Luna Innovations Inc (LUNA) 2006 Q2 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to the Second Quarter 2006 Earnings Call for Luna Innovations.

[OPERATOR INSTRUCTIONS]

At this time, I would like to turn the call over to Dale Messick, Chief Financial Officer for Luna Innovations.

Thank you, Colby, and good afternoon everyone. Before we proceed further with our presentation I would like to remind each of you that statements made by Luna's executives during this presentation include information that constitutes forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, including without limitation, statements made about Luna's plans, objectives, and strategies and management's expectations and beliefs about business results in the future.

We cannot assure you that our expectations will be achieved or that any deviations will not be material. Forward-looking statements are subject to many assumptions, risks, and uncertainties that may cause future results to differ materially from those anticipated including the risk and other factors listed in Luna's filings with the Securities and Exchange Commission. Such filings include Luna's registration statement on Form S1 dated June 2nd, 2006 and its quarterly report on Form 10-Q for the quarter ended June 30, 2006.

All forward-looking statements are based on information available to Luna as of today's date. Luna undertakes no obligations to update any forward-looking statements as a result of any new information, future events, changed expectations or otherwise.

And now I'd like to turn the call over to Kent Murphy, Chairman, President and Chief Executive Officer of Luna Innovations.

Thank you, Dale. First of all, I would like to welcome everyone to our first investor's conference call following our IPO on June 2nd. I especially want to take this opportunity to thank those of you who have chosen to invest in our company. We have a very strong commitment to put the proceeds from our IPO to work to grow the value of your investments and I'll talk more about that in a few moments.

With me on the call today are Dale Messick, Chief Financial Officer, Scott Graeff, our Chief Commercialization Officer, and John Goehrke, our Chief Operating Officer. I will begin by giving you an overview of business developments and our second quarter financial results. Then, Dale will give a deeper insight into the financials after which we will be happy to address your questions.

We'd like to take a moment to review our business model. In the most basic terms, Luna develops technologies through funding alliances with industry, government agencies and universities. In our discussion and our earnings release, we refer to sales related to this business as contract research revenues. As we develop the technology, identify market need, and define the business case Luna focuses its resources and capital to commercialize the technology. These product development activities are where a large portion of the IPO proceeds will be put to use.

The final goal is to see the technology developed into viable products and businesses. The sales they generate are reported as product and license revenues in our financial statements. With that basic understanding, let me start with a review of the financial results that we released earlier today.

Revenues for the second quarter of 2006 increased 26% to $4.9 million from $3.9 million in the second quarter of 2005, reflecting growth in both our operating segments. Even though we had growth in contract revenues, we were unable to recognize revenue as quickly as we had expected because of the time required for us to successfully recruit the highly educated, trained scientists and researchers who also have a passion for bringing product to the marketplace. As a result, we have stepped up our recruitment efforts to keep up with the growth of our contract research business while maintaining our high standards for employees.

During the second quarter, product and license revenues of approximately $760,000, primarily came out of Luna Technologies division and represents sales of our Optical Vector Analyzer and Optical Backscatter Reflectometer. In a moment, I'll talk about our expectations for other products in the coming months.

Our operating expenses increased from $4.3 million in the current quarter from $1 million in the comparable quarter of 2005. A significant increase in the operating expenses was expected in supporting the business strategy to bring products to market within Luna rather than selling the technology at an early stage. There are several important drivers behind this increase.

First, we have increased our resources devoted to product development activity. We believe that as we are successful in bringing these products to market we will accelerate our revenue growth and continue to increase our operating margins. Specifically, we have increased our level of investment in nanotechnology and ultrasound-based product development efforts.

Additionally, we recognize that if we are going to be successful in our business growth strategy to be able to meet the demands of being a public company we need to improve our infrastructure. We have added a total of 15 employees across various administrative functions. These additions, as well as the other costs that come along with being a public company, increased our operating expenses. Also with the acquisition of Luna Technologies since 2005 we added approximately $500,000 to our quarterly operating expenses relative to the second quarter of 2005.

