Luna Innovations Incorporated

Good afternoon and welcome to the Q3 2022 LUNA Innovations Incorporated Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Allison Woody, Director of Administration. Please go ahead.

Good afternoon, and thank you for joining us today. After the stock market closed today, we issued our third quarter 2022 earnings press release. In addition, we posted to the investor relations section of our website a presentation with supplemental information for the quarter. If you do not have a copy of the release or the supplemental materials, please check our website at lunainc.com. We will also post a replay of this call to our website. Some of our comments and discussions today are based on non-GAAP measures. These adjusted numbers exclude the effect of certain non-cash expenses and other items. The adjusted results are a supplement to the GAAP financial statements. Luna believes the presentation and exclusion of these items is useful in order to focus on what we deem to be a more reliable indicator of ongoing operating performance. Before we proceed with our presentation today, Let us remind you that statements made on 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 our expectations regarding future operating results or the ongoing prospects of the company. Actual results may differ materially as a result of a variety of factors. More complete information regarding forward-looking statements, risks and uncertainties is available in the company's SEC filings, which can be found on the SEC website and our website. 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, except as required by law. After our prepared remarks, Scott Grace, President and Chief Executive Officer, along with Chief Financial Officer Gene Nestro and Chief Technology Officer Brian Soler, will be available to take your questions. And at this time, I'd like to turn the call over to Scott.

Good afternoon, everyone, and thanks for taking the time to join our call. I'm excited to be with you today announcing quarterly results demonstrating strong top and bottom line growth and progress against our operational goals. This quarter's strong performance underscores that we have the right long-term strategy and that we are continuing to capitalize on the opportunities in front of us. On calls during the first half of this year, I outlined how the investments we've made and continue to make are critically important to setting us up for future growth. These include investments in both infrastructure and systems, as well as adding capabilities through our recent acquisitions. You will see some of the benefit of those investments and acquisitions start to come to fruition in this quarter's results. To support future growth, I've made some internal changes, adding Eva Hartman as head of human resources, naming Brian Soller as chief technology officer and EVP of corporate development, and moving Jackie Klein, head of operations, and Salvin Faruqi, head of sales, to report directly to me, in addition to Gene and Allison. We have a strong executive team now in place to help us grow Luna into the future. On earnings calls earlier this year, you may remember that I mentioned we still have some work to do in our project-based business, OptiSense and Leos. which in prior quarters had experienced delays in several large customers taking delivery of products. I'm happy to say that most of the delayed projects are back on track, meaning we are able to complete the install and book the revenue in the corresponding quarter. In addition to creating customer stickiness, these larger project-based sales give us good clarity into future shipments. Our book to bill for Q3 helps us feel confident about reaffirming our 2022 outlook. More on that in a moment. Gene, Brian, and I each visited our overseas operations recently. And, in fact, I just returned from a visit to both our German and UK offices. The team is excited about the growth opportunities and leveraging Luna's assets to create that customer stickiness. And it is clear that there is a great deal of value to be unlocked in the combination of assets and IP from Leos and OptiSense and the existing assets at Luna. We remain very optimistic about the increasing potential in these assets and excited about the future. With that, I'd like now to move on to discuss highlights of the third quarter financials and then provide an update on operational accomplishments. For the third quarter of 2022, total revenues were up 43% to $29.2 million compared to the prior year's quarter. On a constant currency basis, revenues were $30.1 million or up 48%. On a purely organic basis, our total revenues grew 25% in Q3 2022 versus the prior year period. For the first nine months, revenues were up 23% versus the same period in 2021. On a constant currency basis, total revenues increased 25%. We continue to experience strong demand for our Luna products. In fact, we realized robust bookings growth in the third quarter 2022 versus last year. Our gross margin was 58% versus 62% in the prior year third quarter. While gross profit increased in Q3 2022 versus last year, the decline in the margin rate was largely due to product mix based on the project-based sales I mentioned earlier. We do, however, expect that the blended margin rate for the full year 2022 will normalize somewhere around 60%. We reported adjusted operating income of $4.2 million for Q3 22 versus $1.7 million for Q3 21. Adjusted EBITDA was $4.5 million in Q3 2022, more than double compared to last year's adjusted EBITDA