Luna Innovations Incorporated

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.

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.

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.