Dale Messick – CFO My Chung – President and CEO

Mark Dalton [ph] John Moses [ph]

Good day, ladies and gentlemen, and welcome to the Q2 2011 Luna Innovations Inc Earnings Conference Call. My name is Lucinia and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of today’s conference. (Operator Instructions) I will now turn the presentation over to your host for today’s conference Mr. Dale Messick, Chief Financial Officer of Luna Innovations. Please proceed sir.

Thank you, Lucinia. Good afternoon and thank you for joining us today as we review our operating results for the second quarter of 2011. Before we proceed 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 may be forward-looking statements that involve risks and uncertainties and are subject to change at any time. 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 filings with the Securities and Exchange Commission. We disclaim any obligation to update any such factors or to announce publicly the result 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, and thank you everyone for joining us on the call today. Overall we had a solid quarter of top line and bottom line growth. This will also be our fourth consecutive quarter of positive cash flow. Revenues grew by 7% over the second quarter of last year led by 39% increase in sales of test and management products and 29% growth in our product development revenue. While revenues in this segment grew significantly for the quarter, we have however seen the sluggish economy negatively impact our test and management bookings activity. Based on this, we will be lowering our full-year projections and guidance as we will share with you later. Our product development relationships with Intuitive Surgical and Hansen Medical continue to proceed on schedule with critical milestones being met. We have continued to raise the visibility of these programs internally as we view that to be of strategic importance. Within our Technology Development segment, revenues from our government research contracts declined to 8% for the quarter relative to the same period last year, principally due to the timing one DARPA project finishing and another one getting released. With our overall revenue growth, and continued control of our operating expenses, we improved our quarterly net loss by 59% compared to a year-ago and as previously mentioned, continued to generate positive cash flow. Last week we introduced our newest fiber optic sensing instrument. This new product utilizes a single fiber as a distributed sensor providing thousands of measurement points for strain or temperature. We expect this new product to effectively compete in applications where today numerous discrete strain gauges are required. Our value proposition is centered around overall cost savings, the number of locations to be tested simultaneously and the ability to post process these thousands of data points. Our initial target market will be in testing as large composite structures such as those in the aircraft and automotive industries. Given the overall value proposition, we expect this to be an important component of our growth over the next couple of years. With that I would turn the call over to Dale for more detail on our financial results.

Thank you, My. For the second quarter of 2011, we expect to report a net loss to common of $289,000 or $0.02 per share compared to a net loss to common of $711,000 or $0.05 per share in the second quarter of last year. The improvement year-over-year was driven by growth and revenues of 7% and more specifically a 38% growth on our product and license revenue which simply pulls through a higher gross margin. Revenues from sales and rentals for our products grew by approximately $840,000 or 41% including a 39% growth in revenue from our tested measurement equipment. Revenues from sales in test and measurement equipment increased by approximately $800,000 to $2.8 million with the highest growth coming from our Optical Backscatter Reflectometer line. Product Development revenues which are also a component of our product and license revenue, increased approximately $250,000 or 29% compared to the second quarter of last year. Revenues in our Technology Development segment declined by approximately $468,000 or 8% due as My indicated to a period of transition between major projects within our Secure Computing group as well as a reduction in other direct contract costs which flows through directly to revenue related to that expired contract. The anticipated follow-on project was awarded in early August. So we should expect to see a decline in this group for the third quarter as well and net revenue picking back up again in the fourth quarter. Gross margins expanded to 38% in the second quarter compared to 37% in Q2 of last year reflecting the revenue growth coming from our product and license segment which generally carries a higher margin than that of the Technology Development segment. Operating expenses were essentially flat at $3.9 million increasing less than a $100,000 compared to the second quarter of 2010. Within our operating expenses, our SG&A cost declined by nearly $100,000 offset by a growth in research and development costs reflecting additional headcount and other related expenses in our fiber optic engineering group. Year-to-date the results are consistent with our comments on the second quarter. Revenues increased by $1.7 million or 10% compared to the first half of 2010 with a proportionate of growth coming from sales of fiber optic tested measurement which increased 57% for the first six months compared to the first half of 2010. Product development revenues also grew by 23% for the first half of the year compared to 2010. Within the Technology Development segment, the year-over-year decline is attributable to the lower revenues in our Secure Computing group. Other areas within the Technology Development segment grew at aggregate 7% versus the first half of last year. With the growth in product revenue almost expanded to 38% for the first half of the year compared with 36% for the first half of 2010. Operating expenses for the six month period grew by approximately $400,000 or 5% for the first half of the year with the growth in R&D expenses noted in the second quarter as well as the incremental cost incurred in Q1 of this year related to the potential proxy contest. Our net loss to common shareholders of $1.4 million for the first half of the year is a 32% improvement over the results for the first half of 2010. Turning to the balance sheet, you’ll see that our cash position continued to improve throughout the second quarter marking our fourth consecutive quarter of positive cash flow. In the second quarter, we completed our new debt facility with Silicon Valley Bank replacing our prior $5 million revolving facility with a new $7 million facility including $6 million of term debt plus a $1 million revolver. We used the proceeds from that new credit facility to repay the prior note to Hansen Medical, and that debt has now been completely extinguished. We ended the quarter with approximately $8.1 million of cash compared to $7.5 million at the end of the first quarter. The execution of the new credit facility is offset by repayment of the Hansen note, contributed approximately $400,000 to the net increase in cash of approximately $550,000. Over the past four quarters the company’s cash balance has improved by $1.9 million. Looking ahead now as My indicated in his remarks, activity levels for new orders and tested measurement equipment had decreased recently and with the current economic climate, it’s difficult to predict when they might recover. Accordingly we expect revenues to soften in the third quarter and potentially into the fourth quarter. We currently expect revenues for the third quarter to be in the $8.5 million to $9 million range with a net loss of $0.05 million to $0.7 million. For the year, we are currently expecting revenues to be in the range of $35 million to $37 million versus our prior estimate of $37 million to $39 million with a corresponding net loss of $2.5 million to $3 million. And with that, I would like to now turn the call back to My.

