This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk01: Hello and welcome to Luna Innovations conference call. Please note that this call is being recorded. I'd now like to hand over to Allison Woody, Senior Director of Administration. Please go ahead.
spk00: Good morning and thank you for joining us today. Earlier this morning, we issued two press releases. one announcing our acquisition of Solixa, an independent provider of distributed fiber optic sensing solutions, and a second announcing a strategic investment in Luna by White Hat Capital. We have also posted a related presentation with supplemental information to the investor relations section of our website. If you do not have a copy of the releases 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, specifically adjusted EBITDA. These adjusted numbers exclude the effect of certain non-cash expenses and other items. The adjusted results are a supplement to our 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 me 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 our projected financial results and outlook, CELIX's expected revenue, the integration of CELIX's employees to LUNA, intellectual property and offerings, and the expected benefits of the acquisition, including the financial impact, the ability to expand offerings to our and Selexa's customer groups, and the ability to expand into additional high-growth markets. 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 our 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 revision to any of the forward-looking statements to reflect future events or developments, except as required by law. After our prepared remarks, Scott Grace, our President and Chief Executive Officer, George Gomez-Quintero, our Chief Financial Officer, and Brian Soller, our Chief Technology Officer, will be available to take your questions. And at this time, I'd like to turn the call over to Scott.
spk03: Good morning, everyone, and thank you for joining us on such short notice to learn about our acquisition of Solixa and the concurrent strategic investment in Luna by White Hat Capital. We're excited to announce the culmination of nearly a year of work and the acquisition of Solixa for upfront cash of $21.5 million. Additional cash consideration of $16.5 million is based on an earn-out against financial metrics through year-end 2024. Concurrently, we are announcing an investment of $50 million in convertible preferred equity by White Hat Capital. Proceeds will be used to fund the SOLICSA acquisition, pay off our approximately $17 million term loan with PNC Bank, and for other growth initiatives. Before we dive into details, I want to extend a very warm welcome to the Solixa team. We at Luna are pleased to have you join us. Each of you bring a unique experience and expertise that will help propel us forward. And we're excited about the success that, together, we'll be able to achieve. I want to commend Solixa founders Mahmoud and Tom on the technology they have built. I am glad that these two gentlemen will be staying with the combined company and know that they will add tremendous value. Glenn Williams, who has served as CEO at Cilixa, led the company to tremendous success and will remain as an advisor through year-end 2024. I'm grateful to Glenn for the company he is handing over to us. Finally, I want to say a special thank you to Allison Gallagher, chair of CELIXA, who has been absolutely instrumental in helping all parties get to our announcement today. And as with any large transaction, there are many people involved in making it happen. My gratitude extends to everyone for all the hard work, especially so close to the holidays and year end. Now let me turn to some of the details of the acquisition. As many of you know, it was during COVID that Luna began to establish a strong global presence, starting with the acquisition of OptiSense. We followed that a year and a half later with the acquisition of Leos, expanding that international footprint. Today, we are announcing the acquisition of Solixa, a global company based in the UK. This move gives Luna even greater international scare. But the more exciting feature of this transaction is the strategic fit within the vision of what LUNA can be. It brings incremental capabilities, talent, and a significant focus on solutions that address issues such as climate change, natural hazards, and an increasing population. Adding SOLIXA elevates the LUNA portfolio, and specifically our sensing vertical. with its distributed fiber optic sensing capabilities including acoustics or DAS, temperature or DTS, and strain or DSS. Beyond that, the combination will extend Luna's reach into new areas such as carbon capture and storage, a rapidly growing market. where distributed fiber sensing is a critical part of ensuring the safety and longevity of advanced systems that are being deployed to keep carbon from being released into the atmosphere. The combination also provides exposure to incremental growth areas, such as sectors of the oil and gas exploration market, the defense market, and it advances our efforts in the geotechnical monitoring market. The net effect is a significant expansion of Luna's served market within the large and growing fiber sensing arena. Solix's capabilities are complementary to Luna's, and we anticipate that the expansion of our served market will be accompanied by revenue synergies with minimal cannibalization as we cross and upsell our new combined portfolio. Importantly, This acquisition will advance our solutions-based offerings with highly integrated solutions with potential for building reoccurring revenue streams. As an example, SOLIX's Edge system helps customers with data acquisition, management, and processing in an integrated cloud-enabled platform, which will accelerate Luna's efforts towards driving to higher levels of reoccurring revenue. As I mentioned a few moments ago, The acquisition offers us exposure to additional end markets, but it also provides us with incremental capability to serve