2016 third quarter financial results and business progress. Joining me from Codexis are John Nicols, President and Chief Executive Officer; and Gordon Sangster, the company's Chief Financial Officer.

During today's call, management will be making a number of forward-looking statements. These forward-looking statements include 2016 financial guidance, including total revenues, revenue growth and gross margin as a percentage of total revenues; the company's expectations regarding future uses of the CodeEvolver technology platform by GSK and Merck and the potential for milestone payments under the company's license agreements with Merck and GSK; the company's expectations regarding potential future CodeEvolver licensing partnerships; the company's expectations regarding revenue growth in its core biocatalyst R&D and product businesses, including growth in enzyme sales to Merck for use in Januvia in the fourth quarter of 2016 and in 2017; the receipt of new orders for services and products for 4Q '16 as well as prospects for increased orders and new business with major pharmaceutical companies; the company's expectations regarding product growth for 2016 for its second commercial enzyme and its commencement of a third round of protein engineering R&D services for its second food industry customer; the company's expectations regarding the development of its own therapeutic drug candidates; the company's ability to expand into adjacent markets and its anticipation of launching an enzyme for use by customers outside of the food ingredient and pharmaceutical industries; the company's expectation that it will continue to receive licensing payments based on its biopharmaceutical partner having exercised its option for a nonexclusive license to a novel enzyme developed by Codexis for the partner's preclinical therapeutic development programs; the company's intention to continue to manage its costs related to new product development and litigation while maintaining a healthy cash balance; and the company's plan to drive toward future sustained profitability.

These forward-looking statements are based on assumptions and are subject to risks and uncertainties that can cause actual results to differ significantly from those projected during the call. Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements. Please refer to the company's annual report on Form 10-K filed with the Securities and Exchange Commission on March 8, 2016, and the company's forms 10-Q filed on May 9, 2016, and August 9, 2016, for some of the important risk factors that can cause actual results to differ materially from the forward-looking statements made on this call.

The content of this call contains time-sensitive information that is accurate only as of today, November 8, 2016. Except as required by law, Codexis disclaims any obligation to publicly update or revise any information to reflect events or circumstances that occur after this call.

Now I'd like to turn the call over to John Nicols. John?

Thanks, Bruce. Good afternoon, everyone, and thank you for joining us. I'm proud to report another quarter of exceptional financial results by Codexis. Net income was $1.4 million, on revenues reaching $14.9 million, which included $4.1 million in product revenues.

When introducing 2016 revenue guidance, we noted our expectation for growth and product revenue as a key component. It's gratifying that year-to-date, our product revenues have increased by more than 60% versus last year. Growth in product sales indicates the momentum of our engineered enzymes being increasingly utilized in our customers' processes.

Our third quarter revenues also included $8 million in milestone revenues earned from the successful technology transfer of our CodeEvolver protein engineering platform to Merck. As with the successful tech transfer to GlaxoSmithKline, we satisfied Merck at every step in the process and successfully completed the transfer ahead of schedule. We continue to show exceptional execution for transferring the technology to our CodeEvolver protein engineering platform licensing partners, noting that each individual tech transfer is customized for the given partner.

As a result of our strong performance, we are reporting our second consecutive quarter of profitability. We also have gained greater visibility on full year revenues as we move toward the end of the year, allowing us to raise the low end of our previous revenue guidance range. We now expect revenues to be between $47 million and $49 million, representing growth versus 2015 of 12% to 17%. If delivered as expected, Codexis will have delivered its third consecutive year of double-digit revenue growth.

Solid sustained financial results like these can only flow from proven business approaches that generate value for both shareholders and clients. Our traction with engineering novel proteins that improve manufacturing processes and reduce costs for the major pharma clients is remarkable as we close 2016. Highly visible pressures to reduce drug pricing for these clients is making cost reduction a growing imperative, and Codexis is increasingly being called on to help in that. 7 out of the top 10 largest pharmaceutical companies are working significant programs with us, in the final 2 quarters of 2016, 7 out of the top 10. Referencing Contract Pharma's Top 25 Pharma and Biopharma Report published July, August 2016 as well as the current Codexis pipeline posted on the Investors section of codexis.com, let me give you a feel for the exciting broad progress we are now making with large pharma.