of $2.1 million. And finally, adjusted EPS was $0.09 per share, tripling the $0.03 we reported in Q3 2021. Before I move to talk about the businesses in more detail, I want to emphasize the great work and the challenges that the team has worked to mitigate, if not overcome completely, so far this year. Our mission remains the same, to build our capability as a company with blue chip customers and to solidify Luna as a clear leader, fully focused on enabling the future with fiber. We will continue to invest capital in our businesses through this year and beyond, because as I've said in the past, the opportunities are virtually limitless. And as always, we will continue to be prudent managers of our expense structure. But it's all about investing in the right areas at the right time and capitalizing on opportunities for rapid, sustainable growth. Now, let me discuss the businesses in more detail. As a reminder, Luna reports as one segment, but our capabilities fall into two categories, fiber optic sensing and communications testing. For the third quarter 2022, our revenue growth was driven by a full quarter of LEO's contribution and solid sales in the legacy businesses of sensing and comms test. As I mentioned, our bookings growth once again exceeded our revenue growth in Q3 2020. 2022. So, let's first discuss sensing, where we use the fiber as the physical sensor to create smart materials and structures. This includes Odyssey for short-range, high-resolution applications, Hyperion for long-range, discrete applications, DAS acquired through OptiSense for long-range, continuous acoustic monitoring, DTS acquired through Leos for long-range continuous temperature and strain monitoring, and terahertz, a technique that leverages fiber technology to produce terahertz wave used to measure layer thickness and density of opaque materials. We achieved very strong double-digit growth in revenue versus Q3 last year, driven both by a full quarter of Leos as well as strong demand for legacy Luna products. In fact, Luna Legacy, Odyssey, Hyperion, and Terahertz product lines each contributed strong double-digit sales growth. Our progress relative to strategic growth areas within sensing continues to yield results. We achieved several key strategic wins in Q3 in infrastructure, security, and energy markets. And bookings for terahertz more than doubled in Q3 2022 versus the same quarter last year and is up strong double digits for the first nine months of 2022 compared to the prior year period. While terahertz revenues remain a smaller fraction of our total sensing revenues, the growth we are experiencing in these applications is a strong indicator that our strategy to get out of the lab and focus on growth and higher volume production and monitoring applications is starting to have a positive impact. Our distributed fiber sensing solutions contributed strong double-digit revenue growth in Q3. As we mentioned on our last call, we experienced project delays that pushed approximately 2.8 million in this segment to the second half of the year, some of which we recognized in Q3. We continue to streamline the LEOS and OptiSense's project-based sales approach as the assets continue to become fully integrated into LUNA. Our Q3 results are proof positive that we are making strong progress And these acquisitions continue to be a key strategic part of Luna's overall offerings and growth. I wanted to highlight a few key wins in sensing as we continue to experience market acceptance and adoption of our fiber sensing technology into monitoring applications for critical infrastructure. We want a project for a large offshore wind farm that combines both our DAS and DTS solutions to monitor the high voltage cables for safety and operability, adding significant value to the overall operation. We want an international airport perimeter security project in Eastern Europe, adding to our list of major infrastructure security wins. We are monitoring significant size perimeter with a single redundant system that provides early warning of intruders to cameras in real time. We were awarded a contract to monitor a water storage tank farm in the Middle East where water is a precious commodity and these sites are critical to a nation's water operation. We continue to provide security systems for oil and gas operators in high-risk operating locations, with new awards in the Middle East at well pad sites for perimeter security. We won a leak detection contract for a water pipeline in the western U.S. Oil and gas operations produce significantly more water than oil from the ground, and this often toxic byproduct needs to be piped away and disposed of correctly. After some recent high-profile leaks that were costly and controversial, the industry is seeking to better monitor these lines with leak detection. Fiber optics, and specifically Luna's unique products, are one of the few technologies that can handle the highly transient nature of these pipelines. And finally, the continued successful penetration of industrial process monitoring markets with our terahertz product, as I mentioned earlier. Moving to comms test, revenues grew as expected in Q3 2022. We made strong progress from an operational standpoint. As a reminder, this area includes our high-end line of communications test products, such as the OVA and OBR, as well as our polarization measurement and control suite and the RIO laser business that we acquired through OptiSense. With the addition of recent acquisitions, this business is now approximately 50% test and