Codexis, Inc. (CDXS) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Q4, 2016 Codexis Inc's Earnings Conference Call. At this time, all participants are in a listen-only-mode. Following management's prepared remarks, we will host a question-and-answer session and our instructions will follow at that time. [Operator Instructions] As a reminder this conference is being recorded for reply purposes. It is now my pleasure to hand the conference over to Jody Cain. Ma'am please proceed.

This is Jody Cain with LHA. Thank you for participating in today's call to discuss Codexis' 2016 fourth quarter and full year financial results and business progress. A slide deck to accompanying today's call is available on the investor section of the Company's website at www.codexis.com. 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 2017 financial guidance including total revenues, revenue growth and operating expenses as well as product revenue, product revenue growth and gross margin as percentage of product revenues. The Company's expectations and it will announce the third CodeEvolver licensing agreement in the second half of 2017 that it will receive revenues in 2017 from this licensing agreement that as a result of total revenues will be higher in the second half of 2017 than in the first half of 2017, and then it will continue to announce new CodeEvolver licensing agreements approximately every one to two years. The Company's expectation regarding future revenues from this CodeEvolver licensing agreement with GSK and Merck, the Company's expectations regarding continued development partnering and regulatory approval efforts with CDX-6114 for its biotherapeutic candidate for the treatment of PKU, the Company's expectations that it'll continue developing additional biotherapeutic products, the Company's expectations regarding sustained product sales under tqo enzymes supply agreement with Tate & Lyle, the Company's expectations regarding the prospects and market availability of the Company's first in time for the use in next generation sequencing for molecular diagnostics and genomics research and its contribution to revenue in 2018, the Company's expectations regarding technical improvement to its CodeEvolver platform licensing technology, the Company's expectations regarding revenues from its revenue sharing agreement with argatroban injectable drug with Exela Pharma Sciences, and the Company's expectations regarding introduction of a protein for a new industrial vertical. 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 and November 8, 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, March 9, 2017. 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, Jody. Good afternoon everyone and thank you for joining us. We've posted a brief slide presentation to accompany today's call on the Investor Section of our company website and we invite you to follow along. I’m proud to report on another highly productive year at Codexis. Turning to Slide 3 on our slide deck, 2016 was our third consecutive year in which we achieved our financial guidance. I'd like to share some highlights of our many accomplishments beginning with revenues. Our total revenues in 2016 increased 17% to $48.8 million reaching the high end of our guidance range and representing a three-year compound annual growth rate of 15%. Additionally, we're reporting gross margin as a percentage of total revenues of 80%, similar to last year and remarkably up from three years ago when we achieved 54%. Sales growth in 2016 came from our core protein catalyst business with product sales increasing 35% on higher demand for our enzymes and R&D revenues up 23%. We delivered on multiple fronts throughout the year with many advancements that strengthen our business as we build a strong foundation for continued growth. Among these, we successfully completed the transfer of the technology portion of our CodeEvolver licensing agreement with GSK and Merck, both ahead of schedule. Discussions with other large pharmaceutical companies to follow GSK and Merck and securing a CodeEvolver platform license have grown in advance. We successfully demonstrated the efficacy of our orally dosable enzyme therapeutic candidate for phenylketonuria or PKU disease now in four different animals including a primate with its gastrointestinal similarities to humans. We built significant momentum in our protein catalyst pipeline, adding new protein engineering service deals throughout 2016 that widen the front end of the pipeline, and we advanced multiple proteins to commercialization creating new sustainable revenue streams for our future in the form of product sales and/or licensing economics. I'd like to highlight four of those pipeline advancements in 2016 to help illustrate the momentum we created in 2016 leveraging our CodeEvolver protein engineering core. First, highlighting that our cost savings model works not only in pharmaceuticals but also in other industry, we commercialized and installed our engineered protein catalysts in Tate & Lyle's food ingredient manufacturing operation. We signed a multi-year enzyme supply agreement with them, setting up to sustain product sales into the food industry going forward. Second, demonstrating that our protein engineering can also aid in the discovery and development of novel biotherapeutics, we delivered for our partnership with the leading biopharmaceuticals company. We exceeded the projects pre-negotiated performance targets, earnings us a success fee plus our first annual license fee payment when they exercise a non-exclusive license option to the technology we created. Third, we started to show the revenue generating engine from the backend of our CodeEvolver platform license deals, earning the first milestone payments from GSK for a CodeEvolver developed enzyme, targeting the transformation of a patented and approved GSK drug process. And finally fourth, we developed our first enzyme for use and test for any market of next generation sequencing for molecular diagnostics and genomics research. We are confident our improved enzymes, the first and series of products we planned to launch to these customers will add value versus incumbent the bio-enzymes. These are just some of the successful examples of long-term value creation we are delivering currently from our protein creating engine. The technology is at the core, but so is our competence to collaborate and partner, by engineering a custom solution than supplying, by licensing the platform then training on it to use, by discovering novel performance attributes then out licensing this application. We are proven partner to a growing number of world's great companies, nimble and experienced to find the ideal way to share the value created by our world leading protein engineering platforms. The universal potential protein based materials is vast and largely untapped. Our core technology and our partnering competences are increasingly tapping into that universe increasingly creating value for our shareholders and clients. Our outlook for 2017 clearly reinforces this continuous this growth. Before I get into that, let me turn the call over to Gordon for a detailed review of our financial results in 2017 and to provide the details of our financial guidance measures for 2017. Gordon?