First and foremost, let me start with Merck as the depth and breadth of our relationship with them is the blueprint by which we desire to drive all other major pharma relationships. Merck is one of our CodeEvolver platform licensees, a major commercial user of a Codexis enzyme for a blockbuster drug and an expansive continuous user of Codexis R&D with the aim to drive lower cost more widely across its drug pipeline.

In the third quarter with Merck, we, number one, completed the CodeEvolver license tech transfer and recognized an $8 million milestone payment; number two, delivered million dollar plus sales of enzymes to Merck's blockbuster Januvia diabetes drug franchise; and number three, lined up and began operation of several new dedicated R&D project teams for their growing list of protein engineering targets.

Note that these new dedicated R&D project teams lined up in the third quarter are on top of an already running set of dedicated project teams. Each of these R&D teams running in parallel at Codexis are focused on different protein engineering targets. Merck sees how widely applicable our protein engineering approach can be to improve their drug manufacturing processes.

Merck is not alone. Also in the third quarter, we delivered multi -- I'm sorry, we delivered million dollar plus commercial product sales to another top 10 pharma company's commercial drug manufacturing process. We finished a six-digit enzyme improvement project for a third top 10 pharma company with aim to improve their recently launched drugs manufacturing route. We lined up a six-digit clinical product order batch for 4Q to a fourth top 10 pharma customer for a Phase 1 oncology drug. We are finishing in 4Q a six-digit enzyme improvement project on a late-stage Phase 2 or 3 clinical drug candidate for a fifth top 10 pharma co, and we broke open a set of enzyme improvement RFPs for yet a sixth top 10 drug company; this one, a company we had never done any material business prior.

And finally, number seven, with GSK. I'm delighted to report that in 3Q, we recorded our first project-specific milestone revenue from GSK under the back-end economics of our CodeEvolver licensing agreement. This collaborative project used CodeEvolver to develop an enzyme to optimize a new biocatalytic process for one of GSK's drugs already on the market. This is the first instance of what we believe will be a series of growing back-end revenues from our CodeEvolver licensing partnerships.

Clearly, we are building momentum with large pharma clients, but that's not the only place we are successfully applying our CodeEvolver protein engineering technology. In the biotherapeutics arena, we were pleased in 3Q to be advised that our biopharmaceutical partner exercised its option for a nonexclusive license to a novel enzyme developed by Codexis. The enzyme was developed using CodeEvolver for use in one of the partner's preclinical therapeutic development programs. We collected a modest annual payment from them in 3Q and expect those annual payments to continue and potentially grow in the future.

In addition, we are advancing the development of our own pipeline of biotherapeutic assets. Advancements have been made on animal trials and pre-IND planning for our oral biotherapeutic candidate for phenylketonuria disease. We have started early-stage animal trials on a second therapeutic enzyme for a different disease condition and have begun discovery efforts for a few other disease targets. All these targets are well suited to have our CodeEvolver protein engineering deliver again.

And finally, our efforts outside of pharma continue to progress as well. By year-end, we expect to finalize the third funded R&D chapter of our work with our second food industry partner. In addition, we have advanced our self-funded enzyme development project for a food ingredient with wide industrial interest, and we are approaching the launch of an enzyme that we have been developing for a wide set of potential customers in a new industry outside of pharma and food.

Our pipeline of projects is diverse, growing and satisfying a very significant set of the world's leading companies. CodeEvolver protein engineering is delivering value in our target markets and creating a stronger growing company for our shareholders to be invested in.

With that, I'd like to turn the call over to Gordon for a detailed review of our financial performance. Gordon?

Thanks, John. As John stated, we're reporting strong financial performance for the third quarter of 2016 with the recognition of a milestone payment and a significant increase in biocatalyst product sales.

Revenues for the quarter of $14.9 million compared with $17.4 million for the third quarter of 2015. The decrease is attributable to high revenues recognized on achievement of milestones and revenues from a revenue-sharing arrangement in the 2015 quarter, partly offset by higher biocatalyst product sales in the 2016 quarter.

Biocatalyst research and development revenues were $10.4 million versus $14.5 million for the third quarter of 2015. The decrease was due to the timing of milestones under technology transfer agreements. In the third quarter of 2016, we recognized an $8 million milestone for the completion of the CodeEvolver technology transfer to Merck, whereas in the third quarter of 2015, we recognized a $6.5 million milestone from our collaboration with GSK and a $5 million milestone from our collaboration with Merck.

