Dale Messick – Interim President and COO Scott Graeff – Interim CFO

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Luna Innovations Incorporated earnings conference call. My name is Katie and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of the conference. (Operator instructions) I would like to now hand the call over to Mr. Dale Messick, President and Chief Operating Officer. Please proceed, sir.

Thank you very much, Katie. Good afternoon, everyone and thank you for taking the time today to join us as we review our progress and results for the third quarter of 2010. Before I go further, let me remind each of you that statements made in this conference call and our public filings, releases, and websites, which are not historical facts, maybe forward-looking statements that involve risks and uncertainties, and are subject to changes at anytime. 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, which may differ materially as a result of a variety of factors discussed in our earnings release and our latest Form 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 website. So with that, let me jump into the results for the quarter. With me today on the call are Scott Graeff, our Interim CFO; and Mark Froggatt, our Chief Technical Officer. I'll start with an overview of our business activities since the last call and then Scott will give the detailed review of the financial results for the quarter. And following that, we will be happy to take any questions. First of all, from a financial standpoint, I am very happy to report that as a result of a $1.5 million improvement in our bottom line and in EBITDA, we did achieve positive cash flow for the quarter of nearly $900,000. That's a very significant milestone for Luna and I am happy to finally not be saying to you on these calls a sentence that starts with, "Except for the legal fee, we would have." Scott will share the details of our financial performance in a moment. But from an operations perspective, I am optimistic about the growth we have been seeing in our product and license segment in particular. After seeing demand decline during the recession in 2009, orders have been growing steadily this year, with third quarter product and license revenues increasing nearly 50% compared to the third quarter of last year. Within that growth, revenues from the sale of our OVA and OBR products nearly doubled compared to the third quarter of 2009, including the first sale of our new portable OBR in third quarter. We also introduced during the third quarter a new benchtop model of the OBR with performance up to 10 times faster than our previous model and the first shipment of that also took place in Q3. While on the topic of product development, I'll just mention that our development projects with both Intuitive and Hansen remain on schedule and we've been able to meet required milestones on time there. The teams continue to work very well together and we are enjoying positive relationships with both of these important customers. So with our growth in sales, new product rollouts, and continuing to meet the milestones in our Intuitive and Hansen projects, I remain very pleased with the progress being made in the product and license segment of the business. In our technology development segment, revenues declined 23% compared to the third quarter of 2009. This decline continues a trend that we've seen throughout 2010, reflecting a decline in new program awards during the time that we were operating in Chapter 11 in the second half of 2009 and the beginning of 2010. Since the programs we are working on in the segment are generally of a long-term nature, the impact of the decline wasn't really seen until 2010. While we were operating in Chapter 11, we were still working the contracts that we had been awarded prior to the filing. As those were later completed and the new awards slowed down, particularly in the higher-value Phase II awards, we saw in 2010 a decline a decline in our contracts backlog and a corresponding decline in 2010 revenues for that segment. Recently, we have received several new awards in Phase II programs and so our backlog has once again grown. At the end of September, our backlog for technology development contracts was in excess of $29 million compared to approximately $23.5 million at September 2009 and a little under $22 million at the end of the second quarter this year. The new large awards we received came from several areas, including three awards for an aggregate of $4.6 million in our Optical Systems Group, one in our Advanced Materials Group for $1 million, and two in our Nanomaterials Group for $1.7 million in total, in addition to an incremental funding of $700,000 on an existing grant in the nano area. Since these new awards and the growth in our backlog are coming late in the year, it's slightly too late to have a significant impact on our 2010 revenues, but we believe it does give us a good starting point for 2011 and an indication for potential growth again in this segment of our business next year, particularly within our Optical Systems Group where we are able to write proposals for new research opportunities based upon the advanced capabilities of our Optical Backscatter Reflectometer platform. So with that, I'll turn the call over to Scott Graeff for a deeper look at the financial results for the quarter.

