Luna Innovations Incorporated
Q4 2019 Earnings Call Transcript

Published: 6 Mar 2020

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the Q4 and Full Year 2019 Luna Innovations Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions].I would now like to hand the conference over to Ms. Allison Woody, Director of Administration. Thank you, please go ahead, ma'am.

[Allison Woody:]

Thank you. Good afternoon and thank you for joining us today. This afternoon, we issued our fourth quarter and full year fiscal 2019 earnings press release. In addition, we posted to the Investor Relations section of our website, a presentation with supplemental information for the quarter. If you do not have a copy of the release or the supplemental materials, please check our website at lunainc.com. We will also post a replay of this call to our website.Some of our comments and discussions today are based on non-GAAP measures, specifically adjusted EBITDA. These adjusted numbers exclude the effect of certain non-cash expenses and other items. The adjusted results are a supplement to the GAAP financial statements. Luna believes the presentation and exclusion of these items is useful in order to focus on what we deem to be a more reliable indicator of ongoing operating performance.Before we proceed with our presentation today, let us remind you the statements made on this conference call, as well as in our public filings, releases and websites, which are not historical facts, may be forward-looking statements that involve risks and uncertainties and are subject to changes at any time, including, but not limited to statements about our expectations regarding future operating results or the ongoing prospects of the company.Actual results may differ materially as a result of a variety of factors. More complete information regarding forward-looking statements, risks and uncertainties is available in the company’s SEC filings, which can be found on the SEC website and our website. We disclaim any obligation to update any such factors or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or development except as required by law.After our prepared remarks, Scott Graeff, our President and Chief Executive Officer; Gene Nestro, our Chief Financial Officer; and Brian Soller, Senior Vice President and General Manager of our Lightwave Division will be available to take your questions.And at this time, I’d like to turn the call over to Scott.

[Scott Graeff:]

Good afternoon, everyone and thanks for joining our call. As Allison mentioned, we issued our fourth quarter and full year 2019 press release at market close. We are joining you today during a period of incredible market volatility driven by concerns over the unknown. We recognize this noise in the market is uncomfortable.Nevertheless, we continue to focus on our performance and on our long-term prospects. As you will hear during our review today, Luna has just exited the best quarter and year in its history. Not only am I incredibly excited to share with you the exceptional results of what we accomplished by executing on focused priorities, but I'm extremely proud of the Luna team. I have to start by recognizing and thanking my Luna colleagues who worked so hard to deliver such great results. Congratulations to the entire team.In my 17 years at Luna, and then Luna's 30-year history, 2019 marked the best year from both an operational and a financial performance perspective. And I believe we're just getting warmed up. You will see that we drove very strong financial results for the quarter and the year. I'll start with an overview of the quarterly financials in a moment. But first, I'd like to reflect on several important accomplishments during 2019 that helped to set us up for continued success in 2020 and beyond.I think about our accomplishments in 4 categories. First

[Gene Nestroas:]

