Luna Innovations Inc. Q4 2009 Earnings Call Transcript

| About: Luna Innovations (LUNA)

Luna Innovations Inc. (NASDAQ:LUNA)

Q4 2009 Earnings Call

March 4, 2010 5:00 pm ET


Dale Messick – CFO

Kent Murphy – Chairman and CEO


Harry Pelling [ph] – C&H Trucking [ph]


Good day, ladies and gentlemen and welcome to the fourth quarter 2009 Luna Innovations Incorporated earnings conference call. My name is Regina and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host for today, Mr. Dale Messick, Chief Financial Officer.

Dale Messick

Thank you, Regina. Before we begin, let me remind each of you that statements made on today's call contain forward-looking statements that involve risks and uncertainties and are subject to change at anytime. 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 or performance, which may differ materially as a result of a variety of factors including those factors described in our earnings release and our filings on Form 10-Q and 10-K with the Securities and Exchange Commission.

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 developments. There is more complete information regarding forward-looking statements, risks and uncertainties in the company's filings with the SEC available on our website.

And now, I would like to turn the call over to Kent Murphy, Chief Executive Officer of Luna Innovations.

Kent Murphy

Thank you very much, Dale. Good afternoon, everyone and thank you for joining us today. We had a good fourth quarter and we are off to a great start in 2010. I'm happy to be able to share some of those things with you today.

Revenues grew by 15% compared to the fourth quarter of 2008 from $7.4 million to $8.5 million, driven by a strong recovery in our product and licensing business, which realized a growth of 128% over last year's fourth quarter.

Adjusted EBITDA, which excludes the litigation and bankruptcy related costs, improved from breakeven for the last quarter of 2008 to $1 million for the fourth quarter of 2009. And for the year, our adjusted EBITDA, excluded those items, improved from $0.3 million to $2.3 million even with decreased revenue during the down economy.

In the fourth quarter, the product and licensing business began to show recovery from the declines that began late in 2008. We finished the year with a strong book of new orders that not only resulted in more than doubling of product revenue for the quarter, but it also provided a healthy backlog of orders to carry into the start of 2010. We are optimistic that growth in this segment of our business could return the levels we were seeing prior to the downturn in the overall economy.

With returning demand for our existing products and planned launches of new products in the near term, it will allow us to penetrate new market opportunities. I believe we are poised for successful year at Luna.

We hope to build on the demand with our participation of the Optical Fiber Communications Conference and Exposition, which is the largest annual gathering of fiber optic professionals in the United States. At the conference, we will have a team demonstrating and promoting our product capabilities including a new portable Optical Backscatter Reflectometer with applications in telecommunications and in sensing, and our recently released OVA 5000 for the telecommunications industry.

Related to our successes in optical sensing and instrumentation is also the work that we continue to do for Intuitive Surgical and others. This past December, we completed the development requires that were contained in our initial agreement with Intuitive. The development teams have achieved remarkable results. And as a result of this success, as we announced back in January, Intuitive and Luna have amended the agreement to expand our development work for them.

We've also kicked off our new development projects with Hansen Medical as well. We have a technology development plan in place with them and have started the work. I'm very happy to report that the Hansen and Luna teams are in fact working very well together and we look forward to a long and mutually rewarding relationship there as well.

One of the benefits that we enjoy from relationships with business partners such as Intuitive and Hansen, as well as working on new product development efforts with entities like the United States Navy, is the ability to develop solutions for their needs and to also advance the overall optical sensing platform. We can then use the enhanced platform in other non-competing markets.

In the past, I have spoken about this model with examples like the ability to use the fiber sensing capabilities in areas such as power generation, whether gas or wind turbines, non-robotic medical applications, transportation, and defense applications. We recently completed our first shipment of our high-speed strain sensing system based on these advances. As we continue to enhance and promote the capabilities of the platform, the cost of higher performance continues to come down, new applications and markets continue to be identified and pursued.

As performance goes up and costs come down, opportunities that we have discussed in the past, as well as opportunities in new markets we are developing a very strong pipeline of future product revenue opportunities. We are beginning to realize the benefits of this optical platform that we visualized back at our IPO and this platform will be a major focus of our business going forward.

