Luna Innovations Incorporated (NASDAQ:LUNA) Q4 2022 Earnings Call Transcript

Luna Innovations Incorporated (NASDAQ:LUNA) Q4 2022 Earnings Call Transcript March 14, 2023

Operator: Good afternoon, and welcome to the Luna Innovations Incorporated Fourth Quarter and Full-Year 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being record. I would now like to turn the conference over to Allison Woody, Senior Director of Administration. Please go ahead.

Allison Woody: Good afternoon, and thank you, for joining us today. Following market close today, we issued our fourth quarter and full-year 2022 earnings press release. As usual you can find the release and a presentation with supplemental information for the quarter 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 a supplement to the GAAP financial statements. 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, maybe 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 Graeff, our President and Chief Executive Officer; Gene Nestro; 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 afternoon, everyone, and thank you for joining us today. I’m pleased to be here to discuss a year of significant accomplishment as well as our 2022 fourth quarter and full-year results. I’ll also share our 2023 outlook. Before I get into the details of the fourth quarter, I’d like to reflect on the year we just closed and comment on what we see for the current fiscal year. Certainly, 2022 was a year of significant execution and achievement. Overall, I would characterize 2022 as a transformational year for Luna. Incredibly, it has been a full-year since we announced the divestiture of Luna Labs and the acquisition of Lios. You will remember that that divestiture in particular was a critical element of execution on our strategy to focus our capital on fiber optic measurement and sensing solutions.

As you may remember, when we set our strategic plan, we knew that we would need to divest assets that were a fit for pure-play fiber optics company and invest in initiatives and assets that were a strategic fit and that would support acceleration of growth. The Luna Labs transaction represented the sale of the last non-core asset in the Luna portfolio. It also eliminated the limitations that were present as a result of the Luna Labs reliance on the SBIR program. So not only the divestiture allow us to become a pure-play in fiber optics, it also removed a natural governor to our growth. We also added important capabilities to our portfolio with the acquisition of Lios Sensing, a set of assets that we knew would put us in a position to lead the market in fiber optic-based sensing solutions for infrastructure, energy, and industrial applications.

In addition, with Lios based in Germany, this acquisition broadened our European footprint. As a result, we enter 2023 with Luna positioned as a global fiber optics leader. We have a more significant international presence and we are poised to further capitalize on all of the opportunities available in our ever-expanding markets. In addition to the last two transactions I just discussed, we also did considerable work to optimize Luna’s operations across our various locations. To reframe, we acquired two substantial international assets during COVID. Integration is hard enough in normal times, but even more challenging during the global pandemic. I’m extremely proud that we were able to assess, acquire, and integrate these two companies all without the advantage of face-to-face interactions.

While remarkable, we did have some need to optimize our acquisitions. We made significant progress through 2022 towards refining our integration. Each of the members of my leadership team have spent time in the UK and Germany, as well as all the other Luna locations. Through the integration work, we gained an understanding about the operating process and with that made necessary changes. We’ve gotten closer to our employees and made determinations about whether we had all the right people in the right seats. We have formulated a more detailed yet holistic view of the company, unified these businesses have executed against our philosophy of one Luna. This is critical to our ability to optimize the whole, thereby increasing efficiencies and preparing for significant scalability.

To drive the kind of growth we believe we are capable of, we need to ensure that our team understands and embraces our vision and culture, understands our approach, and has clear line of sight to their role in serving our customers with excellence. The ultimate purpose of our work is to strengthen the infrastructure of our leading global organization with world-class capabilities. Our investments in infrastructure and systems, as well as added capabilities from recent acquisitions, position us for a strong future in an expanding market with incredible potential. We are headed into 2023 with intense focus on and high expectations for organizational optimization, large customer wins and market advancement. We will talk more about the outlook for 2023 later, but right now, I’ll turn our focus to review of the financial performance for Q4 and the full fiscal year 2022.