Thank you, Scott. And this is my first earnings call with Luna, I'd like to start by saying how excited I am to be here and how grateful I am to have the opportunity to join the incredibly talented Luna team. I worked for some great companies and leaders during my career. I learned a lot from them and I look forward to bringing my knowledge and experience to Luna. I feel lucky to join the business as they are announcing the best quarter and year ever.Rest assured, I feel an immense amount of responsibility to make sure we're well positioned from a financial perspective, to be able to capitalize on all of the wonderful assets we have. Human, intellectual and otherwise. And I do look forward to meeting and working with all of you as we continue to deliver outstanding shareholder returns.Now let's get down to business. I'd like to start by covering a number of components of this quarter's results. First, as a reminder on some of my comparative comments, we sold our optoelectronic components business in July 2018 and the operating results of that business for the fourth quarter and full year of 2018 are classified as discontinued operations in our income statement. Also, as a reminder, in SG&A there is approximately $350,000 in non-cash intangible amortization expenses related to our two recent acquisitions that we’ll be referring in future quarters.Our revenues for Q4 2019 were 19.5 million, compared to revenues of 13.5 million for Q4 2018, representing a 44% year-over-year increase. The increase in revenue year-over-year was composed of a 63% increase in our products and licensing segment and a 16% increase in our technology development segment, continuing our strong revenue growth cadence throughout the year.Within the products and licensing segment, our year-over-year growth continued to be driven by revenue associated with our acquisitions, as well as our strong top-line double-digit growth from our legacy businesses. Our gross profit increased to $10.4 million for the quarter, compared to $6.6 million for the same quarter last year, representing a gross margin of more than 53% in Q4 2019, compared to 49% in Q4 2018.The gross margin improvement reflects in part the changing mix of our revenues, with 67% of our revenues coming from the products and licensing segment in Q4 2019, compared to 59% in Q4 2018. This change in mix is driven largely by our acquisitions and is consistent with our long-term strategy.Operating expenses were $8.7 million or 45% of revenue in Q4 2019, compared to $6.1 million or 45% of revenue in Q4 2018. The increase in SG&A expenses continue to be largely driven by the same two items we've previously discussed. The first driver is the ongoing incremental expense associated with our acquisitions. As we enter Q4, we lapped the incremental amounts for Micron Optics. The incremental expense from General Photonics will continue for another quarter. The second driver of the SG&A increase is higher sales and marketing expenses from our Lightwave division, as we continue to support our increasing revenues. With the revenue growth and gross margin expansion, our operating profit improved to $1.7 million for Q4 2019 compared to $0.4 million in Q4 last year. Net income from continuing operations in Q4 2019 was $2.1 million or $0.07 per share, compared to a loss of $0.1 million for Q4 2018.And finally, a key metric reflecting our underlying operations is adjusted EBITDA. As Scott mentioned, adjusted EBIDTA was nearly $3.2 million for the quarter versus $1.6 million for the fourth quarter of 2018. This robust performance was driven primarily by strong top-line growth from both our legacy businesses and those businesses we acquired combined with our ongoing expense management. For the full year 2019 our revenues were $70.5 million, compared to revenues of $42.9 million for 2018, representing a 64% year-over-year increase. We drove more of that revenue to gross profit delivering $35.2 million or 50% of revenues in the period, compared to $19.4 million or 45% of revenues in 2018. Further with continued focus on expenses, we improved operating income to $3.3 million for the full year from $0.9 million last year, despite the increased investment in our business, particularly in the sales, marketing and engineering resources which we've mentioned previously.Net income from continuing operations was $5.3 million for 2019, compared to $1.2 million for 2018. The decline in net income attributable to common shareholders was due to discontinued operations, which included the gain recognized on the sale of the optoelectronics business in 2018. And finally, we improved net income per diluted share from continuing operations to $0.17 for 2019 from $0.04 per diluted share during 2018.Let me now move on to the balance sheet. Cash increased over $4 million sequentially and we ended the quarter with $25 million of cash-and-cash equivalents, compared to $42.5 million at the end of 2018 and $21.4 million at the end of September. Our working capitalwas $41.1 million at December 31, compared to $56.1 million at the end of last year and $39.2 million last quarter. The change for the year reflects the cash paid for General Photonics in Q1 of 2019 and our stock buyback in September.Scott already discussed our guidance, so I won't repeat it. But I do want to take a moment to talk about the seasonality of our revenue. Our revenue typically increases quarter-on-quarter throughout the year, and historically we have seen approximately 44% to 46% of our revenue occur in the first half of the year, and 54% to 56% occur in the second half. We expect to see this trend continue in 2020.Before I turn it back over to Scott, I want to mention our thoughts on the impact of the coronavirus. Similar to others, we are evaluating the impacts on a daily basis. At this time, with what we know, we do not expect a material impact on our full year results. With that said we will continue to evaluate the impact to our business particularly if the coronavirus becomes a larger global issue. To be cautious, we have suspended all international air travel for our employees.With that, I will turn the call back over to Scott.

[Scott Graeff:]

Thank you, Gene. At this time, I'd like to open up the call for questions. As always, I have Brian Soller, our Senior Vice President, General Manager of our Lightwave division, is also with Gene and me at this time and is also available to address your questions. So, Donna?

[Operator:]

[Operator Instructions] Your first question comes from the line of Spartan. Your line is now open.

[Barry Sine:]

Hey guys, it's Barry Sine with Spartan. Good afternoon. Gene, welcome aboard, I wanted to welcome you by putting you on the spot with some financial questions. First one of gross margin. On both business segments, if you're looking at the supplemental data that's on your website. Both had very high gross margins, and so overall, you had a very high gross margin. Is that sustainable? Was there anything in the quarter that maybe was a little higher than normal? Because those gross margins for both segments are a bit above prior trends.

[Gene Nestro:]

There was nothing specific in the quarter in either one of our segments. I would say consistently, we see our margins where they are year-on-year. We do see quarterly swings here and there due to product mix and other issues. But I think generally we see that going forward.

