Luna Innovations Inc (LUNA) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Luna Innovations Second 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 provisions 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 risks and other factors listed in Luna's filings with the Securities and Exchange Commission. Such filings include Luna's quarterly reports on 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 obligations to update any forward-looking statement as a result of any new information, future events, changed expectations or otherwise. And now I'd like to turn the call over Kent Murphy, Chairman, President and Chief Executive Officer of Luna Innovations.

Thank you, Dale, and welcome to those of you on the call. As on our previous calls, I will 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.

As I hope you've already seen from our earnings release, the second quarter was very successful for us. The Luna story at this point is, while we are still in the early stages of realizing our vision, to grow the Company through the expansion of product sales and licensing transactions.

Our model and vision are being validated by the growth of our technology portfolio and contracts for additional development opportunities and expanding sales of the products we produce from those technologies. Our financial trends are improving with increasing revenues, more stable operating costs and more efficient use of cash.

In reviewing our results, I will start with our earnings. Revenues were greater than we expected in both of our business segments, the net loss was smaller than we expected and our cash balance increased slightly during the quarter. Taking a closer look at those results, most of you will recall that Luna generates revenues in two ways. The first way we generate revenue is through the technology development contracts that we enter into with government agencies and commercial enterprises.

For our business model the revenue from these contracts helps us support larger R&D infrastructure. These contracts have the added value of being the source of intellectual property and technology that could ultimately be used in new products which we would sell or license.

In other words, we are taking intellectual property, whether we obtain it externally or we develop it ourselves, and turning it into shareholder value. Our three technology expertise areas are sensors and instrumentation, health sciences and materials. In the second quarter revenues from technology development contracts grew by 40% to $5.9 million from $4.2 million in the same quarter last year.

Second, we generate revenues through the sale of the products we develop. These revenues include sales of Luna manufactured and branded products, licenses of our technologies and fees earned for developing our technologies into specific products for others outside of Luna.

These products focus primarily on the healthcare, instrumentation and test and measurement markets. Because our business model centers around commercialization of higher margin products using our proprietary technologies, we view the growth of this part of our revenue as an indicator of the success of our business model.

In the second quarter of 2007 products sales represented over 25% of our total revenues compared to 15% in the same quarter last year. In fact, the product and licensing revenues increased year-over-year by 163% from $762,442 in the second quarter of [2007] to $2 million in the second quarter of 2007. And consequently our company overall gross margins improved from 29% in the second quarter of 2006 to 37% in the latest quarter.

Because we're investing in new product development and built the resources to sustain our growth, we experienced an increase in operating expenses year-over-year. The second quarter of 2007 operating expenses increased to $5.2 million, from $4.3 million in the second quarter of 2006. This current expense level has remained fairly consistent since the fourth quarter of last year with operating expenses ranging from $5.1 million to $5.3 million per quarter over the past three quarters.

For the second quarter of 2007 we incurred a net loss of $2.2 million or $0.21 per share, compared to a net loss of $2.7 million or $0.37 per share in the second quarter of 2007. Here we see the real essence of the Luna business model. As we were successful in growing our higher margin product sales base and our proprietary technologies, we can leverage our existing infrastructure to improve the bottom line.

Turning to our operations, I will begin to review our technology development contracts-based business during the quarter. Luna is a world leader in harsh environment sensors based on our unique fiber optic sensing technology.

This past quarter we reinforced that position with the win of a $2.1 million contract with a government agency for the development of sensors and electronics that have the potential to be deployed in future transport vehicles and nuclear power plants. This continues to build on our early successes in harsh environment sensing such as selling a product line in 2004 to a Fortune 300 oil tool company for downhole monitoring of oil wells.

We were also awarded a $1.6 million contract in continuation of nanomaterials for developing photovoltaic applications, which may include increasing the efficiency of solar cells, higher speed telecom devices and more sensitive medical diagnostic equipment. Our Technology Development Group has over 120 scientists and engineers engaged in more than 100 exciting and different funded programs, and are improving the commercialization process all along.

Next, I will review some of the operational highlights from the second segment of our business; the sale of commercial products and the licensing of our technology. As I just mentioned, our products fall into two major categories, healthcare products and instrumentation and test and measurement products. We'll look at our healthcare products first, starting with medical devices, and then we will move the discussion to pharmaceuticals.

In June, we announced our signing of a multi-year development and supply agreement with Intuitive Surgical, the world leader in robotic-assisted minimally invasive surgery. Under this agreement, pending completion of a multi-year development effort, Intuitive plans to integrate Luna's shape sensing technology into their product line.

