Luna Innovations, Incorporated (NASDAQ:LUNA)
Q4 2010 Earnings Call
March 8, 2011 5:00 p.m. ET
Dale Messick - Interim President and Chief Operating Officer
Scott Graeff - Interim Chief Financial Officer
Mark Dalton - Private Investor
Ed Bustamante - One Source Telecom
Good day ladies and gentlemen and welcome to the fourth quarter 2010 Luna Innovations Incorporate earnings conference call. My name is Jeremy and I’ll be your operator for today. At this time all participants will be in a listen only mode. Later we will conduct a question and answer session.
If you need operator assistance at any time during today’s conference please press star, 0 and we will be happy to assist you. I would now like to turn the conference over to Mr. Dale Messick, Interim President and Chief Operating Officer. Please proceed, sir.
Thank you Jeremy. Good afternoon everyone and thank you for joining us today as we discuss the wrap up to 2010 and some of our expectations for 2011. Before we proceed further with our presentation let me remind each of you that the statements made in this conference call and our public filings, releases and Web sites, which are not historical facts may be forward-looking statements that involve risks and uncertainties and are subject to change at any time.
We caution investors that any forward-looking statements made by us are management’s beliefs based on currently available information and should not be taken as a guarantee of future results and performance may differ materially as a result of a variety of factors discussed in our earnings release and our latest filings with the Securities and Exchange Commission. We disclaim any obligation to update any such factors or to announce publicly the result of any revisions to any of the forward-looking statements to reflect future events or developments.
There is more complete information regarding forward-looking statements, risk and uncertainties in the company’s filings with the SEC available on our Web site. So with that I’ll touch on some of the highlights of Q4 and recent events and then Scott Graeff will give more detail on the financial results from last quarter and current expectations for 2011 and then we’ll be happy to take any questions.
The fourth quarter was a strong close to 2010 for us particularly on the product side of the business. Revenues related to our fiber optic test and measurement and sensing applications marketed under our Luna Technologies brand increased 14% compared to the fourth quarter of 2009 with an especially strong uptick in sales to Asia in the last quarter. Along with a higher revenue on the products side, at year end we also carried over a backlog of orders of nearly $1.4 million for shipment in 2011, an increase of more than 60% compared to the backlog that was carried over at the start of 2010.
So we expect to have a good start to 2011 in this area as you’ll hear later in our guidance. This same products group within Luna also supports the shape sensing and localization technologies under development currently for intuitive surgical and enhanced medical. We continue to enjoy strong relationships with these customers and the work there continues to make good progress in the development work for each of them.
In the technology development segment of our business revenues for the fourth quarter increased slightly about 1% over the fourth quarter of 2009 whereas we had been seeing declines throughout most of 2010. Within this area of our business we are seeing some groups that continue to be experiencing program win rates below their historical averages while other groups, most notably our secure computing and communications group and our optical systems group, are seeing significant growth in new programs, creating an offsetting effect when we look at total revenues for this segment of the business.
Q4 revenues for our optical systems group, which has the benefit of being able to leverage the utilization of our OBA and OBR products in their research proposals, increased 27% compared to a year ago while revenues in our secure computing and communications group, which focuses on protecting hardware and software systems and the communications between them, increased 19% compared to the fourth quarter of 2009.
We expect these groups to continue to see solid growth in 2011 and we continue to hire aggressively in these areas to meet that demand. With our revenue growth and continuing control over operating expenses, we were able to achieve a small cash flow positive for the quarter making our second consecutive quarter of positive cash flow. With our Hansen litigation costs behind us we have obviously made significant improvement in both operating expenses and in cash flow.
If we exclude the borrowings under our revolving credit facility during 2010 our net cash usage for the entire year was only a half million dollars. Excluding the revolver we had net cash outflow of nearly $1-1/2 million during the first half of the year, which of course included us paying off our pre-petition liabilities as well as legal fees around our Chapter 11 reorganization. While during the second half of the year we generated almost $1 million of positive cash flow.
So looking back over the year 2010 we increased our product and license revenues by nearly 30% for the year. We extended our development programs for key customers like Intuitive Service Corp. We started a new relationship with Hansen Medical, improved our adjusted EBITDA excluding litigation by 25% and strung together two consecutive quarters of positive cash flow for the first time since our IPO.
