Luna Innovations Inc (LUNA) 2007 Q1 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Luna Innovations First Quarter Earnings Call.

(OPERATOR INSTRUCTIONS)

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

Thank you, Paul. 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 about Luna's plans, objectives and strategies and management's expectations and beliefs about business results in the future.

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 S-1 dated June 2, 2006, its quarterly reports on the Form 10-Q and its annual report on Form 10-K.

All forward-looking statements are based on information available to Luna as of today's date. Luna undertakes no obligation 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, and welcome to those of you who are listening. As in our previous calls, I'll use this opportunity to put our results in the context of where we are in the execution of our growth strategy. Then, Dale will review our results in more quantitative terms, after which we'll welcome any questions you may have.

I'm very pleased to report that the first quarter was a strong start to the year. Revenues came in above expectations. Net loss came in well below expectations, and our cash usage was right on target with planned investment in the faster growing, higher margin product side of our business. Our cash usage also reflects both the anticipated seasonality in our business and the majority of our capital spending for the year.

Luna generates revenues in two ways. The first way is through technology development contracts that we enter into with government agencies, research labs and commercial enterprises that share strong interest in selective product opportunities. The second segment of our business is the sale of commercial products and the licensing of our IP.

In the first quarter of 2007, the revenues we generated from technology development contracts grew by 35% from $3.9 million in the first quarter of 2006 to $5.3 million. More importantly, these contracts continue to provide us with the unique intellectual property that we are successfully commercializing.

Product sales represented 25% of our total revenues in the first quarter of this year compared to 13% in the same quarter last year. In fact, the product and licensing revenues increased year-over-year by 200% from $595,000 in the first quarter of 2006, to $1.8 million in the first quarter of 2007. And consequently, gross margins improved from 30% in the first quarter of 2006 to 34% in the latest quarter.

As expected, the costs of growth also increased as we continue to invest in the development of our healthcare, and instrumentation and test and measurement products. As a result, operating expenses increased from $3.4 million in the first quarter of 2006, to $5.2 million in 2007.

And we incurred a loss for the first quarter of $2.7 million or $0.27 per share. This compares to a loss of $2.1 million or $0.34 per share in the first quarter of 2006. The first quarter was a strong one for Luna from a financial perspective, and it was equally strong from an operational perspective.

I'd like to take a moment to give you some insight into how our operations are progressing. Starting with recent success in technology development in the first quarter, we booked more than $5.3 million in technology development contracts, an increase of more than 13% in new contracts over the first quarter of 2006.

This has always been a growing and important segment of our business that generates new product development opportunities and key intellectual property that we transition into future product and license revenues.

The second segment of our business is the sale of commercial products and the licensing of our technology. We have three primary methods of generating revenue in this segment of our business. One, we sell products under a Luna brand; two, we provide components for someone else's branded products; and three, we license our technology to third parties.

Our products are in two major categories, healthcare products and instrumentation and test and measurement products. On the healthcare products side of our business, specifically medical devices, we recently achieved a milestone in medical devices with the completion of a FDA 510(k) submission for our EDAC QUANTIFIER, a blood circuit monitor that uses advanced ultrasound technology to non-invasively count and measure gaseous emboli during surgical procedures.

The device is already being used at research institutions. FDA clearance would enable Luna to market and sell the EDAC QUANTIFIER for clinical use in the United States. We are also continuing to develop the development of real-time, shape-sensing fiber, built on Luna's existing optical platform, the minimally invasive, intrusive shape-sensing fiber could provide an advantage in the minimally invasive diagnostic surgery and therapy markets.

Within the category of pharmaceuticals, we continue to be encouraged by the preliminary animal data that indicates our platform of nanotechnology for the new therapies may become an important contribution to the treatment of diseases for which the currently available therapies provide limited benefit. We are actively seeking strategic partners in key diagnostic and therapeutic areas to help further these programs.

Now for instrumentation and test and measurement products. We introduced and are now shipping an approved model of our award-winning Optical Backscatter Reflectometer, or OBR, line. The OBR 4400 is a small, easily transportable platform providing unprecedented visibility into fiber components and assemblies and giving users a more complete picture of what truly is happening in their networks.

With industry-leading micrometer resolution, the system takes high-resolution, optical domain reflectometry to the next level by reducing working time and increasing efficiency. We also continue to progress as planned with the joint development project with JDSU that we have discussed on prior calls. We currently expect to complete the development phase by the end of this year.

