Dale Messick - CFO My Chung - President and CEO.

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Good day, ladies and gentlemen, and welcome to the Q1 2014 Luna Innovations Incorporated Earnings Conference Call. My name is Clinton, and I'll be your conference operator today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference.

(Operator Instructions) As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Mr. Dale Messick, Chief Financial Officer. Please proceed, sir..

Thank you, Clinton. Good afternoon everyone, and thank you for joining us today as we review Luna's results for the first quarter of 2014.

Before we proceed with our presentation today, let me remind each of you that statements made in the 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 discussed in our earnings release and our latest Forms 10K and 10-Q as 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..

Thank you, Dale. On today's call we will review key elements about operations as well as provide you with an update on our distributed fiber optic sensing growth initiative. Following my remarks, Dale will go through the financial results for the first quarter and then we will be happy to take any questions you might have.

The results that we release today reflect our performance per sale of our medical shape sensing business to intuitive surgical. We have discussed this transaction with you on previous calls so I won't do that again here unless there are questions later.

The one additional piece of information that I would like to share with you at this time, is that in mid-April we did receive from Intuitive the second payment of $6 million that is still part of the initial purchase price.

Turning to our current and on-going operations, I'm very pleased to report today that our Q1 revenues for both our research and products group were up relative to the first quarter of last year. Contributing to this was a [rebalance] (ph) to growth in our telecom test and measurement products.

In particular, sales of our Optical Vector Analyzer which typically have our highest average sales price and are therefore most susceptible to economic swings, grew in the first quarter. Our OVA provides comprehensive component characterization of optical devices.

It is the only instrument on the market that is capable of providing this level of detail in a single skin. Our research group continues to improve its win rate for government proposals as well as advance certain technologies towards commercialization.

The group that follow discipline, improve proposal writing process that is both led to an increase rate of initial phase one awards as well as an improved rate of obtaining follow on phase II funding. From an organization standpoint, we have recently hired Brian Soller as Vice President, General Manager of our Lightwave Division.

He will be overseeing all the fiber optic based products, services and R&D activities. Having worked previously in Luna, Brian comes to us with an extensive background in our products and in our target markets. Most recently, he served as vice president of marketing from MicronOptics, the leading global supplier of fiber optics sensing equipment.

Brian recognizes the compelling opportunity for growth presented by our fiber optics sensing platform, and we are excited to welcome him back in a leadership role at Luna. With a sale of our medical shape sensing business to intuitive surgical, we are now focused on the execution of our fiber optics sensing strategic initiative.

An important component of this growth initiative is the build out of a dedicated direct sensing sales force. With the additional sales engineers in Q1, we have already seen a 40% increase in a number of qualified sensing opportunities entered into our sales panel.

Our target markets for our sensing product line are the aerospace, automotive, and energy industries. Our distributed fiber optics sensing platform offers these customers a faster, cheaper and higher resolution product than conventional strain gauge or thermocouple data acquisition instruments.

Based on customer feedback and requirements, our product development team will continue to build on these capabilities in order to become a market leader in this space. And with that, I'll turn the call back over to Dale..

All right. Thank you, My.

So before we dive in to numbers, let me point out that our results for the first quarter of 2013 have been restated to now reflect the revenues expenses associated with the medical shape sensing operations to be included within discontinued operations rather than in our operating revenue and cost as when we reported the results last year.

With that reclassification, our 2014 revenues and cost are comparative to the 2013 results have shown. So for the first quarter of 2014, revenues were $4.5 million representing a 9% increase over the first quarter of 2013.

The growth in revenue was driven by higher sales of test and measurement equipment with overall products and licensing revenue growing 22% compared to Q1 of last year. As My mentioned previously, the increase in product sales was largely related to telecom test and measurement, including our OVA product line.

Revenues from our contract research and our technology development segment improved by 2% compared to the first quarter of 2013.

Our overall cost of sales were essentially flat declining less than $100,000 compared to Q1 of last year with higher cost corresponding to the growth and product sales being offset by reductions in the cost of our technology development activities.

As a result of higher products component to our revenue mix, as well as the improved margins within our technology development segment, we realized an improvement of seven points in our overall gross margin to 35% in the first quarter of 2014 compared to 28% in the first quarter of 2013.

Our result in gross profit increased approximately $400,000 to $1,552,000 for the first quarter this year versus $1,135,000 for the first quarter of last year. Operating expenses grew slightly to $3.5 million in the most recent quarter compared to $3.4 million in the first quarter of last year.

