Luna Innovations Incorporated (NASDAQ:LUNA) Q3 2023 Earnings Call Transcript

Luna Innovations Incorporated (NASDAQ:LUNA) Q3 2023 Earnings Call Transcript November 14, 2023

Operator: Good morning. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2023 Luna Innovations Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After these speakers’ remarks there will be a question and answer session. [Operator Instructions]. Thank you. I would now like to turn the call over to Allison Woody, Senior Director of Administration. Allison, you may begin your conference.

Allison Woody: Good morning and thank you for joining us today. This morning we issued our Q3, 2023 earnings press release. As always, you can find the release and supplemental presentation posted to the Investor Relations section of our website. 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 supplement to the GAAP financial segments. Luna believes the presentation and exclusion of these items is useful 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 risks and uncertainties, and are subject to changes at any time, including, but not limited to statements about our expectations regarding future operating results for 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 Graeff, 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.

Scott Graeff: Good morning, everyone, and thank you for joining us today. I’m pleased to be here today to discuss our third quarter results. As Allison mentioned, in addition to Brian Soller, our new CFO, George Gomez Quintero, has joined me for the call today. George joined our team nearly a month ago, replacing Gene Nestro. I want to start by thanking Gene for his contributions to Luna. Under his leadership, we established a scalable foundation by making the necessary investments to improve infrastructure, processes, and systems. These moves have put us in a strong position to be able to continue to drive both organic and acquisitive growth. I’m thrilled to welcome George to the team. He brings to Luna a deep operational focus and significant experience in FP&A, investor relations, treasury, procurement, and credit and collections.

He has had a wide range of experience in public companies, and he has built and developed strong finance teams of all sizes. These experiences will be critical as we continue our pursuit of opportunities that will enable us to further expand our global footprint and elevate our international presence. You’ve heard me say before that our leadership talent is the lynchpin in driving our strategy and capturing the abundance of opportunity with which Luna is presented, and we are well on our way. In addition to George, you remember that we hired Eva Hartmann, our Senior Vice President of HR, almost a year ago, and more recently, Thomas Oldemeyer, our Senior Vice President and Managing Director of EMEA. These have been strategic moves to bolster our senior leadership team and with seasoned professionals who have demonstrated success in international operations and growth across technical environments.

As you know, we’ve made incredible strides in expanding our global footprint via acquisitions in the last several years. I’ve mentioned before that we now have more than a third of our employees outside the United States and more than half of our revenue was generated outside the U.S. In a time frame where we’ve been very purposeful about driving growth, improving infrastructure, and streamlining operations, we’ve also been incredibly intentional about putting the right people in the right roles to support that work. We continue to be strategic about the team who will achieve the targets we’ve outlined. With that reflection on our leadership, let’s turn our attention now to Luna’s third quarter performance. Q3 was a solid quarter for us, in spite of macro headwinds that are affecting businesses across geographies and industries.

The headwinds were a continuation of some of the dynamics we saw in Q2, and they impacted us similarly to many other businesses you’ve already heard report for the quarter. We had a tough comp this quarter, but continued to build momentum. While some challenges hung over from last quarter, we bounced back where we said we would. I will provide some more color in a moment, but overall, our sensing business was pressured, particularly in contract research and terahertz. I would characterize most of the pressure as timing and slower sales cycles, even though we saw some significant wins in this business. Our communications test business had a strong quarter, driven in part by a few recoveries from last quarter. So let’s turn to some of the specifics of Q3.

For the third quarter of 2023, we recorded total revenue of $30.7 million, an increase of 5% compared to the prior year period. Our gross margin was 57%. Adjusted EBITDA was $4.2 million compared to $4.5 million in the comparable quarter last year. Our adjusted earnings per share for the quarter was $0.07. As I mentioned, our sensing vertical experience pressured this quarter, and as a result, revenue was down 6% year-over-year. This was largely driven by tough terahertz comparisons. After several consecutive quarters of double and triple-digit growth, we saw a Q3 decline in revenue on a year-over-year basis due to timing of deliveries related to several large orders on backlog. Our outlook for terahertz is incredibly strong. Bookings and backlog are robust, and the future of the product line is bright.