All of this in a year that started with the company operating in Chapter 11 so I’m very pleased with how far the team at Luna has come this past year. Now what’s new on the horizon for 2011? We expect to continue to build on the successes of 2010 both in terms of financial results and in expanding our products and services. We plan to launch new products focused on using optical fiber to measure strain, opening up new potential markets for us outside of telecommunications.
Many of you may have read that Phillips Medical sublicensed from Hansen the rights to use our shape sensing and localization technology in various fields of malnervotic medical applications. We were aware of this development and had some very preliminary conversations with Phillips as well about Luna’s possible roll in applying our technology to these fields. Potential future relationships with Phillips in this area may or may not happen.
And in any event, it would take some time to determine but we are of course very enthused by the prospect of deploying Luna’s unique technology through products with the global reach of a company such as Phillips. As you know, last year we also initiated a search for the CEO role within Luna. We have been happy with the overall process and the quality of candidates brought forward and we believe that we’re making good progress toward bringing the search process to conclusion hopefully in the near future.
But at this time I’d like to turn the call over to Scott Graeff, our Interim Chief Financial Officer, to give a deeper look at our 2010 financial performance and our outlook for 2011.
Thanks Dale. I’d now like to give the financial results for the fourth quarter of 2010. I will also give highlights for the entire calendar year of 2010. Overall our financial results of operations continued in their positive trend with an increase in overall revenues compared to the fourth quarter of last year.
We did achieve a significant increase in our products and licensing revenue as well as lower operating expenses and improvements in our net loss and adjusted EBITDA. We also achieved positive net cash flow for the quarter. Specifically for the fourth quarter of 2010 we generated revenues of 9.1 million, an increase of 6.2% compared to 8.5 million for the fourth quarter of 2009.
Revenues in our products and license segment experienced an increase of 14.5% to 3.6 million for the fourth quarter of 2010 compared to 3.1 million in the fourth quarter of 2009 primarily due to increased sales in our OBA and OBR product lines. As you’ll recall, we introduced the new OBA 5000 back in the first quarter, the OBR 4200 in the second quarter and the OBR 4600 in the third quarter of 2010.
As a result of these initial product launches in 2010 we experienced additional activity in customer need for devices that are designed for component and short run network testing. The growth in our products and license revenues was complemented by a slight increase in revenues within our technology development segment where revenues increased slightly by 1% from 5.4 million in the fourth quarter of 2009 to 5.5 million in our most recent quarter.
As we have mentioned on previous earnings calls for the past several quarters, our win rate for new research contract awards declined contemporaneously with our reorganization in 2009 and early 2010. We began to see quarter over quarter improvement in the technology development backlog starting on September 30, 2010. As such, the second half of 2010 has shown signs of recovery in our most recent phase 2 awards, specifically in our optical systems group.
And that is noticeable in our technology development backlog, which increased 34% or 6.7 million to 26.3 million at the end of the fourth quarter of 2010 up from 19.6 million on December 31, 2009. Gross profit improved 5.5% from 3.2 million in the fourth quarter of 2009 to 3.4 million in the fourth quarter of 2010. We continued to manage operating expenses for the fourth quarter with a slight decrease of 2% in selling, general and administrative expenses to 3.2 million in the fourth quarter of 2010 compared to 3.3 million in the fourth quarter of 2009.
Operating expenses overall increased by 9% to 3.7 million in the fourth quarter of 2010 compared to 3.4 million in the fourth quarter of 2009 excluding the costs associated with the non-recurring litigation and reorganization activities in 2009. Excluding those costs of approximately 12,500 during the fourth quarter of 2010 compared to approximately 1.5 million in reorganization and litigation fees and 26.6 million in reduction of litigation reserve in the fourth quarter of 2009, operating expenses represented 41% of revenues this past quarter compared to 40% of revenues for the fourth quarter of last year.
With the improvements in gross margin and the increase in revenues our net loss for the quarter was 382,000 in the fourth quarter of 2010 compared to net income of 24.9 million in the fourth quarter last year. Of course last year that included the reversal of more than 26 million in litigation reserve. Including the costs of the common stock dividend related to our outstanding class of preferred stock, the net loss to common stock holders was 475,000, again compared to net income of 24.9 million for the fourth quarter of last year.