I’ll also touch upon a few business highlights before I turn the call over to Gene. For the fourth quarter of 2022, we recorded total revenues of $31.7 million, an increase of 31% compared to the prior year period. Adjusting for the foreign exchange revenue was $32.5 million, up 34% versus last year’s fourth quarter. Our gross margin was 61% in Q4 2022 versus 58% for the three months ended December 31, 2021. Adjusted EBITDA was $4.7 million for the final quarter of 2022 compared to $3.1 million last year. Our adjusted earnings per share for the three months ended December 31, 2022 was $0.08, matching the EPS figure from the prior year period. For the full-year 2022, we grew total revenues by 25% to $109.5 million. On a constant currency basis, we grew to $111.9 million, an increase of 28% and the midpoint of our guidance range.

I’m pleased that the growth was driven not only by last year’s acquisition, but also by very strong growth in our legacy businesses. Adjusted EBITDA was $12.1 million for the 12 months ended December 31, 2022 compared to $7.6 million for the prior year. This put us at the top end of the $10 million to $12 million range we projected for 2022. You can see that the strategic changes we made resulted in a stronger flow through of our topline growth to profit. Adjusted EPS was $0.21 for the year ended December 31, 2022 compared to $0.17 for the prior year. Through last year, you heard me say that investment was critical to both our top and bottom line growth. Our financials are proving that case. We are delivering topline growth and our gross margin and adjusted EBITDA demonstrate that we are creating pull-through leverage to the bottom line.

We have continued strong execution against our strategy and have enjoyed consecutive quarters of positive leverage. We fully expect to carry that momentum forward into 2023. Before we look too far into the future, I want to share some year-end highlights from the businesses. By now, I realize that this may become an old hat to you, but I like to take the opportunity each quarter to remind everyone that our capabilities fall into two categories. First, Fiber Optic Sensing and second, Communications Testing. Let’s start again with sensing where we use fiber as the physical sensor to create smart materials and structures. This includes pairing the following instruments that we manufacture with fiber sensors that allow distributed measurement and monitoring of physical assets like stress, strain, temperature, pressure and more.

ODiSI for short range high resolution applications, HYPERION for long range discrete applications, DAS for long range continuous acoustic monitoring, DTS for long range continuous temperature and strain monitoring and Terahertz, a technique that leverages fiber optic technology to produce Terahertz wave used to measure layer thickness and density of opaque materials. Growth in Q4 in our sensing vertical, which includes both OptaSense and LIOS was 16% compared to the same period last year. Growth was supported by the acquisitive revenues generated in Q4 by Lios Sensing, which we acquired in March of last year. Looking only at the project side of the sensing business where revenues are generated through larger sales that directly or indirectly support large field deployed projects, revenue grew about 10% on a year-over-year basis.

This was a tough comp related to Q4 2021 based on the historically high level of revenues and growth achieved in that quarter. Also, as we have discussed on our last several calls, the project-related business is an area of significant growth, but the associated revenues can be lumpier in nature. We’ve taken and continue to take measures to smooth out these lumps by improving our overall project management approach. Growth in the non-project portion of our sensing business, which includes sales of our legacy ODiSI, HYPERION, and Terahertz products, was up 26% driven by the strong continuing secular drivers that support growth in this market. Overall, our growth strategy in sensing is continuing to drive market adoption of our technologies in a number of key focus areas, including infrastructure, aerospace, energy, and industrial applications of our Terahertz technology.

Let me share just a few example of recent successes that we’ve had in this portion of the business to help you understand why we are optimistic about the future. We were awarded multiple large power cable monitoring contracts in North America, including partnering with Dominion Energy to provide monitoring services for the largest offshore wind project in the United States. Our products will be used to monitor the project’s export cable system, which will transport power to shore. Once fully operational, this system will displace as much as 5 million metric tons of carbon dioxide emissions annually. We are proud to count this amongst our growing list of global flagship installations. We also won a large contract with PT Freeport Indonesia, one of the world’s leading gold and copper mining companies.