Thanks, Dale. I would now like to give the financial results for the third quarter of 2010. Overall, our financial results of operations continued in their positive trend, although with a slight decrease in overall revenues compared to the third quarter of last year. We did achieve a significant increase in our product and licensing revenue, as well as lower operating expenses and improvements in our net loss and adjusted EBITDA. We also achieved positive net cash flow for the quarter. Specifically, for the third quarter of 2010, we generated revenues of $8.6 million, a slight decrease of 3% compared to $8.9 million for the third quarter of 2009. Revenues in our product and license segment experienced a significant increase of 49% to $3.6 million for the third quarter of 2010 compared to $2.4 million in the third quarter of 2009, primarily due to increased sales in our OVA and OBR product lines. As you may recall, we introduced the new OVA 5000 back in the first quarter and the OBR 4200 in the second quarter of this year. During the third quarter, we also launched a new OBR 4600, a version of the Optical Backscatter Reflectometer designed for component and short-run network testing. We have taken several orders for these new OBR 4600s, shipping one in the third quarter and we'll be shipping others in the fourth quarter of this year. The growth in our product and license revenues offset a decline in revenues with our technology development segment, where revenues decreased by approximately 23% from $6.5 million in the third quarter of 2009 to $5 million in our most recent quarter. As we have mentioned on previous earnings calls for the past two quarters, our win rate for the new research contract awards declined significantly during the period of our reorganization in 2009 and early 2010. As such, we may continue to experience year-over-year declines in revenue for this segment of our business. We are beginning to see signs of recovery, as Dale pointed out, in the most recent win rates and that is noticeable in our technology development backlog, which has increased 26% or $6.1 million from $23.5 million on September 30th, 2009 to $29.6 million at the end of the third quarter of 2010. We continued to reduce operating expenses for the quarter compared to last year with a decrease of 31% or $1.7 million, largely driven by a reduction in litigation and Chapter 11 reorganization expenses, as well as the company's continuing ongoing expense savings initiatives. Excluding those costs of approximately $54,000 during the third quarter of 2010 compared to approximately $1.6 million in the third quarter of 2009, operating expenses represented 43% of revenues this past quarter compared to 44% of revenues for the third quarter of last year. With those improvements in operating expenses, our net loss for the quarter improved by $1.6 million to a net loss of $424,000 in the third quarter of 2010 compared to a loss of $2 million in the third quarter of last year. Including the costs of the common stock dividend related to our outstanding class of preferred stock, the net loss to common stockholders was $517,000, again compared to the $2 million for the third quarter of last year. Our net loss for the first three quarters of the year has improved to $2.2 million compared to a net loss of more than $45 million for the first three quarters of 2009. Keep in mind that the first three quarters of 2009 was also adversely affected by approximately $37.6 million in reserves and other nonrecurring charges we recorded associated with the Hansen litigation and our Chapter 11 reorganization. To normalize that and other factors, in our release today, we have provided a reconciliation of our net loss to our adjusted EBITDA, which excludes the cost associated with the litigation reorganization, as well as non-cash cost related to the stock compensation. As a result, our adjusted EBITDA, less litigation and reorganization related items, improved to $950,000 for the third quarter this year compared to $800,000 for the third quarter of 2009 and $2.1 million for the first three quarters of the year compared to approximately $1.3 million for the first three quarters of last year. Turning to our balance sheet and cash flow, we ended the quarter with $7.2 million of cash compared to cash of $5.2 million at the end of 2009 and $6.3 million at the end of the second quarter of this year. Our net change in cash was a positive $900,000 for the quarter, a very encouraging milestone for the company now that the litigation is behind us. In fact, excluding new money from borrowings, the company has not achieved cash flow positive since 2007. Liabilities are a little challenging to compare line by line against the audit balance sheet of December 31st due to the reporting format of the time we were in reorganization. Instead, I will highlight to you that current liabilities of $9.5 million at September 30th compares to $10.7 million of current liabilities at the end of the second quarter of this year, while total liabilities of $12.5 million at September 30th compares to $14 million at the end of the second quarter. Working capital improved to approximately $7.8 million at the end of the third quarter compared to $7.2 million at the end of the second quarter of this year. So you can see that along with our positive cash flow of $900,000 for the quarter, our balance sheet has continued to strengthen overall as well. Looking ahead for the remainder of 2010, based on the information that we have today, we continue to expect a loss for the year in the range of $3 million to $4 million. We also expect revenue for the year to be in a range of $33 million to $34 million, narrowing our previous annual revenue guidance of $33 million to $35.5 million. We are still in the process of finalizing our outlook for 2011 and we will provide guidance on our next earnings call once we receive Board approval. With that, I would like to hand it back to Dale where he can open the call up to any questions that you may have.

Thanks, Scott. Katie, as Scott mentioned, we would like to now open up the call if there are any questions.

(Operator instructions) At this time, I'm showing we have no questions. I would like to hand the call back over to management.

Okay. Thanks very much, Katie. And thank you all for joining us today. We look forward to speaking with you again on our next call.

Ladies and gentlemen, thank you very much for your participation in today's conference call. You may now disconnect. Have a wonderful day.