My Chung - President and CEO Dale Messick - CFO.

Analysts:.

Good day, ladies and gentlemen, and welcome to the Second Quarter 2014 Luna Innovations Incorporated Earnings Conference Call. My name is Sarah, and I'll be your operator for today. And at this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

(Operator Instructions) I'd now like to turn the conference over to Dale Messick, our Chief Financial Officer. Please proceed..

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

Before we proceed with our presentation today, let me remind each of you that statements made in this conference call as well as in our public filings, releases and Web sites 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 10-K and 10-Q filed 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 Web site.

And 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 I will review key elements about our operations as well as continue to provide you with updates on our distributed fiber optic sensing growth initiative. Following my remarks, Dale will go through the financial results for the second quarter and then we’d be happy to take any questions you might have.

I’m excited today to report to you that in the second quarter we continue to see revenue growth, both in terms of year-over-year and quarter-on-quarter. Our overall revenues were up 8% compared to the same quarter last year and 17% sequentially. Both our products and license and technology development divisions contributed to this growth.

At the same time, the headcount and operating expense reductions we did following the intuitive transaction helped to improve our bottom line performance. Dale will provide more detail on these numbers. As we’re now are executing on our single strategic initiative to become a leader in the distributed strain and temperature measurement market.

I thought it would be useful to provide a recap on this initiative. What it is? Why is it attractive to us? And how we will succeed? Fiber optic sensing is an emerging technology that (indiscernible) a market research firm estimates to be over $1 billion today and growing to over $3 billion by 2018.

An attractive segment of this market need is based on a shift towards the use of composite materials, specifically in aerospace, automotive, and wind and energy, as composites are lighter and stronger than metals.

The need for improved testing is driven by the fact that the structure of composite materials are non-uniform and that as a result is insufficient to test only a portion of the structure to determine this overall performance.

The way that engineers today are trying to deal with this characteristic is to try to cover as much of the surface area as possible with individual electrical resistance strain gages.

In something like a new composite aircraft, this is requiring over 7,000 individual strain gages each representing a single sensing point and its corresponding number of data acquisition channels. Not only is this method time consuming, but also costly and still insufficient.

This is contrasted to a 50 meter fiber optic cable with a single channel Luna ODiSI unit providing thousands of sensing points. We not only provide higher resolution, but also dramatic savings in installation and system cause. Our timing and aggressively launching this product seems to be right on.

Yesterday we’re having good working discussions with key customers as they’re acknowledging the need for a better solution than strain gages. What makes our solution unique from other fiber optic sensing companies is our method of sensing, namely Rayleigh scattering versus the most common method of fiber Bragg grating.

Fiber Bragg grating requires etching gratings on to a fiber for each sensing point whereas Rayleigh scattering can use off-the-shelf bare telecom optical fibers. The path into an account with our products clearly stars as the best fit for the final structural fatigue test where numbers of sensors is the major factor.

But then it opens up the opportunity for us to be the test solution for all the individual parts that make up the final structure. This is where the unit volume starts to add up. We’ve also made a number of significant changes through our team since the beginning of the year.

Last quarter I shared with you the addition of Brian Soller as Vice President and General Manager of our Lightwave Division.

Under his leadership we’ve been working on short-term and long-term development plans that will continue to enhance our product offerings to address the unique needs of testing composite materials and other structures where the resolution of our ODiSI platform provides greater insight than previously available.

Later this quarter, we will release a firmware upgrade that addresses a number of the customer comments and suggestions we’ve received. On the sound side, we’ve added to our team two very experienced sounds individuals to help drive our initiative into the sensing market.

Their experience and capabilities will enable us to develop the high-level relationships we need with key targeted customers and to accelerate our displacement of conventional strain gage measurement systems. Our ODiSI wins have included sales to a number of automotive companies in North America, Japan and Europe.

To several aerospace and defense companies in North America and Asia and a vast array of companies doing distributed temperature measurements, especially in the energy market in North America, Asia, and Europe.

In summary, with the divestment of our medical shape sensing business to intuitive surgical, we’re focusing our attention and energy on aggressively executing on our strategic growth initiative of becoming a market leader in distributed fiber optic sensing. With that, I’ll turn the call back over to Dale..

