Will Ulta Salon and Nordstrom Help Solazyme’s Anti-Aging Product Line Grow?

What do renewable fuels, drilling lubricants, and anti-aging creams have in common? Not much, except they can all be produced from microalgae engineered by renewable oils manufacturer Solazyme (NASDAQ: SZYM). The company’s Algenist cosmetic brand has provided the bulk of its… revenue since being sold commercially in 2011 and will reign once again this year before industrial oil production takes over for good in 2015.

The good news for investors is that there’s plenty of positive momentum behind Algenist, which is sold in over 1,300 retail stores in 17 countries — four of which were added in the second quarter. Looking ahead, Solazyme is expanding to all 700 or so Ulta Salon, Cosmetics & Fragrance (NASDAQ: ULTA ) stores in the United States, SpaceNK in Bloomingdale’s, and Nordstrom (NYSE: JWN ) , and is continuing its expansion at Sephora. The bad news is that the cosmetic brand is very far from reaching its revenue target for 2014. Will Ulta Salon and Nordstrom help it play catch up?

Anti-aging algae
Several unique strains of algae produce the compound alguronic acid to protect themselves against harmful UV rays. As it turns out, alguronic acid makes for a mighty fine cosmetic compound, too. It’s the secret behind the success of Algenist and is proven to improve the “appearance of firmness” and “appearance of brightness.” The compound does a better job in this than common cosmetic ingredients such as vitamin C, vitamin E, coenzyme Q10, and others.

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More important than the charts above about improving the “appearance” of skin is the brand’s success with customers. Algenist sales have increased by 37%, 23%, and 21% in each of the last quarterly periods compared to the same period of the preceding year. It may appear that growth is slowing, but sales are growing from relatively low numbers that developed from scratch just a few years ago, which makes older growth look more astounding on a percentage basis. The brand reeled in $10.8 million in the first half of 2014 — just the 10th and 11th quarters of commercial sales. However, it will need to do substantially better in the second half to reach sales targets for the year, which means investors are largely pinning their hopes on Ulta Salon and Nordstrom.

Can Algenist get back on track?
On the 2013 fourth-quarter conference call, Solazyme management told investors it expected 30% growth for Solazyme’s health sciences unit, or SHS, in 2014. The business ended 2013 on a high note, growing nearly 21% for the entire year. That may have made 30% growth look quite feasible, especially when coupled with global store expansion, but Algenist sales are well off pace so far in 2014.

Consider that Algenist would need to turn in its two best quarters ever in the second half of 2014 to meet the expected 30% growth rate for the year. “Best quarters ever” means year-over-year growth of 36% and sales of at least $6.5 million. While the brand grew at 37% in the fourth quarter of 2013, it’s important to remember the cyclical nature of consumer products and how the holiday seasons affect growth at the end of each year. In other words, 36% growth may be a bit of a reach; the brand appears to be on track for its historical annual growth rate of about 21%, which would fall nearly $1.8 million, or 7%, short of guidance.

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Of course, meeting the expectations set by management depends on how quickly that expansion occurs. CEO Jonathan Wolfson expects to have Algenist in over 2,000 stores worldwide by year-end, an increase of 54% from current store count. Simply putting the cosmetic brand on shelves at all Ulta Salon locations within the United States will expand total store count by over 40%. Factor in the new distribution deal with Nordstrom — the first high-end retailer for Algenist — and expansion with existing partners and it’s easy to see the long-term potential for algae-powered cosmetics.

However, the expansion needed to achieve significant traction by now (early in the third quarter) for the additional stores to result in increased sales in the second half of 2014. Investors won’t be able to gauge the success of expansion until third-quarter results are announced.

Will anti-aging cosmetics powered by algae succeed?
Solazyme’s Algenist product line has been a wild success since launching 11 quarters ago. It went from a developmental product in March 2011 to a $20 million brand by the end of 2013. That’s pretty spectacular sales and marketing progress in a historically difficult industry. Despite the potential for a miss on revenue targets in 2014, Algenist is growing handsomely in each quarterly period. I think it may simply be unrealistic to expect the brand to reach $26 million in sales in 2014. Whether or not Ulta Salon and Nordstrom prove me wrong on sales expectations, the potential for future revenue growth from Algenist presents a great high-margin backbone for Solazyme and a good opportunity for investors.

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