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Luna Innovations Incorporated (NASDAQ:LUNA)

Q4 2013 Results Earnings Conference Call

March 13, 2014 5:00 PM ET

Executives

Dale Messick, Chief Financial Officer

My Chung, President and CEO

Analysts

Gregg Greenberg - Wells Fargo

Operator

Good day, ladies and gentlemen. And welcome to the Fourth Quarter and Year End 2013 Luna Innovations Incorporated Earnings Conference Call. My name is Regina, and I'll be your conference operator for today. At this time, all participants are in listen-only mode. Later, we will be conducting a question-and-answer session. (Operator Instructions)

Today’s event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Dale Messick, Chief Financial Officer with Luna. Please go ahead.

Dale Messick

Thank you, Regina. Good afternoon, everyone. And thank you for joining us today as we review Luna’s results for the fourth quarter as well as the full year of 2013. Before we proceed with our presentation, let me remind each of you that statements made in 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 risk and uncertainties and are subject to changes at any time, including but not limited to statements about future financial and operating performance.

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.

Actual results may differ materially as a result of a variety of factors that discussed in our earnings release and our latest Forms 10-K and 10-Q filed with the Securities and Exchange Commission.

We disclaim any obligations 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.

At this time, I’d like to turn the call over to My Chung, President and CEO of Luna Innovations.

My Chung

Thank you, Dale. On today’s call we will begin by reviewing our recent transaction with Intuitive Surgical and updating you on our progress with our key strategic initiative. Following my remarks, Dale will go through the Q4 financial results and then we will be happy to take any questions you might have.

As I am sure, most of you know in mid-January, we completed a very significant transaction for Luna. We sold to our long time development partner Intuitive Surgical, the assets associated with our technology for shape sensing and localization of optical fiber and medical devices.

We have been developing this exciting and promising technology along with Intuitive and others since 2007. On January 20 of this year, we sold the assets associated with it, as well as transfer 10 of our employees to Intuitive for a total value of up to $30 million. We received the first $6 million at closing of the transaction in January. We expect to receive the next $6 million next quarter.

Following that there are additional amounts of up to [$80] million in the aggregate to be received as Intuitive is able to achieve further development milestones and successfully commercialize the system utilizing this technology. Since those future events are under Intuitive’s control rather than ours, I won't speculate on the expected timing for those receipts.

We firmly believe that completing the sale and capturing the value at this time was right for the company and our shareholders. It was also the right opportunity for Intuitive, giving them full control over a dedicated team of very talented engineers to drive this technology and the opportunity it [affords] forward.

Completing this transaction with Intuitive provided two key benefits for Luna. First, it gave us the opportunity to monetize the transaction at an attractive value on an accelerated pace. With the receipt of $12 million in the first half of the year, we will significantly enhance our liquidity.

Second but also related, it gives us the opportunity to concentrate our focus and devote the necessary resources to drive the increased adoption of our solutions for fiber optic sensing of temperature and strain through our ODiSI product line. We plan to utilize a portion of the proceeds from the Intuitive transaction to further expand our sales force, enhance our marketing efforts and continue to improve the functionality of the ODiSI platform.

Although, we did transfer several people to Intuitive, we maintained a core team of extremely capable engineers to drive technological improvements for the ODiSI platform. We continue our focus on marketing ODiSI in automotive, aerospace and energy applications. We are currently doing some rebuilding and reorganizing, making sure that we have our resources properly aligned and prioritized. I believe we are now a stronger company with an improved focus.

I have mentioned on previous calls that we would be building out a dedicated sales force for our ODiSI product line. We have now filled the positions for North America and started to build our funnel of opportunities. We would also be looking to add a salesperson in Europe in the near future.

In the fourth quarter, we were successful in continuing to penetrate our key target markets of automotive, aerospace and energy. Example, sales of ODiSi products we shipped in Q4 included an automotive component manufacturer who is using the ODiSi for measuring strain on parts with complex shapes and aerospace lab, using the product for measuring both strain and temperature in the process of curing composite materials and a company using the product for measuring temperature in the nuclear energy market.

In Q4, we also received internal certification from an aircraft manufacturer for fatigue testing. Our mix of product sales continues to shift more towards sensing applications with double digit growth in product sold for sensing in fiscal year 2013 compared to fiscal year 2012.

Now, I will turn the call over to Dale to further discuss the financial results for the quarter and year.

Dale Messick

Thank you, My. For the fourth quarter 2013, we recognized total revenues of $5.9 million compared to $6.1 million for the fourth quarter of 2012. Our products and license revenues improved 18% to $3 million compared to $2.5 million in the fourth quarter of 2012.

Our technology development revenues decreased $2.9 million in the fourth quarter of 2013 from $3.6 million in the fourth quarter of the prior year, with the bulk of that decline being attributed to lower contract research activity in our optical systems group as we saw throughout 2013. Our gross profit for the fourth quarter of $2 million was essentially flat compared to the fourth quarter of 2012.

