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Luna Innovations, Inc. (NASDAQ:LUNA)

Q4 2008 Earnings Call

March 03, 2009 11:00 AM ET

Executives

Landon Barretto - Moderator/Investor Relations

Kent A. Murphy, Ph.D. - Chairman and Chief Executive Officer

Dale Messick - Chief Financial Officer

Analysts

Michael Lew - Thinkequity, LLC

Landon Barretto

Good day. My name is Landon Barretto, and I'll be the moderator for today's presentation, which is being recorded and will be accessible following this call for 30 days on the Luna Innovations website at www.lunainnovations.com.

Please go to the webcast and presentations portion of the website. Thank you for your interest in Luna Innovations. With me today are the CEO, Dr. Kent Murphy and Chief Financial Officer, Dale Messick. Dr. Murphy and Mr. Messick are going to discuss the company's financial results for the fourth quarter and year-end December 31, 2008.

At the conclusion of the prepared remarks, we'll open the conference for questions. In compliance with SEC requirements, I must read the following statement. Except for historical information, the matters discussed in the conference call, are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements.

Factors that could cause results to differ materially are included in the company's filings with the Securities and Exchange Commission. Forward-looking statements made during today's call are only made as of the date of this conference call and the company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Gentlemen, please proceed.

Kent A. Murphy, Ph.D.

Thank you, Landon, and thanks to all of you for joining us today for the review progress during the fourth quarter and for the full year of 2008. Then Dale, will review our results more quantitative terms afterwards we will welcome any questions you have.

As we previously announced our fourth quarter revenues doubled our previous guidance. In the first three quarters of 2008 revenues increased 24% over the first three quarters of 2007.

And at the time of our last earnings call, our sales pipeline indicated an expectation of growth in the fourth quarter. As the fourth quarter progressed, the continuing decline in the global economy had an adverse impact on our product sales resulting a decrease year-over-year in quarterly revenue.

In recognition of this decline, we took the appropriate steps to reduce our ongoing expenses by reducing our workforce and other related employee expenses, as well as reducing other areas of discretionary spending.

While the fourth quarter was below our expectations for the year, we did achieve a 10% growth in revenue.

We improved our gross margin and bottom-line and also our cash flow. We ended the year with $36.9 million revenue in a net loss of $0.57 a share.

Knowing where the economy is now, let's look at the broader picture for Luna. We are very diverse company. Diverse in the way we create shareholder value. Diverse in our technology platforms and diverse in the markets we go after. We can react quickly. We've been in business for over 19 years.

We've had growing revenues every year. We grew in the last downturn of 2001 through 2003. We are reacting and doing so in a timely fashion. Is the future uncertain, sure it is but we are well-positioned to deal with it.

I'd like to focus now on our nanomedicine development efforts in both Diagnostic and Therapeutics. On the Diagnostics, first with followed by the therapeutics.

On the MRI program, our team at Washu in St. Louis led by renowned imaging expert Dr. Joseph Ackerman published during the fourth quarter of the results of their studies of Luna's HYDROCHALARONE and laboratory molecule.

This additional molecule expands our portfolio of contrast agents to include an agent that penetrates the extra cellular fluid in addition to the blood pool agent, we announced earlier. These two agents provide Luna with the core technology for developing targeted agents for both imaging intravascular and interstitial sites.

We have discussed Luna's HYDROCHALARONE technology for enhancing contrast during MRI procedures and previous communications and press releases.

Earlier in 2008, we announced an award from the National Heart Lung and Blood Institute at the National Institute of Health to develop a contrast agent for imaging, build-up of plaque on arterial walls. This plaque is a major cause of cardiovascular disease and can cause heart attacks and stroke.

If successful Luna's technology could improve physicians' ability to diagnose disease arteries earlier, and thereby improve the management of heart disease.

Luna's program to address this critical need is to produce an MRI contrast agents that selectively accumulate in the thumb cells which are responsible for plaque build-up.

Our research team continues to make progress in targeting our proprietary contrast agent to plaque. In the course of this work, we've discovered that we can use the same targeting technology to direct therapeutic agents to thumb cells.

Our program to diagnose plaque build-up may lead to new therapies for stopping disease in arteries.

We continue to make progress on the hair growth compounds. We developed multiple topical compounds and have continued to improve efficacy through independent third-party testing.

We also continued to draw our interest in organic solar cells, which use our patented carbon nanomaterials to capture more energy and convert it through electricity.