Biocatalyst product sales increased by 123% to $4.1 million compared with the same period in 2015. This growth was primarily related to increased shipments of enzymes to Merck for the production of Januvia as well as increased shipments to another core major pharmaceutical company. We expect revenues from Merck to continue at this higher level into next year and beyond. Revenue from our revenue-sharing arrangement for argatroban with Exela in Q3 was $445,000.

Gross margin as a percentage of total revenues for the third quarter of 2016 was 81%, and this compares with 93% for the third quarter of 2015. The higher gross margin last year reflects the revenue mix favoring milestones.

Turning to operating expenses. R&D expenses were $5.5 million for the third quarter of 2016, a 9% increase from the prior year period primarily due to higher outside services and increased costs associated with higher headcount. SG&A expenses for the third quarter of 2016 decreased 3% to $5.2 million from the prior year primarily as a result of a reduction in rent expense, reflecting the sublease of a portion of our facility.

We're reporting net income for the third quarter of 2016 of $1.4 million or $0.03 per diluted share, compared with net income for the third quarter of 2015 of $5.4 million or $0.13 per diluted share. On a non-GAAP basis, adjusted net income for the third quarter of 2016 was $4 million or $0.09 per diluted share compared with adjusted net income for the third quarter of 2015 of $8 million or $0.19 per diluted share.

Turning to our year-to-date financial results. Total revenues for the first nine months of 2016 were $38.9 million, up 29% over the prior year and included $26 million in biocatalyst R&D revenue and $11.1 million in biocatalyst product revenue.

Gross margin of 81% on total revenues for the first nine months of 2016 is tracking in line with our guidance for the full year.

R&D expenses for the first nine months of 2016 were $16.3 million compared with $15.5 million for the first nine months of 2015, with the increase due to consulting fees for the evaluation of potential new drug development targets as an investment in our future growth, higher outside services and increased cost associated with modestly higher headcount. SG&A expenses were $18.5 million for the first nine months of 2016, up from $16.3 million from 2015 due mainly to higher legal expense and higher consulting fees relating to exploring business development opportunities.

We reported a net loss for the first nine months of 2016 of $3.3 million or $0.08 per share, which was a significant improvement from a net loss for the prior nine-month period of $5.5 million or $0.14 per share. On a non-GAAP basis, we are reporting adjusted net income of $4.5 million or $0.11 per diluted share for the first nine months of 2016 compared with an adjusted net income of $2.3 million or $0.06 per diluted share for the first nine months of 2015.

Cash and cash equivalents as of September 30, 2016, were $14.9 million. This does not include an $8 million milestone payment we earned and recognized in the third quarter and received payment for in October. As such, the milestone was recorded in accounts receivable on our balance sheet as of quarter end. We expect to continue managing our cost related to new product development and litigation while maintaining a healthy cash balance.

In connection with our effort to increased cost efficiencies in the quarter ended September 30, 2016, we began the process of liquidating our Indian subsidiary. In order to accomplish this, we are legally required to maintain our subsidiary's cash balance in an account managed by a legal trustee to satisfy our financial obligations. This balance was previously classified as unrestricted cash and is now included in restricted cash under current assets on our consolidated balance sheets and totaled $0.9 million on September 30, 2016.

And finally, we are narrowing our 2016 revenue guidance range that we introduced on our 2015 fourth quarter call. We now expect total revenues for 2016 to be $47 million to $49 million, which represents 12% to 17% growth over 2015. Our prior guidance was for $46 million to $49 million for the first nine months. Revenues for the first nine months of 2016 totaled $39 million. So we are tracking well against this new expectation. Our revenue guidance assumes growth in our core biocatalyst R&D and product businesses, and we are narrowing our expectation for the range of gross margin as a percentage of total revenues to be in the 80% to 82% range for 2016. We are tracking well against our guidance outlook with gross margin for the first nine months of 2016 at 81%. We'll be introducing financial guidance for 2017 during our fourth quarter 2016 call in early March.

With that, I'd like to turn the call back to John.

Thanks for that financial review, Gordon. Let me close by highlighting our excitement in regards to our progress on multiple fronts.