In our technology development business, in December we acquired the IP assets of Tego Biosciences, which provided us with additional capabilities as we continue our work with the National Institutes of Health and others in the development of nanomedicines. We believe this acquisition gives us a dominant position in carbon-based nanomaterials for therapeutic and diagnostic applications where we continue to develop our early-stage compounds based on our nanomaterial platform.

From an overall corporate point of view, we have announced several events that significantly enhanced our financial condition. First, of course, we completed the settlement with Hansen Medical, providing the framework for us to emerge from Chapter 11 reorganization with our vendors and shareholders largely in tact.

Soon after emerging from Chapter 11, we exchanged $6.2 million of convertible debt into convertible preferred stock, strengthening our balance sheet and completing a critical step in being able to maintain our NASDAQ listing. And finally, we recently announced an improvement in our liquidity through obtaining a $5 million revolving line of credit with Silicon Valley Bank. With these events, we have the completed the steps to provide for our ongoing operations post emergence from reorganization.

With that, I will ask Dale to review the financial highlights with you.

Dale Messick

Thanks, Kent. As many of you know, we issued a release of preliminary results back on January 11th and had a call to review those expectations. In most measures, results that we will discuss today fell within the ranges discussed in that preliminary release.

Our fourth quarter revenues were $8.5 million, representing an improvement of 15% over the fourth quarter of 2008. As Kent mentioned earlier, the growth that we experienced resulted from higher product sales under our Luna Technologies brand. Product and license revenues, overall, increased 128% compared to the fourth quarter of 2008 with strong bookings activity during the quarter that also provided backlog for us to carry into 2010.

Our technology development revenues decreased nearly 10% in the fourth quarter of 2009 compared to 2008. During the second half of 2009, we did experience some slowdown in contract awards while we were operating under Chapter 11, pending the government completing a financial feasibility audit of Luna. That review by the government was recently completed with a positive report following our emergence from Chapter 11 and we expect awards that had been on hold to begin to now be released to us. While revenue in this area was below 2008 levels, we expect that for 2010, the revenue will increase back to the level of 2008 activities.

We recognized $3.2 million in gross margin or 37% in the fourth quarter of 2009 compared to $2.3 million or 31% in the fourth quarter of 2008. Our fourth quarter 2009 margin percentages were consistent with the margins throughout 2008 and 2009. Gross margin back in the fourth quarter of 2008 had been adversely impacted by the accounting for an expected increase in cost to complete one of our development projects.

Operating expenses have continued to improve. I think it's worthwhile to take a couple of minutes to go through this presentation of operating expenses for the quarter as the litigation and reorganization have significant impacts on the presentation in the release.

First, you will see a $26.6 million credit in operating expenses for the litigation reserve. Back in the first quarter of 2009, we recorded a $36.3 million reserve based upon the verdict written by the jury in the Hansen trial. We settled with Hansen for obligations valued at approximately $9.7 million and so we had this reduction in accrued liability flowing through our fourth quarter results. The net $9.7 million obligation can be seen in the full year 2009 column.

Additionally, we recognized $1 million in reorganization costs. These costs include bankruptcy counsel and the administrative costs associated with Chapter 11 such as the claims administration and the U.S. trustee fees, but did not include costs associated specifically with the Hansen litigation itself, which continue to be presented in SG&A, consistent with prior periods.

You can see the total cost of litigation and reorganization activities of approximately $1.5 million for the quarter in our reconciliation of adjusted EBITDA. So if we exclude the operating expenses that are associated with the litigation and reorganization, then our remaining base of operating expenses are approximately $3.4 million in the fourth quarter of 2009 compared to $4 million for the fourth quarter of 2008, a reduction of 15%.

We reported a net income of $24.9 million for the fourth quarter compared to a loss of $2.2 million in the fourth quarter of 2008, but of course the net income was substantially driven by the reduction in the litigation reserve. For the year, we reported a net loss of $20.4 million in 2009 compared to $6.3 million for 2008 with the increase in loss for the year 2009 also being driven by the various expenses associated with litigation and intangible asset impairment charges we also recorded back in the first quarter as a result of the jury verdict.