Using underlying technology we developed for the U.S. Space Program, Intuitive plans to integrate our sensors into their robotic surgical systems, which are currently installed in over 500 hospitals worldwide and growing rapidly. We believe this partnership is a great demonstration of the Luna model and we are extremely excited to be working in association with Intuitive.

As you may have seen, Hansen Medical, who is a competitor of Intuitive Surgical and with whom Luna has done a small amount of work in the past, has filed a suit in connection with our contract with Intuitive. Although it is our general policy not to comment on litigation, I want you to know that we do not believe there is any merit to this suit, which is based upon claims of sharing proprietary or confidential information, and we will defend ourselves vigorously in this matter.

Another one of our medical devices is the emboli detection and classification or EDAC QUANTIFIER. This device is a blood circulation monitor that uses advanced ultrasound technology to non-invasively count and measure gaseous emboli during surgical procedures. As we announced, the FDA has cleared the EDAC QUANTIFIER, which allows us to expand the market for EDAC beyond the research environment to use in clinical settings.

With this initial clearance, we are pursuing our next milestones for the device, which include broadening the capability of the product to detect and quantify solid particles in the blood as well as gaseous emboli, certification of our manufacturing process so the product can be deployed in a clinical environment in the United States and adding additional channels in particular to monitor blood flow to the brain.

We continue to believe that the best means for realizing the value of this product is through a strategic marketing agreement with one of the major players in the medical device market, and we continue to progress in our discussions for a marketing partner. In addition to medical devices, we are also developing technology that is applicable for pharmaceuticals.

In previous calls we have discussed our proprietary TRIMETASPHERE carbon nanomaterials, which we are targeting for use as an MRI contrast agent. We believe the combination of high molecular relaxivity and safety may overcome the limitations of the current technology, although we've not yet begun the clinical trials necessary to validate those claims.

However, our recent discoveries have progressed to a stage where we are actively seeking a partner among the world leaders in this market to support the development necessary to validate the promise of this technology for the next generation MRI contrast medium. We are also pursuing other new applications for carbon nanomaterials.

In partnership with the Virginia Commonwealth University, we have shown that carbon nanospheres are able to block the allergic response in both human cell culture experiments and in mice. We believe that this breakthrough, which was published in the July 1 issue of the Journal of Immunology, could potentially lead to new mechanisms of action to develop novel therapies for allergies using nanomaterials in an entirely new field of medicine we are calling nanoimmunology.

If so, the market potential would be significant. Allergy is the fifth leading chronic disease in the U.S. among all ages, and the third most common chronic disease among children under 18 years old. An estimated 50 million or one in five Americans suffer from some type of allergy. To make this possibility a reality, we plan to seek strategic partners in key diagnostic and therapeutic areas to help further this program.

Now turning to our instrumentation and test and measurement products. As you know from our previous calls, we have made significant investments in building our sales and marketing capabilities for these products. I'm happy to tell you that these investments continue to pay off. In the second quarter we booked twice as much business as compared to the same quarter of last year. We received orders for more than $2 million of these products, and we recognized $1.8 million in product revenue during the quarter.

Included in this success is the sale in our history. In the second quarter we sold multiple Optical Vector Analyzers or OVA to a large optical components manufacturer. By using our product, the customer expects to reduce the cost and time of testing their devices by over 80%.

This sale is significant because of its size and because it should provide us with a great case history we can reference with other perspective customers. For the Luna team, this is especially significant because it is yet another example of how our products are moving from R&D bench tops to the customers' manufacturing floor, and turning single unit orders into multiple system sales.

Last fall we announced an agreement with JDS Uniphase, JDSU, under which we are partnering on the development of new products aimed at field deployable platforms for installation and maintenance testing of modern fiber optic networks. I just wanted to give you an update on that initiative and let you know that Luna's engineering team has been working successfully with JDSU on electronics integration, and we expect a full product launch beginning next year, right on schedule.

So to give you a recap of Luna at this time, our business model is proving itself in financial terms and operating terms. We continue to bring out more products. Our products are becoming increasingly recognized for incorporating proprietary breakthrough technology, our sales capabilities are growing, our pipeline and backlog are growing, and all these are great trends that bode well for our future.

Now, Dale will discuss what that growth means in financial terms.

Thanks, Kent. To begin with our income statement, for the quarter ended June 30 we earned total revenues of $7.9 million, an increase of 59% over the second quarter of last year. Technology Development revenues increased 40% over the second quarter of 2006 as we continue to be successful in not only winning new contract awards, some of which Kent just mentioned, but also attracting and retaining the highly talented individuals necessary to achieve the contract deliverables.