We will provide an early warning monitoring system for the earth and levees that rely in the mining operations. Our technologies will greatly enhance the safety of those structures. Winning the PT Freeport contract is particularly exciting because it builds on work we started last year in the mining industry. As I mentioned then Luna has a preeminent solution for protection of tailings dams and levees used globally by mining companies. The potential in this industry is significant for us. We won a large contract with a major organization in Europe for deployment of fire-detection systems for battery storage facilities. Similar to the PT Freeport win, we know that our technology can greatly enhance the safety of our customer’s operation and as a final example, we secured additional pipeline monitoring awards in Texas, Nigeria, Mexico, and Saudi Arabia in Q4 demonstrating our global reach.

I’d also like to share a quick note on progressing Terahertz. Terahertz revenue grew 47% year-over-year in Q4 where deployments in manufacturing for automotive EVs and industrial adhesives continue to be major drivers. With all of the activity I just outlined, it’s safe to say that we feel very good about the future growth potential of this business and are looking forward to continuing to share updates as we make strategic progress in these critical growth areas. Now moving on to the communications test vertical. 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 modules and the RIO laser business. This business is now 50% test and measurement equipment for communications testing devices and 50% optical components and laser modules, a combination that lends to a variety of photonic applications such as medical devices, sensing systems and LiDAR.

Revenues in this vertical in Q4 2022 grew 59% versus 2021. On last quarter’s call, I talked about a recent large order from our OBR 6200 product for support of the global fleet of F-35 aircraft. I also mentioned we were expecting additional significant follow-on orders. So I’m happy to report that in December, we did indeed receive a large follow-on order for our OBR 6200 from our partner Northrop Grumman. The agreement includes an initial receipt of $3.4 million incremental multi-unit purchase order for the OBR 6200 portable backscatter reflectometer. We are excited to continue expanding our strong relationship with Northrop Grumman and we look forward to continuing our work with them, providing critical testing and monitoring technology for the aerospace and defense industries.

As we’ve discussed before, large recurring orders such as this are a testament to and foundational to the success of our growth strategy. Another very important highlight since we were last together is our announcement that we signed a $14.2 million contract with our longstanding partner, Intuitive Surgical. Deliveries on this significant order began in December and we are moving forward on the program with no delays. We also had a very strong sales quarter for polarization modules recording 27% year-over-year growth. The growth was driven by strong sales associated with the larger OEM contracts I just mentioned, in addition to strong sales of our gyroscope coils for navigation applications. As a final highlight for the Comms test vertical, I’ll note that in Q4 we received multiple large OEM orders for our RIO line of tunable lasers totaling over $3 million for applications in LiDAR and space-based communications.

I also want to provide an update on the ongoing effects of the supply chain challenges. As many others are, we are still experiencing pandemic-related delays in supply chain. Supply chain pressure that we experienced in 2021 carried over into 2022. For example, issues with semiconductor part availability combined with increasing lead times and prices have not abated, though we have seen some improvement. Our team is managing this as best as possible, but we have felt and expect to continue to feel the effects of disruptions in the global supply chain for at least a few more quarters. We’ve created a bit of buffer for ourselves to ensure that we continue to get products to our customers as quickly as possible. You will notice this on our balance sheet in the inventory account.

So what does this all mean for us as we head into 2023? Because of the foundational work we did in 2022, we’ve entered 2023 with a strong leadership team and organizational structure, proven systems and best practices. Our chart for 2023 will be to continue to drive operating excellence that will help to set the stage for greater expansion into new markets where we can deliver our superior capabilities and capture share. With a united team and an expanded sales force, we will drive forward in the pursuit of additional large multi-unit orders and the expansion of existing customer accounts. We are more confident than ever about our strategic direction and excited about the opportunities ahead. We are beginning to reap the rewards of our shift to become a pure-play fiber optics company and we are optimistic about the opportunities in front of us and growth we expect to drive.

We are just getting started and our future is very bright. Knowing this, we are issuing our 2023 outlook ranges, which are total revenues of $125 million to $130 million, adjusted EBITDA of $14 million to $18 million and first quarter 2023 revenue of $23 million to $25 million. As I share this outlook with you, I want to remind you that even with our recent growth, we remain a cyclical business. Like many companies in our industry, we are awaited towards the second half of the year. Q1 historically has been our softest quarter followed by steady acceleration through the remainder of the year, so please keep that in mind as you consider the ranges we are providing today. Before I hand things over to Gene, I want to mention a few more items of interest.