our existing industries, such as our efforts to grow mining and energy. With over 200 patents in the Solixa portfolio, Luna is nearing a robust 1,000-patent portfolio, putting Luna in an ever-stronger position to expand our market share. On the human capital side, The addition of Solixa adds terrific talent in sales, marketing, engineering, and R&D. This will help us fill important positions in our EMEA organizational structure as we continue to expand our global footprint. Overall, the business fits well within the organizations we've built since the acquisitions of OptiSense and Leos. you might remember that those two acquisitions were the result of carve-outs from significantly larger companies. By comparison, Solixil is a fully operational and standalone. And as a result, we do believe that the integration of this acquisition will be less complex than our previous two. In addition, The Luna team has spent significant time during the past year meeting in person with the Solixa team and doing due diligence. White Hat Capital has also visited many of the Solixa office sites and has met with management and done robust due diligence along with the Luna team. All of this gives us confidence that we understand this business, its value to customers, the strength of the technology, and the future potential. And we at Luna are ready to quickly leverage the potential represented by this transaction. As you all know, we have bolstered our leadership team with seasoned professionals, ensuring we have the right people in the right roles to help guide integration and strategic growth. We've done all this with a constant focus on creating a world-class team and building out the capabilities that will provide the greatest potential for the growth of our pure play fiber optics company. Now, let me turn to the investment and partnership with White Hat Capital. You likely read in the morning's press release that the acquisition is being funded by a strategic investment in our company being made by White Hat Capital Partners. The investment comes with a board seat that will be assumed by David Chanley, a managing partner of White Hat. I've had the privilege of spending a good amount of time with David and his colleagues for nearly two years and have had the opportunity to work closely with David, see how he thinks, and we mutually benefited from our joint perspectives on the SOLIXA acquisition. For those of you unfamiliar with White Hat, They've been around since 2016 and focus on concentrated, value-oriented investments in publicly traded technology companies. As we mentioned in the press release about this investment, White Hat knows our space very well and will bring an additive viewpoint to our deliberations. I welcome David to our company and know he will make a great addition to our board. A little bit more about the details of the investment itself. Luna is issuing 52,500 initial shares in a new series of convertible preferred stock to White Hat Capital. Each share has an initial liquidation preference of $1,000 per share, convertible into shares of Luna Commons stock beginning one year from issuance at a conversion price of $6.70 per share. which was a 10% premium to our 30-day volume weighted average price. Until the end of 2026, White Hat will have the right to purchase up to an additional $12.5 million of Series B convertible preferred stock with the same terms. The preferred stock will accrue quarterly dividends payable at Luna's option at either 8.5% annual rate if paid in cash or a 10% annual rate if paid in kind. White Hat Capital has agreed to a 36-month standstill, and the investment not only funds the SOLIXA acquisition, but is also intended to accelerate Luna's business expansion and operational initiatives, while also helping to improve our balance sheet flexibility. As I mentioned earlier, some of the proceeds are also being used to repay our term loan with PNC. As I mentioned in today's press release, we are incredibly appreciative of White Hat's belief and investment in our vision and thrilled to have them as a new partner. I believe that their investment is a vote of confidence in both the acquisition of Cilixa and in the Luna strategy. I do want to highlight that the transaction is expected to be accretive to non-GAAP earnings within the first year. Obviously, with the transaction closing so close to the end of our fiscal year, please note that any significant financial contribution from the acquisition will be realized in fiscal year 2024 and beyond. We are not ready to share our 2024 outlook, but plan to do so as we would normally on our Q4 and year-end call in early March. SOLIXA will be included in that outlook. I hope today's call has given you some insight into why we fully believe that the acquisition will produce outstanding outcomes for Luna. Our investors and shareholders can expect profitable growth and increased value. Our customers can expect a broadened portfolio and intense focus on innovation and bold solutions that will help solve even their most pressing business challenges. And our employees will benefit from extended talent and career opportunities that come with a combination of our two terrific companies. I speak for our entire executive team and on behalf of our board of directors when I say that we are incredibly excited about Luna's future and believe it to be even brighter with the addition of the Solixa team. Before we open the floor for questions, I want to say how extremely proud I am of the passion and energy everyone involved in this transaction has demonstrated. This is an incredibly exciting development made possible by their hard work and belief in a shared vision. Their collaboration, dedication, incredible talent, and sharp insights are certain to keep us on the path to expanding our leading capabilities in fiber optics and securing a position as a global powerhouse. This is a great way to end the year, and we at LUNA wish everyone a happy holiday and happy new year. With that, operator, let's open the call for questions.