Thanks, John. Let me give you some financial highlights from the fourth quarter as well as the full year. Turning to Slide 4 in our presentation, total revenues for the fourth quarter of 2016 were $10 million. This was a strong showing against the difficult comparison from the prior year that included a $3.1 million royalty settlement payment from a non-core legacy customer. So, good growth excluding this one-time payment was 17%, which is consistent with the full year. R&D revenues were $5.3 million for the quarter, down from $6.4 million in the prior year quarter which includes that $3.1 royalty settlement payment. In the 2016 fourth quarter, we recorded $1.8 million in previously deferred revenue from the early completion of our technology transfer to Merck. Product sales for Q4 2016 were $4.2 million, down by 200,000 from the prior year while the decrease was due to fluctuations in demand for our enzyme products. We continue to increase shipments of enzymes to Merck for the production of sitagliptin, the active ingredient in Januvia. Revenue from our revenue sharing arrangement for argatroban injectable drug with Exela contributed $375,000 to the fourth quarter total. We expect revenues from this agreement to continue in this range in the coming quarters. Gross margin as a percentage of total revenues for the fourth quarter of 2016 was 77%. This compares with 78% for the fourth quarter of 2015, which again reflected the recognition of the royalty settlement payment. Gross margin as a percentage of product revenues for the fourth quarter of 2016 was 46% compared to 42% from the fourth quarter of 2015, reflecting an improved sales mix. Turning to operating expenses, R&D expenses were $6 million for the fourth quarter of 2016, a 14% increase from the prior year period primarily due to costs associated with higher headcount and higher outside services related to our PKU biotherapeutic development. SG&A expenses for the fourth quarter of 2016 were $7 million, a 16% increase from the prior year period and reflected a foreign tax receivable write-off and increased costs due to higher headcount mainly due to additions to our business development achievement. The net loss for the fourth quarter of 2016 was $5.3 million or $0.13 per share. This compares with a net loss of $2.1 million or $0.05 per share for the fourth quarter of 2015. On a non-GAAP basis, adjusted net loss for the fourth of 2016 was $2.8 million or $0.07 per share, which compares with adjusted net income for the fourth quarter of 2015 of $600,000 million or $0.02 per diluted share. Turning to our full year financial results, total revenues for 2016 were $48.8 million, which is up 17% compared with 2015. As John stated, this was at the high end of our 2016 revenue guidance range. Total revenues for 2016 included $31.3 million in R&D revenue, $15.3 million in product sales and $2.2 million from the revenue sharing arrangement. Gross margin as a percentage of total revenues for 2016 was 80%, also meeting our 2016 guidance. R&D expenses for 2016 were $22.2 million which compares with $20.7 million for 2015. The increase was due to higher consulting fees which we incurred for the evaluation of potential new drug development targets, marking an important investment in our future growth as well as higher fees for outside services and increased cost associated with our higher headcount. SG&A expenses were $25.4 million for 2016, up from $22.3 million for the prior year mainly due to higher legal expenses associated with our intellectual property litigation, higher consulting fees and the exploration of business development opportunities and the cost related to the higher headcount as I previously mentioned. For 2016, we reported net loss of $8.6 million or $0.21 per share, and this compares with the net loss for 2015 was $7.6 million or $0.19 per share. On a non-GAAP basis, we’re reporting adjusted net income for 2016 of $1.7 million or $0.04 per diluted share. This compares with adjusted net income for 2015 of $3 million or $0.07 per diluted share. Cash and cash equivalences as of December 31, 2016 were $19.2 million versus $23.2 million as if December 31, 2016. We expect to continue to tightly manage our costs related to new product development and litigation. Turning to Slide 5, we're introducing financial guidance for 2017 as follows. We expect total revenue to reach between $50 million and $53 million. We also provide guidance on product sales of $21 million to $23 million, which is a 37% to 50% increase over 2016. Guidance on gross margin for product sales is between 37% and 39%, which is an increase over gross margin on product sales of 36% for 2016. Our revenue guidance assumes the recognition of an upfront payment and the achievement for our first milestone related to our third CodeEvolver licensing agreements, which we expect to announce in the second half of 2017. Given the anticipated timing of this agreement, we expect total revenues to be higher in the second half of 2017 versus the first half of the year. Finally, we are providing guidance for operating expenses which is combined total of R&D and SG&A expenses to increase by between 6% and 8% over 2016. This assumes the full year of expenses related to the development of our PKU drug candidate as we advanced this asset towards an IND. Please note that our reconciliation GAAP to non-GAAP financial metrics is included on Page 8 of this presentation. With that, I'd like to turn the call back to John.