Our research was published in a prestigious journal Nature Materials, and demonstrates an entirely new approach of enhancing organic photovoltaic device performance.

Our nanomaterials were independently verified at the U.S. Department of Energy's National Renewable Energy Lab or NREL as setting a new record for efficiency of the commercially available organic solar cell polymer.

We recently began supplying materials to solar cell manufacturers for further development and testing.

Our modeling shows the efficiencies of greater than 10% could be achievable with some other polymers manufacturers are currently using.

Luna technologies common optical platform continues into expanding markets including medical devices, both robotic and non-robotic monitoring, energy generation and delivery monitoring. We are meeting the development objectives in timeline of our partnership with intuitive surgical for Luna shape sensing technology for using medical robotics for minimal invasive surgery.

We continued to make progress on our shape sensing technology programs with the navy to detect and assess enemy threats in ocean with greater accuracy.

We also launched the PHOENIX Swept tunable laser family, the PHOENIX 1400, a benchtop laser which offers best-in-class wavelength precision and tuning linearity. It's the third product from Luna Technologies launched in 2008.

The PHOENIX MEMs based laser external cavity was the first in the laser family. The Precision Reflectometer 4400 was launched at our European conference in the fall. Here to increase throughput and optical manufacturing.

We will be showcasing our products at the upcoming optical fiber communications conference in California.

Also in the fourth quarter, we were awarded work with GE Aviation on the U.S. Army program to develop an integrated corrosion health monitoring system. GE Aviation selected Luna for the project due to our experience and knowledge of aircraft corrosion and materials and our concurrent development efforts in corrosion monitoring, modeling and prediction.

The goals of this army program are to improve rotorcraft safety, decreased maintenance cost and increase rotorcraft rating.

In the future this work in improving the lifespan, efficiency and operating costs of rotorcraft may have applications in large rotating systems such as wind and gas power generation turbines.

Now I'll turn the call over to Dale, who will discuss our financial results and I will then come back to make some closing remarks after Dale and then answer questions.

Dale Messick

Thank you Kent. Revenues for the fourth quarter of 2008 were $7.4 million compared to $9.9 million in fourth quarter of 2007.

Technology development quarterly revenue decreased slightly from $6.3 million to $6 million, while our product in license quarterly revenue decreased from $3.7 million to $1.4 million.

Within the technology development segment, the decrease related primarily to differences in the timing of acquiring billable materials under some large development contracts.

As you heard Kent discuss already the decrease in our product and license revenue came largely from lower sales of test and measurement equipment as the economy weakened during the fourth quarter of 2008.

In addition during the fourth quarter, our product and license revenue decreased by approximately $600,000 due to a change in our estimated percentage of completion for certain long-term development contracts where an increase in the expected cost to complete remainder of the contract resulted in a lower percentage of completion to-date and therefore lower revenue to be recognized to-date.

At the gross margin level, we realized a 31% margin in the fourth quarter of 2008 compared to a 37% margin in the fourth quarter of '07.

Within the technology development business segment, we improved our gross margin to 33% for the fourth quarter of 2008 compared to 26% in the fourth quarter of the prior year.

Product and license margins declined to 26% compare to 55% in fourth quarter of '07, absent the change in our estimated percent of completion on the product development work that I mentioned previously. Our product and license gross margin would have been approximately 49%, and our overall gross margin would have been approximately 37%.

Operating expenses were flat at $4.9 million in both the fourth quarter of 2008 and '07 included in operating expenses in the most recent quarter was an increase of approximately $700,000 in legal fees for the fourth quarter of 2008 compared to '07. Also reductions in our 2008 incentive compensation plans for management and employees reduced our expenses by approximately $1 million compared to the fourth quarter of 2007.

Other income of $530,000 primarily represents the revenue we've earned to-date, under the terms of grant we received in 2004 with respect to opening our nanomaterials facility.

We continued to carry a $230,000 liability under that grant. We incurred a net interest of expense of $148,000 during the fourth quarter of 2008 compared to interest income of $76,000 in the fourth quarter of the previous year. The increase expense is attributable to the new credit facility that we entered into in May of 2008.

And we incurred a fourth quarter net loss of $2.2 million or $0.19 per share compared to $1.2 million or $0.11 per share in the prior year, again primarily due to the lower product and license revenue.

For the year, revenues increased nearly 10%. Technology development revenue increased 15% year-over-year, while product and license revenue decreased 3% because of that fourth quarter decline.