Thank you, Dale. So in summary we are pleased with our quarterly results. We’re cautious about our outlook. So at this point what we would like to do is open the call up for any questions.

(Operator Instructions) Your first question comes from the line of Mark Dalton [ph]. Please proceed.

Yes, thank you for the call. Two questions and these are more generic, and I don’t know who wants to answer. Overall, would you guys term your quarter relative success and/or are you pleased with the direction the company is headed now?

I would say we’re relatively pleased. We’ve gotten things I would say focused in the right direction. Our SBIRO [ph] wins have gone up relative to previous years and the activity that we’re having as I mentioned with Hansen and Intuitive are highly focused in R&D meeting the commitments that we said earlier in the year.

With your revenue shortfall or I guess reduced earnings as you’ve commented on today, will there be any potential reduction in headcount?

At this point in time, we’re trying to manage through the quarter with really controlling our discretionary spend. We believe we should be able to do that. So at this point we are not looking at any additional headcount reductions.

Very good. And the last comment and this is more of a general one, if you’re relatively pleased with the direction the company is going and this just – it doesn’t just go for the CEO, this would be for directors and officers of the company. As a shareholder and I voice this from quite a few other smaller shareholder, I sure would like to some insider buying from you guys and not just in the stock option sort, we’d like to see you guys – some of you folks there actually doing some buying with your own money. The stock has closed today at $1.30 or $1.40 a share and that’s about as cheap as it could get and some insider buying would look great for a company that’s very, very sparsely followed and just earned just sort of put your money where your – for your primmest conservative [ph], it really looks good for the company and I think it would get more followings and increase some investor appetite forward as well. That’s all I have to say. Thanks for taking my call.

Thank you very much, Mark.

(Operator Instructions) Your next question comes from the line of John Moses [ph]. Please proceed.

Good afternoon gentlemen. I echo the gentlemen, the previous participant. I am getting so critical that you all step up to play as directors and officers and buy some stock. The stock is back to levels now where we saw when we went to the Kent Murphy episodes and also to the Hansen Medical episodes. A $1.40 a share it certainly represents value to me. I would like to ask My Chung a question, would you sell the company for $4.00 sir?

Would I sell the company for $4.00?

Yes.

Are you going to buy it?

I am asking you the question, sir. I don’t need a Socratic method here. Would you sell it for $4.00?

At this point, no.

No. Well let me ask you this question if I may, why would you buy it for a $1.40?

I think I’ve answered that question previously for you.

I don’t think so sir.

Right now we’re on an insider trading.

Well that will lift in few days, okay. And if your lawyer is increasingly tell you it hasn’t I would suggest that you get new lawyers. They haven’t done the company much benefit in the past. I am not trying to be a penny out [ph] here, okay, but the lawyers of this company have laid in down a bad past, so for any number of years recently. So if they are telling you not to buy the stock here, I’d fire them and get some new lawyers, because you’re not paying a very rosy picture here and I don’t see anything that would precludes you sir from buying the stock. So if you only sell it to $4.00 a share, you surely should buy at a $1.40. Do you have any banking loan agreement that precludes the company from buying the stock? Would there be any that precludes the company from making an offer to buy half a million shares at $2.00 a share? Hello.

Yes John, I am trying to recall the exact covenants and I don’t recall a stock buyback program. It’s not something that we’ve been considering, so I think on top of my head, I can’t recall it.

No, you’ve got plenty of cash there and the cash flow is good and it’s time to give some recognition to it, maybe the stock is pretty damn cheap down here at these levels, I know Mr. Messick, you bought some stock at $1.85 if I recall.

Correct.

And Mr. Graeff bought some stock at $1.85. Is that correct?

That’s correct John. You’re correct.

Yes, but the only other guy who stepped up to buy any stock was Mr. White [ph] so like the many of them in. But other directors such as Mr. Cool have not put a penny up other than what they’ve put into pre-options, okay. Now Mr. Cool doesn’t want to buy any stock, I suggest him take a walk and go to another company to be a director. Because I don’t see where he (inaudible), enough on that subject. How many of these new machines that you advertised recently, which I think is a wonderful machine in the US Navy and the Air Force and that would (inaudible). How many of these machines have you sold?

The ODiSI product that we just launched, we haven’t.

I am sorry.

Are you referring to the one we launched last week, John?

Yes, the one that you announced last week. How many have you sold?

We’ve not shipped any of those yet. We’ve just released it last week. We haven’t shipped it out.

No, that’s not the answer I am looking for. When I say how many have you sold, I am not asking you how many have you shipped, have you sold any?

Not yet.

Not yet. What is the selling price of this machine?

About $80,000.

Okay, that seems very reasonable for machines that does as much as this, okay. And if you got a marketing sales force that can’t sell this machine which it seems to be a very valuable piece of equipment, I get a new marketing force. I could sell this to Eskimos to igloos quite frankly, I mean it’s a wonderful machine and you just don’t have the right people marketing it that’s the case, or I am going to let you go out there but I emphasize that you strongly as I can as long with depreciating caller, get out there and put a bid on the stock. And if your lawyer says no, get a new offer. Thank you sir for putting up with my comments.

Thanks a lot, John.

I would now like to turn the call over to My Chung. Please proceed.

So with that just I would like to say again thank you for joining us today on the call. We appreciate your support. And at this point, we will close to an end. Thank you.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.