measurement and 50% optical components and laser modules, the latter of which are used for a variety of photonic applications such as medical devices, sensing systems, and LIDAR. On our last call, we discussed a major win for our fiber test equipment, securing a large multi-unit OBR6200 order with Lockheed Martin in continued support of the F-35 aircraft. Deliveries of these units began in Q3 and will continue through year end. We are expecting significant further follow-on orders for this application soon and will keep you updated on our progress. as this is an important element of Luna's growth within the comms test area. Another very important highlight for this segment includes our announcement last month that we signed a $14.2 million multi-year contract with our long-standing partner, Intuitive Surgical. This new agreement provides for the supply of critical photonic subsystems manufactured by Luna and spec'd in as part of the FDA approval process for Intuitive's next generation robotic surgical system. This is a great example of how many of our products are becoming critical components in large and growing market applications such as surgical robotics, and it speaks directly to our growth potential. We are excited to expand our relationship with Intuitive Surgical and support its visionary leadership in improving human health, and surgical outcomes. Luna is honored to help advance this leadership by supplying critical technologies over the years to come. And finally, within ComsTest, we also had solid double-digit sales growth in Q3 2022 for Luna's polarization modules. Driven by strong sales associated with the intuitive surgical contract that I just mentioned, as well as strong sales of our gyroscope coils for military navigation applications. I want to provide an update on the ongoing effects of the supply chain challenges. We are still experiencing pandemic-caused delays in supply chain, and particularly in printed circuit assemblies. Delays are specifically caused by semiconductor part availability combined with increasing lead times and prices. The Luna team continues to manage this as best as possible, including design changes to replace unavailable components and pre-ordering in larger quantities than we would have in the past. So, while there is significant demand for customers for Luna's products, we have felt and expect to continue to feel the effects from sourcing of semiconductor parts in order to complete customer orders. The industry consensus is that these shortages will continue into 2023. We believe we have sufficient supply to fulfill customer orders for the near term and are working hard on managing this impact as much as possible. While we aren't prepared to provide 2023 guidance until our Q4 call, with only two months left to go in the year, I did want to highlight three areas of focus for us next year. First, we are actively exploring new markets to add growth long-term. More on that in 2023. And as I've said many times in the past, the options for our technologies are virtually limitless. It is up to us to prioritize and capitalize on those opportunities appropriately. Second, we continue to make progress on integrating systems from the various acquisitions. We are driving hard to complete what we call One Luna. And third, we are starting to see our strategy pay off as we consistently win larger orders as we've discussed over the past several years and expect this to continue into next year. A few recent examples of large customers that will move the needle for Luna in 2023 include Lockheed Martin, Northrop Grumman, Airbus, and Intuitive Surgical. We remain committed to serving these partners and all of our customers with excellence, and our sales teams will continue to be trained and incentivized to sell a Luna suite of solutions as opposed to simply individual products. In summary, this quarter underscores that customer demand for Luna's products remains strong, despite ongoing global challenges with supply chain and sourcing. And while I am very pleased with the third quarter results and proud of the Luna team, I also know that we can't rest on these results. As I mentioned on last quarter's call, we still have some work to do to grow profitability, particularly of the acquisitions, at a pace that is acceptable to both me and my executive team. This quarter's results are a good start to getting there. You should know me well enough by now to know that I'm never satisfied, and the team and I will keep pushing the organization to execute against our long-term objectives, to capitalize on opportunities, and to perform to excellence while delivering strong growth to our shareholders. Bottom line, we continue to focus on blocking and tackling and accomplishing our goals. So with only two months of the year left and three quarters behind us, we feel comfortable reaffirming our outlook of total revenues of $109 to $115 million and adjusted EBITDA of $10 to $12 million. I do want to make one observation about the size of the revenue range. As you are aware, our recent acquisitions primarily include large project-based orders. While the majority of these transactions are already included in the backlog, the timing of the installation is largely controlled by our customers. Therefore, the revenue recognition can swing from one period to the next. This means that even with just six weeks left to go in the year, revenue could shift to 2023 and is why we are keeping a broad revenue range. I'll now hand the call to Gene for more of the financial details. Gene?