Dale Messick - Chief Financial Officer My Chung - President and Chief Executive Officer

Greg Greenberg - Wells Fargo Advisors

Good day, ladies and gentlemen, and welcome to the first quarter 2013 Luna Innovations Incorporated earnings conference call. (Operator instructions) And with that, I would now like to turn the conference over to your host Mr. Dale Messick, Chief Financial Officer of Luna Innovations. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining us today, as we review Luna's results for the first quarter of 2013. Before we proceed with our presentation, 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 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 the 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 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. And at this time, I'd like to turn the call over to My Chung, President and CEO of Luna Innovations.

Thank you, Dale. Today I would like to share with you several updates on our overall business performance and strategic growth initiatives, then Dale will review the financial results for the first quarter, following that we'll open the call up for any questions that you may have. As we discussed on our call back in late March, during the first quarter of 2013 we sold the assets in operations of our Secure Computing and Communications group for approximately $6.1 million. To reiterate from our March call, the rationale behind this sale was twofold; one, to allow us to focus on the two remaining strategic growth initiative, both of which leverages our unique capabilities in fiber optic technologies; and two, to improve our liquidity and balance sheet. With the gain that we made on the sale, we realized a net income of $2.8 million for the quarter and significantly improved our cash position, ending the quarter with $10.3 million of cash. With regards to our fiber optic shape sensing strategic initiative for minimally invasive robotic and non-robotic medical surgical systems, we continue to work aggressively toward the commercialization of this technology for Intuitive Surgical and Philips Medical. Our working relationships with each remain strong, with the technical teams working very closely on both sides. In addition to the goal of meeting our agreed upon development milestones, we are also working with each of these partners to formalize our longer-term business relationship, to encompass the logistics and creation of the processes, tools and systems to beat their exclusive supplier for the shapes sensing instrument. Bottomline, these programs are on track for making great strides towards productization, and we continue to be excited about the potential they bring to our future. We are also making good progress with our second growth initiative, related to our ability to measure strain and temperature more thoroughly and cost effectively using distributed optical fiber sensing, rather than discrete electrical strain gauges and thermocouples. Sales of our ODiSI platform continues to grow, increasing 26% compared to the first quarter of last year. Additionally, we are continuing to respond to the markets needs by enhancing the platform with upgraded capabilities, such as faster measurement speeds and higher resolution. We are active in the aerospace market and are continuing to win opportunities in the automotive industry, which has a much shorter new model development cycle. In North America, we have developed a strong pipeline, what we are terming, Testing Services. The customer paid service to have Luna engineering onsite, utilizing our product in the customer's environment, as it means to drive a more rapid adoption of our ODiSI platform. The growth in ODiSI sales helped offset the continued softness in sales of our telecom test and measurement products. The telecom industry remained soft in Q1, especially in North America, resulting in an overall decrease in our product and license revenue for the quarter. Based on the recent earnings announcements, from other telecom test equipment vendors, we believe that the softness we experienced in Q1 is largely an industry issue continuing to be impacted by the weak global economy. We're confident that we will return to growth in this market as the overall industry recovers. Within our Technology Development segment, the optical systems group had a significant decline in their funded backlog late in 2012, which in turn impacted their revenue opportunities for early 2013. In response, we undertook a restructuring of this particular group in January, including realigning it organizationally to work more synergistically with our products group. In this new organizational structure, the group will focus on winning government programs that are more closely in line with our intended product direction. And will also be able to assist in our Testing Services work that I mentioned previously. With this reorganization, we expect that we will be able to more effectively grow revenues. From our financial statement standpoint, the government research revenue contribution of the optical systems group will continue to be reported as part of the technology developmental segment. Our overall contract win rate within our technology development group improved in the first quarter compared to Q1 and Q4 of last year. So we should expect to start to see revenue in this segment improving over the coming quarters. With that, now I'll turn the call back over to Dale, to review the financial results in a little bit more detail.