Product revenue was essentially flat year-over-year, with mixed performance between product lines and markets. Notably, sales over ODiSI high-resolution sensing product reached record levels this quarter. The 72% year-over-year growth in this product line was driven by strong demand and a contract for a large infrastructure project requiring multiple systems. I continue to feel optimistic about the breadth of applications for our fiber-sensing solutions, as evidenced by multiple significant wins this quarter. We were awarded a multi-year fiber-optic monitoring service contract on a transcontinental natural gas pipeline, where our solution will help ensure gas supply from a former Soviet republic to the EU. Luna’s distributed fiber-optic monitoring system provides early warning and highly accurate localization on issues such as intrusions on the pipeline right-of-way, gas leaks, and other potential threats, such as dragging anchors from passing boats.

As another part of the project, Luna’s distributed fiber-optic monitoring system will provide perimeter security for the pipelines above ground facilities, such as compressor stations and other inline facilities that can be vulnerable. We also secured multiple sales of earthquake monitoring DAS instruments to seismic labs on the west coast and to the U.S. government. We now have more than a million and a half in new orders for DAS and DTS systems for pipeline monitoring from the largest energy company in the UAE. We renewed a global supply partnership agreement with one of the world’s largest multinational conglomerates for critical infrastructure monitoring. The agreement covers supply of linear heat detection, perimeter security, pipeline monitoring, and mining product lines to infrastructure operators around the world.

More to come on this as our details get finalized. We also recently deployed the successful application of fiber-optic sensing based traffic monitoring for the state of Utah Department of Transportation, where Luna is providing accurate and timely information regarding the average traffic speed, detecting slow or stop traffic, and estimating journey times between set locations. We won this project jointly with our partner Dura-Line, a leading conduit manufacturer. We also amassed multiple additional awards totaling over a million dollars for power cable monitoring systems throughout the world. This application continues to be a significant driver of growth. Quarterly performance in our communications test business was solid. We realized 26% year-over-year growth in the segment.

As I mentioned earlier in the call, we saw some recovery from the headwinds we experienced in this segment in Q2. Revenue for our laser module business remains strong. Performance in this business line is primarily driven by OEM sales of our RIO lasers into LiDAR and sensing systems. We continued deliveries of our Phoenix laser system to intuitive surgical against the $14 million order placed late last year. We also continued to realize strong sales of our polarization control modules to emerging photonics applications. We’re pleased to share that we’ve secured significant wins with new OEM customers in defense systems, quantum computing, and medical applications. Finally, I hope you saw our announcement last week about the large contract secured in support of a major technology provider’s hyperscale data center.

Our technology will help the provider more accurately assess the performance of transceivers in their data centers as they work to reduce power consumption and data interruptions in those centers. Let me now turn to our outlook. As we keep hearing from others, Luna too, continues to see a less predictable and more challenging macro environment. That said, we know that Luna’s solutions are a superior way for many industries to address critical issues. While I continue to be very optimistic about our future, you undoubtedly saw the downward revision to our revenue range. Obviously, I’m disappointed this direction we went, and although the change is not indicative of any degradation in a demand for our solutions, it does represent a change to what we see closing, getting delivered, and installed before your end.

About a month ago, as we were preparing to announce George’s hire, I spent a good deal of time with our operations and sales leaders. Based on what customers were telling us, we were comfortable reiterating our guidance, but in the last couple of weeks, we’ve had certain customers tap the brakes on some of their projects. We’re still moving forward, we’re just doing it more slowly. As a result of these dynamics, we’re revising our top line guidance to total revenue of $120 million to $125 million, but we are maintaining our adjusted EBITDA range at the same level at which it’s been all year, and that is adjusted EBITDA of $14 million to $18 million. I want to make an additional comment about the size of the revenue range, given that we’re in the last quarter of our fiscal year.