spk01: Thank you, ladies and gentlemen. We are now open for the question and answer session. If you have any questions, please press star and number one on your telephone keypad. Our first question comes from Alex Henderson from Needham. Your line is now open.
spk05: Great. Thank you so much. First off, this looks like a great acquisition, so congratulations to you and your team. I was hoping you could give us some sense of how you think this company meshes with your margin structure. You know, is the gross margin here comparable to... above, below, and do you expect to be able to get some leverage to that gross margin as you move forward? And how do we split between gross margin and what's the increment to quarterly sales and marketing R&D? Can you give us any granularity around the margin structure?
spk03: Yeah, Alex, they're in the project-based, like a lot of our business. We talk about the sensing in EMEA that we acquired through Leos and OptiSense and the DAS and the DTS. So their margins are very similar to that. We range, depending on the project, depending on the product, somewhere in that 50% to 60% range. I think they're certainly in that range. kind of in the low to middle of that range, kind of that 50-55. But we see it creep up a little bit higher on some specific products. So they're in line with what we're doing currently in the project-based business.
spk05: And then any sense of the mix between sales and marketing and R&D, just maybe percentage of OPEX that goes in between those two?
spk03: Yeah, not at this time. We can get back to you on that. But I mean, right now, I don't have at my fingertips the breakout of what that is, Alex.
spk05: One more question, if I could. You're saying it's accretive. I assume that there's some upfront cost to integrate and then the margin benefits improve over the course of the year. So is this dilutive to say, the March and June quarter and accretive to the back half and net accretive?
spk03: Well, we talk about it being accretive to the non-GAAP, Alex. You know, I think, you know, any one time we would back out. So we believe it's accretive to the non-GAAP earnings is what we're representing.
spk05: Yeah, but that's what I was saying. But is it dilutive in the first half of the year and accretive in the back half, or is it, you know, going to be a quarter? Just the quarterly progression of the accretion.
spk03: Yeah, I mean, I think you're right. I see what you're saying. I didn't fully understand the question at first. Yeah, I think, like we said, annually we think it will be, but yeah, it'll step into that. So I think you're probably looking for, you know, it's tighter in the first half of the year and then it will pick up in the second to catch up to that accretiveness.
spk06: Great, thanks. Thanks, Alex.
spk01: Our next question comes from Ruben Roy from Stifle. Your line is now open.
spk04: Thank you, and congrats, team, on the acquisition. Scott, I had maybe a first question at a higher level here, just kind of thinking through the strategy you laid out at your investor day back in May and sort of your long-term targets, et cetera. Question number one, do you think that the Solixa acquisition would be incremental to your longer term growth? And I guess as part of that, just thinking through, you know, adding, you know, scale on the sensing side, does that change the way you're thinking at all about your comps test business?
spk03: No, I mean, I think we consider the comms test business an important piece of what we're doing. It just becomes a smaller piece of the pie. You know, what you heard at Investor Day when you heard me talk about that was the importance of the kind of reoccurring revenue. We believe that in order to achieve what we're laying out in that five-year plan, Ruben, we need the servicing side of it. We need the ongoing monitoring side. And, you know, nearly half of... of Solixa's revenue comes in the recurring fashion. It comes in recurring revenue. So I think that's an important piece of what was very attractive to us um in looking at that it is we've learned over time it is one thing to say that you want to be the monitor of that of that that that asset um and another thing to be executing on that you know involving a 24 7 team that is monitoring that so lixa has made that investment and made those steps forward you know that that go forward plan is was was always part of their strategy and their They're very far along on that. And that was very attractive to us to get that kickstart into that recurring revenue.
