Dale Messick – Chief Financial Officer My Chung – President and Chief Executive Officer.

Gregg Hillman – First Wilshire Securities Al Shams – American Capital Partners.

Good day ladies and gentlemen, and welcome to the Q2 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 follow 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 of Luna Innovations. You may begin..

Thank you, Becky. Good afternoon, everyone and thank you for joining us today as we review our operations and results for the second quarter and the first six months of 2016. A recording of this conference call will subsequently be posted on our website.

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 websites, which are not historical facts, maybe 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 SEC 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. This quarter represents our one year anniversary of our merger with Advanced Photonix, Inc. Similar to our Q1 results, this quarter further highlights the benefits and effectiveness of the transaction in building a stronger company.

As I stated last quarter, the integration and interaction between the two businesses is going very well, as I continued focus on achieving our financial targets and executing on our strategic initiatives. The team delivered in Q2 as we achieved significant revenue growth and an improvement in our bottom line.

With the full year of the merger between Luna and API now behind us, we’re stronger company than either would have been standalone, with greater opportunities for success.

As we now discuss our results for the second quarter, keep in mind that our reported results for the second quarter of last year included only a partial quarter for our API operations as the merger was completed in the middle of May, 2015.

As appropriate, we will take in terms of pro forma, comparisons, as if the companies were combined for the entire second quarter of last year, so that you might have a clear perspective of how the two businesses are performing.

If we compare our Q2 2016 revenues against the combined full second quarter of last year, we achieved the combined revenue growth of 18% year-over-year. Our growth continues to be driven by the two key strategic initiatives we have been focused on since the merger with API.

Mainly, our opportunity for growth in our ODiSI platform as a preferred method for the measurement of strain in composite structure and our opportunity to expand in high speed optical receiver for the 100 gig long haul and 2.5 gig and 10 gig Fiber-to-the-Home markets.

Based on the strength of these two initiatives, our Product and Licensing revenues increased $1.9 million or 22% compared to the combined revenues of Luna and API for the full second quarter of last year.

The large orders for our 100 gig high speed optical receivers and 2.5 gig avalanche photodiodes that we previously announced drove a lot of this growth.

Going forward, we have been in active negotiations with our lead customers for follow-on orders as 100 gig moves integrate or deployment into the metro market and 10 gig Fiber-to-the-Home deployments ramps up.

Joining the second quarter, we expand our APD wafer fab manufacturing capacity, in order to support this expected growth in Fiber-to-the-Home, at the same time improving our gross margins on these products by a factor of two.

With regards to our ODiSI platform for the measurement of strain and temperature, we continue to gain traction in the second quarter, was noteworthy sales of two well known aerospace companies. With the first half of 2016, ODiSI bookings have grown more than 40% versus the first half of 2015.

We recently launched a major enhancement to the ODiSI platform, providing higher performance measurements, while improving the product’s ability to withstand vibration in common test platforms or environments rather. This is a critical step to becoming an improved test method within the aerospace and automotive markets.

As I mentioned at the beginning, we’re seeing very good interaction between each of the divisions. Our research side had only a 5% growth, due to a significant drop in our Terahertz research, as they have shifted towards continued commercialization of our Terahertz system.

The traditional Luna research group had a very strong Q2, finishing up 16% versus last year. In our optoelectronics division in Camarillo continues to be or exceed their budget numbers.

An area that we haven’t touched on in our previous calls is the ongoing development of silicon photonics to support faster connections between datacenters by using higher speed optical signals instead of converting to electrical.

Our Optical Vector Analyzer product or OVA is well suited to evaluate the performance of the silicon photonics devices, as it is capable of measuring all parameters of an optical device in a single scan.

We have begun to see an increase in OVA sales into firms with significant silicon photonic development initiatives underway and we expect this to continue to provide our telecom test sales, some incremental growth over the coming quarters.

With this I’ll turn the call back over Dale to cover in more detail our Q2 financial results, as well as provide you with an update on the share buyback program we instituted Q1..

Thank you, My. Our revenues for the second quarter of 2016 increased $4.6 million to $14.6 million compared to $10 million for the second quarter of 2015.