Our backlog of contracts remains strong and we expect Technology Development revenues to be slightly higher than our second quarter revenues of $5.9 million for each of the remaining quarters of this year. Product and license revenue for the second quarter of 2007 was $2 million, which is more than double our product and license revenue of approximately $760,000 for the same period in 2006.

Sales of our fiber optic test and measurement equipment, primarily the Optical Vector Analyzer and the Optical Backscatter Reflectometer, were $1.2 million for the quarter, while revenue from our product development activities related to our handheld fiber optic test equipment and our surgical shape sensing product and other product development programs resulted in $0.8 million of recognized revenue in the most recent quarter.

To recap, technology development revenue grew 40% compared to the second quarter of last year, while product and license revenue grew 163% compared to last year, for a combined to revenue growth of 59%. Technology Development cost of sales increased 30% to $4 million in the second quarter of this year, from $3.1 million in the second quarter of last year.

The increase is attributable to the 40% growth that we realized in Technology Development revenue, and primarily reflects the additional headcount necessary to deliver the contract requirements. Our gross margin in this segment of our business grew from 26% in Q2 of last year to nearly 31% in the most recent quarter.

Cost of revenues related to product and licensing activities increased $0.5 million to $0.9 million in the second quarter of '07 from $0.4 million in the second quarter of last year, a growth rate of 123% compared to the corresponding revenue growth of 163%. Accordingly, gross margins for the product and license segment increased from 40% in last year's second quarter to 54% in our most recent quarter.

As I just mentioned, gross margins increased compared to the second quarter of last year in each of our business segments individually. In addition to that, the continued growth in products as a higher percentage of our business mix results in overall gross expansion for the Company. We achieved an overall gross margin of 37% for the second quarter of '07 compared to an overall gross margin of 29% in the second quarter of 2006.

Operating expenses were $5.2 million in the most recent quarter, compared to $4.3 million in the second quarter of last year. As we've discussed on previous calls, our operating expenses have increased due to several factors including investments in R&D activities, increased sales and marketing costs, increased infrastructure to support our growth, costs associated with being a public company and other factors.

While operating expenses grew compared to last year, operating expenses as a percentage of revenue decreased from 86% in the second quarter of '06 to 66% in the second quarter of 2007, and as Kent mentioned, have remained consistent at a range of $5.2 million to $5.4 million for each of the past three quarters.

Our resulting net loss improved to $2.2 million in the second quarter of this year compared to a loss of $2.7 million in the corresponding quarter last year, a 20% improvement. Net loss per share was $0.21 in the second quarter of this year, compared to a loss of $0.37 per share in the second quarter of last year.

Turning now to the balance sheet, we ended the second quarter with cash of $13.9 million, and had our first cash flow positive quarter since our IPO. I'll touch more on cash flow in just a minute, but first I'll talk about some other points on the balance sheet. Accounts receivable have grown approximately 0.8 million since year end and of our billed accounts receivables, approximately 88% were current or less than 30 days past due. Inventory has grown to $1.3 million from 0.8 million at year end as we continue to build inventory stock in advance of anticipated continued growth of our product segment.

And the last point I'll touch on the balance sheet is deferred credits, which have increased from 0.9 million at December 31 to 2.3 million at June 30. This increase reflects cash that we have received generally under development contracts in excess of the revenue we are able to recognize under generally accepted accounting principles.

With respect to development contracts, we recognize revenue under the percent of completion method, which may be different than the billing and payment schedules associated with those contracts, which then leads us to cash flow. In the release that we issued earlier today you see our year-to-date cash flow. I'm going to focus mostly on cash flow just for the second quarter in relation to the year-to-date performance.

For the second quarter of this year we had positive cash flow from operations of $0.3 million. The primary drivers of the positive cash flow from operations were our net loss of $2.2 million offset by non-cash charges for depreciation, amortization and share-based compensation totaling $1 million, and an increase in deferred revenue of $1.4 million.

This $0.3 million of cash provided by operating activities compares to a $3 million cash used in operating activities in the first quarter of this year, for year-to-date cash used in operating activities of $2.6 million. Cash used in investing activities, our acquisition of PP&E and capitalized IP cost were $0.5 in the second quarter and $1.4 million year to date.

Cash flows from financing activities were $0.2 million in the second quarter and were a net cash usage of less than $100,000 year to date. For the quarter ended June 30, 2007, we had a net increase in cash of approximately $44,000. To recap, that increase in cash resulted from positive cash from operating activities of $0.3 million and cash from financing activities of $0.2 million, less cash from investing activities of $0.5 million.