Thanks for that financial review, Gordon. We are very proud to provide the strong guidance expectations for 2017 highlighting our confidence and the continued top line growth of the Company. While single digit percentage growth of our revenue is somewhat lower than our recent performance, note that we're offsetting, more than offsetting the headwinds from a $15.5 million in milestone payments we've recorded from the two early CodeEvolver tech transfer completions last year plus the continuing declines expected from our Exela revenue sharing for our argatroban. Core protein catalyst product and R&D service revenues from our pipeline momentum, quality sustaining revenue sources are stepping up to carry our growth in 2017. Let me finish our prepared remarks by reviewing our strategic objectives for 2017 on Page 6 of the investor call deck. Our business is accelerating and expanding on multiple fronts as we kick off 2017. First, our growth is driven by our CodeEvolver platform technology. In particular, the software and algorithms that enable us to engineer optimal proteins are a core source of competitive advantage for the Company. We will continue to invest and upgrading CodeEvolver in particular increasing applying artificial intelligence and machine learning technologies to make us design better proteins even faster and less costly than today. Second, we are focused on delivering on our core protein catalyst business with expected growth of 37% to 50% in product revenues at higher gross margin that reported in 2016. This includes continued growth of our R&D service revenues as we use our CodeEvolver technology to engineer new proprietary proteins. Furthermore, we'll continue to accelerate our protein catalyst penetration into the food industry, expecting 2017 to be the highest revenue year in that industry of all time. Third, we expect to announce our third CodeEvolver licensing agreement with another large pharma company, including recognition of the upfront and first milestone payments. We're affirming our outlook for one new deal every one to two years. The backend economics associated with our GSK and Merck deals will be minimal revenue contributors in 2017, but are expected to ramp up in 2018 and thereafter. Fourth, we'll continue to expand and advance our pipeline of internally developed biotherapeutics. We're performing the necessary preclinical development activities for CDX-6114 our candidate for PKU disease with aim to receive an IND approval from the FDA in the middle of 2018. We're in discussions with prospective partners for CDX-6114, encouraging us that we've a valuable, marketable preclinical asset based on our successful animal research. And we're advancing the discovery of several other promising biotherapeutic candidates in 2017 in hopes to build follow-on successors to what we've been able to do with CDX-6114. Fifth, we expect to demonstrate a credible market acceptance for our new enzymes that validate improvements to customers next gen sequencing and PCR diagnostic results and setting up for what we believe will be a multi-million dollar revenue contributor for Codexis in 2018. And finally, we expect to position our protein creating engine into another new industrial vertical as we move towards 2018, further highlighting the vast applicability of our versatile CodeEvolver platform technology. It's an exciting time here at Codexis. We look forward to updating you on all of these developments as we move through this year. With these comments, I'd like to open the call for questions. Operator?