First, as was highlighted in today's call, our CodeEvolver platform technology is proving its ability to engineer and commercialize enzymes that can reduce the cost and environmental impact of a growing list of manufacturing processes. And this is of increasing importance at this critical time when pharmaceutical companies face increased pressure on their drug pricing. Accordingly, we continue to be encouraged about our advancements discussing CodeEvolver platform technology licensing with other pharmaceutical companies beyond GSK and Merck. Since announcing our first platform license deal with GSK, we have stated that our plans are to enter into a new CodeEvolver licensing partnership at least once every one to two years, and we affirm that outlook once again today.

Second, we continue to impress clients with our protein engineering capabilities. The platform deploys leading-edge synthetic biology modules, uniquely working in concert to create improved proteins. Biology tool enhancements like next-gen sequencing and artificially intelligent bio-algorithmic -- bioinformatic algorithms are driving module improvements, and their orchestration into CodeEvolver is enabling us to create new enzymes across a growing class of enzyme types more quickly and effectively than ever.

Additionally, given the robustness of the platform, coupled with the deep experience base of our scientific staff, we are able to move our R&D team seamlessly from one project onto another without time delays or other inefficiencies. With this fluidity and a robust pipeline of both customer-funded and self-funded programs, we can be rapidly responsive to customers to start new protein engineering projects for them.

And finally, on the financial front, as we move toward year-end, it is gratifying to narrow our revenue guidance to the upper end of our previous guidance range. We are looking forward to completing our third consecutive year of double-digit top line growth as we make progress in driving Codexis toward sustained profitability.

Before opening the call to questions, I would like to introduce the newest member of Codexis' executive team. Michael Aldridge joined Codexis last month in a newly created position of Senior Vice President, Corporate and Strategic Development. Michael is charged with the important functions that include the global expansion of our biocatalyst business, striking new licensing transactions and building momentum for our own biotherapeutic pipeline. He is already tapping into an extensive network of contacts he established during his years as a pharmaceutical executive and health care investment banker.

With these comments, I'd like to open the call to questions. Operator?

(Operator Instructions)

While we're waiting for our first question, I'd like to mention that we will be participating in two upcoming investor conferences. We'll be presenting and webcasting at the Craig-Hallum Alpha Select Conference on Wednesday, November 16, in New York. In addition, we'll be presenting at the LD Micro Main Event Conference on December 7 in Los Angeles. We will also be holding one-on-one meetings with investors during the JPMorgan Healthcare Conference during the week of January 9, 2017, in San Francisco. Please let us know if you're interested in a meeting. Okay, operator, we're ready for the first question.

And our first question comes from Matt Tiampo of Craig-Hallum. Your line is now open.

A couple of questions from me. First, it seems like Merck has seen-- is seeing some ongoing price pressure on Januvia, but it sounds like they're also seeing a nice volume uptick there. I'm just wondering what -- and if it's possible for you to parse out how much of your strength for that enzyme has come from just simply taking share within the Januvia supply chain and how much maybe from end-market growth.

Yes. So as you know, Matt, we've been working over multiple years with Merck to develop and ultimately evolve a new enzymatic which uses Codexis' enzymes for the manufacture of Januvia. Our recent uptick in product sales to Merck for Januvia is mostly a function of Merck shifting their manufacturing network to be using the enzymatic process that we developed. So it's mostly a function of our growing share within their manufacturing network that's been leading to our uptick in product revenues to Merck's Januvia manufacturing.

Great. And then on the potential for another platform license fee, I assume you have some capacity to move forward on that front since you've cleared Merck and GSK. Should we be thinking about sort of the five -- top 10 pharmas that you've highlighted in your call has been sort of the most likely targets, you think, for a second -- or a third license deal?

I think they are amongst the most likely for sure. I think the platform license arrangement is most valuable to the largest of the drug companies because they have are the largest drug pipeline to consider enzyme-improved processes. So the larger, the more likely that the client will be able to justify the cost and effort of a platform license.

And then also just to state the obvious, the fact that we're working so intimately with these other five companies besides Merck and GSK is evidence that these companies are also quite aware and are working active projects to install our enzymatic approach to the manufacturing of drugs. So those are both very strong conditions for making them targets for the next platform license.

Great. And maybe -- sorry, I'll go back to Merck for one second. How many internal R&D teams do you have sort of committed to Merck's ongoing development? And then now many teams did they have at their facility, working on their license version of the platform?

