My Chung - President, Chief Executive Officer Dale Messick - Chief Financial Officer.

Greg Greenberg - Wells Fargo Advisors.

Good day ladies and gentlemen and welcome to the fourth quarter 2014 Luna Innovations Incorporated earnings conference call. My name is Denise and I'll be the 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 for replay purposes. I will now turn the conference over to Mr. Dale Messick, Chief Financial Officer for Luna Innovations. Please proceed sir..

Thank you, Denise. Good afternoon everyone and thank you for joining us today as we review our operating results for the fourth quarter and the full year of 2014. A recording of this conference call will subsequently be posted on our website.

Before we proceed with your presentation today, let me remind each of you that statements made in this conference call, as well as in our public filings, release and website 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 our expectations regarding future operating results or matters relating to the completion of our pending merger with Advanced Photonix and the prospects of the combined company.

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 latest forms 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 expect as required by law.

There is more complete information regarding forward-looking statements, risks and uncertainties in the company's filings with the SEC available on the SECs website and our website. And at this time I’d like to turn the call over to My Chung, President and CEO of Luna Innovations..

Thank you, Dale and thank you all for joining us today. The fourth quarter of 2014 was a busy and exciting one for us. Not only did we finish the year with strong financial results, but we were quite busy with a number of strategic accounts, as well as negotiating the pending merger agreement with Advanced Photonix.

Our fourth quarter revenues were up 32% over the same period last year, driven by a 60% increase in our product sales. This is significant as this is where we set our strategic growth initiatives. Our vision is to be a leader in the distributed fiber optics strain and temperature measurement market.

We achieved our best quarter of product sales for the year with revenues from our ODiSI platform continuing to grow as we made progress in driving the adoption about fiber optic technology as a preferred method for measuring strain and fatigue in composite components and structures.

Unlike aluminum or steel, composites are non-uniform in their composition. Therefore in order to adequately test something like a composite aircraft wing or fuselage, one needed to previously install thousands to several thousands of individual electrical strain gages, trying to cover as much of the surface area as possible.

Each of these individual strain gages would need to be glued onto the structure, then connected back to the single data acquisition channel. So to test a composite aircraft using electrical strain gages one would need an acquisition system with a thousand to several thousands of channels.

This is contrasted to using fiber optic cables, each with the equivalent of a thousand sensing points depending on the length of the fiber. But only a single connection back to our ODiSI system. Our solution not only offers higher resolution, but it is far easier and faster to install and is significantly less expensive.

Our progress in Q4 were also a result of our continued investment in the build out of a direct sensing sales force dedicated to growing our ODiSI product revenues.

Product engineering released a new firmware upgrade that included several key product enhancements, including a touch to locate feature, which allows users to simply touch any location along the length of the fiber and define that spot as a sensor.

The firmware update also included a data visualization software that allows end users to upload an image of the object being tested, than having the temperature and/or strain data color coded and overlaid directly on this image.

Within the product segment of our business, we also saw a recovery of the telecom market and good growth in the sales of our traditional test and measurement products. Our technology development revenues which are focused principally on applied research programs funded by the U.S. government were up 14% for the quarter.

In addition to our revenue growth, another important metric for this segment of our business, is the backlog that we maintain for future development work. Our backlog of $12.8 million at December 31, 2014 was nearly 50% higher than our ending backlog for 2013.

Lastly, while achieving this top line growth in both segments of our business, we have maintained our philosophy of controlling operating expenses, which in turn resulted in positive cash flow from operations for the quarter of approximately $175,000 and a total cash burn for the quarter of only $313,000.

To provide you with a deeper understanding of our financial results for the quarter and year, I will turn to call back over to Dale. Following that I will provide you with an update on where we are with the announced merger with Advanced Photonix..

Thank you My. For the fourth quarter of 2014 we recognized revenues of $6.2 million compared to $4.7 million for the fourth quarter of 2013, an increase of 32%.

Within that product and licensing revenues grew to $2.9 million for the last quarter of 2014, representing an increase of 60% compared to product and license revenues of $1.8 million for the fourth quarter of 2013. The growth in product sales year-over-year was realized primarily in our ODiSI and our OVA products.

