Luna Innovations Inc (LUNA) 2008 Q4 法說會逐字稿

Good day. My name is Landon Baretto, 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.

The 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.

Thank you, Landon, and thanks to all of you for joining us today for the review of progress during the fourth quarter and for the full year of 2008. Then Dale will review our results in more quantitative terms, after which we'll welcome any questions you have. As we previously announced, our fourth quarter revenues fell below our previous guidance. With 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 products sales, resulting in a decreased year-over-year and 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 and 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 a 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 have been in business for over 19 years. We have 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, a team of Wash. U in Saint Louis, led by renowned imaging expert, Dr. Joseph Ackerman, published during the fourth quarter the results of their studies of Luna's Hydrochalrone 1 in laboratory mice.

This additional molecule expands our portfolio of contrast agents to include an agent that penetrates the extracellular 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 Hydrochalrone technology for enhancing contrast during MRI procedures in previous communications in press releases.

Earlier in 2008, we announced an award from the National Heart, Lung, and Blood Institute of the National Institutes of Health to develop a contrast agent for imaging buildup 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 diseased arteries earlier and thereby improve the management of heart disease. Luna's program to address this critical need is to produce an MRI contrast agent that selectively accumulate in the [foam] cells which are responsible for plaque buildup.

Our research team continues to make progress in targeting our proprietary contrast agent to plaque. In the course of this work, we have discovered that we can use the same targeting technology to direct therapeutic agents to foam cells. Our program to diagnose plaque buildup may lead to new therapies for stopping disease in arteries. We continue to make progress on the hair-growth compounds. We have developed multiple topical compounds and have continued to improve efficacy through independent third-party testing.

We also continue to garner interest in organic solar cells which use our patented carbon nanomaterials to capture more energy and convert it to electricity. Our research was published in the prestigious journal, Nature Materials, and demonstrates an entirely new approach of enhancing organic photovoltaic device performance.

Our nanomaterials were independently verified at the US Department of Energy's National Renewable Energy Lab, or NREL, as setting a new record for efficiency of a commercially available organic solar cell polymer. We recently began supplying materials to solar cell manufacturers for further development and testing. Our modeling shows that efficiencies of greater than 10% could be achievable with the some of the polymers manufacturers are currently using.

Luna Technology's common optical platform continues to -- continues into expanding markets, including medical devices, both robotic and non-robotic monitoring, energy generation and delivery monitoring, and we are meeting the development objectives and timeline of our partnership with Intuitive Surgical to adapt Luna's shape sensing technology for use in medical robotics for minimally invasive surgery. We continue to make progress on our shape sensing technology programs with the Navy to detect and assess any threats in the 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. This is the third product from Luna technology 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, geared to increase throughput in 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 a US 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, decrease maintenance costs, and increase rotorcraft readiness. 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 powered generation turbines. Now, I will 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.

Thank you, Kent. Revenues for the fourth quarter of 2008 were $7.4 million, compared to $9.9 million in the fourth quarter of 2007. Technology development quarterly revenue decreased slightly, from $6.3 million to $6 million, while our product and 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've 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 the 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% compared to 55% in the fourth quarter of '07. Absent the change in our estimated percentage 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 have earned to date under the terms of a grant we received in 2004 with respect to opening our nanomaterials facility. We continue to carry a $230,000 liability under that grant. We incurred a net interest 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 increased expense is attributable to the new credit facility that we entered into in May of 2008. 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 in 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 a litigation 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, commensurate with the lower revenue in the fourth quarter of 2008 compared to 2007.

And the only other item I would specifically highlight on the comparative balance sheet is the increase in debt, $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 loss of $6.3 million were noncash charges for depreciation, amortization and stock compensation totaling $4.8 million.

Capital spending and capitalized costs associated with IP activities decreased 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 million at the end of 2008.

Looking forward, we currently estimate our 2009 revenue to be in the range of $37 million to $40 million. This estimate assumes continued growth in our technology development segment, with expected revenues there of $30 million to $31 million, and a year-over-year decline in our product and license segment, with revenues of $7 million to $9 million. With that revenue range, we expect to realize a net loss of $5.5 million to $6 million for the year. In the first quarter, we anticipate revenue of approximately $9 million, with a net loss of approximately $2.2 million. And with that, I will turn the call back over to Kent.

Thank you, Dale. As Dale mentioned, we currently expect flat to modest revenue growth in 2009. In the past, a significant and growing portion of our business has been product development and partnerships with industry leaders in selected market spaces. During 2008, we entered into or continued partnership relationships with global market leaders in surgical robots, heart bypass equipment, oilfield services, telecommunications equipment, power generation equipment and defense systems. The Company continues to make progress towards new opportunities for partnering in solar and wind energy generation, non-robotic 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. At this time, we would be happy to try to answer any questions.

(Operator Instructions)

And your first question comes from the line of Michael Lew with Thinkequity. You may proceed.

Yes, thanks. Good morning, Kent. Good morning, Dale.

Hi, Michael.

Hi, Michael.

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

Certainly, I'm not going to stand here and say that the recession is over. I think that we have -- we're pretty solid in 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, actually, with where it was in the first two months of 2008. But, obviously, there's a lot of year left here.

All right. Have you seen any deferrals or anything along those lines, in regards to the potential bookings, more deferrals?

Yes, certainly that was the case that we saw in the latter part of Q4.

(inaudible)

We haven't [gotten] that same feedback yet on that -- on the product side.

Okay. And also, at the end of the year, with about $15 million in cash, what's the current burn rate on a monthly basis?

We have -- we've gone with a burn of $1 million or less in five of the last six quarters. I think that we will have -- even though 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.

And then, for the outlook, which is calling for expectations for 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?

Certainly, it's not a worst-case scenario. I think it's sort of what we believe is our most likely scenario at this point in time. The technology development forecast is 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.

Okay. And with regards to the shape sensing technology and the ongoing efforts with Intuitive Surgical, what's the next progress milestone, like investors should expect to hear about? Has the environment slowed down the development efforts?

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

Okay. And (inaudible), with regards to the GE Aviation program, how big is this market opportunity, and what -- I guess, what are the next set of milestones we should be looking for?

It is a huge market opportunity for GE, and we would certainly benefit from a part of that. The milestones going forward are demonstrations with the Defense Department that we're currently working with GE on. We've been working with GE for quite some time on these, and we've been in the corrosion industry for literally more than a decade and have built up quite an expertise in the corrosion field.

When do you think this could become a revenue generator?

It would be on the order of 18 to 24 months out.

Okay. Thank you.

Thank you, Michael.

(Operator Instructions)

And you have a follow-up question from the line of Michael Lew with Thinkequity. You may proceed.

Yes, I also wanted to -- if you could also elaborate on the nanomedicine development efforts. Again, obviously, you've talked about the progress in the coronary artery disease. Have you -- how big is this opportunity again, with the contrast agent?

The contrast agent today is controlled by about three compounds. The contrast agent today is about a $1.5 billion market, and I think the major players that we're in talks with certainly unanimously agree that we've got a fantastic agent and that it is -- performs better, it is safer, it does not let the (inaudible) 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 states that are outside of the vascular system, is a tremendous breakthrough. And the fact that we've actually gotten it to stick to foam cells in vitro is another pretty large breakthrough for us.

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

Yes. We've been using commercially available off-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 NREL. And when you combine that kind of efficiency with the new polymers that the three or four organic solar cell leaders are using today, and you put a 20% increase on what they're doing, you've 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.

Okay. Thank you.

Thank you, Michael.

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.

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

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