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

Gregg Hillman - First Wilshire Securities.

Welcome to the Q3 2016 Luna Innovations Incorporated Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host Mr. Dale Messick, Chief Financial Officer of Luna Innovations..

Thank you, Heidi. Good afternoon, everyone and thank you for joining us today as we review our operations and results for the third quarter and the first nine 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. As you have hopefully seen in our earnings release we had a strong third quarter and continued to show significant improvements in our operating results as we have and continue to be keenly focused on top line growth and profitability.

The third quarter of last year was our first full quarter of combined results of Luna and API so for the first time we can easily compare our year-over-year performance without having to reconcile pro forma quarterly numbers.

With our quarterly results now on an apples to apples comparative basis the headline is that revenues continue to grow in our operating loss has been reduced by half.

We have accomplished these results by remaining focused on executing our two key strategic growth initiatives namely high speed a optical receivers for the long haul and metro market build out and penetration of the stress and strain measurement market through adoption of our ODiSI products for testing composite materials and structures.

During the third quarter sales of our ODiSI products increased 43% over the third quarter of 2015. The continued need for improving the fuel economy of cars and airplanes by decreasing their way to drive on their ongoing growth and the use of advanced materials such as composites.

Our ODiSI solution is the most effective way to test these new vehicles. In addition to our sales success in the third quarter this week we issued a press release regarding the use of our ODiSI technology for inventing and monitoring fiber within a composite structure to routinely or continuously monitor it's physical integrity.

At the recent composites and advanced materials expo, a composite smart joint joy that included our ODiSI technology was demonstrated by the University of Tennessee and was a finalist in the awards for composite excellence category.

Further development and deployment of this capability to monitoring fiber is a key step for expanding the market for our products beyond design labs and into the routine maintenance markets. Q3 was a big step forward for our division supporting the ODiSI platform. We’re excited by the recent accomplishments and the growth opportunity this represents.

Within our high speed optical receiver business the second of our key strategic growth initiatives we announced last month the new $2.8 million follow on order for our 100 gig coherent receivers. These products will be deployed by a major telecommunications equipment manufacturer in the China market.

Year-to-date our high speed optical receiver sales have increased more than 50% over the first nine months of last year. We continue to expect strong demand in the build out of the long haul metro market over the coming years driving continued requirements for our high speed article receivers.

In 2017 look for us to roll out our second generation of the 100 gig coherent receiver as well as ramp up sales activity for our 10 gig avalanche photodiodes with the fiber [Technical Difficulty] market. On these calls I typically like to focus my comments on our progress within our key growth initiatives.

Today I would like to also highlight the accomplishment of our research group in growing our technology development updates.

Over the past year or so this group has done a phenomenal job of increasing our proposal win rates particularly in the area of successfully converting phase one development contracts into the higher revenue Phase 2 follow on awards and as a result the third quarter of revenue for this segment of our business has grown more than 30% year-over-year, a tremendous accomplishment.

Overall it is clear to me that our merger with API a year and a half ago has been very successful and was the right decision.

The combined company is growing top line we’re up 16% year over year and our bottom line is improving, not only is evidenced in our Q3 numbers but as you will see in our Q on a pro forma year-to-date basis it is about $2 million improvement. With this I will turn the call back over to Dale to cover more detail of our Q3 financial results..

Thank you, My. Revenues for the third quarter of 2016 increased 11% to $14.6 million compared to $13.2 million for the third quarter of 2015.

The increase in our total revenue was driven by growth in both segments of our business with technology development revenues growing $1 million compared to the third quarter of last year and parking [ph] license revenue is improving 0.4 million year over year.

The increase in our products and licensing revenue was primarily driven by sales of our [indiscernible] systems for fiber optics strain sensing. While the growth in technology development revenue can be attributed to increased win rates in Phase 2 contracts within the SBIR program as My described a minute ago.

Gross profit increased to $5.6 million for the third quarter of 2016 compared to $5 million for the third quarter of 2015 with our overall gross margin remaining consistent at 38% of revenues for both periods.

Operating expenses were $6 million or 41% of revenue for the third quarter of 2016 compared to operating expenses of $5.7 million or 43% of revenue for the third quarter of last year. Amortization of intangible assets associated with purchase accounting for our merger with API included in operating expenses was $463,000 for the third quarter of 2016.

This represents an increase of $158,000 compared to Q3 of last year and accounted for most of the overall increase in operating expenses year-over-year. Our resulting quarterly net loss improved to $0.4 million compared to $0.8 million for the third quarter of 2015.

As I mentioned just a moment ago, our expenses included $463,000 of purchase accounting amortization for the quarter. So without that amortization cost our operating results would have essentially been breakeven for the quarter. We ended the quarter with $13.2 million of cash compared to $13.8 million at the end of Q2.

The decrease in our cash balance during the quarter resulted primarily from $458,000 of debt service during the quarter in addition to a $169,000 of share repurchase activity. Our total outstanding bank debt as of September 30, was $4.8 million or net cash minus debt of $8.4 million.

Year-to-date through September 30, 2016 we have recognized $43.3 million of revenue compared to $28.6 million for the first nine months of 2015. Our reported revenue for the first nine months of 2015 only includes the revenues of API subsequent to our merger in May of 2015.