And finally, we recognized approximately a $350,000 increase in share-based compensation in the second quarter of 2006. With these additional expenses, we incurred a net loss of $2.7 million for the second quarter of 2006 compared to a net income of $44,000 in the second quarter of 2005.

Let's now move from our financial review and onto business activities. I will first discuss contract research and a few of the many opportunities in our pipeline and then I will cover both our commercialization and product development activities. Our contract research group is our engine to innovation and is currently developing many exciting market-driven technologies. We have recently made significant progress in the early detection of corrosion in pipelines which potentially could provide early warning indications prior to environmental mishaps.

Another promising development is in the area of biocidal coatings for the elimination of anthrax spores and other biological warfare agents. These are just a small sample of the many ongoing sensing and material developments within our contract research group. Our success in winning new research contracts has meant that our contract backlog has grown by 24% year-over-year.

On commercialization activities, I'm excited to report that in the second quarter we showcased our Emboli Detection and Classification or EDAC product at the Outcomes 2006 Medical Conference in Key West, Florida. We were pleased with the reaction we got from the conference participants. Our EDAC blood circuit monitor which utilizes our ultrasound technology is now available for sale into the medical research community. Many of you may recall, we anticipated this product release to take place in the third quarter of this year. I am happy to announce that we are able to launch the product early. We received our first order in July and expect to ship later this quarter.

As another example of our market-driven product strategy, we have just signed a joint development and distribution agreement with one of the largest test and measurement companies in the world. With our partner, we jointly launched the engineering and development process early last month in anticipation of signing this agreement. Under the agreement, we will collaborate on the development, marketing, and distribution of a new handheld optical test and measurement instrument.

This new instrument has fiber optic measurement technologies that we expect to have a major impact on lowering the cost of deployment and maintenance of optical networks that are bringing fiber into the home and replacing traditional copper networks onboard air and marine craft. We currently anticipate generating up to $10 million in revenue from the sales of products under this agreement over a period of 24 months from the time we release the product. This product release is scheduled for late 2007.

An additional area of promise that we are involved in is nanotechnology. We are [developing] commercial opportunities using our patented nano materials to enhance performance of products in a number of applications. We continue to make progress towards filing an Investigational New Drug application with the FDA for our first MRI contrast enhancing agent. We've also made some interesting discoveries concerning the biological properties of our nano materials. These discoveries may translate into opportunities that make important contributions in the treatment of a number of diseases affecting people around the world.

Recognizing the importance of accelerating the commercialization of these and other technologies within LUNA, we've recently announced the appointment of Scott Graeff to the new position of Chief Commercialization Officer. Scott has been shouldering two roles in the company serving as both the CFO and the Executive Vice President for Business Development. Now he will focus on assessing technologies, their marketplace potential, and determining the means by which we can maximize our returns on product development investments.

For example, we may determine that the best outcome is achieved through direct product sales, licensing the technology, or by entering into joint development agreements. Scott will ensure that the process and strategy for each product candidate are managed through to completion. In addition, we are moving many other promising technologies through our commercialization process. We are in negotiations with several Fortune 500 companies to collaborate through joint development deals as well as the licensing transactions.

Specifically, we are in negotiations to license our ultra-hydrophobic coating which is a super non-stick coating that may be applied to a variety of surfaces to protect against stains and corrosion. We also have multiple product development agreements in negotiation for our distributed sensing systems to allow distributed temperature, pressure and shape measurements. These relationships will allow us to continue to accelerate our commercialization efforts and increase revenues.

Now I'd like to introduce Dale Messick, our new CFO who recently joined the company to review the second quarter financial results in a little more depth. Dale?

Thank you, Kent. For the quarter ended June 30, 2006 our revenues were $4.9 million representing a $1 million or 26% increase year-over-year. Driving the majority of the revenue increase was approximately $762,000 of product and license revenue, primarily coming from the Luna Technologies division which was acquired in September 2005. Contract research revenues grew by $257,000 or 6.6% year-over-year with growth in this area somewhat constrained by our ability to hire additional resources as quickly as we would have liked to.