The increase of approximately $90,000 in our SG&A expense was primarily due to higher selling cost including additional time spent and business proposal activity with our technology development segment and our additional sensing sales engineers.

We recognize an income tax benefit in continuing operations of approximately $900,000 in the first quarter 2014 and in the first quarter of 2013.

This income tax benefits offset the income tax expense recognized on the gains that are reflected in discontinued operations for sales of medical shapes sensing in 2014 and our secure computing and communications group in the first quarter of last year, which I'll touch on in a moment.

Our resulting loss from continuing operations improved $340,000 from $1.3 million in the first quarter of 2013 to $963,000 in the first quarter this year. Income from discontinued operations was $9.5 million in the first quarter of 2014 compared to $4.1 million for the first quarter 2013.

The 2014 amount reflects the gain on the sales of medical shape sensing business of $10.6 million less estimated taxes of $1.1 million. The gain recognize based on the $12 million that we received from Intuitive thus far and does not include amounts that are contingent upon the technology milestone or royalties in the future.

The $4.1 million income from discontinued operation in 2013 include the gain on the sales of our secure computing group in March of 2013 in the amount of $4.9 million offset by $0.9 million estimating tax on that gain.

Income from discontinued operations in the first quarter of 2013 also includes approximately $250,000 of net contribution from the medical shape sensing development work in that quarter, less $160,000 of net cost incurred by our secured computing group also in Q1 of 2013 prior to the completion of sales of that group.

After considering the gains recognized in discontinued operations, our net income attributable to common shareholders improved to $8.5 million or $0.49 per diluted share, compared to first quarter 2013 income attributable to common shareholders of $2.8 million or $0.17 per diluted share.

Touching on the balance sheet, we ended the first quarter with $10.9 million of cash on hand compared to $7.8 million at the end of 2013. Receivables of $10.5 million at March 31st included the second $6 million instalment due from Intuitive on the shape sensing sales, which My mentioned earlier, was collected in April of this year.

Total assets have grown to $27.5 million at the end of the first quarter of 2014 compared to $19.7 million of total assets at the end of 2013. Our bank debt have continued to amortize and the balance was $1.75 million at the end of the quarter. And with that, I'll turn the call back over to My..

And Clinton, we would now like to take any questions from participants on today's call..

Thank you. Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touchstone telephone. If your question has been answered or you wish to withdraw your question, press star followed by two. Press star one to begin. Please standby for your first question. Your first question comes from the line of (indiscernible)..

Hi. Yes. Thank you. I have a couple of questions. Number one, it seems that you've recorded all the gains and expenses related to the $6 million that you received in April for the second quarter.

So is it true that -- is that true?.

So on the income statement, the gain is reflected. Yes. On the balance sheet side, the $6 million we're sitting is accounts receivable. So all of the $12 million that was due from the upfront payments has been reflected in Q1.

What we haven't reflected here is anything that we would receive in the future from the achievement of the technology milestone or loyalties upon their system sales..

So you report second quarter revenue.

Is that $6 million is pure profit?.

The $6 million was reflected in Q1. So it won't show up in the income statement in the second quarter. They'll show up in the second quarter with the conversion of the accounts receivable into cash..

Okay. I got you..

Thank you. Just one more question. In reference to your bringing Mr. Soller back to the firm, I mean I just looked through and I see that you spent about five years in the firm getting into light path and dealing with Micron for a year.

And in reference to the chargers you now have in your books, do you plan to do any acquisitions maybe in the next year or so?.

What we conveyed at the last earnings call was the appropriate time for us to do acquisitions would be at the point that we've achieved at least breakeven, which we kind of alluded to being around a year to two years from now..

Okay. So that cash is just the [question] (ph)..

That is correct at this point..

Okay. Thank you..

Thank you..

Thank you. Once again ladies and gentlemen, if you do wish to ask a question, then just key star followed by one on your touchstone telephone. Thank you. We currently have no more question at this time. I would now like to hand the call back over to My for closing remarks..

Well, thank you everyone for joining us today. I would like to remind everyone that we would be holding our annual shareholders meeting in Lone Oak on May 20th at 9 a.m., and I hope to see you all there.

If you receive the proxy in the mail, you will not able to attend the meeting in person, please do complete the proxy so that your vote maybe counted. And with that, we thank you again for joining us today..

Thank you ladies and gentlemen. That concludes the conference call for today and you may now disconnect. Thank you for joining. Have a very good day..