Thank you, My.

Before I begin, let me remind you that our comparative results for the second quarter and first half of 2013 have been restated to now reflect the revenues and expenses associated with the medical shape sensing operations to be reflected within discontinued operations rather than in operating revenue and cost as they were when we report our results last year.

With that reclassification, our 2014 revenues and cost are comparative to the 2013 results as shown. For the second quarter of 2014, our revenues were $5.2 million representing an 8% increase over the second quarter of 2013 and a 17% increase over the first quarter of this year.

Our technology development segment experienced a 15% growth in revenue over the second quarter of last year, and 20% growth compared to the first quarter of 2014.

New Contract Awards reflecting higher win rates on new program proposals during the second quarter also provided for growth in our backlog for future development work and in the second quarter with the backlog of $12.1 million compared to $7.8 million at the end of the first quarter and $9.8 million at the end of Q2 last year.

Product and licensing revenue was $2 million flat compared to Q2 of last year, but up 12% over the first quarter of this year as we continue to see a recovery in the telecom market and our expansion into the distributed fiber optic sensing market.

Our overall gross margin for the second quarter of 2014 was 38% or $2 million compared to a 37% gross margin of $1.8 million in the second quarter last year.

As a result of the cost reductions that we took following the sale of the medical shape sensing business earlier in the year, our operating expenses for the second quarter declined to less than $3 million, an improvement of 16% compared to our operating expenses in the second quarter last year.

As a result of these lower costs along with our revenue growth, our pre-tax loss from continuing operations of $961,000 reflects an improvement of $734,000 compared to the second quarter of 2013.

After considering the impact of income taxes and discontinued operations, which for the second quarter of last year also included income from our shape sensing development activities, we reported a net loss to common shareholders for the second quarter of the year of $943,000 compared to a net loss of $978,000 for the second quarter last year.

Year-to-date we’ve realized total revenues of $9.7 million reflecting growth of 9% over the first six months of last year. Our product and licensing segment and our technology development segment have each experienced 9% growth over last year. We remain encouraged by signs of recovery in the telecom market for our products.

Overall gross margins improved to 37% of revenue for the first half of 2014 compared to 33% of revenue in the first half of last year. Our improved margins resulted largely from reduced overhead cost in our technology development segment.

With the growth in revenues coupled with improved margins, our gross profit increased to $3.5 million for the first half of the year compared to $3 million for the first half of 2013.

Operating expenses decreased to $6.5 million for the first half of 2014 compared to $6.9 million for the six months of 2013 reflecting primarily the expense savings in the second quarter that I mentioned previously.

Our resulting pre-tax loss from continuing operations was $2.9 million for the first six months of 2014 compared to a loss of $3.9 million for the first six months of last year, an improvement of $1 million. After considering income taxes and discontinued operations, we achieved a net income of $7.

6 million or $0.44 per fully diluted common share for the first six months of 2014 compared to a net income of $0.11 per fully diluted share for the first six months of 2013.

As a reminder again, discontinued operations includes the sale of the shape sensing business in 2014 and discontinued operations for the first half of last year includes the sale of our secure computing group as well as the operating results of our shape sensing business in 2013.

Turning to the balance sheet, I’ll just highlight that we did receive the second $6 million installment from intuitive surgical during the second quarter as expected. As a result, our cash balance continued to improve and we ended the quarter with $14.7 million of cash.

We had working capital of $18 million as of June 30 compared to working capital of $10.1 million at the end of last year. Our outstanding bank debt balance has continued to amortize as well with the balance declining to $1.4 million outstanding as of the end of the second quarter. And with that, I’d like to turn the call back to, My..

Thank you, Dale and at this point Sarah, if we can open up for questions?.

Certainly. (Operator Instructions) My, it looks like we don’t have any questions in queue right now..

All right. Thank you everyone for joining us today. Again I’m very pleased with the progress we are making financially and operationally, and I look forward to speaking with you again in next quarter. Sarah, we can now conclude today's call..

Okay, thank you. This does conclude today's conference. Thanks all for your participation. You can disconnect and have a wonderful day..