Initial Roll-Out Taking Longer. Long-Term Outlook Still Intact
By Brian Marckx, CFA
Q3 10-Q / Conference Call
SpectraScience (SCIE) filed their 10-Q for the third quarter ending 9/30/2012 and held an investor call. Revenue came in well below our estimate. Despite SCIE's continued hard work behind the scenes which includes training the Pentax sales force and technical staff, increased awareness-building efforts via attendance at several key industry conferences, and their own sales and marketing efforts, revenue has yet to gain much traction. Management indicated that at least of a couple of issues have been a headwind – most notable of which may be that there is not yet an appropriate incentive structure in place for the Pentax reps relative to WavSTAT. This is expected to change – initially with SCIE offering sales incentives (which are to begin immediately) to the Pentax reps and then beginning in April 2013 (the start of Pentax's fiscal/budget year) SCIE may be able to roll these incentives back as Pentax will implement sales quotas for WavSTAT. Some of the other hindrances that management pointed to or at least appear to be factors and which are hopefully similarly short-lived, is that SCIE has been somewhat constrained in committing financial resources to headcount/projects that may further facilitate sales and the typical seasonal slowdown in Europe during the summer months.
While we believe the various headwinds will dissipate over time and the awareness-building and more focused sales efforts will eventually bear fruit, we think it's now clear that the runway to building the initial installed console base (which will then be fed the high-margin consumables) will be longer than previously anticipated. These updated assumptions are reflected in the changes to our financial model which largely reflects an approximate one-year extension (i.e.- delay) to the initial roll-out and related number of system placements. Important to note is that while this update to our model pushes back our estimated ramp in revenue, number of installed units and related volume of consumable sales by about one year, it does not change our fundamental outlook of the business, view of the viability of the revenue model, or expectations for the long-term opportunity of WavSTAT. This also assumes, of course, that SCIE continues to be successful in raising additional operating capital. Our full updated report on SCIE is available here.
Q3 Results
Q3 revenue came in at $151k, down from $311k (-51%) in Q2 and about 55% less than our $332k estimate. While the revenue number was an obvious disappointment, a silver lining is that SCIE indicated these were largely not inventory stocking orders but instead related to end-use demand.
The other positive highlights were gross margin holding up strongly (48%) despite the relatively soft revenue and management continuing to do a good job in keeping a lid on operating expenses ($880k A vs. $1.3 million E) as well as cash burn. The significantly better GM (48% A vs. 16% E) and lower than estimated operating expenses resulted in operating income coming in substantially better than our estimate (-$807k A vs. -$1.3 million E), again despite the miss on revenue.
Net loss and EPS, which benefitted from $1.2 million in non-cash income related to the change in fair value of derivatives (which we don't model given its non-cash nature and required guesswork to do so), were $866k and ($0.01) versus our $2.5 million and ($0.02) estimates.
Cash
SpectraScience exited Q3 with $65k in cash and equivalents, down from $185k at the end of Q2. Cash used in operations in Q3 was $474k, down from $820k in Q2 and $1.1 million in Q1. During Q3 SCIE sold another $480k of convertible debt and $1.6 million in convertible debt and accrued interest was converted to equity. At the end of Q3 $1.4 million of convertible debt remained outstanding. About $884k of this debt was in default as of 9/30/2012 and the remaining will be due within 6 months from 9/30/2012. Management continues to look at financing alternatives and remains in discussions with investment banks to raise additional capital – while we feel confident that SCIE can raise additional operating capital, we also believe that they are attempting to do so in a way that reduces reliance on regular piecemeal raises. Nonetheless, the debt default is a concern (although this debt is convertible to equity at the holder's option) as is the meager cash balance.
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