Gross profit improved by $1.7 million or 14% and our gross margin percentage grew to 38% in 2008 overall compared to 37% in 2007.

Operating expenses increased by approximately $800,000 or 4% year-over-year, included and that increase was $1.1 million growth in outside legal fees. Our operating loss improved to $7.3 million in 2008 compared to $8.3 million in 2007.

Other income of $1.2 million for the year includes primarily the revenue recognized on the grant I mentioned earlier in addition to the net proceeds from the litigations settlement back in the second quarter of 2008.

Our net loss for the year was $6.3 million or $0.57 per share compared to $7.8 million or $0.77 per share in 2007.

Turning to the balance sheet, we ended 2008 with $15.5 million of cash, compared to $12 million at the end of 2007 and $15.2 million at the end of the third quarter of 2008.

The increase compared to the prior year includes the effect of the $5 million term loan that we entered into in the second quarter of this year. Receivables decreased year-over-year commence with the lower revenue in the fourth quarter of 2008 compared to 2007, and the early other items are specifically highlight on the compare to balance sheet is the increase in debts $1.4 million in current liabilities and $3.6 million increase in our long-term debt reflecting again that $5 million term loan that we entered into during 2008.

From a cash flow perspective, cash used in operating activities improved to approximately $800,000 in 2008 compared to $4.2 million in 2007. Included in our net lost of $6.3 million were non-cash charges for depreciation, amortization and stock compensation totaling $4.8 million.

Capital spending and capitalized cost associate with IP activities decrease to approximately $900,000 in the current year from $1.8 million in the prior year. And we received $5.2 million from financing activities primarily the proceeds from that term loan during the year.

Again cash increased $3.5 million during the year to a balance of $15.5 at the end of 2008.

Looking forward, we currently estimate our 2009 revenue to be in the range of $37 to $40 million. This estimate assumes continued growth in our Technology Development segment with expected revenues there of $30 to $31 million and year-over-year decline in our product and license segment with revenues of $7 to $9 million.

With that revenue range, we expect to realize the net loss of $5.5 to $6 million for the year. In the first quarter, we anticipate revenue approximately $9 million with the net loss of approximately $2.2 million.

And with that, I will turn the call back over to Kent.

Kent A. Murphy, Ph.D.

Thank you, Dale. As Dale mentioned, we currently expect flat to modest revenue growth in 2009. In the past, the significant and growing portion our business has been product development and partnerships with industry leaders in selected market spaces.

During 2008, we entered into our continued partnership relationships with global market leaders in surgical robots, heart bypass equipment, oil-field services, telecommunications equipment, power generation equipment and the defense systems.

The company continues to make progress towards new opportunities for partnering in solar and wind energy generation, non-robot medical devices, pharmaceuticals and defense solutions.

We believe that in 2009, we will continue to build on the strength, and with our strong base of technology development contracts coupled with continued management of expenses, we will be able to improve our bottom-line and achieve our financial goals.

We still expect to be adjusted EBITDA positive beginning in Q3 '09 as I said on the last call. And you should expect Luna to continue to launch new products and sign new development agreements throughout 2009. As we continue to drive to adjusted EBITDA positive.

This time, we'll be happy to try to answer any questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Michael Lew with Think Equity. You may proceed.

Michael Lew - Thinkequity, LLC

Thanks. Good morning Kent. Good morning Dale.

Kent Murphy, Ph.D.

Hi Michael.

Dale Messick

Hi Michael.

Michael Lew - Thinkequity, LLC

Hi. Could you further elaborate on the market conditions since you pre-announced the 4Q revenues back on early February 10th, have they improved or they further deteriorated with respect to the each of the segments meaning contract research in product and licensing?

Kent Murphy, Ph.D.

Certainly, I'm not going to stand here and say that the recession is over. I think that we’re pretty solid and our backlog on Technology Development contracts, we ended the year with a little over $29 million in backlog there.

With respect to the product and license segment, it's of course very early in the year. Our bookings activity so far this year has been commensurate and actually with where it was in the first two months of 2008, but obviously there is a lot of year left here.

Michael Lew - Thinkequity, LLC

But have you seen any deferrals anything on those lines of course the potential bookings more deferral?

Dale Messick

Yes. Certainly that was the case that we saw in the later part of Q4, we haven’t found that same feedback yet on the product side.