Our net loss for the entire 2010 year improved to 2.6 million compared to a net loss of more than 20 million for the entire year of 2009. Keep in mind that 2009 was also adversely affected by approximately 16.6 million in reserves and other nonrecurring charges we recorded associated with the Hansen litigation and our Chapter 11 reorganization. To normalize for that and other factors in our release today we have provided a reconciliation of our net loss to our adjusted EBITDA, which excludes the costs associated with the litigation and reorganization as well as non-cash costs related to stock compensation.
As a result, our adjusted EBITDA less litigation and reorganization related items remains relatively flat at approximately 1 million for the fourth quarter of this year compared to 1 million for the fourth quarter of 2009. It did increase for the full year 2010 to 2.9 million compared to 2.3 million for the entire year of 2009. Turning to our balance sheet and cash flow, we ended the quarter with 7.22 million of cash compared to cash of 5.23 million at the end of 2009 and 7.15 million at the end of the third quarter of this year.
Our net change in cash was a positive $64,000 for the quarter, a continued trend that we began to see last quarter when we were 900,000 cash flow positive in the third quarter of 2010. We were nearly 1 million cash flow positive in the second half of 2010, a very encouraging milestone for the company now that the litigation is behind us. In fact, excluding new money from borrowings, the company used only approximately 500,000 of cash in all of 2010.
This $500,000 of cash usage included nearly 2 million in accrued legal fees that were paid in the first half of 2010. Liabilities are a little challenging to compare line by line against the audited balance sheet of December 31st due to the reporting format of the time when we were in reorganization. Instead I will highlight for you the current liabilities of 10.6 million at December 31st compared to 9.5 million of current liabilities at the end of the third quarter of this year while total liabilities of 13.3 million at December 31st compares to 12.5 million at the end of the third quarter.
Working capital improved to approximately 8.1 million at the end of the fourth quarter compared to 7.8 million at the end of the third quarter of this year. So you can see that along with our positive cash flow of 64,000 for the quarter our balance sheet continued to strengthen overall as well. For 2011 the company anticipates continued growth in both its product and license segment and its technology development segment.
Based on information as of today the company expects total revenue for 2011 to be in the range of 37 million to 39 million consisting of product and license revenue of 14 million to 15 million and technology development revenue of 23 million to 24 million. Also for 2011 the company anticipates a net loss for common stockholders in the range of 2 million to 2-1/2 million. For the first quarter of 2011 the company expects revenue of approximately 8 million to 8-1/2 million consisting of product and licensing revenue of 3 million to 3.3 million and technology development revenue of 5 million to 5.2 million.
We would also expect a net loss to common stockholders of approximately 1.3 million to 1.6 million. With that I would like to hand it back to Dale where he can open up the call to any questions that you have.
Thanks Scott. Jeremy, we are ready to take calls if there are any from the audience.
Question and Answer Session
Ladies and gentlemen, if you wish to ask a question please press the star, 1. If your question has been answered or you would like to withdraw your question press star, 2. Our first question comes from Mark Dalton, private investor. Please proceed.
Yes. Thanks for taking my call. I’m just from the buy side here and congratulations on your improved close. A couple of questions - this search for a president and the fact that we’ve got an interim one now, is there any projection when we’ll find a president and get a little more stability there? That may be the wrong word to use but it was so puzzling why the search is taking so long.
Well, Mark, thank you for the question and I don’t think that from a company perspective that there is an issue with stability. I think that our results show that we’ve continued to make the right progress in the operations during the interim period. As I said, the search is progressing very well. It’s along the timeline that we had set out kind of internally for our expectations.
We don’t think that it’s taking longer than it should. We have been happy with the candidates that the recruiter has brought to us and we hope to finalize it in the near future. As I said, I don’t think it’s going to be a long, drawn out process.
And stability was probably a bad word to use. I guess I’m thinking from a hiring perspective I watch your Web site and it looks like your hiring has picked up some and I would just have some at least mild concern of as far as new hires go when you’ve basically got an interim president involved and the concern of new hires but thanks for addressing that.
The second question - how much will these purported Congressional cutbacks hurt you guys as far as your government contracts abilities go? Or do you see any affect there at all?
Actually it’s something that we’re watching closely. We have been in contact with our key customers and believe that if the continuing resolution doesn’t get passed and there is some shut down that we’d be able to continue to work on the existing projects that we have. What it may mean is some delays in the timing of awards for future contracts.