By now, you are likely aware that some of our sales include large project-based orders. We have many of these transactions included in our backlog, and the timing of delivery and installations 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 into next year and is why we are keeping a broad revenue range. With that overview, let me turn the call over to George for his remarks on the quarter’s financials.

George Gomez-Quintero: Thank you, Scott, and good morning, everyone. I am excited to be here today as the newest member of Luna’s team. As I got to know Scott and the rest of Luna’s leadership, I grew increasingly impressed with their vision, intellect, and commitment to solving complex problems for very demanding customers. Luna’s solutions address the needs of global customers in multiple verticals, and the breadth of opportunity represents significant potential for value creation. I am looking forward to meeting many of you in the months to come and to partnering with Scott and the team to drive Luna’s growth and shareholder value creation. Now, let me provide some additional detail on our Q3 results. The third quarter revenue was $30.7 million, an increase of 5% year-over-year.

The increase was driven largely by strong performance from our Comms Test business, specifically a rebound in sales to our government and defense customers, as that business continues to recover from the headwinds, we mentioned last quarter. Gross margin of 57% for the three months ended September 30 of 2023 was 62 basis points below prior year. The decrease in gross margin was driven primarily by product mix. Operating expenses were $16.5 million, an increase of 7%. Sequentially, OpEx was actually down 3.5%, reflecting some of the cost efficiency initiatives, management initiated as part of our one Luna strategy. Operating income was $1.2 million for the three months ended September 30, compared to operating income of $1.5 million for the prior year period.

The company had net income of $461,000, compared to net income of $1.2 million in the prior year period, and adjusted EBITDA for the quarter was $4.2 million, compared to $4.5 million for the prior year period. Turning our attention to the balance sheet, we ended the quarter with $6 million of cash and cash equivalents, compared to $6 million at December 31, 2022. However, importantly, cash increased nearly $3 million sequentially. Our working capital was $65.2 million at the end of the quarter, compared to $54.2 million at the end of 2022. The increase was primarily due to increases in accounts receivable and inventory. I want to make a few additional comments about these changes. In the third quarter, accounts receivable increased $6 million versus year end 2022, as we had a disproportionately large number of units that shipped at the end of September, leaving no time to collect before the quarter cutoff.

Inventory increased $6.7 million versus December 31, 2022. We are still dealing with supply chain challenges, so when certain inputs become available, we purchase the number we anticipate needing. We’ve been talking about the higher levels of inventory consistently for the past year. As we’ve discussed, we are focused on improving inventory turns, and are confident we will be able to do so. In addition, I think it’s instructive to look at the sequential change in inventory, which shows roughly a 3% increase. We are working hard to ensure we are only holding the inventory we absolutely need. Our total debt outstanding was $31.9 million compared to December 31, 2022 amount of $23.2 million. The increase was primarily due to a $12 million drawdown of the revolver offset by a reduction in the term loss.

Overall, we had a solid quarter despite the tough comparisons resulting from the significant COVID rebound in the third quarter of fiscal year 2022. I’ve now been at Luna for one month, and I’m even more excited about the company’s potential than I was during the interview process. I have already been to the UK and Germany to meet our teams there. We have some terrific assets, and I look forward to continuing to dig in and help Luna achieve the potential I know it has. With that, I will turn the call back over to Scott for his concluding thoughts.

Scott Graeff: Thank you, George. Before we open the call for your questions, I want to take this opportunity to emphasize our belief in being as transparent as possible about the events we see unfolding and their impact on the business. While we’ve seen real pressure from evolving macroeconomic headwinds, we want you to know that we’re making real-time changes to ensure that we’re able to continue to deliver shareholder value. We remain bullish in our vision and the long-term results we’ve outlined. Now, Brian, George, and I would be happy to take questions about today’s presentation. So, Krista, please open the call for Q&A.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of David Kang from B. Riley. Please go ahead.

David Kang: Thank you. Good morning. First question regarding fourth quarter, actually, I’m more interested in next year since we already know fourth quarter outlook. How should we think about next year? Should we expect still double digit growth? Or maybe – first half maybe started slowly and kind of a strong second half? Any color on next year outlook?