We recently announced an upgraded distributed sensing system, or DSS. Luna's DSS can be used to monitor real-time structural health, highlight hot spots or potential failures or optimize process control and has potential applications on aircraft, naval ships, civil structures, manufacturing plants and power generation and distribution equipment.

Additionally, we were awarded $1.6 million in contracts to provide low-cost, common sensor electronics for use in next-generation defenses against ballistic missile attacks. This product will go into vehicles that are designed to intercept incoming ballistic missile warheads outside the earth's atmosphere and destroy them by a means of high-speed collision, a practice commonly referred to as hit-to-kill.

Currently, these intercept vehicles are expensive to design and manufacture because of the many customized components. Our solution offers common sensor electronics and data communications that consist of adaptive sensor electronics with a standard fiber optic communications interface, which would substantially reduce integration and development costs.

The missile defense contract represents a perfect example of how we are able to take an existing program and fast track it to develop solutions that address real needs. This is in keeping with our business model of moving applied research through the prototype phase and also what we believe will become a large-scale product brining many benefits to the defense community.

I'll wrap up by reiterating that we are pleased with the overall growth in the business that we achieved during this quarter and the continued trend in year-over-year growth in all segments. Specifically, we are very pleased with the growth in new opportunities under technology development and continued traction of our products in the marketplace.

Now, Dale will review first quarter 2007 financial results.

Thanks, Kent. I'm pleased to report a successful quarter for us in financial terms. We exceeded the top line and bottom line guidance that we gave on our last call. And as Kent mentioned earlier, we see the trends of growing product sales and expanding margins.

For the quarter ended March 31, 2007, Luna achieved revenues of $7.1 million, representing an increase of $2.6 million or 57% over revenues of $4.5 million for the first quarter of last year. Technology development revenues grew $1.4 million or 35% versus the same quarter of last year, as the hiring of additional employees in this area throughout 2006 provide increased levels of direct labor applied against our growing backlog of research contracts.

Product and license revenue grew $1.2 million or 200% year-over-year, primarily from the continued strength of demand for our optical test and measurement equipment as we noted in the fourth quarter of last year. Optical test and measurement accounted for $1.3 million of our product and license revenue for the quarter.

Cost of revenues increased $1.5 million or 47% compared to our 57% growth in revenues. Technology development cost of revenues grew $0.9 million, compared to the $1.4 million growth in revenue for the segment. The additional costs largely reflect the increased direct labor and overhead, associated with the growth in employees hired throughout 2006 to fulfill the increasing backlog of development contracts.

Cost of revenue for product and license sales grew $0.5 million, representing growth of 200%, consistent with the growth rate we realized in product and license revenue. Gross margins for this quarter, again demonstrate a key aspect of our business model. As we are successful in growing the product and license segment of our business, we should expect to realize expanding gross margins.

Overall, our gross margin of 34% for the quarter represents an increase of four percentage points, compared to the first quarter of last year. We realized a 28% gross margin for technology development activities during the first quarter of '07 compared to a 26% gross margin in the same period last year. We achieved a 55% gross margin in our product and license segment during the first quarter of this year and also 2006.

Our improvement in gross margin percentage was therefore driven by both improvement within our technology development segment and by overall revenue mix. Gross profit was $2.4 million for the first quarter of 2007, compared to $1.3 million for the same period last year.

Operating expenses were $5.2 million in that most recent quarter, compared to $3.4 million in the first quarter of 2006. This level of expenses is consistent with the expense levels realized following our initial public offering in June of last year. Operating expenses of $5.2 million were also approximately $100,000 less than our operating expenses in the fourth quarter of 2006.

As I spoke about last quarter, we believe that we largely have the necessary G&A infrastructure already in place to support our growth expectations, and so controlling G&A expenses continues to be a significant component of our operational strategy. We ended the quarter with a net loss of $2.7 million, which compares to a loss of $2.1 million in the first quarter of last year, but significantly better than our earlier guidance of a loss of $3.3 million.

The improvement from our earlier guidance resulted primarily from three factors, first, the contribution of higher product sales driving revenue that was in total $0.2 million better than our guidance; second, approximately $0.2 million in timing differences for planned expenses; and third, reductions in various discretionary SG&A expenses.

Turning to the balance sheet and cash flows for the quarter, our usage of cash was consistent with our expectations for the quarter when the seasonality of our business is taken into account and the capital expenditures we had planned for the quarter.

We ended the quarter with $13.9 million of cash. I'll cover more on the cash flow in a moment after we cover the rest of the balance sheet items. Accounts receivable grew $0.7 million in the first quarter, which was significantly more than we had expected. Cash collections were slow during the month of March, but did catch up significantly in April, and we're not seeing any significant collectability issues in AR at this time.