Michael Lew - Thinkequity, LLC

Okay. And also you ended the year was about 15 million cash, what's the current burn rate on multi-basis?

Kent Murphy, Ph.D.

We gone with a burn of $1 million or less than five of last six quarters. I think we will have, we had a cash accretion in the fourth quarter of 2008. I think we're going to get back on that $1 million or so burn rate in the earlier quarters of 2009. We may have even a little over $1 million of cash usage in Q1.

Michael Lew - Thinkequity, LLC

And then for the outlook which is calling for expectations or modest growth, what are the assumptions that are embedded in this? Is this would you consider this like a best case or worst case scenario?

Dale Messick

Certainly it's not a worst case scenario. I think its sort of we believe is our most likely scenario at this point in time. The Technology Development forecast a significant percentage of that has already been awarded to Luna. So it's a matter of us performing against those contracts with respect to the product and license forecast particularly in the area of Telco product sales we've still assumed a meaningful decline year-over-year just with the uncertainty in the economy.

Michael Lew - Thinkequity, LLC

And with regards to the shape sensing technology. On the ongoing efforts with intuitive surgical, what's the next progress milestones investor should expect to hear about, and has the environment slowed down the development efforts?

Kent Murphy, Ph.D.

The environment has not slowed down the development efforts at all. Intuitive prefers that we not discuss progress that we're making with them that I can tell you we're on-time on-schedule for everything that they're expecting from us at this point?

Michael Lew - Thinkequity, LLC

Okay. Kent with regards to the GE Aviation program, how big is the market opportunity? And I guess, what are the next milestones we should be looking for?

Kent Murphy, Ph.D.

It is a huge market opportunity for GE and we would certainly benefit from a part of that. The milestone going forward are demonstrations with the defense department that we are currently working with GE, we've been working with GE for quite sometime on these. And we've been in the corrosion industry for literally more than a decade and it built-up quite an expertise in the corrosion field.

Michael Lew - Thinkequity, LLC

When do you think this can become a revenue generator?

Kent Murphy, Ph.D.

It would be on the word of 18 to 24 months up.

Michael Lew - Thinkequity, LLC

Okay. Thank you.

Landon Barretto

Thank you, Michael.

Operator

(Operator Instructions). And we have a follow-up question from the line of Michael Lew of Thinkequity Llc. You may proceed.

Michael Lew - Thinkequity, LLC

I also wanted to, if you can also elaborate on the nanomedicine development efforts. Again obviously you've talked about progress in coronary artery disease. Have you have biggest opportunity again for the contrast agents?

Kent Murphy, Ph.D.

The contrast agent today is controlled by about three compounds. The contrast agent today is about $1.5 billion market and I think the major players that we’re in talks with certainly unanimously agree that we got a fantastic agent and that is performs better. It is safer. It does not let to gather any amount of the molecule. We've had a lot of third-party testing to verify that recently, and the progress that we've made on the targeting is the most important part in my mind because the targeting of diseases is something people have talked about for more than a decade and they've not had a stable platform to make that happen. And the fact that we are progressing with animal testing proving we have a stable molecule and have recently developed a form of that molecule that gets into the interstitial spaces within the body where we can begin to image disease state that are outside of the vascular system is a tremendous break through and the fact that we've actually got it to stick to firm cells in Vitro is another pretty large breakthrough for us.

Michael Lew - Thinkequity, LLC

And with regard to the organic solar cell efforts what efficiency levels have you been able to demonstrate. You mentioned ultimately you'd expect to reach over 10%?

Kent Murphy, Ph.D.

Yes, we've been using commercially available of the shelf polymers which are not what the industry leaders are using. We have increased efficiency by more than 10%, somewhere in the 20% range is where we've done the latest results for Inmarel. And when you combine that kind of efficiency with the new polymers that three or four organic solar cells leaders are using today and you put a 20% increase on what they're doing. You got commercially viable organic solar cells. So we are actually working with multiple groups, supplying them with our materials and we hopefully expect to see similar results and will be moving from there.

Michael Lew - Thinkequity, LLC

Thank you.

Kent Murphy, Ph.D.

Thank you, Michael.

Operator

And there are no additional questions at this time. I'd like to turn the call back over to Mr. Dale Messick and Dr. Kent Murphy for closing remarks. Gentlemen, you may proceed.

Kent Murphy, Ph.D.

Thank you again very much for your time. We appreciate your continued support of Luna, and we look forward to talking with you at the next earnings call.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Have a good day.

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