Because of our success rate in winning new contract awards, we have experienced growth of about 24% in our backlog and bringing in additional skilled employees should allow us to grow revenue in this area at a higher rate. As Kent mentioned previously, we did increase our hiring activities in the second quarter and therefore believe that we'll begin to see a higher growth in this area beginning in the third quarter.

On the cost of sales side, our contract research costs increased 11% year-over-year compared to the 6.6% in revenue. This is another place where the longer hiring cycle for research personnel is evident. We experienced more hours in non-billable recruiting and training type activities which could otherwise have been utilized in contract billable activities. Overall, including both contract research and product and license cost of sales increased approximately $713,000.

Our gross profit also increased by approximately $306,000 or 27.5% to $1.4 million in the second quarter 2006 compared to $1.1 million in the second quarter of 2005. Our gross margin percentage improved year-over-year to 28.8% in the second quarter of '06 from 28.4% in the second quarter of 2005 with the higher margins generally achieved in product sales outweighing the slight margin erosion that I just described in contract research.

As Kent mentioned previously, we had a significant growth in operating expenses from $1 million to $4.3 million but that growth was in line with our expectations for the quarter. I think it's worthwhile to reiterate the key drivers of that growth. First, our overall business strategy focuses on developing a pipeline of significant technological improvements with market applications that we can commercialize. In order to progress this strategy, we believe that we must increase the amount of resources devoted to product development for promising technologies and applications.

We've increased our level of activities in several areas including nanotechnologies and ultrasound technologies as you've heard Kent talk about. Our quarterly spending in these two groups alone increased $735,000 year-over-year.

Second, we made necessary improvements to our infrastructure. We added 15 administrative personnel to better manage our growing work force and our additional legal and financial reporting responsibilities. We also added executives in the areas of operations, commercialization and finance, and as expected our professional service fees increased in conjunction with Luna becoming a public company.

Third, with the acquisition of Luna Technologies, we added approximately $500,000 to our operating expenses in comparison with the second quarter 2005, representing the SG&A of Luna Technologies as a previously stand-alone company. And we incurred a charge per share based compensation of approximately $353,000 in the second quarter of 2006 that we didn't have in 2005.

Interest income and expense improved to be income of $109,000 in the second quarter of '06 versus a net expense of $25,000 in the same period of 2005. The improvement was driven by interest earned on the invested cash balance including the proceeds from the Carilion financing in 2005 and the proceeds of the IPO in June 2006.

We incurred a net loss of $2.7 million or $0.37 per weighted average share outstanding in the second quarter of 2006 versus a net income of approximately $44,000 or $0.01 per weighted average outstanding on a fully diluted basis in 2005.

On our balance sheet, you see the cash impact of the IPO in which we received net proceeds of approximately $17.7 million and other matters from the cash flow statement that we'll cover in a moment. We ended the second quarter with cash and cash equivalents of 26.7 million.

Accounts receivable decreased by approximately $982,000 since December of 2005, primarily due to a higher shipping of products at year-end 2005 driving up the receivables balance at December 31st and the subsequent collection of those receivables in 2006. The cost basis of intangible assets increased approximately $430,000 from increased goodwill reported with respect to the Luna Technologies acquisition, capitalized cost associated with patent activities and the acquisition of technology used in our EDAC product.

On the liability side, accounts payable decreased by $1.3 million, mainly reflecting normal timing differences as well as some non-recurring professional services in late 2005 that were included in accounts payable at December 31st. Accrued liabilities increased $1.3 million at June 30th, largely due to costs associated with the IPO that had not been invoiced or paid as of June 30.

Turning now to the cash flow statement, the company had a net use of cash from operations during the six months ended June 30, 2006 of $2.7 million. The year-to-date net loss as of June 30th was $4.8 million including non-cash charges for depreciation and amortization of $502,000 and share-based compensation of $762,000 for the six months. Cash capital expenditures were approximately $633,000 year-to-date and of the $430,000 total increase in intangible assets that I spoke of earlier, the cash component was $197,000.

