Dale Messick - CFO My Chung - President and CEO.

Dave King - B. Riley & Company.

Good day ladies and gentlemen, and welcome to the First Quarter 2016 Luna Innovations Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to introduce your host for today’s conference, Mr. Dale Messick, Chief Financial Officer for Luna Innovations. Mr. Messick, you may begin..

Thank you, Andrea. Good afternoon and thank you for joining us today as we review our operations and results for the first quarter of 2016. A recording of this conference call will subsequently be posted on our Web site.

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 change at any time, including but not limited to statements about our expectations regarding future operating results or the ongoing prospects of the 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 Web site and 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, and thank you all for joining us today. This month represents our one year anniversary of our merger with Advanced Photonix, Inc.

As our financial results shows, the combination has enabled us to build a stronger Company by reducing our overhead costs, expanding our manufacturing capabilities and focusing on the execution of our strategic growth opportunities. I’ve been very pleased with my leadership team in working together as one Company.

We meet regularly to ensure that we’re all aligned with the priorities we have set and that we’re overcoming any unforeseen obstacles.

On our last call back in March I spoke about improving our bottom line through execution of our key strategic growth initiatives for 2016; namely, the continued growth in our ODiSI fiber optic sensing platform for high resolution measurements of strain in composite materials and structures, and growth in our high speed optical receivers for the metro/long haul and fiber to the premise markets.

Today I am happy to report that we are off to a good start relative to these two strategic initiatives. Revenues from the sale of high speed optical receivers and ODiSI mainframes more than doubled in Q1 of 2016 compared to Q1 of 2015.

The growth in high speed optical receivers resulted from product shipments against the two large orders we announced last year; one for 100 gig coherent receivers; and the other for 2.5 gig avalanche photodiodes.

We’re especially excited about the outlook for our 2.5 gig avalanche photodiodes as we’re nearing the completion of the process improvements, we’ve been making in manufacturing as it will allow us to significantly shorten our manufacturing time and improve our gross margins for these devices by almost 2x.

We’ll be completing the remainder of the $7 million order for 100 gig coherent receivers this quarter and look to complete negotiations for a follow-on order. ODiSI revenues came from increased activity in the automotive industry and academia/universities with significant growth in Asia.

We’ve also received positive feedback from the initial systems sold last year into aerospace that they have been used successfully to detect composite structural issues that were difficult, if not impossible, for their current strain gauged system define. Our job now is to refine and enhance our capabilities to fit into their test ecosystem.

We’ve also recently developed the more robust sensor that will operate in high vibration situations such as on a racing vehicle. Our Terahertz revenues were up 36% year-over-year with increased systems sold through our value added resellers in North America and research systems sold into Asia.

Our government research revenue continues to have a high win rate in phase one proposals, followed by an equally strong conversion rate to the higher value phase-twos. Our technology development revenues were up 12% over the same period last year.

The growth we had in sensing, high speed optical receivers, Terahertz, and government research, was offset somewhat by a softer quarter for our traditional telecom test and measurement products. The release of CapEx seems lower this year than in previous.

We are however still optimistic in the year as the activity related to silicon photonics ramps up. Our telecom products provide unique visibility into these new optical lipid devices. Our net loss improved $1.2 million compared to Q1 of 2015.

Sorting through the pluses and minuses of merger related cost in 2015 and the purchase accounting impacts in 2016, our adjusted EBITDA improved $228,000 compared to the first quarter of 2015. Lastly, our backlog as of March 31st leaves us well positioned to continue our growth throughout 2016.

We ended the first quarter with $10.9 million of backlog for our products and an additional $19.3 million of backlog for the technology development segment. With that, I will turn the call back over to Dale..

Thank you, My Chung. So revenues for the first quarter of 2016 increased $8.6 million to $14 million compared to $6.3 million for the first quarter of 2015.

The increase in our total revenues was driven primarily by growth in our product and licensing revenues, which grew to $10.3 million for the first quarter of 2016 compared to $2.5 million for the first quarter of the prior year.

While technology development revenues increased to $3.7 million for the first quarter of 2016 versus $2.9 million in Q1 of 2015.

On a pro forma basis, the combined revenues of Luna and API for the first quarter of 2015 were $11.8 million compared to the $14 million we recognized in the first quarter of 2016 for a pro forma growth of 19% in total revenues. Similarly, on a pro forma basis, our products and licensing revenue improved 21% compared to the first quarter of 2015.

Gross profit increased to $4.8 million or 35% of total revenues for the first quarter of 2016, compared to $2.3 million or 43% of revenues for the first quarter of 2015.

Consistent with what we reported in our conference call last quarter, the decline in margin year-over-year was a function of product mix with a higher proportion of the revenues in 2016 coming from sales of our 100 gig coherent receivers, which typically carry a lower gross margin than the sales of our test and measurement instruments.