I'm not going to answer the first question explicitly. Merck has just finished tech transfer. They have purchased the license and have set up a team that can do multiple protein engineering projects in parallel, certainly more than two, maybe as many as four or five with the team and the equipment that they've set up. But currently, they are just about to embark on stepping up their parallel projects in their brand-new CodeEvolver facility. We're doing -- right now, we have more than their capacity projects installed in place right now within Codexis' R&D team. So it's more than their capacity currently.

Great. And then on your oral PKU asset, what are the next steps that we should be looking for in terms of progress with that asset? How do you think you'll message that over the coming months?

Yes. We continue to be encouraged by the progress of our oral PKU drug candidate. I highlighted in the prepared remarks that we've done additional animal testing that encourages us and that we've done additional planning to be able to approach the FDA to be able to trial the drug in human trials. That's the so-called IND event. And so we're doing mostly planning work right now. So the next event for us to detail for our investors is explicit statements of our progressing towards those milestones, sharing a little more data about the efficacy in the animal trials and starting to detail how we might be approaching strategic companies to consider a market testing of what this asset might be worth to strategic partners at this preclinical stage.

Great. And sorry, any thoughts on timeline as to when we might hear more about that?

Yes. Last quarter, I got a similar question, Matt. I don't recall if it was from you or somebody else, but we said it will be towards the end of this year or early next year. And it's unlikely to be before Christmas, but it's still very likely that we'll give a lot more clarity as we begin next year.

And our next question comes from R.K. of H.C. Wainwright. Your line is now open.

John, just a couple of quick questions. You've talked about 7 of the top 10 pharma companies working with Codexis at this point. So what's the nature of these relationships, in the sense are they more like the Merck kind of relationship or a GSK [side]? And also, within the new five, if you can call them that, what's the time line in terms of where the relationship is, such that can you kind of keep them over the next couple of years or next three, four years as one at a time? Or they -- can they come up as a lump sum in the next year to 18 months?

Okay. I'll do my best. The good news is, is that the amount of activity we have with the largest pharmaceutical companies right now is -- has been accelerating and is a very strong part of our activities and our revenues. So that's really good. We detail a lot about Glaxo and Merck. So I'll keep those comments about those two clients off to the side and just focus on these other five.

I mentioned that one of these companies, we have never done any business at all with. That's extremely encouraging. So we've gotten them to understand our technology, gotten their openness about their -- the chemistries of their small molecule drugs to the point where they are excited, and we believe are set up to start doing real enzyme engineering work to overhaul potentially multiples of that great client's processes. So that's from nothing to an exciting activity set for the company, but it's very early stage.

As you know, we go through a progression of relationship -- business relationships with clients when we're working to reduce the cost of their manufacturing processes by designing enzymes from R&D, where we design a novel enzyme for R&D fees. We work with the client to get the enzyme to hit performance targets with R&D fees. Often time then, we will wait because most of our projects with big pharma are targeting clinical programs. So we have to wait for needs for material. We then will supply batches of clinical orders. I highlighted one of those in my prepared remarks with one of these five clients. Those are nice six-digit orders that they need the enzyme to make their drug to do their next clinical phase, all the way to getting our enzyme -- our commercially designed enzyme to be installed in their commercial process so that when they make the drug that they'll need the catalyst -- the biocatalyst to make their drug. And they'll be consuming and buying our product on a somewhat regular basis, kind of like we're doing with Merck and their Januvia business.

So that's the complexion of how revenue unfolds over time. I just described a multiyear process, but I think the whole effort with these five clients is relatively modest or earlier stage. Some of them are in clinical phase programs for our clients. Some of them are in engineering stage. And we mentioned two of our product sales are fully commercialized, one to Merck for Januvia, and a second one to an unnamed large top 10 client as well.

So hopefully, that helps, R.K. I know I didn't answer your question precisely, but that gives you certainly a good complexion of how revenue should unfold with these clients over time. Maybe one more comment before I open it back up to you.

Ultimately, when a client sees just how widely applicable the protein engineering approach is to designing novel drug processes, there is a tipping point where they see that it's far more economically and strategically beneficial for them to enter into a platform licensing arrangement instead of working with us on a project-by-project basis. And we're hopeful that over time -- and Matt Tiampo asked the question, that over time, some of these companies will advance to platform licensing relationships like we've gotten with GSK and Merck.