Thank you, sir. [Operator Instructions]

While we're waiting for our first question, I'd like to mention that we'll be participating in two upcoming investor conferences. We'll be presenting at the Craig-Hallum Institutional Investor Conference on May 30th in Minneapolis and at the Jefferies Healthcare Conference been held June 6th through 9th in New York. A webcast for the Jefferies Conference presentation will be available on the Investor section of our website. Okay, operator we're ready for the first question.

Yes, sir. Our first question will come from the line of Matt Tiampo of Craig-Hallum. Please proceed.

I wanted to start off maybe with we can drill down a little bit on contract R&D and specifically on sort of the regular way contract R&D. It looks like kind of back of the envelope backing out milestone payments that was probably about $9 million this year. What are your expectations for growth their going forward and is that back of the envelope maths sort of in the right ballpark?

I'll let Gordon answer the back of the envelope. This is really strong part of the revenue outlook for the Company. We grew our R&D service deals and revenues from those deals in 2016 compared to 2015, and we expect this area to be a continued significant source of growth for us as we have started 2017 and have built in growth expectations for larger R&D service revenues in 2017, as we built and provided you our guidance, as part of what's lead us to increase our headcount in R&D as we ended last year that moderately increase headcount in R&D enables us to do more projects. In addition, the productivity of our protein engineering continues to improve. So, we're able to deliver results in quicker periods of time. So the net effect is we're able to produce, engineer more and more new proteins with our R&D capacity, and that's a key source of our revenue growth in the recent pass and certainly moving through 2017.

Yes, to answer your question about the calculation Matt, you need to remember that we have, we're able to recognize deferred revenue on the completion the tech transfers to both Merck and GSK, which totaled $3 million to $4 million during the quarter or about $1.8 million for Q4. The R&D service revenues are certainly growing and we expect them to grow even faster. And partly that's enabled by Merck paying for and not only having the lab in the room facility back east, but also came for additional teams here because they're embracing the technology so much that they're seeing more and more products that it can be used on. So, it's a helped by Merck certainly we're seeing that grow in other areas as well.

Great, thank you. Just maybe another point of clarification on your expense guidance, Gordon. Is that 6% to 8% OpEx growth? Is that in reference to GAAP or non-GAAP operating expenses?

That's GAAP expenses.

Great. And then to sort of last one from me and then next to hear the update on the PKU program, but maybe moving forward. What are boxes that are left to be checked this year in terms of getting us to the point we're ready for an IND submission? And if you could remind us maybe to refresh, how much you spent to-date and then what your thoughts are on path forward over the next year and when you think might be the optimal time to seek a partner?

I'd say, I think I'll your questions in slightly different order. Through last year, we have invested including internal expenses in the range of $2 million to develop the PKU by our therapeutic candidates. Those costs increased in 2017 compared to 2016 as we move towards seeking the IND approval of the FDA, and that the major elements of the preclinical development work that we're spending on this year will be the creation of stockpiles of materials to do toxicology and ultimately prepare for the early trials in humans, and also the expense associated with actually doing longer term toxicological assessment of our drug candidate.

Okay. And then in terms of the boxes left to check to get us to IND from here?

Those are the primary boxes. They take time. They take time to produce these materials. The particular toxicology support that we're doing is a 28-day study that's misleading in terms of how long it takes. It actually takes the better part of three to four months to do a 28-day study including all the analytical work associated with that. And so, that's, those are the primary elements of workflows to move towards an IND. We'll also have communications with the FDA along the way. We're developing what would be our approach for doing clinical trial work, Phase 1 clinical work, but that's really mostly consultancy work along with the team to assess the various optionality for testing this drug in early human trials, but those are the major boxes to check to reach an IND.

And then maybe just can you give us a little bit of sense for the magnitude. I mean I think BioMarin spent roughly $20 million to get their products, their enzyme products to an IND. We're talking about another 18 million or your guidance would suggest significantly less than that?

Yes, our guidance does suggest it's significantly less than that. We've included the full year of IND enabling costs in the OpEx guidance that we provided on today's call; and while it is greater than the 2 million, we spent it's certainly remarkably less than $10 million built into our OpEx outlook for 2017.

Thank you. Our next question will come from the line of Kevin DeGeeter with Ladenburg. Please proceed.