Operating expenses were $6.2 million or 44% of revenue for the first quarter of 2016 compared to operating expenses of $4.9 million or 92% of revenue for the first quarter of last year.

Operating expenses associated with API added $2.7 million for the first quarter of 2016 including the [acquisition] expense related to purchase accounting and non-recurring merger related costs included our Q1 2015 operating expenses were $1.8 million.

Our resulting net loss improved $1.2 million to $1.5 million loss for the first quarter of 2016 compared to an operating loss of $2.7 million for the first quarter of 2015.

Adjusted EBITDA also improved year-over-year to an adjusted EBITDA loss of $0.1 million for the first three months of 2016 compared to an adjusted EBITDA loss of $0.4 million for the first three months of 2015, and a reconciliation of net loss to adjusted EBITDA is included for you in the earnings release that we distributed earlier today.

We ended the quarter with $15.2 million of cash compared to $17.5 million at the end of 2015.

The decrease in our cash balance during the quarter was expected given factors such as our debt service, the normal timing of payments such as annual royalty fees that are paid in January each year based on the product sales of the previous year, and the planned capital expenditures we’ve talked about for the last couple of quarters.

I’ll point out that while our actual capital expenditures reported for the quarter are only $138,000, you can see on our balance sheet that prepay expenses and other current assets also increased $377,000 which was largely driven by cash deposits that we were required to make on additional purchase of equipment that had not yet been received as of March 31st.

Our total outstanding bank debt as of March 31st was $5.7 million for net cash minus debt of $9.5 million. And with that, I’ll turn the call back over to My..

All right Andrew. At this point, I’d like to open up for any questions..

Thank you [Operator Instructions]. And our first question comes from the line of Dave King with B. Riley. Your line is open..

Just few questions regarding your optical business, first of all I was just wondering if you can talk about the long haul segment. How much growth is there? I guess I am asking for sustainability and where are we in terms of our U.S. metro upgrade cycle? Any color on those two segments would be appreciated..

So the $7 million order that we announced last year which is the revenue that we shift in Q1 with some additional revenue forecast for Q2, that was 100 gig for the long haul market. Our expectation going forward is that we should receive a follow on order for the remainder of this year.

I guess we're in negotiations now as we complete the current commitment..

And then on the metro, North American metro upgrade cycle.

Are you participating in that cycle?.

Not at this point. The regions that we’re participating in right now for the long haul is in the Asia market, we’re not a big player as of yet in the North American market..

And how about the Chinese fiber to the premise, or the GPON, can you give us the latest updates, visibility and your expectations going forward? Are we still in a growth phase right now or maybe starting to kind of tight toe a little bit, or any color….

It's probably much in a growth phase. We’ll start shipping that in the second quarter.

And then as I mentioned the improvements that we’re making to the manufacturing process will really start to kick-in in Q3-Q4 at which point the margins that we will make on delivery of those products in the second half of the year will be significantly greater than in the second quarter. We see a lot of activity going on there.

We’ve got the big commitment that was announced last year for a one year program and we’re working with a number of other players that are about to place additional orders..

Now, are these all mainly Chinese or other international customers as well?.

Again it's mainly Chinese. Chinese as well as in South Korea..

The margin improvement, you talked about towards the end of the year, when that happens, I mean you still expecting that to be fairly strong at that point in the Chinese GPON market, or fiber to the premise?.

I think it's starting at this point and we’re expecting a bunch more to come-in in the second quarter as well, and in the third quarter..

So how long do you think this cycle will last? I always get that question from investors….

I think the 100 gig is here for a while, it will move from long haul to metro, natural progression. As far as the 2.5 gig market, the transition that a number of players are moving towards is to 10 gig product..

When is that going to happen, when is the crossover?.

I think you’ll start to see that in the second half of the year, more towards the fourth quarter. They’re looking at design wins now..

So will you have a separate 10 gig product by then, or what’s your product roadmap then?.

That is the plan to have a 10 gig product by then..

Any kind of like component bottleneck or maybe a chip bottleneck, semiconductor bottleneck, I’ve been hearing from some of your peers that there seems to be some kind of component shortages or chip shortages? And also how your capacity, seems like everybody is having problem with that?.

As far as 100 gig part or is it 2.5 gig?.

Both, actually both, I am interested in both….

We haven’t seen any parts issues, 25 gig we’re making the wafers ourselves. So we’re in full control of that. As far as the 100 gig, I haven’t really seen anything..

Thank you [Operator Instructions]. I am showing no further questions at this time. I would now like to turn the call back over to My Chung for any closing remarks..

Okay, thank you Andrea. I would like to thank all of you for joining us today. And we look forward to updating you on our next quarterly call..

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may all disconnect. Everyone have a great day..