Okay, that's great. And then it's from your press release, announced in your opening remarks. You're talking about GSK's project-specific revenue that you received this quarter. Is this the kind of average size that you expect in the future? And what's -- and what kind of visibility do you have? Because you talked about how excited you are for trying to get a series of growing revenues based on this relationship. Again, we always get into a trouble of understanding the timing of these things. Is there -- any color on that would be helpful.

Sure, sure. Certainly, we're excited that we're already starting to see revenues from the back end of these platform licenses, the first one with our first deal with GSK. The way the milestone structure is set up in the contract with GSK, it's a stream of milestone payments that grow as the drug for GSK grows. So this is an early milestone. So it's small relative to our hope for longer-term milestone payments from GSK. So if this particular project continues to advance, the next milestone payment for this particular program would be larger than the payment we just recognized and received in the third quarter.

Visibility will be challenging. But these could be significant pieces of our overall revenue. So we will surely be giving some color commentary as we give you our 2017 financial guidance outlook in the beginning of next year, as Gordon mentioned. If there -- if we expect any milestone payments to come from the back ends of these two licensing partnerships, we would likely give details in our guidance outlook to those being forthcoming or not. So --

Okay, one last question and then I'll step back into the queue. Regarding the biopharma partner, in terms of the nonexclusive license that you recently signed with them, is this for the technology, I mean, for the platform itself? Or is this for the product? And if it is for the product, could you potentially -- I mean, could you see that potentially, there could be additional products from the same partner?

It is a preclinical program area with this biopharma partner. I don't have a lot of visibility to how many different programs that partner may have that could, in principle, use the enzymes we develop. So it's hard for me to know. The annual payment is not a function of the number of products from our clients but actually the advancement of product through their pipeline. If that's helpful.

And our next question comes from Kevin DeGeeter of Ladenburg. Your line is now open.

This is actually Jay Colby on the line for Kevin. So in the prepared remarks, you mentioned that the general biotech pharma pricing trends were providing a positive boost for Codexis. Could you elaborate on what you're seeing? And are these conversations more R&D focused or a product focus, working on commercial drugs or in the clinics?

It's both, and it's just a broad kind of conversation at higher levels. I think you're aware of the higher-level issues facing the large drug companies, in particular, regards pricing of their drugs. Of course, they will defend the rationale for their pricing as part of their strategy, but they are also increasingly looking backwards to the manufacturing groups to find ways to reduce cost as a way to mitigate potential price erosion. And the more progressive companies are going even farther upstream and putting pressure on R&D departments to come up with better processes in the first place before they file for the FDA approval. And actually, it's in that area that we see the most energy coming back to Codexis, where we see a growing set of requests, a growing set of projects to design our catalysts into their clinical-stage processes early as a way to install ultimately longer lower -- longer-term lower cost processes.

Okay, great. Thank you. And I guess on the same lines, has this had any impact on your ability to price newer contracts?

We priced our contracts for value. We have to share the cost savings benefit with our client. Otherwise, they wouldn't move with us. So if we create a $100 of value, just for example, we're negotiating who gets what piece of that $100. If it's -- if we're able to design a biocatalyst that reduces the cost by 30%, all things equal, we're increasingly successful at getting a higher enzyme price than if we're designing an enzyme that reduces the cost of the process by 5%. And so that gives you a feel for the kind of customization of pricing, if you will, that is appropriate and warranted and the way we price our enzymes with our clients.

Okay. Thanks. And then with your experience with GSK and Merck on the platform agreement, what is -- what has the lead time looked like from, sort of when you began discussions about a broad platform license agreement to when you sign the papers?

Well, those are the first two deals. They're not -- it's really hard to translate because we've been talking to many, many companies about a platform licensing arrangement ever since we announced the GSK deal back in 2015 -- I'm sorry, in 2014. So we've been talking to many companies for two years, and obviously, outside of Merck, we haven't yet consummated a third deal. And some of those customers, in principle, we've been talking to for a couple of years. So it's not fair to compare with Glaxo and Merck.

Every client has around -- reception to the concept of a platform license justification. Every client has a somewhat different pipeline of drugs to consider how much money biocatalysis can save. Every client has a different attitude about how important it is to invest in cost reductions. So we're finding every client to be a very unique set of conversations, but as a whole, we continue, quarter after quarter, to be encouraged that this is an outstanding model for working biocatalysis into a large company, and we are promoting it as a preferred way to work strategically with major pharma partners. So we're encouraged that we're going to continue a stream of deals beyond GSK and Merck accordingly.