I want to kind of get into a question of how much visibility you have on product revenue growth and maybe kind of start by looking at this in the context of 2016, the 35% growth year-over-year. So, Gordon, how much of that was principally new customers that contributed have 35% growth and how much of it was existing in our expansion on existing relationships and contracts?

It's a mixture of new and existing customers, Kevin. A big contributor was sitagliptin from Merck. They're rolling the production of sitagliptin for Januvia to a second and then a third facility worldwide, and so we're benefitting from that push on sitagliptin as it takes over using our technology in different manufacturing facilities. So, we're expecting to see that continue to grow pretty strongly in 2017, and the rest as a mixture of kind of generic and branded pharmaceutical customers mainly who are adding to the strong growth that we saw of 35% for the year.

And with regard to your guidance for the third CodeEvolver agreement 2017, can you just kind of walk me through -- what appears to be a really high level of confidence that you have with regard to the timing in the second half of '17. Specifically, it's a significant interval from kind of where we stand today. So, what are you seeing today that gives you a high level of visibility on [Indiscernible] that you're projecting being three plus months off?

So, first, there's increasing awareness of the value of the type of deal we did with GSK and the world of larger pharmaceutical companies. And that's enabled us to really deepen and expand the number of significant conversations we're having with other large pharmaceutical companies about the value and the applicability of this kind of a platform licensing arrangement for them as well as that bodes well, not only for the third deal, but also thereafter. With respect to the third deal, I would say that we're in significant discussions with several that have advances to the point where we believe that we're within that six or so months' window of actually having a transaction. And so clearly that indicates a reasonably advanced state, but not a complete state of finalizing the transaction, which obviously still have drafting and contractual work to be done before we can announce the effective transaction milestone for the Company. But again we're quite confident, we built it into our guidance, it's looking very solid with respect to continuing CodeEvolver platform licensing accordingly.

And then maybe just one last one for me and it pretends to development of additional biotherapeutic programs and enzymes. Can you just walk us through what you've learned in context of development of PKU? And how you're applying after both selection of additional potential opportunities and your thought process with regard to in general the optimal time line or position for being able to extract value for partnership? Should we expect any future compounds also go closer to IND filing before potential partnering?

Sure, yes, a couple of questions in there. So, first, we see that our CodeEvolver protein engineering can enable improvements in multiple kinds of biotherapeutics. Obviously, like in the case of PKU, the creation of improved enzyme therapeutics and that's a very natural target for our company. And that's a pretty wide universal potential disease targets that we can go after theatrically with a novel enzyme therapeutics, so we've been -- the technologies bodes well to create new improved biotherapeutics in the enzyme therapeutic space. I'd say much of what we've learned in 2016 was actually studying those various part disease targets. They're the current solutions, if they need to those potential targets; and basically some economic and business analysis around those targets, that we've factored together with the technical feasibility coming up with the better product, using our platform together to create our follow up pipeline. It's pretty early days for these follow on projects we've been primarily focused on the advancement of the candidates for PKU, but we're excited about the prospects. We're confident about the success of CodeEvolver to create new candidates to assess in animal model et cetera. I think the second question was when does the stage of our development warrant kind a talking to external parties. I think that's pretty clear that, it's no sooner than after you've gotten some data that a candidate we've created with the technology actually delivers attributes and efficacy results in animal. So, we'll need to be creating candidates using CodeEvolver, identifying lead candidates from CodeEvolver, and then trialing them in animals, and getting successful animal results before we would ever showoff a new candidate to a strategic company. In addition, we would of course want to get our patent filings and our intellectual property in place as well. So, those are -- once we've got those two in place then it's time, if we want to start sharing our biotherapeutic candidates with third parties. Does that answer your questions?

It does. Thanks so much John.

Thank you. Our next question will come from the line of Swayampakula Ramakanth with H. C. Wainwright. Please proceed.

A couple of questions, for me to think a different way in terms of R&D revenue and the sustainability of that R&D revenue going forward is to kind of think through the pipeline snapshots that you had provided in the middle of the year last year. I know it was one of those one-off things that you tried to do for us last time, but at least at a high level could you kindly tell us where you're in terms of the number of projects on the commercial side and the pre-commercial side. So, we can kind of have an idea as to how you're doing, where there could be some growth within those two areas?