With the change in the revenue mix being slightly more weighted toward product and licensing in Q4 2013, the gross margin percentage improved to half a point to 36.7% compared to 33.2% in the fourth quarter of 2012. Operating expenses for the fourth quarter of 2013 were significantly impacted by additional cost incurred in connection with the sale of fiber optic shape sensing technology.

The $4.2 million of operating expenses in the fourth quarter of 2013 included approximately $0.8 million of incremental cost that were incurred and recognized because of the transaction. Additionally, the Q4 operating expenses include $0.3 million of expense for rent on space that we have subleased.

You can see it offsetting $0.3 million of other income from that sublease. It offsets the rent expense in OpEx. Excluding those transactions in met costs, our operating expenses would have remained flat at approximately $3.1 million for the fourth quarter of 2013 compared to also $3.1 million for the fourth quarter of 2012.

Our loss from continuing operations grew by $0.5 million to $1.6 million compared to $1.1 million in the fourth quarter of last year. The $0.5 million increase in the loss from continuing operations can be summarized as the impacts of the $0.8 million we recorded in transaction-related expenses, offset by $0.4 million benefit that we recognized in income taxes related to continuing operations.

[We will] (ph) continuing operations. In the fourth quarter of 2012, we also recognized a positive contribution of $0.5 million from the operations of our secure computing and communications group, which we started in the discontinued operations section of our income statement. We recall that we sold the secure computing and communications group back in March of 2013.

In the fourth quarter of 2013, we recognized $0.3 million of income tax expense in discontinued operations, offsetting the amount of the tax benefit that I mentioned we recognized in our loss from continuing operations.

Our net loss to common shareholders was $2 million for the fourth quarter of 2013 or $0.14 per share, compared to $0.6 million or $0.04 per share for the fourth quarter of 2012. Again, that increase net loss of $1.4 million can be summarized as a combination of $0.8 million in transaction-related expenses in Q4 2013, plus the $0.5 in discontinued operations of the Secure Computing Group in 2012.

For the year, we recognized revenues of $22 million in 2013 compared to $26.4 million in 2012. Product and license revenues in 2013 decreased by $0.6 million or 5.6% compared to 2012 due to sales of prototype shape sensing units in 2012 that did not recur in 2013.

Technology development revenues were $11.4 million in 2013, compared to $15.1 million in 2012. And as we mentioned on our call throughout 2013, we had a lower level of contract research in our optical systems group during the year, accounting for approximately $3.2 million of the decline for the year.

Our gross profit for the year accordingly decreased to $8 million in 2013 compared to $10.4 million in 2012. Operating expenses increased to $13.6 million for 2013 compared to $12.8 million in 2012. And as I mentioned earlier, the increase in OpEx is tied to the incremental cost recognized in conjunction with the shape sensing sale transaction.

Our resulting loss from continuing operations was partially offset by the gain that we realized on the sale of the Secure Computing Group in the first quarter of 2013. So after considering the after-tax gain of $3.3 million from discontinued operations, we recognized a net loss to common stockholders of $0.8 million or $0.06 per share for the full year compared to a net loss of $1.5 million or $0.11 per share for the full year of 2012.

We also ended 2013 with $7.8 million of cash compared to $6.3 million at the end of 2012. The changing cash included $5.1 million in net proceeds from the sale of the Secure Computing Group, as well as $1.6 million in debt service for our term loan and our capital leases. Our remaining balance on bank debt at December 31st was $2.1 million.

And with that I would like to now turn the call back over to My.

My Chung

Well, thank you, Dale. And hopefully, you’ve seen some positive results from us and we are very well-positioned going into 2014 year. At this time, we’d open up for any questions that you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Gregg Greenberg with Wells Fargo.

Gregg Greenberg - Wells Fargo

Hello. Good afternoon, gentlemen. First, the housekeeping question on the initial $12 million that you get from Intuitive Surgical, I think you previously mentioned that after cost, after expensing to get about $9.5 million. How much of that have you already put in the past quarters to use (inaudible) -- past quarter’s expenses?

My Chung

So I am not sure I entirely followed Gregg, but as I said we had about $800,000 that we’ve recognized in Q4 2013 for transaction-related expenses.

Gregg Greenberg - Wells Fargo

Okay. A little capital allocation question, I mean again the cash balance at the end of the quarter was the $7.8 million?

My Chung

Yes.

Gregg Greenberg - Wells Fargo

Okay. So assuming you get the second pay $6 million and we have some more expenses, you’re going to have $10 million on top of that. So you’re going to have $17.8 million and you have $25 million mark to cap. As far as capital allocation goes, you certainly can’t need anywhere near close to that to get to wherever breakeven is and any other investments you need to do, so what kind of things is the Board and you guys consider you’re going as far as that goes?

Dale Messick

Gregg, there is not a specific plan that we’re ready to roll out at this point on use of those proceeds. I think My has talked about, we’ve got some initial things that we want to do in terms of building our sales force and some improvements to the platform itself to broaden the base that we can market it to, but beyond that, that’s really all that we’ve got in place at this point.

Gregg Greenberg - Wells Fargo

Okay. Makes sense. Understand. And can you really answer it further? As far as what’s left in the business which is what we’re focusing on the growth, the quarter looked good as far as sequential growth and growth year-over-year, so it’s about -- as far as on the product side like $3 million in revenue, is that -- did I read it correctly?