Obviously a significant portion of our business is tied to government contracting so it’s important to us that we keep an eye on it. The groups that are growing, particularly the optical systems group and the secure computing groups I think are writing proposals that will be compelling in the future. So while we are at risk of cutbacks in future funding we don’t have any specific adverse insight into that currently.
Okay. And the last question - thanks for taking them - I’ve been a shareholder with you guys for a long, long time and just wondering here and you guys showed us what you’ve been through in the last two or three years and we’ve watched that closely. But hopefully now we’re back on the homestretch. Any projection when you guys will actually be profitable? I know that’s a Pandora’s box question but you’ve had losses for a long time and you are narrowing them significantly but any idea when we could expect profitability out of you folks?
Yes. So that’s obviously a good question Mark and Scott gave some guidance that said we expect our net loss to common next year to be in the 2-1/2 range and a net loss in Q1 of 1.3-1.6 million. So obviously that means that we see that tightening up considerably in the second half of the year in order to make that full year guidance.
So it’s somewhat of a seasonal business for us. We typically have our lowest performance in Q1 and then get better as we go through each year. So I think we’ll see that again in 2011.
And would it be fair to assume that the hiring pick up it looks like you guys have got now could possibly be commensurate with some new growth?
Yes. If you look at the new hires that are out there or the opportunities that are out there, I think there’s about 15 or so that are out on the Web site right now. Most of those relate to either our optical group or our secure computing group so it’s certainly commensurate with where we expect to see the growth in 2011.
Very good. Have a nice evening.
Great. Thanks very much Mark. I appreciate it.
Our next question comes from Ed Bustamante with One Source Telecom. Please proceed.
Yes. Hi. I am also an individual shareholder and have been with you guys a while and I was calling - my question today was on the Hansen Medical arrangement that was just announced with Phillips. Throughout their Web site they announced the partnership was a joint venture with you guys. Can you kind of elaborate a little bit how you guys are going to play a part in that arrangement?
Well, first of all the Hansen and Phillips agreement was not something that we were specifically a party to. That was a sublicense of rights that Hansen had to our shape sensing localization technology in certain fields. They sublicensed that on to Phillips. They really are able to do that outside of us.
So as I said, we have had some very preliminary discussions with Phillips. We would like to have an arrangement with them to continue to develop that for non-robotic applications and be able to market that in products for Phillips. But those are discussions that will be ongoing to try to reach a conclusion there.
Okay. Thanks for a great quarter guys and keep up the good work. Thank you.
Ed, I appreciate it very much. Thank you.
As a reminder ladies and gentlemen, star, 1 if you have a question.
I’m in no hurry to see you get a full time CEO unless he’s a very special kind of a guy. What is your headcount now?
Our headcount is about 185.
185 - noticing the career list that you’ve posted. It seems like are you having any difficulty finding the people or finding the right people?
Well, I don’t think we’re having that much difficulty in finding the right people. They are unique skill sets and because of what we’re doing we do look for very specific skill sets. So there is a lot of weeding out that we have to do in order to make that final hire. But we have not had a situation where we have had positions that were open for a long period of time that we were really trying to get filled in order to meet the customer expectations.
Okay. If you had to look at your business and break it down, what particular area could see very significant growth if some good things happen?
I think that we continue to be most excited about the products side of the business, the fiber optic as I mentioned. We’ve been very focused in telco for since the beginning. We expect to actually launch that out with some new products that would go into strain measurements so going into a mechanical measurement instead of a telco test. That’s something that we would like to get out the door later this year.
It’s going into an established market where there is already an alternative product that is available that’s not fiber optic based. So we’ll be competing against established technology but we believe that we’ve got a compelling value proposition that we’ll be able to make some significant wins there although they’ll have to ramp up.
And I think as we enter John, as you know, coming up on our fourth year of working with Intuitive and now over a year with Hansen, the advancements of the sensing is pretty exciting.
Thank you for your hard work. I’m more excited now than I have been in probably 2-1/2 years. I think it’s a better company now than it’s been four years so congratulations.
Thank you John. I appreciate that very much.
And at this time I’d like to hand it back over to Mr. Messick. There are no more questions.
Great. Thank you Jeremy and thanks very much everyone for joining us this afternoon. We do look forward to speaking with you again at the end of the first quarter.
Ladies and gentlemen, that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.
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