Sure, we intend like when we rolled out the pipeline summary slides which we still post on our investor section of our website. We promise that we would do that at least annually and I think that's what you should expect is that we'll formally update. It takes a fair amount of work and we've to be very rigorous and looking at the data to fill out that kind of a chart, but you should expect that again in the middle of the year. I think Matt started off questions around R&D service revenues. That has been a core growing part of our revenue in 2016 and is growing part of our revenue in 2017. So, that's strongly indicative of the growth of pre-commercial protein engineering projects. When we do R&D services, we're doing pre-commercial work where engineering proteins that never existed before, so obviously those were commercial. So, we see growth in that area. We see growth across the various sectors of pharmaceuticals. We're in particularly growing our successes in creating new proteins for existing patented approved drugs, one of the programs we've worked on in the CodeEvolver license with GSK is a patented and approved drug. We also have been successful in advancing an enzyme development for another major pharmaceutical company for another patented and approved drug. So, that's a nice growing area and we like the business case profile of engineering proteins for drugs that are already on the market. The volumes are known. It de-risks the project to know that there's an actual production versus projects that are in the earlier stage where they can fall off because of bad clinical results. So, that's the pre-commercial side. On the commercial side, that's strongly indicative and strongly tied to our product sales, which Gordon and I both highlighted remarkably on this call. We're very strong in 2016 and are very key part and very strong growth outlook for product sales in 2017. And we expect both existing products that were already commercial last year to show growth characteristics in 2016. We also expect growth of products for new installations to contribute to our growth product sales for 2017 as well.

In terms of now talking about commercial products and going back to thinking about Januvia genomic franchise. What percent of the manufacturing capacity has been converted by Merck to utilize enzyme through the CodeEvolver project? And also are do you think that Merck at point will convert all of its facilities that produce this franchise, the Januvia genomic franchise to your system, the CodeEvolver protein system?

Hi, RK. This is Gordon. I don't think they'll convert older manufacturing facility to our technology. There are certain countries where it just wouldn't work a while to qualify our new way of making sitagliptin for them because markets are too small. But they're roughly to say 40% to 50% of the way they're right now, and it's continuing to grow. We expect growth in 2017.

And then, two other questions, the first one is on the next generation sequencing product line that you had indicated to us in the middle of last year or the second half of last year. And it looks like some work has been done on this at this point so that you can get into the market at a big -- at a higher level in 2018. But what should we expect to see in 2017 in that sector? Would you be able to introduce something, some enzymes into the market and start some commercialization; and as the year progresses, we should see that sector get speeded up so that we it becomes a multi-million dollar sales in 2018. What's the strategy there?

I think what you've said was very close to what you should expect to see from us. So, we made the announced actually in January. We did disclose that we will working on creating enzymes for a new sector in the middle of last year and those connect together. I think that's why you refer to us talking about this last year. In our announcement in January, we said we would be making data quantities available for customers. We have an enzyme. Our first enzyme that's targeting the next generation sequencing machines, we are very proud of the performance of that enzyme. We've been testing it in-house. We are making materials available to clients roughly currently. And so, what you would see next is continued encouragement that the customers are saying that our enzymes are better than incumbent enzymes they're used to using. And if that follows to the next step, we would be generating at least some sales in 2017. It will take some time. We wouldn't want to set an expectation for you or other investors are okay that. There is going to be significantly material revenues this year. But if we're successful, we should be setting up for the sales to be significant for us in 12 months. So that when we're coming out with our guidance for 2018 around this time next year where it's a significant part of those the total revenues of the Company next year. We would expect to validate our belief that these would be overall higher margin product sales than our standard product sales, which we give guides on expect to be 37% to 39%. Aggregate in 2017, the sales of enzymes into the next gen sequencing we expect to be higher than that, because we think we're going to be able to deliver a value in ways that are quite value creating for our customers, helping them to do -- to use the next gen sequencing machines, to get better diagnostic results for example than they were able to with the enzymes that prepare the samples today.

Last question from me and thanks for giving us the teaser on -- going to introduce a new industrial vertical, but can you give us any more color than that in terms of getting into a new vertical in 2018?

No, actually we -- that's a quick answer. But we're talking about customers in multiple other industry sectors. Our catalyst -- our protein catalyst can reduce the cost of making any complex chemical. There're many complex chemicals being developed and made in the pharmaceutical industry and some of the most complicated chemistry takes place in that industry. So, that's why it's been a great target for the entire history of our company over the last 15 years, but there's a lot of complex chemistry being developed and being manufactured in many other industries. We've really had remarkable success in the food industry. We're now applying our protein engineering and novel proteins into next gen sequencing. I'm encouraged that we'll continue to show off applicability with new customers in new industries and that's where we're setting out a qualitative guidance for -- in this call is that you should expect to continue to see us do that.

Thank you. [Operator Instructions] Our next question will come from the line of Steve Schwartz with First Analysis. Please proceed.

I guess the first question is with respect to your CodeEvolver discussions that are going on right now for the next licensing agreement. I think I have a picture of this, but I'd like your color. The conversations are not so much that there's a competitive technology to CodeEvolver. I suspect it comes down to more on whether or not the economics of a licensing deal makes sense to the license fee, potential license fee, is that correct?

Some -- partially. the other reality is that these customers can garner some benefits from our protein catalyst just by working with us on a project-by-project basis. So, of course, we'll do R&D services for our core all of pharmaceutical companies. We're doing some major business with 15 out of the top 20 as you know already, Steve. So, the choice is really which is the better way to apply protein catalysis into their company to apply protein engineering into their company to continue to work on project-by-project one-off basis with Codexis or to step up build the team, to work on more projects more quickly with more control without having to work with the third party. And as you know, we've commenced GSK and Merck of that, and we continue to make great traction for all the companies as well.

Okay. So, is it safe to say then the potential license fees here that you might close the deal with this year are people you're already doing work with through our R&D services?

Yes, I mean all things equal. If they work with us, they've seen our protein engineering work for projects of relevance to their company. They're much more inclined to work a platform licensing of course.

In the presentation with respect to CodeEvolver, you've talked about with the strategic objectives, your Artificial AI and AI algorithms improving those. Is that something then that automatically as part of a licensing agreement gets passed on to GSK and Merck? Or does that offer you a additional revenue opportunities with your licenses? How does that play through?

Yes, potentially is the quick answer. When we have stuck our deals with GSK and Merck, they get the state-of-the-art of our technology all the way through the technology transfer completion. And as you know, both GSK and Merck are finished with the technology transfer, so they have walked in our state-of-the-art as if the completion date, so 2Q last year GSK and 3Q for Merck. So, they have the state-of-the-art at those points in time in the past and as we said in the presentation and it's fairly obvious, we continue to improve the CodeEvolver technology. And we of course have ongoing very intimate conversations with our two key licenses and potentially future licenses about how we're improving the CodeEvolver technology and it could be lead to some opportunities for follow on licensing upgrades.

Fantastic that's good to hear. And my two next questions I think you've been answered, so the answer should be quick, but with respect against to outlook for your outsourced work to licensees, namely Merck. You've added personnel, it sounds like you expect the revenue related to that work to be increasing in '17?

Yes, it's going to be a key part. I mean the growth of revenues from product sales and the growth of revenues from IND service deals are the key underpinning for year-on-year growth for the company in 2017.

And then the last one is just with respect to a PKU but more broadly molecule development, so there is been a lot of discussion about your activities with PKU today. But are you working on developing other molecules that are not related to PKU?

Yes, all of our follow up biotherapeutics versus they're all large molecule biologics because our core technology creates proteins. They're targeting other disease conditions, they're not targeting PKU, they're -- we think that enzyme therapeutic or another protein based therapeutic could help alleviate the disease conditions of these other targets and that's what we're working on.

Can you put a number around what is in that pipeline and at least those that have come far enough along that you think there might be potential three, four, or five years out for an IND?

Sure, the only real information we've provided is that last year -- last quarterly earnings call I mentioned that one of our follow-on biotherapeutics beyond PKU has begun animal research and then there was a couple of other targets where we're in discovery where we haven't even identified a candidate that warrants doing any animal research. So, pretty much with ourselves.

One preclinical, one in several in discovery?

I think that's fair.

Thank you. There're no further questions in the queue. So, now, I would like to turn the conference back over to management for closing comments and remarks.

Okay. Thank you very much. I’d like to close by thanking you for joining us this afternoon. We’re very proud of our strong financial and operational performance and are excited about our future prospects. We look forward to providing progress report on our next quarterly conference call. Everyone have a great day. Thanks.

Ladies and gentlemen, thank you for participation on today’s conference. This does conclude the program and you may all disconnect. Everybody have a wonderful day.