[Scott Graeff:]

Yeah, I think Barry as we’ve mentioned before, I think when you talk about seasonality, I mean obviously we have a strong mix in the fourth quarter of products versus our contracts business and they carry a much higher gross margin. So you'll see that blended, be higher in Q4 than others. Yeah very favorable mix in Q4. So…

[Barry Sine:]

Okay. The other financial item that that stood out, that I thought was interesting was the R&D expense side. But again, that's broken out in your supplemental. As a percentage of revenue that number is above where it has been in -- I'm just looking at last the prior seven quarters. So that's trending up, you're spending more and more on R&D, and I know, you guys have talked in the call about some new products you have. It sounds like that new product development is continuing and even accelerating, given the clue I have about higher R&D spending.

[Brian Soller:]

Yes, hey, Barry, this is Brian. What you're seeing there are some nonrecurring expenses related to qualification of some of the new products we've gotten on the market in 2019. So, I’ll let Gene talked to the basis of that going forward, but from my perspective, looking at our R&D spend, you know, that's created by the lightweight division, and in particular, getting the 6,200 products that we mentioned, qualified for and ready for full production. And those are the kinds of things that don't necessarily recur. They certainly happen periodically as you get new products ready for the market, that product in particular had a fair bit of a qualification required for military standards as we discussed in the past. So, that's what you saw there.

[Barry Sine:]

Okay, that makes sense. Thank you. Gene, you also [audio gap]

[Operator:]

You’re still connected, sir.

[Brian Soller:]

Okay, we lost Barry. So you may have to go onto the next question Donna.

[Operator:]

Your next question comes from Singular Research. Your line is open.

[Jim Marrone:]

I basically have two questions. One is the -- first one of will be a financing question and then for a follow-up question will be one in regards to operations. So starting with the financing questions, just in regards to extinguishing the preferred shares and restructuring your capital structure, do you have a sense of what weighted average cost of capital is and how much is decreased from before the restructuring to after the restructuring? And kind of the motivation between for the repurchase program, why deploying the cash towards repurchase program as opposed to using that cash say, for acquisitions or for other purposes? And I'll ask the operations question.

[Scott Graeff:]

Yes. Jim, I'll address the, what our thought was behind the share repurchase program. I think, as we continue to, the stock price increase, we believe that was us getting out and executing our strategy to being able to properly communicate that strategy as well as deliver on it. So, we believe that we find out that we wanted to establish that the Company believes that we were setting new low watermarks for the stock and we wanted to put our money behind that.So we thought an immediate return to shareholders of buying back the 130,000 shares for the right use for $2 million worth of our capital. I think you're right as you see the balance sheet now, as it sits with 25 billion in cash with no debt, I think we will look at other opportunities to put that money to work and be creative with that cash on our balance sheet. On the weighted average cost of capital, I don't know, Gene, do you have any to add to that?

[Gene Nestro:]

We may have to follow up with on the one. Okay, But we can we can imagine, I mean material decrease in cost of capital with the extinguishing the prefs.

[Scott Graeff:]

Yes, I think naturally with paying off the debt in March or May of last year. And then the dividends going away from the preferred buyback, I will see that the cost of capital go down. I think we'll have to follow up with you or Gene will follow up with you on what that lack is for Luna.

[Jim Marrone:]

And if I can just follow up with a quick operations question. Just if you can provide a little bit more color on the F-35 program. Can you give us an idea like, is this -- is the product going into like the existing fleet? Or is it a new build? And can you give us a sense of whether it's the existing fleet or a new build, what percentage is being employed with the Luna product? And where can go from there and perhaps just the kind of the pipeline with crossover into the commercial part of the business?

[Brian Soller:]

This is Brian, I'll answer that question. So the 6200, which we began shipments of late last year. And continued now with the follow on order and will continue into this year is for F-35 aircraft that are already deployed in the field. So they're about 450 to 500 or so in the field right now with more coming every day. And they all need this type of equipment for sustainment of the fiber optic links on the aircraft. The good news is that we see this starting around the later part of this year and Luna is a sole source as a provider to the F-35 program for this kind of equipment. There are about 14 F-35 per squadron and they're looking at 2 or so per squadron so you can kind of look at it that way. And the number of units and field grow, we expect our sales to grow as well.

[Jim Marrone:]

And in terms of the pipeline with crossover into the commercial space, can you give us an idea where we're going with that?

[Scott Graeff:]

Yes, I’ll let Brian give a little bit more color on that, but I -- I'd say, as you know, commercial kind of will follow military. But when you look at a customer like Lockheed Martin, we talk a lot about the F-35, but there is the F-24. And there's a lot of planes, military planes that are being made as Lockheed Martin that our product is obviously relevant there. There's plenty of military applications outside of Lockheed that I made reference to in my presentation here. But we will all currently in the process of rolling this out as well and willing to coming from once in years commercial application as well.