The increase in our total revenues were driven primarily by growth in Product and Licensing revenues, which grew to $10.5 million for the second quarter of 2016 compared to $6.3 million for the second quarter of the prior year, while Technology Development revenues increased to $4.1 million for the second quarter of 2016 versus $3.7 million in Q2 of 2015.

Our pro forma basis, the combined revenues of Luna and API for the second quarter of 2015 were $12.4 million compared to the $14.6 million we recognized in the second quarter of 2016 for a pro forma growth of 18% in total revenues. Similarly on a pro forma basis, our Product and Licensing revenue increased 22% compared to the second quarter of 2015.

Gross profit increased to $5.2 million or 35% of total revenues for the second quarter of 2016 compared to $4.2 million or 42% of revenues for the first quarter of last year.

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 100 gig coherent receivers, which typically carry a lower gross margin than the typical sales of our historical test and measurement instruments.

The gross margin of 35% was consistent with the margins we realized in the first quarter of 2016. Operating expenses were $5.8 million or 40% of revenue for the second quarter of 2016 compared to operating expenses of $6.3 million or 63% of revenue for the second quarter of last year and $6.2 million in the first quarter of this year.

$6.3 million of operating expenses in the June, 2015 quarter included $1.7 million of non-recurring merger-related fees and only a partial quarter of expenses associated with the operations of API.

Operating expenses in the second quarter of 2016 also included a $0.5 million of amortization expense associated with purchase accounting compared to only $0.1 million for the second quarter of 2015.

Our resulting net loss improved $1.4 million to $770,000 for the second quarter of 2016 compared to an operating loss of $2.2 million for the second quarter of 2015, and an operating loss of $1.5 million in the first quarter of this year. We ended the quarter with $13.8 million of cash compared to $15.2 million at the end of Q1.

The decrease in our cash balance during the quarter resulted primarily from $1.2 million of capital expenditures during the quarter, most of which related to the build out of the capacity for APD manufacturing in Ann Arbor as we discussed on our past couple of earnings calls, in addition to $458,000 of debt service during the quarter.

Our total outstanding bank debt as of June 30 was $5.2 million for net cash minus debt of $8.6 million. Year-to-date through June 30 of 2016, we’ve recognized $28.6 million of revenue compared to $15.4 million for the first six months of 2015. Again, our revenue for the first half of 2015 includes only a partial period for the operations of API.

If we compare our first half 2016 revenues to the combined six months of both Luna and API for 2015, total revenues increased 18%.

Gross profit increased to $10 million for the six months ended June 30, 2016 compared to $6.5 million for the first half of 2015, representing overall margins of about 35% for the first half of 2016 compared to 42% for the first half of 2015.

And as I mentioned previously, the decrease in gross margin percentage is a function of our revenue mix with now more revenue being generated by the optical receiver product line. Operating expenses were $12 million for the first half of 2016 compared to $11.2 million for the first half of 2015.

Operating expenses in 2015 included $3.5 million of non-recurring merger-related expenses, and operating expenses for the first half of 2016 included a $1 million of amortization expense related to purchase accounting, again compared to just $0.1 million for the first six months of 2015.

Our resulting net loss improved by $2.6 million to $2.2 million for the first half of 2016 compared to a net loss of $4.8 million for the first half of last year. As we mentioned on our last call, we’ve been successful in maintaining a backlog that leaves us well positioned to continue our growth throughout 2016.

We ended the second quarter of 2016 with $10.1 million of backlog for our Product and Licensing segment and in additional $18.6 million of backlog for the Technology Development segment. Finally, I also like to mention that we did begin purchasing shares of our common stock under the repurchase plan that we announced in early June.

We implemented a 10b5-1 plan and made our first purchase on June 15. Through the remainder of June, we purchased a total of 59,000 shares of our common stock at an average price of a $1.22. And with that, I’ll now turn the call back over to My..

Thank you, Dale. And at this time we’d be happy to take any questions that you may have..

Thank you. [Operator Instructions] And our first question comes from the line of Gregg Hillman with First Wilshire Securities. Your line is now open..

Yes.