I recently attended OFC, a premier trade show event hosted in San Diego for telecom and data center optics. As I walked the floor, it was as busy a scene as I’ve ever seen in the last 10 years. That kind of activity is proof positive of what’s going on in the market and the opportunities available to us. I’m also happy to share with you that Luna will host its first ever Investor Day this spring in New York. Details will be issued soon, so I look forward to seeing many of you to share even more about where we are headed. I want to wrap-up the way I started. 2022 was a transformational year for Luna. I believe we sit in rarefied air as a company that set a five-year strategic plan and actually delivered against it in the middle of a pandemic.

Our steady execution against this plan allow us to be in the position we are today, a pure-play fiber optic company. If you are wondering what comes next, I hope you’ll consider attending our Investor Day. I’m happy to take questions about any of the topics I’ve discussed today, but for now, I’ll turn the call over to Gene. Gene?

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Gene Nestro: Thank you, Scott. As we just heard from Scott, 2022 was a year of significant achievement. The financials and business highlights he shared demonstrate our strategic focus and the abundance of our long-term opportunities. As he mentioned, we made incredible strides last year by completing the divestiture of Luna Labs, finalizing the integration of OptaSense, managing the onboarding of LIOS, and now operating as a pure-play fiber optics company. It marked a culmination of our work against our five-year strategy and puts us in an incredibly strong position for 2023 and beyond. You may remember me saying at last year end that putting a scalable foundation in place was critical to our ability to efficiently drive both organic and acquisitive growth.

We spent much of this past year laying this groundwork and while we still have some work to do, we are happy with our progress and look to create synergies we can leverage going forward. We are proud of the fact that we accomplished all of this while continuing to manage through the residual complications of the COVID pandemic. I am particularly proud of the entire finance team without whom we would not have been able to accomplish all of this work. There was an incredible amount of heavy lifting that had to be done behind the steams throughout 2022 in order for us to be where we are today. With a strong foundation, consolidated operations and expanded capacity, we are well prepared for market expansion and continued growth. With that as context, I’ll turn our attention to fourth quarter and full-year results.

Revenues for Q4 2022 increased 31% to $31.7 million on a GAAP basis. On a constant currency basis, revenue increased 34% to $32.5 million. The increase in revenues was driven largely by the Lios acquisition and strength and communications test products. Our gross profit increased to $19.3 million for the quarter compared to $14.1 million for the same quarter last year, representing a gross margin of 61% this quarter versus 58% in Q4 last year. The increase in gross margin was primarily due to mix as product sales comprised a higher portion of our total sales this quarter versus Q4 2021. Going forward, we continue to expect our gross margin to be approximately 60%. Operating expenses were $17.9 million compared to $13.1 million in Q4 2021. The primary drivers of this increase were Lios, which was not included in prior years Q4, employee cost, product redesigns and IT spend.

Our operating profit was $1.5 million and 4.6% of revenue compared to $1 million and 4.3% in the prior year quarter. As we’ve mentioned before, adjusted EBITDA is a key metric reflecting our underlying operations. Adjusted EBITDA for the quarter ended was $4.7 million, an increase of $1.6 million from last year’s Q4. For the full-year revenues increased 25% to $109.5 million on a GAAP basis and increased 28% to $111.9 million using constant currency. We are pleased that annual revenue was within our guidance, especially considering the lingering impacts of the COVID pandemic. The increase in revenues year-on-year was driven largely by the Lios acquisition, increasing adoption of our Terahertz technology and strength and communications test products.