[Brian Soller:]

Yes, commercial aircraft or in the process of integrating fiber optics as well. They tend to be a little bit behind the cutting edge, high-tech fighter jets. But that processes is well began, and we're in lockstep with OEM. We do business with them today and we have with our previous versions of this product, and then we stuck in there to grow outside and other applications including data center, conductivity and other types of general fiber optic tests.

[Operator:]

We have a follow-up question comes from Spartan. Your line is now open.

[Barry Sine:]

So, I have a couple more questions if you don't mind. Gene, you mentioned the coronavirus impact, which obviously is all on investors' minds. Scott, your industry, the optics industry recently had a major industry conference at the West Coast. I'm wondering if attendance was impacted there, if you see lower attendances, does that mean few orders come out of that and/or fewer M&A deals? is that a place where perhaps you would strike some relationships for M&A deals? Any impact there?

[Gene Nestro:]

Yes, Barry, that conference you speak of is OFC and its next week in San Diego. So, we will be at that conference next week, so I'll have to follow up and answer that question after the conference occurs. So -- but it is a big industry trade show and while the attendee list is probably been skinny down somewhat due to our friends in Asia. I believe the website of the conference itself says that it’s still on and going strong. So, I'll let you off the follow up with that, but it is a great conference to meet a lot of industry leaders as well as other opportunities there.

[Barry Sine:]

So if that were canceled, would that impact potentially orders or your ability to do M&A?

[Gene Nestro:]

No. Barry, I think the way to look at it is, if it were cancel, which I don't think it will be, but it doesn't start till next Tuesday. It would make our jobs to those ends a little bit more difficult. It's much more efficient when everyone's in the same place as you can imagine. So, it certainly drives an efficiency, but there's nothing that we view that we want to get done, that we won't be able to get done for some reason we don't go to the show.

[Barry Sine:]

Okay. And then, Scott, you guys gave guidance which again is pretty aggressive outlook for 2020. What visibility do you currently have towards that guidance in terms of orders that are already on the books? You talked in your opening remarks about acceleration of adoption of some of your technologies. How much do you know that, that is driving that guidance right now?

[Scott Graeff:]

Right, as I've told you before, Barry, we give guidance and I give it based on what I see in front of me at the current time. And what we see right now based on Brian being here 18 years and myself being here 18 years, I think we look at what is in front of us and historically, what we have booked and you know the contract side of the businesses, is much more heavily booked for the year.But what we see from a funnel fill from an activity perspective, what is currently booked? What's in the pipeline? What do you see the momentum going with getting larger orders in the multiple unit orders coming down the pipe with some of the new products that we've come out with? I feel good about the guidance we gave. I don't -- and I try to be as transparent as I can't, and I give what I see.And if that changes, you will be the first to hear from me. But I feel confident given what I see in looking at this. We take this very seriously giving guidance and you see that throughout 2019 in what we deliver and we continue that on in 2020. So, that's as best I can give you right now.

[Barry Sine:]

Okay, and then I want to wrap up with a couple of questions on M&A, if you don't mind. The Company is considerably larger than you were a year or two ago looking at the income statement or the market cap. Does that open up a new range potential acquisitions or most of what you're looking at smaller on the order of what you've done in the past? So should we think about larger acquisitions now going forward?

[Scott Graeff:]

Well, I mean, certainly, we have a pretty unlevered balance sheet probably as unlevered as you can get, which is probably a good thing to have. But, my attitude towards M&A has always been, we've done a lot of work to set a strategy and make sure that it's clear and concise. So when I look at M&A, it has to be a couple things. Number one, it has to fit with what we are. We're fiber optic test and a measurement company. So it has to fit within our strategy. And I've always said on -- I'm not up for overpaying. And it has to be accretive.So we continue to look at things that fit that those parameters. So I don't know if I put a necessary deal size on how I look at M&A. But if it fits sand it's not overpriced and it's accretive we're going to probably have a conversation with them. But I don't necessarily look certainly our position now when you look at $25 million in cash, no debt, no prefers no warrants. The balance sheet is as clean as it can possibly be.And I said, I wanted to get these two acquisitions that we did under our belt and get fully integrated. We said now two quarters in a row, I reiterate the point that the integration is complete. So we will have our eyes downrange back and looking at things that might make sense. But they have to fit our criteria.

[Barry Sine:]

So just to follow up on that are there anybody, any companies you're talking to currently you have in your sights currently? And my reading of your comments just now, is that a transaction of some type, or more than one this year is more likely than not. Is that fair?