Technology development revenues grew 14% to $3.2 million in the fourth quarter of 2014 versus $2.9 million in the prior year quarter. Our growth in this segment came primarily from our intelligence system group, which focuses on development of various sensor technologies and our nanomaterials group.

Overall margins improved to 36% of revenues in the fourth quarter of 2014 compared to a gross margin of 31% four the fourth quarter of 2013.

The improved gross margin resulted from revenue mix and product sales typically carry a higher margin than our contract research activities and it accounted for 48% of Q4, 2014 revenues compared to 39% of our revenues in the last quarter of 2013.

Our product revenue mix in Q4, 2014 also returned to higher average margin than with product sales in the fourth quarter of the prior year. Our resulting gross profit was $2.2 million for the fourth quarter 2014 versus $1.5 million for the fourth quarter of 2013.

Operating expenses declined to $3.1 million in the fourth quarter of 2014 compared to $4.2 million in the fourth quarter of 2013.

Transaction related expenses recognized in the fourth quarter of 2013 related to the Intuitive transaction were approximately $0.6 million higher than the transaction expenses recognized in the fourth quarter of 2014 related to the API proposed merger activities.

Additional expense savings compared to the prior year quarter resulted from lower professional fees, as well as lower labor costs and expenses associated with the transfer of employees in the Intuitive transaction and subsequent G&A headcount reductions.

Following our 32% revenue growth and reduced operating cost, our operating loss for the fourth quarter 2014 improved to $0.9 million compared to an operating loss of $2.8 million for the fourth quarter of 2013.

After recognition of income from discontinued operations, which for 2013 included the operating contribution from our prior medical shape sensing business, we recognized a $1.1 million improvement in our net loss attributable to common stock holders, with a loss of $0.9 million attributable to common stock holders for the fourth quarter 2014 compared to a net loss attributable to common stock holders of $2 million for the fourth quarter of 2013.

Turning to our full year operating results, revenues for 2014 grew 16% to $21.3 million compared to $18.3 million for 2013. Product and license revenue increased 31% in 2014 compared to 2013 with a growth coming primarily from increased sales of ODiSI and OVA products as I mentioned with our forth quarter results.

Technology development revenues increased 7% compared to 2013. Our overall gross margin for 2014 improved at 37% of revenues compared to an overall gross margin of 33% for 2013.

As I noted for Q4, the improved margin resulted from our revenue mix with product and licensing revenue accounting for 43% of our revenues in 2014 compared to 38% of our total revenues for 2013 and a higher average margin for our product mix in 2014.

Our result in gross profit improved to $7.8 million in 2014 compared to a gross profit of $6 million in 2013. Lower transaction related expenses and cost savings initiatives following the Intuitive transaction in January 2014 drove a $1.7 million reduction in operating expenses in 2014.

Operating expenses were $12.3 million for 2014 compared to $14.1 million of operating expenses for 2013. Income from discontinued operations of $9.3 million in 2014 includes the net of tax gain on the sale of the medical shape sensing business to Intuitive in January of 2014.

The tax expense included there in discontinued operations is mostly offset by an income tax benefit of $1.1 million reflected in our loss from continuing operations.

Similarly income from discontinuing operations includes the net of tax gain realized in 2013 on the sale of the secure computing and communications business in addition to the 2013 operating contribution of the medical shape sensing business.

Related tax expenses recognized in discontinued operations for 2013 is largely offset also by an income tax benefit recognized in continuing operations.

After considering income from discontinued operations, we recognized a net income of $6 million of $0.40 per share attributable to common stock holders for 2014 compared to a net loss of $0.9 million or $0.06 per share attributable to common stock holders for 2013.

Turning briefly to our balance sheet and cash flow, we ended 2014 with $14.1 million of cash compared to $7.8 million of cash at the end of 2013, with the increase being driven by the proceeds from the sales of our medical shape sensing business.

We continue to reduce our outstanding bank debt during 2014 with only $625,000 remaining on the term loan at December 31, 2014 compared to $2.1 million outstanding at the end of 2013. The remaining item I would highlight for you is the increase of $1.4 million in property and equipment at the end of 2014 compared to 2013.