Of course, this timing of collections activity also had an impact on our month-end cash balance. Inventory grew primarily in finished goods as we depleted much of our finished goods inventory at year, and are building some supply back up so that we can meet customer demand schedules and have a small supply for things like demos available when needed.

Capital spending was $0.8 million for the quarter. We currently expect CapEx in future quarters to be considerably less than we incurred in Q1 and not to exceed $2 million for the full year. On the liability side, I'll point out that we repaid $215,000 of debt that was assumed with the acquisition of Luna Technologies back in 2005 and became payable when we terminated a facility lease.

Turning back to cash flow, you see on the statement of cash flows that we used $3 million of cash in operating activities, $0.8 million in investing activities and $0.2 million in financing activities. As I said previously, that level of cash usage was consistent with our expectations for the quarter, given the seasonality of our earnings. We provided guidance on our last earnings call of an expected net loss of $9 million to $9.5 million for the year of which $3.3 million was expected in the first quarter.

Accordingly, considering the expected loss, coupled with our capital spending needs for the quarter, we anticipated this decrease in cash and expect to see declining rates of cash usage as we proceed throughout the year. The improvement that we might have seen in cash usage due to our bottom line improvement was offset by the growth that we had in accounts receivable at the quarter-end.

As I said earlier, collections on AR were back up in April, so I don't currently see this as a continuing concern in our cash flow for Q2. Looking at near-term expectations, for the second quarter, we currently expect to generate revenues of approximately $7.4 million or approximately $0.3 million above first quarter revenues. The growth compared to the first quarter this year is expected to come primarily from our technology development segment.

As we discussed previously, our stronger quarters for product sales have historically been the third and fourth quarters of the year, and we expect that to be the case this year as well. Also, as I previously mentioned, we do have some timing differences in operating expenses that were planned for the first quarter that will be incurred in future quarters.

However, we also intend to continue to look for opportunities to reduce discretionary and G&A spending. And so, we expect a net loss for the second quarter of approximately $2.6 million. We remain on target to meet our full-year expectations that we established on our last call, and affirm our revenue guidance of $30 million to $32 million for the year, and a net loss of $9 million to $9.5 million.

And now, I'll turn the call back over to Kent.

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

(OPERATOR INSTRUCTIONS)

And your first question comes from the line of Paul Cheng with ThinkEquity. Please proceed sir.

Good morning, guys, and congratulations on a good quarter.

Okay Paul, thank you.

Thank you, good morning.

Good morning. Could you -- on the EDAC front, you guys have filed the application. Can you kind of talk -- walk us through the timing of that, what you expect and what's realistic? And the, I have a follow-up question.

We -- the EDAC was recently just filed. Again, we worked through a third party to get that filing on with the FDA. And having gone through that third party, the expectation is that we would get a faster response and a faster approval time through the FDA. But being a federal agency, we can't make any predictions there.

Okay, fair enough. And the second question is, in light of the departure of the COO in, I guess it was early, mid-April, any kind of disruption in terms of like day-to-day activity as -- like it was pretty involved in kind of execution on the daily basis, and also like any related expenses related to kind of his departure?

Well Paul, I -- certainly, our COO was intimately involved in the day-to-day operations. And we quickly got those duties reassigned within the company and continue to march forward, and particularly, the COO was highly involved in the optical test and measurements. But, we think we've got a good team there. And they've picked up the ball and continued to deliver for us.

From and expense standpoint, of course in the second quarter, we're going to have the expense recognition for the termination, that I think was in the 8-K that we filed previously. We don't see a near-term replacement of that expense. We're going to absorb that responsibility internally, at least for the foreseeable future. So, as we progress throughout the rest of the year, that'll be a little bit of cash -- or, I'm sorry, and expense savings for us.

Thank you, and congratulations again.

Great, thanks Paul.

Thanks, Paul.

(OPERATOR INSTRUCTIONS)

And at this time, I'd like to turn the call back over to Mr. Kent Murphy, CEO, for closing remarks.

Thank you, Paul. Thank you all for your interest in Luna and your participation on the call today. As a reminder, we will be having our first Annual Shareholders Meeting this coming Monday, May the 14th in northern Virginia. We look forward to seeing many of you there, and in the near future, and speaking with you again on our second quarter earnings call. Thank you.

Thank you for attending today's conference. This concludes the presentation, and you may now disconnect. Have a great day.