spk04: That's really helpful, Scott. I guess a follow-up would be, you know, it looks like from the slides you put up that the yen markets are very complementary and Solix is playing in markets that you're not addressing currently. Yeah. Well, I guess the question, though, would be, you know, is that recurring revenue applicable to your markets, you know, from day one? Can you, you know, kind of, you said you used the term cross-sell on your prepared remarks. Just wondering if, you know, kind of, if that's going to take time to kind of reach over to some of your existing customers and markets, or if this is something that you can, you know, get going pretty quickly.
spk03: Yeah, you know, I'll let Brian, he dove into that. You know, we're very excited about the carbon capture process. markets that they're in. That is not something that our current technology was was able to penetrate that. So that was very exciting. And we do look at parlaying that software into our products to get more of that servicing ongoing revenue. I'll let Brian talk a little bit more.
spk02: Yeah, we think there are markets that are a little more primed for the model. Scott mentioned carbon capture, which is where it's sort of already up and running. But this will help us with our tooling on the product to the solution side. So it will advance our efforts so that we can continue on the market side, pushing the markets to adopt the model. And it is applicable across any application where the equipment is installed permanently, which is most of our applications now. When you look at energy, when you look at infrastructure, pipelines, et cetera, that's all permanent installation, and we believe that model should apply in all of those.
spk04: Okay. I just have one final one. Thank you, Brian. Scott, just, you know, you're probably going to want to wait until March for this, but I'll ask anyway if you can give us a sneak peek on, you know, what the earn and outs might entail. Are they revenue-based, project-based, margin-based, or all of the above? Any, you know, kind of early detail on that would be helpful.
spk03: Yeah. I mean, you know, look, we think, you know, revenue is important. But we think gross margin is important. So gross profit is important. Revenue is important. And I think you will see both of those factoring into that earn out. They certainly can control revenue, and we can control revenue, and we can control the gross profit. What I want to be careful of, and you have to be careful of all earn outs, is what gets done below that. You know, and so we chose to keep it at, you know, at those two important metrics, you know, top line and that gross profit line. So you'll see those as the drivers to that earn out.
spk04: Excellent. Thanks for all the details and congrats again. Yep. Thanks, Ruben.
spk01: If you'd like to ask any questions, please press star and number one on your telephone keypad. Our next question comes from Alex Henderson from Needham. Your line is now open.
spk05: Yeah, great. Thanks. So you guys have a fair amount of seasonality to your business. I get it that 50% of their business is recurring, but would it be reasonable to assume that the seasonality that you see is comparable to the seasonality that they see. So when we're modeling in the incremental revenue, it would follow the same pattern.
spk03: I think we see similar seasonality, Alex, in what they're doing versus us. I mean, people are just slower to you know, to kind of reach out and budgets are getting set in Q1 and doing things like that. So I think you'll see somewhat seasonality, but we certainly do hope to flatten out what we have seen at Luna. You know, time will tell, but, you know, our second half is so heavily loaded. You know, we're 42, whatever it ends up being, 42 to 44 in the first half. And, and then the difference there in the second half. So I think it'll be somewhat similar, but we do hope that the addition of Selexa will help flatten some of that out.
spk05: Okay, but up front for the first year of modeling, we should assume the same Seasonal pattern.
spk03: Yeah. And I think, you know, Alex, we'll be able to give a little bit more color on that when we announce the 2024 guidance right now. We have a lot of work to do to sit down and roll them into our very bottoms up detailed budget process and things like that. So that's why I chose not to give guidance for 2024 right now. I believe there's work to be done to sit down with them in early January to go through that. So as soon as we can give that, guys, we will certainly come out with that and help you guys in layering in to the 24 kind of numbers. We just aren't prepared today to talk about that right now.
spk05: Yeah, but we've got to model it. Thanks so much.
spk03: Yeah.
spk01: We have our next question from David Kang from . Your line is now open.