If we compare our nine months of 2016 revenues to the combined nine months of Luna and API for 2015 total revenues increased 16% year over year.

Gross profit increased to $15.6 million for the first nine months of 2016 compared to $11.5 million for the first nine months of 2015 representing overall margins of 36% for the year to date 2016 compared to 40% for the first nine months of 2015.

The change in our gross margin percentage is a function of our revenue mix with the results of operations from API being included for only the partial period in 2015. Operating expenses were $18 million for the first nine months of 2016 compared to $17.9 million for the first nine months of 2015.

Operating expense in 2015 included $3.5 million of nonrecurring merger related expenses. Operating expenses for the first nine months of 2016 included $1.5 million of amortization expense related to purchase accounting compared to $0.6 million for the first nine months of last year.

Our resulting net loss improved by $2.9 million to a loss of $2.7 million for the nine months ended September 30, 2016 compared to a net loss of $5.6 million for the nine months ended September 30, 2015.

As we mentioned on our last call we've been successful in maintaining a backlog that leaves us well positioned to grow our revenue through the remainder of 2016 and into 2017.

We ended the third quarter of 2016 with $10.1 million of backlog for our product and licensing segment and an additional $22.8 million of backlog for the technology development segment. Now I will hand the call back over to My..

Thank you, Dale. And at this time I would be happy, Dale and I to take any questions that you may have..

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

On the ODiSI [Technical Difficulty] did you are you saying publicly what the actual revenue is for that thing? For that division?.

No, we really haven't broken that out by that detail at this point, Gregg..

I guess what your overall feeling for ODiSI whether you think it would be material to the company in 2017 material operating income?.

We believe it is. We’re gaining a tremendous amount of traction today in the market. We've been endorsed by major aerospace manufacturers and we have a lot of activity going on in the automotive space today..

[Operator Instructions]. Your next question comes from the line of Gregg Hillman with First Wilshire. Your line is open. .

Yes I had a follow-up on it.

The other fibers at home, what's happening with that all initiative? What you see happening and what has to happen before that really gets up to where HSO or?.

So right now we have samples out for evaluation with quite a number of players in the China market. We anticipate that those evaluations will be completed within the quarter at which point we will start delivering volume sometime in early part of Q1..

For the 10-gig..

Right, for the 10-gig APDs..

And would you do a press announcement when you finally start to [Technical Difficulty] know what's going on?.

Yes that is our own preference whenever we could if we can't name the customer we would do it in third party..

Yes. So Gregg, to be clear we do have 10-gig, 8-gig that we’re shipping currently but we will announce when it comes around is -- when we get to a commitment for a single large purchase from a customer..

Okay.

And then just from the telecom company you seem go through cycles up and down capital purchases and where is your [indiscernible] in terms of the macro factors that’s driving the telcos right now that drive your purchases of your products but you're further down the food chain, are the macros favorable or improving or what your take on that for HSOR and also part of [indiscernible]?.

Yes so the HSOR yes the way that we characterize HSOR is both a 100-gig receiver side as well on the 10-gig APD as well what we've got remaining on the 2.5 gig, all right. The majority of the opportunities that we are chasing today which is coincides with our competitors is really the build out that's going on in China.

That's all funded by the government dollars, best guess today is good for at least another 3% or so plus years. That's where they're spending the money and I think again if you look at our competitors. They're benefiting from that as well..

Do you think you will be able to diversify your customer base in that area, get some other tailwinds with Americans or European?.

Absolutely. We’re right now clearly looking to grow the revenue. One stash [ph] moving in a moving fairly stable fashion, the next big opportunity for us which is more global than it is China is the expansion that's going to go on in the data center market.

And so you'll start to see the HSOR revenue to diversify from that and I think that's the same with our competitors..

And what's the timing of the data center market for that to get correct do you think?.

Data centers are happening today, all right with the volumes or the lower volume is the data center is not necessarily in China market is more of Europe and North American.

All right, so the revenues that people are getting from that space today is smaller that's why from an authorization on our side we put that secondary person to build out on the long haul market But eventually if you track the what's happening with the Amazons of the world, Facebook and Google's they will command a lot of the data communications..

And I'm not sure -- early in the call did you talk about Terahertz as a segment earlier in the call?.

No we left that out. It's not on purpose per say that part of our business is actually doing very well. They're getting very good traction, there was an article in fact recently talking about Terahertz technology, Wright-Patterson Air Force Base that just happens to be our technology.

So we’re gaining traction in it, that team is working very well and we're making progress but it's not as high of a revenue stream as we are achieving today on the high speed optical receiver side..

Is that division breakeven? The Terahertz division?.

Not yet, getting close but not quite there yet..

I'm showing no further questions at this time. I would now like to turn the conference back to My Chung..

Thank you. Thank you everyone for joining us today. I would like to close with the call with a reiteration that we’re making significant progress both operationally and financially and I look forward to updating you again at the end of the next quarter. Thank you..

Ladies and gentlemen this concludes today's conference call. Thank you for your participation and have a wonderful day. You may all disconnect..