Cash flows from operating activities of $0.3 million in the quarter, compares to cash used in operating activities of $3 million in the immediately preceding quarter. The primary drivers of the improvement were $0.5 million improvement in net income or net loss, and a $1.4 million increase in deferred revenue in addition to the various changes in our other working capital account balances.

Looking forward to the third quarter, we currently expect to see continued growth in both segments of our business. We expect total revenues for the quarter to be approximately $8.7 million, consisting of approximately $6.2 million in Technology Development revenues and approximately $2.5 million in product and licensing revenue.

We anticipate a net loss for the quarter of approximately $2.3 million. We also reiterate our guidance for the year of expected revenues in the range of $30 million to $32 million and a net loss in the range of $9 million to $9.5 million.

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

Thank you, Dale. Before I open up the call to questions I want to take a moment to welcome Mike Daniels to Luna's Board of Directors. As many of you might know, Mike is internationally recognized in the technology community for a number of successes including leading SAIC's acquisition of Network Solutions, helping to build that company into a large multi billion dollar enterprise. Mike is a rare combination of both visionary and business person and excels in both. His advice and involvement will be a great asset for us all.

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

(OPERATOR INSTRUCTIONS)

And your first question is from the line of Michael Lew with ThinkEquity Partners. Please proceed, sir.

Hi, thanks for taking my questions. First, things are shaping up very well with regard to EDAC, you've mentioned that you're still in the process of identifying a marketing partner. I mean how many potential candidates are you engaged with? And what would be a reasonable time frame to expect a partnership announcement?

We're currently in discussions with several different organizations and we hope to bring a partner together in the next quarter or two.

Okay. And you also mentioned a manufacturing certification process, how long or lengthy is the process? In other words, what has to be done?

We're at the final stages of that and expect approval in the next few weeks to a month.

Okay. Well I know it would still be considered early, but have you started to lay out maybe a preliminary roadmap for taking EDAC abroad internationally?

Certainly several of the partners that we're talking to do would have a capability of doing that.

Okay. Well thank you very much.

Okay.

(OPERATOR INSTRUCTIONS)

And your next question is from the line of Jonathan Hoopes with ThinkEquity Partners. Please proceed.

Yes thank you, it's Jonathan Hoopes with an H. A quick question for you, if you could just walk us through the roadmap and when investors, we should be expecting a crossover on revenues from product and licensing relative to Technology Development?

Yes, I think that we're going to continue to see the Technology Development grow, but the products and licensing grow at a quicker rate, just like we have seen ever since the IPO. As far as an actual crossover, there's still a big delta between those revenue numbers. I don't expect it to actually cross over within the next couple of years, but we certainly see the product and licensing side continuing on an accelerated pace.

Okay. So, probably not until '09 at the earliest?

That's right.

Great. Thanks.

Your next question next question is from Mike Self with Lake Union. Please proceed.

Hey guys, congratulations on a great quarter.

Thanks very much, Mike.

I have a question for you. As far as in regards to the test and measurement business, where do you guys see that in broad strokes? Where is that business going in two, three years out? I'm just looking for kind of a general idea on what you think of that business as a whole.

We see ourselves continuing to develop partnerships in that space as well that have larger footprints to get our products out, and continuing to launch new and improved products, including the handheld, as well as other components that can help build the test stands on the manufacturing processes, as well as testing and verifying installation procedures as fiber-to-the-home is rolled out.

Great. Thanks a lot.

Thanks, Mike.

And we have a follow up from Michael Lew. Please proceed.

Hi, yes I have another question. You mentioned on the nanomaterials front, specifically with regards to the use of carbon nanospheres to inhibit the allergic responses. You stated you're looking for a pharmaceutical partnership to validate the findings, again what would be a reasonable time frame to expect a partnership announcement for the development?

We're expecting to work with a diagnostic partner first, a therapeutic partner after that.

Okay. And you mentioned there are about 50 million people that suffer from allergies, could you characterize or quantify the addressable market opportunity?

It's well over $2 billion.

All right, well thank you very much.

You're welcome.

And we have no further questions. I'd like to turn the call over to Dr. Murphy for closing remarks.

Thank you very much, Paul. Thank you all for your interest and participation in the call today. We look forward to speaking with you again on our third quarter earnings call. And for those of you who are planning to attend ThinkEquity's G5 conference in mid September, I hope to have the opportunity to see you there in person.

Thank you for attending today's conference, everyone. This concludes the presentation. Have a great evening.