Thank you, My. As I mentioned earlier, we recognized a net income attributable to common shareholders of $2.8 million for the first quarter of 2013 compared to a net loss to common shareholders of $0.4 million in the first quarter of 2012. This improvement in the bottomline was driven by a gain of $4 million that we recognized in our sale of the Secure Computing and Communications group on March 1, as reflected in the discontinued operations section of our income statement for quarter. And I'll touch more on that section in a moment. Our revenues for the quarter, now excluding Secure Computing, declined $4.5 million in 2013 compared to $6.7 million for the first quarter of last year. Technology development revenues were $2.6 million compared to $3.9 million in the year ago quarter, with the decrease being mostly favorable to our optical systems group, which My addressed in his earlier comments. Product and licensing revenue declined to $1.9 million for the first three months of this year compared to $2.7 million in the first quarter of 2012. Revenues from our ODiSI products improved 26% versus Q1 of last year, partly offsetting a $0.8 million decrease in revenues for our telecom related products. Bookings from Asia grew nearly 40% compared to Q1 of 2012, while North America was down for the quarter. Additionally, within this segment, our product development revenues decreased $0.2 million, resulting from decreased development work associated with Hansen Medical. Our resulting gross profit for the quarter was $1.4 million compared to a gross profit of $2.7 million in the first quarter of 2012. Gross margins decreased from 41% of revenue in the first quarter of last year to 31% in the first quarter of 2013, influenced primarily by the incurred overhead rate on our government research contracts, a product mix and a short-term increase in the cost of lasers used in our sensing products. Operating expenses remained flat overall at $3.3 million. SG&A cost decreased $0.1 million compared to the first quarter of the last year, while R&D expenses increased to similar amount. The increase in the R&D reflects higher utilization of our engineers on internal projects during the quarter versus our funded product development related activities. After utilizing $0.8 million of NOL carry forwards to offset the majority of tax expense on the gain we recognized in the Secure Computing sale, our resulting net loss from continuing operations was $1.1 million dollars or $0.08 per share for the first quarter of 2013 compared to a net loss from continuing operations of $0.7 million or $0.05 per share for the first quarter 2012. We recognized after-tax income of $3.9 million from discontinued operation in the first quarter of 2013 compared to income from discontinued operations of $0.4 million in the first quarter of 2012. The 2013 balance includes a gain on the sale of our Secure Computing and Communications group of approximately $4.9 million, offset by $0.1 million in operating losses from that group for the quarter prior to the sale in March and $0.9 million in estimated tax expense associated with the gain. As I mentioned a moment ago, the tax attributable to the gain on sales is mostly offset by a tax benefit reflected in continuing operations from the utilization of existing NOL carry forwards. After the recognition of our income from discontinued operations, our resulting net income attributable common shareholders was $2.8 million or $0.17 per share on fully diluted basis compared to a net loss of $0.4 million or $0.03 per share fully diluted for the first quarter of 2012. Including the proceeds from the sale of the Secure Computing group, our cash balance at March 31 improved to $10.3 million compared to $6.3 million at the end of 2012. Net cash representing our cash balance minus the outstanding balance on our term debt improved to $6.9 million at March 31 compared to $2.7 million at December 31 of last year. And now, I'll turn the call back to My.

Thank you, Dale. At this time, we will be happy to take any questions that you may have.

(Operator Instructions) The first question is from the line of Greg Greenberg with Wells Fargo Advisors. Greg Greenberg - Wells Fargo Advisors: A couple of questions, as far as I think you may have alluded to it, not including Secure Computing, which you just sold. Was headcount up, down or the same in this quarter?

Excluding the people that left with Secure Computing, headcount was pretty -- it was down a few from reorganization of the optical systems group, but not a significant decline. Greg Greenberg - Wells Fargo Advisors: And then, as far as I know in the press release you talked about EBITDA and adjusted EBITDA, but your actual cash used in operating activities, because of this the taxes sort of [muddled] (ph) a little bit, it was $272,000 or something like that in the quarter, which actually was better than a year ago?

Correct. We had a good quarter for collections on AR. That the AR balance improved by about $2 million in the quarter and that's, of course, created positive cash flow for was. Greg Greenberg - Wells Fargo Advisors: And then on distributed sensing you mentioned in your remarks about automotive and aerospace. And I know in one of your blog post you've been talking about wind turbines. Is there any other areas that you're targeting that we should know about?