Dale Messick

Yes, right, that’s $3 million.

Gregg Greenberg - Wells Fargo

Okay. I know you guys don’t give guidance. Any color you can give as far as and I know obviously the contract R&D has been down and that will change few things as far as a breakeven. And obviously, we’re hoping in a long run for not more than breakeven from the core business. But any color you can give us on kind of business plan and when we see profits and breakeven?

Dale Messick

Yes. As you start your conversation or your question Gregg, we have been -- we haven’t been giving guidance and I don’t want to start that here. Obviously, we’ve got some revenue outflow from the product development work that we used to do and shape-sensing. And so, we’re looking for growth in the product side of the business, specifically that Odyssey platform growth to start offsetting the lost revenue from the product development side. But I can’t really put out there where we see the breakeven point coming.

My Chung

A little bit more color on that Gregg, a little bit more color on that, what we found is that trying to sell the Odyssey product lines through manufacturers’ reps really doesn’t work for us because of the displacement we make to current technology. So the growth in the product line revenues will very much be tied to how quickly and how much we continue to grow the direct sales force. So, what you will see is that as we expand our sales and marketing costs, we will grow accordingly.

Gregg Greenberg - Wells Fargo

Okay. As far as in your prepared remarks, you made some nice comments about a few customers in different industries, will there be a time where we will be able to find out which customers those are by name?

My Chung

That’s really dependent on a lot on our customers. We’ve found that in the number of cases that we have asked to do press releases or announcement of that natures, people are fairly protective, keeping in mind that we deal with fairly large-sized organizations and the group that we sell to are not necessarily in control of releasing that and we typically run into the brick-wall when they go up the chain looking to get endorsement.

Gregg Greenberg - Wells Fargo

Okay. Last question, any update you can give us on the corrosion testing, I think it was the navy that was running?

My Chung

We continue to make progress on that. We are in discussions today with a number of aircraft companies looking to do trials, but nothing significant quite yet for us to put out a press release.

Gregg Greenberg - Wells Fargo

Okay. Thank you very much.

Operator

Your next question is from the line of Gale (indiscernible) and he is a Private Investor.

My Chung

Good afternoon.

Unidentified Analyst

Hello, have you received the $12 million that you were supposed to receive?

Dale Messick

So the terms of the transaction were for us to receive $6 million at closing and then another $6 million, 90 days after closing. So, we have received the first $6 million. We did get that at closing in mid-January and the other $6 million, as My mentioned that’s due in the second quarter in April.

My Chung

So the numbers that we gave you for ending 2013 does not include that $6 million. When we announced Q1 results, it will include the first $6 million of the $12 million.

Unidentified Analyst

Okay. And any plans to pay out a special dividend with that money?

My Chung

There are currently no plans to do that. We think that the best use of funds today is really to help grow the topline revenue.

Unidentified Analyst

By acquisitions or?

My Chung

By sale of the ODiSI product line, by focusing on the initiative that we set forward. We believe the target market that we are going after is significant and what we are putting in place as far as sales, marketing and engineering will allow us to capture major portion of that.

Unidentified Analyst

So this is all generic growth, not acquisitions. Am I correct?

My Chung

You’re correct. Now that doesn’t preclude us looking at acquisitions, because as Dale mentioned, we are not looking to spend that $12 million in any significant way.

Unidentified Analyst

So why not pay it out as a dividend?

My Chung

Because it leaves us with the ability to do as you suggested look at acquisitions to bulk up. But the right time to look at acquisitions is after we’ve gotten our own house in order, right. And then that’s where the focus for 2014 is to build the revenue side, get it to a point of penetration that we’re looking at and then explore what else can we add to this thing to accelerate our growth, but you’re on the right track. So that’s why we’ve kind of held off. Again, I think the right thing is to reinvest the money and to take this company to the level that it has the potential to be.

Unidentified Analyst

Okay. Now in the press release, you have mentioned that there is potential for this technology that you sold for $12 million to be sold to other industries. Is this something that you’re shopping around now or not?

My Chung

Not really, we maintained it. So what we’ve got exclusive royalty free license back for all the applications outside the medical. And we've been doing research programs on it. We will continue to do that, but our focus short-term is very much on the sensing side.

Unidentified Analyst

Okay. But this technology in no way will keep in to be a 3-D printing bonanza that’s going on right now with all these companies making 3-D printers?

My Chung

No, we really don’t fit into that market there.

Unidentified Analyst

Okay. All right. Fair enough. Thank you.

My Chung

Thank you.

Operator

Ladies and gentlemen, this concludes the question-and-answer portion of today’s broadcast. I would like to turn the call back over to Mr. My Chung for any closing remarks he would like to make.

My Chung

Okay. Well, I say, again, thank you for everyone for joining us today. I think the company is in the best position as ever been, and we look forward to continue to report to you our quarterly results. Thank you.

Operator

Ladies and gentlemen, thank you so much for your participation today. This does conclude the presentation and you may now disconnect. Have a great day.

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