[Scott Graeff:]

Yes, I would just say that we have a lot of conversations. I wouldn't say anything's imminent. I wouldn't say there's anything that you can expect to hear from me in a week. But I would say that we continue to talk to folks and continue to lay out our M&A approach to that, which is what I laid out for you. I wouldn't say anything is imminent. As you know when the stock the last two weeks, we're going to look like the last two weeks. But we are where we are. So -- but I wouldn't say anything is imminent, Barry.

[Operator:]

Next question comes from the line of [Sharmac Capital]. Your line is now open.

[Unidentified Analyst:]

Yes. Thank you. I'm just wondering, Scott, if you can talk a little bit further about the automotive market? You mentioned that you're making some good progress there with Odyssey product.

[Scott Graeff:]

Right.

[Unidentified Analyst:]

I'm wondering give us some examples and talk about, maybe a little more detail about the prospects there, generally what's going on there?

[Scott Graeff:]

Sure. Well, and I'll let Brian jump in here as well. He is out in front of a lot of customers on the floor more so than I am. But, what we've done, the Odyssey is relevant, because remember the Odyssey goes out up to 50 meters because 8 channel, with those 8 different directions for 50 meters. So, it's perfect for structures the size of automotive and an example think of the part that holds the seat to the vehicle itself. That part is being made with composites and it's being made on a 3D printer.So we can work on that 3D printer to embed the fiber while that product is being made, and unlike traditional steel, if you back into something, your bumper may get dented, but with composites you may not actually see a blemish at all, but it may have messed with the structural integrity of say that part that is in there out of composites is attaching the seat to the vehicle. So, there may have been some structural integrity issues that have happened. Our fiber can tell you whether there has been some issues there, that's an example that always comes to me. Brian, if you want to.

[Brian Soller:]

Yes, sure. So, the automotive industry is going through a cycle of light-weighting electrification. I think most people are pretty familiar with that. But in the end, the design of cars is really moving towards more and more use of lightweight and composite materials, and of course, electric power trains. So, that actually draw -- that kind of macro driver is what is what drives the need for new test equipment to verify and qualify new materials.So, composite material that are being used for structural elements of the car anywhere and everywhere really that can take weight out of the car, needs to be fully qualified in the design cycle, and that's where our Odyssey fiber optic sensors come in. So that's been a nice driver for us over the last several years. Another example is, in particularly in 2019 and then Q4 we added a number of really high-quality sales as soon as the larger OEMs for integrating our optical fiber into the composite casing that goes around the battery system for an electric vehicle.There's quite a lot of tests that goes into ensuring safety of the electric power train, and these are very large, typically lithium-ion batteries, which, it's very important to qualify rigorously for safety. And, our Odyssey fiber allows very high precision very accurate measurements of things like thermal expansion and thermal strain and stress within those systems. So, those are a few examples of what's driving our Odyssey technology and new test equipment in general in automobile.

[Unidentified Analyst:]

Okay. And I'm sorry, the second example Brian that is a case with the batteries. You're using the Odyssey product there as well?

[Brian Soller:]

Yes. Those are both examples of where we're using the Odyssey product in automotive.

[Unidentified Analyst:]

Okay, the composites and the batteries.

[Brian Soller:]

Yes.

[Unidentified Analyst:]

Okay. That's terrific. And so, you're mainly working with the OEMs right now?

[Brian Soller:]

Yes, that's correct. Yep, we work with the design and engineering teams we send all, pretty much all, not all, but most of the major automotive OEMs. And we hope to make that all by the end of this year and integrating Odyssey Technology into their design systems for new designs.

[Unidentified Analyst:]

That's impressive. And you say all you mean, the big 3 and in the U.S. the, big 2 or 3 over in Asia and in German companies did well?

[Brian Soller:]

That's correct. Yes. Now, I'd like to use the phrase that Scott used during the prepared remarks. We're in the early innings with each of those. But yes, we do have -- they are the majority of those books in Japan, in North America and in Germany are using Odyssey Technology.

[Operator:]

[Operator Instructions] There are no questions on queue. I'd like to turn this over to Scott for his final comments.

[Scott Graeff:]

Alright. Thank you, everyone for joining us today. As I hope you will take away from our call. I'm incredibly proud of the strong results delivered by our employees across the Company. As you know, we worked extremely hard to increase our public profile throughout 2019 and increase our participation in conferences and other venues so that we can meet with more of you in person. We fully expect to do so again in 2020.I want to conclude by mentioning that we plan to hold our Annual Shareholder Meeting this year on Monday, May 11th in New York City. We hope to see many of you there. Please watch your e-mail for more details in the next several weeks.With that, I'd like to thank you for your time and interest in Luna Innovations.

[Operator:]

This concludes today's conference call. You may now disconnect.