Okay. And then last from me. Can you just -- what do you think about, first, timelines for an update on the new food industry enzyme and also the new vertical you're working on? Thank you.

So the program that we're finishing in the fourth quarter with our second food industry company will need additional R&D chapters. It is an aggressive target. We're -- continue to be very encouraged by the results and the partners' attitude to drive through those R&D chapters. So that will take some time.

The self-funded program for a food ingredient that has widened food industry interest, we're hopeful that in the coming 12 months at least, we'll be disclosing what that is and how we're bringing that to market and in what format. So I think it's that kind of time frame and I'd say similarly with respect to our new enzyme for the new vertical.

Again, as a priority on these programs, we're very excited about both of them. We think it makes great sense for us to fund these by ourselves because it's giving us additional leverage to drive better economics for launching these enzymes as we advance the R&D with our own -- we basically derisk the project before we promote it to clients.

(Operator Instructions) And our next question comes from Steve Schwartz of First Analysis. Your line is now open.

So first question is just with respect to the milestone revenues, if you could help me understand the components of the $11.5 million. I understand, at least in my model, I've got some amortized amounts for about $1.1 million between the two, GSK and Merck, and then of course, you took in $8 million. What's the rest that gets you to the $11.5 million?

Steve, it's Gordon here. A variety of R&D service revenue projects with major pharma and the food industry customers. We had accelerated amortization with GSK back in the -- earlier this year because we wrapped the whole thing up. In this case, with Merck, we were able to achieve all the deliverables under the milestone requirements for wave two and the completion of tech transfer, but there was some ongoing effort through November to wrap up the whole project. So we will be recognizing some of that accelerated amortization in the fourth quarter.

I see. So like GSK, for example, when you -- from July of '14, when you amortized the $6 million, that gives you about $0.5 million a quarter. So you're saying that $0.5 million was higher for GSK because you've accelerated now, right?

Well, the upfront, yes, was amortized over three years. We finished in roughly two. So we were able to accelerate the remaining year, which was roughly $2 million earlier this year.

$2 million, okay.

Yes. So from Merck, the upfront was amortized -- originally over 24 months was what we anticipated, but we finished the project in 15. So we will be able to recognize the balance of that in Q4.

Okay. So in other words, where we had some of those amortized amounts carrying into '17, we should be eliminating those?

Yes. We'll be able to recognize it in '16, yes.

Oh, that's good to know, okay. And then just with respect to the higher payroll expenses. So I think you commented on it in the press release, and you've made some comments here on the conference call. It sounds like it's more salaried bodies plus they are higher level of contract employees. Merck is part of that. Is Merck the salaried people or contract people?

It's not -- I think it's not contract people. It's more we had outside services for a variety of reasons and some consulting that was earlier in the year. The increased headcount cost primarily relates to a modest increase in R&D staff because our pipeline is so full with projects plus the internally funded projects that we were able to modestly increase the number of people in R&D over the last three or four months.

Okay. So is this third quarter expense level kind of your go-forward rate for that expense?

I think, roughly, that's fair to say, yes.

Okay. And then with respect to Exela and argatroban, the $445,000, is that -- typically that's where that level will probably stay going forward, do you think or --

That's the best we can tell at the moment. There may be some pick-up in that. I think that, that will probably be next year. We're not anticipating a pick-up in the fourth quarter.

Okay, okay. And then with respect to the Merck payment, the $8 million, I think when you did a press release in early October, you kind of suggested that money came in, in the fourth quarter, was going to be recorded in the fourth quarter. Is there any reason or -- of importance that we should note why it seems to have gotten -- moved to the third quarter versus fourth quarter? Is that just simply some accounting mechanism?

It's just the accounting because we were able to recognize the revenue in the third quarter, but we didn't -- 30-day payment terms, we didn't get the cash until 30 days later in October.

Okay, okay, all right. I have a few strategy questions, but I'll get back in queue. And if there is time, I can circle back -- we'll talk about those things. Thanks.

And I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Nicols for any further remarks.

Okay. Thank you. I'd like to close by thanking you for joining us this afternoon. We're proud of our strong financial and operational performance and are excited about our prospects for the quarters and years to come. We look forward to providing a progress report on our next quarterly conference call. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect.