It's Time for Solazyme Management to Come Clean

Source: Solazyme.

Shares of Solazyme , the renewable oil manufacturer powered by synthetic biology, have been absolutely crushed in recent weeks. The broader indices haven't been doing very well, either, but there's more to the company's slide than an adjusting stock market.

Yes, Solazyme is one of the most shorted stocks on the market. Yes, crude oil prices are diving (but that doesn't have much to do with Solazyme's fall). However, delays at the company's 100,000-MT facility in Moema, Brazil, are beginning to test the patience of investors and the market. And no, these aren't delays that lead to downtime already scheduled into the ramp-up period for a new facility. Unfortunately, by this point, it's quite obvious something larger is amiss.

Have bigger problems really occurred?
The answer appears to be a resounding "yes" for many compounding reasons. In fact, I believe the writing has been on the wall for some time now. Could small and untimely delays really have occurred exactly as management described and immediately before every quarterly conference call in the last year? Sure, it's certainly possible, but very unlikely, especially given the language used during disclosures. The timeline of events -- and foot-in-mouth quotes from management -- might say it all.

Source: SEC filings, Seeking Alpha transcripts, author.

The first hint of a substantial setback (or setbacks) at Moema dates back to November 2013. Although investors were told that the 100,000-MT facility was expected to produce its first batch of commercial oils in 4Q13, CEO Jonathan Wolfson stated that the installation of additional equipment would push production into 1Q14. It was probably the right move, as the new equipment would increase the flexibility of the facility when switching production between food and chemical products -- a capability that few, if any, other manufacturing facilities have ever had.

As Wolfson said on the 3Q13 conference call, "Up until a few days ago we expected to stay on our previously committed production timeline." You could chalk that up to some unfortunate timing, but while additional equipment could very well have been added, a continuous stream of delays since has forced investors to revisit the original statement. It seems apparent that production was never going to begin a few days before the call.

On the next quarterly conference call, which took place at the end of February 2014, management once again left investors unsatisfied. Rather than announcing the start of production, Wolfson simply stated, "the clock will start soon at Moema, with initial fermentation operations just getting under way." Investors could have given the benefit of the doubt once again, since 1Q14 (the new deadline) didn't end for another month.

Yet, the only announcement at the end of March was a $202.8 million capital raise, underwritten by Goldman Sachs. The next conference call took place in May 2014, but management had more bad news. Production couldn't start because the facility was suffering from intermittent power and steam issues:

Our facility has been experiencing intermittent power and steam availability resulting from the start-up of a new co-gen facility at the adjoining Moema sugar mill... It's a big disappointment, not to be able to report from our first commercial product for Moema today. We were really hoping to do that right up to the wire.

Most investors may not be aware, but it isn't uncommon for companies to screen questions by analysts or participants and for the queue to be set by the reporting company. No surprise, then, that Goldman Sachs asked the first question -- and that it was about production delays. Analyst Brian Lee opened the question and answer session by asking Solazyme management if the delays had anything to do with the process or technology, to which Wolfson replied:

The answer is no, not at all. In fact, unlike other technologies that are bringing up the first of their kind commercial plant, Solazyme is actually running at very large scale, our technology today at Clinton/Galva we've already produced four completely distinct and unique products and sold them and are shipping every day. The delays have nothing to do with the process.

When Wolfson said that the issues had nothing to do with the process, he was speaking about the fermentation process. Investors could once again have given the benefit of the doubt, but when I visited company headquarters the day after that call, top management officials could not meet with me because of a last minute trip to Brazil. Now, I'd certainly want management to take an active role in putting out fires that arise when leading a company, but if something as simple and uncontrollable as intermittent steam and power were the culprits, then what's the value of dragging a good chunk of your team to Brazil?

The next conference call took place at the end of July and followed the new precedent of disclosures by failing to provide the monster news investors were waiting to hear. David Cole, then-president who worked very closely with the team at Moema, told investors that all unit operations were "installed and aligned." Additionally, Cole said Solazyme expected to expand production beyond the three large-scale fermentation tanks that were being used at the time and producing two different products, though at a limited capacity.

There may be no issues with fermentation or big setbacks, as management maintains, but a few key disclosures may not add up quite as investors would like. In the recent press release announcing that Cole was transitioning out of his role as president and resigning from the Board of Directors to return to his former role as strategic advisor, Solazyme buried the following business update:

Solazyme's core fermentation technology is performing well at Moema, with ongoing successful large-scale fermentations of two different products in multiple full-scale production vessels. Although the key downstream unit operations are functional all the way to oil production, and modest quantities of finished product continue to be produced and shipped, downstream processes at Moema require further optimization and are not yet operating on a fully integrated basis. This is an area of significant focus and ongoing improvement.

Aside from being suspiciously hidden from view, this tells investors a few things. First, in the 75 days since the last conference call, Solazyme did not add any additional products to the mix at Moema. That could be because of an unrelated issue with attaining permits in Brazil, longer than expected market development timelines, or bigger issues with the process. It should be noted that other diversified industrial biotechs are ramping slowly not because of technical issues, but because they're waiting for markets to develop. Solazyme has announced that its customer base has expanded mightily this year, but investors don't know how many are purchasing low-margin fuel blends, which Solazyme has stated, through SEC filings, comprise a good chunk of current production -- something that surprised even me.

Second, downstream recovery equipment -- the most standard part of the entire manufacturing process at Moema, used by oil seed crushing companies for decades -- would conceivably be the least likely part of the process to encounter problems. It's awfully convenient to use confusing engineering language (something I attempted to overcome in a recent series) and encourage investors that any and all delays are not related to fermentation processes, which have set back many next-generation industrial biotech companies and removed the privilege of having Mr. Market's benefit of the doubt. Solazyme can't have it both ways.

The drilling lubricant Encapso doesn't need much downstream processing, so it could help Solazyme through any delays. It's being produced in small quantities on two continents. Source: Solazyme.

Third, and perhaps most worrisome, is that the company has yet to announce that all fermentation tanks are operating, so far only stating that "multiple full-scale" bioreactors have been used. Investors will want to keep an eye and ear open for any updates on the next quarterly conference call next month. Of course, it is possible that process scheduling has played at least some role in the delays. Remember, Moema is a very large facility with a very complex process.

Shady business
Given the lack of transparency by Solazyme, investors may also want to pay close attention to the resignation of Ann Mather as Audit Committee Chair. Teams get shaken up quite often, especially as companies grow, and former DuPont CFO Gary Pfeiffer is an excellent replacement and addition, but this is the kind of move that could signal bigger problems on the horizon. Consider that the press release (and two others) hit the wires after markets closed on October 9 -- and after Solazyme fell 8.5% on very heavy volume. Individual investors apparently didn't have access to the same information as some heavyweight funds.

Source: Google Finance.

It's also a bit worrisome that current CTO Peter Licari unloaded one-third of his total holdings on September 9. Yes, the trade occurred in a 105-B trading plan, but the trade included more shares than the total shares involved in all transactions by Licari dating back to July 2013. There were no major option exercises to stem the massive trade, either.

What continued delays mean for investors
It's not the end of the world (tough to believe with the recent cliff-diving share price). If your investing time horizon is very long and extends well past the end of this decade, then the impacts could be quite small when the technology is proven in the long run. The problem is, while many investors define their time horizons as long term, it's much easier to say than to practice. For now, continued delays likely mean a complete lack of trust between investors and management, delayed revenue ramp-up, continued misunderstanding by Wall Street, and a volatile share price.

What continued delays don't mean
For many people who think next-generation industrial biotech platforms are a pipe dream, my critique of Solazyme's management team may solidify your position. However, management missteps -- and even the bigger than expected manufacturing obstacles that aren't fully disclosed -- don't imply that the company's renewable oil technology will never work. At this point, I have no reason to believe the platform won't work if given enough time. My message continues to be about patience by reminding investors that Solazyme will take much longer to realize its growth potential and, now, encouraging management to keep an open dialogue with investors.

Management teams are comprised of humans, which have been known to make mistakes from time to time. Sweeping problems under the rug in hopes of saving the public image of your company, vision, or passion is somewhat understandable, though in no way justifiable. When problems cannot be contained or solved behind closed doors -- something that may be happening right now -- news inevitably leaks out, and management risks losing credibility.

Solazyme needs transparency
Depending on the severity of the problems at Moema, investors could be reeling in volatility or lackluster growth for more than a few quarters or years. If moderate problems are at hand, then Solazyme is difficult to pass up at a market valuation under $500 million. At this point, however, I would wait for the conference call -- and likely longer -- to gauge exactly what is going on behind closed doors. The company's cash pile will burn up more quickly than most realize, an additional dilutive capital raise is all but certain before any facilities reach a steady state, and the way I've pieced together management's track record doesn't exactly make me want to load up on shares. The price looks incredibly low, relatively speaking, but don't make the mistake of thinking it cannot go lower.

The continuous string of delays and untimely setbacks can be connected to hint that bigger problems have occurred or are occurring at Moema. The lack of transparency has damaged the strong and trustful relationship between investors and Solazyme management, which opens many dangerous avenues for CEO Jonathan Wolfson not just with investors, but employees, too. When management provides an update on November 5, it needs to capitalize on the opportunity to regain investor trust.