spk07: Thank you. Good morning, and my congrats as well. First, can you give us revenue by geography and also who their key customers are and their concentration, please?
spk02: Yeah. I don't think we're going to prepare to get into the revenue by geography, but it's not too far off of, in terms of the detail anyway, Dave, but it's not far off of what you see kind of in the Luna historical. It's kind of 40, 50% North America, and then the rest split between a little, you know, maybe 30 and EMEA 20 APAC kind of a breakout. And then bigger customers, you know, A little less than half their business is really in the oil and gas space, and it's really all the big names in oil and gas exploration in that space. And then the rest of their business breaks down into about 40% environmental and infrastructure monitoring, and that's where carbon capture lies, and so that's a lot of larger energy companies as well. And then about 10% defense, North American defense, which is actually an area that we believe we can see some pretty early synergies by having a North American-based HQ, and it drives some top-line growth.
spk03: Yeah, I mean, I think seeing a little more than half, I guess, like Brian said, Dave, in oil and gas, you can imagine where a lot of that lies geographically with oil and gas, and then the other half, You know, the carbon capture like Brian mentioned, defense, mining, environmental monitoring, things like that, making up the other 50% or so. You know, it's got a lot of European presence. I mean, we do have – they do have, like we have, you know, in the EMEA area in doing a lot of these projects. You know, Europe has just been much more of a thought leader in monitoring the assets that are out there. You know, EMEA and Europe is mandating some of those, and so we're seeing a lot more activity, which is why – These additions that we've done over the last three years with OptiSense, Leos, and now Solixa end up being based in Europe because of that. They always have a presence, like the carbon capture initiative is based here in Montana for Solixa, but the headquarters and bulk of the folks lie in Europe, David.
spk07: Got it. And just wondering if you can provide any more color as far as you said, it will be a creative, just wondering if you can provide a little bit more color. Are we talking about maybe a couple of percent or maybe more meaningful? Yeah.
spk03: Yeah. I mean, I think till we get our hands around this again, that's really why I'm talking about. And I know, you know, I get Alex's point, but, but, you know, until we get rolled up into a detailed budget process bottoms up. But it's, It's not, you know, it was important for us to make sure with some modest synergies that we got to a creativeness on an adjusted non-gap, you know, kind of earnings basis within a year. That was important to us. You've heard me say that before, you know, as we look at these, you know, inorganic growth areas. And so that was something that we, but I wouldn't look at it being tremendously creative, but we make sure that it is.
spk07: Got it. And my last question is, you didn't mention anything about fourth quarter. Are you reaffirming or no comment?
spk03: Yeah, I don't think there's any reason, you know, to, you know, what we said still stands true. There's, you know, you know the business, David. It's, you know, there's a lot of book in turn that needs to go on and things like that at quarter end. But I don't have any reason to change anything or give you any insight into anything right now as it relates to, you know, Q4.
spk07: Got it. Thank you.
spk03: Yep. Thank you, Deb.
spk01: Our next question comes from Charles Knowles, shareholder. Your line is now open.
spk06: Well, I like the timing of this. Merry Christmas to you, too. I was curious to how many people are in this company.
spk02: But a little over 100, hey, Charles, nice to talk to you, a little over 100 people, about 80 of those in the U.K., and then they're split between Texas facility, Montana facility, as Scott mentioned, for carbon capture, a handful of people in Canada and in the Middle East as well.
spk06: Okay, great. Sounds fun. Thanks. All right, well, have a good holiday, Scott. Yep. Thanks, Chuck.
spk01: If you'd like to ask a question, please press star and number one on your telephone keypad. That's star and number one on your telephone keypad. Looks like we don't have any incoming questions as of the moment. We'd now like to turn back the call over to the president and CEO, Scott Grave. Thank you.
spk03: All right. Well, thanks, everyone, for joining us today. Again, You know, have a happy holiday, and it wasn't perfect timing, but it was what it was. We weren't going to not do our due diligence, and this is kind of how the timing shook out. So we appreciate all the efforts done by our folks and you guys taking the time to join this call. So happy holidays, and with that, operator, we'll end the call today.
spk01: Thank you so much. This concludes the meeting for today. You may now all disconnect. Have a happy holidays, everyone.
Disclaimer