Scott Graeff: Yes, I think we continue to feel the way that we always have on 2024, I think what’s out there and the comments that we have made on 2024 continue to stay the same. We see these things that have pushed – pushing into Q4 and 2024. So we don’t see anything changing from what we already have out there, Dave, that we’ve talked about with everyone in regards to 2024.

David Kang: Got it. And then Comm Test, great to see quick recovery. Just wondering how sustainable that is?

Scott Graeff: I’m sorry. I didn’t understand that. Could you say again?

David Kang: Yes. Comm Test sounds like rebounded last quarter. Is that sustainable recovery or was just a couple of orders kind of making it, appear to be a quick recovery?

Scott Graeff: Yes. No, Brian, you want to –

Brian Soller: Yes. We talked about this last time that we saw that headwinds in that segment would, would persist maybe through the middle and part of the year. We saw a nice kick back up to normal levels in Q3 and we continue to have good visibility into the next few quarters. And we believe that’ll be a sustainable a sustainable comeback rather than just kind of a one-off.

David Kang: Got it. And my last question is on Terahertz, just update on the EV battery testing opportunity and update on the capacity expansion plans?

Scott Graeff: Yes. That continues to remain strong, Dave. What we have is a tough comp in Q3 of last year, we had a big delivery to a big customer. But we continue to work through that. A lot of that is already in backlog. It’s just a matter of when that gets delivered, but that continues to be strong across multiple customers, and most notably with a very large customer. And Brian, I don’t know if you want to add to any of that?

Brian Soller: Yes. I mean, the, the order book is strong. The backlog is strong. We look to finish the year on a high note for that product. And the capacity build out is on track and looking for another strong year next year.

David Kang: Can you remind us your capacity – actually quantify, I remember it was like the four times capacity expansion. Is that correct?

Scott Graeff: That’s correct. Yes, for our capacity, yes.

David Kang: Yes. Got it. Thank you.

Scott Graeff: Thanks Dave.

Operator: Your next question comes from the line of Paul Essi from William K. Woodruff. Please go ahead.

Paul Essi: Yes. Thanks for taking my question. I want to talk a little bit more about the balance sheet. You’ve got – correct me if I’m wrong, about $35 million in credit lines and you’re up to $32 million. How much do you expect to be able to squeeze as far out of your working capital in the third, or I’m sorry, in the fourth quarter, or in the first quarter next year?

Scott Graeff: Yes. Good question, Paul. We continue to see as we’ve said, first half of the year is a little bit more difficult on us. And the second half is really harvesting. You saw us harvest about $3 million in Q3. And I think you’ll continue to see. We don’t see – OpEx is going to hold pretty steady and we will be able to leverage off that. So with – what we see as much larger revenue in Q4 that will fall through. So we should again see a strong Q4 as it relates to cash generation and working capital. George, I don’t know if you want to add –

George Gomez-Quintero: I think that’s it [ph].

Scott Graeff: Okay.

Paul Essi: Okay. The other question, this order with the data center win, is this something that has legs? I mean given everything that’s going on with AI, is this kind of a quasi-AI play and you see more customers and a larger market out there? Can you give us some color on that?

Scott Graeff: Yes, sure. Yes, we do believe it has legs. We’ve made a lot of progress with one relatively significant customer. We saw the announcement this week and we look to be able to replicate that with other customers in the space that has to do with high speed testing of many, many data sockets, optical sockets in parallel, which is really the key to being able to enable this large scale deployment whether it be in any type of hyperscale data center, but certainly that includes AI data centers. So yes, it’s a nice solution from our team in Chino, California that make our polarization management and control modules.

Paul Essi: And you guys out knocking on doors, you have a good sales funnel in that product?

Scott Graeff: Yes, yes, we do.

Paul Essi: Okay. Last question, maybe an update a little bit on the F-35, how that’s going? I know there was a Terahertz follow-on order out there somewhere. You’re planning on getting it by year end update on that. And then very quickly, where do we stand with the F-22 and make it with the air buses? Are we still looking 2025 for the air bus business?