By looking at our presentation of adjusted EBITDA, we normalized those impacts on the quarter and the year for a consideration of improvement in the ongoing operations of the company. Excluding the impacts of litigation and reorganization, we realized adjusted EBITDA of $1 million in the fourth quarter of 2009 compared to a breakeven adjusted EBITDA in the fourth quarter of 2008.

For the year, adjusted EBITDA improved to $2.3 million compared to $0.3 million for the year 2008. This $2 million improvement in adjusted EBITDA for 2009 clearly demonstrates the significant impact that the company's cost saving initiatives taken throughout 2009 have had on our operating results.

Turning to the balance sheet for a moment, let me just point out the line about midway through the liability section that is captioned, "Liabilities subject to compromise." This is a presentation that is required due to our Chapter 11 status as of year-end and this line includes the following liabilities.

First, it includes the $9.7 million litigation reserve that I discussed earlier. Subsequent to year-end, this $9.7 million reserve became a $5 million note payable and $4.7 million of issued common stock. That "liabilities subject to compromise balance" also includes the $6.2 million in convertible notes, plus accrued interest that were exchanged for preferred stock subsequent to year-end. The remaining balance represents our then outstanding pre-petition payables.

We ended 2009 with $5.2 million of cash with cash flow during 2009 including the repayment of our $5 million term loan and the payment of legal fees associated with the litigation and reorganization. As Kent mentioned previously, we recently enhanced our liquidity with a new $5 million revolving credit line tied to a percentage of our accounts receivable.

Looking forward to 2010, we currently expect top line growth in both of our business segments. Notably, we expect product and license revenues to be in the range of $9.5 million to $11 million for 2010, returning to the levels similar to 2008 prior to the overall downturn in the economy. We also expect technology development revenues to return to their pre-Chapter 11 levels in the $26 million to $27 million range.

Our projected net loss, with the expenses of the Hansen litigation and the reorganization largely behind us, is in the range of $2.8 million to $3.5 million for the year, which translates to a projected adjusted EBITDA of positive $2.4 million to $3.9 million for the year.

For the first quarter of 2010, we currently expect to report revenues in the range of $7 million to $7.5 million with a corresponding net loss of approximately $1.5 million to $1.8 million.

And with that, I'd like to turn the call back over to Kent.

Kent Murphy

Thank you, Dale. Before we turn the call over for questions, I would like to close with just a few thoughts on where we've been and where we are going.

We are a company with a 20-year history with most of those years being profitable. In the years before the IPO, we used those profits to make investments, which resulted in great returns for Luna. We've used the proceeds from the IPO to invest in many opportunities and unfortunately, in the defense of a lawsuit. Those investments have moved many opportunities forward and today, some have already made it to new products. Others are still moving forward and with high probability, we believe will be introduced in the future as products as well.

In the near term, Luna is in a position to be generating positive quarterly cash flow. With 2009 being a down year for the economy, the lawsuit, jury verdict, Chapter 11, settlement, and emergence, we have maintained our reputation for outstanding customer service, while also delivering excellent product and services, all while reducing our baseline operating expenses and improving adjusted EBITDA.

Our company has never been so clear in our vision in exactly what each division and group's goals are for the future. We have never been more motivated and there is a genuine feeling of excitement throughout our entire company. The progress combined with possibilities for our future make 2010 and beyond a tremendously exciting time for us.

Now, we would be happy to take any questions, Regina.

Question-and-Answer Session


Thank you, sir. (Operator Instructions) Your first question comes from the line of Harry Pelling [ph] with C&H Trucking [ph].

Harry Pelling – C&H Trucking

Are you ready?

Kent Murphy


Harry Pelling – C&H Trucking

I was (inaudible) to hear your speech and I'm proud to say that I'm associated with you and I think during that discussion you just had, you answered any question I had.

Kent Murphy

Great. Thank you very much, Harry. We appreciate it.

Harry Pelling – C&H Trucking

Thank you and wish you all the best. God bless you.

Kent Murphy

Thank you so much.


And there are no further questions in the queue at this time.

Kent Murphy

Thank you all for being on the call. We look forward to talking with you during the next call. We appreciate the attendance.


Ladies and gentlemen, thank you so much for your participation in today's conference. This concludes our presentation and you may now disconnect. Have a wonderful day.

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