First of all, can you talk about financial reporting segmentation like under what circumstances would you start to breakout some of these segment? You’re talking about a lot of segments – in the future such as – I don’t know Fiber-to-Home or ODiSI or other things?.

Yes. Gregg, right now, we don’t have a plan for a further segmentation of the product and license revenues. We do look at it all as an optical support kind of function. So we think it’s appropriate for them to be bundled together on a single line.

Something got that dramatically significant compared to all others we would need to start, probably breaking it out separately. But at this point the various operations are none are so much greater than the others that it would require that..

Okay. And, well, you didn’t talk too much about Fiber-to-the-Home.

Could you give us like a little update on that?.

Yes. So we’re very much in it. We started off with a contract to fund the 2.5 gig side, right. That changed recently in that where 2.5 gig is going today is less with an APD and more with what they call a super TIA.

So it eliminates the part that we currently have in there, although we have turned up our activities on the 10 gig side, and all the new contracts that we’re looking to close for the remainder this year is a lot more than the 10 gig then it is on the 2.5..

Okay.

And then maybe you could talk about the datacenter and the fiber optic, that’s a test product you have for datacenters or is that correct?.

On the datacenter side, we don’t have today a Picometrix’s part per se, they were actively selling into the datacenter. We do support a 100 gig for the long haul as well as our big expansion that we’re working on short-term is more on the metro side, necessarily the data side – datacenter..

Okay.

Well then what were you talking about silicon photonics? That was for the datacenter, right?.

Okay. Yes, that is indeed for the datacenter, all right. That is more – we’re selling that into the development side today. As you know that that initiative is being led in a lot of ways by University of Santa Barbara. They have an OVA; the product that we talked about, as well as quite a number of the other sites.

But they are still very much in the research side. Lately, the activity levels really picked up because datacenter is the future of market. And when you think about the size of transceivers today and the power that they draw, silicon photonics resolve that. So that’s part of the other reason why.

We have an opportunity in datacenter, but we think – we’ve got enough right now on the Picometrix side to wrap our arms around the growth and long haul, as well as it’s expansion in the metro, and then to spread ourselves too thin and try to go after the datacenter as well. We will cover that.

Silicon photonics on the telecom side, the traditional Luna side, we’ll get our first-hand on where’s that technology involved indeed, replace the transceivers that are going in there now..

Okay. And then finally, My, on the ODiSI.

What gives you confidence that the ODiSI will be immaterial near to the company in next year?.

Well, I think the most recent customer meetings that we’ve had gives me a high degree of confidence. The latest revision that we introduced was very well received – resolved a number of issues and concerns that the customer had in terms of the measurement stability.

They basically at the end of that meeting gave us a thumbs-up and told us to continue to move forward. So I think on the aerospace side, we are very well positioned today. We’ve been as you know having quite a number of success with the companies there.

They had some great concerns how all the revision that we just introduced solved quite a number of that. And I think the last visit that they made they gave us pretty much a thumbs-up to move forward..

Okay. Thanks for your remarks..

Thank you very much, Gregg..

[Operator Instructions] And our next question comes from the line of Al Shams with American Capital Partners. Your line is now open..

Yes. Good afternoon, gentlemen. I was just curious about the stock buyback authorization.

What did the – what level did the Board authorized for that in terms of total shares to be repurchased?.

So the Board authorized a total of up to $2 million..

Okay..

They didn’t know in private how many number of shares..

Okay, okay.

And so what do we have left at this point?.

At this point – yes. That I said, we did just under $100,000 through Q2..

Okay..

So we’ve got most of it left still..

Okay, great. Thank you..

Sure. Thank you..

And I’m showing no further questions at this time. I would now like to turn the call back over to Mr. My Chung for closing remarks..

Thank you. Thank you everyone for joining us today. As you can see, we are very much focused on execution at this time. And as I also mentioned, the team is working extremely well together. In fact, our next venture as team is really working on a three-year strategic plan.

Trying to pull everybody’s thoughts together on that and make sure that we continue to take advantage of the opportunities that we have facing us and really building an exciting growing and profitable company. With that, I’d like to thank everyone again for joining us today and we look forward to the next earnings 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..