In the fourth quarter of 2014 we moved into new space for our Blacksburg Virginia facility, the largest of our locations, and that new space included $1.6 million of lease hold improvement costs for build outs included in the lease.

That $1.6 million is offset by a $1.6 million differed rents within accrued liabilities that we will amortize over the lease term and is the driver of the increase that you see in accrued liabilities from December 2013 to December 2014. And with that I’d like to turn the call back over to My. .

Thank you, Dale. Before we open up the call for questions, let me give you a quick update on our proposed merger with Advanced Photonix.

As I discussed on the call with our announcement of the proposed transaction, we believe that the merger of LUNA and API will result in a bigger and better company with a strong balance sheet and a combined annual revenue base of more than $50 million.

In addition, we expect significant cost savings as a result of combining the two public companies into one, thereby eliminating the duplicate costs of public company compliance along with other potential operating synergies.

By joining forces with Advanced Photonix, we would create a company with a strong position in optical products and technologies, with increased tests and measurement capabilities to address the needs of a broader market base, and in turn provide us with tremendous opportunity for continued growth.

The greater revenue base of the combined company, along with our expense savings will also provide an accelerated path for us toward improved cash flow and profitability. As far as the timing of the transaction process, we filed the Form S-4 with the SEC in early February; however that filing has not yet become effective.

Because of SEC rules regarding the age of financial statements required for registration statements, we are now required to amend the From S-4 to include our Q4 updated financial statements and related disclosures following the filing of our Form 10-K before the SEC can declare the S-4 effective.

We currently expect to get the 10-K filed within the next few days and soon thereafter file the amended S-4.

Depending on the time that is necessary for the SEC to declare the S-4 effective, we and API will schedule our shareholders meetings and then once the registration statement is effective, we will mail our proxy materials to our respective shareholders.

While we can’t yet nail down a specific date because of the uncertainty of the SEC process, our current planning timeline would anticipate a shareholders meeting in the first half of May. Denise, we would now be happy to take any questions from today’s participants. .

[Operator Instructions]. Our first question comes from Greg Greenberg with Wells Fargo Advisors. Please proceed. .

Hi, good afternoon. .

Hi Greg. .

Hi.

As far as the merger goes, can you talk about a little bit of the cross selling potential? Is really API sales force going to be able to distribute the new products that are driving the growth of LUNA now?.

Yes, so the two main product lines that API has is one out in Camarillo, California which is called Optosolutions. It’s a photo dial based product line, and then the other big business that they have is in Ann Arbor, Michigan, their high speed optical receivers.

When you look at the primary customers that they are selling to, a lot of them are similar customers that we sell our tested measurement products to. Different groups within the customer base, but the same customer.

Now when you stand back and look at the challenges that all three entities, Optosolutions, HSOR as well as what Luna has, being the size that we are individually, we are all three of us gaped in terms of hiring enough sales people to cover the world.

Now you group them together and you look for opportunities whereby we could have the same sales person that’s calling on let’s say company A for one of the three.

Suddenly while they are there, also because he happens to be there and talk to other people within the company that’s interested in the other two product lines, that’s where we will see this engine. We have not mapped that in necessarily in our first year financials. I think that’s something that will evolve over time. .

Okay, and then any public information from [Indiscernible] as far as how Intuitive Surgical is progressing with the medical product in regards to future milestones and earn-outs. .

Nothing at this time. There are no updates. .

Okay.

How many employees does API have approximately?.

They also have about a 120, somewhere as high as 200. .

You stay well below that 500 limit for the....

Yes, that’s correct. .

Okay. All right, thank you. It certainly looks like where the growth initiative is for Luna standalone is you guys are delivering to Luna. Thanks. .

Thanks very much Greg. .

Thanks Greg. .

We have no further questions. I will now turn the call back over to management for any closing remarks. Please proceed. .

Well, I’d like to thank everyone again for participating on today’s call. As you can see, we are headed in the right direction, a very strong quarter. We are excited about the opportunity to merge with Advanced Photonix.

We believe that the combination is best for both shareholders and it’s just it’s on an accelerated path to success, and with that again, thank you for joining us today. .

This concludes today’s conference. You may now disconnect. Have a great day everyone..