Those are the primary ones, because we have a very, very strong test with composite materials and those three industries lead the composites space. Greg Greenberg - Wells Fargo Advisors: And I noted, again in one of the blog posts, it talked about a presentation that led to a presentation to the entire Boeing organization. So has that presentation taken place? Is there any feedback you've gotten from it?

That presentation has taken place and we've actually had a very good response rate, (inaudible) over 30 years old maybe, it was that high. It was a significant number. Our CTO did the WebEx and it was extremely well attended. Greg Greenberg - Wells Fargo Advisors: And then any anecdotal comments you hear from customers using the ODiSI B or these other distributed sensing solutions?

They are finding it as easy as we said it was and there is lot more of detail in terms of what's happening than they've seen before. Greg Greenberg - Wells Fargo Advisors: And then as you think about the business actually your press release said that this call will discuss financial results, business developments and expectations for the remainder of 2013. Can you share more of the expectations? In other words, somebody was just looking at these quarters result. They probably wouldn't see that much to get excited about. What should we expect for the remainder of 2013?

As we said on the call, the big drop in Q1 was on our telecom test products, right. And that will cover as the overall telecom market recovers. I think that's the linkage. Greg Greenberg - Wells Fargo Advisors: On the telecom side, that's been a recurring scene for a while, correct?

That is correct. The telecom market has been fundamentally down. I'll say, it started to decline in the second quarter of 2011. Greg Greenberg - Wells Fargo Advisors: When that turns, you think there is pent up demand for your solutions?

Yes. And we're hearing that from the manufacturers themselves. Greg Greenberg - Wells Fargo Advisors: Let me see if there is anything more I wanted to ask you. So going back to distributed sensing and the aerospace, you have got, I think it's with the Navy. You have got couple or one helicopter ceded up. Any update you can give us on that?

Not at this time. Greg Greenberg - Wells Fargo Advisors: Good notice in the Q, which I just had a chance to browse in the last few minutes. Finished goods, look like it was up as far as inventory, should I think of that as through the finished goods for minimally invasive surgery type machines or for ODiSI B product or any guidance you can give?

It is stock related to the shapes, I think it's related to the telecom and sensing products. So I think in particular that you should read into that. Greg Greenberg - Wells Fargo Advisors: And then on your partner Intuitive Surgical for whatever reasons sometime around March or February or April of every year it seems that you announce extension of an agreement for one year. I haven't seen anything like that out from you. Is there any update to that relationship or has it just moved into a new phase?

We're still working with Intuitive. I think, My had in his comments that we are actively engaged in working on a longer-term contract with them to get through the development commercialization process, but some times these things take longer than we would like them to. But we are still active with them. Greg Greenberg - Wells Fargo Advisors: I think last question, which I know is very, very small side business, but is very interesting, those sort of self-cleaning uniforms. I know you have got another demonstration coming up in the fall. What could this opportunity turn into? Is there something that is way on the back, but certainly not one of the top two or three things that we're looking at, but any update to that?

None at this time. I think we're still trying to wrap our arms around the actual process we would go through to commercialize that technology, all right. Clearly the development work that we've done, it's been very well received. The question is, how do you transform that technology into something that is attractive both from a quality perspective as well as price perspective in the general market. And we have not put a lot of effort into that. I think that that's the gating item. We get a lot of inquires from it. But because we're short on resources, we have not done what we needed to do from a marketing standpoint. Greg Greenberg - Wells Fargo Advisors: So might that be an opportunity that would be right from partnering, and are you giving away some upside, but not having to focus on it?

Yes, I believe so. It is something that we're looking at within 2013 here. We have actually established a commercialization steering committee internally to start prioritizing some of the technologies that we have available and figuring out what's next nonetheless, as we complete the strategic initiatives that we're focused on now.

Ladies and gentlemen, it looks like we have no other questions.

Thank you, everyone for joining us today. And as a reminder, we will be hosting our annual stockholders meeting in Roanoke on Tuesday, May 21, at 9 AM, and we hope to see you all there. And with that I'd like to thank everyone for participating today.

Ladies and gentlemen, that will conclude today's call. Thank you very much for joining us. You may now disconnect. Have a good day.