We realized net proceeds from our IPO of $17.7 million. The net change in cash for the six months was an increase of $14.2 million and, excluding the IPO proceeds, was a net decrease of $3.5 million. Again, our ending cash balance was $26.7 million. And with that I'll turn the call back over to Kent.

Thank you, Dale. Colby, we are now ready to receive questions from the participants.

[OPERATOR INSTRUCTIONS]

Your first question comes from the line of David Edwards with ThinkEquity. Please proceed.

Hi guys, how are you?

Hi David.

Great David.

I wanted to talk to you one was about -- a couple of questions, first is around OpEx. Can you give us an idea of what you're expecting between now and the end of the year as you're adding more people to the business both for contract research and the product side of the business?

Yes I think that the OpEx line that you see now is a pretty good baseline for perhaps some of the normal business growth but certainly not of the magnitude that you've seen year-over-year, of course. With the -- the additional personnel that we're going to be bringing on are going to be largely concentrated in the contract research area which will go up into the cost of sales and the revenue line according.

Okay so more of the -- so the growth is going to be on the cost of sales side than the OpEx side?

I think that's right.

Okay and since -- one of the things that's obviously true about the stories is so many of these product areas in which you're talking about have some fairly long-term views. What can you talk about in terms of milestones that we should be looking for and expecting for the rest of the year?

We expect on the EDAC product, we expect to begin sales on the EDAC product for research purposes only until the end of this year and expect FDA clearance Q1 '07. We expect to continue to make progress on our MRI contrast agent towards a filing of an IND in the middle part of '07 and we'll keep you up-to-date on the progress there.

Yes, Dave I would add to that -- this is Scott Graeff, I would add to that as Kent alluded to we have quite a few licensing transactions that we have in the works right now and they're under negotiation so I would look for several of those coming up here in the next -- this quarter and next quarter clearly.

That's great. Excellent, well thanks a lot. Congratulations on your first public quarter.

Thanks Dave.

Thank you Dave.

Your next question comes from the line of John Roy with Hambrecht. Please proceed.

Hey Kent. I've got some fairly mundane questions here but helpful for filling out our models. The share count going forward ,should we go ahead and use the 15.7 or the 7.2 as a good estimate? What do you think, Dale?

Well the 7.2 is the weighted average for the quarter. We ended with 9.8.

Okay.

So that's going to be pretty close on the basic shares for a while here especially as we're in a lock-up period.

Right.

But I think that 15.8 on a fully diluted is probably a good number for a while.

Okay, and the options expense, do you see that continuing pretty much? I know it's hard to tell but the 350K you saw this quarter you think that's a reasonable kind of number to be thinking about?

It's reasonable. I think it's going to go up a little bit but not on a order of magnitude.

And in terms of the hiring cycle, do you feel like you're done now or do you feel like you're going to continue to add people? I know you said you added 38 in the quarter? Is that going to continue to grow or what do you guys think?

We'll still be adding mostly on the contract research side.

But not admin people like this unnecessarily?

I didn't hear.

I'm sorry we cut out on the question there.

Sorry, you said mostly on contract research, so then not necessarily more overhead or more admin people?

That's correct.

Just another 15 persons.

Yes.

And on the investment in the nano and the ultrasound I know you said it's been about 735 this quarter or more this quarter year-on-year.

Correct.

Do you see that continuing to increase or continuing to pretty much stay where it is?

I think that -- I think that we've gotten our investments level up to about where it's going to be -- it's an increase over where it was in 2005 but we're up to the operating level now in those areas that we want to be.

So we shouldn't see more necessarily in that area?

No.

Great, thanks guys.

Thank you, John.

[OPERATOR INSTRUCTIONS] At this time there are no further questions appearing in queue.

Thank you, Colby. Thank you very much everyone for your interest in Luna and participation on the call today. We look forward to seeing you at the ThinkEquity Conference in San Francisco and look forward to talking with you again our third quarter earnings call.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.