Our gross profit increased $14.9 million to $66.5 million for the year compared to $51.6 million last year, representing a gross margin of 61% versus 59% last year. The increase in gross margin was primarily due to revenue mix. As I mentioned previously, we expect our gross margin to be approximately 60% going forward. Operating expenses for the year were $68.4 million versus $54.1 million last year. Lios and its associated amortization added $9.5 million. The remainder of the increase was due to employee costs, commissions on higher sales and product redesigns as we continue to prepare Luna for its future growth. For the full-year, operating loss of $1.9 million improved to $700,000 from the prior year. Let me move now to the balance sheet.

We ended the quarter and year with $6 million of cash and cash equivalents compared to $17.1 million at the end of 2021 as we funded the Lios acquisition with cash and debt. Our working capital was $54.2 million on December 31 compared to $49.8 million on December 31, 2021. Our working capital increased slightly due to the full-year impact of the Lios acquisition, as well as an increase in inventory due to expected product redesigns and the lingering effects of COVID on our supply chain. Our total debt outstanding is $23.2 million as of December 31, 2022. Overall, and as Scott mentioned, we had a solid performance in Q4 and the full-year. Let me now address our outlook for 2023. As you heard Scott say earlier, our outlook ranges are total revenues of $125 million to $130 million, adjusted EBITDA of $14 million to $18 million and first quarter 2023 revenue outlook of $23 million to $25 million.

With that, I will turn the call back over to Scott.

Scott Graeff: Thank you, Gene. Brian, Gene and I would be happy to take any questions at this time. Chad, please open the call for questions.

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Q&A Session

Operator: Thank you, sir. We will now begin our question-and-answer session. And the first question will be from Jim Marrone from Singular Research. Please go ahead.

Jim Marrone: Yes. Thank you for taking my call gentlemen. Maybe €“ I have a few questions. Maybe let’s just start with the supply side headwinds that you mentioned in the call. I think from previous calls you mentioned that the supply side constraints were actually coming from the clients and not so much from Luna. So is that still the case? Or is Luna also experiencing supply side constraints?

Scott Graeff: Yes. I think the answer is both, Jim. We are €“ most of what we experience is delays on the project side and they are supply delays related to our customers on the project base. But we have seen supply issues and why I talked about on our side was, we have quite a bit of cash tied up on the balance sheet due to loading inventory higher than we normally would because of being able to chase down some of the parts that we need. So we’re able to get them, we’re having to buy a lot more of them and pay a higher price. And Brian is that fair or do you want to

Brian Soller: Yes. I think that’s accurate. I mean, we’ve seen, as Scott mentioned, some easing and that easing has mostly been on the project side and the impact on our customer base. And we’re still experiencing delays and procurement and Board development longer than €“ much longer than typical, but that’s been the case for the last 18 months. So yes, it’s really both with a little bit of easing on the customer side.

Jim Marrone: Okay, good. Thank you for that insight. And is that what’s kind of weighing in on the bottom line are these additional costs because the revenue growth seems to be there. I think it does have the acquisition in there in that revenue growth. But in terms of the adjusted EPS being flat, is the additional costs on the bottom line? Is that what we’re seeing there?

Gene Nestro: So if you take a look at this year and you look at our headcount and you would take where we ended last year plus Lios, we actually have €“ when you add those two together, a headcount reduction. So we were looking and keeping our headcount in line and our cost in line. So I don’t think that’s the case. It’s just timing. I think of when you look at some of these expenses that come in, I’m not sure, are you looking at year-over-year or quarter or

Jim Marrone: Well, just the 4Q EPS being flat, the adjusted

Gene Nestro: Yes.

Jim Marrone: So I guess it’s other operating costs from

Gene Nestro: Yes. I think we’re certainly experiencing more operating costs. We’re experiencing higher prices. We did increase a lot of our ASPs, but some of these project-based deliveries, Jim, have been out there for quite some time. So there’s no chance to increase some of those, but we’ve bought things throughout the year. So we have experienced a higher cost that I think is reflected in that adjusted EPS flatness that you’re seeing.

Jim Marrone: Yes. Okay. Thank you for that color. And also it may have been addressed in prior calls, I can’t recall. But has there ever been any thought as far as providing segment results maybe between sensing and testing, or even geographically if you’re expanding it to Europe, I don’t know if it’s ever been addressed before?